Category: Tax

Two Views of Charities

The Tampa Bay Tribune has put out a list of “America’s Worst Charities,” based on payments to solicitors. Dan Pallotta offers some reservations regarding that approach:

[T]he overhead question has a number of flaws. A few of the easy ones to talk about and describe are, first, it operates on a mistaken theory of waste. So, a [soup kitchen] tells you $.90 of your donation goes to the cause and you think: Well, that’s great, now I know that they don’t waste any money. But you don’t know that at all. How do you know they are not wasting the $.90 that’s being spent on the cause? That’s where all the money goes; that’s where the largest opportunity for waste is. Related to that, it tells you nothing about the quality of services. So, that soup kitchen can tell you $.90 of every donation goes to the cause and you’ll never learn that the soup is rancid. . . .

Next, the percentage of your donation that goes to the cause depends entirely on how the charity defines the cause. So, the more broadly they define the cause, the higher the percentage they can tell you is going to the cause. It actually operates on a false theory of transparency as well, because unless you know the underlying accounting and definitions of the cause, there is no transparency in that simple articulation of an overhead percentage. Worse, this demand the charities keep overhead below prevents them from spending money on the overhead things they have to spend on in order to grow. And that’s how we institutionalize the miniaturization of these organizations.

Pallotta offers many provocative thoughts on how success is measured in the nonprofit sector.


Agencies in the Cathedral?

AgenciesAreas of law dominated by government agencies haven’t taken advantage of the rich literature on property rules and liability rules, which are “workhorse concepts that permeate every corner of the economic analysis of law.” In their 1972 article Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, Calabresi and Melamed observed that there are fundamentally two types of remedies: (1) property rules, such as injunctions or disgorgement, which aim to deter, and (2) liability rules, like compensatory damages, which aim to compensate. This framework has paid rich dividends in areas like torts, property, IP, contracts, and conlaw — but seems to have bypassed areas of law dominated by agencies.

Government agencies’ remedies can be classified as either property rules or liability rules. For example, if a business has a permit from the EPA but violates the permit’s conditions, the remedy could be either taking away the permit (a property rule), or requiring proportional compensation (a liability rule). Similarly, if a broker has a license from the SEC and violates securities law, the remedy could be either yanking the license (a property rule), or requiring compensation for the harmed parties (a liability rule).

I apply the property rule and liability rule framework to my favorite agency — the IRS — in a forthcoming Virginia Law Review article. When a taxpayer violates a tax-law requirement, the remedy can be either yanking the taxpayer’s favorable tax status (a property rule), or requiring compensatory additional tax (a liability rule). Counterintuitively, anecdotal evidence shows that property-rule remedies may be less effective at deterring violations, because the threat of political and media blowback may make the IRS unwilling to impose a draconian property-rule remedy. As a result, when Congress protects a requirement with the property-rule remedy of yanking a favorable tax status, politically-powerful or sympathetic taxpayers are rarely deterred from violating the requirement. The IRS doesn’t dare impose it. Surely similar problems plague enforcement by other agencies.

Anyone working in any agency-dominated area of law could consider how the property-rule/liability-rule framework fits into their area.


Gently Nudging with Liability Rules?

No Smoking symbolWhy have sexual harassment and anti-smoking laws been so successful in changing entrenched social norms in the U.S. over the past few decades? In a 2000 U. Chicago Law Review article, Dan Kahan observed that combatting these ills took the approach of “gentle nudges,” imposing moderate remedies that were within the range of what decisionmakers (e.g. judges and juries) thought was reasonably proportional to the violation. Because these moderate remedies were enforced, norms shifted, and lawmakers could ratchet up the remedies. By contrast, Kahan observed that “hard shoves” imposing remedies substantially exceeding social norms fail to be enforced or to change norms. For example, France tackled sexual harassment by making it a criminal offense, which French society saw as vastly disproportionate. As a result, French sexual-harassment law went unenforced against conduct that would have easily incurred liability under U.S. law, and French norms barely shifted.

There is an underexplored connection between Kahan’s “gentle nudge” vs. “hard shove” dichotomy, and Calabresi & Melamed’s “property rule” vs. “liability rule” dichotomy. Calabresi & Melamed observed that remedies are either (1) liability rules, such as compensatory damages, or (2) property rules, such as injunctions or prison, which aim to deter. Liability rules generally overlap with “gentle nudges” in that they aim for proportional compensation. Property rules largely overlap with “hard shoves.”

The debate over the relative merits of property rules and liability rules has raged in academia and the courts. Bringing Kahan’s observations into the mix weighs in favor of liability rules, which are more likely to be enforced – and to shift norms.

I explore the relationship between these two dichotomies in sections II.C.3 and IV.C of a forthcoming article looking at IRS enforcement (or lack thereof). But their interrelationship is promising for anyone interested in either the property-rule/liability-rule debate or in altering social norms.


