NYU Tax Policy Colloquium on Herzfeld, Defining Taxes in Economics, Accounting and Law

 Yesterday was our penultimate NYU Tax Policy Colloquium session. The semester has certainly gone fast. Mindy Herzfeld presented the above paper, and here are some quick thoughts that I had in response:

1. Overview

In a number of areas, legal rules distinguish between "direct" and "indirect" taxes, and treat them quite differently. Often "direct tax" means income tax (and wealth tax if pertinent) in particular, while "indirect tax" describes VATs, excise taxes, and so forth. The paper looks at 4 distinct areas in which some version of this happens:

a) US Constitution - Direct taxes, unlike indirect taxes, must be apportioned. As we discussed earlier in the semester, in connection with our discussing this paper by Jake Brooks and David Gamage), in 1895 Pollock held (contradicting prior authority) that income taxes are direct taxes for this purpose, although the 16th Amendment then intervened with respect to the need for apportionment. 

b) International trade law - VATs, as indirect taxes, can exempt exports without violating WTO rules. Income taxes, by contrast, as direct taxes, have been held to violate the WTO if they have export subsidies. The US learned this the hard way by losing WTO litigation with respect to its DISC rules, then FSC, then ETI.

c) Foreign tax credits - Under US federal income tax law, foreign tax credits are allowed only for other income taxes (or certain levies that are deemed to be in lieu of income taxes) that look sufficiently like out income tax. Recent proposed regulations make it clear that digital services taxes (DSTs) are not creditable.

d) Financial accounting - Income taxes get detailed reporting in financial statements. Other taxes show up, at best, in a single line entry for "Other Taxes," or may even be amalgamated with other above-the-line items without separate reporting - e.g., being included in the cost of goods sold.

2. Overall takeaways

I personally find "direct tax" vs. "indirect tax" too underspecified and formalistic to be of much use analytically. However, once we recognize that the distinction often cashes out as things like income taxes vs. things like VATs, one can start drawing meaningful contrasts. Consider the following polar distinctions between pure or typical income taxes, and pure or typical VATs and other consumption taxes.

a) Is the normal return to waiting being taxed? In a pure income tax the answer is yes; in a pure consumption tax (such as a VAT) the answer is no. In practice, however, things may be far more blurred. For example, the existing US income tax has provisions such as the realization requirement, expensing for various capital outlays, and lower capital gains than ordinary income rates, that may make it more consumption tax-like. For that matter, a consumption tax that uses the "traditional IRA" methodology (deduct savings today, tax them when used to fund consumption) may place a tax burden on saving if the later tax rate is higher than the earlier one.

b) Is the tax base domestic production, or domestic consumption? An income tax is typically origin-based, while VATs are generally destination-based. Thus, in theory the income tax reaches all domestic production, and a VAT all domestic consumption. Note, however, that in practice each may exempt or tax-favor a significant portion of its presumed base. Plus, actual income taxes may have destination-based features. Consider, for example, the use of sales-based formulary apportionment in US state income taxes, along with US source rules for royalties that rely on where the items is used.

c) Who is the tax "on"? - We commonly think of business income taxes as being "on" the business itself. But when they collect and remit VATs or retail sales taxes (RSTs), we think of these taxes as being "on" the consumer. This distinction, however, lies somewhere in between being an economic incidence theory and being based on the taxes' formal features.

d) Administrative timing - Income taxes often allow deferral for economically accrued income (and for such income that has accrued for financial accounting purposes). They also often have deferred resolution of reporting and audit issues. These tend not to be issues (at least, for the latter, to the same degree) with respect to consumption taxes such as VATs.

The paper performs a service by laying out such issues as these across the various contexts. But a question of interest is what main takeaways one should derive from the comparisons.

One takeaway might be that problems arise when these distinctions prove to be less binary in practice than they are in theory. However, this view was more prominent in earlier drafts of the paper than it is in the current one.

