At the Canadian Tax Foundation\u27s Twelfth Tax Conference, Professor Blum discussed what role the judiciary and the legislature should each play in closing some of the loopholes present in the tax code.    Professor Blum argues that the courts should limit themselves to the legislative intent of a particular tax rule to close these loopholes.  He then examines what the legislature has done to close loopholes (qualifying certain rules, enacting specific rules as loopholes appear, or attempting comprehensive reform of a specific area of tax law), and ends with an appeal to a reasonable tax law

Blum, Walter J.

English

University of Chicago Law School: Chicago Unbound

4 The Law School Record Vol. 8, No.1The Tax Avoidance Problem tn theUnited Statesby Walter J. BlumProfessor of LawThe University of Chicago Law SchoolThe following paper was delivered at the Twelfth TaxConference of the Canadian Tax Foundation in Winni­peg, Canada, in November, 1958. It is printed herewith the kind permission of the Foundation.I have taken on the task of commenting brieflyupon the tax avoidance problem under the UnitedStates income taxes.Let me begin by defining the problem. I conceiveof it as centering on the question of what is to bedone about efforts of taxpayers to minimize theirtaxes by arranging their affairs in more or less abnor­mal or forced ways so as to comply literally withstatutory provisions that confer certain tax advan­tages. Please note that I have narrowed the topicsomewhat. Excluded from it are attempts to stretchor distort accounting judgments or classifications incomputing taxable income. Also left out are effortsto defraud the government by willfully and knowinglymaking out a false return, or by manufacturing untrueevidentiary documents, or by doing the numerousProfessor Walter J. Blum.things that are commonly regarded as tax crimes.My subject concerns the gentle and sophisticated taxdodger who hopes to succeed by taking advantageof the law rather than by disobeying it. Fcrtunately,I am not called upon to locate a precise line of de­marcation between tax avoidance and tax fraud orevasion.Our campaign against the tax dodger has beenanchored mainly in the judiciary and legislature.While the Treasury has attempted to combat avoid­ance in the promulgation of regulations, this activityhas been of secondary importance, except where thestatute confers special power on the administrators inavoidance situations. Some commentators have sug­gested that the most logical way to deal with thewhole tax dodger problem would be to invest theTreasury with broad substantive power to refine thestatutory rules in response to taxpayer ingenuity.There is, however, virtually no support for undertak­ing so far reaching a reform in our tax system. Onthe contrary, the impartiality of the Treasury is stillwidely questioned.The courts generally have been in the forefront indealing with the avoidance problem. From the judi­cial perspective, the central question can be restatedas this: Under what circumstances is formal compli­ance with the explicit terms of the statute enoughto attain a tax advantage which it purports to confer?Obviously this is basically a matter of statutory inter­pretation. But it is one of peculiarly vital importancefor our tax structure. If the courts were to hold theview that form always must prevail (unless the legis­lature has specified otherwise), tax dodging wouldbe too easy, the public would soon become disturbed,and the voluntary compliance foundation of our sys­tem would be weakened. If the courts were to takethe extreme opposite view that form need never pre­vail (unless explicitly provided by statute), tax lawwould become too uncertain, and the resulting chaoswould materially impede business and financial opera­tions. Our courts understandably have chosen a mid­dle ground: form must sometimes prevail but notalways. And thus we face the basic judicial problemof under what circumstances is it to prevail?In reading the innumerable decisions in which thisquestion was at issue, one is not likely to find manycomfortable answers. In part the difficulty lies in therhetoric of saying that a taxpayer is free to arrangehis affairs so as to minimize taxes, and that a tax sav­ings motive is immaterial in applying the statutoryrules (unless the statute states otherwise). This kindof talk by courts solves nothing. The intent to mini­mize taxes cannot control the question whether fcrmshould prevail because almost all rationally plannedbusiness transactions do take taxes into account; andVol. 8, No.1 The University of Chicago Law SchooiThree members of the Supreme Court of Illinois are graduates of the Law School. Pictured above, at the dinner for entering stu­dents, are, l�ft to right, justice Walter V. Schaefer, jD'28, justice Harry B. Hershey, [D'Ll., and justice Charles H. Davis, jD'31.it should be equally plain that if such an intent werenot present, there would be no tax dodger problem.Another part of the difficulty is that decisions oftenseem to be by invective alone. It appears that thetaxpayer loses because something he has done is saidto be a "sham" or "artifice," or "device" or even worse.Such a finding might be a sound basis for decisionwhere the taxpayer has represented that he has donesomething - such as organized a corporation - whenin fact he has done nothing of the kind. In the caseswe are dealing with, however, the taxpayer in facthas followed the form he has selected, even thoughhe chose it only because of tax considerations. Tocall one of these transactions a sham is merely a wayof stating the conclusion that the form is not control­ling, without telling us why adherence to form in theparticular case was not acceptable. It probably isalso a way of revealing the emotional reaction of thecourt to the taxpayer's