Paul L. Caron

Friday, September 15, 2023

Weekly SSRN Tax Article Review And Roundup: Speck Reviews Hemel's Phaseouts

This week, Sloan Speck (Colorado; Google Scholar) reviews a new work by Daniel J. Hemel (NYU; Google Scholar), Phaseouts, 74 Tax L. Rev. __ (2024):


Since the transition from class tax to mass tax in the Second World War, the U.S. income tax system has applied income-based limitations to tax expenditures. In Phaseouts, Daniel Hemel explores why rational policymakers might prefer these benefits-specific limitations (which can be drafted as phaseouts or phase-ins, or as ceilings or floors) to “the more straightforward alternative” of an unrestricted benefit coupled with revenue-neutral rate adjustments across income levels (2). Phaseouts, of course, are legion in today’s Internal Revenue Code, and Hemel does his usual brilliant work in elucidating the contours and stakes of these pervasive provisions, even when deployed by a Congress less disinterested—and perhaps less rational—than one might prefer.

Hemel elaborates—and persuasively rejects—three enduring rationales for phaseouts, then replaces these old justifications with three new ones. The old rationales are that phaseouts limit revenue loss (which rests on the incompleteness of conventional tax expenditure accounting), advance distributional goals (which depends entirely on the relevant baseline), and better target benefits (which again requires a partial view of how tax expenditures operate in the federal budget). The new rationales involve externalities, internalities, and complementarities. To the extent that these effects vary by income with respect to a given status or behavior, then policies that seek to manage these effects also should vary by income. For example, if health insurance is a complement to labor for low-income taxpayers, then reasonable lawmakers might focus subsidies on that cohort. Hemel develops this analysis in several case studies, which make a convincing case for expanding or harmonizing some existing phaseout regimes while repealing others.

The three old justifications for phaseouts are, in some sense, structural, in that they don’t really depend on the specifics of the tax expenditure under consideration. Similarly, Hemel engages three existing critiques of phaseouts—they impose “hidden taxes,” increase complexity, and stigmatize recipients—that also apply without regard to any particular social objective. By contrast, Hemel’s novel approach appropriately treats phaseouts as integral to—fundamentally part of—the social policy at stake. Whether phaseouts are warranted depends on a bespoke analysis of how policy goals intersect with empirical evidence and on-the-ground experience. Under these conditions, the conventional practices of heuristic lawmaking seem doomed to fail; lawmakers can’t paint by numbers when the numbers themselves are unknown. One possible solution is to expand Congress’s institutional subject-matter expertise, a hallmark of the executive branch but not traditionally associated with the legislative—and perhaps even less so in an age of resurgent populism.

As constructed by Hemel, phaseouts essentially create status- or activity-based rate differentials among lower-income taxpayers but eliminate these differentials among higher-income taxpayers. Examples abound, including the Child Tax Credit, which, for joint filers, phases out quasi-linearly between $400,000 and $440,000. For households with income less than $440,000, the status (and, frequently, activity) of having dependents generates effective rate differentials. But Hemel’s definitional framework extends beyond these straightforward mechanics, capturing features such as the adjusted gross income floor for medical expense deductions. These hidden phaseouts should face the same scrutiny, on the same terms, as the more usual suspects.

Indeed, one probably could press Hemel’s definition to implicate a number of ostensibly “unphased-out benefits” (15). For example, the $10,000 limitation on deductions for state and local taxes doesn’t formally depend on claimants’ income. In practice, however, deductible taxes vary positively with income within a given geographic jurisdiction (see, for example, the IRS sales tax tables), and, for some identifiable set of high earners, there’s no marginal tax benefit for additional state and local taxes paid. Similarly, lending conventions generally restrict large-principal mortgages to high earners. From this perspective, the home mortgage interest deduction’s benefits phase out (as well as phase in) based on income, albeit indirectly and by virtue of non-tax regulation and private norms that are both commendable and invidious. For these as-observed correlations between income and substantive restrictions on benefits, there’s presumably some pragmatic penumbra beyond which one shouldn’t (or wouldn’t) scrutinize further. The alternative, I think, risks collapsing whole reams of otherwise-innocuous statutory restrictions into the phaseout analysis.

Finally, my intuition is that there’s something special—for political economy or other reasons—about phaseouts that operate solely on the far upper reaches of the income spectrum. The Child Tax Credit’s phaseout, for example, starts at the 98th percentile of household income (8), which has a quasi-universal flavor. One might even imagine a “Bezos rule” in which a very small number of very high earners face curtailment or elimination of many or all tax preferences—a tightly drawn and hard-hitting variant of the alternative minimum tax. The rich truly might be different from you and me, and their money might just be the start. To the extent that Hemel’s externalities, internalities, and complementarities coalesce across class, one might be able to set universal phaseout norms independent of specific policies.

Overall, Hemel’s article dramatically reconfigures the longstanding debate about phaseouts. Part of Hemel’s project is rehabilitative, and he laudably gives the concept a second life in the literature. But the larger intervention might be that, for many policy choices, sweeping precepts matter less than context. Policymakers and academics in multiple fields, inside and outside of taxation, should find Hemel’s insightful article compelling in its arguments and conclusions.

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

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