3. U.S. constitutional law

Here "direct tax" has a distinctive historical meaning. The phrase was inserted into the Constitution's text at a time when modern income taxes (even in the sense of what the US had during the Civil War) did not yet exist. Moreover, while in other areas (such as WTO law) it's clear that an income tax is viewed as a direct tax, this apparently was not the case in US constitutional law until the Supreme Court in 1895, pursuant to its right-wing members' ideological mission of combating socialism, so held in not incredibly good faith.

Today's right-wing Supreme Court majority will undoubtedly likewise so hold, if an unapportioned wealth tax comes before them. But many who are more on the left disagree, and much of the dispute comes down to the question of how much precedential weight (if any) one should give Pollock.

In my view, however one comes out in the end, this is a rather hard issue to relate to the other three that the paper discusses. The distinguishing point is that it involves the interpretation of cryptic eighteenth century text that predated the modern context.

4. Trade

Again, the WTO bans export subsidies in direct taxes such as income taxes, but it allows indirect taxes (such as VATs) to tax imports and exempt exports.

The historical and political grounds for this distinction may pre-date the WTO, reflecting earlier stages such as the GATT. But in economic models, based on idealized models of an income tax on the one hand and a VAT on the other, it makes perfect sense.

Suppose that we have, on the one hand, an origin-based income tax that reaches all domestic production, and on the other hand a VAT that reaches all domestic consumption. Then an export subsidy in the income tax, equivalently with an import tariff, violates free trade principles and ought to be struck down under a global free trade agreement. By contrast, the VAT's taxing the full value of imports and exempting exports does not violate free trade principles and should not be struck down. Without providing the full analysis here, it is simply tautologically correct under the assumed premises.

So what's the problem with drawing these distinctions in WTO law? Insofar as the analysis is correct, US resentment of the decisions striking down DISC, FSC, and ETI, and associated griping about why the VATs (which everyone else has) do better, is simply misguided.

But in fact there are two big problems with accepting the binary distinction in current WTO law:

a) The models are too simple - As noted above, it's not quite true that actual income taxes reach all domestic production and only that, whereas VATs reach all and only domestic consumption.

Starting with the income tax, suppose various income tax preferences either wholly or partially exempt production for the domestic market. (E.g., consider tax preferences for real estate). Then tax-favoring exports may not, on balance, cause the latter to be, in the aggregate, more favorably taxed than the former. Indeed, it's conceivable that export subsidies might in practice push towards leveling the playing field.

Turning to the VAT, suppose (as is generally true of existing VATs) that it exempts or effectively excludes lots of domestic consumption, and that this tends mainly to benefit domestic production. Examples might include food, financial services, the informal economy, and small businesses that are exempted. Collecting the full VAT on imports, when home production often escapes being taxed, might end up being a bit tariff-like.

b) Hybrid instruments - Recent decades have seen the birth of the proposals that occupy space in between existing income taxes and VATs. For example, the Hall-Rabushka flat tax, David Bradford's X-tax, and more recently the DBCFT put businesses on what is effectively a VAT plus wage deductions. Most legal experts view this as making them direct taxes for WTO purposes, with the consequence that they might be viewed as containing illegal export subsidies. But proponents say: Why should they be treated any differently than VATs, when the economics are the same? (Whether they are actually the same depends on how one analyzes the wage deduction, but here they note that it could be placed in a separate tax instrument from the VAT, avoiding any WTO violation even if the overall economics were now in fact entirely the same).

The conclusions I would reach are as follows. First, it's a serious question whether the application of the binary distinction to actual income taxes and VATs is more problematic than the textbook economic analysis would suggest. This is partly an empirical question: how consequential are the real world deviations from the pure models?

As to the hybrid instruments, I (and most others) tend to accept the proponents' argument that finding WTO violations for what are essentially formalistic reasons does not make a great deal of sense. But even if this is so, the rise of hybrid instruments may present real challenges for the binary WTO distinction that could get worse if and as further variants in the hybrid space emerge.

