Taxing by default.
This paper is the first in the Canadian legal literature to address "tax elections", which bestow upon taxpayers the ability to choose among two or more available tax treatments for a single taxable event. I argue that policymakers should adopt a rebuttable presumption in favour of setting default treatments according to the preferences of a majority of eligible taxpayers, unless a "penalty default" structure can he shown to convey sufficiently valuable information to the government. To illustrate how such a presumption would work in practice, I apply it to two similar but inconsistently structured tax elections in the Income Tax Act relating to transfers of property to a spouse and to a corporation (subsections 73(1) and 85(1), respectively). I find that the design of subsection 73(1) is sound--its majoritarian default of tax-deferring "rollover" treatment avoids unnecessary transaction costs and squanders no information-forcing role. On the other hand, subsection 85(1) is counter-majoritarian, and the information disclosed jointly by taxpayers and corporations via the 85(1) election can be obtained at lower cost by requiring corporations to routinely report information about contributions of property. Mandatory reporting would also bolster the government's anti-avoidance efforts. Thus, amending subsection 85(1) to reverse its default treatment would make an important corner of the income tax less costly and, at the same time, more equitable.
Cet article est le premier dans la litterature juridique au Canada d'aborder la question des choix fiscaux, qui accordent aux contribuables la possibilite de placer un seul fait generateur de l'impot sous plusieurs traitements fiscaux. Je postule que les decideurs pohtiques devraient faire l'adoption d'une presomption refutable en faveur d'introduire des traitements fiscaux par defaut, selon les preferences de la majorite des contribuables admissibles, a moins qu'une structure > s'avere a meme de communiquer de l'information suffisamment importante au gouvernement. Pour demontrer la demarche pratique d'une telle presomption, j'applique cette derniere a deux types de choix fiscal dans la Loi de l'impot sur le revenu qui sont similaires mais structures de facon inegale : le transfert d'un bien en immobilisation a l'epoux et celui a une societe (paragraphes 73(1) et 85(1)). Je trouve que la conception du paragraphe 73(1) est valable : sa regle majoritaire par defaut, lequel consiste en un traitement de roulement a imposition reportee, evite d'ajouter des couts de transaction et d'obliger de l'information. En revanche, le paragraphe 85(1) est contre-majoritaire, et les informations declarees conjointement par les contribuables et par les societes sous le paragraphe 85(1) peuvent etre obtenues a moindre cout si on oblige les societes de faire des declarations habituelles concernant leur apport de biens. D'ailleurs, la declaration obligatoire renforcerait les efforts du gouvernement contre l'evitement fiscal. Donc, une modification du paragraphe 85(1) en vue de changer son traitement par defaut peut rendre cette procedure en droit fiscal moins couteuse et plus equitable.
Introduction I. The Transaction Cost Implications of Default Setting II. Setting Defaults to Reveal Information III. The Opposite Defaults of the Subsection 73(1) and 85(1) Elections A. Why Offer a Rollover in the First Place? B. The Subsection 73(1) Rollover 1. Mechanics 2. Statutory History C. The Subsection 85(1) Rollover 1. Mechanics 2. Statutory History IV. Evaluating Subsections 73(1) and 85(1) A. Subsection 73(1) B. Subsection 85(1) Conclusion Introduction
Even though most Canadians may not think of taxes as optional, there are over 230 provisions in Canada's Income Tax Act (the Act) (1) that give taxpayers a choice regarding how to calculate their taxes. (2) These "tax elections" are so ubiquitous as to sometimes go unnoticed as a matter of design and have generated little discussion among academics and tax experts in Canada. (3) However, ignoring the design of tax elections is perilous for a tax system that seeks to be both equitable (to engineer an after-tax distribution of resources that accords with social norms of fairness) and efficient (to raise a required amount of revenue at minimum cost).
