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The More Things Change The More They Remain The Same

Posted on June 27, 2022

Today’s post is the last in the three-part series from Professor Bryan Camp addressing how to classify tax regulations under the APA. In today’s post, Bryan considers whether current tax administration involves social policies and non revenue raising functions more so today than the past. He concludes by offering observations on two recent cases, Oakbrook Land Holdings v Commissioner and Rogerson v Commissioner. Les

To recap: we are concerned with the question of how must Treasury regulations be promulgated to be in conformity with the APA. All agencies must conform to the APA. No one doubts that. The discussion is about the proper relationship—or fit—of Treasury Regulations to the APA. Jack Townsend posted his views that the APA does not require most Treasury regulations to be issued through the notice and comment process because they are interpretive regulations and not legislative regulations. Kristin Hickman posted her views that ALL Treasury Regulations are legislative. And she says her views are the new orthodoxy.

But if hers is the new orthodoxy, there are still heretics. I’m one. I agree with Jack that most Treasury Regulations are properly classified as interpretive regulations.

In my last post I attempted to show how everyone in the 1940’s and 1950’s believed most Treasury Regulations were interpretive. Kristin properly responds with a “so what.” Times change and Kristin pushes the idea that the function of tax administration has transformed from revenue raising to social policy implementation. She’s not the only one. I encourage readers to check out these two great articles: Susannah Camic Tahk, Everything is Tax: Evaluating the Structural Transformation of U.S. Policymaking, 50 Harv. J. Legislative 67 (2013); Linda Sugin, The Great and Mighty Tax Law: How the Roberts Court has Reduced Constitutional Scrutiny of Taxes and Tax Expenditures, 78 Brooklyn L. Rev. 777 (2103).

So today’s post is to take a look at the claim that tax administration has changed sufficiently to change how we classify Treasury Regulations. Big caveat here: it also may be that other changes in the law or in society now make it appropriate to classify Treasury Regulations as legislative and not interpretive. I’m not going there today.

Much of the recent scholarship on how tax administration has changed focuses on various transfer programs—notably the Earned Income Tax Credit (EITC) and the Affordable Care Act (ACA). Some commentators have suggested that the social welfare function served by the EITC should trigger a reformed due process analysis for tax administration. I really like this article by Megan Newman, Low-Income Tax Gap: The Hybrid Nature of the Earned Income Tax Credit Leads to its Exclusion from Due Process Protection, 64 Tax Lawyer 719 (Spring 2011). And Les keeps telling me that tax issues for Low Income Taxpayers are really issues about subsidies.   He gives a great presentation of these views in his article Nina Olson: A Champion for Taxpayer-Centered Tax Administration, 18 Pitt. Tax Rev. 117 (2020). Surely it seems that the IRS is now tasked with jobs would be foreign to those living in the 1940’s and 1950’s.

I agree with much of that. The basic idea is that much of the tax laws serve non-revenue raising functions. That necessarily means that what are ostensibly tax regulations may serve those functions as well, including poverty relief, etc. I get that. What I am skeptical about are claims that tax administration today involves social policies more than it did at or before enactment of the APA. Remember, that’s our inquiry: has tax administration changed such that tax regulations today are doing something qualitatively different than they did in the 1940’s and 1950’s when everyone agreed with Professor Davis that “the great bulk of Treasury Regulations under the tax laws clearly are interpretative rules, not legislative rules….” Davis, Administrative Law Text (1959) at p. 87.

I have three reasons to doubt claims that tax administration today involves social policies more than it has in the past.

First, I don’t even know the baseline. How do you measure the extent to which tax laws are “oriented” towards or away from revenue collection? In her “Administering The Tax System We Have” article, Kristin made a good stab at it. She tried to quantify by studying tax regulations over a three year period. She created a fairly elaborate coding system and concluded that a substantial % of tax regulations were “oriented away” from revenue raising. One of several difficulties with that project was that she had no historical baseline. So while she could draw some (debatable) conclusions about the current allocation of administrative efforts between “revenue-raising” and “social policy” implementation, she could draw no historical conclusions.

