R9941 Tax Complexity, Reform In George Mason 1994

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r9941

TAX COMPLEXITY, REFORM, AND THE ILLUSIONS OF
TAX SIMPLIFICATION
SheldonD. Pollack*

..[N]o one understands
the IncomeTax Law [the RevenueAct of 1913] ex.
sufficientintelligenceto understandthe questions
not
persons
who
have
cept
that ariseunder it."

SenatorElihu Root of New York (1913)
"simplicity in modern taxation is a problemof basic architecturaldesign.
Presentlegislationis insufferablycomplicatedand nearlyunintelligible.If it is
not simplified,half of the populationmay haveto becometax lawyersand tax
accountants."

Henry C. Simons,Federal Tax Reform (1950)
..The complexity of our code in the main is not there becauseof some mischief. Most of it is there in the effort to do more perfectjustice'"

Senator Russell Long, Former Chairman, Senate Finance
Committee
lNrRooucuoN
Inasmuchas only the rudimentaryStructureof a taxing scheme
waslaid out in the first incometax law, the RevenueAct of 1913,rthe
many detailsrequiredto give concretemeaningto the statutewereleft
Accordingly,the newly imposed
decades.
to be filled in over subsequent
more complicatedduring its
progressively
became
federal incometax
process
of gradualand incremental
first decadesas it evolvedthrougha
of the tax laws
adjustmentsto the original tax laws. The development
entereda secondphasewhen the incometax was radicallytransformed
into a "mass tax" during World War II' In the post-Warera' espe* AssistantProfessor,
Universityof Delaware;UniverCollegeof Busincssand Economics,
l9E6'
sitVof Rochester,B.A., 19?4;CornellUniversity,Ph.D., 1980;Universityof Pennsylvania,
of
School
University
York
New
of
Schenk
H.
Dcborah
Professor
thank
wishes
to
J.D. The author
Fund
Law for her helpful commentson an earlier draft of this article and the Gowen Fellowship
of the Law Schoolof the University of Pennsylvaniafor its generousfinancial support'
166-81
' Pub.L. No. 63' 16,c h. l 6 ' 3 8 S t a t . l 1 4 '

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Gro. MnsoN lNnrp. L. Rrv.

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cially during the 1970sand 1980s,the level of complexityof the indramatically.'As reflectedby the sheernumberof
cometax increased
provisionsof the federal incometax, there was a virtual explosionin
the complexityof the tax code in the post-Warperiod.s
In light of this dramaticincreasein complexityof the federalincometax, there is a tendencyto equatetax reform with tax "simplification."a Indeed,tax simplificationhas emergedas one of the perennial
themesin the academictax literature.6Somereform effortshavebeen
directedat specificprovisionsof the tax codeand regulations.Other
proposalsamountto little more than broadpleasfor generalsimplifica.
tion and appearto be politicallymotivated.For instance,HouseWays
and Means Chairman Rostenkowskiand then Finance Committee
Chairman Bentsenpicked up on the theme of tax simplificationand
introduceda packageof proposals
provisions
in 1991.6Theseproposed
weremostlywindowdressingand focusedon simplification
of reporting

2 In a recentinterview,ProfessorMartin Ginsburgrecountsthat evenunder the Internal
RevenueCodeof 1954therewereonly a few statutoryand regulatory"monsters"for tax lawyers
to struggleto master.Under the 1986tax code,the monstersnow seemto dominatethe playing
field. ,SeeMartin D. Ginsburg,Interview With ProfessorMartin D. Ginsburg, l2 ABA SrcrroN
Or TrxrrroN NEwslnrrEn, Fall 1992,at 6-12.
werefirst publishedin l9l3 by Com" The InternalRevenueCodeand Treasuryregulations
merceClearingHouse,Inc. (CCH) in a singlevolumeconsistingof little more than 400 pages.
This remainedthe casethroughWorld War II. Presently,the tax codeand regulations
take up a
total of eight volumesand over 36,000pages.Therehas beena comparableexplosion
of "law" in
other policyareasas well. For instance,Title II of the SocialSecurityAct of 1935wasonly four
pageslong whenenacted,grew to 50 pagesby 1950,and explodedto 200 pagesin the 1970s.This
did not evenincludenew sectionsof the statute,suchas medicare.Mlnrun Dnnrurcr, Acrxcy
UNoEnSrnrss:Tur Soctlr Srcunrrv AoMrNrsrnerroNrN AMERTcAN
GovrnNlrrNr 201 (1990).
' See,e.g.,David Brockway,The ProcessBehindSuccessfulTax Reform,3l Vrll. L. Rrv.
1803,1803(1986)("True tax reformwill not be achievedunlessthereis significantsimplification
of codeprovisions.").
o See,e.g.,HrNny C. Srrr,roNs,
Frnrul T,lx Rnnonu 28-30( 1950);Paul McDaniel, Federal
Income Tax Simplifcation: The Political Process,34 Tlx L. Rrv. 27 (1978); Federal Income
Tax Simplifcarfon(CharlesH. Gustafsoned., 1979);U.S. Departmentof Treasury,Officeof Tax
Analysis, Tax Reform for Fairness,Simplicity, and Economic Growth: The Treasury Department Reportto the President,25Tt'xNorEs 873 (1984);Joint Comm.on Tax'n,95th Cong.,lst
Sess.,Issuesin Simplificationof the IncomeTax Laws (Comm.Print 1977);SidneyL Roberts,
Simplifcation Symposium,34 Tlx L. Rnv. 5 (1978); Boris I. Bittker, Iar Reform and Tax
Simplification,29U. Mlrrrlt L. Rnv. I (1974);DeborahH. Schenk,Simplifcationfor Individual
Taxpayers:Problemsand Proposals,45Tu L. REv. l2l (1989);CharlesA. Mclure, Jt., The
BudgetProcessand Tax Simplifcation/Complication,45Tex L. REv. 25 (1989).
6 Trx Srrrlpr-rrrcArroN
Acr Or 1991,S. Doc. No. 1394,H.R. Doc. No.2777,102dCong.,
lst S es s(.1991) .

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32r

Goldbergpromotedtax
on tax returns.Evenformer IRS Commissioner
simplification,but he left unstatedpreciselywhat that meant.T
Theseand many other proposalsfor simplificationmake for good
press,but do not addressthe fundamentalcausesbehindthe rise in tax
complexity.Few of the reformersposturingfor simplificationof the tax
laws recognizethe inherentdifficultiesin any attempt to simplify the
code.Someof the excesscomplexityis attributableto effortsby policymakers to accomplishtoo much through the tax laws. In other instances,the great complexitiesof the tax laws are attributableto prior
reformsenactedin the pursuitof evergreaterpurity in the tax laws.As
SenatorRussellLong oncequipped:"The complexityof our codein the
main is not there becauseof somemischief.Most of it is therein the
effort to do more perfectjustice."sLong'spropositionis worth consideras evidencedby Long's
ing, evenif it lacksa certaincritical perspective
own willingnessto enactcountlessspecialprovisionsfor the solebenefit
of his constituentgas and oil industries.
The causesbehindthe enormouscomplexityin the tax lawscannot
callsfor "simplificabe reducedto any singlefactor.Thus,open-ended
tion" to cure the problem of complexityring almost as hollow as the
claim that tax complexityis attributableto the searchfor "more perfect justice" in the tax code-both claimsare overlysimplistic.In order
to considerwhy
to intelligentlydiscusstax simplification,it is necessary
the tax laws becameoverly complexin past decades,and to recognize
tax lawyersearntheir
the infirmityof overlycomplextax laws.Because
livelihoodfrom such complexities,many will be reluctantto acknowledgethat there is evena "problem" at all.
To understandthe adverseeffectscausedby overly complextax
laws,oneneedsfirst to view the federalincometax from a broadhistorical perspectiveto placethe developmentof the tax systemas a whole
within the contextof the peculiarstructureof Americanpoliticalinstitutions.Complexitydoesnot enter the tax codeso much out of malevodemandsmade
lenceas throughmisguidedreform effortsand excessive
on tax laws as the vehiclefor implementingpublic policy.After understandingthe broadercontext,it is possibleto identify thosetrendsin
recenttax policymakingthat have contributedto this unfortunaterise

7 See Lane Davenport,Marianne Evans,and Sean Ford, Goldberg Still Beating Drum For
Simplifcation;Says /RS Budgetis Way Out of Balance,45Tlx Norrs 1398(1989).
E TrrvrorHvJ. CoNlrN Er ,',L.,TlxrNc Csorcrs l4l (1990) (quotingSenateFinanceCommitteeHeailngsonTax ReIorm Proposal,Volume3,99th Cong.,2dSess.,53(1986)(statement
of SenatorRussellLong, FormerChairman,SenateFinanceCommittee)).

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in tax complexity.The dilemmathat we may very well confrontis that
the more we attempt to do through the tax code-whether to achievea
"more perfect justice" or implement social economicpolicies-the
more we end up making the tax laws evenmore complex.In doing so,
we underminethe capacityof the citizenftaxpayerto comprehendthe
legal obligationsimposedunder the regimeof the federalincometax.
I. Coupr-ExrryIu Tnn FnorRnr INcour Tnx Llws
A.

The First Regime of the Federal Income Tax
L

The Original Tax System

Tax complexityis not a new phenomenon,
althoughit has reached
new heightsin recentdecades.Since 1913,excessive
complexityhas
beena constantcomplaintof taxpayersas well as a favoritethemeof
reformers.eBut to taxpayersand counselwho havegrown accustomed
to the statutoryexcesses
and regulatoryquagmiresthat seemedto becomethe norm in the 1980s,the first incometax laws would appear
relativelystraight-forwardand uncomplicated.
For instance,the originalForm 1040("Return of AnnualNet Incomeof Individuals"),put in serviceby the Bureauof InternalRevenue in 1913,was only threepageslong,includingall its variousschedules. It containedonly a single page of instructions.loThe return
requiredtaxpayersto computeand report just two separateitems,
"grossincome" and total "generaldeductions,"and providedrelatively
straightforwardschedules
for computingeach.The tax was imposedon
net incomeabovea $3,000exemptionthat was "receivedor accrued"
during the calendaryear, thus employinga hybrid methodof tax accountingthat borrowedconceptsfrom the cashand accrualmethodsof

e SenatorElihu Root of New York in l9l3 wroteto a friendwho had complainedaboutthe
complexity
ofthe Revenue
Act of 19131
"I guessyou will haveto go tojail. Ifthat is the resultof
not understanding
the IncomeTax Law I shall meetyou there.. . . [F]or no one understands
the
Income Tax Law exceptpersonswho have not sufficientintelligenceto understandthe questions
that ariseunderit." Quotedin Henolo Dusnorr, THr UNrrno Srerns Tlx Counr: AN HrsronrcALANALYSTS
l2 (1979).
ro The 1993 Form 1040is just two pageslong, but completinga complicatedreturn may
require the use of dozensof schedulesand workshcets.Form 1040alone is now accompaniedby
almostfifty pagesof instructionsand worksheets.

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tax accountingso familiar in the moderncode.rrEssentially,the 1913
incometax resurrectedthe short-livedCivil War incometax as well as
the tax return usedfifty yearsearlier.r2
Of course,many sophisticatedtaxpayersstruggledwith the new
that the l9l3
relatively"simple" incometax form.reNotwithstanding
versionof the federalincometax was rather basicand pristineby toas far too
day's standards,it alreadywas perceivedby contemporaries
complicatedto be understoodby the averagetaxpayer.raThe impact
and shockfelt by thoseconfrontingthe new federalincometax law for
the first time in 1913may havebeenevenworsethan the bewilderment
felt today by thosewho make their first acquaintancewith the present
incarnationof the code.The sheernoveltyof the idea of measuringan
individual's"income," as the new tax required,was part of the reason
that the first incometax laws would havestruck individualsas so complex and shocking.'6Corporationswerealreadyfamiliar with the notion
of computingincomeover a definedaccountingperiod,both for financial and tax purposes.A federal businessprivilegetax, similar in essenceto an incometax, had been enactedand sanctionedfour years
prior to the ratificationof the SixteenthAmendment.ro
But individuals
were not yet accustomed
to measuringtheir humanendeavors
in terms

!r See I.R.C. aa6(c) (cash and accrual methodsas "permissiblemethods" for computing
$
taxableincome).[All citationshereinare to the Internal RevenueCode of 1986,as amended,
unlessotherwisespecified.]
'1 The tax return used during the Civil War employeda similar framework. However,the
return used in 1865 listed separatelyeach sourceof income (specifically,all "profits from any
trade, busincss,or vocation,"rental incomefrom land or buildings,"profits realized" from the sale
of real property,as well as interestand dividends)and allowedfor "proper" deductionsrelated to
that sourceof income.Allowing for deductionsfor lossessustainedon the sale of real estate,
interestpaid, rent actually paid for the taxpayer's"homestead,"and an annualexemptionfor
the tax wasimposeduponnet incomeabovea $600personal
$600of salaryfor military personnel,
exemption.For an accountof the Civil War incometax, see Roy C. Burny & Grrpys C.
BlrxEv, TxE FeoEnll INcorrarT,c,x2-8 (1940);R,rNpolru E. Plul, T,rxlrroN rr rHr UNrtnn
Srrres 7-29 (1954).
rE Indicativeof the fact that eventhe rudimentarytax returnusedfor the Civil War income
tax was difficult for taxpayersto comprehend,Abraham Lincoln overpaidhis taxcs for 1864 by
$1,250, a sizable amount by contcmporarystandardsof wealth. The incident is rccountedin
Drvro BunNnru, A Lnw Unro Irsrlr: Tsn IRS ANDrHE Asusr or Powrn 13 (1989).
t' See supra note 9.
r! Except for the brief experiencewith the Civil War incometax, a half ccntury prior to the
l9l3 income tax, citizens had only known "indirect" forms of taxation. Whilc transactionsand
salcswcre subject to excisetaxes and custom duties, the conceptof treating an individual as a
taxableeconomicunit was relativelynew,evenin 1913,
!! The corporatebusiness
privilegetax wasincludedin the Payne-Aldrich
Tariff Act of I 909,
In Flint v.
whichwasimposed"with respectto the carryingon or doingbusiness"of corporations.
StoneTracy Co.,220 U.S. 107 (l9ll), the U.S. SupremeCourt held the tax to be a business