5. Foreign tax creditability

The US rules limiting foreign tax credits (FTCs) to income taxes in the US sense can lead to some odd results. For example:

--A Haig-Simons income tax, while a truer income tax than ours, would not be creditable because it would not use realization.

--Some years ago, Bolivia considered replacing its corporate income tax with a flat tax, but then backed off when it learned that this tax, unlike the instrument that it was replacing, would be non-creditable. Flat tax proponents responded, with understandable indignation, that it was hard to see why the US would seek to discourage such a tax change, rather than regarding it as an internal Bolivian decision that had no adverse impact on US interests. On the other hand, it is true that VATs (which a flat tax resembles, as it is simply a VAT plus wage deduction) are not creditable, a feature of the US rules that has not attracted significant complaint.

The big current issue in this area is the recently issued proposed regulations that make it clear that DSTs paid by US companies abroad do not get the FTC. They might already have been non-creditable because they are gross, not net, taxes, but the proposed regs also take aim at them for not following traditional international norms with respect to tax jurisdiction.

My own view about this is twofold. First, I think the US rules are logically wrong (or inconsistent) in thus distinguishing between DSTs and traditional source-based income taxes (or more specifically taxes in lieu thereof, such as gross withholding taxes). But second, the denial is at least arguably in the US national self-interest.

The logic supporting DST creditability - As Wei Cui has argued (and as I largely concurred here), multinationals often have limited marginal costs of using their digital platforms in a given country. Thus, a tax on their gross advertising revenues from exploiting a particular national consumer market may not be all that different from their net revenues. Indeed, a gross measure might even come closer in practice to capturing the true net than a purported net measure in which they got to play lots of fun and games.

Additionally, DSTs generally have a very traditional corporate income tax aim. They seek to impose some tax on income that the multinationals derive from tapping their consumer markets. This truly is domestic source income if one adopts a destination-based rather than an origin-based view of source (and actual income taxes do indeed do this to a degree), yet the companies have been able to avoid paying it because they don't need physical presence, permanent establishments in the jurisdiction, etc. In that sense, they are in substance traditional / playing defense rather than offense, however novel their means of doing this may be. So there is a powerful logic in favor of the view that they are merely in lieu of traditional corporate income taxes, and hence as a matter of logical consistency ought to be creditable just like the traditional instruments that they, in effect, aim to revivify.

National welfare grounds for denying FTC creditability - But this is not to say that the US ought to credit them. As I have written in various formats (for example, here), it generally does not make sense, as a matter of unilateral national self-interest, to offer resident companies 100% reimbursement of their foreign taxes paid. And, while this can potentially make sense reciprocally or multilaterally (i.e., we'll credit your income taxes if you credit ours), the US is not in the position of imposing DSTs that it would like other countries to credit.

More broadly, however, why should we generally limit creditability to foreign income taxes? As noted, for example, here, the policy reasons for doing this are, at best, far from obvious. Perhaps the best and only reason one can come up with is that this is the deal countries implicitly made - insofar as there ever was a deal to begin with. That is, the reciprocal practice in fact applied to income taxes and nothing else (albeit, not really to income taxes given that one could exempt foreign source income instead of crediting the source-based taxes).

6. Financial accounting

Whether or not financial accounting should provide for greater disclosure than it does with regard to non-income taxes, it is easy to understand why it requires the more extensive income tax disclosure than it does. Reason 1 is that deferral for taxable income relative to accounting income means that there are deferred liabilities to consider - not similarly an issue in the ordinary course for, say, VATs. Reason 2 is that income tax reporting positions that are uncertain to prevail may commonly linger unresolved for a significant time - again, less of an issue in other contexts (where disclosure may be required in special cases where there is such an issue).

While those two reasons are surely the operative ones in practice, there's arguably a third reason why we might be glad that financial accounting provides as much information about companies' income tax liabilities as it does (which is not to say that it currently provides enough, or does the analysis entirely right). Because the income tax planning space is so capacious, especially internationally, capital markets may derive valuable information from disclosure of how much in such taxes given companies are paying relative to their reported financial accounting income. For example, investors might like companies that are very aggressive. Or, they might alternatively fear that such companies are also aggressively managing reported earnings and/or engaging in managerial diversion of profits. Either way, they may learn more from reporting about income tax liability than from that concerning other taxes that are less planning-susceptible.