Second, it is not clear whether this recent tax scholarship reflects real change or just a change in awareness among tax academics. Collecting taxes has always been intimately bound up with social policy. Scholars in other disciplines have known this for forever. Economics know this. Check out Joseph Schumpeter’s 1918 classic “The Crisis of the Tax State”, an extended (and rather hyperbolic) examination of the relationship between taxation and social economy. Historians know this. See, Isaac William Martin, Ajay K. Mehrotra, and Moica Prasad, The New Fiscal Sociology: Taxation in Comparative and Historical Perspective (Cambridge University Press 2009), collecting essays from many historians. No free link to the book, but you can check out my review of it in the Am. Journal of Legal History. In particular, historians of slavery know this. See e.g. Robin Einhorn, American Taxation, American Slavery (U. Chicago Press, 2006).  Political Scientists know this. See, e.g. Julian E. Zelizer, Taxing America: Wilbur Mills, Congress, and the State, 1945-1975 (Cambridge University Press 1998). Folks, that’s just pulling off the top of my head from stuff I’ve actually read. I’m sure a little digging will reveal much more.

Third, while I agree that the objects of Congressional solicitude have expanded (EITC, ACA premium credits, clean energy tax credits), I am skeptical that this represents a fundamental shift in the use of the tax laws. I think it rather represents a shift in which social policies get put in the tax laws. History gives us many examples of how Congress has used the taxing power for purposes other than revenue raising. I think a few examples from this history shows the difficulty in arguing that tax administration is now, in any relevant sense, more “oriented away” from revenue raising than it was before the APA.

We tend to think that because historical actors had simpler technology they also had simpler minds. They did not. They just did not have the internet. Throughout history there have always been really strong non-revenue raising policies embedded in tax provisions, and folks have always been acutely aware of the non-revenue effects of tax laws.

Let’s take a look.  

Start with Formation of the Republic. The first use of tax law to further a social policy and not raise revenue is right there in Article 1, Section 2, Clause 3 of the U.S. Constitution. It’s the great compromise: in exchange for allowing enslaved persons to be counted for representation purposes, the Constitution also created a tax break: “direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons.” That’s a tax law. And it was about must more than revenue raising! It was about embedding slavery into the new American republic.

Not everyone bought into the compromise. Some Southerners opposed it because they feared Congress would use taxation to achieve abolition. Since enslaved persons were property, abolitionists would use the federal power to impose “a grievous and enormous tax on it, so as to compel owners to emancipate their slaves rather than pay the tax.” That’s from the formerly sainted Patrick Henry, as quoted in Robin Einhorn, American Taxation, American Slavery (U. Chicago Press, 2006). at 181. Others disagreed with Henry’s analysis, but the very robustness of the debate demonstrates the awareness in the 1780’s of how tax systems are used for non-revenue purposes.

Move to the early republic. Understand that before 1862 the federal government’s revenue came almost entirely from tariffs. Historical Statistics of the United States, 1789-1945, Table Series P 89-98 (“Federal Government Finances”), pp. 295-298. Ok. Do YOU want to argue that tariff legislation did not have a significant non-revenue function? I thought not. But if you really think that tariffs were even mostly about revenue raising, I recommend you read this commentary from one of the leading tariff lawyers of his day: William McKinley, The Tariff in the Days of Henry Clay and Since: An Exhaustive Review of Our Tariff Legislation from 1812 to 1896 (Henry Clay Publishing Co., 1896). He’ll set you straight. And the title is not misleading. It’s an exhaustive read. While we might today ignore tariffs because they account for so little of the federal government’s revenue, remember again that in the mid-1800’s, tariffs were pretty much the entire funding mechanism.

And yet it was during this very time—mid 1800’s, when tax administration was chiefly focused on tariff administration—that courts created the doctrines regarding both issuance and authority of tax guidance that lawyers in the 1940’s believed to be in harmony with the commands of the APA. That’s in my History of Tax Regulations article.

