Federal fairness to state taxpayers: Irrationality, unfunded mandates, and the "SALT" deduction

Michigan Law Review

Volumn 106, Issue 5, 2008, Pages 805-852

  Galle, Brian ^a  

^a FLORIDA STATE UNIVERSITY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 42149087029     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (464)

1. The AMT, I.R.C. §§ 55-58 (2000), is a parallel tax system to the ordinary individual income tax, intended originally to ensure that high-earning individuals able to claim, many large deductions would nonetheless be obliged to pay a substantial amount of tax. See MICHAEL J. GRAETZ, DECLINE (AND FALL?) OF THE INCOME TAX 113 (1997). For a more detailed background, see The Alternative Minimum Tax, REVENUE & TAX POL'Y BRIEF (Cong. Budget Office, Washington, D.C.), Apr. 15, 2004, available at http://cbo.gov/ftpdocs/53xx/doc5386/04-15-AMT.pdf;
2. Leonard E. Burman et al., The AMT: Projections and Problems, 100 TAX NOTES 105, 106-115 (2003)
3. [hereinafter Burman et al., Projections];
4. and Leonard E. Burman et al., The Individual AMT: Problems and Potential Solutions, 55 NAT'L TAX J. 555, 555-96 (2002).
5. The Alternative Minimum Tax, supra note 1, at 2.
6. Edmund L. Andrews, Democrats Seek to Lead the Way in Tax Overhaul, N.Y. TIMES, Apr. 9, 2007, at A1;
7. Steven R. Weisman, Rangel Offering Broad Tax Plan, and Big Target, N.Y. TIMES, Oct. 31, 2007, at A1.
8. The AMT works by obliging a taxpayer to recompute her tax using a different standard deduction amount and omitting most of the individualized deductions she ordinarily could claim. I.R.C. § 56(b)(1)(A)(ii). The deduction for state and local tax is among the most important of the deductions that must be omitted in this recalculation. See Kim Rueben, The Impact of Repealing State And Local Tax Deductibility, 37 ST. TAX NOTES 497, 498 (2005).
9. See Burman et al., Projections, supra note 1, at 115 (observing that, in order to take true measure of the horizontal equity of the AMT, analysts would have to consider its effect on the major deductions it impedes);
10. Beverly I. Moran, Stargazing: The Alternative Minimum Tax for Individuals and Future Tax Reform, 69 ORE. L. REV. 223, 240-68 (1990) (arguing that the AMT cannot be justified on its own and instead is a sort of laboratory for testing out a tax scheme in which its prohibitions apply more broadly). To my knowledge, Linda Beale is the only scholar who has attempted, albeit briefly, to sum up the fairness implications of the AMT.
11. Linda M. Beale, Congress Fiddles While Middle America Burns: Amending the AMT (and Regular Tax), 6 FLA. TAX REV. 811, 817-76 (2004).
12. JOINT COMM. ON TAXATION, ESTIMATES OF FEDERAL TAX EXPENDITURES FOR FISCAL YEARS 2003-2007, at 20, 27 (2002).
13. WILLIAM VICKREY, AGENDA FOR PROGRESSIVE TAXATION 18-24 (1947);
14. Henry Aaron, What is a Comprehensive Tax Base Anyway?, 22 NAT'L TAX J. 543, 543-44 (1969);
15. Beale, supra note 5, at 861-66;
16. see also Rueben, supra note 4, at 498 (noting that proponents of the deduction continue to raise this argument).
17. I.R.C. § 164; see JOINT COMM. ON TAXATION, supra note 6, at 27. The 2008 budget cost of permitting AMT taxpayers to deduct state and local taxes is estimated at $75 billion.
18. Ian Urbina, Bush Plan Could Imperil Tax Write-Off for New York, N. Y. TIMES, Dec. 27, 2004, at B1;
19. PRESIDENT'S ADVISORY PANEL ON FED. TAX REFORM, SIMPLE, FAIR, AND PROGROWTH: PROPOSALS TO FIX AMERICA'S TAX SYSTEM 70, 83-84 (2005), available at http://www.taxreform.panel.gov/final-report/Tax.Reform_Ch5.pdf.
20. The term originates with the public-finance economist Richard Musgrave. RICHARD A. MUSGRAVE, THE THEORY OF PUBLIC FINANCE 160 (1959);
21. Richard A. Musgrave, In Defense of an Income Concept, 81 HARV. L. REV. 44, 45 (1967).
22. Scholars before and after Musgrave have described the same concept in slightly different terminology. E.g., A.C. PIGOU, A STUDY IN PUBLIC FINANCE 44 (3d rev. ed. 1962) (analyzing "equal sacrifice among similar and similarly situated persons");
23. HENRY C. SIMONS, PERSONAL INCOME TAXATION 30 (1938) ("[T]ax burdens should bear similarly upon persons whom we regard as in substantially similar circumstances ....").
24. There has been an ongoing debate in the scholarly tax community over whether horizontal equity is an important norm on its own or whether instead it is simply a placeholder for other societal values. For proponents of horizontal equity, see, for example, Joseph M. Dodge, Theories of Tax Justice: Ruminations on the Benefit, Partnership, and Ability-to-Pay Principles, 58 TAX L. REV. 399, 451-53 (2005)
25. [hereinafter, Dodge, Theories];
26. Joseph M. Dodge, A Combined Mark-to-Market and Pass-Through Corporate-Shareholder Integration Proposal, 50 TAX L. REV. 265, 275 n.42 (1995);
27. David Elkins, Horizontal Equity as a Principle of Tax Theory, 24 YALE L. & POL'Y REV. 43, 87-88 (2006) (arguing that horizontal equity could be defended using some general theories of justice);
28. Kevin. A. Kordana & David H. Tabachnik, Tax and the Philosopher's Stone, 89 VA. L. REV. 647, 656-57, 667-68 (2003);
29. Richard A. Musgrave, Horizontal Equity: A Further Note, 1 FLA. TAX REV. 354 (1993);
30. and Richard A. Musgrave, Horizontal Equity, Once More, 43 NAT'L TAX J. 113, 113-22 (1990).
31. Critics include CHARLES O. GALVIN & BORIS I. BITTKER, THE INCOME TAX: HOW PROGRESSIVE SHOULD IT BE? 128-29 (1969);
32. LIAM MURPHY & THOMAS NAGEL, THE MYTH OF OWNERSHIP 37-38, 99 (2002);
33. Louis Kaplow, Horizontal Equity: Measures in Search of a Principle, 42 NAT'L TAX J. 139, 139-54 (1989);
34. Paul R. McDaniel & James R. Repetti, Horizontal and Vertical Equity: The Musgrave/Kaplow Exchange, 1 FLA. TAX REV. 607, 611, 621-22 (1993);
35. and David A. Weisbach, Line Drawing, Doctrine, and Efficiency in the Tax Law, 84 CORNELL L. REV. 1627, 1646-48 (1999).
36. In this Article, I assume that equal treatment of similarly situated individuals is an important norm in its own right. I acknowledge, however, that our efforts here to measure whether two individuals are "similar" in a meaningful sense may suggest that the endeavor as a whole faces some fundamental difficulties. See infra text accompanying notes 195-236.
37. VICKREY, supra note 7, at 18-24;
38. Aaron, supra note 7, at 543-44;
39. Beale, supra note 5, at 861-66.
40. See U.S. DEP'T OF THE TREASURY, THE PRESIDENT'S TAX PROPOSALS TO THE CONGRESS FOR FAIRNESS, GROWTH, AND SIMPLICITY: GENERAL EXPLANATION 63 (1984), available at http://www.treas.gov/offices/tax-policy/library/tax-reform/pres85All.pdf;
41. U.S. DEP'T OF THE TREASURY, TAX REFORM FOR FAIRNESS, SIMPLICITY, AND ECONOMIC GROWTH: GENERAL EXPLANATION OF THE TREASURY DEPARTMENT PROPOSALS 63 (1984), available at http://www.treasury.gov/offices/tax-policy/library/tax-reform/tres84v2All.pdf [hereinafter TREASURY REPORT];
42. Brookes D. Billman & Noel B. Cunningham, Nonbusiness State and Local Taxes: The Case for Deductibility, 28 TAX NOTES 1107, 1111-12 (1985);
43. Charles R. Hulten & Robert M. Schwab, A Haig-Simons-Tiebout Comprehensive Income Tax, 44 NAT'L TAX J. 67, 68-71 (1991);
44. Louis Kaplow, Fiscal Federalism and the Deductibility of State and Local Taxes under the Federal Income Tax, 82 VA. L. REV. 413, 417 (1996);
45. J.B. McCombs, A New Federal Tax Treatment of State and Local Taxes, 19 PAC. L.J. 747, 754 (1988);
46. Edward Yorio, The President's Tax Proposals: A Major Step in the Right Direction, 53 FORDHAM L. REV. 1255, 1278 (1985);
47. see also Daniel Shaviro, An Economic and Political Look at Federalism in Taxation, 90 MICH. L. REV. 895, 907-08 (1992).