I demonstrate in this paper that improperly structured tax elections in the Act can impose substantial transaction costs on taxpayers and the government, while squandering their intended benefits and disproportionately burdening those taxpayers least able to navigate the complexity of the election. From the standpoint of the taxpayer, a tax election offers flexibility and the potential to decrease her tax liability, but also requires her to invest resources in understanding the election. She must determine which available tax treatment is best, as well as learn how to comply with the election and bear the costs of filing it with the government (either by herself or through her tax representative).
From the standpoint of the government, another set of costs and benefits of tax elections is at play. On the cost side, tax elections require the government to invest resources in administering the election. The government must bear the costs of processing the elections that are filed by taxpayers, implementing the elective treatment as a basis for calculating taxes owed, and fielding requests from taxpayers who want to modify or withdraw tax elections (in cases where such changes to elective choices are permitted by law).
On the benefit side for the government, however, is the notion that elections can act as "screens". In the tax context, a screen is a choice offered by government that forces (at least some) taxpayers to separate into two different groups. (4) The government's resulting observation--into which group a taxpayer self-selects when presented with the tax choice--may prove useful in administering, enforcing, or tailoring the tax law. (5) In this paper, I will refer to such observations about the self-selection of taxpayers as "information"--defined narrowly as taxpayer-specific inferences that can be made by the government upon observing taxpayers' elective choices. In cases where such information is produced by an election, the information's measurable benefits must be traded off against the costs of having an election, whether or not it is structured as a penalty default-that is, as a default treatment that is contrary to what a majority of taxpayers would prefer.
Here, I analyze the trade-offs at the heart of tax elections to tackle the most basic--but arguably the most important--aspect of designing a tax election: how to determine the tax treatment that will be available to taxpayers by default. To distill a clear set of principles for policymakers, I examine the nature of the transaction costs presented by tax elections as well as the literature on default rules in the law, with an eye toward designing tax elections in a "least-cost" manner. (6) Specifically, this approach seeks to maximize the measurable benefits of a given tax election while minimizing the election's measurable costs, such as transaction costs generally or complexity costs more specifically. (7) Such an approach, while limited in that it focuses only on measurable benefits and costs, has the benefit of allowing these to trade off against one another and be calculated on a net basis, thus ensuring that fewer measurable resources in society will be devoted to activities related to tax compliance, and instead resources can be put to more productive uses.
My examination results in a straightforward prescription: policymakers should adopt a presumption that an election's default treatment should be aligned with the result that most taxpayers would prefer. This presumption is consistent with the conclusions of tax scholars Heather Field and Emily Cauble in the American context. However, I argue that this presumption should not be ironclad: it can be overcome if structuring the election as a penalty default allows the government to glean information that can be used to improve the tax system, provided that such information cannot be obtained at lower cost by other means.
How might these default-setting principles be put into practice? To illustrate how my prescription can be applied to the status quo, I explore two provisions of the Act that contain tax elections: subsections 73(1) and 85(1). These allow a taxpayer's transfer of appreciated property to a spouse or to a corporation, respectively, to be treated not as a realization event that triggers tax on any gains in the property but, depending on the choice of the taxpayer, as a "rollover" transaction in which tax is deferred until the transferee disposes of the property. (8) Despite their similar contexts, these two tax elections have opposite default treatments. Under subsection 73(1), the taxpayer defaults into rollover treatment. In contrast, subsection 85(1) requires that a taxpayer seeking rollover treatment affirmatively file an election.
Applying the default-setting prescription, I argue that subsections 85(1) and 73(1) should be structured consistently--with rollover treatment as the default. Evidence suggests that the majority of taxpayers who interact with both provisions prefer rollover treatment. Moreover, for those taxpayers who face high costs of compliance or who are unsophisticated about taxes, filing an election may prove too costly or burdensome to be workable. And there is little evidence that a rollover election could convey information to the government in the screening sense; taxpayers may have idiosyncratic reasons for wanting to obtain or depart from rollover treatment, and their choices in this regard would not seem to support inferences that would be useful to the tax authorities. As a result, setting the default treatment of the subsection 85(1) election as a rollover so that most taxpayers are not required to incur the costs of...
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