Taxing America

Karen B. Brown, Mary Louise Fellows

• Publisher: NYU Press
• Year: 1997
• ISBN:
  9780814786246
• Topic: Diritto
• Subtopic: Diritto tributario

In the winter of 1996, Steve Forbes--publisher, heir, and presidential candidate--captured the American imagination with his proposal for a flat tax. But while Mr. Forbes claimed that such a tax would level the economic playing field by eliminating countless loopholes and miles of red tape, his actual proposal betrayed such claims to fairness by overtaxing workers and undertaxing financial capital.

In the face of recent proposals for dramatic and far-reaching tax reform, Taxing America takes a critical look at the way the federal government collects its revenue and exposes the bias at the heart of a system which claims to be objective and fair. Contrary to traditional tax scholarship, these writers argue that an awareness of disability discrimination, economic exploitation, heterosexism, sexism and racism is crucial to any analysis of tax policy.

Gathering together essays whose topics range from federal housing policy to environmental clean-up costs to tax treaty policy making, Karen B. Brown and Mary Louise Fellows present a philosophy that is as simple as it is radical: economic arrangements contribute significantly to the creation of social hierarchies and the perpetuation of discrimination. Given this reality, Brown and Fellows maintain that the goal of the federal tax law should be social justice and the disruption of discriminatory and exploitative practices.

PART I
EXPANDING THE TAX DISCOURSE: NEW WAYS TO THINK ABOUT WEALTH, INCOME, RACE, AND GENDER

1
Fiction in Tax

LILY KAHNG

Legal fictions have long made us uneasy.¹ Jeremy Bentham, perhaps legal fiction’s most vociferous critic, described it as a “syphilis, which runs in every vein, and carries into every part of the system the principle of rottenness.”² What is a legal fiction? Although scholars have disagreed over its precise definition, generally speaking, a legal fiction is a false statement of fact or a false factual construct used to serve a legal end. For example, in medieval times, English common- law courts had jurisdiction only over causes of action arising within England. However, a court could acquire jurisdiction over a foreign cause of action if the parties to the action made a false assertion that the foreign place giving rise to the action was in England.³ A more modern example of a legal fiction is the tax doctrine of constructive receipt, under which a cash method taxpayer is deemed to have received income when in fact she has not.⁴

Legal fictions have been defended as providing a creative way to reach equitable results.⁵ Thus, for example, the doctrine of constructive receipt prevents a cash method taxpayer from artificially deferring income from one year to the next by manipulating the timing of its receipt. However, legal fictions historically have been criticized for a variety of reasons. Bentham abhorred them because, among other reasons, he believed that they, along with the rest of the common law, made the law inaccessible to the people.⁶ Henry Maine criticized legal fictions for obscuring the law to lawyers, thereby hindering their function.⁷ John Chipman Gray thought legal fictions were “dangerous tools” when used to change the law rather than merely to classify established rules.⁸ Gray also thought it important that the user of a fiction be aware of its fictional nature. He said, “One should always be ready to recognize that the fictions are fictions, and be able to state the real doctrine for which they stand.”⁹ Lon Fuller, like Gray, emphasized the importance of recognizing that fictions are fictions and warned that the danger of a legal fiction lay in its user’s unawareness of its fictional nature.¹⁰

In tax, fictions abound. A taxpayer can be in “constructive receipt” of income;¹¹ foreign taxes can be “deemed paid” by a foreign corporation’s U.S. shareholder;¹² “transitory” corporations can be “disregarded” in a corporate reorganization.¹³ Each of these fictions serves to achieve a desired policy result and appears to avoid the dangers described by Bentham, Maine, Gray, and Fuller. However, tax fictions can be dangerous. They can mask underlying motives and biases and they can cause unforeseen harms. This essay will illustrate the dangers of fictions in tax by tracing the emergence of one such fiction, that of marital unity, the notion that a married couple is an indivisible unit rather than two individuals with separate and distinct rights in income and wealth.

THE GENESIS OF THE FICTION OF MARITAL UNITY

As recently as 1942, all taxpayers were taxed as individuals. However, not all married individuals were taxed in the same way. Married individuals residing in community-property states received certain tax advantages over married individuals residing in common-law states. Under the Supreme Court’s 1930 decision in Poe v. Seaborn,¹⁴ income earned by a husband in a community-property state was taxed half to him and half to his wife. (This essay refers to men as earners and wealth holders because men were the dominant earners of income and holders of wealth during this time period.)¹⁵ In contrast, income earned by a husband in a common-law state was taxed completely to him. Poe v. Seaborn’s income-splitting rule allowed husbands in community-property states to pay less tax than husbands in common-law states, because income splitting mitigated the effect of progressive tax rates. In Lucas v. Earl¹⁶ the Supreme Court denied husbands in common-law states the ability to reduce tax liability by shifting personal service income to their wives through contractual assignment. Husbands in common-law states could shift income to their spouses through other devices, however, such as family partnerships and trusts. The Internal Revenue Service (IRS) often challenged these devices as sham transactions and heavily litigated the issue.¹⁷