48. 2 TREASURY REPORT, supra note 12, at 63;
49. Hulten & Schwab, supra note 12, at 68-71.
50. See Kaplow, supra note 12, at 490.
51. See, e.g., Jon D. Hanson & Douglas A. Kysar, Taking Behavioralism Seriously: The Problem of Market Manipulation, 74 N.Y.U. L. REV. 630, 633 (1999);
52. Edward J. McCaffery & Jonathan Baron, Thinking About Tax 2-4 (Univ. S. Cal. Law Sch., Olin Research Paper No. 04-13 & Univ. S. Cal., CLEO Research Paper No. C04-10, 2004), available at http://ssm.com/abstract= 567767.
53. McCaffery & Baron, supra note 15, at 3.
54. Brian Galle, A Republic of the Mind: Cognitive Biases, Fiscal Federalism, and Section 164 of the Tax Code, 82 IND. L.J. 673 (2007).
55. See Billman & Cunningham, supra note 12, at 1108;
56. Rueben, supra note 4, at 498; U.S. Dep't of the Treasury, Fact Sheet on the History of the U.S. Tax System, http://www.treas.gov/education/ fact-sheets/taxes/ustax.shtml (last visited Oct. 6, 2007) (noting that the income tax of 1862 included deductions for "other taxes paid").
57. H.R. REP. NO. 88-749, at 44-45 (1963), as reprinted in 1964 U.S.C.C.A.N. 1313, 1357-58. I argue elsewhere that it is possible that overlapping state and federal tax bases in fact cause crowd in of state tax rather than crowd out. Galle, supra note 17, at 702-09.
58. Daniel Patrick Moynihan, Constitutional Dimensions of State and Local Tax Deductibility, 16 PUBLIUS 71, 76 (1986) (citing floor statement of Rep. Justin Smith Morrill).
59. To be fair, Congress explained that its main concern was discouraging states from taxing income and that it was making sales taxes deductible to avoid encouraging states to shift from sales to income taxes. H.R. REP. NO. 88-749, at 1357.
60. However, studies show little or no change in states' preferences for sales taxes in response to the federal deductibility of other tax options. Gilbert E. Metcalf, Deductibility and Optimal State and Local Fiscal Policy, 39 ECON. LETTERS 217, 217, 219 (1992).
61. Yet Congress now has reenacted sales-tax deductibility. I.R.C. § 164 (2000). If deductibility does not, in fact, cause states to shift away from sales taxes, why are they deductible again? The 1964 Congress additionally justified retaining deductibility of the property tax as an effort to avoid shifting the "distribution of Federal income taxes between homeowners and nonhomeowners." H.R. REP. NO. 88-749, at 1357. It is hard to fathom what this might mean, other than perhaps that Congress believed (counterfactually, for the most part) that landlords do not pass the costs of property taxes on to their renters. See Kenya Covington & Rodney Harrell, From Renting to Homeownership: Using Tax Incentives to Encourage Homeownership Among Renters, 44 HARV. J. ON LEGIS. 97, 107 (2007) ("[R]enters effectively pay the costs of mortgage interest and real property taxes ....");
62. Peter Mieszkowski & George R. Zodrow, Taxation and the Tiebout Model: The Differential Effects of Head Taxes, Taxes on Land Rents, and Property Taxes, 27 J. ECON. LITERATURE 1098, 1125 (1989) (describing empirical data suggesting landlords are able to pass on property-tax costs to renters).
63. Contra Billman & Cunningham, supra note 12, at 1115 n.31 (noting the economic debate on this point).
64. Alternatively, Congress might have meant to suggest that there would be winners and losers from changing the deductibility rule, since current home prices would likely decline in. response to a loss of deductibility. See Mieszkowski & Zodrow, supra, at 1127-31 (reviewing evidence that home prices typically reflect costs and benefits of government services). Probably the best reading of this passage is that Congress was acknowledging that the political opposition to removing the deductibility of property taxes was too steep to overcome.
65. See Burman et al., Projections, supra note 1.
66. Horizontal equity bears that cumbersome name in order to distinguish it from vertical equity, which is the tax-policy term for distributive justice. JOSEPH M. DODGE, THE LOGIC OF TAX 88 (1989).
67. Id.
68. Id.
69. E.g., William D. Andrews, Personal Deductions in an Ideal Income Tax, 86 HARV. L. REV. 309, 335-36 (1972);
70. Thomas D. Griffith, Theories of Personal Deductions in the Income Tax, 40 HASTINGS L.J. 343, 386-88 (1989).
71. This theory of income was set out most famously in Andrews, supra note 26, at 313-15.
72. See supra note 11.
73. See Kirk J. Stark, Fiscal Federalism and Tax Progressivity: Should the Federal Income Tax Encourage State and Local Redistribution?, 51 UCLA L. REV. 1389, 1414 (2004).
74. Tax scholars disagree as to whether utility is an appropriate ground for comparing different taxpayers. Many commentators, noting the serious theoretical problems in making any but the broadest generalization about individual utility, suggest instead that the fundamental measure of taxpayers should be their "ability to pay." See HENRY SIMONS, PERSONAL INCOME TAXATION 30-31 (1938);
75. Joseph Bankman, The Case Against Passive Investments: A Critical Appraisal of the Passive Loss Restrictions, 42 STAN. L. REV. 15, 40-42 (1989);
76. Noël B. Cunningham & Deborah. H. Schenk, The Case for a Capital Gains Preference, 48 TAX L. REV. 319, 363-64 (1993);
77. J. Clifton Fleming, Jr. et al., Fairness in International Taxation: The Ability-to-Pay Case for Taxing Worldwide Income, 5 FLA. TAX REV. 299, 301 n.1, 307-08 (2001);
78. Barbara H. Fried, The Puzzling Case for Proportionate Taxation, 2 CHAP. L. REV. 157, 188-89 (1999);
79. Richard A. Musgrave, ET, OT and SBT, 6 J. PUB. ECON. 3, 5 (1976) (describing the intellectual history of economic approaches to horizontal equity);
80. Eric M. Zolt, The Uneasy Case for Uniform Taxation, 16 VA. TAX REV. 39, 42 (1996).
81. Ability to pay is typically defined as a taxpayer's access to money or other primary goods. Dodge, Theories, supra note 10, at 449-50;
82. see also SIMONS, supra, at 49.
83. In response, some economists (and others) maintain, that horizontal equity measured by income alone would be seriously flawed because it would neglect the role of individual preferences for other goods, such as leisure. See WALTER J. BLUM & HENRY KALVEN, JR., THE UNEASY CASE FOR PROGRESSIVE TAXATION 49-51 (4th ed. 1963) (describing the equal-sacrifice principle);
84. DAVID GAUTHIER, MORALS BY AGREEMENT 271-72 (1986);
85. HARVEY ROSEN, PUBLIC FINANCE 345-48 (1995);
86. Martin Feldstein, On the Theory of Tax Reform, 6 J. PUB. ECON. 77, 82-83 (1976);
87. Harvey S. Rosen, An Approach to the Study of Income, Utility, and Horizontal Equity, 92 Q.J. ECON. 307-10 (1978).
88. Another potential problem with the ability-to-pay standard is its seeming inability to answer certain policy questions. See Andrews, supra note 26, at 326-27;
89. Edward J. McCaffery, Tax's Empire, 85 GEO. L.J. 71, 78-79, 84, 143 (1996) (making this critique of both ability-to-pay and utilitarian approaches);
90. Daniel N. Shaviro, Uneasiness and Capital Gains, 48 TAX L. REV. 393, 407 (1993) (questioning whether ability-to-pay theorists can explain why they focus on income rather than wealth or liquidity);
91. Stephen Utz, Ability to Pay, 23 WHITTIER L. REV. 867, 939-49 (2002);
92. cf. Griffith, supra note 26, at 346
93. (criticizing earlier theories of deductibility on the ground that they did not by themselves supply any theory to explain what should be included in the concept of income). Section. 164 is a good illustration. Do I have a lesser ability to pay federal tax if I have also paid state taxes? If I have chosen to pay state taxes, then I had an ability to pay either the state or the federal government. Which should have the superior claim requires a theory not of tax but of federalism. We might argue that state taxes are not really chosen but are compulsory. That claim seems inconsistent with the Constitution, see U.S CONST. art. IV, § 4 (guaranteeing to states a republican form of government), and, in any event, probably depends on a contestable theory of political philosophy outside the realm of tax. A third difficulty of ability-to-pay theory that comes to the fore when we analyze § 164 is that it does not by itself explain whether "imputed" income should be taxable. See Dodge, Theories, supra note 10, at 449 n.203.
94. That is, services that a taxpayer provides herself do not create primary goods that could be distributed to others and therefore arguably should not be considered part of her ability to contribute to the cost of government. See Andrews, supra note 26, at 326.
