TaxProf Blog op-ed: Bullock v. IRS and the Future of Tax Administrative Law (Part II), by Daniel Hemel (Chicago):
In Bullock v. IRS, a federal district court in Montana held that states have standing to challenge the IRS’s rollback of information reporting requirements and that those requirements can only be amended through notice and comment. As my last post explained, the immediate significance of the decision is that noncharitable tax-exempt entities—including but not limited to politically active section 501(c)(4) groups—will have to disclose their large-dollar donors to the IRS (though not to the public). But the potential implications are much broader than that. The decision in Bullock suggests a possible new path for states to exert influence over federal tax policy through administrative law litigation. This post explores that possibility.
Bullock is the latest in a series of cases that might be seen as auguring the end of “tax exceptionalism.” By “tax exceptionalism,” I refer to the long-held view that general principles of administrative law—such as Chevron deference for agency statutory interpretations and the notice-and-comment requirement for agency rules—do not apply in the tax domain. Paul Caron put forward an early and influential critique of that view in his unforgettably titled 1994 article “Tax Myopia, or Mamas Don’t Let Your Babies Grow Up to Be Tax Lawyers.” Kristin Hickman advanced the attack on tax exceptionalism in a series of significant articles starting in the mid-2000s. The effort to end tax exceptionalism scored a major victory in January 2011 when Chief Justice John Roberts, in the case of Mayo Foundation for Medical Education and Research v. United States, said that the court was “not inclined to carve out an approach to administrative review good for tax law only.” Declarations of the “death of tax exceptionalism” soon followed.
Tax exceptionalism is a difficult idea to defend. Nothing in the Administrative Procedure Act exempts tax from its reach. The Internal Revenue Code is complicated and intricate, but so are the conservation-related provisions in title 16, the agricultural provisions in title 7, and the securities laws in title 15. (Indeed, by one measure, those statutes are even more complicated than the federal tax laws.) The revenue-raising functions of the IRS are vitally important, but no more so than the functions of, say, the Nuclear Regulatory Commission. (I, for one, would prefer a revenue shortfall over a power plant meltdown.)
And yet the end of tax exceptionalism also ought to raise anxieties. In many other areas of administrative law, interest groups line up on both sides. Consider the names of some of the leading cases involving other areas of regulation. For example, in Motor Vehicles Manufacturers Association v. State Farm Mutual Automobile Insurance Co., carmakers defended the National Highway Traffic Safety Administration’s decision to roll back airbag and automatic seat belt requirements, while car insurers wanted NHTSA to impose more stringent car safety standards. In Chevron U.S.A. v. Natural Resources Defense Council, the oil and gas giant supported the Reagan EPA’s more polluter-friendly definition of “source” under the Clean Air Act; the NRDC advocated for the Carter administration’s more environmentally protective definition. Similar symmetries arise in other areas: unions vs. employers at the Department of Labor; broadband providers vs. content providers at the Federal Communications Commission; shareholders vs. issuers at the Securities and Exchange Commission; and so on.
Tax is different in two ways. The first difference is legal. Under Supreme Court case law, Peter can’t sue the IRS for giving Paul an illegal tax break, even if the break to Paul might mean that Peter will end up paying more. According to the court, it is simply too uncertain that Peter will materially benefit if Paul’s tax break is undone. “Pure speculation,” the court has said, is insufficient for constitutional standing. The second difference is political. While there are pro-regulatory and anti-regulatory lobbies facing off on many issues, there is not—or at least there historically has not been—a strong coalition of pro-tax interests with the resources to pursue complex and costly administrative law litigation.
Tax, to be sure, is not the only area of administrative law in which the alignment of interest groups is lopsided. Public benefits law is arguably characterized by the same imbalance, and for much the same reasons. Peter can’t sue the Department of Health and Human Services for improperly extending Medicare benefits to Paul, and even if he legally could, he wouldn’t have much of an incentive. (Perhaps in light of this asymmetry, Congress explicitly exempted all “matter[s] relating to . . . benefits” from the notice-and-comment requirement’s ambit, though the Health and Agriculture Departments both waived that exemption in 1971.) My colleague Jonathan Masur has noted similar asymmetries in certain areas of patent law and immigration law as well.
