Article

Four Principles of Optimal Tax System Design

03/2013; DOI: 10.2139/ssrn.1303717

ABSTRACT Although optimal tax theory dominates both tax economics and tax law scholarship in the upper academic ranks, legal academics make remarkably little use of it in their day-to-day work. This is unfortunate. Although I am unwilling to accord efficiency the primacy that optimal tax theory gives it, the behaviorally distortive effects of tax rules should be of concern regardless of one’s normative perspective. Distortive effects are not merely inefficient; they affect fairness and administrability as well. We know, for example, that if the relevant supply or demand curve of a nominal taxpayer is elastic, she is unlikely to bear the ultimate burden of a tax or rule. If so, the burden of a tax or rule that is supposed to be borne by one group may in fact be shifted to another. Tax shelters and the administrative problems they create similarly cannot be understood without taking into account the behaviorally distortive effects of the rules on which they rely.The paper proposes four nonmathematical principles that, consistently applied, should result in rules that minimize such distortion:1. Tax liability should not turn on factors as to which taxpayer is relatively indifferent (“relative indifference”).2. The least distortive tax base for any taxpayer is whatever that taxpayer would seek to maximize in the absence of taxation (“taxing the maximand”).3. If what taxpayer would seek to maximize in the absence of taxation is a number already computed for non-tax purposes, tax administrative costs will be minimized if the tax base equals that reported number (“taxing the reported maximand”).4. Taxpayers should be classified for tax purposes by reference to whatever it is they would seek to maximize in the absence of taxation (“classification by maximand”).All else being equal, rules consistent with these four principles are more likely to be efficient, more likely to effect intended distributive goals, and less likely to invite tax avoidance than rules that are not.The paper then illustrates the power of these principles by applying them to a problem that has long resisted solution: design of a minimally distortive system for taxing corporations, particularly multinational groups. Such a minimally distortive system, it concludes, would tax all publicly-reporting corporate groups, domestic and foreign alike, on their adjusted book income, computed on a consolidated basis and allocated among jurisdictions using a single factor formula based on sales adjusted by industry-average profit-to-sales ratios.

0 Bookmarks
 · 
617 Views
  • Source
  • Source
    [Show abstract] [Hide abstract]
    ABSTRACT: In passing Sarbanes-Oxley, Congress missed an opportunity to address the impact on auditor independence and corporate governance of the tax services provided by auditors to reporting companies and their executives. Although the SEC's adopting release for auditor independence rules suggests that audit committees should not approve auditor tax services for transactions that lack a business purpose, the only non-audit tax service that the rules unambiguously prohibit is auditor representation of audit clients on tax issues in court proceedings. This Article argues that the SEC's approach fails to respond adequately to the multidisciplinary expansion of audit firms. In particular, this Article contends that the inadequacy of audit committees' information about audit firms hinders their ability to perform key functions of selecting auditors and approving non-audit tax services. Similarly, directors likely have insufficient information about a reporting company's tax risks to permit effective monitoring of internal tax and accounting functions or company participation in potentially abusive tax transactions. Those information asymmetries also leave investors without tax risk information that would otherwise factor into investment decisions. To address these problems, this Article urges the SEC to ban auditor provision of certain tax shelter services. These rules need not invent a separate, SEC-generated definition of problematic tax shelters. They can simply adopt by cross-reference the reporting categories for corporate tax shelters established in the IRS's recently finalized corporate tax shelter regulations. The Article also proposes two types of internal tax risk disclosure, also based on the IRS reporting categories, to enhance company directors' decisionmaking. The audit firm tax risk profile and reporting company tax risk profile would provide objective information to directors about audit firm and reporting company promotion of, and participation in, aggressive tax transactions. As an additional benefit, the profiles would counter the tendency of auditors to acquiesce in promoters' analysis of aggressive tax transactions. Finally, the Article proposes certain public disclosure based on these tax risk profiles, and a series of strict liability penalties to deter non-disclosure and ensure adequate review.
    11/2003;
  • Source
    [Show abstract] [Hide abstract]
    ABSTRACT: A revised and updated version of the 1995 article (Va. Tax Review) on the evolution of US transfer pricing rules.
    09/2007;

Full-text

Download
6 Downloads
Available from