Thursday, August 22, 2019

Trump's (Sort of Revived) Proposal to Cut Capital Gains Taxes Unilaterally is Illegal, But Could He Get Away with it?

by Michael C. Dorf

Earlier this week, President Trump re-floated an idea that he and various GOP politicians have previously proposed: the notion that via unilateral executive action, he could effectively cut the capital gains tax by indexing the cost basis of investments to inflation.  As of this writing, Trump has backed away from that idea; but given how quickly he changes his mind, this or a similar proposal could be back on the agenda within a matter of weeks or days, if not minutes.  Notwithstanding that uncertainty, therefore, this seems like a good moment to offer an analysis of Trump's proposal.

As Prof Buchanan explained in a column last year, even a person who somehow concludes that such indexing would be a good idea as a matter of policy must nonetheless concede that a different policy choice has been made by Congress, which provided for inflation indexing in other statutory provisions but not in the capital gains provision.

Accordingly, an Office of Legal Counsel memo (from p. 136 of the link) in the Bush I administration concluded that the President and Secretary of the Treasury lack authority to construe cost in the calculation of taxable capital gains as inflation-adjusted cost. As Prof Buchanan notes, proponents of executive unilateralism on capital gains argue that the 2002 SCOTUS ruling in Verizon Communic. Inc. v. FCC fatally undercuts the argument of the Bush I OLC, but that's just not true. As Daniel Hemel & David Kamin explain convincingly in a recent article in the Yale Journal on Regulation, the Verizon case at most undercuts one relatively unimportant argument on which the OLC memo relied. Overall, there remains no good basis for executive unilateralism here.

But wait. Could the Trump administration get away with a unilateral executive capital gains tax anyway? Suppose that Trump asks AG Barr to pressure OLC to rescind the Bush-era memo, that it complies by giving a torture-memo-style fig leaf of cover, and that the IRS then treats all returns taking advantage of the inflation-adjusted basis as lawful. Would anyone have standing to challenge the new policy? It's true that the government's failure to collect tax revenue lawfully owed by some taxpayers could harm the rest of us, but that sort of diffuse harm is a so-called generalized grievance for which standing is disallowed. So Trump could get away with it, right?

Wrong, say Hemel and Kamin. They point to five categories of potential plaintiffs who could have standing: (1) Congress (or to be more precise, the Democratic-controlled House); (2) states that will lose revenue because their tax codes piggyback on federal definitions; (3) brokers who will lose money due to compliance and other costs; (4) some taxpayers who would actually be disadvantaged by the rule change; and (5) charitable organizations.

In my view, Hemel and Kamin make plausible arguments for standing for each of these five categories, but only the fourth category strikes me as a slam-dunk. Still, one might conclude, as long as there is a category of taxpayer who would be disadvantaged, that's enough for standing, right? Maybe not. I can think of two ways in which the Trump administration might get away with its proposed change notwithstanding the fact that a taxpayer whose tax liability goes up under a new rule clearly has standing to challenge that rule.

(1) Hemel and Kamin identify two circumstances in which a taxpayer could face greater liability under inflation indexing of capital gains. One involves the interaction of such indexing with the deduction for charitable giving. The other involves investments in real estate investment trusts (REITs) and regulated investment companies (RICs). They also note that other commentators have identified other potential losers from indexing. As I said, I agree that such taxpayers would have standing to challenge indexing as applied to them.

But here's the thing: What do they win if successful? They get a judgment declaring the additional tax liability unlawful. They might get an injunction, but that would depend on whether the Anti-Injunction Act allows them to sue proactively rather than to pay the tax and then sue for a refund. In either case, however, the scope of relief could be limited to themselves. True, the court ruling that the executive branch lacked the unilateral authority to mandate inflation indexing would be binding as a matter of precedent in all future cases. Thus other taxpayers whose tax liability was increased by indexing could rely on the precedent and pay the lower tax based on the non-indexed basis.

However, that still would not prevent the IRS from treating returns that owe less tax due to indexing as lawful. To block that, one would need plaintiffs who can object not only to their own tax liability going up but to others' tax liability going down. And that means relying on one or more of the other categories of potential plaintiffs that Hemel and Kamin identify, whose standing is less clear-cut.

To be sure, it would take an extraordinary act of defiance for the administration to stick with the idea that it has discretion to construe cost for capital gains tax liability as inflation-adjusted cost even after a Supreme Court ruling to the contrary. Maybe not even the Trump administration would go that far?

(2) But there is a way in which Treasury could write its rule that would prevent any lawsuits by individuals whose tax liability would go up and thereby prevent a situation in which it openly defies the courts. It could simply write a rule giving taxpayers the option of using an inflation-adjusted basis if they wished to. That would still be illegal (because there is still no wiggle room in the underlying statute), but now no taxpayers see their tax liability go up.

Accordingly, I am left thinking that it might be possible for the administration to get away with the proposed illegal course of action, subject to three remaining points.

First, I want to be clear that in expressing some doubt about standing for the potential plaintiffs in Hemel and Kamin's categories (1), (2), (3), and (5), I am speaking descriptively and predictively, not prescriptively. If I had my druthers, I would favor substantially broader standing than the Supreme Court tends to allow.

Second, as Prof Buchanan noted last year, giving the richest Americans a tax cut is bad politics, especially in an election year. However, that is no guarantee that the Trump administration won't try it anyway, because despite Trump's populist rhetoric, (with the exception of his trade wars) he has governed pretty much as an enthusiastic stroke-the-rich Republican. Non-wealthy voters who have stuck with Trump up until this point are unlikely to abandon him due to another giveaway to the wealthiest voters. Or at least Trump and his advisers might so conclude.

Third and finally, there remains a possibility that the Trump administration could get away with indexing capital gains to inflation but only temporarily. Suppose the scenario I've described above plays out but that a Democrat wins the 2020 presidential election. If that new Democratic president were to reverse the Trump policy, taxpayers who took advantage of inflation indexing on their returns in 2020 could be assessed with a deficiency plus interest (but presumably no penalty), allowing the Treasury to recoup the windfall.

There would be some unfairness in doing so, to be sure. Investors who sold assets in 2020 because they had little or no after-inflation-adjusted capital gains might have held onto the assets if they knew that the non-adjusted basis would be used to calculate capital gains tax. However, any such unfairness can be mitigated by Democratic candidates announcing now that they will reverse the illegal Trump plan, so that no investors could say that they reasonably relied on it. And even in the absence of such an announcement, the claim of unfairness would not be a sufficient ground for resisting the tax liability.