The concern about asymmetry is that the administrative law of tax will become a one-way ratchet: any IRS action that increases tax liabilities or compliance costs will trigger litigation, while any action that reduces liabilities or relieves compliance burdens will go unchallenged. The asymmetry concern is only moderately mitigated by the Tax Anti-Injunction Act, which limits pre-enforcement challenges to IRS action. The Tax Anti-Injunction Act can delay an administrative law challenge to an IRS action that increases liabilities. It cannot make the issue go away forever.
Part of what makes Bullock v. IRS such an intriguing—and potentially impactful—case is that it suggests a way that the administrative law of tax can become somewhat more symmetrical. Bullock shows us how states can use administrative law mechanisms to push back against IRS actions that reduce revenue or—as in Bullock itself—reduce the quantity and quality of information available to federal and state tax authorities. The standing-related arguments that Montana and New Jersey make—and the court in Bullock accepts—potentially apply to a much broader set of IRS actions.
As recapped in the last post, the states’ case for standing in Bullock is two-pronged. The first argument hinges upon section 6103(d), which allows state tax authorities to gain access to federal tax return information. The plaintiffs in Bullock argued (successfully) that an IRS action that limits the information collected by the agency also thereby limits the information available to state tax authorities. States are thus uniquely positioned to challenge such an action on “informational injury” grounds. (Note that “informational injury” is a standing argument; not a merits argument. The challenge will only succeed if a court concludes that the IRS action was unlawful for some independent reason.)
The second argument for standing is somewhat more complicated and less certain. The argument applies only when a state explicitly ties its tax laws to federal tax law (e.g., by basing its definition of income for state tax purposes on the federal definition of “adjusted gross income” or “taxable income,” or by requiring taxpayers to submit to state authorities the same information they must submit to the IRS). In those cases, an IRS action that reduces federal tax liabilities or relaxes information reporting requirements will mechanically reduce state tax or information collections as well.
Of course, states are allowed to change their tax laws. If, for example, the IRS relieves noncharitable tax-exempt organizations of the obligation to report the names and addresses of substantial contributors, then New Jersey—which previously required those organizations to submit copies of their federal tax returns to the state attorney general—can add a further requirement that the organizations include their substantial contributor lists too. But as the Bullock court noted, changing state law requires resources (legal resource, drafting, and so on). IRS actions that reduce revenue or limit information collection therefore impose real costs on states.
The argument is not without its complications. In particular, Supreme Court case law on the subject is a tangled mess. In the 1976 case Pennsylvania v. New Jersey, the Keystone State sued its neighbor to the east for maintaining an allegedly unconstitutional commuter tax. Pennsylvania noted that its income tax laws allow residents to claim a credit for taxes paid to other states, so New Jersey’s tax had the effect of increasing residents’ credits and thus reducing Pennsylvania’s revenues. Maine, Massachusetts, and Vermont filed a similar suit against New Hampshire. The court, in a short per curiam opinion, concluded that the plaintiff states lacked standing. “The injuries to the plaintiffs’ fiscs were self-inflicted, resulting from decisions by their respective state legislatures,” the court said, adding that “[n]o State can be heard to complain about damage inflicted by its own hand.”
Pennsylvania v. New Jersey is a puzzling precedent. Sure, the plaintiff states could have avoided the injury in question if they had changed their own tax regimes. But no one thinks a coal power plant lacks standing to challenge an EPA air quality standard just because it could have avoided the injury by switching to wind. Changing state tax law is perhaps less costly than reconfiguring a power plant (though anyone who has ever tried to change state tax law can tell you it ain’t easy). That shouldn’t matter, though, because even “an identifiable trifle” is sufficient for standing, and the cost of changing state law is more than trifling. Moreover, the plaintiff states in Pennsylvania v. New Jersey had reasons for allowing their residents to claim credits for taxes paid to other states. If they had rescinded or modified those credit arrangements, they would have ended up with—from their own perspective—suboptimal state tax laws.
