Paul L. Caron

Friday, October 23, 2020

Weekly SSRN Tax Article Review And Roundup: Roberts Reviews Holderness's Insidious Regulatory Taxes

This week, Tracey Roberts (Cumberland) reviews a recently posted work by Hayes Holderness (Richmond), Insidious Regulatory Taxes.

Roberts (2020)In Insidious Regulatory Taxes, Hayes Holderness takes issue with state legislatures’ use of taxes to regulate individual behavior. He clarifies that regulatory taxes are “insidious” when a state legislature chooses to use a tax in order to avoid the level of state and federal constitutional scrutiny imposed on direct regulation. Federal and state courts have generally deferred to legislatures on tax matters because the U.S. Constitution and state constitutions grant legislature the “power of the purse.” Judicial attempts to curtail this power may be viewed as a violation of the separation of powers doctrine. Holderness argues that while judicial deference may be appropriate when the legislators’ goals are to raise revenue, that deference is not justified when legislators are acting with a regulatory purpose and when their goal in using a tax is to skirt the level of scrutiny applied to direct regulation.


Holderness draws upon tax expenditure analysis to provide a framework (a) to guide the legislature on the use of tax as a regulatory mechanism, and (b) to guide the courts in the degree of deference they employ. Stanley Surrey, the Secretary of the Treasury in the late 1960s and 1970s, developed the concept of tax expenditures in response to the increasing complexity of the tax system and the compounding difficulty of tax administration. Congress had begun to use the income tax to provide subsidies to special interest groups. Surrey was concerned that tax subsidies undermine revenues, undercut fair and efficient administration, systematically advantage high income taxpayers, and create distrust in the tax system. However, Holderness is concerned with a problem that occupied little of Surrey’s writings: negative tax expenditures. Negative tax expenditures produce more revenue than would be gained simply from measuring net income.

Holderness argues that legislatures should weigh the following factors in deciding whether to use tax as a regulatory tool: (1) expertise relative to the matter being regulated, (2) existing legal structures (and institutional competence in administering the law) and (3) public reaction to the law / behavioral responses. Scholars have applied similar rubrics to analyze the income tax system as an alternative mechanism to administer public benefits and to address Surrey’s concerns about complexity and administrability. However, most regulatory taxes are excise taxes, not income taxes. Excise taxes do not involve the same degree of complexity as the measurement of income, the eligibility verification for exemptions, exclusions, deductions and credits, and the clarification of the proper tax unit / household size. Excise taxes require a determination of: (1) What are these items? (2) Who owns / produced them? (3) How much do they weigh / what is their volume? Holderness could further clarify the application of the tax expenditure analysis by working through specific problems that have actually arisen in state administration of controlled substance taxes.

Holderness argues that courts should give less deference to tax statutes (a) when the legislature is using tax to regulate and (b) when there are statutory or constitutional provisions that would have created impediments for direct command-and-control regulation. The first difficulty the courts will face, and this is discussed in the existing taxing power cases, is how to discern legislative intent. Respected judicial doctrines of statutory interpretation have been developed in opposition to reviewing legislative history precisely because it is so difficult to discern the hearts and minds of a group comprised of hundreds of legislators. When Alexander Hamilton wrote the Federalist papers arguing for a federal taxing power, he contemplated taxes on alcohol as a great source of revenue, acknowledging that they would also have the beneficial effect of reducing drunkenness. Should this statement trigger additional scrutiny of alcohol excises? Note that excise taxes were the nation’s primary source of revenue along with tariffs on imported goods until the passage of the 16th Amendment authorizing an income tax in 1913.

Second, all taxes have some behavioral effects. As an economic matter, the revenue-raising capacity of an excise tax is often inextricably intertwined with its attraction as an object of commerce (and the related danger to society). “Sin” taxes are often imposed on goods that have an addictive quality. Individuals have an inelastic response to taxes on addictive substances. State legislatures turn to sin taxes during economic downturns specifically because they provide a stable source of revenue; they are superior revenue-raisers because they do not change individual behavior.

Third, the rubric employs a form of cost-benefit analysis as to whether one agency or another is in a better position to assess the harms and the benefits of the activity being regulated. If the main concern is about the loss of constitutionally protected rights, cost-benefit analysis is inapposite. Cost-benefit analysis has historically run into difficulty placing value on human life. It will perform no better in assessing the value of essential liberties. The Bill of Rights exists precisely to trump cost-benefit analysis; it protects the interests of (and costs to) the minority from the will of (and the benefits to) the majority.

Holderness argues that taxes are an incursion on freedom. In most cases, however, taxes pose less threat to freedom because the taxed activity is still allowed. Activities that are subject to direct regulation may be banned, or limited in ways that drive producers and consumers from the market. Taxes, as a form of market regulation, grant those that are subject to the tax the discretion to decide how to comply. Taxes are generally favored by regulated industries because each company can evaluate how to comply at least cost (invest in abatement or pay the tax). Additional detail about the ways that the courts are (mis)handling the constitutional and other challenges to regulatory would be helpful to focus these debates.

Finally, legislatures often impose excise taxes on items that have a diffuse, but significant, effects on public health, safety, and welfare, such as scheduled drugs, tobacco, alcohol, firearms, and emissions. Public health and safety are common pool resources, not unlike air, water, and the global atmosphere. Applying his analysis in the context of taxes to control the trafficking of illicit substances, Holderness advocates for legislatures to impose higher criminal penalties rather than imposing controlled substance taxes. However, criminal penalties do not actually offset the societal harm or the social costs incurred from the distribution and availability of the drugs. Even if higher criminal and civil penalties and enhanced enforcement may reduce the presence of cigarette smoke, alcohol-related deaths, fire arms-related violence, and pollution-related illness and death, they do not provide recompense for those who are harmed. The taxing power permits legislatures to exact payment equal to the social harms imposed by the flow of these items. What could be a more important revenue raising power than to charge the costs of activities that shift risks and costs to the public to those engaging in that activity?

Taxes and regulations can have unintended consequences. Holderness is clearly concerned about the way that the tax authorities choose to enforce the law against the most vulnerable and least enfranchised. Narrowing the argument to focus on inequity in administration and enforcement could clarify the problem and prevent the remedy he proposes from itself generating unintended consequences.

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

Scholarship, Tax, Tax Scholarship, Tracey Roberts, Weekly SSRN Roundup, Weekly Tax Roundup | Permalink