cunning.A similar trouble is encountered in decisions whichgo against the taxpayer on the precept that the taxresult is to be governed by what was actually donerather than by some declared purpose, or that thetransaction under scrutiny is not in fact what it ap­pears to be in form. These are both ways of statingthat in the particular case substance is to govern overform, but in themselves they fail to teach us whythese cases differ from the many situations in whichform does control.Equally unenlightening are most of the decisionswhich rest merely on a purported discovery of a moreor less particularized legislative intention. Almostalways the actual controversy arises because the leg­islature has not provided a sufficient guide on thepoint and the court is called upon to repair the omis­sion. Although judicial deference to legislative inten­tion is statesmanlike, it need not obscure the fact thatContinued on page 28Vol. 8, No.1 The Unioersitq of Chicago Law School 29will suffice. If only a modicum of such purpose isenough, the skilled tax practitioner perhaps can becounted on to arrange for its presence. But if a verysubstantial dose is demanded, the requirement mightdefeat many transactions which the business commu­nity regards as normal. From the Treasury's view­point, however, the uncertainty might be other thanan evil. Taxpayers are forced to operate without aroadmap for successful tax dodging, and the resultingdoubts about the terrain clearly have the effect ofreducing the magnitude of the problem by discour­aging experimentation with novel transactions.These characteristics of the judicial approach tocoping with tax dodging bring us to the legislativeefforts. In the main they have followed three patterns.One has been to specifically qualify certain ruleswith a hroad directive regarding the consequencesof a tax savings motive or an absence of businesspurpose. Legislative directions of this nature havebeen given a variety of expressions. The taxpayer isto lose if tax avoidance is found to be a principalpurpose, or he is to lose only if it is found to be theprincipal purpose, or only if it is found to be a majorpurpose; and furthermore, the words with which theburden of proof is placed on the taxpayer have dif­fered in their forcefulness. All such directives, how­ever, have one thing in common. Regardless of theirparticular phrasing, they embody a kind of circularity.Improper tax minimization is enjoined by requiringa showing that tax avoidance was not high on thelist of motivations. But since the transaction, if itpasses muster, does result in a tax advantage, andsince we can't expect the rational taxpayer to beShown above is a Class of 1924 Luncheon held for Hon.Willis H. Ritter, Chief Judge, U. S. District Court for theDistrict of Utah, and a member of the Alumni Board. Re­sponsible for the arrangements teas Charles A. Bellows, whois standing, second from left.blind to this fact, the courts ultimately are requiredto distinguish between acceptahle tax minimizationand unacceptable tax avoidance. It is only a slightoverstatement to say that these legislative directivesinveigh against tax dodging by instructing the courtsto strike down instances in which tax avoidanceloomed large, without defining what tax avoidance is.The courts thus must determine when minimizationconstitutes avoidance, and when such avoidance is solarge a component of the motivation as to run afoulof the statutory directive. It can be seen that a legis­lative business purpose rule operates essentially notunlike its judicial counterpart.An important exception deserves mention. A stat­utory directive-and particularly one that explicitlyputs discretionary power in the hands of the Treasury-is apt to cause taxpayers to seek prior administrativeclearance of transactions which conceivably could runafoul of the anti-avoidance doctrine. POSSibly themost significant consequence of the statutory direc­tives is to place enormous leverage in the Treasurythrough its power to rule or refuse to rule on pro­posed transactions. The wisdom of this result has notgone unchallenged.A second legislative pattern has been the enact­ment of specific rules to meet new tax avoidance sit­uations as they are discovered. This approach, forexample, has typified our handling of the capital gainversus the ordinary income question presented bybonds issued at a discount and bonds purchased withcoupons detached. Its efficacy depends in large parton the willingness of the legislature to backstop theContinued on page 36During his recent visit to Chicago, Hon. Willis W. Ritter,/D'24, Chief Judge, U. S. District Court, Salt Lake City,lunched with residents of the Law School Dormitory. In thepicture above, features of the new Law Buildings are beingpointed out to the Judge.36 The Law School Record Vol. 8, No.1Bernard A. Petrie, LLB'30, of Friedrich, Petrie and Tweedle,in Hammond.Wilbur J. Glendening, JD'34, in practice in Hammond.Tax Avoidance Problem in U. S.