95. On the other hand, she may well have more income available for other consumption as a result, since she need not pay someone else to build her deck or hum a soulful tune. See id. at 324. We could apply a very similar analysis to the question of state and local taxes. As we will see shortly, we can think of local taxes as a purchase of government services. Many of these services, such as security or clean streets, could not easily be transferred to others. But they may also replace essential services the taxpayer once provided for herself or free the taxpayer to use her available dollars to acquire those services. Ability-to-pay theory assumes a certain base of income that should be exempt from taxation to account for these necessities. If government provides or facilitates them, it is arguable that this base amount should be reduced, resulting in a higher tax. Ability-to-pay theory thus has no clear answer to the question, whether receipt of these additional services should count as income, which might or might not completely offset the deduction for taxes paid. Accordingly, although I acknowledge that ability-to-pay theory represents a major strand of modern tax theory, I largely set it aside in this Article. However, my analysis should still be of interest to those who find ability to pay the most attractive metric, so long as they are willing to assume that government services should count as income.
96. See supra note 12.
97. 2 TREASURY REPORT, supra note 12, at 63;
98. Hulten & Schwab, supra note 12, at 68-71.
99. Largely for the sake of simplicity, I regard all state services as consumption. As I explain later, some forms of state spending may or may not be seen as the equivalent of a consumer purchase, depending on one's political philosophy.
100. See Yorio, supra note 12, at 1281.
101. Professor Zelinsky, on the other hand, would grant a deduction for state taxes tied to state expenditures where the proper view of income would have resulted in federal deductibility if the same expenditure had been made by an individual. Edward A. Zelinsky, The Deductibility of State and Local Taxes: Income Measurement, Tax Expenditures and Partial, Functional Deductibility, 6 AM. J. TAX POL'Y 9, 10-11 (1987).
102. Kaplow, supra note 12. A related set of arguments concern whether the deduction, if not required out of any sense of fairness, might still be appropriate as a subsidy to the States.
103. See Galle, supra note 17, at 680-95;
104. Rueben, supra note 4, at 498-99.
105. Incidence is a term used by economists to describe where the actual financial burden of a tax falls. For example, the unemployment tax is nominally paid by employers. But unless the market for labor is highly inelastic, employers will simply reduce wages by the amount of the tax. Thus the economic bite of the tax - its incidence - is on workers, not employers.
106. E.g., Kaplow, supra note 12, at 451-52, 459-60.
107. Id. at 426.
108. See id. at 431-34, 439.
109. Id. at 432.
110. See id. at 434, 440-41.
111. See id. at 491.
112. Id. at 432.
113. See id. at 439.
114. See, e.g., LIONEL ROBBINS, AN ESSAY ON THE NATURE AND SIGNIFICANCE OF ECONOMIC SCIENCE 140-41 (3d ed. 1984);
115. William J. Baumol, Community Indifference, 14 REV. ECON. STUD. 44, 47-48 (1947);
116. George J. Stigler & Gary S. Becker, De Gustibus Non Est Disputandum, 67 AM. ECON. REV. 76, 76-77 (1977).
117. See John C. Harsanyi, Utilities, Preferences, and Substantive Goods, 14 SOC. CHOICE WELFARE 129, 130-35 (1997);
118. Yew-Kwang Ng, From Preference to Happiness: Towards a More Complete Welfare Economics, 20 SOC. CHOICE WELFARE 307, 308-12 (2003).
119. Compare Amitai Etzioni, The Case for a Multiple-Utility Conception, 2 ECON. & PHIL. 159, 164-65 (1986);
120. Harsanyi, supra note 45, at 134;
121. Daphna Lewinsohn-Zamir, Consumer Preferences, Citizen Preferences, and the Provision of Public Goods, 108 YALE L.J. 377, 380-83 (1998);
122. and Daniel Kahneman & Richard H. Thaler, Anomalies: Utility Maximization and Experienced Utility 2-3 (Dec. 1, 2005) (unpublished working paper), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id= 870494, with Stigler & Becker, supra note 44, at 78-89.
123. Kaplow notes in his other work that an ideal measure of utility might properly consider hypothetical guesses about what individuals would want if perfectly rational. See Louis Kaplow, A Fundamental Objection to Tax Equity Norms: A Call for Utilitarianism, 48 NAT'L TAX J. 497, 504 (1995).
124. He does not develop that idea in any great depth and does not raise it in his discussion of § 164. See id.
125. See Hanson & Kysar, supra note 15, at 643-86;
126. Christine Jolis et al., A Behavioral Approach to Law and Economics, 50 STAN. L. REV. 1471, 1477-79 (1998).
127. See Hanson & Kysar, supra note 15, at 645-46, 672.
128. Id. at 674-76;
129. Daniel Kahneman et al., Experimental Tests of the Endowment Effect and the Coase Theorem, 98 J. POL. ECON. 1325 (1990);
130. Russell Korobkin, The Status Quo Bias and Contract Default Rules, 83 CORNELL L. REV. 608, 625-30 (1998);
131. Cass R. Sunstein, Endogenous Preferences, Environmental Law, 22 J. LEGAL STUD. 217, 225-27 (1993) (summarizing studies).
132. See Hanson & Kysar, supra note 15, at 675;
133. Daniel Kahnemann & Amos Tversky, Prospect Theory: An Analysis of Decision Under Risk, 47 ECONOMETRICA 263, 279 (1979) (showing that the value function for losses is steeper than the value function for gains).
134. W. KIP VISCUSI, FATAL TRADEOFFS: PUBLIC AND PRIVATE RESPONSIBILITIES FOR RISK 150 (1992);
135. Hanson & Kysar, supra note 15, at 688-89;
136. Sunstein, supra note 50, at 227.
137. Theorists have also described countervailing effects that return markets to what they would look like if comprised entirely of strictly rational actors. The correctives, however, generally depend on the presence of an effective market. See Christine Jolis, Behavioral Economics Analysis of Redistributive Legal Rules, 51 VAND. L. REV. 1653, 1657 (1998).
138. McCaffery & Baron, supra note 15, at 4.
139. See Edward J. McCaffery & Jonathan Baron, The Political Psychology of Redistribution (Univ. S. Cal., CLEO Research Paper No. C05-4, Legal Studies Research Paper No. 05-8, & Law & Economics Research Paper No. 05-8 & Univ. of Pa. Inst. for Law & Econ., Research Paper No. 05-11, 2005), available at http://ssrn.com/abstract-695305.
140. Jolis, supra note 52, at 1669;
141. Richard H. Thaler, Anomalies: Saving, Fungibility, and Mental Accounts, 4 J. ECON. PERSP. 193, 199-201 (1990);
142. Edward A. Zelinsky, Do Tax Expenditures Create Framing Effects? Volunteer Firefighters, Property Tax Exemptions, and the Paradox of Tax Expenditure Analysis, 24 VA. TAX REV. 797, 804 (2005).
143. McCaffery & Baron, supra note 54, at 26-28;
144. see also Lewinsohn-Zamir, supra note 46, at 390.
145. McCaffery & Baron, supra note 15, at 24, 27.
146. Id. at 26. I report these results with the usual caution that laboratory tests of economic behavior may not perfectly predict real-world behavior.
147. Hanson & Kysar, supra note 15, at 667;
148. Cass R. Sunstein & Richard H. Thaler, Libertarian Paternalism Is Not an Oxymoron, 70 U. CHI. L. REV. 159, 1177 (2003).
149. Hanson & Kysar, supra note 15, at 667-68;
150. Sunstein & Thaler, supra note 59, at 1177-78.
151. McCaffery & Baron, supra note 54, at 42;
152. McCaffery & Baron, supra note 15, at 25-26.
153. See Hanson & Kysar, supra note 15, at 662;
154. Amos Tversky & Daniel Kahneman, Judgment Under Uncertainty: Heuristics and Biases, 185 SCIENCE 1124 (1974).
155. See George R. Karvel et al., Minnesota Business Migration: Relocation, Expansion, and Formation in Border States, AM. EXPERIMENTAL Q., Summer 1998, at 67.
156. Cf. William W. Bratton & Joseph A. McCahery, The New Economics of Jurisdictional Competition: Devolutionary Federalism in a Second-Best World, 86 GEO. L.J. 201, 223-24 (1997) (arguing that public goods may be bundled together in so many different ways that only a republic with as many jurisdictions as people could ensure a perfect match between all of an individual's preferences and the services his or her jurisdiction provides).
157. See Sunstein & Thaler, supra note 59, at 1196-97.
158. McCaffery & Baron, supra note 54, at 19.
159. One possible story would rely on the tendency for tax penalties to seem more onerous than benefits of equal magnitude. See Sunstein, supra note 50, at 233.
160. A taxpayer might pay fifty dollars but feel as though the actual sting is more like one hundred dollars. Cf. Lewinsohn-Zamir, supra note 46, at 390 (observing that citizens misestimate the costs of providing public goods). She might then demand one hundred dollars worth of perceived benefits in exchange. If there is a jurisdiction that matches this set of preferences (perhaps by providing less of other benefits not valued by our exemplar taxpayer), she will realize a surplus.
161. See McCaffery & Baron, supra note 15, at 14, 18;
162. Daniel McFadden, Free Markets and Fettered Consumers, 96 AM. ECON. REV. 5, 10 (2006).
163. See Adam D. Galinsky & Thomas Mussweiler, First Offers as Anchors: The Role of Perspective-Taking and Negotiator Focus, 81 J. PERSONALITY & SOC. PSYCHOL. 657, 665-66 (2001);
164. McCaffery & Baron, supra note 54, at 53.
165. It is worth noting here that another form, of irrationality - racism - also undermines the assumption that taxpayers have located in order to equalize taxes and benefits. See Vicki Been, "Exit" as a Constraint on Land Use Exactions: Rethinking the Unconstitutional Conditions Doctrine, 91 COLUM. L. REV. 473, 517-18 (1991).
