University of Michigan Program in Law and Economics

From Here to Eternity: The Folly of Perpetual Trusts

Lawrence W. Waggoner — Mon, 29 Apr 2013 07:47:22 PDT

Trusts that can operate for as many as a thousand years or even forever, typically for the benefit of the settlor’s descendants living from time to time, now and in the future, are all the rage in banking and estate-planning circles. Before 1986, when Congress passed the federal generation-skipping transfer tax (GST tax), settlors had little incentive and probably little desire to establish perpetual trusts, even though they were permitted to do so under the law of Wisconsin, South Dakota, or Idaho. The GST tax created an artificial incentive for the wealthy to establish such trusts.

The origin of the perpetual-trust movement is the GST exemption, which is part of the GST tax. When Congress granted the GST exemption, it did not impose a durational limit on trusts that qualify for the exemption, but instead relied on state perpetuity laws to supply that limit. The reliance on state perpetuity laws was badly misplaced. At the instigation of state banking groups and estate-planning attorneys, states began to pass legislation allowing trust settlors to create perpetual trusts — trusts that can last for several centuries or even forever. With state perpetuity laws out of the way, the wealthy began creating perpetual trusts in significant numbers.

This essay questions whether the state legislators who vote to authorize perpetual trusts and the wealthy who create them are thinking through what they are allowing or putting in place. The essay shows the folly of such trusts, primarily by producing a table projecting how, with each step down the generational ladder, the number of beneficiaries will proliferate and the settlor’s genetic connection with the beneficiaries will decline.

The essay then points out that the primary responsibility for the perpetual-trust movement rests not with the state legislators or the wealthy, but with Congress. The primary responsibility for curtailing it also rests with Congress, but so far Congress has not acted. The American Taxpayer Relief Act of 2012 made the problem worse, by making the $5 million ceiling ($5.25 million as adjusted for inflation) on the GST exemption permanent.

Comprehensive tax reform is now on the agenda of the House Ways and Means Committee, but no public Committee document indicates an interest in curtailing the GST exemption for perpetual trusts or even an awareness of the problem.

The only agency of the federal government that has publicly taken an interest in curtailing the GST exemption for perpetual trusts is the Treasury Department. The Treasury Department’s position is that the absence of a durational limit on the GST exemption is inconsistent with the purpose of the exemption and undermines the policy of the GST tax. Treasury’s proposed solution, however, is disappointing because it is not as effective as it could be: Treasury would allow perpetual trusts created before enactment of its proposal to continue to be unburdened by a durational limit and would allow perpetual trusts created after enactment to qualify for the GST exemption, but would have the exemption expire 90 years after the trust was created.

The Treasury Department’s proposals are better than nothing. If enacted as part of comprehensive tax reform (or as part of a smaller measure), they would gradually dampen the perpetual-trust movement and its associated perpetual GST exemption. But they would leave many trusts and much wealth exempt from GST tax for much longer than Congress originally intended. Once enactment would appear possible, the stampede would be on to get in before the deadline. Super-rich clients who were on the fence would be encouraged to establish GST-exempt perpetual trusts before the door closed on the opportunity.

The essay concludes by offering Congress a solution that is consistent with the original intent of the GST exemption and would be truly effective to end the perpetual-trust movement.

Meaning in the Natural World

Joseph Vining — Thu, 18 Apr 2013 07:19:31 PDT

James Boyd White devoted much of his work to the rescue of meaning in language, art, and the human world. A turn to the natural world may underscore his confidence that an individual's statement of law can be more than a disguised expression of individual will and desire. This essay may also suggest one more way toward hope that a realistic sense of the natural world need not threaten confidence in the reality of beauty and meaning in our human world.

Methods for Multicountry Studies of Corporate Governance (and Evidence from the BRIKT Countries)

Bernard S. Black et al. — Mon, 25 Mar 2013 09:15:02 PDT

We discuss the perils in multicountry studies of corporate governance (CG), focusing on emerging markets. The existing studies are massively multicountry studies, which cover many firms across many countries, but rely on the same limited governance elements in each countries, have few firm-level control variables, and use pure-cross-sectional data. This paper discusses the severe data and construct validity issues in these studies, proposes methods to respond to those issues, and applies those methods through a study of five major emerging markets (Brazil, India, Korea, Russia, and Turkey). We develop unique time-series datasets on governance in each country. We address construct validity by building country-specific indices which reflect local norms and institutions. These similar-but-not-identical indices predict higher firm market value, both in each country and when pooled across countries. In contrast, a “common index” that uses the same elements in each country, has no predictive power. Firm fixed effects results differ substantially from cross-sectional or pooled OLS, and firm random effects. Results are also sensitive to choice of control variables (strongly so with the weaker cross-sectional and pooled OLS specifications), and to the functional form for the dependent variable and how one addresses outliers.

