-- Posted by Neil H. Buchanan
In two posts earlier this month (here and here), I discussed some of the social justice-related reasons that we tax large "prizes" and gifts. In both posts, I referred to a classic argument in the tax policy literature, which is a variation on the "no free lunch" notion that every decision to favor one party will disfavor one or more other parties. Shortly after writing those posts, I had reason to re-read a recent article by Professor Shu-Yi Oei, who is currently the Hoffman F. Fuller Associate Professor of Tax Law at Tulane University Law School. (Note: Oei is pronounced "wee.")
Professor Oei's article provides an innovative framework for thinking about the nature of policy tradeoffs, in a way that extends my analysis from a static (moment in time) analysis to a dynamic (as time passes) framework. In so doing, she offers an important insight in how to think about the justice of "giving people a break."
Each semester, at the beginning of my basic Federal Income Taxation
course, I am confronted by students who view tax cases as categorically
different from any other kind of legal case. At least when we are
talking about human taxpayers, a tax case tends to take on a
David-versus-Goliath framing, and students understandably are pulled
toward an attitude that says, “Oh, come on, give these people a break! It’s just the government on the other side of the case, and the money
will mean nothing to it, in the larger scheme of things. Where there is
any doubt at all, maybe we should give the taxpayer more than the
benefit of that doubt.” This widely held attitude has caused me to spend
time at the beginning of every semester explaining to students that tax
evasion is not a victimless crime. Failing to collect taxes that are
legally owed has consequences for other real people, not just for that abstract thing called "the
The title of Professor Oei's article, Who Wins When Uncle Sam Loses? Social Insurance and the Forgiveness of Tax Debts (46 U.C. Davis Law Review 421 (2012)) is the logical equivalent of the question that I ask my class every semester: "Who Loses When a Taxpayer Wrongly Wins?" Because Uncle Sam represents all of us, "the people" lose when an individual taxpayer wins. Imagine that a taxpayer has tried to take a deduction, and the facts of the case suggest very strongly (but not conclusively) that the deduction was illegitimate. Because tax cases are to be decided on the preponderance-of-the-evidence standard, the taxpayer should lose. But the ever-present temptation is to say, "Come on, let's let 'em off the hook! What's the big deal?"
The big deal is that the uncollected money must either be offset by (1) increasing
other people’s taxes, or (2) failing to provide services that the
government otherwise would have provided to eligible recipients, or (3)
increasing the deficit. And although increasing the deficit is often
very good economic policy, increasing it because of uncollected taxes
generally is not. (By the way, if I have provided any value-added to this debate over time, it is in explicating how the "increasing the deficit" option is logically equivalent to the first two options. See my earlier posts, linked above.)
Thus, at best, any argument for tax forgiveness has to
be based on the belief that distressed taxpayers are more deserving
than all of the people in line for potential use of those uncollected
funds, an argument that would require knowing that the average
distressed taxpayer is worse off than the average person whose, say,
access to disability health benefits would be reduced by the
government’s smaller revenue base. Most importantly, the same logic extends not just to giving people a break vis-a-vis existing tax laws, but to policy debates over changing the tax laws. Want to repeal the estate tax? Great, how are you going to pay for it?
This no-free-lunch argument is hardly simple or obvious, but it is absolutely true. That is, it is not a matter of opinion. Even so, the apparently natural intuition among most people who have never thought about the issue is to imagine that tax breaks (either ad hoc, or as a matter of repealing or reducing certain taxes) are free to everyone. But how does Professor Oei take what is already simply a true statement that is beyond debate, and add an innovative twist?
Professor Oei’s paper picks up where the no-free-lunch argument leaves off. Importantly, however, she limits her analysis to the "collections" stage of the tax enforcement process, in which the Treasury Department is authorized to provide relief to taxpayers who demonstrate "need," in very carefully specified ways. Therefore, we are not talking about simply giving people a break in general, merely because they are arguably in a gray area. Although the paper identifies a number of reasons that people are offered relief from full payment obligations, perhaps the core reason is a matter of simple equity: Sometimes people are so economically distressed that fairness demands a change in their tax status. (There is also the idea that "you can't get blood from a stone," but we can put that aside here.) The difficult issue is determining whether their economic need is greater than the economic needs of the other people who, under my arguments (1)-(3) above, will lose out when this distressed taxpayer wins.