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[Yol,2:2

of "net income."Nor werethey accustomed
to beingtreatedas discrete
economics1i1s-"4seounting" for their livesas so many living balance
sheets.No matter how benign the federal incometax may appearby
today'sstandards,it represented
a milestonein the development
of the
relationshipbetweenthe citizen and the state,transformingthe American citizen into a new categoryof being-the Taxpayer.
Oddly enough,the simplicity of the first "bare-bones"tax laws
may haveactuallycontributedto the initial confusionbecausethey provided taxpayerswith insufficientguidanceas to what was being measured and how to measureit. Successive
decadesof refinementof the
statutesby lawmakers,as well as the issuanceof interpretiveregulations by the TreasuryDepartmentunder the authority grantedby the
RevenueAct of 1928,17somewhatclarified the meaningof the basic
conceptsof the federal income tax. These interpretationsbrought
greatercertainty and predictabilityof outcometo subsequent
generationsof taxpayers,attorneys,and tax experts.
2. Role of the FederalCourts
During the first decadesof the federal income tax, the federal
courtsand the Board of Tax Appealscontributedmuch fleshand blood
to the statutes.r8
Indeed,the basicnatureof the statutesand the broad,
expansivelanguageused by Congressin drafting the initial revenue
laws made extensivelitigation inevitable. Accordingly, the federal
courts were drawn into a processof articulating the meaningof the
most basicand fundamentalconceptsof the incometax.

privilegetax, and not an incometax which wouldhavebeenprohibitedunderArticle I, Section9
of the U.S. Constitutionas a "direct tax."
r? Pub.L. No. 78-562,ch. 852,45 Stat. 790,791 (1928).
'6 The Board of Tax Appeals was establishedunder the RevenueAct of 1924, ch. 234,
$ 900, 43 Stat. 336-38.The Board was technicallyan "independentagencyin the executive
branch," rather than a judicial body. In fact, the Board (which was renamedthe Tax Court of the
United Statesin 1942)functionedmuch as a federaltrial court. In 1969,in recognitionof this,
Congressrenamedthe body the "United StatesTax Court" and reclassifiedit as a so-called"Article I" federalcourt (i.e., a judicial entity createdunder the authority grantedto Congressin
Article I of the U.S. Constitution).26 U.S.C.A. g 7441 (Law. Co-op.1993).Nevertheless,
the
hybrid nature of the Tax Court still raisesproblems.See,e.g.,Freytagv. Comm'r, lll S. Ct.
2631(1991) (concerning
the powerand authorityof the "specialtrial judges"of the Tax Court);
see also Note: Special Trial Judges, The Tax Couil and the AppointmentsClause:Freytag v.
Comm'r,45 Tlx Lrwynn 497 (Winter 1992).For a historyof the U.S. Tax Courr,seeHrnolo
Durnorr, Tnr UNrrro Srerns Tex Counr: AN HrsroRtcAl ANALysrs(1979).

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a. DefiningIncome
The federalcourtswere calledupon to definethe most fundamenconcept
of the tax laws-what is "income" for purposesof the new
tal
tax. The statutorydefinitionof "income" providedin the RevenueAct
of 1913merelymirroredthe languageof the newly ratifiedSixteenth
Amendment,which sanctionedthe impositionof a "direct" tax on "incomes,from whateversourcederived.
Since 1913,the statutory
languagehas remainedvirtually identical.The presentdefinitionis
foundin Section6l(a) of the InternalRevenueCodeof 1986and simply states,somewhattautologically,
that: "grossincomemeansall incomefrom whateversourcederived.. . ."2oThe broad net cast by the
statute providesconsiderableroom for debate and disagreementbepersonsover what constitutes'(ins66s"-especially,
tweenreasonable
wherethe sourceis a gift, bequest,life insuranceor someother source
of incomeexemptby statuteor judicial doctrine.
Given the minimal and somewhatcryptic statutory definition of
income,it was perhapsinevitablethat the United StatesSupreme
Court would be called upon to providefurther clarificationof the concept of incomevery early in the history of the new tax. ln Eisner v.
Macomber,the SupremeCourt struggledwith the concept,declaringin
1920that "incomemay be definedas the gainderivedfrom labor,from
capital,or from both combined.o"t
In this statement,
the Court (probably unintentionally)considerablynarrowedthe constitutionaland statutory definitionof incomeas it stronglyimplied that absentthe contribution of labor or capital, a gain would not be includedin income.
wouldleavevastcategories
Suchan interpretation
of "gain" out of the
statutoryscheme,and hence,out of the reachof the federaltax collector. In construingthe statute so narrowly,the Court introducedadditional confusioninto an alreadyuncertainarea'zand offeredlitigationminded taxpayersa basisfor disregardingthe broad all-encompassing
statutorydefinitionof incomewhen preparingtheir tax returns.
le U,S. CoNsr.amend.XVI.
'?ol.R.C. $ 6l(a). Thc 1939 Internal RevenueCode relied upon a somewhatmore wordy
definitionof "grossincome" in section61(a), while the 1954tax code returnedto a definition
closerto that first usedin 1913.
r! Eisnerv. Macomber,252 U.S. 189, 207 (1920).
ry See MlnvrN A. CHrnsLsrErN,
Frornrl INcour TlxlrroN 7 (4th ed. 1985)("[C]ould it
be assertedthat 'labor' or 'capital' somehowinheresin every human activity?The Macomber
properties
definitionapparentlypossessed
whichmadeit difficultto applyin an absometaphysical
lut ef as hion. . . . ") .

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[Y ol .2:2

From the practitioner'sperspective,this confusionwas a positive
development.It supportedaggressive"reporting positions"that would
excludefrom taxableincomeaccessions
to a client'swealth not derived
from either labor or capital (suchas gifts) and inviteslitigationover
suchclaimedexclusions.'3
It was not until 1955 in the caseof Commissionerv. Glenshaw
Glass Co. that the SupremeCourt finally settledthe issueby embracing the broadlanguageof the SixteenthAmendment,includingvirtually everythingin income.The Court definedincomeas all "accessions
to wealth,clearly realized,and over which the taxpayershavecomplete
The judicial adoptionof this broaddefinitionalsoresolved
dominion."2a
the issuereasonablywell for purposesof creatingan administrabledefinition of incomefor the tax code.The statutoryschemeis that every
"accession"to wealth is presumptivelyincludedin incomeunlessotherwise specificallyexcludedby statute, and in some limited circumstances,by judicial doctrine.26
The Bureauof Internal Revenueand
later, the InternalRevenueService,had alwaysadoptedthis structure

2sSee,e.g.,Bogardus
v. Comm'r,302U.S.34 (1937);Robertson
v. UnitedStates,343U.S.
(1952);
7ll
Commissioner
v. Duberstein,
363 U.S. 278 (1960)(donative
intentrequiredfor nontaxablegift).
8 ' Com m is s ioner
v . G lens haw
G las sC o . , 3 4 8U . S . 4 2 6 , 4 3 1( 1 9 5 5 ) .
26Since the broad definitionof incomewas adopted,there is little room left for judicial
exceptions
to the generalrule that all "accessions
to wealth" are includedin income.Howcver,
during the yearsof the Depression
in the 1930's,the courtscommonlyenunciatedexceptions
to
the broad definitionof inclusionin income.For instance,after outliningthe rule for including
incomerealizedon the dischargeof indebtedness-acommonoccurrence
during the Depression
when the value of real propertydeclinedseverely,leavingmany mortgagelendersinadequately
securedand willing to acceptpartial pay-offsof loans-the courtscarvedout a numberof rather
dubiousjudicial exceptionsthat are only recentlybeing withdrawnby the courts(althoughthe
Treasury never acquiescedin most of thesedecisionsfrom the first). See Kirby Lumber Co. v.
UnitedStates,284U.S. I (1931)(in the majorityopinion,JusticeHolmesholdsthat incomewas
realizedby a corporationupon acquisitionof its own debt instrumentfor lessthan face value);Dtt
sea Bowersv. Kerbaugh-Empire,27lU.S. 170 (1926) (where"overall transaction"was a loss,
incomenot recognizedon dischargeof debt for less than face value); Fulton Gold Corp. v.
Comm'r,3l B.T.A.5l9 (1934) (reductionin non-recourse
debt is treatedas a basisreduction
rather than recognizedas income).Kerbaugh-Empireand Fulton Gold have beenseverelycriticized by courtsand the IRS for years.See,e.g.,Vukasocvich,
Inc. v. Comm'r, 790 F.2d 1409,
l4l4 (9th Cir. 1986).Indeed,the wholedebt-discharge
areais still not supportedon a firm theoretical foundation,as evidencedby the recentbizarre caseof Zarin v. Comm'r, 92 T.C. 1084
(1989),rev'd,916 F.2d 110 (3d Cir. 1990)(compulsive
gamblerlost $3.5 million in casinogambling on credit and in settlementwith casino,he paid $500,000of the debt-lRS assertedthat
taxpayerrecognized$3 million of incomefrom cancellationof indebtedness).
For one of the better
discussions
of Zarin, seeDanielShaviro,The ManWho Lost Too Much: Zarinv. Commissioner
and the Measurement
of TaxableConsumption,54Tlx L. Rrv. 215 (1990).

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in litigation as the basic framework of the federal income tax even
prior to the Court'sadoptionof a similarview of "income"in 1955.
In these and other early decisions,the federal courts crafted a
practicaland administrableconceptof incomefor the new incometax;
and evenas the tax codeevolvedand providedgreaterdetailsof other
statutorydefinitions,the definitionof "income" remainedvery much a
question determined by referenceto these early judicial decisions.
However,there still remainsa sizeablegrey areaas to what amountsto
incomesubjectto the grasp of the federal incometax, evenafter decadesof judicial construction.26
The courtsalsoperformedthe essential
taskof drawingthe boundariesof administrativepowerby reviewingthe governmentos
own interpretationsof the tax statutes.While the courtspaid all the usualdeferenceto the expertiseof the tax expertsin the administrativeagencies
with respectto their interpretation
of the tax laws,therewaslittle hesitancy to find in favor of taxpayersagainstthe tax authorities.Through
extensivelitigation over the basic issuesarising under the federal incometax, the courtsenunciatedthe broad doctrinenecessary
to fill in
gapsin the tax lawsand restrained
the considerable
the tendencyof the
governmentto construethe tax laws entirely in its own favor. In this
respect,the federalcourts playedan instrumentalrole in the development of the federalincometax.
3. Developmentof the Tax SystemDuring the First Regime
During the first quarterof a centuryunderthe new federalincome
tax-the "first regims"-1fis statutoryframeworkof the tax was clarified by Congress,
the administrative
capabilitiesof the Treasurywere
expandedand refined,and the courts acquiredexperienceand skill in
professionalized
interpretingthe tax laws.Likewise,as the increasingly
and specializedbar becamemore familiar with the meaningof the new

20"Construction"hasbeendefinedas the "drawingof conclusions
respecting
subjectsthat lie
beyond the direct expressionof the text, from elementsknown from and given in the text which are in the spirit thoughnot the letterof the text." FneNcrsLTEBER,
conclusions
Legal and
Polilical Hermeneutics
44 (F.H. Thomas1880),quoteddnWilliam F. Harris ll, BondingWord
and Polity: The Logic of AmericanConstitutionalism,T6Au. Por. Scr. Rrv. 34,40 (1982);see
a/so Frank H. Easterbrook,
Legal Interpretationand the Powerof the Judiciary,7 Hlnv. J.L. &
Pus. PoL'v 87 (1984);SheldonD. Pollack,ConstitutionalInterpretationas Political Choice,48
Utrrv. Ptrr. L. REv. 989 (1987).

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tax laws through experiencerepresentingclients,a new legal specialist
was born-the tax lawyer.2?
Thus,the first regimeof the federalincometax was markedby the
gradualinstitutionalizationof the tax system,the professionalization
of
roles played by the participants,and the specializationof functions
within the administrationof the tax system.This specializationincludedlocatingthe powerto interpretthe tax laws throughadministrative regulationsand the powerto actually collecttax revenuesin separate officesand agencies.During this period,the basicstructureof the
federalincometax was laid out and the participantsin the administration of the tax laws eventuallycameto understandthe rulesof the tax
system.In addition, Congressmade continual refinementsto the tax
statutesbasedupon experiencein administeringthe tax laws. These
statutory refinements,along with judicial doctrine as it had evolved
since1913,werecodifiedin the InternalRevenueCodeof 1939.'?t
The
1939tax codeincludedmostof the basicfeaturesof the presentincome
tax regime.The "expansive"languageof the first revenuestatuteswas
given detail through decadesof statutory amendments,administrative
pronouncements,
and judicial review.Yet, evenafter payingfederalincome tax for more than a quarter of a century, the new tax code of
1939struckcontemporaries
as forbiddingand enigmatic.2e
During the first regime,the existingadministrativecapacitiesof
the Americangovernmentprovedto be sufficientlydevelopedto collect
the revenuefrom the incometax. Becauseonly l%o of the population
wassubjectto the individualincometax in 1913,and only 57o subject
to the tax in 1939,there was no great pressurefor an expansionof
1? From 1905to 1916,the AmericanBar Associationmaintaineda StandingCommitteeon
Taxationwhich participatedin the enactmentof the RevenueAct of 1913.The ABA's Special
Committeeon InternalRevenuewasinstrumentalin the creationof the Boardof Tax Appeals.In
1939,the ABA approvedthe organizationof the Sectionof Taxation,which todayplaysa prominent role in advisingthe Treasuryand IRS on concernsof the tax bar. For a discussionof the role
of the Tax Section,see Harry K. Mansfield, A Brief Unoficial History of the Tax Section 1939-1989,44
Tnx LewyEn 4 (1990).
Pub.
L.
No. 76-1.
'r
20No lessa distinguished
figurethan JudgeLearnedHand expressed
with
thesesentiments
respectto the complexityof the 1939tax code:
ln my own casethe wordsof such an act as the IncomeTax, for example,merelydance
before my eyesin a meaninglessprocession:cross-reference
to cross-reference,
exception uponexception- couchcdin abstracttermsthat offer no handleto seizehold of
- leave my mind only a confusedsenseof some vitally important, but successfully
purport,which it is my duty to extract,but which is within my power,if at
concealed,
all, only after the most inordinateexpenditureof time.
JerrrrsS. Eusflce, Tax Complexityand the Tax Practitioner,45Tt* L. Rrv. 7, 7 (1989).

