Deregulation has been a major priority of the Trump administration since the president’s first days in office. Implementing it in the tax area is still a work in progress that’s been heavily shaped by the events that preceded it.
Just over four years ago, the IRS and Treasury stood on the brink of major changes in the way tax regulations would be developed, written, and reviewed. The confluence of pivotal judicial developments and the new administration meant that preambles and the review process were poised for dramatic changes. The Tax Cuts and Jobs Act served as both an accelerant and a testing ground for the increased focus on procedure. The ongoing effort has had its share of growing pains, some of which have yet to be fully worked out, but it has had a profound effect on the regulatory process and its products.
One significant influence on the IRS and Treasury’s tax guidance practices in the past four years has been Altera Corp. v. Commissioner, 145 T.C. 91 (2015) — it and other cases have prodded the IRS and Treasury into changing the way they draft regulations and other guidance. In Altera, the Tax Court found that Treasury’s rationales and responses to comments given in the preamble to cost-sharing regulations were deficient.
Although the IRS and Treasury won Altera in the Ninth Circuit (Altera Corp. v. Commissioner, 926 F.3d 1061 (2019)), they “certainly have understood that the prior practices in terms of explaining their reasoning were deficient and have done an excellent job of correcting those deficiencies,” said Patrick J. Smith of Ivins, Phillips & Barker Chtd. “It’s like night and day compared to the way they did things before,” he added, pointing to the voluminous explanations of decisions and responses to comments in preambles that have come out in the last few years.
The new review process in the Office of Management and Budget’s Office of Information and Regulatory Affairs, court decisions, changes in IRS and Treasury personnel, and increased congressional attention to tax administration issues are among the factors shaping the tax regulatory process in recent years, said Kristin E. Hickman of the University of Minnesota Law School, who previously served as a special adviser to OIRA. She added that the past four years have challenged the IRS in many ways, including its continued budgetary constraints; implementation of the TCJA and the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136); and the effects of COVID-19.
Early Focus on Regulatory Burden
The early deregulatory measures affected tax rules less than they did other regulations generally. In the early months of 2017, the White House and the Republican-controlled Congress used the Congressional Review Act to undo 14 rules issued toward the end of the Obama administration, according to data from the George Washington University Regulatory Studies Center. But none of those rules concerned tax.
The Economic Report of the President issued in February 2020 touted the 2-for-1 order from January 2017 as having resulted in more than two significant regulations being eliminated for each new significant regulation that has been finalized. Ten days after assuming office, President Trump signed an executive order that required agencies to implement the one-in, two-out policy for regulations issued in 2017. (Prior coverage: Tax Notes, Feb. 13, 2017, p. 786.) For years beyond 2017, the order requires that any regulation that would increase incremental cost be offset by eliminating existing rules. The impact of the 2-for-1 order on tax regs was primarily the removal of 296 “deadwood” regulations (T.D. 9849).
On April 21, 2017, the White House issued Executive Order 13789, which directed the Treasury secretary to review all significant tax regulations issued after January 1, 2016, and consult with OIRA on them. The order required a report to the president identifying any of those regulations that impose an undue financial burden on U.S. taxpayers, add undue complexity to the tax laws, or exceed the IRS’s statutory authority.
The order also directed Treasury and OMB to review and potentially reconsider the scope and implementation of the exemption in Executive Order 12866 for some tax regulations from the review process. That order was issued in 1993, and it required OMB review of regulatory actions likely to result in an annual effect on the economy of $100 million or more, materially hurt the economy or a sector of the economy, or raise novel legal or policy issues.
The effect of the early deregulatory efforts by the Trump administration on tax regulations was more muted than what came during the second year, but that was in part because of the passage of the TCJA in December 2017. The new law and the attendant need for guidance that it produced brought review of tax regulations to the forefront.
April 2018 MOA
On April 11, 2018, Treasury and the OMB signed a memorandum of agreement (MOA) on how OIRA would review tax regulatory actions. The MOA prescribed review when a regulatory action may create a serious inconsistency or interfere with an action taken or planned by another agency, raise novel legal or policy issues, or have an annual non-revenue effect of $100 million or more. Treasury is obligated under the MOA to update OIRA quarterly on planned guidance by describing the regulatory action, identifying any significant policy changes, and articulating the basis for determining whether the action should be reviewed. Because of this, formal cost-benefit analyses are now required of more tax regulations than previously.
The MOA put regulations from the IRS and Treasury on the same footing as other regulations from the executive branch, except that it gave OIRA only 45 days to review tax regulations. The typical review period is 90 days. The IRS also had a grace period for a year after the signing of the MOA in which it wasn’t required to do as much economic analysis as other agencies. Jerry Ellig of the Regulatory Studies Center looked at the economic analyses that the IRS and Treasury produced during that period from April 2018 to April 2019 and identified areas in which the IRS could improve its assessments, particularly by moving to a pre-statute baseline and avoiding the blanket claim that clarification of the law is a benefit. (Prior analysis: Tax Notes, May 20, 2019, p. 1181.)
When OMB released its first regulatory agenda after the MOA was signed, the number of significant tax projects jumped from six in the prior year to more than 50. (Prior coverage: Tax Notes, Oct. 22, 2018, p. 516.) The spring 2020 unified agenda lists 187 projects for the IRS. (Prior coverage: Tax Notes Federal, July 6, 2020, p. 150.)
Because the MOA wasn’t prompted purely by the Trump administration’s deregulatory agenda, “I do not foresee that the memorandum of agreement will be rescinded, irrespective of who wins the election,” Hickman said. The MOA had the support of then-OIRA Administrator Neomi Rao and the Trump administration, but bipartisan support from Congress played an important role in pushing Treasury to agree to OIRA review of tax regulations, she said.
