William W. Oliver Professor of Tax Law at Indiana University Maurer School of Law in Bloomington. Find my research at http://ssrn.com/author=48125 and my full publication list at http://www.law.indiana.edu/people/lederman/publications.shtml. I teach Income Tax, Corporate Tax, Tax Procedure, and Tax Policy Colloquium. I generally write about tax compliance and tax administration, the U.S. Tax Court, and the federal income tax as it applies to individuals and corporations. I'm on Twitter at https://twitter.com/leandra2848; come for the law and policy tweets, stay for the #taxvalentines!
There is an extensive set of literatures on tax compliance and evasion, often discussing the traditional economic model (the deterrence model) and/or behavioral theories such as social norms or tax morale. (For recent examples summarizing the theories, see this article by Kathleen Delaney Thomas, this one by Adam Thimmesch, or this one by yours truly.) There is also a separate accounting literature on fraud.
A key concept in this accounting literature is the “Fraud Triangle.” Yet despite the important role this theory plays within the accounting literature, the Fraud Triangle does not seem to have permeated the tax compliance literature, particularly the relevant legal literature.
For example, a search in “Secondary Materials” in Lexis for “‘fraud triangle’ w/50 tax!” turns up only one article, which is not a tax article but does cite a 2006 Tax Notes article authored by three CPAs. That article is James A. Tackett et al., “A Criminological Perspective of Tax Evasion” (paywalled). Yet, the Fraud Triangle should not be overlooked by scholars outside of accounting. It provides a powerful tool with which to conceptualize tax evasion. And, as discussed below, it helps provide a framework that both supports the deterrence model and allows other factors to coexist with deterrence.
The Fraud Triangle and the Fraud Diamond
The Fraud Triangle derives from three factors that criminologist Donald R. Cressey originally identified in a 1951 article in the Journal of Accountancy, “Why Do Trusted Persons Commit Fraud?: A Social-Psychological Study of Defalcators.” As discussed in his 1951 article and his 1953 book, “Other People’s Money: A Study in the Social Psychology of Embezzlement,” Cressey developed the factors that became the Fraud Triangle out of in-depth interviews with inmates who had been convicted of trust violations such as embezzlement. The three factors were labelled the “fraud triangle” by Steve Albrecht in the early 1990s. The elements of the Fraud Triangle, as discussed by Albrecht and others, are “perceived pressure” (usually financial), “perceived opportunity” to commit the fraud, and “rationalization” that the actions are justifiable or appropriate in the context of the situation. Albrecht and his coauthors of a 1979 KPMG study of convicted perpetrators of fraud “found that the decision to commit fraud is determined by the interaction of all three forces.” Continue reading “Tax Evasion and the Fraud Diamond”→
Transparency is a widely accepted judicial norm. It increases courts’ accountability and thereby increases the confidence and trust litigants and the general public have in courts’ decisionmaking. The comparatively limited access afforded to Tax Court documents is a longstanding issue. The reason Tax Court transparency differs from that of other courts is partly structural, in that the Tax Court isn’t as neatly situated in the federal government’s org chart as Article III courts, administrative agencies, or even Article I courts such as the Court of Federal Claims. (In fact, even which branch of government the Tax Court is located in has presented a puzzle.) Accordingly, the Tax Court traditionally has created many of its own rules and procedures, such as ones governing access to its documents. This means that the question is also partly cultural. As discussed below, access to Tax Court documents has increased over time, and the appointment of several new Tax Court judges may mean that we see further changes in the future.