Taxonomy of Innovation Incentives

SIP folks don’t talk enough with tax-law folks, and vice versa. This has some unfortunate results. IP has become a leading tax-avoidance vehicle, without drawing sufficient notice from IP scholars and practitioners. And R&D tax incentives are rarely evaluated alongside patents, prizes, and research grants as effective ways to foster innovation.

An insightful article forthcoming in the Texas Law Review, by Daniel Hemel and Lisa Larrimore Ouellette, takes a big step in bridging this gap. They observe that all innovation incentives can be broken down along three dimensions: (1) who decides (government vs. the market), (2) when paid (ex ante vs. ex post), and (3) who pays (government vs. users). For example, patents are market-driven, with money delivered ex post, from users of the patented technology. By contrast, R&D tax incentives are market-driven, with money delivered ex ante, from the government.

These three dimensions lead to a 2 x 2 x 2 matrix, suggesting a total of eight types of innovation incentives. But only five are currently used: patents, prizes, research grants, R&D tax incentives, and patent boxes (which provide favorable tax rates on patent income). As a result, Hemel and Ouellette’s taxonomy suggests three new mechanisms to encourage innovation. Their taxonomy also teases out some exciting new insights on the relative merits of existing innovation incentives, including some previously overlooked benefits of R&D tax incentives.



Tall Latte with a Double Shot of Tax Avoidance

StarbucksLogoIntellectual property has become a major tax-avoidance vehicle for multinationals. Front-page articles in the New York Times and Wall Street Journal have detailed how IP-heavy companies like Apple, Google, and Big Pharma play games with their IP to avoid taxes on a massive scale. For example, Apple uses IP-based tax-avoidance strategies to reduce its effective tax rate to approximately 8%, well below the statutory 35% corporate tax rate (and well below most middle-class Americans’ tax rates).

Two characteristics of IP make it the ideal tax-avoidance vehicle. First, the uniqueness of every piece of IP makes its fair market value extremely hard to establish, allowing taxpayers to choose whatever valuations result in the least tax. Second, unlike workers or physical assets like factories or stores, IP can easily be moved to tax havens via mere paperwork.

But Starbucks is a bricks-and-mortar retailer dependent upon physical presence in high-tax countries. It wouldn’t seem to be in a position to use these IP-based tax tricks. Yet in an excellent, eye-opening paper, Edward Kleinbard (USC) delves into the strategies that Starbucks uses to substantially reduce its worldwide tax burden. Most interestingly, Starbucks puts IP like trademarks, proprietary roasting methods, operational expertise, and store trade dress into low-tax jurisdictions. Kleinbard cogently observes that the ability of a bricks-and-mortar retailer like Starbucks to play such games demonstrates how deep the flaws run in current U.S. and international tax policy.



The IRS Scandal, Property Rules, and Liability Rules

IRS LogoRegardless of your take on the IRS targeting conservative groups applying for 501(c)(4) status, the episode demonstrates once again that Congress, the Administration, and the media have multiple avenues to pressure the IRS to act or to reconsider earlier actions. This susceptibility to political pressure has broad, counterintuitive implications for how to best deter violations of requirements throughout tax law.

In their path-breaking law & economics article, Calabresi & Melamed observed that every entitlement can be protected by either a property rule (e.g. injunctions, disgorgement of profits) or a liability rule (e.g. compensatory damages). The same is true in tax law. When a taxpayer violates a requirement for a favorable tax status, the tax code either imposes additional tax proportionate to the harm (a liability rule) or imposes the draconian penalty of taking away the tax status entirely (a property rule).

Which rule is most likely to deter a well-connected organization from violating a requirement imposed on it by tax law? At first glance, property rules (i.e. yanking the organization’s favorable tax status) appear to be the most effective deterrent. But the IRS routinely hesitates to take this draconian step, which would result in complaints to Congress, the Administration, the media, and other organizations. Even if the tax code, as written, imposes this property-rule remedy, the IRS can and often does decline to impose it in practice.

Examples of this problem abound throughout tax law. My favorite example is a real estate investment trust (or “REIT”) that had its IPO in 2007 and revealed in its SEC filing that it was in clear violation of one of the requirements (I.R.C. § 856(a)(2)) to qualify as a REIT for tax purposes. How brazen! But what was the IRS to do? The requirement is protected by a property rule: the only remedy available to the IRS was to take away the REIT’s favorable tax status entirely. This would have been draconian. All the REIT’s shareholders would have complained to their congresspersons, the financial press would have run stories, and the National Association of Real Estate Investment Trusts would have raised a ruckus. The IRS didn’t dare impose this property-rule remedy. The IRS did nothing, and the REIT suffered no consequences for the violation.