Husbands in community-property states also enjoyed favorable estate and gift tax treatment. (For the sake of simplicity, this essay will discuss only the estate tax and not the gift tax. The gift tax, however, has a parallel history and raises similar issues with respect to married individuals.) For example, if a decedent bequeathed his entire estate to his widow, he was taxed only on half of the community property transferred to her because of a presumption that the wife already owned the other half.¹⁸ In contrast, a common-law decedent who bequeathed his entire estate to his widow was taxed on it all.¹⁹

The disparate treatment of community-property and common-law married residents caused much disgruntlement, and the first federal attempt to redress the disparity came in 1942. The Revenue Act of 1942 (1942 Act) increased the estate tax on decedents in community-property states to equalize their tax liability with decedents in common-law states. The equalization was achieved by requiring most community property to be taxed entirely in the estate of the first spouse to die. The 1942 Act, of course, provided for exceptions. Two types of community property, that derived originally from the surviving spouse’s separate property and that derived from personal service income of the surviving spouse, continued to be taxed one-half in each spouse’s estate.²⁰

Obviously, married residents of community-property states were not pleased by the increase in their estate taxes. They complained that the increase caused hardships and inequities.²¹ In the meantime, married residents of common-law states continued to be unhappy with their heavier income tax burden. Pressure mounted on state legislatures in common-law jurisdictions to adopt community-property systems in order to obtain favorable income tax treatment for their constituents. Several states (Oklahoma, Oregon, Michigan, Nebraska, Pennsylvania, and the Territory of Hawaii) succumbed to the pressure by enacting community-property regimes.²² (All repealed their community-property laws after the federal legislation of 1948 discussed below.)

In 1948 Congress resolved the turmoil in both the income tax and the estate tax. For the income tax, the Revenue Act of 1948 (1948 Act) created an income-splitting scheme, under which all husbands could shift half of their income to their wives for tax purposes.²³ For the estate tax, the 1948 Act repealed the 1942 provisions that had increased the estate tax on residents of community-property states and in its place created a marital deduction. The new marital deduction permitted common-law decedents to transfer up to one-half of their property to their surviving spouses tax free, thus lightening the estate tax burden on commonlaw residents and equalizing it with that of communityproperty residents.²⁴

The adoption of income-splitting introduced one element of the fiction of marital unity: all married couples were treated as if they shared their income whether or not they actually did. Stated another way, married couples with equal amounts of income were deemed to be equal for tax purposes despite the fact that husbands and wives had differing rights to the income depending on whether they resided in community-property or common-law states. For example, a husband living in a common-law state, who had complete control over his earnings, was taxed at the same rate as a husband living in a community-property state, who by law had a right to only half of his earnings.

Clearly, the immediate political goal in adopting this fiction was to reduce tax liability for husbands residing in common-law states.²⁵ Less clear is whether the fiction furthered some independent policy goal and, if so, what deliberative process Congress undertook in determining that goal. The deliberative process should have weighed the costs of income splitting against its benefits. Income splitting had certain administrative benefits. It eliminated the incentive for common-law states to switch to community-property regimes and thereby eliminated the cost of shifting from one system to the other. It also removed the incentive for residents of common-law states to use devices, such as partnerships and trusts, to shift income to their spouses, which eliminated the cost of creating and policing such devices. Both the Report of the House Committee on Ways and Means and the Report of the Senate Committee on Finance cite these two administrative benefits as the reasons for adopting income splitting.²⁶ Neither report, however, mentions the costs of income splitting. One cost was that income splitting mismeasured income to the extent that it ignored the differing economic rights allocated to husbands and wives under differing state property law regimes. Another cost was its effect on married women’s property rights. Income splitting eliminated the political pressure on common-law states to provide married women with the stronger property rights of a community-property regime.

The Special Tax Study Committee, which recommended that the Ways and Means Committee adopt income splitting, at least mentioned the differing rights of married women in different states. Its report explicitly stated that uniformity in the taxation of married couples among common-law and community-property states was the desired policy goal and that the differing rights of married women in different jurisdictions were not significant for tax purposes: “The fact that the legal rights of [a man’s] wife under the State law may differ . . . does not seem to justify the significant differences in Federal income taxes payable. There has come to be rather, general agreement that spouses with similar incomes should pay similar Federal taxes, no matter where they live.”²⁷

This conclusion of the Special Tax Study Committee, however, does not reflect a reasoned policy analysis. Instead, the committee fell prey to the danger of which both Gray and Fuller warned: it failed to recognize the fictional nature of the fiction. Rather than recognizing the fictional nature of treating all married couples as if they shared their income, the committee relied upon the fiction to trivialize the differing allocations of rights between husband and wife under common law and community property. The committee defined the policy goal as “equ...