Is this binary distinction also susceptible to breaking down in practice? Maybe so. Had the US adopted the DBCFT in lieu of the existing corporate income tax, back when the House Republican leadership was briefly contemplating doing such a thing, this would have given the financial accounting authorities an interesting classification challenge. They were probably as relieved as anyone not to have to face it. But in any event, the issues that control how best to draw lines in financial accounting appear to me to be quite distinct from those that are most relevant, say, for WTO purposes.

In the end, therefore, these various disputes may all end up proceeding on separate tracks, even if to a degree they employ common language and concepts.

"Bittker's Pendulum" now available for download

 My November 1 Tax Notes article, "Bittker's Pendulum and the Taxation of Multinationals," is now available for download here. It may be taken down briefly as they confirm that I had permission to post it, but (as I do) it will then promptly (I hope) be restored.

New drafts and publications

 I have just now posted on SSRN a copy of my short piece, "Tax Law, Inequality, and Redistribution: Recent and Possible Future Developments." It's available here, where you can also read the abstract.

On Monday, I will be posting on SSRN my recent Tax Notes publication, "Bittker's Pendulum and the Taxation of Multinationals."

I also today submitted to the publisher a final manuscript for my forthcoming book "Bonfires of the American Dream in American Rhetoric, Literature, and Film." The next stage is copyediting, and the target date for publication is May 2022.

NYU Tax Policy Colloquium on Mason & Knoll, Unbundling Undue Burdens

 Yesterday at the colloquium, we discussed the above article, coauthored by Ruth Mason and Michael Knoll. In a welcome departure from COVID-era norms, they were actually both physically present for the event.

The article is the fruit of a LOT of research, including careful reading of a large number of Supreme Court cases on the dormant commerce clause (DCC), in both the tax and regulatory realms. This is one of those times when one says: I'm glad they did it, so I don't have to. These cases are notoriously turgid, all over the place, and difficult to fit into a coherent framework. But they are also, I think, important.

1) SOME SHORTHAND BEFORE WE GET STARTED

Let me start with a bit of background shorthand from the paper, so that the terms noted here can simply be plugged in below.

Internal consistency - In the 2015 Supreme Court case of Maryland v. Wynne, the Supreme Court struck down a Maryland tax provision on DCC grounds as violating "internal consistency." (Knoll and Mason wrote an amicus brief, urging analysis that the Court then adopted.) This term is useful but not immediately intuitive, and hence worth explaining briefly here.

Maryland's income tax taxed residents at 3.2% percent on both Maryland and non-Maryland income. It provided no credit for non-Maryland state income taxes paid on non-Maryland income. It also taxed nonresidents on Maryland source income at 1.25%.

Maryland argued that this tax oughtn't to present a DCC problem. After all, it taxed Maryland residents' outside income at the same rate (not a higher rate) than their local income, and it taxed non-residents at a lower rate than residents. But the tax was struck down as discriminatory against interstate commerce because it violated internal consistency.

The question asked by internal consistency is whether, if each of say 2 states adopted the challenged rule, cross-border transactions between them would be disfavored relative to same-state. The answer here was YES. Suppose we have Maryland 1 and Maryland 2, each with the same rules. A resident of either state would pay tax at a 3.25% rate on in-state income. But income earned in the other state would face a 4.45% tax rate (3.2% under one's own state's residence-based tax, and 1.25% in the other state from the source-based tax, with no abatement given the lack of home-state credit).

Knoll and Mason, along with Alan Viard, have discussed elsewhere why internal consistency is a sound economic method for identifying provisions that are tariff-like in the sense of burdening cross-border activity relative to one-jurisdiction activity. Obviously, an overt tariff would violate internal consistency, since only cross-border trade would lead to its being incurred, but the aim here is to generalize the concern and the inquiry.