In fact, Professor Oei deliberately makes her task even more difficult, by pointing out that a taxpayer who reaches the collections stage of the process – that is, a person who has not paid taxes owed for so long that the government has initiated enforcement actions against her – will generally be in such dire economic straits that there will be other creditors who are also trying to collect from her. This means that a government that fails to collect taxes from that citizen will often not actually provide relief to the citizen herself, but will instead effectively transfer money from the government to the taxpayer’s other creditors. (Professor Oei’s interests and expertise in bankruptcy law shine through here.) Because tax debts have priority in bankruptcy, any time a taxpayer’s tax collections are reduced or eliminated, it is possible that a non-distressed creditor will reap the windfall of the government’s mercy.
Thus, a non-collection decision not only burdens other citizens (again, through higher taxes, reduced services, or increased federal borrowing), but it might do so in a way that merely makes non-needy creditors whole. As social policy, then, forgiveness of tax debts might well be regressive, transferring funds from the public at large to high-income individuals and businesses, rather than being the progressive transfer in favor of the financially needy that it would otherwise seem to be.
Having set herself a rather Herculean task, Professor Oei then makes a convincing argument that there might be a way to conceptualize even these inadvertently regressive transfers as socially beneficial. She argues that there is a “social insurance” aspect to the non-collection of tax debts, which might indeed justify a failure to collect taxes from financially distressed citizens.
Professor Oei distills her social insurance argument on p. 464 of the article: “[T]ax non-collection is accurately described as government provided insurance when taxpayers collectively transfer to the government the risk of inability to pay a tax debt, and such taxpayers pay a price for the risk transfer. Further, tax non-collection is social insurance because participation is mandatory for all taxpayers” (footnotes omitted). The most intuitive way to describe this argument, I think, is to say that the possibility of non-collection is part of the long-term deal for all citizens. That is, taxpayers know that they might face financial difficulties at one time or another, and that they might need help from the government to deal with those hard times.
Paying on an ongoing basis for the possibility of occasional tax forgiveness is thus a valuable social insurance benefit, in exactly the way that insurance to cover unexpected medical emergencies is a valuable benefit for which people pay monthly premiums. Precisely because non-payment by one taxpayer transfers burdens onto other taxpayers, every citizen implicitly pays a social insurance premium every year. Yes, some non-distressed creditors might occasionally get a windfall, but that is part of the deal over time as well.
As Professor Oei describes the implicit transaction, therefore, occasional non-payment of taxes by financially distressed taxpayers is built into the system by collecting higher taxes from everyone else, or providing fewer benefits, or running larger deficits. I was especially pleased to see that the article notes the intergenerational aspects of this bargain, by which taxpayers across time collectively insure against everyone’s risk of occasional distress. This type of cross-generational insurance is arguably, as Professor Oei notes, uniquely well provided by governments, because of well-known market failures in insurance markets.
Still, one might be skeptical that this argument proves a bit too much. The good news is that Professor Oei shares that skepticism. Indeed, the last section of the article analyzes a series of difficult questions raised by her approach, perhaps most importantly including the question (at p. 477): “How Should Tax Non-Collection Interact with Other Avenues by Which the Government Provides Social Insurance and a Social Safety Net?” Although the article cannot answer that question definitively, it is a big step forward to think about this in the dynamic way that Professor Oei suggests, with costs and benefits provided over each person's lifetime, and over many overlapping lifetimes.
At the very least, therefore, Oei’s characterization of the problem significantly advances the debate, creatively re-framing an old question in a way that highlights the social justice aspects of what otherwise might seem to be a mere technical matter of administrative enforcement. Tax scholarship is fun!