­Continued from page 29statute year after year with a considerable mass ofmore or less trivia. Even with a completely cooper­ative legislature, however, the approach cannot avoidthe vexatious problem of the innovator. Should theearly bird be allowed the advantage which is beingdenied to others, so that speed and daring in taxavoidance is rewarded; or should the legislation bemade retroactive to cover everybody; or should somecompromise position be taken? Generally we haveshied away from giving our so-called loophole clos­ing measures an effect prior to their date of enact­ment or introduction into the legislature, probablyin the thought that retroactivity is unsportsmanlikeand may even be unconstitutional. But we frequentlyhave accompanied them with an expression of com­mittee intention that no inference about the prior lawis to be drawn from the statutory charge, thus offer­ing the courts a free hand to make the law for theearlier period. Occasionally we have tried to movein the opposite direction by statements to the effectthat the new statutory language is intended only tobe declaratory of what is thought to be the existinglaw. While this procedure may be persuasive withthe courts, it cannot serve to bind them. _A third legislative pattern has consisted of dealingmore or less comprehensively with a given area oftax law by trying to anticipate the situations whichmight arise and prescribing specifically on which sideof the tax line they fall. The collapsible corporationprovisions of our statute are illustrative of this tech­nique. Such highly detailed provisions answer manyparticular questions which actually arise or mightotherwise come up-but at a very real price. Obvi­ously they add considerably to the bulk of the law.It is also evident that the legislature can neither an­ticipate all the line-testing questions which mightarise nor safeguard completely against ambiguity inthe many words employed in disposing of the ques­tions covered. Inherent in this technique, moreover,is what some regard as the unfortuante quality ofproviding tax minimizers with an excellent blueprintof avoidance plans which apparently have receivedlegislative blessing. Specificity and clarity, in brief,make the use of tax savings techniques a lot easierand the code a lot longer.To this juncture I have considered tax dodgingfrom the standpoint of combating it; I shift now tothe perspective of the tax practitioner. While as aninformed citizen he might well feel that the artfultax dodge should be checkmated-although I hopehe will take care that the cure is not worse than theirritation-as a practitioner he should avoid con­fusing ethics and common sense. Since it is the37Vol. 8, No.1 The University of Chicago Law Schoolindeterminacy of the legal rules that is at the heartof the tax avoidance problem, I see no moral orethical inhibitions against trying out new and doubt­ful schemes. Practitioners need feel no guilt in send­ing up trial balloons. But I am convinced thatfrequently such experimentation represents poorjudgment and sometimes verges on being foolish. Imean only that all things considered, including anassessment of the chances of success and the costsof losing, the taxpayer's interests would be betterserved by taking an alternative path. All too often,from the taxpayer's vantage-point, the real vice ofbeing a tax-minimization pioneer is not that the planultimately fails to gain the tax advantage scught, butthat in choosing the dodge, the taxpayer foregoesother tax opportunities or business or estate planningopenings which are unquestionably available to him.Permit me to add, parenthetically, that I couplethe freedom of practitioners to experiment with abroad license in the administrators to shoot at thetrial balloons. Furthermore, it may be that our sys­tem is deficient in not penalizing unsuccessful experi­ments more heavily than now in view of the costswhich they impose on the whole legal apparatus.There is one respect in which the pursuit of taxminimization does or should raise an ethical questionfor practitioners. All too often the willingness to takethe gamble rests not alone on the cleverness of theplan but in part on the thought that the facts asstated in the tax return and accompanying documentswill not Hag the arrangement for the administrators.Thus it is hoped that the plan may succeed becauseit is passed over without a test on the merits. Evenif such incomplete disclosure does not violate legalstandards, I submit that it comes precariously closeto being unsporting conduct and to trenching on thehigh ethical standards to which professional menassert they aspire.It would produce a misleading emphasis to end onthis moralistic note. Instead I prefer to remind youof what ultimately lies at the base of the tax avoidanceproblem. Tax dodging arises in acute form only be­cause our tax statute, in defining taxable income,makes distinctions which depart from a comprehensivemeasurement of a taxpayer's actual economic en­hancement. Thus our tax law distinguishes betweena dollar of ordinary income and a dollar of capitalgain, a dollar of realized income and a dollar of un­realized income, and so forth. All of us feel andusually act on the feeling that, in maximizing ourincome or our economic enhancement, a dollar is adollar. When the tax law distinguishes between dol­lars, it must do so in terms which are unrelated tothe real economic position of the taxpayer and which,in this sense, are arbitrary. The essence of the taxavoidance problem is found here: where the basicdistinction drawn by the law is itself arbitrary, nosatisfactory general principle is available for decidingwhen taxpayers should be defeated in their attemptsto move themselves across to the favorable side ofthat arbitrary line.At a Class of 1912 luncheon honoring Judge Walter L. Pope,JD'12, U. S. Court of Appeals for the Ninth Circuit, JudgePope, left, is shown with classmates Judge Ebner ]. Schnack­enberg, U. S. Court of Appeals for the Seventh Circuit, center,and David Levinson of Chicago, who arranged the meeting.Hon. Walter L. Pope, JD'12, Judge of the U. S. Court ofAppeals for the Ninth Circuit, and a member of the AlumniBoard, at lunch with the Editors of the University of ChicagoLaw Review. At left, Michael B. Douty, of Chicago, A.B.Swarthmore College; and Robert Doan, of Dayton, S.B. IndianaUniv., S.M. Univ. of Illinois; at right, Alan V. Washburn,Editor-in-Chief, of Rapid City, S. D., A.B. Shimer College.

The Tax Avoidance Problem in the United States

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The Tax Avoidance Problem in the United States

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