Note that the inquiry does not involve actually looking at what other jurisdictions do. Although I agree with Mason and Knoll that this is an appropriate mode of inquiry into both the DCC and international equivalents (e.g., the ECJ's review of member tax provisions that are charged with violating the EU's commitment to a single market), the point for now is just that it offers a powerful and convenient analytic.

Pike balancing - In Pike v. Bruce Church (1970), the Supreme Court struck down an Arizona rule requiring cantaloupes that were grown in-state to be boxed in-state. The claimed rationale for the rule related to letting consumers know that particular cantaloupes were from Arizona (thus, e.g., spreading awareness of their quality). But it violated the DCC by burdening companies from out-of-state that might have boxing facilities (and cantaloupes) from elsewhere. "Pike balancing" is the process of thus weighing benefits vs. the burden on interstate commerce where it is a single-state issue. That is, one is looking at the Arizona rule independently of the question of how it fits with other states' rules.

Bibb balancing - In Bibb v. Navajo Freight Lines (1959), Illinois had required truckers that were using its roads to use curved mudflaps to protect the cars behind them, whereas other states were requiring straight mudflaps. The Supreme Court struck down the rule under the DCC. Here the issue involved "interaction burdens" rather than a single-state analysis. That is, there was nothing wrong with curved mudflaps as such. But given other states' widespread adherence to a straight mudflaps requirement, trucks engaged in interstate commerce would have to stick on new mudflaps - kindly made available, for a fee, by local Illinois businesses - if they wished to use Illinois roads. Just as in Pike, the court balanced legitimate in-state benefits (e.g., suppose the curved mudflaps worked better, at least under Illinois' road conditions) against the burden to interstate commerce. But Bibb balancing differs from Pike balancing because it not only requires examining a broader set of questions regarding how different states' regulations interact with each other, but also (if a DCC violation is found) may in effect require the courts to pick between alternative rules and cement one of the choices in place simply because it has become the prevalent one. This has various downsides, such as its potentially impeding the emergence of new and improved approaches. But if one doesn't do it, one is inviting states to play the kind of destructive game that Illinois may conceivably have been engaged in here.

Green margarine rules - This term isn't in the paper, but I find it expositionally useful. Wisconsin is a big dairy state, and hence a butter producer. Margarine predominantly comes from outside the state. For many years, Wisconsin forbade the in-state sale of yellow margarine. (I remember hearing decades ago from my parents that Wisconsin required margarine to be green, which apparently is not true - it could be white under the rule. But let's say green because it is more vivid.)

A green-margarine rule in a dairy state looks on its face like it is simply there to help consumers tell apart margarine and butter. But in context it may be sneaky protectionism, aimed at reducing consumer demand for the imported relative to the local product because yellow is the color that looks right to them in this context.

It seems to me that the green-margarine rule ought to have been challenged on DCC grounds, but if it was the challenge apparently failed, and there is no well-known precedent. So let's just call this type of effort at disguised protectionism a "green margarine rule." Whether we group a challenge to it under Pike or Bibb (an issue that I discuss below), it seems clear that there is a DCC issue that may need, under existing precedent (but for good reason) require the court to balance the burden to interstate commerce against the legitimate (i.e., non-protectionist) benefits.

2) UNDERLYING THEORETICAL BASIS FOR THE DORMANT COMMERCE CLAUSE

The DCC can reasonably be viewed as reflecting an underlying set of views about both economics and politics. These are worth describing briefly because they affect not only its merits (some Supreme Court members, and of greater intellectual interest also some commentators, want to get rid of it), but also its interpretation.

In brief, the DCC empowers the federal courts to strike down state rules (whether taxes or other regulation) that are protectionist. The classic protectionist rule is an overt tariff, but a DCC inquiry also looks at provisions that are challenged as being tariff-like.

