The President’s Power To Tax Doesn’t Stop at Carried Interest, by Daniel Hemel
Gretchen Morgenson writes in this week’s New York Times Sunday Business section:
There is a lot about this problem of income inequality—and about the economy over all—that Mr. Obama cannot control. Still, there is something he could do right now to help narrow the widening gulf between rich and poor. In one deft move, Mr. Obama could instruct officials at his Treasury Department to close the so-called carried interest tax loophole that allows managers of private equity and hedge funds to pay a substantially lower federal tax rate on much of their income.
No one can predict with complete confidence whether a court would uphold as-yet-unwritten Treasury regulations addressing carried interest, but I agree with Morgenson (and with the tax experts she cites) that such regulations—if written carefully and finalized after notice and comment—quite likely would pass judicial muster. What Morgenson doesn’t mention, though, is that when it comes to tax reform measures that the Obama administration could implement on its own, carried interest is just the tip of the iceberg. President Obama might not be able to make much of a dent in income inequality without legislative action, but he could raise billions of dollars in revenue while addressing some of the most objectionable tax avoidance strategies employed by U.S. corporations and high-net-worth individuals.
In a forthcoming Cornell Law Review article, The President’s Power To Tax, I set out a list of tax reform measures that the Obama administration could accomplish without an act of Congress. All the items on the list are measures that the Obama administration has included in past “Greenbooks.” (The Greenbook is a compilation of legislative proposals on tax-related matters that the President sends to Congress each year.) These are, in other words, reforms that the President has asked Congress to pass, even though his administration already has all the authority it needs. The list includes:
— Ending the “Double Irish Dutch Sandwich.” U.S. multinationals such as Apple and Google have managed to defer U.S. corporate tax on income from foreign sales indefinitely. One way they can do so is by using the “Double Irish Dutch Sandwich,” an arrangement involving two subsidiaries based in Ireland and one in the Netherlands. For the arrangement to work, the Dutch subsidiary needs to be considered a corporation under Irish and Dutch law but a pass-through entity under U.S. law. (See pp. 21-24 of the Cornell article for more details.) There is no act of Congress that entitles the Dutch subsidiary to pass-through treatment; the Double Irish Dutch Sandwich strategy relies instead on the “check-the-box” regulations promulgated by the Clinton administration in 1996. President Obama could instruct Treasury officials to amend those regulations so that subsidiaries treated as corporations under foreign law are accorded the same treatment under domestic law. Such a change—which is almost certainly within the administration’s power—would spell doom for the Double Irish Dutch, and would raise more than $2.5 billion in revenue over the next decade.
— Preventing Oil and Gas Companies from Claiming Foreign Tax Credits Without Paying Foreign Tax. The Obama administration has called on Congress to prevent U.S. oil and gas companies from claiming foreign tax credits from overseas activities even when the countries in which those companies are active impose no corporate income tax. The only reason why oil and gas companies can claim these credits (which offset their U.S. tax liabilities) is that a regulation promulgated by the Reagan Treasury Department in 1983 allows them to do so. The Obama administration has the all power it needs to rescind the Reagan-era regulation; no act of Congress is necessary. The Treasury Department’s own estimate is that rescinding the Reagan-era rule would raise $10 billion in revenue over the next decade.
— Cracking Down on Abuse of Family Limited Partnerships To Avoid Estate and Gift Tax. For decades, wealthy individuals have used “family limited partnerships” (FLPs) to avoid estate and gift taxes on transfers to children and other relatives. (For a straightforward explanation of a typical FLP strategy, see this 2014 article from Forbes.) In 1990, Congress gave the Treasury Department broad regulatory authority to crack down on FLP abuse. But instead of exercising this authority, the Obama administration has sought congressional support for changes to the FLP rules. One such change would, according to the administration’s own estimate, raise more than $18 billion over the course of a decade. Yet despite talk about imminent regulatory action, the Treasury Department has thus far declined to proceed unilaterally.
The list goes on. Other examples include: repealing the lower-of-cost-or-market inventory accounting method; cracking down on abuse of grantor-retained annuity trusts; preventing taxpayers from claiming charitable contribution deductions for giving up the airspace above their historic homes; and disallowing a deduction for payment of punitive damages. Again, these are all reforms that the Obama administration has endorsed—and has asked Congress to pass. And in each case, it is at least arguable (and in some cases quite close to certain) that the administration already has the authority to act on its own.
So why is the Obama administration waiting around for a do-nothing Congress to act? The Cornell article runs through several potential explanations. One such explanation focuses on the political cost/benefit structure of revenue-raising. The political benefits of revenue-raising measures come primarily from voters and interest groups who gain from more government spending; the political costs come primarily from taxpayers who have to pay more because of the reform. The President can’t spend on his own—appropriations require an act of Congress—and so can’t reap all the political benefits himself. And while the President can raise revenue on his own (or, more precisely, his Treasury Department can promulgate revenue-raising regulations), the President then has to bear all the political costs. So if the President has to share the political benefits of revenue-raising with Congress, he also has good reason to want Congress to shoulder some of the costs—which is generally what happens when Congress passes and the President signs a revenue-raising bill. Congress, for its part, would prefer to slough the political costs off on the President. The result is (at least in some cases) a game of political hot potato, in which Congress and the President each pass responsibility off to one another and neither takes the necessary action. (For a more formal derivation of this result in game-theoretic terms, see pp. 46-54.)
Another factor at play is PAYGO, the rule that tax cuts and entitlement expansions must be “revenue neutral.” When PAYGO is in effect, any tax cut or entitlement expansion must be offset by new revenue elsewhere in the same bill. While PAYGO is designed as a deficit-reducing rule, it sometimes can have the opposite effect: PAYGO may discourage the administration from issuing regulations that raise revenue because by doing so, the administration loses the ability to use those revenue raisers as offsets for the tax cuts or entitlement expansions that the President supports. For example, if the Obama administration promulgated regulations addressing family limited partnership abuse, then it could raise $18 billion over the next decade, but it wouldn’t be able to use that $18 billion as an offset for a potential Medicaid expansion. This, too, helps to explain why the President asks Congress to pass revenue-raising tax reforms even when his administration already has the authority it needs to proceed unilaterally.
Perhaps in President Obama’s final few months in the White House, he and his top tax officials will be willing to implement some of these revenue-raising measures via regulation, even though that likely means they’ll take a lot of flak from wealthy individuals and corporations that have to pay higher taxes as a result. After all, President Obama isn’t running again for anything, so he doesn’t need to raise money from donors (except perhaps for his presidential library). And one happy result of legislative gridlock might be that the PAYGO consideration will fall by the wayside: there is no reason to save up revenue-raising measures to offset the cost of comprehensive tax reform or an entitlement expansion if there is no chance that Congress will pass significant legislation of any sort this election year. Or perhaps even if President Obama doesn’t act, his successor will decide that the political costs of revenue-raising regulations are worth it, especially in light of rising voter concerns about income inequality and tax avoidance by the wealthy. Without a crystal ball, I can’t say. What does seem clear, though, is that President’s power to pursue tax reform via regulation is vast, even if it is a power that now lies largely latent.
Cross-posted at Whatever Source Derived.