Move to the Civil War. Few would argue that the Revenue Act of 1862 was anything other than a revenue raiser. Yet even there Congress wrestled with social policy, in the form of what tax breaks to give various classes of taxpayers. That’s what we call “tax expenditures” today. For example, shortly after Congress enacted the very first income duty in 1862, folks pointed out that the failure to tax owner-occupied housing constituted a tax subsidy that discriminated against renters. There was back and forth on this issue for several years. Congress even created a special Commission to study the problem. But Congress refused to tax the imputed income of self-owned property, for policy reasons. In fact, Congress explicitly excluded the rental value of self-owned homes from gross income but, to equalize, permitted a deduction for house-renters of their house-rents. Revenue Act of 1864, 13 Stat. 223, 281 (§117).  When the income tax was reinstated in 1913, Congress dropped the house-rent deduction (but kept the imputed income exclusion), over the objection of then Senator (and future Justice) Sutherland, who protested this discrimination against house renters. See Seidman’s Legislative History at 992-993.

Move to 1913. Let’s talk charities. When it revived the income tax in 1913, Congress had social policy reasons for exempting certain organizations if they were organized “exclusively” for various purposes, including religious, charitable, scientific, or educational purposes, so long as “no part of the net income of which inures to the benefit of any private stockholder or individual.” 38 Stat. 114, 172.

Whatever you believe the social policy for tax exempt organizations to be—and Professor Atkinson gives a thorough review of many of them in his article Theories of the Federal Income Tax Exemption for Charities: Thesis, Antithesis, and Syntheses, 27 Stetson L. Rev. 395 (1997)—the policy is in considerable tension with the revenue function of tax, even if the JCT (for reasons I do not understand) does not include this exclusion in its yearly list of tax expenditures.

The BIR was left to grapple with drawing the social policy lines in the 1910’s and 1920’s, long before the APA. For example, would income derived from unrelated business activities be subject to tax if it was used entirely for an organization’s exempt purpose? The BIR said yes; the Supreme Court said no. Trinidad v. Sagrada Orden de Predicadores de la Prvincia del Santisimo Rosario de Filipinas, 263 U.S. 578 (1924). What about a company formed to provide employment to members of a certain labor union, all of whose the profits went to the labor union? Was its income exempt? The BIR said no. And here’s a funny thing: that position was embedded in sub-Treasury guidance and never challenged. Legislative rule? Interpretive rule? The original decision was in Office Decision (O.D.) 523, 2 C.B. 211 (1920). The position was re-affirmed by Rev. Rul. 69-386, 1969-2 C. B, 123, and up until the TE/GE “scandal” was found in IRM 05-21-2014)(“Nonqualifying Activities”). I don’t know where it is now.

But What About the EITC? It is commonly believed that Congress created the EITC in 1975. See, e.g. Dorothy Brown, The Tax Treatment Of Children: Separate But Unequal, 54 Emory L. J. 757, 766 (2004). Not quite. It is more accurate to say that Congress revived the EITC in 1975. The EITC first appeared in §206 of the Revenue Act of 1924 in the form of a tax credit equal to 25% of earned income. The credit continued until 1932 when it was demoted to a deduction. This smaller relief eventually died in 1944, succumbing to the revenue demands of WWII, the expansion of the class tax to a mass tax, and the creation of the standard deduction.  

The social policy behind the 1924 EITC was similar to that of the 1975 EITC and was equally in tension with revenue-raising. Actually, it appears more in tension with revenue raising. Both policies were intended to “orient” the law towards promoting social justice and “orient away” from revenue raising. But guess what, folks. Concepts of social justice change. The current EITC is viewed as being in lieu of welfare payments to the poor, the idea being that this netting mechanism is more efficient than having one hand of the government paying out benefits while the other hand collects taxes. The 1924 EITC had a similar social policy but directed at a different class of taxpayers: wealthy wage earners who had the same income as those whose income was due to returns from capital. And why did Congress view that as social justice? Why because those wage-earners needed help to save for their retirement in a way that those who were able to generate income from capital did not need. And since those earning income from captial had gotten a HUGE tax subsidy starting in 1921, wage earning accounts, lawyers, and doctors believed they were getting shafted. Equalizing those classes of taxpayers involved a potentially larger hit to revenue than shifting welfare payments to the poor into the tax laws. The legislative history contains back-and-forth debates in Congress over the extent to which revenue needs outweighed the social policy, and vice versa. You can find the grody details in Bryan Camp, Franklin Roosevelt and the Forgotten History of the Earned Income Tax Credit, 20 Green Bag 2d. 337 (2017).