The DCC thus applies a bit selectively with regard to the totality of distortions that might arise from a given state's having distinctive taxes or other rules. Other problems may be addressed by Congress, exercising its legislative powers under the active commerce clause (ACC), but are thought to lie outside the proper scope of DCC review.

For example, whenever two states have different tax rules in any way, this can violate locational neutrality. For example, if State A has a lower income tax rate than State B, this creates an incentive to earn income in A rather than B. But while Congress may address locational neutrality problems under the ACC, the courts don't do so under the DCC.

Likewise, there may be spillovers such as that resulting from a race to the bottom. An example is tax competition - if one views it as normatively creating a race to the bottom, rather than (as I discuss below) to the top. Again, Congress can address this under the ACC, but courts don't under the DCC.

Another issue is tax exportation (actual or attempted), but to things from getting too longwinded I will leave it out here.

Economics - There is a long tradition, prominent (for example) in the work of Adam Smith, to the effects that tariffs are generally inefficient. Indeed, unless a given jurisdiction has the requisite market power, it is likely to make itself worse-off on balance, not just the people in other jurisdictions, by reason of imposing them. Moreover, while it's true that "optimal tariffs" (where one has the requisite market power) can benefit the jurisdiction that imposes them, there is still likely to be deadweight loss from the standpoint of all jurisdictions - suggesting that they should all agree to forgo even optimal tariffs if they are making this choice behind the veil.

If we accept the generalization that tariffs are bad, and what's more view the federal courts under the DCC as well-situated to police the field, then it may make sense to hand them this power. But locational neutrality has far less definite policy implications, once one accepts that it nonetheless makes sense to allow inter-jurisdictional rule variation. So relegating this to the ACC and legislative choice makes sense.

Likewise, the only difference between a "bad" race to the bottom and a "good" race to the top is how one views the suggested equilibrium normatively. Consider the classic case of Delaware's preeminence with respect to corporate law. This was once viewed as a race to the bottom, allowing managers to exploit the shareholders by reason of incorporating in a place where the governance rules are lax. Then it came to be viewed as a race to the top, on the ground that capital markets work well enough to incentivize good place of incorporation choices by founders and managers. Thus, the question of whether the race to Delaware should be addressed at the federal level depends on one's view of how well capital markets are functioning - an issue completely distinct from that of the spillover process as between the states, when Delaware succeeds in capturing this business. Once again, the implication is that this is a legislative policy choice, and hence reasonably placed within the reach of the national legislature under the ACC, but not handed to federal courts under the DCC.

Politics - Why is there even a problem with tariffs (other than optimal tariffs), if sub-federal jurisdictions don't generally benefit from imposing them? So why even bother with higher-level oversight. The standard answer is that jurisdictions are prone to enacting tariffs, and other tariff-like protectionist provisions, due to interest group politics. For example, concentrated producer groups and their lobbyists prevail legislatively over diffuse consumer interests.

So there is also a political theory under which the states might actually want federal oversight, including via the federal courts and the DCC, in order to help protect them against themselves. But this theory is about protectionism in particular. In other scenarios, even if the states are willing to concede (and indeed have conceded) ACC powers, they may not want to make it federal oversight as automatic and widespread as the DCC may make it with respect to protectionism. Plus, again, the optimal remedy isn't so clear with respect to locational neutrality and race to the bottom vs. the top scenarios.

3) SINGLE-STATE ANALYSIS

Again, both internal consistency as in Wynne, and Pike balancing, involve a single-state analysis. One is looking at a given state's rules in isolation, not at how different states' rules interact as in Bibb.

Under existing doctrine, endorsed by Knoll and Mason, internal consistency is distinctively relevant to tax cases, and results in per se finding of commerce clause violation - no Pike balancing needed. This potentially raises issues of tax exceptionalism that I discuss below. But herewith are a few efforts to poke at the distinctiveness, notwithstanding that (for reasons I'll omit here) I am generally comfortable with this state of the doctrine.