In the past, the Tax Court’s more limited transparency has sometimes violated judicial norms and has sometimes created access inequities. For example, although the Tax Court is required by statute to make its reports and evidence “public records open to the inspection of the public,” for years the Tax Court kept its Summary Opinions confidential, which I protested in 1998 in a short Tax Notes article called “Tax Court S Cases: Does the ‘S’ Stand For Secret?”. Although Summary Opinions lack precedential value, they are Tax Court opinions, revealing how the judge deciding the case (typically a Special Trial Judge) thinks about the issues. The Tax Court’s practice of sharing those opinions only with the parties to the case meant that the IRS had a copy of every Summary Opinion but taxpayers typically could not access the opinions in other Small Tax Cases (S cases). This created an uneven playing field. Secrecy can also lead to suspicion of favoritism or other inequities, concerns that existed in an analogous situation, in the era when the IRS did not make Private Letter Rulings (PLRs) public but large firms collected them. Litigation challenging this lack of transparency resulted in legislation, requiring PLRs to be disclosed (with taxpayer information redacted). Continue reading “Increased Transparency in the U.S. Tax Court: Has the Moment Arrived?”→
I’m currently at the #SEALS2018 conference in Ft. Lauderdale, but I wanted to quickly note that the opinion of the 9th Circuit panel in Altera Corp. v. Commissioner was withdrawn today. This follows the replacement of Judge Reinhardt, who passed away on March 29, with Judge Graber. Recall that the July 24 opinion in this important case reflected a 2-1 decision, with the late judge in the majority, as Christopher Walker and others had noted. (For my previous coverage of Altera, see here and here.)
A screenshot of the court’s order appears below. It will be interesting to see what happens after the new panel confers!
In a 2-1 opinion, a panel of the Court of Appeals for the Ninth Circuit has reversed the U.S. Tax Court in Altera v. Commissioner. (I don’t have a link yet to the opinion because it just came out this morning, but will add it as a comment when I do.) The decision is great news for IRS rulemaking: the Court of Appeals upheld a Treasury regulation in the face of a procedural challenge that alleged that “although Treasury solicited public comments, it did not adequately consider and respond to those responses, rendering the regulations arbitrary and capricious under State Farm.” Altera, slip. op. at 27. The court found that Treasury’s approach to the regulation (a cost-sharing regulation under Code section 482) satisfied State Farm‘s requirements. Id. at 37. The Court of Appeals also accorded the regulation Chevron deference. Id. at 46.
In my view, this is the right outcome. (Full disclosure: Susan Morse and Stephen Shay spearheaded an amicus brief in the Ninth Circuit in favor of the Commissioner, in which I joined, along with Dick Harvey, Ruth Mason, and Bret Wells.) Treasury did consider and respond to the comments it received on the regulation; it simply had a different approach to the substance of the regulation than the taxpayers commenting did. The Court of Appeals explains:
“In short, the objectors were arguing that the evidence they cited—showing that unrelated parties do not share employee stock compensation costs—proved that Treasury’s commensurate with income analysis did not comport with the arm’s length standard. Thus, the thrust of the objection was that Treasury misinterpreted § 482. But that is a separate question—one properly addressed in the Chevron analysis. That commenters disagreed with Treasury’s interpretation of the law does not make the rulemaking process defective.”
“Because the Commissioner does not contest the applicability of the APA or Chevron in this context, this case does not require us to decide the broader questions of the precise contours of the application of APA to the Commissioner’s administration of the tax system or the continued vitality of the theory of tax exceptionalism.”
Id. at 25 n.5. Dan Shaviro has blogged about the decision on Start Making Sense, noting that “the Chevron standard for reviewing administrative regulations . . . may well be on the Supreme Court’s chopping block in the near future.”
I would expect more coverage of the Altera decision soon. For prior Surly coverage, see here.
On April 5, the Indiana University Maurer School of Law’s Tax Policy Colloquium welcomed Len Burman from Syracuse University and the Urban Institute/Tax Policy Center, who presented “The Rising Tide Wage Credit.” This intriguing new paper is not yet publicly available.
The paper proposes replacing the existing Earned Income Tax Credit (EITC) with a new credit, the Rising Tide Wage Credit (RTWC), which, unlike the EITC, would be universal for workers, rather than phased out above low income levels. The RTWC also would differ from the EITC in that the amount of the RTWC would not depend on the number of children the taxpayer has. Instead, the RTWC would be a 100% credit in the amount of a worker’s wages, up to $10,000 of wages. The credit could be claimed on the taxpayer’s tax return, or subject to advance payment via the taxpayer’s employer. Thus, the maximum credit for an unmarried taxpayer would be $10,000, and for a married couple filing jointly would be $20,000. (The credit would not have a marriage penalty.) The credit would be indexed to increase with increases in GDP.