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administrativepowersinto the area of taxation.soThus, the traditional
nineteenthcentury system of administration-minimal state institutions, organized by political parties, subject to judicial reviewer-predominatedthroughout the first regime of the federal inof the federalincometax
cometax. However,the gradualdevelopment
system,including the code itself and the collectionsystem,was radically and abruptly altered by the revenuecrisis occasionedby World
War I.
During the fiscalcrisisof the war, policymakerslearnedan important lessonabout the individual income tax-the amount of revenue
collectedcan be increasedfairly easily through the tax systemwith
only relatively minor tinkering and adjustmentsto tax rates and exemptionlevels.Accordingly,the wartime crisis for additionalrevenue
led to higher marginal tax rates,therebytransformingthe nominal
tax.82
structureof the federal incometax into a highly progressive
PoliticalscientistJohn Witte has describedthe impact of World
War I on the developmentof the federalincometax as follows:
The First World War had an important impact on the incometax, rapidly
transforming it from a highly contestedbut insignificant sourceof revenue
into a major tax. Rate and provisionadjustmentsmade over severalyears
turned what was almost a proportionaltax into one with a highly progressive
nominalrate structure.ss

Despitethe importanceof World War I on restructuringthe federal
incometax, the impact of the War provedto be transitory.Evenduring
the height of World War I, only a relativelysmall proportionof the
citizenrywas eversubjectto the federalindividualincometax. In addition, as revenuerequirementsof the federal governmentreturned to
more traditional patterns after the War, tax rates also were quickly

to Figurescited in Timothy J. Conlan et al., Taxing Choices:The Politics of Tax Reform 17
( l 990).
8r SeeSrnpnENSxownoNsr, Burlprxc A NEw Aurnrclx Srrrr: Tsr Exprrxsroxof Nerrour- AprralNrsrRArrvE
Crrrcrrrns, 1877-1920,29 (1982) ("Together, courts and parties
formedthe bulwark of the early Americanstate.").
tt The top tax rate imposedduring World War I was 71% on incomeover one million dollars. Rosrnr E. Hrll & AlvrN RlausHrl, Txr Fnr Trx 20 (1985).
8r JoHN F. Wlrrr, THr Polrrrcs ANp DrvrlopurNr Or Tnr Fropnrl lxcorrlr Trx ll0
( I 98s ) .

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reducedto pre-War levels.sa
Furthermore,followingthe War, the fedleadingTreasurySecretaryAneral governmentactuallyran surpluses,
drew W. Mellon on a crusadefor the repealof the wartimeexcessprofits tax.36
B.

The SecondRegime: The Transformation of the Tax System

The critical needfor revenuebrought on by World War II led to
dramatic increasesin tax rates as well as the transformationof the
federalincometax from a "classtax" into a "masstax" affectingmost
of the citizenry.soThe expansionof the American administrativestate
a conceptualand ideologduring the New Deal had alreadyestablished
ical acceptance
of public administration,pavingthe way for the subsequentexpansionof the tax administrativestateduring World War II.37
During the War years,tax rates and the volume of revenuecollected increaseddramatically.ssSimilarly, the number of tax returns
filed by individualsincreasednearly eightfold from 1940 to 1945.80
From the initial l%o of the populationthat was subjectto the individual incometax in 1913,the figurehad risento only a modest5Vo by
1939.40
However,this changeddramaticallyover the courseof World
War II. Furthermore,the structuralchangesto the tax codeoccasioned
by the war were not withdrawn following World War II as they had
beenafter World War I. The higher tax ratesand the expandedscope
of the tax did not return to pre-War levels,and they continuedto increase,althoughmore slowly,throughoutthe post-Waryears.By 1950,
u Id. at 96; see also BLnrEv and Buxnv, supru note 12, at 189-334(accountof Mellon
plan for tax reductionduring 1920s,includinglegislationthat reducedwartimesurtaxrates,cstate
taxes,and corporationtaxes in 1924, 1926 and 1928, respectively).
E5Mellon, TreasurySecretaryundcr four presidents,playedthe leadingrolc in the return to
tax "normalcy." Under Mellon's long reign at Trcasury, wartime debt was significantlyreduced
and the budget actually yielded surplusesfor elevenstraight years,cvcn as the wartimc excess
profits tax was abandoned.See Paul, supra note 12, at 122-42.While tax rates decreascd,thc
relative contributionof the incometax to total federal revenueincreasedduring the 1920s.RrcHenp B. GoopB,THE INDrvrDUerlNcoun Tu 2-3 (1976).
8" ,SeeC. EucnNp StEuEnLE,Trtr Tlx DEclonr How TlxEs Clur To Dorrrrx,rrrTgn
Pust-rcAonxpe l3 (1992);Wnrn, supranote 33, at 110-30.The mostcomprehensive
discussion
of the incometax during World War II is foundio Pr.r, supra note12, 249of the expansion
^l
392.
E?See DoNlrp R. BneNo, ConponerrsruANo Tnr Rur-EOr Lrw: A Sruoy Or Tnn NnttoNrt Rrcovrny Aotr,ttNIstnrnoN(1988);seealso, SrownoNnx, supra note 31, at 288-90.
86See Wtttr, supra note 33, at l10-30.
8e CoNLeN,supra note 8, at 18.
{o See Gooon, supra rl.ote35, at 3.

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as much as 59Voof the populationwas subjectto the individualincome
tax, and that figure increasedto SlVo by 1970.4rRevenuefrom the
federalincometax roseto 45Voof all federaltax receiptsby 1950,and
by 1985,the figurehad risento 73Vo.a2
Thus, the great impact of World War II on fiscal policy was that
the federalincometax emergedas the most significantsourceof revenue for the federalgovernmentas both tax ratesincreasedand moreof
the populationbecamesubjectto the tax. The federalincometax also
of Ameribecameone of the most wide-rangingand all-encompassing
can public policies,affectingmany aspectsof socialand economiclife
of the citizenry through the public policiesbuilt into the tax codeand
imposingwhat may very well be the most burdensomeobligationof
citizenship.
Perhapsthe singlemost important changein the tax laws implementedduring World War II that made possiblethe creationand extraordinary growth of the post-War tax administrativebureaucracy
Withwas the introductionof so-called"withholdingat the source."ns
holding was contemplatedand favoredby thosewho enactedthe first
incometax in 1913,in particularCordellHull (Dem.,Tenn.),Chairman of the HouseWays and Means Committee.Supportersgenerally
viewed with favor the British system of "collection-at-the-source,"
which imposeda flat rate on prescribedpaymentsand was indifferent
to the incomeor financialstatusof the recipient,and thus, was highly
administrable.aa
Withholding at the sourcewas not actually put into effect until
1943 pursuant to the Current Tax PaymentAct enactedduring the
wartime crisis for revenue.Until this legislation,the individualincome
tax waspaid solelythroughquarterlypaymentsof estimatedtax for the
current year.a6The Rooseveltadministrationhad beenrecommending

ar Id. at 19.
12 Id.
4' See,e.9., Bunxnlu, supra note I 3, at I 5 ("Although the withholdingstatute traditionally
receivesonly passingattentionfrom most tax scholars,its importancein increasingthe basic
powerof the IRS cannotbe overstated.").For a discussionof the politics behindthe enactmentof
the first withholding requirements,see PrruI-,supra note 12, at 333-34.
tt .SeeBL,rKrv eNo BLnrnv, supranote L2,at75,5ll-20. Proponents
ofwithholdingat the
sourcealso lookedto the Englishexperiencewith envy as it raisedsignificantrevenuethrough this
device.
{r This is still thc methodof paymentof tax with respectto sclf-earnedincome..SeeI.R.C.
$S 6315,6654 (Law. Co-op.1993).Technically,there is no requirementto pay suchestimated
taxes.However,therc are penaltiesfor the failure to make adequatequarterly paymentsof one's
individualswould not needto make any inannualincometax liability, Absenttheseprovisions,

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withholding requirementsin order to speedup the collectionof the
badly neededrevenueto which the nationalgovernmentnow laid claim
under the newly expandedfederalincometax. The new legislationcreinterest and diviated a new obligation for payersof compensation,
dendsto withhold a prescribedamountof incometax from the payment
itself.aoIn addition to the introductionof withholding at the source,
"information reporting" requirementsalso were createdand imposed
upon the samecategoriesof payers.Later, legislationwas enactedto
interest,and dividendsto report
require the payersof compensation,
deOver subsequent
such paymentsto the IRS on an annual basis.az
cades,withholding and information reporting requirementswere constantly expandedthrough the incrementaltax policymakingprocess.
Information reporting providesthe IRS with independentnotice
and verificationof much of the grossincomeof most of U.S. resident
taxpayers.With information reporting applicableto the payment of
wagesto employees,
remunerationpaid to independentcontractors,interest and dividend payments,and even the gross proceedsrealized
from the sale of stock and securities,the IRS now has availableto it
significantinformationregardingthe tax statusof a significantpercentage of taxpayers.Of course,such information is uselesswithout the
administrativecapacityto digest the vast, and potentiallyoverwhelming, volumeof informationthat the IRS receivesfrom payerswith respectto taxpayers.Computersnow offer the IRS the capabilityto correlate and match all the vast and otherwise incomprehensible
informationgatheredfrom thesepayers.aE
On the whole, withholding
greatly
changedthe postureof the IRS and
and informationreporting
the incometax from a "self-assessed"
tax paid on an annualbasisby
the taxpayerhimself,to one in which paymentsand a gooddeal of the

cometax paymentsuntil April lsth of the followingyear - the due date for their incometax
r€turn.
16The withholdingrequirements,
expandedgreatlysinceintroducedin 1943,are now found
in the I.R.C.at $S 3401-06.
'? Theseobligationsare imposedupon payersunder I.R.C. SS 6041-50N.
{t The IRS computersystemis hopelessly
out-of-date.Under the Bush administrationthe
IRS began an $8 billion modernizationprogram. Scott R. Schmedel,Tax Report: The IRS Is
Reshaping,Wlu Sr. J., July 7,1993, at Al. Such a measureis believedto be cost-effective.
Memoriesof a much-publicized
breakdownin the IRS computercollectionsystemin 1985still
haunt the attempt to rely upon computersto keep track of so much of the economicactivity
subject to the incometax.

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relevant information is in the hands of the taxing authoritieseven
beforethe taxpayerstarts to preparean annual tax return.ae
With the introductionof incometax withholdingduring the war
years,the Internal RevenueServicewas able to enhancethe enforcement of compliancewith the tax laws.60This trend continuedover the
next decadesas computershave allowedevengreaterand more extensive withholdingrequirementsto be imposedupon private,third-party
payerssuchas employers,banks,and securitiesand brokerageclearing
houses.With suchnew and enhancedtoolsfor ensuringwithholdingat
the source,the Internal RevenueServicehas emergedas one of the
most productiveof administrativeagencies.Notwithstandingthe popular perceptionthat the IRS is somehowinefficientin its operations,its
ability to administera masstax with over one hundredmillion tax returns filed annuallyand collectnearly one trillion dollarsof revenue
eachyear, is truly a miracle of modernbureaucracy.ot
If World War II helpedto establishthe federalincometax as one
of the most important fiscal tools of the American polity, tax policymakingduring the immediatepost-War era followedmuch the same
patternsthat had prevailedduring the pre-War, Depressionera politics.62Furthermore,the post-Wat era was a period of relativecalm in
the political world with respectto the federal incometax. During the
entire decadeof the 1950s,there was little notablelegislationother
than the enactmentof the InternalRevenueCodeof 1954-essentially
a recodification,rather than a departurefrom current law.6sFor the
remainderof the decade,the federal tax laws remainedquite stable
and constantwith little significantlegislationenacted.6{

ao Evenwith the powersderivedfrom withholding,informationreporting,and computers,in
1993the IRS still faceda backlogof some$71 billionof unpaidtaxes.Tom Herman,Tax Report,
W nll Sr . J . , J an.20, 1993,at Al .
!o For an interesting,if uncritical portrait of the Internal RevenueService,see John C.
Chommie, The Internal RevenueService (1970).
!r The IRS predictedthat it would receivcnearly 113 million individualtax returnsfor tax
year 1992 by the end of September1993.This representsa slight decreaseover the prior year.
Daily Tax Report(BNA), September28, 1993,G-3. Nearly one trillion dollarswascollectedfor
tax year 1988.BunNH,c,l"r,
supra note 13, at 22. The IRS'own budgetis $7.4 billion underthe
fiscalyear 1994budgetput forth by the Clinton administration.Drrlv Tex Rnponr, June 10,
1994,G-4.
!r For a dcscriptionof post-War patternsof tax policymaking,seeWnre supra note 33 at
I 3l- 54.
!E For a discussion
of the 1954revenuebill, seeWtttn, supra noto 33, at 148-50.
6r One importantpieceof tax legislationenactedduring the 1950swas the additionof SubchapterS to the Internal RevenueCodein the TechnicalAmendmentsAct of 1958,H.R, Doc.
No. 8381,85th Cong.,2d Sess.

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The new massincometax providedthe TreasuryDepartmentwith
significantly more revenue and became the most important single
sourceof federalrevenue.However,to accommodate
this expansionof
the tax and the rise in tax rates,the tax administrativestatehad to be
augmentedto collectthe revenueavailableto the governmentunderthe
expandedfederal incometax.66While the traditional nineteenthcentury administrativestatehad beenadequatein collectingthe tariff, and
was easily adaptedto administerthe early incometax laws, the wartime enlargementof the incometax required a major expansionand
reconstitutionof the federaltax bureaucracyto administerthe revenue
laws as a masstax applicableto millions of new taxpayers.66
A good deal of the complexitythat invadedthe tax code in the
post-War era can be traced to this transformationof the incometax
into a masstax and to the relatedexpansion
of the tax administrative
state. However,the causesbehind the explosionin tax complexityin
the post-Warera go beyondthesefactorsalone.To understand
the explosionin complexitythat hasbeenwitnessedsincethe 1970s,it is necessaryto considerother factors that have contributedto the unprecedentedrise in tax complexity.
II. Souncrs oF TAX Corvrpr-Bxrrv
A.