166. For more discussion of the difficulties of this alternative, see infra text accompanying notes 197-200.
167. Kim Rueben & Len Burman, Deductibility of State and Local Taxes, 108 TAX NOTES 363, 363 (2005);
168. see STANLEY S. SURREY & PAUL R. MCDANIEL, TAX EXPENDITURES 3 (1985).
169. Jonathan Klick & Gregory Mitchell, Government Regulation of Irrationality: Moral and Cognitive Hazards, 90 MINN. L. REV. 1620 (2006);
170. cf. Kahneman & Thaler, supra note 46, at 20 (noting that the fact of biases does not by itself establish the appropriate policy response).
171. Klick & Mitchell, supra note 73, at 1633-41.
172. Id. at 1626.
173. See id at 1626, 1629-33 (explaining the importance of information "feedback" to correcting biases).
174. Cf. Jon Elster, More than Enough, 64 U. CHI. L. REV. 749, 754 (1997)
175. (reviewing GARY S. BECKER, ACCOUNTING FOR TASTES (1996) and arguing that "the very idea of intentional change of time preferences is incoherent");
176. McFadden, supra note 68, at 10-11 (identifying problems with attempts to debias consumers).
177. See Klick & Mitchell, supra note 73, at 1653-56 (acknowledging that the authors' conclusions are to a large extent contingent on unavailable empirical data);
178. cf. Nathan Berg & Gerd Gigerenzer, Psychology implies paternalism?: Bounded rationality may reduce the rationale to regulate risk-taking, 28 SOC. CHOICE WELFARE 337, 340 (2007) ("[T]he policy implications of theoretical and empirical departures from neoclassical rational choice are indeterminate.").
179. But see Klick & Mitchell, supra note 73, at 1656 (claiming that irrational behavior often changes readily in response to education and self-correction).
180. However, reasonable sources of information exist about related issues, such as whether the local government is spending the money that it raises efficiently. See, e.g., Timothy Besley & Anne Case, Incumbent Behavior: Vote-Seeking, Tax-Setting, and Yardstick Competition, 85 AM. ECON. REV. 25, 25-26 (1995) (describing a model in which voters evaluate incumbent performance by reference to success or failure of officials in neighboring regions);
181. cf. Andrei Shleifer, A. theory of yardstick competition, 16 RAND J. ECON. 319, 319-20 (1985) (suggesting that efficient cost structures of regulated firms could be inferred from cost structures of comparable producers).
182. My analysis here follows recent economic studies of hidden bundled pricing. Xavier Gabaix & David Laibson, Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets, 121 Q.J. ECON. 505 (2006).
183. Many firms impose a variety of hidden charges: in Gabaix and Laibson's example, some hotels add on hidden costs in the form of extra fees for gym access, Internet access, local calls, and the like. Other hotels do not. At first, this was puzzling to economists. Id. at 506-07.
184. Why would the hotels offering one bundled (and, presumably, higher) price for everything not expose the hidden fees of their competitors? Id. The answer, it seems, is that they had nothing to gain by doing so.
185. Id. at 508. Customers tended to split into " sophisticated" and "unsophisticated" customers.
186. Id. Sophisticated customers already knew about the hidden fees. Unsophisticated customers could not easily be debiased, and if they were, that would only have prevented the bundled-price hotels from imposing their own hidden fees on. the unsophisticated in the future.
187. Id. at 509. Thus there was no incentive for any market participant to debias.
188. Id. at 509-11.
189. For an earlier work with similar implications for debiasing, see William H. Redmond, Consumer Rationality and Consumer Sovereignty, 58 REV. SOC. ECON. 177, 180 (2000), which argues that advertising and easy credit "inhibit the self-corrective learning process which would otherwise return consumers to a rational state." For some tentative thoughts in the economics literature about the implications of these kinds of findings for political markets, see Bruno S. Frey & Alois Stutzer, Does the Political Process Mitigate or Accentuate Individual Biases Due to Mispredicting Future Utility? (Mar. 1, 2004) (unpublished manuscript, on file with author), available at http://law.usc.edu/academics/centers/cslp/ conferences/bpf_04/papers/documents/Frey_Stutzer_Misprediction.pdf.
190. In this sense, the candidate is similar to the bundled-fee hotel: she does not want to gain a short-term competitive advantage at the price of sacrificing her long-term opportunities for extracting hidden rents.
191. Daniel Kahneman et al., Back to Bentham? Explorations of Experienced Utility, 112 Q.J. ECON. 375, 379-99 (1997);
192. see Etzioni, supra note 46, at 160;
193. Daniel Kahneman & Robert Sugden, Experienced Utility as a Standard of Policy Evaluation, 32 ENV'T & RES. ECON. 161, 162, 167 (2005);
194. Kahneman & Thaler, supra note 46, at 2.
195. Kahneman & Thaler, supra note 46, at 2-3.
196. This example, although ridiculous, reflects a large literature on the possibility that individuals can possess what appear to be inconsistent or contingent preferences. E.g., JON ELSTER, SOUR GRAPES: STUDIES IN THE SUBVERSION OF RATIONALITY (1983);
197. Kahneman & Thaler, supra note 46, at 3;
198. Amartya K. Sen, Rational Fools: A Critique of the Behavioral Foundations of Economic Theory, 6 PHIL. & PUB. AFF. 317 (1977). Additionally, preferences may be formed by individuals' prior experiences so that they are contingent in a different sense - contingent on the individuals' past, including their past consumption.
199. See Sunstein, supra note 50, at 236, 238.
200. One caveat is that not all shifts in preferences in response to new information result in greater experienced utility. As Elster argued, many individuals adopt preferences that misrepresent their highest and best choices because those choices are unattainable, and the feelings of cognitive dissonance and dissatisfaction that might result from frustration may exceed the benefits of pursuing the higher good. Thus, he writes, "[r]elease from adaptive preferences ... may be good on the autonomy dimension while bad on the welfare dimension." ELSTER, supra, at 138.
201. In the end, Elster claims that the only meaningful welfare measure is satisfaction of fully informed and autonomous preferences, so the apparent disutility that we would experience upon release from our self-imposed misperceptions is no disutility at all when utility is properly measured. Id. at 132-33, 135-36.
202. In essence, Elster adopts a version of objective utility - utility measured according to what individuals ought to want, rather than what they express. See infra text accompanying notes 202-208.
203. See, e.g., Kenneth G. Dau-Schmidt, An Economic Analysis of the Law as a PreferenceShaping Policy, 1990 DUKE L.J. 1, 22-24;
204. Richard H. McAdams, Relative Preferences, 102 YALE L.J. 1, 80-83 (1992).
205. See Dau-Schmidt, supra note 85, at 18-19.
206. See Hanson & Kysar, supra note 15, at 696-721.
207. See Sunstein & Thaler, supra note 59, at 1161, 1192-93 (explaining that the meaning of the term "preferences" can be unclear when what people want is itself contingent on the perceptual frame within which their choices are made).
208. See id. at 1165 (arguing that consumer preferences "might change as a result of consumption.");
209. see also Kahneman & Sugden, supra note 82, at 168-69;
210. Redmond, supra note 80, at 185.
211. By hypothetical utility, I mean a measure of individuals' utility based on satisfaction of the preferences that they might or ought to have rather than those expressed in an imperfect market by less than completely rational consumers. See Harsanyi, supra note 45, at 133-34;
212. Lewinsohn-Zamir, supra note 46, at 381 n.9 (explaining that use of hypothetical or objective preferences forms a major alternative to the use of expressed preferences alone).
213. For criticism of the argument that it might meaningfully be said that there is more than one utility, see Timothy J. Brennan, A Methodological Assessment of Multiple Utility Frameworks, ECON. & PHIL., Oct. 1989, at 189.
214. See Gregory Mitchell, Libertarian Paternalism is an Oxymoron, 99 NW. U. L. REV. 1245, 1253 (2005) (arguing that behavioral law and economics does not predict when consumer preferences will be stable and when they will instead be the products of perceptual biases).
215. For an abbreviated roundup, see Stark, supra note 29, at 1410 n.81.
216. Bratton & McCahery, supra note 64, at 235;
217. see Shaviro, supra note 12, at 964-65.
218. See Bratton & McCahery, supra note 64, at 236 (observing difficulty for consumers in identifying the quality of education a jurisdiction produces);
219. cf. Lee Anne Fennell, Beyond Exit and Voice: User Participation in the Production of Local Public Goods, 80 TEX. L. REV. 1, 2-3 (2001) (observing that legal scholars have struggled to measure the quality of education services).
220. See Bratton & McCahery, supra note 64, at 223-25;
221. Shaviro, supra note 12, at 964-65.
222. See Susan Rose-Ackerman, Tiebout Models and the Competitive Ideal: An Essay on the Political Economy of Local Government, in 1 PERSPECTIVES ON LOCAL PUBLIC FINANCE AND PUBLIC POLICY 23, 28 (John M. Quigley ed., 1983).
