Kai Konrad’s outstanding paper, Dynamics of the Market for Corporate Tax-Avoidance Advice, advances a formal economic model that explores the interactions between private-sector experts and public administrators in the struggle over tax compliance. In broad brush, these interactions are familiar: first, expert tax advisors develop a new tax-avoidance technique, which they sell to clients. Then, other advisors learn of and copy the technique, and avoidance runs rampant. Finally, outraged legislators or regulators shut down the technique. Tax shelters are born in obscurity, enter a promiscuous adolescence, and die young—the James Deans of the Internal Revenue Code. One of Konrad’s principal innovations is to explicitly model the delay between the promulgation of a particular tax avoidance technique and its denouement through government intervention. For virtually all reasonable delays, Konrad’s model yields “a permanent innovation/regulation loop”—stable equilibria with cycles of private-sector tax avoidance (ranging from moderate to obscene) and public-sector crackdowns (which may absorb significant resources). Both periods impose potentially significant social costs, which reinforces how pernicious tax avoidance likely is.
Indeed, Konrad’s paper opens a number of opportunities to connect empirical evidence to his theoretical predictions. Most prominently, if innovative tax advisors have an incentive to disclose tax strategies to regulators, we should be able to identify the mechanisms through which this dissemination occurs. For high-level firms with large corporate clients, professional networks and communities of interest provide enough close contact to make this type of disclosure plausible. (And might favor closing the revolving door from public to private practice for these individuals.) In addition, Konrad raises questions about whether we should expect to see “macro” cycles of tax avoidance or many overlapping “micro” cycles associated with particular tax strategies, which might appear as a steady-state. Although Konrad argues for the latter (which would make quantitative substantiation of his model more difficult), the U.S. experience with tax shelters seems closer to the former. The forces driving these macro cycles of tax abuse—perhaps norms or rules of conduct among tax advisors—warrant some speculation.
Furthermore, Konrad’s model (very reasonably) assumes an ex ante category of transactions that constitute innovative tax avoidance—a category that (laudably) extends beyond generic, prepackaged deals and includes bespoke techniques that have the potential for generalization. In practice, however, this category is less clear, and governmental responses may reflect legal and normative uncertainty about whether particular transactions are or are not abusive. For example, a regulatory agency might choose rifle-shot guidance over a broader change, depending on the risks of being challenged and the legal infrastructure in place to support either approach. In addition, innovative tax strategies may re-open substantive and normative debates about tax law and policy among lawmakers. Government is not monolithic (and, in the United States, very much not so), and lawmakers may view the emergence of a tax problem as an opportunity to renegotiate law or policy within the public sector—possibly with help from lobbyists connected to innovative tax advisors or their clients. These interactions add a further layer of complexity to the processes that Konrad models.
Finally, Konrad alludes only briefly to mandatory disclosure rules in the body of his paper, though such rules serve as the motivating force behind his project. Depending on how these rules are crafted, they may shorten the time between the development of an innovative tax strategy and its discovery by regulators. Indeed, if these rules reduce the lag sufficiently (or the lag is sufficiently short to begin with), tax advisors may no longer find it profitable to develop and market new avoidance techniques—a pretty dramatic positive outcome. Alternatively, mandatory disclosure rules might simply cause any lag to more closely approximate the compromise outcome, discussed above, that propagates a malignant cycle of avoidance and regulation. This question, which Konrad’s model does not engage directly, seems to be the ball game for mandatory disclosure rules. More development of this aspect of Konrad’s paper is warranted.
In conclusion, Konrad’s informative and engaging article should prove crucial to debates about corporate tax avoidance, particularly in the international context. Konrad’s article should be of interest to legal scholars and economists, as well as others working in areas involving public and private dynamics in regulation.