Economic Complexity

The dramaticincreasein the levelof the complexityof the federal
incometax laws during recentdecadeshas not goneunnoticed.6T
Inpoliticians,and the
deed,it hasbeena favoritethemeof tax academics,

05 See Cttotr,lr,ttE,
supra note 50, at 24 ("The broadeningof the incometax baseduring the
early yearsof World War II to embracemostof the nation'swageearners,necessitated
the utilizationof a numberof new and innovativecollectiontechniques.").
s The total revenuecollectedby all levelsof government
in the UnitedStateswas$50 billion
in 1944duringthe heightof World War II; $100billionin 1956;9500billionin 1977;and $l
trillion in 1984.RoN,c,Lo
F. Kruc, MoNnv, TruE, rNp Por-rrrcs:INvrsrurrr Tlx Sugsrorlnrrs
lNo At"tpnrclr Druocn,lcy 16 (1993).
67 Writing in 1950,Henry Simonselegantlylamentedthe increasedcomplexityof the tax
laws, but could offer only a vague explanationfor it and little hope for relief: "Simplicity in
moderntaxation is a problemof basicarchitecturaldesign.Presentlegislationis insufferablycomplicatedand nearlyunintelligible.If it is not simplified,half of the populationmay haveto become
tax lawyersand tax accountants."Srrrt',roNs,
supra nole 5, at 28. See also Hlr-l and RlsusHrl,
supra nole 32, at 5 ("The current U.S. incometax systemis a nightmareof complcxity.").

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tax bar.68However,the many explanationsoffered for the increased
complexityof the tax laws are lessthan convincingor satisfactory.The
problemof tax complexitygoesto the heart of what is wrong with tax
policymakingin the post-War period, and thus, requiresmore than
simplisticexplanationsor eloquentlamentations.
The reasonmost often cited for the increasedcomplexityin tax
lawsis the purportedincreasein the complexity'
of the "world" in general, and in the economyin particular.Accordingto this commonargument, the tax laws were necessarilyexpandeddurrng the post-Warperiod in response
to, and to copewith, the increasinglysophisticated
and
complicatedworld of business,corporatefinance,and economicrelations. Purportedly,as businesstransactionsbecamemore complex,
Congresswas requiredto modify the incometax lawsjust to keepup
with the new practicesof business.6e
l.

InternationalTaxation

Thereis a gooddeal of truth in the argumentthat the increasing
complexityof businesstransactionsleads to increasingcomplexityin
prothe tax laws. For instanceafter the 1950s,Americanbusinesses
gressivelyexpandedtheir activitiesin foreignmarketsand foreigncorporationsincreasingly
beganto do much more business
in the United
States.This changein the internationaleconomicenvironmentdemandedadaptationof incometax laws to governthe taxationof multinationalbusiness
transactions
and corporations
conductingbusiness
in
severaljurisdictions.Accordingly,the provisionsof the tax code with
greatlyexpanded
respectto "internationaltaxation"so
beginningin the

0EFor a discussion
of the forcespushingtowardgreatercomplexity,seegenerally,StanleyS.
Svrrey, Complexity and the Internal RevenueCode: The Problem of the Managementof Tax
Detail,34 Lrw & CoNrrMp.Pnoss.673 (1969);SidneyI. Robertset al.,A Reporton Complexity and the IncomeTax,27 TxxL. REv.325 (1972);JamesS. Eustice,Tax Complexityand the
Tax Practirioner,45 Trx L. REv. 7 (1989).
osSee,e.g.,Wnre, supra note 31, at 149 ("[T]he U.S. economyhad becomemuch more
complexby the 1950s,and the rudimentarylaws of the early incometax werc no longersufficient."). In a comparableexample,Wildavskyattributesthe complexityof the budgetingprocess
to similar factors.Aenox B. WILorrvsry, TnE Por-rrrcsor rxr Buocrrnny Pnocrss8 (1964)
("Budgetingis complex,largelybecauseof the complexityof modernlife.").
oo Within the contextof the U.S. incometax laws,"internationaltaxation"hasa somewhat
misleadingusage,referringto the taxationby the U.S. of domesticcorporations
and U.S. persons
with foreign branchesand/or incomesourcesoutsidethe United States,as well as taxationof
foreigncorporations
and
and individualswith U.S. sourceincomegainedby conductingbusiness
investmentactivitiesin the United States.For an excellentand comprehensive
three-volume
trea-

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1960s.Someof the most complicatedprovisionsto deal with international tax issuesin the code were introducedduring the 1980s.For
instance,foreigncorporationsconductingbusinessin the United States
must now confront extremely complicatedstatutes and regulations
which requirethem to determinetheir "U.S. source"income,ottheir
"effectivelyconnected"U.S. income,62
and their U.S. interestdeductions.83
They alsomust negotiatethe "branch profitstax"6aand complicated economicanalysisrequiredwith respectto so-called"intercompany transfer-pricing."66
There is little doubt that in international
taxation, tax complexitycaught up to internationalbusinesspractices
with a vengeanceof its own.
2. Tax Law and BusinessForms
Whateverthe initial appealof the argumentthat the tax lawsincreasedin complexityin response
to the increasingcomplexityof the
world, the economy,or evenlife itself, it is not entirelyconvincing.For
instance,the argumentassumes
that the useof new entitiesto conduct

tise coveringall aspectsof internationaltaxation,seeJosepsIsrNnnnoH,IxtgnNertoNer-TlxlrroN: U.S. Tlxlrror or FonsrcNTlxplyEns eNo FonrrcN INcorur(1990).
or See I.R.C. 861-62 (1986) (defining income from "U.S. sources"and incomefrom
$
sourcesoutsidethe U.S.). Specificprovisionsof the tax codegoverningthe taxationof foreign
corporationsand nonresidentaliens are found in Subpart II of SubchapterN of the Internal
RevenueCode.
62 For the deinition of "effectivelyconnected"income,seeI.R.C. 86a(c) (1986).
$
os For example,the determination
of the portionof a foreigncorporation's
U.S. debt allowable as a deductionunderthe U.S. incometax lawsrequiresan allocationof world-widedebt based
uponthe locationof the foreigncorporation's
assets.
SeeTreas.Reg.S L882-5(interestallocation
rule) promulgated
underthe authorityof I.R.C. $ 882(c)(l)(A) (1986).Seac/so I.R.C. $ 863
( l 9 86 ) .
ot Seegenerally,I.R.C. 884 (1986).
$
o0 Intercompany
transfer-pricing
is governedunderI.R.C. $ 482 (1986).Spurredon by media accountsof foreigncorporationsgrosslyunderpayingtheir U.S. incometaxes,the Treasury
Departmentbeganto pay seriousattentionto transfer-pricingin the 1960s.A Srupy on INrERcoMpANy
PnrcrNc,Notice 88-123,1988-2C.B. 45E,at 6-10.Treasuryissueda so-called
A Sruov on INrEncompnNv
PnrcrNc,
"White Paper"in 1988on the questionof transfer-pricing.
Notice 88-123,l9E8-2 C,B.45E. The White Paperwas a radicaldeparturefrom the usual attempt by the Treasuryto describeand addresseveryconccivable
transactionand set of factsand
circumstancesin its regulations.This paper was devotedexclusivelyto transfer-pricing.Howcver,
after publicationof the White Paper,the TreasuryDepartmentbeganthe inevitablebarrageof
regulations,and many taxpayersobjectedto them on various grounds.The Treasury retreated
somewhatand issued"simplified"regulationsin Januaryof 1993,Nevertheless,
eventheseregulations imposehighly technicalstandardsthat must bc negotiatedto avoid having the IRS recompute a corporation'sincome,Treas. Reg. $$ 1.482-l through 1.482-2and TemporaryReg.
$S 1.482-lTthough1.482-7T.

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businessled to the expansionof the tax laws to regulatesuchdevelopThis is contrary to the thesisthat Amerimentsin businesspractice.os
the needsand interests
and
developed
to accommodate
can law evolved
of the dominanteconomicinterestsof civil society-i.e., moderncapitalism.67The former impliesthat autonomouspolitical elites are capable of respondingto attemptsto avoid the incidenceof the incometax
by crafting new statutesand regulationsto cope with such developmentsin businesspractice,while the latter argumentpresumesthat law
developsin conformitywith the needsof the businesscommunity.
It is relativelyeasyto find examplessupportingboth sidesof the
argument.For instance,in 1958 Congresspassedlegislationthat provided for the creationof an entirely new tax entity, the so-called"S
corporation,"for the expresspurposeof providingbusinesswith a new
"pass-through"entity as an alternativeto the traditionalbusinesscorporation.sE
The S corporationis strictly a creatureof the federaltax
code,and its creationillustrateshow the tax laws can developto accommodateprivate economicinterests.
However,just as often it is the tax laws that producechangesin
businesspractices,as well as in statecorporatelaw. The impact of the
tax law on businesspracticeand statelaw is illustratedby the creation
of anotherentirely new legal entity for conductingbusiness-the limln 1977,Wyoming becamethe first state to
ited liability company.so
enacta statuteauthorizingthe organizationof limited liability companies,and Florida followedsuit in 1982.However,as late as 1988,there
were only a handful of limited liability companiesactually organized
co See, e.9., Wtrrn, supra note 33, at 149 ("To match the complexity,the codc neededto
distinguishbetweencorporations,corporationswith incomeearnedabroad,partnerships,holding
Complex
companies,
and a wide variety of tax-exemptand partially tax-exemptorganizations.
organizationslead to complex sourcesand flows of incomeand costs,which in turn lead to demands for different treatment.").
az See,e.g., MonroN J. Honwtrz, THB TnrNsronMATroN
or ArraEnrclttLlw: 1780-1850
(1977);and Tnr TnrNsronMArroNoF AMERTcAN
Lew: 1870-1960(1992) (evolutionof Amcrican law as reflectingdictates of private capital).
6t SubchapterS (containedin
$$ 136l-79 of the 1986 Internal RevenueCode) was first
addedto the tax codeby the TechnicalAmendments
Act of 1958,H.R. Doc. No.8381,85th
Cong., 2d Sess.The provisionswere not in the original Housebill, but rather were addedby the
SenateFinanceCommittee.Sea S. Rnp. No. 19E3,85th Cong.,2d Sess.,1958C.B, 1009.The
legislativeintentionsbehind the creationof this new taxable entity haveneverbeenvery clear to
the courts, thus making it difficult to construethe many restrictionsand rules governingSubchapter S corporations.Howcver,therc were clear statementsas to the needto accommodatethe
interestof businessin somesort of corporatepass-throughentity.
0o For a discussionof the benefitsand problemsof using a limited liability company,see
SheldonD. Pollack, Use of a Limited Liability Companylor Conducting Businessin Pennsylvania, LXIY Pr. Brn Ass'N.Q. 142 (July 1993).

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under thoselaws.Then in 1988,the IRS issueda favorablepublic ruling regardingthe tax treatment of a Wyoming limited liability company.Stimulatedby the Service'sclassification
of the Wyominglimited
liability companyas a partnershipfor federalincometax purposes,
this
became
"hot"
nearly
rushed
new businessentity
and
all other states
to
As a result,the landscapefor
enacttheir own versionsof the statute.To
businessand tax planningincludesyet one more entity, as well as all
the new interpretiverules and regulationsnow being consideredby
Treasurytax expertsto distinguishthe limited liability companyfrom
Here,
other pass-throughentities-S corporationsand partnerships.Tr
the evolutionof statecorporatelaw accommodated
the dictatesof ecoin federaltax law.
nomic interestsand developments
However,it can hardly be said,evenin this strongcase,that the
federaltax laws developedto serveor evenaccommodateprivate economic interests.Businesses
and individualinvestorsalreadyhad turned
away from the traditionalforms of business
corporations.
They began
to utilize alternativebusinessentitiessuchas partnershipsand common
law creations,like the Massachusetts
businesstrust, preciselybecause
of the more favorabletax resultsthat could be achievedthroughuseof
such entities.As tax lawyerscame to recognizethe advantagesto be
gainedby "restructuring"the traditionalforms of businesstransactions
through the use of partnerships,businesspracticeschangedto accommodatethe federal incometax code.This suggeststhat tax laws play
an independentrole in shapingthe developmentof businesspractices,
rather than merely reflectingand servingthe needsof private capital.
The expansionof the federal tax schemewithin civil societyhad an
impact upon how the economydevelopedand contributedin its own
way to the increasein complexityof businesspractices.Thus, the rise
in complexityof the tax laws cannotbe attributedsolelyto an increasingly complexeconomyand businessworld. Rather,the tax laws themselvescontributedto the complexityin the businessworld.

7o As of September1993,a total of thirty-frve stateshad alreadyenactedstatutcsproviding
for limited liability companies.The Limited Liability Company-An Emerging BusinessForm of
Choice,LXIY CorporationGuide (P-H) P 18.1 (Sept. 15, 1993).See also,State-by-StateTax
Treatmentof LLCs Reviewed,Srern Tex Rnvrsw (CCH) (Oct. ll, 1993).
?t The IRS has not yet revisedthe regulationsto adequatelydistinguishbetweenS corporations and partnerships,which are similar, but differ in important respects.This task has already
begunwith respectto limited liability companies.
See,e.g.,Rev. Proc.92-35,1992-l C.B. 790.

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Tax Reform, Preferences, and the Rise in Complexity

Much of the increasedcomplexityin the tax laws resultedfrom
the tax policymakingprocessitself, rather than from the externaleconomic environment.It is often the casethat high-mindedtax reform
proposalsend up as nightmaresof complexityoncetranslatedinto regulationsby the tax expertsin Treasury.In the wake of the successof
tax reform effortsin the 1980s,it is apparentthat many of the reform
measuresadoptedby Congressand giveneffectthroughTreasuryregulationsthemselves
causedmuch of the increasedcomplexityin the federal incometax laws. Consider,for example,such tax reformsas the
passiveactivity lossruleswhich were aimedat eliminatingtax shelters.
The passiveactivity lossruleswereenactedby Congressto deal a death
blow to the tax shelterindustry once and for all.72The basicidea behind this reform was to preventtaxpayersfrom using lossesgenerated
from "passive"activities(that is, tax deductionsfrom tax sheltersand
other passiveinvestments)to offsetincomederivedfrom eitherportfolio
investments(dividendsor interestincome)or earnedincome(wagesor
self-earnedincome).73This approach appearsrelatively simple and
straight-forward,but lookscan be deceiving.
The problem,onceagain,was that the vagueand overly-broadlanguageintroducedinto the tax codein the burst of tax reformismproved
to be uselessagainstthe planningof tax lawyers.It againfell to the tax
expertsat Treasuryand the Serviceto providethrough regulationthat
which was otherwiseunattainablethrough statute.Unfortunately,the
resulting passiveactivity loss regulationsissuedby Treasury are so
comprehensive
as to be incomprehensible
to taxpayers,the judgeswho
adjudicatedisputesover the interpretationof the federal statute,and
evenmost tax lawyers.
Introducedin successive
setsof Treasuryregulations,the passive
activity loss regulationsalreadyamount to over five hundredof pages
that must be navigatedby any taxpayerinvolvedin multiple investment
activities.Indeed,the regulationsrequire someforty pagesjust to define what is meant by an "activity"-a vital enterprisewhen it is

7r The passiveactivity loss(PAL) rulesare found at I.R.C. 469 (Law Co-op.1993).
$
't Proposalshad been formulated in the 1970sby Treasury tax expertsto limit the gse of
artificial tax lossesto shelter other ordinary income. However,such proposalswere modest ir,.
scopecomparedwith what wasultimatelyenactedin 1986.The conceptbehindthe passivtactirity lossruleswas first set out in legislationin 1983by SenatorsMoynihanand Chafee,and later
was reintroducedin the Senatetax reform bill.

