Weekly SSRN Tax Article Review And Roundup: Speck Reviews Hasen's Rules, Standards And Detection

This week, Sloan Speck (Colorado) reviews a new work by David Hasen (Florida), Rules, Standards and Detection (2018).

David Hasen’s paper, Rules, Standards and Detection, develops a formal economic model to explore and quantify the interrelationship of detection with the choice between rules and standards. Hasen deploys his highly tractable model toward two principal ends. First, Hasen’s model reveals that compliance costs have severe effects on parties’ responsiveness to regulators’ increased efforts at detection. Hasen finds that, when compliance costs are high, enforcement plays second fiddle to adjustments to legal rules in terms of fostering good behavior. By contrast, when compliance costs are low, audit becomes a more potent factor in encouraging compliance. Second, Hasen elaborates an important qualification of his first point. Under a view of regulation as ameliorating negative externalities, low compliance costs imply that the social costs of noncompliance also are small. Although the magnitude of these costs depends on the specific facts at issue (and, in particular, on the relevant elasticities of supply and demand), these considerations temper the broader point that compliance dollars are best spent in low-cost situations.

Hasen’s findings flow, in part, from the fact that standards create what he calls a “low-cost option.” That is, taxpayers have an incentive to take aggressive legal positions that produce private benefits if not detected, since they incur relatively low costs—typically, denial of benefits without penalties—if successfully challenged by regulators. If the net returns to noncompliance are high, increased detection does little to foster compliance. Strikingly, an increase in detection rates from 1% to 10% (an order of magnitude!) yields only a three percentage-point bump in the level of private compliance effort. And, if I’m reading Hasen’s data correctly, raising detection rates to 50% from 10% adds just one more percentage point in compliance effort. Under these conditions, converting a standard into something more rule-like does significant work.

Critical to these claims is Hasen’s construction of penalties for noncompliance. Drawing on intuitions about how regulators treat the regulated, Hasen notes that regulators rarely impose penalties on parties that make “a good-faith effort to comply” with a standard, the correct application of which will be adjudicated ex post. As a loyal tax scholar, Hasen posits that an effort that leads to a 40% likelihood of compliance is sufficient to avoid penalties—a “substantial authority” threshold, for the initiates. (Different thresholds, of course, might attach depending on whether a regulated party discloses the relevant activities to regulators, and, in this way, detection intersects with understandings of good-faith behavior.) Although almost certainly accurate as a descriptive matter, Hasen’s perspective on penalties warrants more exploration as an intellectual prior. For example, does the rule of law compel some forbearance when the regulated cannot discern the law’s full contours before acting? Ignorance of the law may be no excuse, but it might mitigate an extreme punishment. Still, I found myself wondering about the road not taken. What would happen if we imposed strict liability for penalties in connection with the violation of standards? Hasen’s model could provide a vehicle to find out.

In addition, Hasen defines “detection” as “the probability of review”—a wholly reasonable choice for his model. On the ground, however, “review” has many layers, each of which embodies significant nuance. Even if a regulated party is selected for audit, the audit team still must identify the legal issues raised by that parties’ various activities, then develop the facts that pertain to those legal issues, then (perhaps) confirm that their view in the instant case doesn’t conflict with broader agency objectives, then negotiate with various stakeholders over how to resolve the entire mess in a reasonable way (or a ways that’s unreasonable but livable. At the end of the day, one understands how the first boots on the ground, as it were, might identify a few errant valuations of property and call it a day. Further complicating Hasen’s definition of detection is the fact that many large or sophisticated parties face almost constant scrutiny from their regulators, which places tremendous pressure on issue identification and selection. (The conventional advice is to let these folks use the office by the elevator, so they don’t feel guilty keeping East Coast hours in the mornings and Midwestern hours in the afternoons.) All of these factors feed into overall odds that parties will get caught taking a legally impermissible position, but they also serve as a reminder that some thick description of the mechanics of detection might uncover connections or covariations with other inputs in Hasen’s model, particularly in the penalty process.

