Yesterday we continued our theme this semester of branching from tax towards other law, rather than towards public economics, by discussing the above paper. "Categorical non-enforcement" is a label that one might, subject to dispute, extend to the Obama Administration's currently contested immigration plan, but there are also various tax applications of the concept. More on this momentarily.
Despite the paper's title suggesting that it is "for" the allowability of categorical non-enforcement, it's probably better viewed as anti-anti-categorical non-enforcement, in the sense of questioning standard arguments against it from con law, which it argues rest on drawing exaggerated or unpersuasive distinctions.
As an initial aside, however, one of the things we happened to look at in the course of the day was excerpts from the Obama Administration's Office of Legal Counsel (OLC) memo explaining why the immigration plan is within the President's power to faithfully execute" the laws. I was a bit disappointed by the OLC's reasoning, finding it a bit thinner than I would have liked, given that as a matter of policy I am highly sympathetic to what the Administration is trying to do. For example, it relies on the claim that the "categorical" policy of suspending deportation within certain categories is actually case-by-case, since they could actually override it for unstated reasons in any particular instance, which they don't appear actually to be planning to do. This is arguably a bit formalistic, rather than substantive. And it relies on the fact that Congressional legislation deliberately extended other benefits to the groups that get favorable treatment here, ostensibly showing consistency with Congressional intent. But that might be a bit like saying that, if the bank gives me a toaster when I open a new savings account, the underlying intent supports also separately giving me a clock radio.
None of which is to say that a 5-4 Supreme Court vote striking down the immigration plan would merit much of a presumption that it had been reached through good-faith legal reasoning, rather than on political grounds. Too much water under the bridge at this point (even before we get to see what they do in King v. Burwell).
But anyway - back to the paper. It does a nice job of showing that it's hard to draw lines between permissible and impermissible exercises of executive discretion regarding how to enforce the tax laws in the face of limited resources and diverse underlying objectives on the part of Executive Branch officials. Here are a few examples, all raised in the paper, but arguably very different from each other.
1) President Romney in 2013, or present Bush-Walker-Whomever in 2017, announces categorical non-enforcement of the estate tax. "I will not allow a single IRS auditor to review any Death Tax issue whatsoever. It's time for us to drive a stake through this heart of this unfair, job-destroying, family-farm-endangering monstrosity." The OLC memo in support notes that Congress repealed the estate tax for 2010, then raised the exemption amount, and left substantial scope for avoiding it through tax planning even though the "loopholes" were well-known. It also claims that estate tax audits may be considered after all on a case-by-case basis, under criteria that it declines to explain and in seeming tension with the President's sweeping statement.
Whether or not this hypothetical executive quasi-repeal of the estate tax would be justiciable, I would call it clearly illegitimate. But I would agree that the Romney, Bush, Walker, or Whomever Administration could shift some audit resources from the estate tax to other areas that it cared more about (e.g., EITC enforcement). I would probably disagree with this shift as a matter of policy, but presumably up to a point this is what elections are about. After all, it seems unlikely that the Executive Branch is required to set audit rates purely on the basis of an objective of maximizing correctly-determined tax revenue, even though that objective should presumably be an important input to the allocation of auditing and other such resources.
2) Frequent flyer miles appear clearly to be taxable under section 61 of the Internal Revenue Code, in cases where one accumulates through business use (deductible or reimbursed) and then uses them for personal travel. True, there are some valuation and timing issues, but there basic taxability seems clear. Nonetheless, the IRS has announced that it will not assert income tax deficiencies by reason of people's using such frequent flyer miles. In other words, it's effectively acting as if there were an unenacted exclusion for the value of such items.
This is certainly categorical non-enforcement of a kind. But note the likely motivation for it: Any attempt to enforce would lead to a huge outcry, almost certainly followed by the prompt bipartisan enactment of legislation blocking enforcement or expressly excluding at least standard-case frequent flyer miles. So the IRS commissioner who directed a shift to enforcement would merely get the Congress mad at him or her without actually accomplishing anything.
Arguably there is a kind of "rule of law" violation here. If Congress wants frequent flyer miles excluded, they should say so through legislation. But the IRS is not really to blame here, e.g., in the sense of showing a proclivity to over-reach. It is just declining to fall on its sword and get another black eye with Congressional leaders in exchange for no benefit (other than to the rule of law in general). I certainly can't blame the IRS for not being so noble as to want to take a bullet for abstract reasons here.
3) It has recently come out that the IRS audit rate for large and complex partnerships is about 0.8 percent, despite the fact that there appears to be a lot of suspect or outright bogus tax planning going on this sector. (More on this on May 5, when Gregg Polsky will be presenting a paper on this topic at the colloquium.) The reason the audit rate is so low, even though the IRS is thereby leaving a whole lot of lawful tax revenue on the table, is that it simply lacks the staffing and expertise, especially in light of extremely complicated audit requirements that Congress imposed with respect to large and complex partnerships in the 1980s. It therefore is fair to say that the low audit rate here represents a shocking and costly misallocation of auditing resources, albeit one reflecting constraints that the IRS faces rather than its own preference for any such misallocation.
The paper argues: Why not go to full-out non-enforcement here, so that what's going on even at 0.8% will be more transparent? Might this help induce Congress to address the problem? (It's presumably not unaware of the problem today, but, even apart from political gridlock and Republican hostility to high-end enforcement, there is the fact that high-income partners who are benefiting from the aggressive tax planning have friends in both parties.)
I'm not entirely sympathetic with this argument. In effect, the IRS commissioner, Secretary of the Treasury, or some other such individual should start shouting, jumping up and down, waving his or her hands in the air, etc. But going all the way to zero enforcement isn't quite the point (and might further backfire if it effectively invited others to join the party).
4) The paper discusses a well-known partnership tax case called Diamond v. Commissioner, in which the IRS succeeded in requiring a taxpayer to treat the receipt of a profits interest in exchange for services as a taxable event. The IRS quickly, it appears, came to agree with commentators who viewed the decision in Diamond as anomalous. The holding not only departed from standard practice, but raised valuation issues, and arguably was in tension with generally taxing labor income on a realization basis. The IRS decided not to follow up, or use Diamond in audit disputes, but for a long time failed to explain its position publicly, presumably in part because it was still figuring things out.
Was this categorical non-enforcement of Diamond? I would view it instead as IRS determination of what it thought the law actually was in this area. At worst, the IRS might have been a bit slow to announce (as it eventually did) how it actually viewed and would be proceeding in this area, but it wasn't declining to enforce Diamond if it didn't agree that this decision (in just one circuit) offered a reliable general guide to how the receipt of profits interests in exchange for services generally should be taxed.
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