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rememberedthat the rules generallyrequirea taxpayerto accountfor
each such separateactivity.TlThe increasedcomplexityhas eventemperedthe enthusiasmof thosewho initially sawthe passiveactivity loss
rules as the vehicleto tax "fairness."76
Some have argued that despitethe inordinatecomplexityof the
passiveactivity loss regulations,becausethey successfullyshut down
the tax shelterindustry,the overalleffect has beento simplify the tax
laws.76
whether or not suchis the genuineessence
of tax simplification,
the majority of taxpayershave never had to confront thesetechnical
rules simply becausethey do not investin businesses
in which they do
not activelyparticipate.However,for thosewho do. someof the most
impenetrable
and convolutedregulationsawait them.?z
In much the sameway, the original issuediscount(OID) rules
which were intendedto preventtax avoidancethrough deferral of the
paymentof tax78and the infamousSection89 proposedregulations
which weremeant to preventdiscriminationin the useof pensionplans
and other tax-favoredbenefitsby managementto the exclusionof
workers.The Section 89 regulationsimposedcomplexand incomprehensibleruleson employerswith respectto qualifiedretirementplans.?e
Theseregulationsultimatelywerewithdrawnby the InternalRevenue
Servicein direct responseto the significantpublic outcry againstthis
7' In an effort to simplify theseregulations,
the 6nal regulationswereshortenedconsiderably,
purportedlyreducingthe complexityof the rules.SeeTreas.prop. Reg. 1.469-4.
$
7Esee, e.9.,StephenP. Allen, Fixing The passive
Activiry LossRules,50Tlx Norrs l4l9
(Mar. 25, 1991)("The PAL ruleshavebeenquite effectivein dealingwith tax shelters.Unfortunately,they havealsoproduceda serioussideeffect:a substantialincreasein tax law complexity.
In makingthe tax systemmore fair, congresshas also madeit more incomprehensible.").
76 stanley A. Koppelman, At-Risk and passive
Activity Limitations: can complexity be
Reduced?,45Trx L. Rev. 97, 105-06(1989)("Notwithstanding
the lengthand detailof the
PAL rules,they representa net simplificationof the tax system.The success
of theserules in
eliminatingcomplextax shelterinvestments
has simplifiedthe investmentdecisions
for mosthigh
incometaxpayers.").Notwithstandingthe implicationsof ProfessorKoppelman'sstatement,it is
probablyfair to say that mostof the taxpayerswho previouslywrestledwith complextax shelter
investments
would gladly do so again if only giventhe opportunity.
7? As onecommentator
hasput it: "It is nowthreeyearsafter the enactmentof the limitation
on passivelosses.
And somethingis terribly wrong.From a simpleidea to limit tax sheltersthere
has developeda set of statutory rules and administrativeregulationsof immensecomplexity.The
complexityof theserulesis so Sreatthat most taxpayerswill neverbe able to understandthem."
Richard M. Lipton, PALs at Three: what we Know, what ll/e Don't Know And wat ltlent
l4trong,67Trxrs 715 (1989)(emphasis
in original);seealso RichardM. Lipton,pALS ar Four:
Living with the Regulations,68 Tlxrs 779 (1990).
7ESee infra notes90-91and accompanying
text.
?o I.R.C. g 89 (prior to 1989amendment).

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34r

"regulatorynightmare."80
Theseand other regulatorynightmareswere
originally conceivedof as reformsand implementedto preventabuses
of the tax laws. However,they ultimately increasedthe complexityof
the tax laws to the point where they nearly become dysfunctional-where taxpayersand the Servicecan no longer understandor
apply the tax laws.sr
The congressional
tendencyto implementmore and more domestic
policythroughso-called"tax expenditures"is anothersignificantdevelopment in tax policymakingthat accountsfor a large portion of the
increasedmagnitudeand complexityof the tax laws. Paul McDaniel
has written that "the useof tax expenditures
constitutesthe singlebiggestcauseof complexityin our tax system."82
This may be something
of an overstatement,
but it is hard to quarrelwith the assertionthat tax
expenditures
contributemuch to the increasein complexityof the tax
havebeendefinedas "thoserevenuelossesatcode.Tax expenditures
tributableto provisions
of the Federaltax laws which allow a special
exclusion,
exemption,
or deductionfrom grossincomeor whichprovide
a special credit, a preferential rate of tax, or a deferral of tax
liability."83
By the 1960sit wascommonpracticeto usetax creditsand preferencesto implementsocialand economicpolicy. The effort to incorporate so much domesticpolicyinto the tax coderequirestax policymakers to draw ever more subtledistinctionsbetweenthosetaxpayersand
transactionsintendedto qualify for the tax benefitsand thosewho are
perceivedto be abusingtheseprovisions.
Thesedistinctionsinevitably
require increasinglycomplicatedrules and regulations.Social policies
as diverseas encouraging"researchand development"sa
and low in-

60 Pub. L. No. 101-40, 203 (1989)repealedI.R.C. 89. Seealso Elin Rosenthal,
Seaion
$
$
89 Foes Unimpressed
by Treasury'sAttempts at Compassion,42Te,xNorEs 528 (1989);Elin
Rosenthal,SoberingThoughtsIntrude on Eulogy of Section89, 45 Tax Notes930 (1989).
6t The tax laws becomedysfunctionalwhen they becomeunadministrable,
and thus, no
longerraisesufficientrevenuedue to the inability of evenwell-intentioned
taxpayersto comply
with them.
62 Paul McDaniel, Federal Income Tax Simplification: The Political Process,34 Trx L.
Rr v . 27 ( 1978) .
18The Congressional
Budgetand Impoundment
Act, Pub. L. No. 93-344,$ 3(a)(3),88Stat.
298,299 (1974).For a comprehensive
discussion
of legisof the dynamicsof the politicalprocess
lating tax expenditures,
seeSrlNr,ny S. Sunnny,Prruwrys ro Trx REnonu:Tur CoNcrpr or
(1973);SreNr,syS. Sunnsy & Plul R. McDeNrnr-,
T,rx ExpENorrunEs
Trrx ExpeNprrunns
(1985);JoxN F. Wrrre, Tnr Polrrrcs eNo DsvEr-oprr{ENT
oF rHE Frprnll lNcorlrrTlx, Chs.
14 and l5 (1985);Josrps A. Ppcsrrmr.r,
FrpEnll Trx Por-rcy355-63(1987).
E{ I.R.C. 174 (Law. Co-op.1993),
$

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throughtax credits,and providingdeductionsfor charicomehousingE6
table contributionsso
all contributein their own way to increasingthe
burdenimposedby the tax code.
While tax reformistshave attackedthe use of the tax systemto
implement policy, congressmen
find the use of tax incentiveshighly
conduciveto satisfyingtheir own needsas electoralcreatures.Eventhe
wholesaleassaulton tax expenditureslaunchedthrough the Tax Reform Act of 1986,as radical a departuresfrom traditionaltax policymakingas that represented,
madeonly a dent in the complexityreAs the traditionaltax policymakinghas
sultingfrom theseprovisions.
itself since1986,the useof tax expenditures
reasserted
to makepolicy
hasincreased
again,therebyassuringthat tax complexitywill remaina
salientfeatureof the federalincometax for the foreseeable
future.
C. EconomicAnalvsis in the Tax Code
The tax code also has grown in complexityas policymakersand
the tax expertsin the Treasury Departmentbecameincreasinglysophisticatedin perfectingthe underlyingconceptsof the income tax.
This is especiallythe casewith respectto purifying and refining the
statutory definitionof income.The federal incometax restsupon the
conceptof taxing incomereceivedor accruedduring the taxableyear.87
As the tax expertshavebecomemore adeptat definingtaxableincome
in economicterms,statutoryprovisionshavebecomemorecomplicated.
Economicanalysishas been introducedinto the tax code in order to
eradicateperceivedabusesof the tax rules (i.e., avoidanceof tax) by
those taxpayerswho themselvesunderstandhow to manipulateeconomic conceptsto their own advantage.
The new "economicprovisions"introducedin the 1980scontributed someof the most complicatedrules to the tax code.For instance,
taxpayersoncecould purchaseso-called"zero coupon"bondsor other
corporatedebt obligationsand defer the receipt and taxation of the
"interest" payableon such obligationsuntil the date of maturity (or
redemption).""
Such deferralis viewedas unwarrantedfrom the per-

tc I.R.C. 42 (Law. Co-op.1993).
$
to I.R.C. 170 (Law. Co-op.1993).
$
tI See,e.g.,Treas.Reg. 1.4a1-l(a)(eachtaxableyear is a separateunit for tax accounting
$
purposes).
8t For a cashbasistaxpayer,the interestincomewouldnot be taxeduntil actualor constructive receipt.SeeTreas.Reg.$ 1.451-l(a).

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spective of the Haig-Simons definition of incometo in that the
debtholder'seconomicpositionhas been enhancedover the courseof
the year as much as if the interesthad actually beenpaid, especially
wherethe issueris in soundfinancialconditionand there is no reason
to questionits ability to satisfy the obligationto pay the accruedunpaid interestat maturity.
Accordingly the original issuediscount (OID) rules were introducedin the 1980s,refining prior effortsto control this deferralof inThe OID rulesimposetaxationon the interest(and
comerecognition.oo
allow for a relateddeductionto the payer) basedupon the conceptof
the economicaccrualof the interestrather than uponits actualreceipt.
This may be sound policy if the sole objectiveof the tax laws is to
ensurethat taxableincomereplicateseconomicincome.However,the
OID rules introducedan extraordinarylevel of complexityinto the tax
laws by adding the economicaccrual concept.If simplicity in the tax
statutessuch
codeis respectedas one of the goalsof tax policymakers,
as the OID provisionsmust be considereda mixed blessing."
Another exampleof how the introductionof economicanalysisinto
the tax codecontributedto an increasein the complexityof the tax
lawswas foundin the campaignagainst"tax arbitrage"wagedduring
the 1980s.e2
The simplestexampleof tax arbitrageariseswhenan investor borrows in order to invest in a tax-exemptmunicipal bond.
Under prior tax law, the investorcould deductall of the interestpaid to
carry such a tax-preferredinvestment,while the interestincomepaid

60 "Personalincomemay be definedas the algebraicsum of (l) the marketvalueof rights
exercisedin consumption
beand (2) the changein the valueof rights exercisedin consumption
tweenthe beginningand end of the periodin question."Henry C. Simons,PersonalIncomeTax:
The Defnition of Incomeas a Problemof FiscalPolicy 50 (1938).This "economic"definitionof
incomeformulatedby Henry Simons,but generallyreferredto as the Haig-Simonsdefinitionof
incomein deferenceto economistRobert Haig's earlier contribution,positsthat economicincome
is the sum of the accumulationof wealth and consumptionover whateverperiodof time is adopted
for purposesof measurement.For a discussionof the Haig-Simonsdefinitionof income,sec Richard B. Goode, The EconomicDefnition of Income, in CoupnnHENsrvrlxcorvrETlxrrroN l-36
(JosephA. Pechman,ed. 1977).
e0The original issuediscountrulesarc found at I.R.C.
S$ 1271-75.
or The Treasuryregulationsinterpretingthe OID rules are 441 pageslong and utilize extremelycomplicated
economicconcepts.
In somecasesit requiresa computerto performthe computationsrequiredunder the regulations.
er Tax arbitrageinvolvestaking advantageof the differentialrate of return on investments
arising solely from the different tax treatment of different sourcesof income..9eeEucrNn C.
Srrurue, Tlx DEcloE: How T,c,xEs
Clur ro DourNerr rnr PusLtc AceNol,30-33 (1992);
David J. Shakow,Confrontingthe Problemof Tax Arbitrage,4STtx L. REv. I (1987).

344

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on the investmentwould be exemptfrom incometax.e3The resultcould
be a profit derivedsolelyfrom the differentialcreatedby the tax code
itself. While this particularsimpleversionof tax arbitrageis now disallowed under the tax code,ea
other forms still remain part of standard
tax planning.For instance,investmentsin IRAs, Keoghplans,qualified
ERISA plans,and deductionsfor home mortgageinterestinvolvetax
arbitrageopportunitiesavailableto most taxpayers.ed
Each of the provisionsthat createssuch an arbitrageopportunity
is really nothing more than a tax preferenceenactedto encouragetaxpayersto movetheir capital into favoredactivities.Tax complexityrereformersintroduceprovisionsto the tax
sults when economic-minded
in
limit
the
laws order to
ability of taxpayersto benefitfrom the tax
preferences
that generatearbitrageopportunities.
D.