223. See Kahneman & Sugden, supra note 82, at 171-72.
224. Bratton. & McCahery, supra note 64, at 233-34;
225. Shaviro, supra note 12, at 964.
226. See, e.g., Dorothy E. Roberts, Welfare Reform and Economic Freedom: Low-Income Mothers' Decisions About Work at Home and in the Market, 44 SANTA CLARA L. REV. 1029, 1049-52 (2004).
227. Besley & Case, supra note 79.
228. Id. at 30-31.
229. See Galle, supra note 17.
230. See Richard Briffault, Our Localism: Part II - Localism and Legal Theory, 90 COLUM. L. REV. 346, 420-21 (1990).
231. As Professor Bakija and Professor Slemrod have noted, there is little empirical work investigating this intuition. Jon Bakija & Joel Slemrod, Do the Rich Flee From High State Taxes? Evidence From Federal Estate Tax Returns 1 n.5 (Nat'l Bureau of Econ. Research, Working Paper No. 10645, 2004), available at https://wwww.nber.org/papers/w10645.
232. That is, the fact that the taxpayer cannot obtain her full measure of utility from her expenditures is not the result of her local tax regime but rather of failures in the local private market to provide goods that would be equally as welfare enhancing at the same price.
233. See, e.g., Shaviro, supra note 12, at 961-63 (arguing that tax exporting is at least unobjectionable in some circumstances).
234. The following three paragraphs draw extensively from Galle, supra note 17, at 688-89.
235. See Shaviro, supra note 12, at 911.
236. See Russell Krelove, Efficient Tax Exporting, 25 CAN. J. ECON. 145, 153 (1992);
237. Gordon M. Myers, Optimality, Free Mobility, and the Regional Authority in a Federation, 43 J. PUB. ECON. 107, 108-09 (1990).
238. See Krelove, supra note 108, at 153;
239. Myers, supra note 108, at 108-09;
240. cf. Shaviro, supra note 12, at 908 (describing the distortionary effects of tax exporting).
241. Shaviro, supra note 12, at 908.
242. Bratton & McCahery, supra note 64, at 235;
243. Shaviro, supra note 12, at 964-65.
244. See Bratton & McCahery, supra note 64, at 236;
245. Fennell, supra note 94.
246. See infra text accompanying notes 133-149.
247. Tax Found., Federal Spending By State Per Dollar of Taxes Paid, 1981-2004 (Mar. 6, 2006), http://www.taxfoundation.org/research/show/347.html (last visited Oct. 6, 2007).
248. Rueben & Burman, supra note 72, at 363 (listing the top total-dollar recipients of deduction as California, Illinois, Maryland, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania, and Virginia).
249. Dean Lacy, A Curious Paradox of the Red States and Blue States: Federal Spending and Electoral Votes in the 2000 Election (Mar. 2, 2002) (unpublished manuscript, on file with author), available at http://psweb.sbs.ohio- state.edu/faculty/hweisberg/conference/Lacy-OSUConf.PDF.
250. See Rueben, supra note 4, at 500.
251. See Bratton & McCahery, supra note 64, at 212;
252. Mieszkowski & Zodrow, supra note 21, at 1121-23 & n.39, 1138.
253. Consistent with this theory, the current regressive structure of the deduction roughly approximates a system in which low-income migrants pay an inclusion while stable, wealthy property owners get a deduction. But that arrangement, too, is wrong if we cannot tell whether the migrants are moving in order to free ride or instead are responding to efforts to export taxes onto them. Another possible reason not to tie net payments made to a locality's neighbors to an inclusion is that in some cases the neighbors are simply leeching. Cf. Zelinsky, supra note 33, at 34 (observing that a decision to live in the suburbs may be based on desire to free ride on expenditures by a neighboring city).
254. See, e.g., WILLIAM A. FISCHEL, THE HOMEVOTER HYPOTHESIS: HOW HOME VALUES INFLUENCE LOCAL GOVERNMENT TAXATION, SCHOOL FINANCE, AND LAND USE POLICIES 51-57 (2001);
255. Sheryll D. Cashin, Localism, Self-interest, and the Tyranny of the Favored Quarter: Addressing the Barriers to New Regionalism, 88 GEO. L.J. 1985, 2012-13, 2015 (2000);
256. Bruce W. Hamilton, Property Taxes and the Tiebout Hypothesis: Some Empirical Evidence, in FISCAL ZONING AND LAND USE CONTROLS 13 (Edwin S. Mills & Wallace E. Oates eds., 1975);
257. Mieszkowski & Zodrow, supra note 21, at 1099.
258. In jurisdictions that are already fully developed, "implicit" or "heterogeneous" zoning can occur. See Bruce W. Hamilton, Capitalization of Intrajurisdictional Differences in Local Tax Prices, 66 AM. ECON. REV. 743 (1976);
259. Mieszkowski & Zodrow, supra note 21, at 1140. Absent some method for hedging out newcomers, demand increases for a relatively fixed amount of housing. Prices then increase until they reach the point where they exactly equal the value of the services delivered by the jurisdiction. Free riding is thus most likely in intermediate scenarios in which there is room for new housing but less than fully restrictive zoning.
260. See MYRON ORFIELD, METROPOLITICS 5 (1997);
261. Fennell, supra note 94, at 80-81.
262. Wallace E. Oates, The Effects of Property Taxes and Local Public Spending on Property Values: An Empirical Study of Tax Capitalization and the Tiebout Hypothesis, 77 J. POL. ECON. 957, 966-67 (1969).
263. For conflicting views about the enduring viability of the Oates study, compare Been, supra note 70, at 522-23,
264. which claims that later studies support Oates, with Richard Schragger, Consuming Government, 101 MICH. L. REV. 1824, 1830 (2003),
265. which reviews WILLIAM A. FISCHEL, THE HOMEVOTER HYPOTHESIS: HOW HOME VALUES INFLUENCE LOCAL GOVERNMENT TAXATION, SCHOOL FINANCE, AND LAND-USE POLICIES (2001), and calls results of later studies "somewhat mixed."
266. See Bratton & McCahery, supra note 64, at 240-41.
267. See Note, Making Mixed-Income Communities Possible: Tax Base Sharing and Class Desegregation, 114 HARV. L. REV. 1575, 1588-89 (2001).
268. In addition, granting a deduction for property taxes paid would be a windfall for property owners to the extent that owners do not in fact bear the economic burden, or incidence, of the property tax. Cf. Michael L. Goetz, Tax Avoidance, Horizontal Equity, and Tax Reform: A Proposed Synthesis, 44 S. ECON. J. 798, 802 (1978) ("[I]f capitalization is complete, an existing tax preference is not a source of horizontal inequity.").
269. A number of studies suggest that the incidence of the property tax is distributed across all owners of capital. See Mieszkowski & Zodrow, supra note 21, at 1110-17, 1127-31 (surveying the theoretical and empirical literature). That is, investors shift away from real property as a result of the property tax, bidding up the price of alternative investments. At equilibrium, investors should be indifferent between property and lesser-taxed investments. Thus property owners likely suffer a smaller diminution in real wealth (relative to what they could obtain from investing in anything other than, property) than would be suggested by the face amount of the property tax they pay.
270. See Neil S. Siegel, Commandeering and Its Alternatives: A Federalism Perspective, 59 VAND. L. REV. 1629, 1644 (2006);
271. Richard B. Stewart, Federalism and Rights, 19 GA. L. REV. 917, 961 (1985).
272. See Kaplow, supra note 12, at 428.
273. Robert W. Adler, Unfunded Mandates and Fiscal Federalism: A Critique, 50 VAND. L. REV. 1137, 1231-54 (1997);
274. Edward A. Zelinsky, Unfunded Mandates, Hidden Taxation, and the Tenth Amendment: On Public Choice, Public Interest, and Public Services, 46 VAND. L. REV. 1355, 1356 (1993).
275. See Lynn A. Baker, Conditional Federal Spending After Lopez, 95 COLUM. L. REV. 1911, 1951 (1995);
276. Richard P. Revesz, Rehabilitating Interstate Competition: Rethinking the "Race-to-the-Bottom" Rationale for Federal Environmental Regulation, 67 N.Y.U. L. REV. 1210, 1216-17 (1992).
277. Of course, self-interested behavior by federal officials may contribute to federal demands for more state-level regulation. See, e.g., Zelinsky, supra note 129, at 1369-89 (identifying politicalprocess failures that may lead to excessive federal lawmaking).
278. Relatedly, the federal government may impose regulatory mandates to accompany its grants in order to ensure that the grant serves the purpose of encouraging efficient state regulation. See Wallace E. Oates, An Essay on Fiscal Federalism, 37 J. ECON. LIT. 1120, 1126-27 (1999). As I discuss in Part V, we would not want taxpayers to be able to deduct the costs of conditions the federal government imposes to encourage efficient state behavior.