The MOA has clearly affected the reg drafting process, Hickman said. But exactly how the MOA plays out daily may depend on who’s in charge of OIRA, and a subsequent administration may modify the nuances of the review process for tax rules and regulations. A year after the MOA was signed, both Rao and Hickman left OIRA, but the process for review was firmly in place then, and it doesn’t seem to have been altered much since.
Smith said the before-and-after versions of regulations that show what changes were made during OIRA’s review suggest that few happen during the review process. He said the revamped process is a big change that will hopefully have a greater impact as time goes on and the government officials who are implementing it become more experienced.
March 2019 Policy Statement
On March 5, 2019, the IRS and Treasury issued a policy statement that reaffirmed their “commitment to a tax regulatory process that encourages public participation, fosters transparency, affords fair notice, and ensures adherence to the rule of law.” It suggested that the use of temporary regulations would be limited to “exceptional circumstances” and promised that a statement of good cause would always be included in any temporary regs.
The policy statement also addressed guidance that isn’t issued as regulations and pledged to adhere to the requirement that this subregulatory guidance not be used “to modify existing legislative rules or create new legislative rules.” The statement reiterated that the IRS won’t take positions inconsistent with its subregulatory guidance and that it won’t seek judicial deference to interpretations that appear only in subregulatory guidance.
The sharp decline in the use of temporary regulations is one positive result of the policy statement, Smith said. But there is still work to be done. The IRS and Treasury tend to issue regulations that purport to give them the authority to expand the regs’ scope by publishing documents in the Internal Revenue Bulletin, such as notices, he said. “The practice of doing this in regulations is a clear violation of the notice and comment requirements in the Administrative Procedure Act and is an area where I think there is room for improvement,” Smith said.
More Work in Progress: Economic Analyses
The promise of economic analyses is that they will compel agencies to consider the effects of regulations more systematically, but that hasn’t yet come to fruition. The recent history of the IRS and Treasury’s attempts to conduct regulatory impact analyses for tax rules is one of uneven steps toward the ultimate goal of a useful final product. Part of the problem is that including how a tax regulation helps fulfill Congress’s intent in enacting a statute isn’t as easy to execute as, for example, including an assessment of how an environmental regulation improves health outcomes. (Prior analysis: Tax Notes, Nov. 7, 2016, p. 749.)
There’s room for improvement in the way the IRS performs its economic analyses, but it has also noticed some types of regulatory benefits and costs that other agencies often ignore. Ellig said the agency has been qualitatively trying to assess the costs and benefits of regulations, but that Treasury’s tremendous analytical capabilities haven’t yet been brought to bear on tax regulations quantitatively.
The IRS, like many agencies, has also struggled to analyze the underlying problem, instead simply asserting that its regulations are necessary to implement the statute, Ellig said. “But citing a statute isn’t the same thing as analyzing a problem,” he noted.
However, the IRS is adept at identifying inefficiencies such as when taxpayers make wasteful investments solely for tax purposes, Ellig said. “The idea that people will spend money to try to create or avoid transfers of wealth is a fundamental economic insight that other agencies hardly ever include in their economic analyses,” he said.
Smith said he has been disappointed in the cost-benefit analyses accompanying regulations because they largely omit consideration of how taxpayers will likely respond to a regulation. “I would like to see more of an understanding of how the different tax rules affect real-world behavior,” he said, pointing to situations like the nonresident alien interest reporting requirements, under which affected individuals would withdraw their money from U.S. banks.
In a recent report from the Washington Center for Equitable Growth criticizing the implementation of cost-benefit analyses of the TCJA, Greg Leiserson proposed eliminating the requirement altogether and instead requiring an assessment of revenue impacts, the distribution of the tax burden, and compliance costs. Leiserson said the focus on efficiency is misplaced and that it stems from the framework for cost-benefit analysis mandated by OIRA. “OIRA guidance, however, is well-suited only to a limited set of economic questions, primarily those related to externalities and decision-making biases, and when distribution is not a primary concern,” he wrote.
Another aspect of the discussion of regulatory impact analyses is that tax regulations aren’t uniformly concerned with raising revenue. The regulatory and social welfare programs that Congress has chosen to administer through the tax code should be susceptible to a regulatory impact analysis, as is done for similar direct spending or command-and-control programs, Hickman said. The broader question whether regulatory impact analysis is appropriate for tax regulations might need to distinguish between traditional regulations oriented toward revenue-raising and regulatory programs in the tax code, and whether and to what extent the regulatory impact analysis should be different in those two situations, she said.
The deficiencies in regulatory impact analysis of tax regulations aren’t unique to the past four years, and the pattern suggests that Treasury and the IRS may be improving. For example, the cost-benefit analysis of the section 385 regulations proposed in 2016 (REG-108060-15) addressed only anticipated revenue and compliance costs, omitting any discussion of alternatives, behavioral effects, or distribution of the tax burden. At the time, cost-benefit analyses weren’t required to be included in preambles, so that analysis was separate. (Prior coverage: Tax Notes, Apr. 22, 2019, p. 526.)
But subsequent economic analyses seem to have moved closer to the standards set out in OMB’s Circular A-4. The IRS is still on a learning curve, and since it has had a later start than other agencies, it could still take time to refine its economic analysis practice.
The shift in regulatory practices at the IRS and Treasury over the past four years hasn’t been solely attributable to the effects of the Trump administration’s priorities, but the administration’s imprimatur is clearly reflected in many of the new practices and procedures. The result is a more refined process for drafting and reviewing guidance that remains unfinished.