Weekly SSRN Tax Article Review And Roundup: Speck Reviews Chaim's The Common Ownership Tax Strategy

This week, Sloan Speck (Colorado; Google Scholar) reviews a new work by Danielle A. Chaim (Bar-Ilan; Google Scholar), The Common Ownership Tax Strategy, 101 Wash. U. L. Rev. 501 (2023).

Over the last decade-and-a-half, economists and corporate law scholars have unpacked the consequences of index-based mutual funds’ burgeoning ownership of equity in public companies. In The Common Ownership Tax Strategy, Danielle Chaim synthesizes and extends this literature as it applies to taxation. Chaim argues that mutual funds’ substantial stakes in broad swaths of companies—“diversified-yet-concentrated” ownership—facilitate a tax avoidance strategy that Chaim terms “corporate flooding.” Essentially, firms can simultaneously increase their overall tax avoidance, overwhelming the IRS’s enforcement capacities and driving down the odds that the IRS will detect abusive practices by any one firm. This rising tide of tax avoidance raises all mutual funds’ boats, and the costs are distributional: fund managers and their moderate- to upper-income clientele benefit.

In this important article, Chaim devotes significant space to the mechanisms by which firms might coordinate in corporate flooding—and there potentially are many, ranging from latent to implicit to express. Firms that seek inclusion on various indices may watch the market in tax abuse and conform accordingly. Alternatively, mutual funds may attempt to impose blanket governance edicts on all the firms in their portfolio, which may steer those firms towards tax minimization. Finally, mutual fund managers may encourage tax avoidance (licit and less so) through communications “made secretly or in coded language.” Some anecdotal evidence supports this more direct route. In elaborating the pathways of corporate flooding, Chaim uncovers plenty of potential guns, and lots of smoke, but no clear smoking gun. And, really, none is needed to buy into the cause-and-effect that Chaim posits; any of these mechanisms—or all of them together—could support Chaim’s conclusions.

The absence of a concrete pathway draws into question the role of common ownership in the empirical phenomenon of corporate flooding. Public companies clearly observe each other’s financial performance and act accordingly. As Chaim notes, common advisors—investment banks, accountants, and law firms—also share knowledge among these companies. Mutual funds’ common ownership may intensify these mechanisms for corporate flooding, but they still exist in the absence of such ownership. To the extent that corporate flooding is a threshold phenomenon, even mild tax avoidance pressures across the market may prove sufficient to see some effect, even if common ownership allows for greater abuse. (Indeed, one could reframe the postwar history of corporate tax avoidance as a story of flooding in the context of taxpayer norms and limited enforcement.) From this perspective, common ownership is just one star in the constellation of inappropriate tax avoidance, and government’s most effective response might involve another policy level.

The idea of corporate flooding has legs, however, outside of the realm of common ownership. Specifically, some thick description of the phenomenon’s texture seems warranted. Chaim’s analysis builds on econometric studies that examine companies at the cutoff between the Russell 1000 and Russell 2000 indices. Chaim posits that corporate flooding occurs among larger companies as well, perhaps with even greater intensity. But corporate flooding may look different for large and small public companies, or across different industries, or for public companies controlled by founders. For example, flooding may work best for small companies that implement (cheaper) off-the-rack tax avoidance strategies. Baseline audit odds start at lower level, even if the IRS would detect those strategies more frequently on audit. For large companies with higher baseline audit rates, (more expensive) bespoke tax avoidance schemes might prove harder to detect and thus more effective in the flooding context. To the extent that corporate flooding applies broadly, any unevenness in application has implications for the best solutions to the problem.

Chaim’s normative prescription involves penalizing mutual funds that own big chunks of public companies with tax deficiencies. While both pragmatic and palatable, this solution requires the IRS to levy these deficiencies (or perhaps penalties) on public companies—the very outcome whose structural absence contributes to the problem that Chaim identifies. The rabbit, in some sense, needs to be put into in the hat. A more-controversial alternative might look to regulation by the SEC, perhaps modeled after the recent rules for disclosure of investment funds’ ESG strategies. The broader point is that this tax problem seems tailor-made for a nontax intervention, especially if, as Chaim highlights, common ownership threatens corporate governance in other ways.

Overall, Chaim’s excellent article proposes a compelling framework for thinking about the nexus of corporate ownership and tax gaming. This framework, as Chaim notes, may apply to other areas of law that rely on private-sector compliance. For this reason, Chaim’s tightly reasoned article is essential reading for scholars and policymakers who deal with corporate enterprises

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

• Andrew D. Appleby (Stetson), Formulary Apportionment: A New Framework for Personal Income Taxation, 52 Pepperdine L. Rev. (forthcoming 2025)
• Kimberly A. Clausing (UCLA), The Green Transformation and Tax Policy Criteria (June 30, 2024)
• Michael Dambra (SUNY Buffalo, Sch. Mgmt.), Andrew Glover (U. Wash., Foster Sch. Bus.), Charles M.C. Lee (U. Wash., Foster Sch. Bus.) & Phillip J. Quinn (U. Wash., Foster Sch. Bus.), ETFs and the Wash Sale Loophole (July 17, 2024)
• Rita de la Feria (U. Leeds), What is Tax Fairness?, 33 EC Tax Rev. 142 (2024)
• Osman Geyik (Dicle U.), Gamze Yıldız Şeren (Namık Kemal U.) & Robert W. McGee (Fayetteville St. U., Dept. Acct.), An Empirical Analysis on the Effect of Taxpayers’ Educational Level and Marital Status Factor on Their Attitudes and Behaviors Towards Taxes, 9 Bull. Econ. Theory & Analysis 427 (2024)
• Savvas Kostikidis (Indep.), New Rationale and Design for Taxes on Gratuitous Wealth Transfers (June 27, 2024)
• Antonio Lopo Martinez (U. Coimbra), Innominate Accounting Evidence in Tax Litigation: An Analysis of Atypical Modalities (June 30, 2024)
• Libin Zhang (Fried Frank), International Tax Reform and the Biden-Harris Tax Pledge, 107 Tax Notes Int’l 35 (July 4, 2022)

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