Internal consistency in form, but arguably not in substance - Suppose a state with a retail sales tax imposes a use tax rate (for purchases of out-of-state) that exceeds the sales tax rate on sales made in-state. On its face, this is a clear violation of internal consistency, and indeed it could scarcely look any more tariff-like. But suppose that widespread avoidance of the use tax meant that this was, in the aggregate, moving towards the overall equalization of effective tax rates on in-state vs. in-bound sales. Would this potentially offer a defense, at least requiring the court to evaluate the underlying merits instead of striking down the higher nominal levy per se? If so, do we enter the realm of Pike balancing?

No internal consistency violation in form, but arguably yes in substance - Recall the Wisconsin "green margarine rule." On its face, this has nothing to do with internal consistency. But suppose we consider this requirement equivalent to an explicit tax - and Wisconsin indeed had a margarine tax, on top of the green margarine rule - and generalized it as "Impose a special tax on mainly non-local businesses that compete with mainly local businesses" - then one could view it as an internal consistency violation. Is this a helpful perspective, at least in the quest for intellectually consistent rules across the board?

Can internal consistency apply beyond tax? - In the green margarine example right above, I considered both calling the rule in effect a tax, and stating it in a more general form (which the state imposing it would of course dispute). But what if we look at single-state analyses of other standard examples from outside the tax realm. Thus, recall Pike, in which, as discussed above, Arizona tried to require in-state boxing of Arizona cantaloupes. 

Suppose that all states required in-state boxing of in-state cantaloupes. Then you have 2 cantaloupe-growing states, Arizona and California. Any one-state cantaloupe grower can enjoy the efficiencies (if there on balance) of boxing everything at the same plant. But any two-state cantaloupe grower needs to have two boxing plants, one in each state. This might conceivably create competitive disadvantage for multi-state cantaloupe growers.

I run through this simply as a way of getting a better handle on how internal consistency fits into the broader doctrine. It may not matter substantively whether or not we call this an internal consistency violation - although it might conceivably aid us in identifying suspicious cases - unless the identification meant that there would be a per se violation in lieu of Pike balancing. So one has to consider the case for tax exceptionalism, which again I will get to shortly.

4) INTERACTION PROBLEMS

Again, Bibb balancing pertains to interaction problems, which involve a disparity between states' rules, rather than how any one of them operates in isolation. And again, the problem with Illinois' rule requiring curved mudflaps was that it imposed a cost on out-of-state or multi-state trucks given that straight mudflaps were generally required elsewhere. The paper argues that, while Bibb balancing may be necessary given the ingenuity of legislators (or lobbyists) in particular states - along with the barriers to Congressional action and the difficulty of proving malign intent even if one deems that a suitable focus in principle - it has also proven especially tricky in practice, including because it may effectively place an existing prevalent rule beyond the reach of evolutionary change that might conceivably have been for the better.

The paper usefully distinguishes 3 scenarios regarding how such evolution, if permitted to go forward, might systematically unfold. One is the Delaware scenario of race to the bottom (or to the top, depending on one's normative view regarding the end state).

A second is the California scenario, so named because California is a big enough player, given the size of its economy, to prescribe rules that companies will then decide to follow nationwide. (E.g., if it has tougher emission rules for cars than the federal government, companies may decide that it's cheapest simply to follow those rules nationwide.)

A third is the Balkans scenario, a term that the paper uses in the spirit of "balkanization"), in which markets get segmented by reason of incompatible regulatory rules. A classic instance of this problem was the instance in which the ECJ had to deal with Germany's requiring that liqueurs have at least 25% alcohol, while France required that they not have more than 20% alcohol. The ECJ solved the problem here, arguably Solomonically, by invoking a rule called mutual recognition, under which each state had to allow the sale of liqueurs that met either rule.

DCC issues arise under the Balkans scenario, leaving the Delaware and California scenarios purely for the federal legislative power under the ACC. But one complication here is that it won't always be so clear which scenario presents itself most forcefully.

