Taxation

Jason S. Oh

Why do income tax systems across the world consistently feature progressive marginal rates? The existing literature tells a political story focusing on the top of the rate schedule and the preferences of the poor and the middle class. According to this standard view, higher rates at the top result from the poor and the middle class using the political process to “soak the rich.” However, this explanation is inconsistent with research showing that public policy is generally more responsive to the preferences of the rich. Explaining marginal rate progressivity as a universal (and exceptional) triumph of the poor and the middle class rings hollow.

This Article resolves the tension in the existing literature by demonstrating how progressive marginal rates are consistent with the preferences of the rich. Marginal rate progressivity is the combination of two policies—higher rates at the top and lower rates at the bottom. This Article shifts the focus to the bottom of the rate schedule and argues that the rich and the middle class benefit from inframarginal tax cuts—rate cuts at low levels of income. The intuition is that taxpayers benefit from rate cuts if they occur at levels that are at or below their own income.

This means that rate progressivity is not entirely progressive policy. Increasing marginal rates at the top increases the progressivity of the fiscal system. But marginal rate cuts at low levels of income can have the opposite effect. They are particularly pernicious because they can be framed as “low-income” tax cuts. A cynical view of marginal rate progressivity is that it allows the rich and politicians to pay cheap lip service to progressivity, even though there are many better tools available for achieving that goal. Unfortunately, cutting inframarginal rates remains politically popular. Both House Speaker Paul Ryan and President Donald Trump’s tax plans feature such tax cuts prominently. Understanding the regressive effect of inframarginal rate cuts has never been more important.

Zachary D. Liscow

For generations, debates over what level of government should pay for local government services—most notably school funding—have largely boiled down to a simple pair of assumptions. Having the state or federal government pay for services promotes equality across rich and poor areas, but hampers local tailoring and thereby reduces citizens’ choice sets. Economists call this an equity-efficiency trade-off—centralized funding promotes equity but undermines efficiency.

This Article argues that this presumed trade-off is not as stark as generally thought, as it ignores important and underappreciated reasons that centralization promotes choice and thus efficiency. Specifically, more centralized funding helps people live where they prefer to live, unburdened by artificially needing to pay more for services in poor jurisdictions with large numbers of impoverished households who can pay little for services themselves. This insight should not only shift the scholarly debate on the equity-efficiency trade-off, but also supply important, real-world payoffs for debates over school funding and similar programs. Put simply, centralized funding promotes equality and, by promoting choice, efficiency.

The Article does not merely make a theoretical argument; it also empirically tests the claim using natural experiments across the country in centralizing state funding for schools. The Article finds large efficiency benefits. The results also show that more centralized financing has encouraged people to move back to central cities, suggesting a second, hidden efficiency benefit to more centralized financing: It promotes the positive externalities associated with central city living. The Article could thus broaden support for more centralized funding of local services, something that could fundamentally reshape not just academic debates over fiscal federalism, but also state and local fiscal policy and urban living.

Erin Adele Scharff

Cities are once again on the rise and have become the site of major public debates, from income inequality and immigration policy to where and how Americans should live. While municipal leaders are often eager to fill the void in political leadership left by Congress and state elected officials, they are often hamstrung by state home rule laws, which define the powers states grant to municipalities. These laws limit, among other things, municipal taxing authority. Recently, local government scholars have wrestled with whether and how to grant municipalities more fiscal authority, but such scholarship has not provided a unified theory of municipal taxing authority.

This Article considers in detail whether and how to expand city taxing authority. It argues that state law should grant municipal governments “presumptive taxing authority.” This presumptive taxing authority would parallel municipal regulatory authority and be similarly subject to state preemption law. Such reform would open the door to more municipal revenue innovation, while ensuring that the state can vindicate its weighty policy interests.

Aaron M. Bernstein

In the wake of United States v. Windsor, the IRS determined that a validly married same-sex couple is married for federal tax purposes regardless of their state of residence. A same-sex spouse residing in a state that does not recognize same-sex marriage is required to file federal taxes as married under federal law but is prohibited from filing as married in-state, thereby creating incompatibility—a filing status mismatch—between her federal and state income taxes. In order to resolve this, states should not require a same-sex spouse to prepare a pro forma “unmarried” federal return for state filing purposes, as this is inefficient to administer and enforce, and creates an inequitable compliance burden on the taxpayer. Nor should states delink their base from federal income or remove from their state tax codes all references to federal tax law, as this reduces tax efficiency. Instead, states should place traditional concerns of tax efficiency and equality above narrower same-sex marriage policy objectives when crafting their tax systems. Tax efficiency and equity require that states at least permit resident same-sex married taxpayers to allocate income and deduction figures already computed for their federal returns when preparing their state returns.