My Bottom Line: Certainly tax administration has changed since enactment of the APA. But the changes that are perhaps most relevant to administrative law are procedural changes, not a reorientation of the tax system or a re-balancing of revenue and non-revenue functions. That is, while I am skeptical that the tax system created by Congress has changed in ways that create a different relationship with the APA, I am concerned that the tax system administered by the Service has changed, and dramatically. As I spell out in excruciating detail elsewhere, tax administration is now driven by computer and computer coding. Bryan T. Camp, Theory and Practice in Tax Administration, 29 Va. Tax Rev. 227 (2009). This debate about “legislative” and “interpretive” regulations is less important, I think, than recognizing that agency rules encoded in computers have a “force of law” in a much more immediate and real-world way than do the issuance of tax regulations. Just ask anyone whose electronic filing is rejected! But I don’t hear Kristin or anyone demanding that every computer coding change go through notice and comment process! I think these changes create a need to rethink conceptions of due process, but leave that discussion to a different time and place.

Concluding Thoughts: The Weird Results If All Regs Are Legislative

Kristin’s views are definitely trending and becoming the new orthodoxy. In fact, you are likely committing malpractice if you are not mounting a procedural attack on any and all administrative guidance adverse to your client!  

But some weirdness is starting to appear. Go read Judge Guy’s concurrence in Oakbrook. Then go read Judge Toro’s recent opinion in Rogerson v. Commissioner, T.C. Memo 2022-49 (May 12, 2022). Or just keep reading my scribbles here.

The issue in Oakbrook was whether the taxpayer was entitled to a massive deduction for a conservation easement. The statute requires that a conservation purpose must be guaranteed in perpetuity. §170(h)(5)(A). Treasury has issued a regulation saying that to meet the perpetuity requirement easement agreements must provide for a particular distribution of proceeds if unexpected events require the later sale of the property subject to the easement. Treas. Reg. 1.170A-14(g)(6)(ii). The IRS did not think the Oakbrook easement met the statutory perpetuity requirement because it did not meet the regulatory requirement.

Channeling Kristin’s views of tax regulations, the taxpayer argued that the regulation was invalid because Treasury had not properly promulgated it. The government said “no, we issued the regulation properly.” Two of the judges in Oakbrook agreed with the government and found that Oakbrook did not comply with this validly issued regulation, splitting with the 11th Circuit.

Judge Guy, however, took a different approach. He agreed with the taxpayer that the Treasury Regulation was improperly issued and so was invalid. In fact, he recites the Myth of Mayo by using it to justify, without explanation, his sub-silentio conclusion that the proceeds regulation was a legislative regulation. Here’s what he says, using the money quote from Mayo:

“The Department of the Treasury must play by the same rules as other federal agencies. The Supreme Court made that clear when it refused to carve out an approach to administrative review good for tax law only and expressly recognized the importance of maintaining a uniform approach to judicial review of administrative action.” (internal quotes omitted)

I hope you see the myth there. The battle in Oakbrook was not a battle about what deference to give the regulation; it was about whether the regulation was validly issued. A void regulation gets no deference because there’s just no there there, just empty space where a regulation might have been. So who cares what Mayo says about deference? Kristin is correct that courts do not appear to care whether Treasury regulations are or are not subject to notice and comment requirements. Everyone in this case assumed the regulation was legislative.  

But was it? Judge Guy’s concurrence undercuts that assumption. After finding the regulation void he then went on to say that the taxpayer loses. He still thought that the easement agreement did not satisfy the perpetuity requirement. Why? Well, gosh, he interprets the statute to reach that conclusion! He applies traditional tools of statutory interpretation to decide what the word “perpetuity” means and then finds that Oakbrook’s easement agreement did not satisfy his judicial interpretation of what “perpetuity” requires.

Hmmm. So let me get this straight: when Judge Guy does it we call it “interpretation.” But a Treasury Regulation doing the same thing is not an interpretive regulation? It’s a legislative regulation? That makes no sense to me.

Rogerson presents a similar scenario. There, the taxpayer had a bunch of losses from a yacht leasing activity in 2014, 2015, and 2016. They were passive losses and, as readers know, that meant he could only take them against gains from passive activities. Thus says §469(a). It just so happened that he reported a bunch of gains from ownership in three S corporations in those years, all of which he reported as passive activities. The trouble was, for the nine years prior to 2014, he had reported his involvement in the predecessor corporation as active.