Would this REIT have been so brazen if the requirement had, instead, been protected by a liability rule, which would merely have imposed additional tax proportional to the violation? Almost certainly not. And that is the counterintuitive result: liability rules are often more effective in practice than draconian property rules in deterring taxpayers from violating tax-law requirements.

The relative merits of property rules and liability rules in tax law are explored in depth by this forthcoming Virginia Law Review article.


Money Laundries

I was recently reading a Money Laundering Threat Assessment (from 2005), and the following lines came up on p. 49:

[T]he trust laws of some jurisdictions have aided money launderers in their use of trusts to conceal identity and to perpetrate fraud. In certain jurisdictions, such as the Cook Islands, Nevis, and Niue, the trust laws no longer require the names of the settlor and the beneficiaries to be placed in the trust deed, permit settlors to retain control over the trust, and allow trusts to be revocable and of unlimited duration.

My question is: why is this even called a trust? Shouldn’t it bear some other name? At least Liechtenstein has the decency to call its creepy money-hiding methods “Anstalts.”

The larger consequences here are terrifying. The wealth defense industry has created an environment where all manner of swindlers, thieves, and terrorists can hide ill-gotten gains. As a forthcoming University of Pennsylvania piece by Shima Baradaran, Michael Findley, Daniel Nelson, and J.C. Sharman puts it:

On the whole, forming an anonymous shell company is as easy as ever, despite increased regulations following 9/11. The results are disconcerting and demonstrate that we are much too far from a world that is safe from terror.

I nevertheless expect that most of the centomillionaire and billionaire class will continue to fight efforts to crack down on shell companies and trusts, and will find ample “help” to argue their case. Perhaps someone will even pen an ode to financial privacy. Meanwhile, we have no idea what taxes may be due from trillions of dollars in offshore wealth, or to what purposes it is directed.

Expect to hear many more stories on this issue. The stakes could not be higher. As Liu Xiaobo has stated, corruption is the “officialization of the criminal and the criminalization of the official.” Persisting even in a world of brutal want and austerity-induced suffering, tax havenry epitomizes that sinister merger.

Carried Interest Loophole: Is Anyone Still Defending It (for Free)?

The New York Times ran an excellent opinion piece yesterday on the bizarre carried interest loophole, tailor-made to nearly halve the tax rate for a tiny sliver of financiers:

Millions of general partners in investment funds receive carried-interest income when they earn profits for their clients. Since these partners do not have to risk any of their own capital, carried interest is really a taxpayer-subsidized fee for managing their clients’ money . . . . No other affluent Americans enjoy this benefit. A brain surgeon, stockbroker, corporate lawyer or actor will have to pay the new top marginal rate percent, while a general partner who manages other people’s money pays, on carried-interest income, only the 20 percent rate on long-term capital gains. . . . The difference in revenue to the United States government when this combined income is taxed at 20 percent rather than at 39.6 percent is about $11 billion annually.

I imagine there are plenty of think tanks happy to characterize this discrepancy as a reflection of (their donors’) wisdom and free enterprise at work. I vaguely recall some academics defending it years ago. But is anyone still doing so, given that we now know how lavishly the finance sector is subsidized, and how tax policy exacerbates inequality in so many other ways?


Volume 60, Issue 2 (December 2012)

Volume 60, Issue 2 (December 2012)


The Battle Over Taxing Offshore Accounts Itai Grinberg 304
The Structural Exceptionalism of Bankruptcy Administration Rafael I. Pardo & Kathryn A. Watts 384
Patients’ Racial Preferences and the Medical Culture of Accommodation Kimani Paul-Emile 462


“Not Susceptible to the Logic of Turner”: Johnson v. California and the Future of Gender Equal Protection Claims From Prisons Grace DiLaura 506

The Boy Scouts and Discrimination

Imagine the Boys Scouts of America discriminated on the basis of race. In this hypothetical, no black parents are allowed to lead troops, and no black children are even allowed to join them. If your child were eligible, would you let him become a Boy Scout? My guess is that the answer would be no. There are plenty of alternative extracurricular activities available, including other scouting clubs, so why belong to a racist one whose policies stigmatize innocent children and perpetuate hostility towards a group based on a completely irrelevant characteristic? In fact, you might not want to support them in any way. The federal government certainly does not: groups that discriminate on the basis of race are ineligible for government funding and cannot qualify as a tax exempt organization. In short, no government money would flow to them, not even in the form of tax breaks. As an expressive association, the Boy Scouts might have a constitutional right to discriminate, but that doesn’t mean that our tax dollars should help them.

In recognition of National Coming Out Day on October 11, let’s tweak the hypothetical and substitute sexual orientation for race. Shouldn’t the results be the same?