"Back-Stop" Tax Reform

As Congresshas relied more and more on tax preferences
to make
public policy, it also has been forced to adopt other reform measures
(suchas thosethat governtax arbitrageand bond discountin original
issues)preciselyto closethe "leaks" in the tax baseand preventthe
"abuses"attributableto over-useof suchtax preferences.
In suchinstances,tax policymakerscan be seenas rectifyingtheir own poorjudgment and excessgenerosityin enactingtoo many tax preferences
in the
first place.CharlesMclure has referredto measuresdesignedto limit
the use of tax preferences
as "back-stop"provisionsintendedto "prepreferences
vent the abuseof tax
andfor the appearanceof inequity
Through back-stopreforms,the tax laws necessarilybecomeeven
more complicatedas new provisionsare introducedtoday to limit the
es I.R.C. 265 (Law. Co-op.1993),addedto the tax codein 1954,wasenactedto prevent
$
such a result by disallowingthe interestexpcnseincurred to acquireor "carry" tax-exempt
obligations.
x This form of tax arbitrage is prohibited by I.R.C. 265. Municipal governmentsusedto
$
engagein the reverseof this transaction.
They borrowedat interestratesbelowmarketrates(on
accountof the interest-free
treatmentaffordedsuchinterestunderI.R.C. $ 103)and reinvesting
the bondproceeds
in higheryieldingmarkets,with the interestincomeexemptunderI.R.C. $ I l5
(exemptionfrom federal incometax for "governmentalentities"). This practice is now outlawed
by I.R . c . $ 148.
e! Charles Mclure points out that there are now more than a half dozendifferent types of
"interest" in the tax codeand varioustracing rules designedto distinguishone form from another
for tax purposes.
Mclunr, supra note 5, at 63.
so Id. at 43.

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applicability of yesterday'stax preferences.The incremental poliis generallyincapable
cymakingprocessthat generatestax preferences
of such a radical step as abandoningthem altogether,evenonce they
Incremental
are denouncedby the same policymakersas abusive.eT
policymakingtendsto producesonly minor adjustmentsto existingtax
policies,and back-stopreformsare highly compatiblewith sucha strategy of policymaking.
Perhapsthe best illustration of how incrementalpolicymakingis
conduciveto back-stopreform was the introductionof the alternative
minimum tax (the AMT).08 Introduced in the Tax Reform Act of
1969,the AMT is a separate,paralleltax systemto the "regular" federal incometax. It is an "add-on" tax intendedto back-upor correct
for the inadequacies
of the federalincometax itself. This parallel tax
tax basein which deductionsatsystembeginswith a comprehensive
preferences
deemed
to be most abusiveare
to
those
tax
tributable
Under current law, "alternative
addedback to adjustednet income.ee
minimum taxableincome"is subjectto a two-tier tax of 26Voand 28Vo
for individuals.It was originally introducedas a flat l0vo rate and increasedover the courseof the next twenty-fouryears of incremental
policymakingby a seriesof back-stopreforms.roo
As the many preferences
addedto the tax codehaveaccumulated
over the years,taxpayershaveutilized them to an increasingextentto
reducetheir overall tax liabilities.Not only is this all perfectlylegal,
but it is preciselywhat the statuteswere "intended" to do-namely,
induceindividualsand corporationsto engagein thoseeconomicactivities or purchasethose goodswhich were singledout by Congressas
particularly worthy of subsidy.
The alternateminimum tax demonstrateshow the tax law lends
itself to incrementaltax policymaking.It waspoliticallyeasierfor Congressto adopt this parallel tax regime,publicizedas a reform, rather

m To be somewhatmore critical, the back-stopreform provisionsreflect a lack of integrity.
Measuresthat wer€ once introducedas favorableto the enhancementof the public interest are
recharacterizedas abuseswhen taxpayerstake advantageof the tax benefitspreviouslyofferedby
Congress.Examplesinclude investmenttax credits,accelerateddepreciation,interestexpenseand
the possessions
tax credit under I.R.C. $ 936.
ot The alternativeminimum tax is found at I.R.C,
$$ 55-58.
s In computingalternativeminimum taxablc income,the taxpayermust add back deductions allowed for purposesof regular incometax such as certain interestdeductions,depreciation
and exemptions.
See I.R.C. $ 56.
rooThe latest rate increase,from a flat 24% to the aforementionedtwo-tier rate schedule,
Act of 1993,Pub. L. No. 103was implemented
by the recentlyenactedRevenueReconciliation
66, at $ 1320,107St at .416 ( 1 9 9 3 ) .

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than to sweepthe tax preferences
out of the tax codealtogether.After
preferences
if
use
of
the
tax
to
reducetax liabilitieswas the proball,
lem, then reducingor eliminatingthem from the tax codewould be the
logicalsolution.ror
As such,the alternateminimum tax reflectsthe worst tendencyof
incremental policymaking-tinkering with change at the margins
rather than confrontingthe underlyingproblems.And oncea provision
suchas the AMT findsits way into the tax code,it is virtually impossible to repealit other than in the enthusiasmof a massivetax reform
effort such as occurredin 1986. Of course,even if repealedin such
reformist'szeal,old provisionshavea nasty habit of beingrecirculated
as the next decade'sreform. This was true of the investmenttax credit
which resurfacedonly eight years after its most recent repeal in
1986.'0'Likewise,incrementalpolicymakingsuccumbstoo readily to
the temptationto expandthe scopeof back-upreform provisions,as has
beenthe casewith the alternativeminimum tax, both in terms of applying it to more tax preferences
and in increasingtax ratesfor AMT.
Becauseof this expansionof the back-upreform, more and more taxpayersnow find themselvessubjectto the alternateminimum tax, although a high percentageof them apparentlyremain entirelyunaware
of the tax or their obligations
and liabilitiesunderthis provision.Backup reform provisionshaveonceagaincontributedto tax law complexity
in that they havecreatedconfusingstatutesto which taxpayersdo not
adhere.
III.

Tsr Tlx Gevrn

One way to comprehendthe dynamicsbehindthe expansionin the
complexityof the tax lawsis to imaginethe incometax lawsas estabror Somehavesuggested
that the problemis "piggishness"in over-usingtax preferences
to
reduceone'stax liabilities.The alternativeminimum tax is the kind of solutionput forth to impose"selectivelimitations" on such abuseof tax preferences.
See Daniel Shaviro,SelectiveLimitationson Tax Benefits,56 U. Csr. L. REv. I 189( 1989).Determiningwhena taxpayertakestoo
much advantageof tax preferencesis an entirely openquestion,and attemptingto determincwhen
a taxpayerhasover-used
tax preferences
inevitablyresultsin onemoresetof complicated
calculations which taxpayerswill be forced to confront. The AMT has producedexactly this result.
ro2In his 6rst Stateof the Union on February17, 1993,PresidentClintonformallyset forth
his new economicprogramto Congress.This includeda proposalto reintroducethe investmenttax
credit. The investmenttax credit was first introducedin1962, suspended
briefly in 1966,termipursuantto the Tax ReformAct of 1986.
natedin 1969,reinstatedin 1971,and finallyabandoned
This proposalwas ultimatelydroppedin the wake of much criticism..SeeMortimer M. Caplin,
. . . And Drop InvestmentTax Credits,WALL Sr. J., Mar. 29, 1993,at Al2.

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lishing a kind of game.'oeThe tax laws createa vast edifice,complete
with rules and proceduresthat must be followedby thosewho, for better or worse,are requiredto play.loaAs with any game,differentstrategieswill producesuperioroutcomes,and in the courseof playing the
game over time thesestrategiesbecomeevidentto the playersthemselves,and they will adapt accordingly.But the concernhere is not so
much the dynamicsand logic of play-the subjectof gametheory-but
rather with the developmentof the structuresof the gameand the impact of such developmenton the rules.Toward this end, consideration
of the players' interestsin playing the game shedslight on why the
rulesdeveloped
as they did.
of the taxpayer(or
The point of the tax gamefrom the perspective
tax lawyer) is to minimize one'stax liability (or that of one'sclient)
while complyingfully with all of the rulesdirectlyon point.Of course,
since the "rules" are really federal statutesbuttressedby criminal
sanctions,a failure to play by the rules can result in significantfines
suchpenaltiesfor failHowever,notwithstanding
and imprisonment.106
ure to complywith the tax laws("tax evasion"),thereis no shortageof
methodsby which taxpayerscan minimize or avoid taxation ("tax
avoidance").Indeed,it becomesquite evidentrather early in the career
of everytax lawyerthat any businesstransactioncan be structuredin a
follow from
number of different ways, and different tax consequences
different structuresfor the deal; this is true notwithstandingthe doctrine enunciatedby the SupremeCourt that substancerather than
form shoulddictate the characterizationand taxation of a particular
economicarrangement
or transaction.loo
generationsof taxpayersand lawyersconfrontedthe
As successive
tax laws,the rulesof the gamebecameapparentand the meaning,conro3This analysisof the tax systemas a gamecan be traced to the seminalwritings of Oskar
Morgensternand John Von Neumann.See Tne THEoRyor Glurs nNo EcoNotrrlcBEs,qvton
(1944).Among the first applicationsof gametheory to socialsciencewere WILLIITUH. RIrEn,
Tnr TsEonv or Pourrcll CoelrrroN (1962);J,c,rrrEs
M. BucseNr.Nand GonooN Tullocr,
Tnr Clrculus or CoNsnNr:Locrcel FouNoerloNsor CoNstltutroNlr- DEtrrocnlcv(1962).
r0{ The fact that taxpayersare forced to play the tax game doesnot affect the strategiesor
outcomesof play, nor is it particularlyunusualthat a game is coercive.For instance,William
Riker analyzedthe dynamicsof the competitiverelationshipbetweenthe United Statesand the
Soviet Union in terms of an involuntary "two-person" game. See Rtrrn, supra note lO3.
to6SeeI.R.C.
$$ 7201,"1206,7343(criminalsectionsfor tax evasionand fraud).SeeSheldon D. Pollack, The Penalty For Tax Fraud Against A Corporation,Tun Tex ADvrsER464 (July
1992);Hrnny G. BrlrEn, Trx Fneuo,rNo EvrsroN(1983).
ro3CIR v. Court HoldingCo,324 U.S. 331,334 (1945)("The incidence
of taxationdepends
uponthe substance
of a transaction.. . . [T]he transactionmust be viewedas a whole,and each
of the sale,is relevant.").
step,from the commencement
of negotiations
to the consummation

348

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and outcomesof particular setsof tax rules were revealed.
sequences,
Much of the initial "learning stage" of the game was playedout between1913and 1919duringthe first regimeof the federalincometax.
In any game,the levelof play will rise to higherlevelsas playersfully
learn the range of movespossibleunder the rules.rozFurthermore,as
in their play, the rules
the playersbecomemore and more sophisticated
of the game also may be modifiedto counteractand balancethe increasedlevelof skill of the players.As a result,the gameitself becomes
more and more complexas it becomeshighly institutionalized.ros
It is impossibleto predict a priori who will benefit from an increasein the complexitylevelof a game.For instance,in a gamesuch
of the enormouscomplexityare thoseplayers
as chess,the beneficiaries
with the greatestcapacityto foreseethe outcomeof the possiblesuccessivemovesof an opponent.In baseball,the progressive
institutionalization of the game resultedin shifting the balanceof power amongthe
players.toe
In the earlystagesof the game,beforethe rulesand logicof
the game were fully revealedto players,hitters prospered.This was
becauseplayersin the field had not yet fully "learned" their roles,
meaningthey had not yet masteredtheir play. Accordingly,hitters had
what todaywould be considered
improbablyhigh batting averagesfrom
1900throughthe 1940's.Thereafter,players,especiallythe pitchers,
becamemoreproficientin their skills,and ruleswerechangedwith the
expressintentionof restrictingthe successof hitters.One examplewas
the raising of the pitching mound which resultedin batting average
declinesin the post-Warera of the l950s.rr0
In the tax game it is difficult to know with much certaintyat any
particularmomentwho is winning-the tax lawyersor the IRS. The
dynamicsof the tax gameappearto be that oncesomeclevertax law-

roz As everychild quickly learns,the rangeof possibleoutcomesfor the gameof tic-tac-toeis
too limited, and hence,play soon becomesboring. Likewise, checkerssoon bores most players,
although,in fact, thereare millionsof possibleoutcomesin checkers(asopposed
to tic-tac-toe).It
is just that the gamesall resembleeachother,and thus, offer no great excitement.
becameincreasinglyinstitutionalized
'ot For instance,the U.S. House of Representatives
throughoutthe courseof the nineteenthcentury.The role of "rcpresentative"becamemorc profcssional,decisionmaking
becameroutinizedand formal, leadershipbecamehierarchical,and rules
becamemore complexas the Housebecameprogressivelyinstitutionalized..SeeNelson W. Polsby,
The Institutionalizationof the U.S. House of Representatives,62Au. Pol. Scr. REv. 144
( l e 68) .
'oo The following argumentconcerningthe effectsof institutionalizationon baseballstatistics,
in particularbatting averages,
was put forth by StephenJay Gould, Losing the Edge,VrNrrv
Fltn. March 1983.at 120.
rro Id,

t9941

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yer recognizes
a new maneuverarounda particularprovisionof the tax
code,and usesit successfully
to reducethe tax liability for a particular
type of transaction,the maneuverquickly becomesknown throughout
the tax bar and the IRS eventuallylearnsof it.rrr Thereafter,new regulationsand perhapsevennew statutes(the "rules" of the tax game)
are adopted,shifting the advantageback to the taxing authoritiesfor a
periodof time.rr2As this occurs,the rulesof the gameinevitablybecomea bit more complicated,and the tax lawyersmust learn to play
and devisenew strategiesunder the new rules.The tax gameis unusual
in that one participantalso acts as the refereeof the competition,empoweredto write new rulesto favor its own side.ttsIn sucha game,it is
not surprisingthat the rules grow ever more complexas the competitorf refereeconstantlyrewritesthe rules to its own advantage.
This increased
complexityin the tax lawscan resultin greateruncertaintywhen the complexityof the rulesof the tax gamereachthe
point whereplayersno longerunderstandthem, and hence,cannotpredict the outcome.In a variation on this theme,it has beensuggested
that a moderatelevel of tax complexityis desirablefrom the perspective of both the tax bar and the tax authorities.lra
Accordingto this
argument,higher levelsof uncertaintyincreasethe cost of litigation,
and accordingly,increasethe taxpayer'sinterestin pre-trial settlements
whichreducethe tax lawyers'fees.The IRS, too,generallyfavorsmoderately high levelsof complexitywhich make for greateruncertainty,
and impels taxpayersto comply with the tax laws, or upon audit, to
settle their disputes (thereby maximizing revenue for the govern-

Irr Becausethe tax expertsin the TreasuryDepartmentand the IRS generallycomeout of
privatetax practice,thesetechniquesof tax avoidanceeventuallybecomeknown to the taxing
authorities.This shouldbe seenas one benefitfrom the so-called"revolvingdoor" betweenbusinessand governmentofficials.
Itt Examplesof suchnew IRS regulationsrelateto the so-called"May Storestransaction"
utilizingpartnershipdistributions,the useof the Section754 electionto step-upbasisin partnership assetsin the context of a consolidatedreturn, and the taxation of new complex financial
instrumentsdesignedto take advantageof the treatmentof contingentinterestunder the OID
rules.See,e.9.,Treas.Reg. $ 1.1275-4(g)(bifurcationof contingentdebt instruments).
rr8 In this respectthe tax game is analogousto what would result were gamblingcasinos
permitted to amend the houserules in responseto successby gamblersin beatingthe odds- for
instance,by banning "card-counting." Of course,state gaming officialscan usually be persuaded
to makesuch rule changeson behalfof the casinos.
rr{ SeeMichelleJ. White, Why Are TaxesSo Complexand Who Benefits2,47Trx Norns
341 (1990).A tax attorneyin the film madefrom John Grisham'sbest-selling
novel,THe FrnM,
(1991),statesthis cynicalview as follows:"It's a game.We teachthe rich how to play it so they
can stay rich - and the IRS keepschangingthe rules so we can keepgetting rich teaching
them." Quotedby GeorgeWill, The Tangleof Egosand Rules,NEwswEEK,July 26, 1993,at 60.