Not only is the Pennsylvania case confusing, but its precedential value is uncertain. Sixteen years later, in Wyoming v. Oklahoma, the court faced what seemed like a similar issue. Wyoming, which imposes a severance tax on coal extraction, sued Oklahoma for adopting a law mandating that coal power plants in the state buy at least 10 percent of their coal from in-state sources. The law meant that Oklahoma coal plants would buy less Wyoming coal, and Wyoming would collect less in coal severance taxes. Wyoming, of course, could have chosen to tax something other than the severance of coal. But no matter: the Supreme Court (without citing—much less distinguishing—Pennsylvania v. New Jersey) concluded that Wyoming had standing due to its “direct injury in the form of a loss of specific tax revenues.”
The Fifth Circuit struggled to reconcile the Pennsylvania and Wyoming cases in its 2015 decision striking down the Obama administration’s Deferred Action for Parents of Americans (DAPA) policy. There, Texas law allowed individuals who are “lawfully present” in the United States to obtain certain state benefits, such as subsidized drivers’ licenses. The DAPA policy, by expanding the definition of “lawfully present,” would have increased the cost to Texas of its subsidy. The Fifth Circuit found that Texas had standing to challenge DAPA in court. The court said that Texas—like Wyoming, but unlike the plaintiff states in Pennsylvania v. New Jersey—was suing in response to a “significant change in the defendants’ policies.” (The New Jersey and New Hampshire taxes under challenge in the Pennsylvania case had been longstanding, though a recent Supreme Court decision had cast doubt on the constitutionality of the New Jersey tax and made clear that the New Hampshire tax was invalid.) The Fifth Circuit also said that Texas—like Wyoming but unlike the Pennsylvania plaintiffs—had no easy alternative that would have avoided the injury in question.
The distinctions drawn by the Fifth Circuit are far from satisfying. Delay in challenging an unconstitutional policy is perhaps cause for applying the equitable doctrine of laches, but it has little to do with standing. And the fact that a plaintiff could avoid an injury at low cost is not a bar to standing in other contexts. No court asks how much it would cost the utility to switch from coal power to natural gas. As long as the Pennsylvania and Wyoming cases both remain on the books, the standing of states to challenge federal tax laws that reduce state tax revenue will remain under a cloud of uncertainty. The win by Montana and New Jersey in Bullock is one data point suggesting that these theories of state standing are viable; it certainly does not resolve the issue.
Assuming states can overcome the standing hurdle (and the related zone-of-interests test mentioned in the last post), the question remains: Will they emerge as repeat challengers to revenue-reducing IRS actions? State attorneys general—and in particular, AGs from blue states—have actively used administrative law doctrines to challenge Trump administration deregulatory efforts related to air pollution, chemical safety, health insurance, oil drilling on federal lands, student loans, and a number of other policy areas. Bullock could be the harbinger of a similar phenomenon in tax.
Or it could be a one-off. Bullock is a tax case, but in the national news coverage it is first and foremost a “dark money” case. The politics of tax and the politics of campaign finance are not the same. A state official who brings a lawsuit aimed at blocking a taxpayer-friendly IRS action could face blowback from voters. In the bluest parts of the country, though, this may be changing. It’s not inconceivable that a blue state AG would have the incentive and inclination to sue the IRS to stop regulatory changes that favor high-income individuals and corporations.
If states (or a subset of them) do take on this additional role, then they would help to bring some symmetry to an area of administrative law characterized by lopsidedness. Judicial review of IRS actions would no longer be the one-way ratchet that it so far seems to be. Justifiable concerns about tax ordinaryism would not be allayed entirely, but they would be somewhat softened. The IRS’s incentives, moreover, might be meaningfully affected, as the revenue-reducing or deregulatory option would no longer be the path of least resistance for the agency in every case.
Some readers may dismiss this possibility as a progressive pipe dream, either because they think that the standing doctrine hurdles are too high or that the incentive structures for state officials—even in the most left-leaning states—offer little reward for litigation of this sort. Time will tell. If Bullock is not the beginning of a trend, it remains a significant case in its own right. But it could turn out to be much more.