279. Printz v. United States, 521 U.S. 898, 918-33 (1997); New York v. United States, 505 U.S. 144, 161-66 (1992).
280. See Reno v. Condon, 528 U.S. 141, 149-51 (2000).
281. See Lynn A. Baker & Mitchell N. Berman, Getting Off the Dole.' Why the Court Should Abandon Its Spending Doctrine, and How a Too-Clever Congress Could Provoke It to Do So, 78 IND. L.J. 459, 460, 484 (2003);
282. Albert J. Rosenthal, Conditional Federal Spending and the Constitution, 39 STAN. L. REV. 1103, 1105-06 (1987).
283. See Thomas R. McCoy & Barry Friedman, Conditional Spending: Federalism's Trojan Horse, 1988 SUP. CT. REV. 85, 124.
284. That temptation would be especially powerful in small states, where capturing any new source of revenue might have a substantial effect on the state's bottom line. See Bratton & McCahery, supra note 64, at 267.
285. See supra text accompanying notes 48-66.
286. See Sunstein, supra note 50, at 218 (describing "measures that appear on their face to promise vigorous . .. regulation but that in the enforcement process amount to little more than mere words").
287. As Professor Sunstein points out, officials may also want to enact legislation that only appears stringent in order to simultaneously claim, credit for responding to constituent demands for action and avoid blame from the regulated parties. Cass R. Sunstein, Paradoxes of the Regulatory State, 57 U. CHI. L. REV. 407, 430 (1990).
288. Of course, this strategy is only effective if the regulated parties are more attentive to the political process than the constituents demanding regulation. A number of scenarios make this split plausible. See Peter H. Aranson et al., A Theory of Legislative Delegation, 68 CORNELL L. REV. 1, 38-39 (1982).
289. This analysis implies that the possibility of illusory mandates also undermines any argument that the deduction is required to account for overlegislation by self-serving public officials. See Zelinksy, supra note 129. That is, even if federal officials serve their own ends rather than the public's, they often can do so without imposing real costs on states.
290. For general descriptions of the logrolling bargaining process, see JAMES M. BUCHANAN & GORDON TULLOCK, THE CALCULUS OF CONSENT: LOGICAL FOUNDATIONS OF CONSTITUTIONAL DEMOCRACY chs. 10-13 (1962),
291. and William H. Riker & Steven J. Brams, The Paradox of Vote Trading, 67 AM. POL. SCI. REV. 1235, 1240 (1973).
292. For a more detailed discussion of the holdout problem, see infra text accompanying notes 171-174.
293. See Brian Galle, Getting Spending: How to Replace Clear Statement Rules with Clear Thinking About Conditional Grants of Federal Funds, 37 CONN. L. REV. 155, 187 (2004).
294. 42 C.F.R. § 431.53 (2006).
295. 20 U.S.C. § 1412(a)(1)(A) (2000).
296. 42 U.S.C. § 7511 (2000);
297. see Sunstein, supra note 139, at 408-10.
298. 20 U.S.C. § 1416.
299. See Galle, supra note 142, at 193.
300. See Harold J. Krent, Delegation and Its Discontents, 94 COLUM. L. REV. 710, 717 (1994)
301. (reviewing DAVID SCHOENBROD, POWER WITHOUT RESPONSIBILITY (1993));
302. Jonathan R. Macey, Public Choice and the Legal Academy, 86 GEO. L.J. 1075, 1080 (1998)
303. (reviewing JERRY L. MASHAW, GREED, CHAOS, AND GOVERNANCE: USING PUBLIC CHOICE TO IMPROVE PUBLIC LAW (1997)).
304. Galle, supra note 142, at 193-95.
305. E.g., Individuals with Disabilities Education Act: Hearing Before the H. Comm. on Government Reform, 107th Cong. (2001) (testimony of Marca Bristo, Chairperson, Nat'l Council on Disability) (claiming that federal enforcement actions were not sufficient to encourage states to comply with IDEA and that a large majority of states were significantly noncompliant).
306. See Gonzaga Univ. v. Doe, 536 U.S. 273, 285-86 (2002);
307. Alexander v. Sandoval, 532 U.S. 275, 286-87 (2001).
308. See Brian D. Galle, Can Federal Agencies Authorize Private Suits Under Section 1983? A Theoretical Approach, 69 BROOK. L. REV. 163, 206-07, 218-19 (2003);
309. Matthew C. Stephenson, Public Regulation of Private Enforcement: The Case for Expanding the Role of Administrative Agencies, 91 VA. L. REV. 93, 94-95 (2005).
310. See Richard Briffault, "What About the 'Ism'?" Normative and Formal Concerns in Contemporary Federalism, 47 VAND. L. REV. 1303, 1320 (1994).
311. For an example of one effort at such, a definition, see Zelinsky, supra note 33, at 22-29.
312. See Richard Briffault, Public Finance in the American Federal System: Basic Patterns and Current Issues, 2 COLUM. J. EUR. L. 533, 537-39 (1996).
313. Galle, supra note 142, at 187-91.
314. Id. at 186-87.
315. See David A. Super, Rethinking Fiscal Federalism, 118 HARV. L. REV. 2544, 2568-69 (2005).
316. Cf. Jeffrey Schoenblum, Taxation, the State, and the Community, 23 SOC. PHIL. & POL'Y 210, 213-14 (2006) (considering whether net benefits and burdens of tax and government should be assessed at the individual or community levels).
317. David F. Bradford & Wallace E. Oates, Towards a Predictive Theory of Intergovernmental Grants, 61 AM. ECON. REV. 440, 443-45 (1971);
318. Ronald C. Fisher, Income and. Grant Effects on Local Expenditure: The Flypaper Effect and Other Difficulties, 12 J. URB. ECON. 324, 325 (1982).
319. See New York v. United States, 505 U.S. 144, 168 (1992);
320. Roderick M. Hills, Jr., The Political Economy of Cooperative Federalism: Why State Autonomy Makes Sense and "Dual Sovereignty" Doesn't, 96 MICH. L. REV. 813, 861, 874 (1998).
321. See Briffault, supra note 155, at 543-45.
322. Under classic economic theory, a grant should have almost no effect on state spending. Because money is fungible, even an earmarked federal grant should simply reduce slightly the price for all a state's expenditures, in effect redistributing the grant evenly to every beneficiary of state spending. For example, suppose a state chooses to spend $100 million, of its $1 billion budget on highways. The federal government gives the state $50 million earmarked for highway spending. The state still prefers to tax its citizens and allocate its resources in such a way that it spends $100 million, on roads (or, to be precise, a bit more than $100 million, as a result of the added wealth represented by the grant). Bradford & Oates, supra note 160, at 444-45;
323. James R. Hines, Jr. & Richard H. Thaler, Anomalies: The Flypaper Effect, J. ECON. PERSP., Fall 1995, at 217, 218.
324. The effect should be that the state reduces its own spending on highways by $50 million and either cuts taxes by $50 million, distributes the $50 million proportionately among all its other spending priorities, or, more likely, a mix of the two. Fisher, supra note 160, at 328;
325. Oates, supra note 131, at 1129.
326. For obvious reasons, matching grants change this calculation, as states are willing to spend more in order to obtain more federal funds. Stephen J. Bailey & Stephen Connolly, The flypaper effect: Identifying areas for further research, 95 PUB. CHOICE 335, 336 (1998).
327. In practice, however, the effect of federal earmarking is often to shift state spending in compliance with, the earmark or mandate, even if there is no explicit matching requirement. Fisher, supra note 160, at 329-30 (analyzing earlier studies);
328. Oates, supra note 131, at 1129.
329. No coherent theory currently explains why states respond this way to federal grants. Sang-Seok Bae & Richard C. Feiock, The Flypaper Effect Revisited: Intergovernmental Grants and Local Governance, 27 INT'L J. PUB. ADMIN. 577, 583-85 (2004);
330. Fisher, supra note 160, at 324;
331. Hines & Thaler, supra, at 220-22. Thus it is uncertain whether state spending in response to federal grant conditions increases or decreases actual constituent welfare.
332. See Robert C. Ellickson, Law and Economics Discovers Social Norms, 27 J. LEGAL STUD. 537, 539-40 (1998);
333. Jon Elster, Social Norms and Economic Theory, J. ECON. PERSP., Fall 1989, at 99, 99-100.
334. Galle, supra note 142, at 193.
335. Briffault, supra note 155, at 542-43;
336. David Freeman Engstrom, Drawing Lines Between Chevron and Pennhurst: A Functional Analysis of the Spending Power, Federalism, and the Administrative State, 82 TEX. L. REV. 1197, 1243-44 (2004).
337. Peter J. Smith, Pennhurst, Chevron, and the Spending Power, 110 YALE L.J. 1187, 1234 (2001).
338. See Engstrom, supra note 166, at 1249.
339. In addition to this problem, many federal conditions are attached to a variety of grants, so determining any one day on which a state chooses to accept the grant and all its associated conditions is problematic. Smith, supra note 167, at 1234-36.
340. See Mark Seidenfeld, A Civic Republican Justification for the Bureaucratic State, 105 HARV. L. REV. 1511, 1554-55 (1992).
341. Galle, supra note 142, at 195 n.244.
342. See John O. McGinnis & Ilya Somin, Federalism vs. States' Rights: A Defense of Judicial Review in a Federal System, 99 NW. U. L. REV. 89, 94-100 (2004).