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ment).rrdPresumably,the policymakerswho createtax complexity,introducecomplexityinto the tax code,or at leasttolerateit, to enhance
the Treasury'scollectionof revenueunder the incometax laws.
This kind of applicationof gametheoryto an analysisof the developmentof tax complexityfocuseson the conflictinginterestsof the key
playersof the gamein determiningwhat theyconsiderto be an optimal
level of complexitywith respectto the rules of the game. However,
such analysisdemonstrates
the limits in applyinggametheoryto the
tax system.The analysisis usefulin explainingthe behaviorof taxpayers, tax counsel,and the IRS in terms of elucidatingthe economicinplayers.In doingso,gametheoryassumes
terestsof the respective
that
the playersmake decisionsbasedupon a rationalassessment
of their
own self-interestsnarrowly definedin terms of the maximizationof
their economicpositions.However,whenthis analysisis appliedto the
politicaleliteswho actuallymake the rulesof the tax game,it breaks
down.When political elitesare portrayedas "players" and their behavior is explainedin terms of the calculationof economicand rational
interests,the conclusionis that they will be revenue-maximizers,
behaving as "predatory" rulers.ttoSimilarly, a pure economicmodelwill conclude that politicaleliteswill raisetax ratesto "point E" on the socalled "Laffer" curve,rrTdisregardingthe interestsof civil society.rrs

lrc Accountantsare said to benefitfrom high levelsof complexityas well as it pushestaxpayers to seekprofessionaladvicein preparingtheir tax returns.Accordingto one economist,for most
U.S. corporations
with assetsof lessthan $l million (constituting90% of all U.S. corporations),
the costof compliancewith the federaltax laws is significantlyhigher than their tax liabilities.
SeeArthur P. Hall, AccountingCosts,Another Tax, Wlll Sr. J., Dec.9, 1993at Al6. A study
by Professors
JoelSlemrodand MarshaBlumenthalhasestimatedthat for 1992,the total costof
compliancefor the Fortune500 companies
amountedto $1.055billion,or $2,1I million per company- seventypercentattributableto federaltaxation,and the rest to stateand local taxation.
"" See Margaret Levi, A Theory of Predatory Rule, l0 Pol. & Soc'y 431 (1981). Levi
presentsthe generalthesisthat "rulers are predatoryin that they try to extractas much revenue
as they can from the population."Id. Seealso, Or Rulr eNp RpvrNur 3 (1988).
rr7 The Laffer curve was put forth by supply-sideeconomistArthur Laffer, a member
of
PresidentReagan'sEconomicPolicy Advisory Board,to showthat at somehypotheticalpoint on a
curvecomparingrevenuewith tax rates,revenuewill reacha maximum("point E"), and thereafter declineas tax ratesincreasefurther.SeeFouNo,c,rroNs
or Supply-Sror EcoNorvrrcs:
Tnnory
ero EvtprNcr (Victor A. Cantoet al. eds.,1983);Surrlv-SrnE Ponrpolro SrnerEctrs (Victor
A. Canto & Arthur B. Laffer eds.,1988).For a discussion
and assessment
of thc theoriesbehind
the Laffer curve, seeDrvrn G. D,rrvrns,
Ulnro srlrns Tlxrs exo Tlx Poucv 6l-68 (1985).
theory that revenuewill decrease
as tax ratesincreasebe"E It is an axiom of supply-side
yond somehypotheticalrevenue-maximizing
pcak ("point E') on a curve comparingrevenucwith
tax rates (the so-called"Laffer" curve). At point E, revenuewill reach a maximum,and thereafter declineas tax ratesincreasefurther. For a critical discussion
and assessment
of the theories
behindthe Laffer Curve,seeDrvrrs, supra note l17, at 6l-68.

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Yet, it is clear that political elites do not behavethis way. Such
rational explanationstake into account only pure economicmotives
such as revenuemaximizationand ignoreall the personaland institutional motives and interestsbehind tax policymaking.For example,
policymakersdo not want to raise tax rates too high becausethey will
have to answerto their constituentsfor the higher rates.In openand
democraticpolitics,suchas that which prevailsin the Westerndemocracies,political elitesare continuallysubjectedto popularcontrolsexerted through electoralpoliticsand the openexpression
of public opinion. Arguably, electoral competition and public opinion imposesa
significantdegreeof popular control over political elites and renders
them accountable
to the citizenryin somefashion.tre
The interestof
political elites in maximizing state revenueat the expenseof overall
economicgrowth can be temperedand restrainedby electoraland popular pressures.
The behaviorof political elites forcedto competein
electionsfor the right to hold office may be effectivelycheckedand
restrainedevenwithout the electorateunderstanding
the specificdetails
of this conflictof interestover marginaltax rates.Recentexperience
in
provoke
Americanpoliticssuggests
that sharpincreases
in tax ratescan
strong populistresistancethat is quickly translatedinto restraintsimposed on political elites through the mechanismsof democratic
politics."o
Likewise,the impact of ideologies(suchas tax reformismand the
liberal political tradition itself) on the behaviorof political elitesis left
out of game theory. So while game theory doesoffer insightsinto the
dynamicsof the tax gamein which taxpayers,tax authorities,and tax
lawyersall participate,it provideslittle insightinto how and why the
tax game developedover time. Ultimately, the political eliteswho are
responsiblefor making the rules of the tax game (which accountfor

rro The seminal statement of this view of electoral politics is found in JosEpH A.
ScxutrrRrrEn,Certteusl.r, SocrrLrsrr,r,
lr.ro DErrrocnncv(Ch. XXII, Another Theory of Democracy) 269-83(1950).RobertDahl built upon Schumpeter's
theme,arguingthat electionsinsure
that "political leaderswill be somewhatresponsive
of someordinarycitizens."
to the preferences
Ronpnr A. Dnul, A PnnElcr to DEuocnlrrc TsEony l3l (1956).Othershavesuggested
that
electionsalsocreatea senseof legitimacyand stability that benefitspolitical elitesand the regime
itself. See,e.g.,BrNlrrurx GtNsrrnc, TUE CoNsEeurNcEs
oF CoNsEm:ElrcrroNs, CrrrznNs,
CoNtnol eNo Popur-ln AceurEscENcE(1982); TnE CrprrvE PusI.rc: How Mlss OprNroN
PnomornsSrArn Powrn (19E6).
populist,anti-taxmovementthat beganin Califor'ro For example,considerthe grass-roots,
nia with Proposition13. For a discussion
of this anti-tax politics,seeSusrn B. HlNsrN, Tnr
Potttlcs oE TrxerroN: REvrNue Wrrnour RrpnEsruurrox (Ch.7 - The 1978Tax Revolt:
Causesand Consequences)
212-50(1983).

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the increasedcomplexity)are driven by much more complicatedmotives and intereststhan what is assumedby game theory.
IV.

Tlx Rnronu: Tlx SItvtpI-IrtcenoN?

A.

The ConsumptionTax: Changingthe Tax Game?

Notwithstandingthe many significantefforts to reform the tax
laws over the courseof the past decades,the tax codehasonly become
more complexand confusing.Such "innovations"as the alternative
minimumtax only add to the complexityof the tax law withoutreally
addressingthe underlying factors behind the perceivedproblems.r2r
The result is that the problemsof the old systemare preservedwhile
new problemsare createdas the reform provisionsare inadequatelyintegratedinto the presenttax regime.
While incrementalpolicymakingso often resultsin back-stopreformsthat clutter the tax codewith evergreatercomplexity,the lesson
politicalcoalitioncan sucof 1986is that occasionally
an extraordinary
ceed in breakingout of the pattern of incrementalistpolicymaking.
Such radical departuresfrom "politics as usual" and incrementalism
are rare in tax policymaking.Indeed,the 1986Act may be the only
But, as the tax codebecomesmore comexamplein our experience.r22
plex and cumbersome,
it may eventuallyreachthe point wherethe tax
systemcan no longer raise revenueefficientlyrze
and compliancewith

supra part III.D.
'2r Saediscussion
t22See,e.g.,Srrurnlr, supra note36, at I ("By mid-1984,analysisand debateon majortax
reform was underway,culminatingin the Tax Reform Act of 1986-the most comprehensive
reformof U.S. tax lawseverundertaken.");John F. Witte, The Tax ReformAct of 1986:A New
Era in Tax Politics?19 AMERTcAN
Polrrrcs Quenrnnlv 438,441(Oct. l99l) ("TRA can only
be viewedas a remarkablelegislativeaccomplishment
and by far the most radical exampleof
peacetime
tax reform in history.");DanielShaviro,BeyondPublic Choiceand Public Interest:A
Study of the LegislativeProcessas lllustrated by Tax Legislation in the 1980s,139U. Pr. L.
Rrv. l, 5 (Nov. 1990)("[T]he 1986Act was the all-time leadingexampleof tax reform.").
rrt Increasingcomplexityand the inability to simplify the tax laws may eventuallyresultin
someform of systemfailure:
Becauseof the scopeof tax reductionprovisionsand the complexity of the code, it is
doubtful . . . that the incometax can meet potential revenueneedsin the future .
[or] that it can be "reformed"to expandthe tax baseand/or simplifythe system.Thus,
the radicalnatureof changeover time and the inability of the systemto resistchange
createa policy morassthat is perpetuated
by its own structure.
'\Nnrt, supra note 33, at 20. Even if Witte was overly pessimistic
in his assessment
of reform
effortsto expandthe tax base,he was correct in viewingthe complexityof the tax codeas a

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353

the tax lawswill decline.t"Suchdevelopments
pressures
couldincrease
for a radical restructuringof the tax code.
As the legitimacyand revenue-raising
capacityof the federalincome tax have beenquestionedover the past decades,there has been
interestin abandoningthe federalincometax schemealtoconsiderable
getherin favorof an alternativetax system.This sentimentis reflected
in academicproposalsfor variousforms of a consumptiontax. Dumping the federalincometax in favor of a nationalconsumptiontax would
be the ultimate form of tax "reform" - abandoningall the tax expenditures, back-stopreformsand specialinterestprovisionsaccummulated
overthe courseof the eighty-yearhistoryof the incometax. Additionally, sucha radical changewould havea major impact on the practicing bar. A gooddeal of the expertiseof the tax bar gainedfrom eight
decadesof experienceunder the federal incometax would be negated
as a new tax game,completewith its own rules and dynamics,took its
place.While thereis little likelihoodthat the federalincometax will be
abandoned
soon,or eventhat a nationalconsumption
tax will be introducedas a supplementto the incometax, suchproposalsare no longer
matters of mere speculationamong tax academics.The consumption
tax has emergedon the political agenda.r26
The primary argumentof proponentsof a consumptiontax rests
uponthe assertion
that thereare advantages
to be derivedfrom taxing
consumptionrather than income.The notion is that the presenttax
regimetaxes"income," includingthe return on investmentcapital and
thereby createsdisincentivesfor savingsand incentivesfor consumption. This taxationof savings,it is argued,is unwantedin an economy
that on one hand dependsupon capital formationfrom the investment
of savingsand simultaneously
savesrelativelylittle. This is not a new
observation.'26
However,the appealof the argumenthas increasedin

potentialcauseof systemfailure.A four trillion dollar nationaldebt is onegoodindicatorthat the
tax systemis alreadyreachingthat point.
ua Thereis merit in the argumentthat the increased
complexityof the tax lawshasresulted
in lesscompliance,and hencelessrevenuefor the Treasury.See,e.g.,EugeneCarlson,Tax Complianceby Small Businesses
Eroded in the'80s, Wrll Sr. J., June 27,1991, at B-2, (quoting
former I.R.S. CommissionerFred T. Goldberg,Jr. from testimonybeforethe House:"We believe
that mostnoncompliance
is unintentional.Much of it is due to the complexityof the tax laws.").
r35Numerousbills havebeenin the worksfor the introductionof a nationalconsumption
tax.
None haveactuallybeenreportedout of the HouseWaysand MeansCommitteefor a voteon the
floor of the House.
rrc.See,a.9.,Tnouls HoBBEs,LrvtlrrrlN Plnr II, chap.30 (1651):"For what reasonis
there,that he which laborethmuch, and sparingthe fruits of his labor, consumethlittle, shouldbe

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recent decadesas the U.S. economyhas failed to achievesatisfactory
levelsof savingsand investment.
There are many different variationsof consumptiontaxes.127
Examplesof different versionsof consumptiontaxesincludeexcisetaxes,
salestaxes,the value-added
tax (VAT) and expenditure
taxes.Excise
taxes are imposedupon particular commodities(e.g., cigarettes,alcohol, gasoline,or such luxury items as yachtsor furs). Salestaxes are
imposedupon salesof broadcategoriesof commoditiesor services,and
are generallycollectedby the seller.The VAT is a commonform of
national taxation in Europe, and also was recently adoptedby New
Zealand and Canada (in the case of the latter, in the form of the
Goodsand ServicesTax adoptedin l99l).r'z8This type of tax is imposedupon the value added to a particular commodityby the businessesengagedin the various stagesof the manufacturingprocess.
(Thus, the tax essentiallyis imposedupon the differencebetweenthe
business's
salesand its purchases.)
The basicfeatureof all thesetaxes
(sales,exciseand VAT) is that they are ultimatelyimposedupon the
consumptionof goodsand servicesn
rather than on savings.
An expendituretax is a consumptiontax that essentiallyis imposedupon individualconsumers,
rather than upon sellersor manufacturers. An expendituretax may be structuredfollowing a "cash-flow"
modelin which taxationis imposedupon net consumption
of the individual over the accountingperiod.l2oOne of the purportedadvantages
of taxing "consumption"is that it resultsin greater "equity."rsoThe
notion is that an individual'sconsumptionpresentsa fairer base for
taxation than income.Others arguethat consumptiontaxesare simply
more "efficient" with respectto avoidingdistortionsin the formationof
capital(an argumentcommonlymadeby economists).r8r
On the other

charged,more then he that living idley, getteth little, and spendethall he gets;seeingthe one hath
no more protectionfrom the Commonwealth
then the other?"
of variousforms of consumption
taxes,seeJosEpHA. PEcurrrlN,
"? For a broaddiscussion
Frorur Trx Por-Icy (Ch. 6 - ConsumptionTaxes) (1987);seealso Nrcsol,ls Klrpon, AN
ExprNoIrun,ETex (1955);EcoNoMrcCnorcEs1984(Alice Rivlin ed. l98l); Drvrrs, supranote
117,at 77-90.
rrt The CanadianGoodsand ServicesTax, Bill C-62, effectiveJanuary I, 1991,replacedthe
federalsalestax in Canada.
lfe See William D. Andrews,A Consumption-Typeor Cash Flow PersonalIncome Tax,87
Hnn v . L. Rr v . lll3( 1974) .
180See,a.g.,Alvin Warren, llould a ConsumptionTax Be Fairer Than an Income Tax? 89
Yrr - E L. Rr v . l08l ( 1980) .
'E' This perspectiveis reflectedin PncnmeN,supra note 100; JosephBankman & Thomas
Griffith, Is The DebateBetweenan Income Tax and a ConsumptionTax a DebateAbout Risk?