Because the proposed new credit would not vary with the number of children the taxpayer is supporting, the paper also proposes increasing the child tax credit from $2,000 to $2,500, and proposes making the child tax credit fully refundable (rather than partly refundable, as it is under current law). The RTWC and the increase in the child tax credit would be funded by a value added tax (VAT). The paper estimates that the proposal could be fully funded with an 8% VAT, along with federal income tax on the RTWC. A VAT was chosen as the funding mechanism because it is closely correlated with GDP. The paper discusses 3 illustrative examples and includes a table that shows the overall progressivity of the proposal under certain assumptions. Continue reading “IU Tax Policy Colloquium: Burman, “The Rising Tide Wage Credit””→
On March 22, the Indiana University Maurer School of Law’s Tax Policy Colloquium welcomed Prof. Emily Satterthwaite from the University of Toronto Faculty of Law, who presented “Optional Taxation: Survey Evidence from Ontario Microentrepreneurs.” This interesting new paper is not yet publicly available.
The paper explores Canada’s “small supplier” exemption from value-added tax (VAT) registration. Canada’s exemption allows suppliers with less than CAD $30,000 of sales (turnover) in a year to avoid registering for and complying with the VAT unless they opt in. (This amount is not indexed for inflation, and Emily’s paper explains that this threshold is fairly low.) Although it may seem odd for someone to opt into a tax system, as Emily’s paper explains, some small suppliers have incentives to do so: if they buy supplies subject to VAT, they can offset that against VAT owed, and obtain a refund if VAT paid exceeds VAT due. In addition, some small suppliers may be encouraged by their VAT-registered customers to become part of a formal supply chain, because the VAT those customers pay on inputs is creditable. The downside of registering is the cost of doing so, which includes the requirement to file an annual return regardless of whether VAT is owed. Continue reading “IU Tax Policy Colloquium: Satterthwaite, “Optional Taxation: Survey Evidence from Ontario Microentrepreneurs””→
On March 1, the Indiana University Maurer School of Law welcomed Surly’s own Prof. Diane Ring from Boston College Law School as the fourth speaker of the year in our Tax Policy Colloquium. Diane presented a new paper, which I believe is not yet publicly available, titled “Silos and First Movers In the Sharing Economy Debates.” This interesting paper focuses on the classification of workers in the “sharing” or “gig” economy as employees or independent contractors, arguing that “[t]wo interacting forces create the most serious risk for inadequate policy formulation: (1) silos among legal experts, and (2) first-mover effects.” (Page 1 of the draft.) The silo argument is that lawyers operate in subject areas that are isolated from each other, such that tax experts, for example, fail to perceive the effects of tax-related worker-classification rule changes on non-tax (such as employment) law, and vice versa. The first-mover argument is that the first actors on the worker-classification issue can wield outsized influence, shaping the debate in legal contexts other than the one directly affected.
On February 28, Prof. Stephanie McMahonfrom the University of Cincinnati College of Law gave a faculty workshop at the Indiana University Maurer School of Law. She presented her paper titled “Tax as Part of a Broken Budget: Good Taxes are Good Cause Enough.” The thesis of the paper is that Treasury regulations are needed to effectuate the statutory tax laws consistent with Congress’s budgeting expectations, and that given the importance of the revenue raised by taxes to the functioning of the U.S. federal government, tax regulations should be excused from the Administrative Procedure Act’s pre-promulgation notice-and-comment process under the APA’s “good cause” exception. The paper thus tackles two arguments that Prof. Kristin Hickman has advanced in her work: post-promulgation notice and comment is insufficient for tax regulations, and there is no reason for “tax exceptionalism” in administrative procedures. Stephanie’s paper also contains a detailed explanation of the tax legislative process.
On February 15, the Indiana University Maurer School of Law welcomed Prof. Ari Glogower from Ohio State University Moritz College of Law as the third speaker of the year in our Tax Policy Colloquium. Ari presented his paper titled “Taxing Inequality,” which argues in favor of a federal wealth tax and proposes a mechanism for integrating the base of such a tax with the base of the federal income tax. Ari’s paper sparked a really interesting discussion both in and outside the workshop on a wide range of issues, from distributive justice to the mechanics and likely impacts of his proposal.
