TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, March 30, 2006

Logue Presents Optimal Income Tax Penalties When the Law is Uncertain Today at Northwestern

Klogue_1 Northwestern_2_2 Kyle D. Logue (Michigan) presents Optimal Income Tax Penalties When the Law is Uncertain at Northwestern today as part of its Advanced Topics in Taxation Series organized by David Cameron and Philip Postlewaite. Here is the abstract:

This Article examines the optimal income tax penalty in circumstances in which the tax law is uncertain – that is, when the precise application of the tax laws to a taxpayer’s particular situation at the time of the investment decision is not entirely clear. The Article begins with the assumption that there will always be some degree of substantive uncertainty in the tax laws. Two interesting questions arise out of this assumption: One, how certain should a taxpayer be if she is going to rely on a particular interpretation of a substantively uncertain tax rule? Two, what penalty regime would give the taxpayer the right incentives with respect to relying on substantively uncertain tax laws?

With these questions in mind, the Article observes that there is no a priori “right” level of legal certainty that a taxpayer should have before relying on a particular interpretation of uncertain tax laws. Rather, the optimal threshold of substantive legal certainty depends on a number of factors, including the amount of taxes at stake and the expected pre-tax profit from the transaction in question. I conclude that, applying the standard assumptions from the economic literature on deterrence, the optimal tax penalty regime – the one that would induce the optimal reliance (or non-reliance) on uncertain tax laws depending on the circumstances – would involve (a) a rule of strict liability with respect to taxes owed as well as to the penalty, and (b) a penalty that roughly approximates the famous Bentham-Becker punitive fine, which is calculated by dividing the harm (here, the underpaid tax) by the ex ante probability that the harm would be detected.

The Article also explains why a fault-based approach to tax penalties, under the standard assumptions of the deterrence model, would not work as well as the strict-liability approach. This is because the fault-based approach comparatively has high administrative costs of the former, cannot properly regulate activity levels, and has relatively unattractive distributional consequences. If we relax some of the traditional assumptions, however, there is a second-best argument for the use of fault-based penalties at least in some circumstances.

The Colloquium will be held at 4:00 p.m. CST in Rubloff 339 at Northwestern Law School.

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