343. Hills, supra note 161, at 861, 874;
344. Earl M. Maltz, Sovereignty, Autonomy and Conditional Spending, 4 CHAP. L. REV. 107, 113 (2001).
345. Galle, supra note 142, at 188-89.
346. Id. The Spending Clause allows Congress to legislate in. a variety of ways that would be beyond the scope of its other delegated powers. South Dakota v. Dole, 483 U.S. 203, 207 (1987).
347. See Galle, supra note 142, at 188-89.
348. See id. at 186-87.
349. Hills, supra note 161, at 856;
350. Ilya Somin, Closing the Pandora's Box of Federalism: The Case for Judicial Restriction of Federal Subsidies to State Governments, 90 GEO. L.J. 461, 476 (2002).
351. See Baker, supra note 130, at 1951;
352. Revesz, supra note 130, at 1216-17.
353. See Elkins, supra note 10, at 47-48.
354. But see Joseph E. Stiglitz, Utilitarianism and Horizontal Equity: The Case for Random Taxation, 18 J. Pub. Econ. 1, 30-31 (1982).
355. See DODGE, supra note 23, at 287-90.
356. Cf. Elkins, supra note 10, at 48-49 (noting that a tax system may increase economic efficiency by imposing penalties on inefficient actors and that this penalty may be inconsistent with pure horizontal equity);
357. Zolt, supra note 29, at 70-71 (observing that taxes imposed to correct for externalities often cannot be uniform).
358. See supra text accompanying notes 130-131.
359. To see why the deduction has this effect, recall that the deduction is generally more valuable for higher-income taxpayers. It follows that states with more high-income taxpayers will derive greater value from the deduction, shifting money away from lower-income states. See STEVEN MAGUIRE, CONG. RESEARCH SERV., STATE AND LOCAL TAXES AND THE FEDERAL ALTERNATIVE MINIMUM TAX 4 (2005).
360. See supra text accompanying notes 175-177.
361. See Reuven S. Avi-Yonah, Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State, 1.13 HARV. L. REV. 1573, 1586-99 (2000) (describing how tax havens prevent other nations from setting optimal tax levels).
362. Id.
363. See Steven A. Dean, Philosopher Kings and International Tax: A New Approach to Tax Havens, Tax Flight, and International Tax Cooperation, 58 HASTINGS L.J. 991 (2006) (proposing a regime in which large nations pay fees to tax havens to persuade them not to act as havens).
364. See PRESIDENT'S ADVISORY PANEL ON FED. TAX REFORM, supra note 9, at 83;
365. Oates, supra note 131, at 1126-27.
366. For a mathematical model of this prediction, see Craig Volden, Intergovernmental Grants: A Model of Political Competition in a Federal System 9-22 (unpublished manuscript, on file with author), available at http://www.kellogg.northwestern.edu/meds/papers/econ_volden.pdf.
367. See Baker, supra note 130, at 1933-36;
368. McCoy & Friedman, supra note 135, at 86;
369. Somin, supra note 177, at 468;
370. Stewart, supra note 127, at 971.
371. For an in-depth discussion of the evidence and its best interpretation, see Brian Galle, Federal Grants, State Decisions, 16 SUP. CT. ECON. REV. (forthcoming 2008) (manuscript at 69-78, on file with author), available at http://papers.ssrn.com/sol3/papers. cfm?abstract_id=963915.
372. See Shaviro, supra note 12, at 919-21, 925-26.
373. See Brian Galle, Designing Interstate Institutions: The Example of the Streamlined Sales and Use Tax Agreement ("SSUTA"), 40 U.C. DAVIS L. REV. 1381, 1396, 1402-28 (2007) (analyzing the effects of choice of institutional form on the tradeoff between diversity and other federalism values).
374. I elaborate on this point in more detail in my discussion of the subsidy arguments for and against the deduction. Galle, supra note 17, at 696-701.
375. DODGE, supra note 23, at 301-06.
376. The foundational article in optimal-income-tax theory is J.A. Mirrlees, An Exploration in the Theory of Optimum Income Taxation, 38 REV. ECON. STUD. 175 (1971).
377. For a lawyer-friendly summary of optimal-tax theory, see Joseph Bankman & Thomas Griffith, Social Welfare and the Rate Structure: A New Look at Progressive Taxation, 75 CAL. L. REV. 1905, 1946-58 (1987).
378. On the assumption of identical utility functions, see id. at 1947.
379. See DODGE, supra note 23, at 305-06;
380. DANIEL SHAVIRO, WHEN RULES CHANGE: AN ECONOMIC AND POLITICAL ANALYSIS OF TRANSITION RELIEF AND RETROACTIVITY 27-32 (2000);
381. Bankman. & Griffith, supra note 196, at 1947-48;
382. Musgrave, supra note 29, at 6 n.4, 8-9, 14 (examining various compromises that administrable measures of equity demand).
383. Cf. Musgrave, supra note 29, at 16 (arguing that presumption of identical utility functions is too inaccurate to be satisfying grounds for tax theory);
384. Daniel Shaviro, The Man Who Lost Too Much: Zarin v. Commissioner and the Measurement of Taxable Income, 45 TAX L. REV. 215, 224-26 (1990) (claiming that, while it is administratively necessary to use income or consumption as proxies for well-being, tax policy should still be "guided by the goal of approaching as closely as possible what we believe are the underlying subjective realities").
385. See BLUM & KALVEN, supra note 29, at 53.
386. Even in a world of rational actors, designing a tax system based on utility is difficult because individuals who are taxed based on their reported or observed utility will obviously have incentives to underreport. A variety of economists have imagined theoretical solutions to this problem, with generally mixed results. See Fried, supra note 29, at 170-72 (summarizing and critiquing Lindahl, Samuelson, and Tiebout).
387. Kaplow, supra note 12, at 439;
388. see also Sunstein. & Thaler, supra note 65, at 1191 (noting the authors' "reliance on behavior as an indication of welfare").
389. See supra text accompanying notes 48-67.
390. See John C. Harsanyi, Morality and the theory of rational behaviour, in UTILITARIANISM AND BEYOND 39, 55-56 (Amartya Sen & Bernard Williams eds., 1982);
391. Kaplow, supra note 47, at 504;
392. cf. Lewinsohn-Zamir, supra note 46, at 379, 394 (arguing that consumer preferences should be assessed in. light of how those preferences would be expressed absent collective action problems).
393. For alternative notions of objective utility, see ELSTER, supra note 84, at 125-40,
394. which claims that a meaningful measure of welfare requires the satisfaction of fully autonomous choices; MARTHA C. NUSSBAUM, WOMEN AND HUMAN DEVELOPMENT 150-55 (2000), which argues that preferences are simply an "epistemic" tool for identifying central human, capabilities and universal values;
395. and Amartya K. Sen, Women, Technology and Sexual Division, TRADE & DEV., 1985, at 195, which develops an argument that welfare measures should include not only mental states but also human "functionings" and "capabilities." For a helpful overview and critical discussion,
396. see TM. SCANLON, WHAT WE OWE TO EACH OTHER 108-43 (1998).
397. As an additional note, objective utility should not be confused with what Professor Kahneman labels "objective well-being," which, in his usage refers to "happiness data" from self-reporting, brain imaging, and the like. Daniel Kahneman, Objective Happiness, in WELL- BEING: THE FOUNDATIONS OF HEDONIC PSYCHOLOGY 3 (Daniel Kahneman et al. eds., 1999).
398. JOHN RAWLS, A THEORY OF JUSTICE 12, 136-42 (1971).
399. See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 453-54 (3d ed. 1986).
400. See Bankman & Griffith, supra note 196, at 1953-66.
401. See James S. Fishkin, Justice Versus Utility, 84 COLUM. L. REV. 263, 266, 269-70 (1984)
402. (reviewing UTILITARIANISM AND BEYOND (Amartya Sen & Bernard Williams eds., 1982));
403. Kaplow, supra note 47, at 509 n.1;
404. cf. Donna M. Byrne, Progressive Taxation Revisited, 37 ARIZ. L. REV. 739, 753 (1995) (explaining that interpersonal utility comparisons are difficult, in part because they invite the comparer to supply her own standard for comparison);
405. Lewinsohn-Zamir, supra note 46, at 381 n.9 ("[I]t may be argued that the hypothetical preferences theory is not a theory of preferences at all.");
406. Sunstein, supra note 50, at 222 ("[I]t may be impossible to describe something as a 'preference' without undertaking some controversial normative tasks.").
407. But see Harsanyi, supra note 45, at 142-44 (arguing that hypothetical utility can be neutrally measured by observing behavior of other similar individuals).
408. See MURPHY & NAGEL, supra note 10, at 38-39;
409. Thomas D. Griffith, Should "Tax Norms" Be Abandoned? Rethinking Tax Policy Analysis and the Taxation of Personal Injury Recoveries, 1993 WIS. L. REV. 1115, 1152-55, 1158.
410. I include in this group both strict utilitarianism as well as "welfarism" writ more broadly. They differ insofar as utilitarianism, is indifferent to distributions of utility except to the extent that such differences impact individually experienced utility, while other forms of welfarism may take utility into account but also factor in considerations about the most desirable distribution of utility. For a more in-depth account, see Matthew D. Adler & Chris William Sanchirico, Inequality and Uncertainty: Theory and Legal Applications, 155 U. PA. L. REV. 279, 291-95 (2006).