The issue in the case was whether Mr. Rogerson materially participated in the S corps in the three years at issue. The statute is notoriously unhelpful here, saying only that a taxpayer’s participation in an activity is active when the taxpayer “materially participates” in the activity. The statute then says a “taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is—(A) regular, (B) continuous, and (C) substantial.” §469(h)(1). Ok. Sure. But what do those words mean? How are we to interpret those words? Well, there are regulations for that.

The applicable regulations say that a taxpayer can satisfy the statutory requirement if they meet any one of seven tests laid out in the regulation. One of the tests is that the taxpayer has materially participated in the activity for five of the ten years before the year in question. Temp. Treas. Reg. § 1.469-5T(a)(5).

Yep. It’s one of those Temp. regs from long, long ago that was grandfathered when Congress revised §7805 to limit Temp regs to three years. This one is from 1988. To complicate matters, Treasury issued associated regulations after that and then modified them with the result, says Judge Toro, that “today, the five of ten test appears in a temporary regulation, while the rule explaining how the five of ten test should be applied appears in a final regulation.” Op. at 18.

Flourishing the exceptionalism myth, the taxpayer’s attorney attacked the Temp. Reg., trying to avoid having his material participation in prior years count against him in the years at issue.  If the taxpayer could get that nasty regulation voided, then it would appear the taxpayer would be home free.

Not so fast. It is true that Judge Toro thought the regulation was valid and applied it. Bummer for Mr. Rogerson. But then Judge Toro adds an analysis much like Judge Guy’s concurrence in Oakbrook; he looks at whether Mr. Rogerson’s activities were material participation within the meaning of the statute, disregarding the regulations.

“To summarize, Mr. Rogerson would not prevail even if he were correct about the procedural validity of the five of ten test, because we find that he was regularly, continuously, and substantially involved in the operations of RAEG during 2014, 2015, and 2016 within the meaning of section 469(h). Accordingly, we need not decide whether the five of ten test is procedurally valid and turn instead to Mr. Rogerson’s final argument.” Op. at 27.

Hmmm. So let me get this straight: if you maintain (as Kristin does) that the Treasury Regulation creating the five in ten rule was a “legislative” action and not an “interpretive” action, then is not Judge Toro also engaging in a “legislative” action? Just like Judge Guy? Contrariwise, if you say Judge Toro was engaging in mere “interpretive” actions, then how is a Treasury Regulation that does the same thing any different? How is it not an interpretive action as well?

There are several answers to that. Kristin’s answer, of course, is the Myth of Mayo: Mayo transformed ALL Treasury regulations into legislative rules because they now carry the mythic “force of law.” Treasury would agree that this regulation was a legislative one, but for a different reason: the regulation was not issued under the general authority in §7805 but was instead issued under specific authority given Treasury to “specify what constitutes…material participation…for purposes of this section.” § 469(l)(1).

To me neither are satisfactory answers.   Both are form-over-substance reductions.  Kristin’s answer that “force of law” makes a rule legislative is not only reductionist but also circular. It obliterates the APA distinction, despite her protestations (she writes “The fact that Treasury regulations do not qualify as interpretative rules does not mean that no agency pronouncements qualify as interpretative rules; plenty of agency pronouncements, including by the IRS, fall under the interpretative rule category for APA purposes. Just not Treasury regulations.”). Treasury’s answer used to make some sense but has become disconnected from substance over time as Congress randomly authorizes regulations in specific statutes when the general authority would suffice. In Rogerson, for example, Treasury did not need specific authority to interpret the statutory test for material participation. Ya got three statutory words: regular, substantial, continuous. What those words mean is an interpretive task, whether done by a single judge or by the Treasury Department.

I think there’s a better way to distinguish “interpretive” from “legislative” rules. It involves looking at each agency, and evaluating what the agency action is attempting to do in relation to its organic statute. It’s an agency-by-agency determination, not some unified field theory of administrative law. The APA is not a hammer. But I promised Les I’d keep this under 4,000 words and I’m already over that, so I must leave those thoughts for another day.

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