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355

hand, someargue that consumptiontaxes are "regressive"sincecona higherpercentage
of
sumptionby lower incomeindividualsrepresents
their incomethan it doesfor wealthyindividuals.This problem,if it
indeedis a problem,can be solvedthrough an expendituretax, which
tax rate structure.
can includea progressive
In the end, however,perhaps the most significant obstacleto
consumptiontax is the great difficulty
adoptingan expenditure-styled
phasing
present
incometax and phasingin a consumption
in
out the
tax.ls2The problemarisesbecausesavingspreviouslytaxed under the
old tax regime(savingsin after-taxdollars)must be identifiedand provided with someform of exemptionunder the new regime;otherwise,
thesedollars would be taxed a secondtime if they are subsequently
consumed.Proponentsrecognizesuchproblems,but often dismissthem
as solvable.However,if there is someextendedperiodduring which the
new tax is phasedin while the incometax is phasedout, there will be
two tax regimeswhichtaxpayersmust followand planaround.Accordingly, sincea radical break with the past is impossible,the tax scheme
in effectduring the transitionperiodwould be evenmore complexthan
the current systemsincetwo tax systems(threeif the alternativeminimum tax is counted)would be in place.For this reason,the problems
from introducinga consumptiontax into an economyalreadygoverned
by an incometax regime are much greater than thoseconfrontedby
nationswith developing,emergingeconomiesthat have never had an
incometax.r33In such cases,the choiceof a consumption
tax as opposedto an incometax is considerablymore appealing.However,introducinga consumptiontax into an economyhavingeighty yearsof experiencewith an incometax would be far more problematic.
Becauseof the difficulty in implementingan expenditure-type
consumptiontax, excise-type
consumptiontaxeshavebeenmorecommonly
usedin recentdecadesas revenueenhancersto complementthe federal
incometax. For example,excisetaxes have recentlybeenimposedon
luxury items suchas yachtsand high pricedimportedautomobiles,
and
proposed
gasoline
have been
for
and energyconsumption.Such taxes
are more conduciveto incrementalpolicymakingand can be more easily grafted onto the current tax regime.

DoesIt Matter? 4'1Tlx L. Rrv. 377 (1992). Supply-sideeconomistsalsofavor consumptiontaxes
to the extentthcy encourage
savings.
r8r Mclure identifiestransitionrules as one sourceof the complexityof the tax laws.See
Mclunr, supra note 5, at 51.
18"See,e.g.,CharlesA. Mclure, Jr. & GeorgeR. Zodrow,ImplementingDirect Consumption TaxesIn DevelopingCountries,46Trx L. Rev. 405 (1991).

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B . The Problem of Complex Tax Laws
While there has beenmuch concernof late with a tax codethat is
beyondthe ability of the "average"taxpayerto comprehend,little has
beensaid to identify preciselythe problemcausedby suchcomplextax
laws. Rather, it is simply generallyassumedthat becausethe tax code
is complex,there must be a problem.
Such a simplisticpositionis powerlessagainstthe retort that most
of the complexityof the tax codeis seldomconfrontedby the avera1e
taxpayer,who generallyfiles a simpleForm 1040,or more likely, Form
1040-EZ(the "easy" versionof the individualreturn for thosein the
positionof havingfew deductions
unenviable
to claim).Presumably,
if
mostof the tax law complexityaffectsonly wealthytaxpayersand businessesfor whom hiring professional
tax advisersis standardprocedure,
therereally is no problemwith the manycomplexprovisions
of the tax
laws. In other words,complexityis a problemonly if it reachesthe
middleclass.
To the extent that the computationof tax liabilities, filling out
forms and satisfyingthe multitudeof filing requirementscan be simplifiedfor a majorityof individualtaxpayers,
as it wasby the 1986Act,rsa
even while businesses
and wealthy taxpayersconfront increasedcomplexity, political expediencies
very well may be satisfied.That may be
sufficientto alleviatethe pressures
on policymakers.But there is something cynicalaboutthe view that tax complexityis a problemonly if
felt by the averagetaxpayerfor it misperceives
the natureof the problem of complexityin the tax laws.
Recordkeeping
is burdensome
and confusingfor the taxpayer,and
the ability of the averagetaxpayerto understandthe fundamentalsof
the tax law and preparehis or her own tax return is a prerequisitefor
effectivetax policy.rsdBut the focus of tax reform should not be on
simplifyingthe preparationof tax returns.Simplificationof preparation
is usually accomplishedby eliminating tax deductionsor imposing
r8{ see sre,FFon tuE JorNt corrruttrEgoN
TlxltroN, Grlrnll ExpllNltrop or tur Tlx
Rpronu Acr oF 1986I I (1987)(statingthat "[S]implificationof the tax codeitself is a form of
tax reduction. . . . The Act reducesthe complexity of the tax code for many Americans.
Taxpayerswho will usethe standarddeductionrather than itemizetheir deductions
will be freed
from much of the recordkeeping,
paperwork,and computationsthat were requiredunder prior
law.").
rEoSee, e.9., Deborah H. Schenk,Simplification
for Individual Taxpayers:problems and
Proposals,"45 T,rx L. REv. l2t, 166-6'l(1989) (discussion
of how complexrecordkeeping
requirementsbreednoncompliance).

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thresholdrequirements(such as adjustedgross income) which most
taxpayerswill be unableto satisfy,and therefore,they will not be permitted to use a particular deduction.'36
Such a notion of simplification
will be of little comfort to thosewho losethe benefitof the deduction.
The reasonsfor tax simplificationgo beyondthe difficulty of filling
out tax returnsand computingdeductions.The presentsystemof taxation has contributedmuch to the bureaucratization
of modernlife and
the increasedregulationof economiclife, for both individualsas well as
businesses.
Those unsympatheticto the problem of governmentoverregulationof businessshouldrecognizethat an overlycomplextax system also adverselyaffectsindividuals.ls?
The tax laws havea peculiarimpact upon privatebehaviorinsofar
as they do not strictly prohibit particularprivateactionor conduct,but
rather establisha broad framework of incentivesand disincentives
throughwhich privateactivityis subtlyaltered.The tax lawsimposea
superstructureabove and beyond the legal framework that prevails
underthe liberalpoliticaltradition.For example,a certainactivitymay
be entirely"legal" in the sensethat there are no prohibitionsagainst
suchbehavior.However,underthe tax laws,suchactivitycan carry a
price-the burdenof additionaltaxation.Tax liability createsa disincentiveto transactingone'sbusinessactivitiesin that particular form
just as surelyas if therewerean outrightlegalprohibitionagainstsuch
conduct.In this respect,the tax laws seemto be exemptfrom a traditional tenet of the liberal political tradition-specifically, the rule of
law. t s E

The rule of law assumesthat citizensare governedby clear legal
prior to taking efstandards,
and that thesestandardsare enunciated
fect, therebyprovidingcitizenswith noticeof prohibitedbehaviorand
t8oFor instance,seethe discussion
of tax simplificationin SrEurnlr, supra note36, at 13637 ("Among the major simplifications
achievedby tax reformwasthe eliminationof recordkeeping and tax calculationsfor thoseno longereligiblefor certaindeductions.").
re?Speakerof the Virginia Senate,Richard E. Byrd (1910),in oppositionto ratificationof
the SixteenthAmendment,gave the followingpropheticwarning of the dangersof a national
incometax: "A hand from Washingtonwill be stretchedout and placedupon everyman'sbusiness;the eye of the Federalinspectorwill be in everyman'scountinghouse.. . . The law will of
necessity
haveinquisitorialfeatures,it will providepenalties,
it will createcomplicated
machinery.
Under it men will be hailedinto courtsdistantfrom their homes.Heavyfinesimposedby distant
and unfamiliartribunalswill constantlymenacethe tax payer.An army of Federalinspectors,
spiesand detectiveswill descendupon the state [of Virginia]. . . . Who of us who have had
knowledgeof the doingsof the Federalofficialsin the Internal Revenueservicecan be blind to
what will follow?" Blerny and Bllrrv, supra note 12, at'10.
'8EThe classicstatementof the principleof the rule of law is foundat FnrronrcHA. Hlvrr,
Tsn CoNsrrrurroNoF Lrsnnry 162-75(1960).

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the sanctionsattachedto violationsof theserules.Fundamentalto the
conceptof the rule of law is the notionthat legalstandardsof public
behaviorbe known,or at leastknowable,by the citizenry.To the extent
that the tax laws are publiclaws that similarlyshouldbe governedby
complexitymeansthat
the principlesof the rule of law, the excessive
by
the legal standardsenunciatedthereundercannotbe comprehended
thosesubjectto sanctionsfor a failure to comply.Perhapsthe best expressionof the caseagainstoverlycomplexand changinglaws is found
in an oft-quotedpassagefrom JamesMadisonin The Federalist:
It will be of little avail to the people,that the lawsare madeby men of their
own choice,if the lawsbe so voluminousthat they cannotbe read,or so incoherent that they cannot be understood;if they be repealedor revisedbefore
they are promulgated,or undergosuch incessantchangesthat no man, who
knowswhat the law is today, can guesswhat it will be to-morrow.Law is
definedto be a rule of action; but how can that be a rule, which is little
known,and lessfixed?r8e

When the levelof complexityof the law becomesso great that those
what it is that the
who are subjectto its sanctions
cannotcomprehend
law requiresof them, then the rule of law has beenabandoned
as an
operativeprinciple.In many respects,this has becomethe sad stateof
tax policymaking.
CoNcI-ustotr
The tax law shoulddevelopthroughjudicial constructionof generin the tax laws,ratherthan
ally statedprincipleslaid out by Congress
prescriptive
rules"l4omadeby tax buthrough"ever morecomplicated
over the course
reaucrats.Unfortunately,the tax laws havedeveloped
in entirelythe oppositedirection.The tax codehas
of the pastdecades
becomea massiveand impenetrableedifice of rules and regulations
that describeand governnearly all spheresof economiclife and businessactivity.
Reform legislationsuch as the Tax Reform Act of 1986 only
addednew complexityto the tax codeevenwhile purportingto achieve
!3eTHE FsorneLrst No. 62, at 381 (JamesMadison)(New York: New AmericanLibrary,
ed ., l96l) .
r'o Peter C. Canellos,Acquisition of Issuer Securities by a Controlled Entity: Peter Pan
Seafoods,May DepartmentStores,and McDermotl,45 Trx Lrw. l, 14 (1991).

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purer incometax. Provisions
enactedin 1986contriban aesthetically
uted additionalcomplexityas policymakerswere required(first in statutes,and later in administrativeregulations)to draw increasinglysubtle distinctionsbetweenwhat is allowedand what is disallowed.Such
over-legislating,
aptly describedas "hyperleXis,"rrr
threatensto swamp
weightof suchsubtledistinctions.
the tax codewith the accumulated
One consequence
of excessive
complexityin the tax laws is that it
periodicallystimulatesdemandsfor simplificationof the federalincome
tax. Tax simplificationhas beenchampionedby politicians,academics,
bureaucrats.and evenat varioustimes the tax bar itself. The issueof
overly complextax laws also raisesa numberof important philosophical issuesthat are beyondthe scopeof the immediateinquiry. Nevertheless,theseconcernsshould be kept in mind as the impact of tax
policyupon the broaderAmericanpoliticalsystemis considered.
What are the implicationsfor domesticpolicymaking
whenthe tax
political
codebecomesoverlycomplex?What is the underlying
agenda
of thoseseekingspecificreforms,suchas closingloopholesor abolishing
tax shelters?How are individualtaxpayers(the citizenscomprisingthe
political community) and their rights and libertiesaffectedby an almostincomprehensible
systemof tax laws,regulations,
and rule by tax
bureaucrats?
Are there limits to how far the tax administrative
state
shouldintrudeinto the livesof individualtaxpayers(aswell as corporationsand businesses)
to raisemaximumrevenuefrom the tax laws?Or
to achievean "aesthetically"pure tax code?
Theseare the kinds of questionsthat we will needto collectively
grapplewith through political discourseas the tax laws increasein
complexityand tax policy plays such an important role in contemporary Americanpolitics.

t'! The term was definedas "a pathologicalconditioncausedby an overactivelaw-making
gland." BaylessManning, Hyperlexis:Our National Disease,Tl Nw. U. L. REv. '767,76'l
(1977).Manningwrote:"Statutorycodes,suchas thosein the fieldsofcommerciallaw and taxation, are becomingever more particularistic,longer,morecomplex,and lesscomprehensible.
We
are drowningin law." Id.



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