The paper focused first on why we should have a federal tax on wealth. The draft points to rising economic inequality, and it grounds the need for a wealth tax in the theory of “relative economic power.” That theory, borrowed from political science, focuses on spending power—as opposed to actual spending—as a source of economic power. The basic idea is that the mere ownership pf wealth creates economic power without spending it. Moreover, “excessively unequal distributions of economic resources and market power can result in unequal divisions of political and social power as well.” (p.19) One of Ari’s paper’s contributions is to apply this economic-power theory as a justification for a progressive tax system.
The draft then describes the problem that tax-system designers have in imposing both a wealth tax and an income tax. Because the two types of taxes are imposed on different bases, if the taxes are not coordinated, taxpayers with very different abilities to pay based on their income or wealth may be taxed identically. The paper includes some nice examples of taxpayers with the same income but vastly different stocks of wealth and vice versa. It shows, for example, that a taxpayer with $200,000 of current income and no wealth (or negative wealth in the form of student-loan debt) has lower ability to pay than a taxpayer with $200,000 of current income and $35 million in wealth. (Ari’s talk included a great slide featuring an image of Scrooge McDuck swimming in money as the wealthy taxpayer, but for whatever reason, he resisted our suggestion to rename the paper “Taxing Scrooge McDuck”!) Continue reading “IU Tax Policy Colloquium: Glogower, “Taxing Inequality””→
On February 1, the Indiana University Maurer School of Law welcomed Prof. Jake Brooksfrom Georgetown Law School as the second speaker of the year in our Tax Policy Colloquium. Jake presented an early draft of a paper titled “The Case for Incrementalism in Tax Reform,” which led to a lively and interesting discussion about what incrementalism is, what constitutes fundamental reform, how politics may affect the making of tax policy, and whether and how tax law differs from other fields of law.
The paper, which is not yet publicly available, argues that “fundamental tax reform,” while sometimes necessary, should not generally be the goal of tax policy, and that instead, policymakers should take an incremental approach to changing tax laws. “Incrementalism” has a long history in political science, and was first described by Charles Lindblom in an influential 1959 article, “The Science of Muddling Through.” In general, Lindblom’s approach in that article was to reject the urge to use a formal method that involves clarifying the principal goals up front, identifying the means to achieve them, and then analyzing every relevant factor in the decision. Lindblom instead advocated the use of a more casual method that he termed “successive limited comparisons,” which ignored important possible outcomes or alternatives and did not involve distinguishing means and ends. (Page 81 of Lindblom.) Lindblom argued that this “muddling through” approach was not only what was actually practiced by administrators, but also a method for which they need not apologize because administrators are less likely to make serious and lasting mistakes if they proceed through small, incremental changes (pp.86-87). As Jake acknowledges, Lindblom wrote at a time with much more limited ability to model and process large quantities of empirical data. He notes that incrementalism has continued to be an important theory in the literature. Despite technological advances, we cannot see the future, and there remain limits to what empirical data can help us predict.
Jake’s argument is driven in part by arguments in favor of tearing the Internal Revenue Code out by its roots and starting over. I agree with Jake that such an approach seems extremely risky. Policy driven by rhetoric and “horror stories” risks being ill-conceived, hasty, driven by political rent-seeking, and even destructive, as I have written about in the context of IRS reform. But does that necessarily mean that legislative tax changes should take a Lindblom-style incremental approach? Continue reading “IU Tax Policy Colloquium: Brooks, “The Case for Incrementalism in Tax Reform””→
On January 18, the Indiana University Maurer School of Law welcomed Prof. Tom Brennan from Harvard Law School as the first speaker of the year in our Tax Policy Colloquium. Tom presented an early draft of a paper co-authored with Robert L. McDonald, Debt and Equity Taxation: A Combined Economic and Legal Perspective. We had a lively and interesting discussion about it in the workshop, as well as over dinner.
The paper, which I do not believe is publicly available yet, deals with the taxation of hybrid securities. It describes current law on how those securities are categorized as debt or equity, as well as the history of how the law developed. The paper criticizes the binary categorization of hybrid instruments as either debt or equity. It thus argues for a bifurcated approach.