411. See Stiglitz, supra note 179, at 36.
412. On the other hand, one could also respond that ignoring the problems of expressed preferences and assessing "utility" solely on the basis of actual consumption is itself not a neutral choice. E.g., Patrick B. Crawford, The Utility of the Efficiency/Equity Dichotomy in Tax Policy Analysis, 16 VA. TAX REV. 501, 514-15, 521 (1997);
413. see also BLUM & KALVEN, supra note 29, at 69 (arguing that the "ostensibly scientific" approach of measuring consumer behavior "frequently conceals a normative judgment either about the way people ought to value money or about the social value of typical expenditures at different levels of income" (footnote omitted)).
414. See .NUSSBAUM, supra note 203, at 117 (noting this possible argument in favor of welfarism).
415. See Schoenblum, supra note 159, at 223, 230 (arguing that experts and bureaucrats cannot be trusted to make objectively correct tax-policy decisions, while also asserting that this same problem applies to efforts at employing utilitarianism);
416. cf. Stiglitz, supra note 179, at 38-39 (arguing that horizontal equity may be a check against distortions of utilitarian analysis within the political process).
417. It should be noted that at least one of Rawls's explicit goals was to counter this argument by appealing to claims that "all can accept." John Rawls, Kantian Constructivism in Moral. Theory, in MORAL DISCOURSE AND PRACTICE: SOME PHILOSOPHICAL APPROACHES 247, 248 (Stephen Darwall et al. eds., 1997);
418. see McCaffery, supra note 29, at 75-76.
419. For a selection of the various perspectives on this front, see supra note 10.
420. In a future work, I will offer a freestanding justification for horizontal equity. For now, it is perhaps sufficient to say that we could think of horizontal equity as expressing our belief in a default presumption in favor of the existing status quo distribution, and that this default presumption is useful to the extent that it represents an incomplete agreement to formulate tax policy while taking as given all of the surrounding facts and preferences of society. Viewing the goals of equity in this way, we might see significant difficulties in invoking any single notion of hypothetical utility across state boundaries. The states, after all, are themselves sovereign in some sense. Therefore, a question exists as to whether one single policy judgment about the appropriate measure of utility is consistent with our ideal of state individual political sovereignty.
421. For an overview of the ex ante-ex post question, in welfare theory generally, see Adler & Sanchirico, supra note 209, at 285-322.
422. For contrasting views of its application, compare Donald T. Hornstein, Reclaiming Environmental Law: A. Normative Critique of Comparative Risk Analysis, 92 COLUM. L. REV. 562, 595-98 (1992),
423. with Kaplow, supra note 10, at 143-48.
424. For the early definitive work, see Frank I. Michelman, Property, Utility, and Fairness: Comments on the Ethical Foundations of "Just Compensation" Law, 80 HARV. L. REV. 1165 (1967).
425. RAWLS, supra note 204, at 380-8.1.
426. See SHAVIRO, supra note 197, at 18;
427. Ronald Dworkin, What is Equality? Part 2: Equality of Resources, 10 PHIL. & PUB. AFF. 283, 294 (1981).
428. That is, if an owner knows she will be compensated for takings or other losses, she will invest in property at risk of loss without respect for that loss, even, if society would be better off if she avoided investing. See Lawrence Blume & Daniel L. Rubinfeld, Compensation for Takings: An Economic Analysis, 72 CAL. L. REV. 569, 596-97 (1984);
429. Louis Kaplow, An Economic Analysis of Legal Transitions, 99 HARV. L. REV. 509, 531, 54.1 (1986).
430. There is considerable nuance to this claim. See Barbara H. Fried, Ex Ante/Ex Post, 13 J. CONTEMP. LEGAL ISSUES 123, 129-31 & n.11 (2003);
431. Kaplow, supra, at 536-50.
432. See Barbara H. Fried, Compared to What? Taxing Brute Luck and Other Second-Best Problems, 53 TAX L. REV. 377, 393-94 (2000) (identifying a similar argument but disagreeing with some of its premises);
433. Michael J. Graetz, Retroactivity Revisited, 98 HARV. L. REV. 1820, 1834-35 (1985);
434. cf. Adler & Sanchirico, supra note 209, at 361 (noting that ex ante equity analysis of capital gains taxation might be indifferent to distributive consequences of divergence between winning and losing investments);
435. Stiglitz, supra note 179, at 1-2 (pointing out the possibility of defining horizontal equity in tax by reference to ex ante distribution of probable outcomes). Key to this argument is the point that if individuals are aware of the extent of the risks they run, they can insure against them. Thus, if risk is disproportionate to insurance, negative ex post outcomes result from a choice not to insure.
436. See Adler & Sanchirico, supra note 209, at 285-322 (explaining conditions in which this would likely hold true).
437. Some commentators have argued that state taxes should be deductible to the extent that they are redistributed to others, on the ground that those funds are not consumed by the taxpayer. Boris I. Bittker, Income Tax Deductions, Credits, and Subsidies for Personal Expenditures, 16 J.L. & ECON. 193, 200-01 (1973).
438. However, the extent to which transfer payments really do not benefit the transferor, even ex post, is questionable. See DODGE, supra note 23, at 103;
439. MURPHY & NAGEL, supra note 10, at 145-48.
440. Fried, supra note 2.19, at 145-46, 148;
441. Kaplow, supra note 219, at 549-50.
442. See Kaplow, supra note 219, at 596.
443. See Fried, supra note 219, at 157-58;
444. Kaplow, supra note 219, at 549.
445. One might also argue that ex ante utility is a poor fit for our tax system generally. After all, we permit deductions for losses on investments, I.R.C. § 165(c)(2) (2000), when, it might be said that on average the investment was simply a bet that failed to pay off. It should follow, as a matter of ex ante utility, that the loser is no worse off than one whose investments gain and should be entitled to no deduction. Since this is not the law, the argument would go, we can. conclude that our law generally rejects the use of ex ante measures of utility. It is possible, however, that our decision to grant the deduction reflects not a purely equitable analysis but rather a calculation that in the absence of a deduction, individuals would underinvest. Cf. Evsey D. Domar & Richard A. Musgrave, Proportional Income Taxation and Risk-Taking, 58 Q.J. ECON. 388, 389 (1944) (explaining that in the absence of deductibility for losses, individuals will choose less-risky investments than they would absent tax).
446. See Galle, supra note 17, at 696-701.
447. See Fried, supra note 219, at 136-49, 157-58;
448. Daniel Markovits, How Much Redistribution Should There Be?, 112 YALE L.J. 2291, 2300-03 (2003).
449. Fried, supra note 219, at 157-58.
450. For example, a strict utilitarian in a society in which distribution is unimportant would say that there is no difference between the ex ante and ex post views because overall utility is the same in either. See Adler & Sanchirico, supra note 209, at 334. Thus before we can critique either view, we must first specify a social-welfare function with some distributive component.
451. See Stiglitz, supra note 179, at 30 (observing that the opportunity for savings implies that lifetime smoothing of year-to-year inequalities may still be inequitable).
452. Cf. Zolt, supra note 29, at 93-94 (arguing that use of horizontal equity to evaluate annual tax assessment may be misguided since justice in distributions often happens over period of years).
453. Comm'r v. Tufts, 461 U.S. 300, 307 (1983).
454. See Boris I. Bittker & Barton H. Thompson, Jr., Income from the Discharge of Indebtedness: The Progeny of United States v. Kirby Lumber Co., 66 CAL. L. REV. 1159, 1160 n.5, 1163-64 (1978) (describing reasons loans may change in value during the life of the loan).
455. See id. at 1165-66;
456. Joseph M. Dodge, Exploring the Income Tax Treatment of Borrowing and Liabilities, or Why the Accrual Method Should Be Eliminated, 26 VA. TAX REV. 245, 248, 280 (2006).
457. JOSEPH M. DODGE ET AL., FEDERAL INCOME TAX: DOCTRINE, STRUCTURE, AND POLICY 286-87 (3d ed. 2004); see I.R.C. § 7872 (2000) (treating portions of certain below-market-interest loans as income).
458. U.S. CONST, art. IV, § 4. I am grateful to Ron Pearlman for suggesting a version of this argument.
459. See DODGE ET AL., supra note 233, at 288-90, 299-300 (providing examples of below-market loans and phantom repayment obligations);
460. Bittker & Thompson, supra note 231, at 1187 (providing the example of cancellation of indebtedness).
461. That, of course, is the classic account of the basic justification for judicial review formulated by John Hart Ely, among others. JOHN HART ELY, DEMOCRACY AND DISTRUST (1980);
462. Frank I. Michelman, Welfare Rights in a Constitutional Democracy, 1979 WASH. U. L.Q. 659.
463. That is not to say that the theory is without its own problems. See, e.g., Paul Brest, The Substance of Process, 42 OHIO ST. L.J. 131, 134-37 (1981);
464. Laurence H. Tribe, The Puzzling Persistence of Process-Based Constitutional Theories, 89 YALE L.J. 1063, 1072-77 (1980).