One great strength of Hasen’s paper is its ecumenical approach to disciplinary divisions. Like much of the seminal literature on the rules-standards debate, Hasen’s conclusions implicate a number of areas of law, and he appropriately caveats his conclusions by noting that the underlying legal content and institutional structures matter when designing mechanisms to improve compliance. The question remains, however, of whether there is something special about tax law. Few would question that taxation is suffused with rules, with standards interspersed both as primary legal authority and backstops for more rule-bound regimes. A robust and thoughtful practitioner community is tasked with making sense of this morass—and also plays a role in making this area of law more complicated and arcane. Hasen speculates that complex, interlocking bodies of rules may function as standards under his model, and taxation might prove an area to explore this claim, as well as to empirically test some of his other predictions. This type of exploration is a natural extension of Hasen’s paper.

In conclusion, Hasen’s excellent paper makes a significant and careful contribution to important debates both inside and outside of taxation. Hasen’s article should be of interest to the legal community broadly, and in particular to those scholars focused on tax.

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

• Philip Bazel (Calgary), Jack Mintz (Calgary; CESifo) & Austin Thompson (Calgary),
• 2017 Tax Competitiveness Report: The Calm Before the Storm, 11 Sch. Pub. Pol’y Publications, no. 7 (2018)
• Elizabeth Chorvat, Optimal Distortionary Taxation (2018)
• Tessa Davis (South Carolina), Freezing the Future: Elective Egg Freezing and the Limits of the Medical Expense Deduction, Ky. L.J. (forthcoming 2018)
• Chase Edwards (University of Louisiana–Lafayette), Justin Ward (Jones Walker, LLP) & Casey Carder (University of Arkansas at Little Rock), How to Drive an RV Through a Loophole: The Ethics and Legality of LLC Formation for Sales Tax Avoidance, 28 S. L.J. 47 (2018)
• Michelle Hanlon (MIT), Edward L. Maydew (UNC) & Daniel Saavedra (UCLA), The Taxman Cometh: Does Tax Uncertainty Affect Corporate Cash Holdings?, 22 Rev. Acct. Stud. 1198 (2017)
• Hatim Hussain (Gujarat National Law University), Reinventing Regulation: The Curious Case of Taxation of Cryptocurrencies in India, 10 NUJS L. Rev. 3 (2017)
• Jeyapalan Kasipillai, Mei Yee Lee (Monash University Malaysia) & Sakthi Mahenthiran (Butler University), Proliferation of Hidden Income and Tax Evasion: Perceptions of Malaysian Professionals, 18 Austl. J. Asian L. 1 (2017)
• Omri Y. Marian (Irvine), Is All Corporate Tax Planning Good for Shareholders?, 52 U.C. Davis L. Rev. __ (forthcoming 2018)
• Ruth Mason (Virginia), State Aid: Arm’s-Length on Appeal, 158 Tax Notes 771 (2018)
• Susan C. Morse (Texas), Government-to-Robot Enforcement, 2019 U. Ill. L. Rev. __ (forthcoming)
• Susan C. Morse (Texas), Seeking Comparables in Patent and Tax, 37 Rev. Litig. Brief __ (forthcoming 2018)
• Ugo Panizza (Graduate Institute of International and Development Studies) & G. Mitu Gulati (Duke), The Hausmann-Gorky Effect (2018)
• Flavio Rubinstein (FGV DIREITO SP) & Gustavo Gonçalves Vettori (University of São Paulo),
• Taxation of Investments in Bitcoins and Other Virtual Currencies: International Trends and the Brazilian Approach (2018)
• Daniel Shaviro (NYU), Evaluating the New US Pass-Through Rules, 2018 Brit. Tax Rev. (forthcoming)
• Miranda Stewart (Melbourne; ANU), Redistribution Between Rich and Poor Countries, Tax & Transfer Pol’y Inst., Working Paper 4/2018 (2018)
• Miranda Stewart (Melbourne; ANU), “Waiting for Consensus of the Experts?” Expert Discourse and the Politics of Tax Reform (2018)