To illustrate, consider Moorman Mfg. Co. v. Bair, the 1978 Supreme Court case that, by a 5-4 vote, upheld Iowa's rule (which was novel at the time) replacing the standard 3-factor formula (sales, property, and payroll) for determining in-state income with a purely sales-based formula. Consider the following 3 scenarios that, based on knowledge at the time, might conceivably have transpired:

Scenario 1 - The prior near-consensus in favor of the 3-factor formula is required by each state's choosing whatever formula worked for it best. E.g., Iowa reportedly chose sales because it was a "market state" in which there wasn't much corporate property or payroll. Suppose that similarly self-interested choices were made by "property states" and "payroll states." National businesses might then have found themselves including more than 100% of their national income in one state or another, disfavoring them relative to one-state businesses. This would systematically disfavor interstate commerce, relative to one-state activity, and arguably would have supported intervention under the DCC even if it doesn't quite achieve Balkans levels of disjuncture. But this is not in fact what happened.

Scenario 2 - The diversity between states' formulas ends up imposing tariff-like extra administrative and compliance burdens on national businesses. Again, this is not what happened, and it was perhaps never a realistic threat, but again we'd be in DCC territory. This resembles the 1967 National Bellas Hess case, overturned by Quill and then Wayfair, which held at the time that use tax compliance was simply too administratively burdensome to be demanded of national businesses. I recall the case saying that there were 50,000 separate sales tax districts, including mosquito abatement districts. And in a pre-computer age this simply imposed too much burden. It is plausible that National Bellas Hess was a reasonable decision when issued, and only became unreasonable later as the rise of computer technology and the Internet both (a) triggered the growth of interstate commerce, and (b) made compliance far cheaper than it had previously been.'

Again, this scenario might in principle have supported a DCC challenge to what Iowa was doing in Moorman, but even at the time probably was not factually plausible.

Scenario 3 - What actually happened is that states learned of the advantages that they would enjoy, via tax competition, from using sales-only allocation. States didn't want to discourage the local placement of property and payroll, and sales were far less tax-elastic insofar as this depended on where the consumers lived. So there was a race to the bottom towards sales-only apportionment - AKA a race to the top, if you happen to view this as a better approach than use of the 3-factor formula. Good or bad, it does seem to lie outside the DCC's concerns.

5) TAX EXCEPTIONALISM

Lately and with good reason, tax folk have tended to be more self-conscious than previously about tax exceptionalism. This is the view that tax cases are unique and distinctive, and hence should be treated differently than non-tax cases. (By using the word "cases," I don't mean to restrict myself to DCC cases or other litigation. It arises as an issue in a variety of realms.)

The paper early on criticizes doctrinal instances of what it calls "unjustified tax exceptionalism," such as the 4-factor DCC test for tax cases under Complete Auto Transit v. Brady (1977). But it later explains why tax exceptionalism may be justified with respect to treating internal consistency violations as per se adversely dispositive in tax cases, but not non-tax cases. This is distinct from requiring Pike balancing.

It makes clear that it is being substantive rather than formalistic in how it defines tax cases for this purpose. For example, a Pigovian tax would be treated like regulation in terms of DCC review. Likewise, issues of administrative burden from complying with a tax (as in my hypothetical Scenario 2 for Moorman) would face balancing. But when it's just a matter of getting revenue, the paper argues that money is money. So a state's interest in getting tax revenues in a particular manner that violates internal consistency is trivial, since they can get the same $$ some other way.

In response, one could argue that not all tax revenue is the same, in that states may have particular reasons for wanting to raise $$ in one way rather than another. But agreed, in a case such as Maryland v. Wynne, once one has shown through internal consistency that the provision does indeed have the tariff-like effect (whether intended or not and actualized or not) of burdening cross-border activity relative to one-state activity), the state's legitimate interest in getting the $$ exactly this way, rather than in some other way, might reasonably be viewed as fairly trivial (making the formal occurrence or not of balancing rather a non-event). Whereas, under, say, the Pike or green margarine scenarios, it may be more necessary to look in detail at the state interests, even if they end up being deemed trivial.