Akari Atoyama-Little

Single mothers are responsible for raising one in five American children. They are disproportionately poor women of color. This Note explores the Internal Revenue Code’s provisions that, though facially neutral, disadvantage single motherhood in effect. Although the tax code’s progressivity does some work to alleviate poverty among single mothers, major income tax provisions intended to support families fail many single mothers precisely because of their low-income status. Many of the benefits go to higher-income families, who tend to be married couples. This Note argues that the tax code should do more to support single mothers. Specifically, this Note argues that the existing federal child and dependent care credit should be made refundable so that it reaches more single mothers and better functions as an incentive to procure quality care for children.

Sara Sternberg Greene

The Earned Income Tax Credit (EITC) is the largest federal antipoverty program in the United States and garners almost universal bipartisan support from politicians, legal scholars, and other commentators. However, assessments of the EITC missed an imperative perspective: that of EITC recipients themselves. Past work relies on largely unconfirmed assumptions about the behaviors and needs of lowincome families. This Article provides a novel assessment of the EITC based on original data obtained directly from 194 EITC recipients through in-depth qualitative interviews. The findings are troubling: They show that while the EITC has important advantages over welfare, which it has largely replaced, it fails as a safety net for low-income families. The problem is that the EITC provides a large windfall to families only once per year, during tax refund season. However, low-income families are particularly vulnerable to financial shocks and instability. Not surprisingly, such events rarely coincide with tax refund season. Without a fix, the EITC leaves many families on the brink of financial collapse. In the years to come, many more low-income families may file for bankruptcy or become homeless. Despite this grim outlook, this Article suggests a straightforward and promising new way to distribute the EITC that maintains the program’s advantages while also providing a more secure safety net for low-income families in times of financial shock and instability.

Joshua D. Blank & Nancy Staudt

Many people—perhaps most—want to make money and lower their taxes, but few want to unabashedly break the law. These twin desires have led to a range of strategies, such as the use of “paper corporations” and offshore tax havens, that produce sizable profits with minimal costs. The most successful and ingenious plans do not involve shady deals with corrupt third parties, but strictly adhere to the letter of the law. Yet the technically legal nature of the schemes has not deterred government lawyers from challenging them in court as “nothing more than good old-fashioned fraud.”

In this Article, we focus on government challenges to corporate financial plans—often labeled “corporate shams”—in an effort to understand how and why courts draw the line between legal and fraudulent behavior. The scholars and commentators who have investigated this question nearly all agree: Judicial decision making in this area of the law is erratic and unpredictable. We build on the extant literature with the help of a new, large dataset, and uncover important and heretofore unobserved trends. We find that courts have not produced a confusing morass of outcomes (as some have argued), but instead have generated more than a century of opinions that collectively highlight the point at which ostensibly legal planning shades into abuse and fraud. We then show how both government and corporate attorneys can exploit our empirical results and explore how these results bolster many of the normative views set forth by the scholarly and policymaking communities.

Jonathan D. Grossman

The False Claims Act (FCA) imposes severe penalties on those who commit fraud against the federal government. The statute currently requires violators to pay treble damages plus a statutory penalty of five to ten thousand dollars per violation. The goal of the statute is to deter fraud by setting punitive damages at a high level. However, the tax law, as currently interpreted by the Internal Revenue Service (IRS), blunts the force of the statute by allowing a violator to deduct a portion of an FCA damages award as a business expense. Specifically, Treasury regulations allow for the deductibility of any portion of an FCA settlement or damages award that is paid to the whistleblower, known as the “relator,” who brings suit under the FCA for the alleged fraud. This Note argues that, for reasons of efficiency and equity, the IRS should change its current position and disallow relator fee deductions.

Meredith M. Stead

Over the past several decades, Congress has turned increasingly to tax expenditures rather than to direct outlay programs to implement social welfare programs. Such a trend creates economic distortions and has proven disadvantageous to taxpayers in lower socioeconomic classes. The newest twist is in the area of disaster relief. Unprecedented before 2001, tax relief targeted to a disaster in a specific geographic region has now been established on two occasions-in the wake of the 9/11 attacks and in the aftermath of Hurricane Katrina. This Note argues that, in a disaster, both the vulnerability of lower-income taxpayers and the weaknesses of the Internal Revenue Code as an instrument for social programs are amplified. This problem was particularly acute after Hurricane Katrina. Congress should therefore reconsider the current trend toward using tax expenditures rather than direct relief in such situations, or alternately structure other relief to correct for its shortcomings.

Leandra Lederman

Virtual worlds are increasing in commercial importance. As the economic value of computer-generated spaces soars, questions of how to apply our tax law to transactions within them will inevitably arise. In this Article, Professor Leandra Lederman argues for federal income tax treatment that reflects the differences between “game worlds” and “unscripted worlds,” arguing that the former should receive more favorable tax treatment than the latter. Specifically, she argues that transactions in game worlds such as World of Warcraft should not be taxed unless the player engages in a real-market sale or exchange. By contrast, in intentionally commodified virtual worlds such as Second Life, federal income tax law and policy counsel that in-world sales of virtual items be taxed regardless of whether the participant ever cashes out.

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