The core of the current draft is a proposed new approach to debt and equity that considers the capitalization of a corporation as a whole and taxes the components in line with the underlying economics. The paper disaggregates the risk-free return, the risky return, and abnormal returns (rents). The paper proposes two possible systems of taxation: the “unlevered equity system” and the “levered equity system.” In the unlevered equity system, debt consists of risk-free obligations (like short-term Treasury bills) and equity is unlevered ownership of assets. In the levered equity system, the definition of debt is the same but equity is fully leveraged ownership of assets (fully financed by risk-free obligations). Under the unlevered approach, although particular investors may own a mix of debt and equity, the corporation itself effectively issues no net debt because it issues no risk-free obligations.
A key insight of the paper applies the Domar-Musgrave economic result that, under certain assumptions, risky returns on assets do not bear tax. Brennan and McDonald point out that the Domar-Musgrave insight also applies to corporations, although the securities are liabilities for them instead of assets. (Many years ago, I applied Domar-Musgave analysis in an article of mine on the tax favoritism for entrepreneurship, but I had not thought about its possible application to corporate income, which is a fascinating idea.) The implication of that insight, as Brennan & McDonald note, is that the risk-premium portion of return on investment effectively does not bear tax. As a result, under the unlevered system, all corporate income would bear corporate tax because the unlevered system does not have any net debt obligations. By contrast, adopting the levered system would make the corporate tax burden only rents, given a tax deduction for debt. The paper explains that this reaches the same result as the Mirrlees Review’s exemption for “normal returns” on corporate capital, as well as the allowance for corporate equity (ACE), if the ACE deduction is defined in a particular way. Continue reading “IU Tax Policy Colloquium: Brennan & McDonald, “Debt and Equity Taxation: A Combined Economic and Legal Perspective””→
The 2018 Tax Policy Colloquium at the Indiana University Maurer School of Law will kick off next Thursday, January 18, with the presentation by Harvard Law School professor Tom Brennan of a fascinating and timely paper he is co-authoring with Robert L. McDonald, Debt and Equity Taxation: A Combined Economic and Legal Perspective. Tom is a terrific speaker, and I expect the workshop to be really interesting.
Last year, I did a closing post noting that some themes had emerged in the semester’s colloquium. This year, I plan to blog each workshop afterwards, with permission of the speakers. The full workshop schedule follows after the jump. If you will be in Bloomington and are interested in attending one or more workshops, just let me know and I can send you the paper once I receive it. (Most of the paper drafts will not be publicly available.)
The Tax Policy Colloquium is a course for students; I expect about 14 this semester, including a visiting scholar from another school on campus who has asked to audit. I conduct a background session with the students to help them get up to speed on the concepts presented in the paper draft. Typically, the actual workshops are attended not only by the students but also by my colleague David Gamage, senior tax attorney/Maurer alumnus Tim Riffle, and a few other faculty–law school colleagues and/or tax or economics faculty from other schools on campus. Sometimes other members of the community attend, such as a tax professor from another law school; another attorney practicing in Bloomington or Indianapolis; a student not enrolled in the class (Shuyi Oei‘s and Ben Leff‘s talks in 2016 were particularly popular with other students!); and/or a local judicial clerk. Eric Rasmusen from the IU Kelley School of Business and Margaret Ryznar from IU’s McKinney Law School in Indianapolis have each attended several of the talks.
Tax professors are of course among the many people affected by the recent, significant changes to federal tax law. I have heard from several people wondering how best to adapt their courses starting in January to these changes. I think that exchanging ideas and sharing syllabi, etc., may be very helpful.
Accordingly, several of us have each agreed to serve as the point person for a particular course. The point person can set up an email list for those who express interest by email, and then use that list to exchange questions, ideas, syllabi, URLs, handouts, etc. with others teaching the same course. Of course, casebook authors may also be working on updates, and other listservs may be helpful, but these distribution lists will allow those interested to participate in topic-focused groups to exchange materials and ideas in advance of and throughout the semester.
The point people thus far are the following Surly bloggers, for the following courses:
To get on an email list, please email the applicable point person. And folks interested in serving as a point person for another course (i.e., in setting up the email list and getting it started), please post in the comments below, with the course name and your email address.