Weekly SSRN Tax Article Review And Roundup

This week, David Gamage (Indiana) reviews a new article by Ari Glogower (Ohio State), Taxing Capital Appreciation, Tax Law Review, Vol. 70, No. 1, 2016.

Income and wealth inequality have been rising as issues of national concern.  One would think that these concerns should motivate tax reform proposals designed to address income and wealth inequality.  However, many leading tax law experts believe that the current structure of the U.S. income tax cannot support much higher tax rates at the high end.  As Avi-Yonah and Zelik have persuasively explained, the reason is that we are “trapped” by our realization and capital gains rules.

The realization rule—that gains are not taxed until realized by sale or similar transaction—has long been understood as the “Achilles heel” of the income tax.  The higher the tax rate on capital gains, the more that wealthy taxpayers are incentivized to delay realization of gains, and accelerate realization of losses, while borrowing to the extent that money is needed to fund consumption. Because of these sorts of realization games, economists estimate that the revenue maximizing tax rate on capital gains is probably in the range of between 28% and 32%.  Hiking the capital gains tax rate above this range would thus be expected to decrease revenues.

Largely because of these concerns, many prominent tax academics have called for replacing the individual income tax with a progressive consumption tax.  Yet I, and others, have argued against such proposals.

What is needed, then, are proposals for how to fix the problems created by the realization doctrine that would enable meaningful progressive taxation of capital income.  Thankfully, Ari Glogower’s recent paper offers what is probably the best of such proposals to date.

Glogower calls his proposal “deferral tax accounting.”  I will not attempt to summarize his proposal here, instead I direct interested readers to Glogower’s excellent article.  As a teaser, I’ll note that key features of Glogower’s proposal would resolve concerns about valuation and liquidity that have plagued many earlier proposals for abolishing the realization rule.

Perhaps the primary downside to Glogower’s proposal is its complexity.  It is not easy to explain how the proposal operates even to tax experts.  It is more difficult to imagine how the proposal could be conveyed to the general public.  Even if the proposal is limited to apply to only the top one percent or so of taxpayers, the proposal’s complexity could be a political impediment to it being adopted.

This obstacle could perhaps be overcome were the political messaging focused on the abuses the proposal targets, rather than the proposal’s complicated mechanics.  Yet, regretfully, I suspect that more work will need to be done on simplified messaging before this proposal—or any like it—will be taken seriously by Congress. 

This should not detract much from Glogower’s impressive contribution.  It is helpful to start with the substance of tax reform before turning to messaging.  Yet ultimately both are needed, and so I hope that future work will build on Glogower’s article to devise a politically feasible approach for fixing the realization doctrine.           

Here’s the rest of this week’s SSRN Tax Roundup:

• Celeste Black (Sydney), The Attribution of Profits to Permanent Establishments: Testing the Interaction of Domestic Taxation Laws and Tax Treaties in Practice, British Tax Review, Vol. 2017, No. 2, pp. 172-203, 2017
• Darien Shanske (Davis), Interpreting State Fiscal Constitutions: A Modest Proposal, Rutgers Law Review (Forthcoming)