Bargaining Over Loyalty

Daniel A. Crane — Mon, 25 Feb 2013 06:41:39 PST

Contracts between suppliers and customers frequently contain provisions rewarding the customer for exhibiting loyalty to the seller. For example, suppliers may offer customers preferential pricing for buying a specified percentage of their requirements from the supplier or buying minimum numbers of products across multiple product lines. Such loyalty-inducing contracts have come under attack on antitrust grounds because of their potential to foreclose competitors or soften competition by enabling tacit collusion among suppliers. This article defends loyalty inducement as a commercial practice. Although it can be anticompetitive under some circumstances, rewarding loyal customers is usually procompetitive and price- reducing. The two most severe attacks on loyalty discounting—that loyalty discounts are often disguised disloyalty penalties and that loyalty clauses soften competition—are unlikely to hold as a general matter. Nor are arguments that customers only accede to loyalty inducements because of collective action problems generally true. Dominant buyers who face few collective action problems frequently use loyalty commitments to leverage their buying power and obtain lower prices.

Why It’s Called the Affordable Care Act

Nicholas Bagley — Fri, 15 Feb 2013 11:42:20 PST

The Patient Protection and Affordable Care Act of 2010 (“ACA”) raises numerous policy and legal issues, but none have attracted as much attention from lawyers as Section 1501. This provision, titled “Maintenance of Mini-mum Essential Coverage,” but better known as the “individual mandate,” requires most Americans to obtain health insurance for themselves and their dependents by 2014. 1 We are dismayed that the narrow issue of the mandate and the narrower issue of free riding have garnered so much attention when our nation’s health-care system suffers from countless problems. By im-proving quality, controlling costs, and extending coverage to the uninsured, the ACA means to address many of those problems. And it’s about time. The United States has lower insurance coverage rates and lower life expectancy than most developed countries, and our system does poorly on several di-mensions of quality. Worse still, we spend much more on health care than any other country—$2.5 trillion, or 17.6 percent of gross domestic product, in 2009.2 These measures of total spending mask grave distributional con-cerns: 52 million people went without insurance during some part of 2010.

US Subpart F Legislative Proposals: A Comparative Perspective

Reuven S. Avi-Yonah et al. — Fri, 15 Feb 2013 11:26:02 PST

This article reviews recent US proposals to amend the US Controlled Foreign Corporation (CFC) rules, also known as Subpart F. It places the US debate in a comparative perspective by describing how the US proposals fit in with developments in other countries that have CFC rules.

Launching the Insider Trading Revolution: SEC v. Capital Gains Research Bureau

Adam C. Pritchard — Fri, 15 Feb 2013 11:20:18 PST

Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.1 marked the resurgence of the SEC in the Supreme Court, sparking a decade-long winning streak there. The Capital Gains decision, although turning on an interpretation of the Investment Advisers Act of 1940,2 also gave the green light to the SEC to push the boundaries of its power in other areas. Moreover, Capital Gains suggested that the SEC could expand its power through agency and judicial interpretation of existing statutes and regulation, without resorting to the cumbersome rulemaking process under the Administrative Procedure Act, or still more daunting, seeking legislation. After its victory in Capital Gains, the SEC would push an aggressive interpretation of § 10(b) of the Exchange Act in the lower courts, particularly the Second Circuit, to crack down on insider trading. This Chapter uncovers the seeds of the SEC’s insider trading crusade in Capital Gains and how that opinion influenced subsequent securities jurisprudence. I proceed as follows. Section I provides background on the SEC and its relationship with the Supreme Court prior to Capital Gains. Section II follows the SEC’s Capital Gains enforcement action as it made its way up through the district court and the Second Circuit. Section III explores how the case unfolded in the Supreme Court. Section IV then assesses Capital Gains’ long-term impact. A brief Conclusion follows.

Effectively Curbing the GST Exemption for Perpetual Trusts

Lawrence W. Waggoner — Fri, 15 Feb 2013 11:14:14 PST

Current law allows a married couple to transfer up to $10.24 million into a trust that is exempt from the federal generation-skipping transfer tax. The proposal would deny the GST exemption prospectively, unless the trust must terminate within one of three perpetuity periods: (1) 21 years after the death of a life in being; (2) 90 years after creation; or (3) after the death of the last living beneficiary who is no more than two generations younger than the settlor. Atrust now in existence would be allowed a grace period during which it could be modified to terminate within the allowed period, but absent modification, the trust would lose its GST exemption at the end of the grace period. The proposal is offered as a part of the Shelf Project, a collaboration of tax professionals to develop proposals raising revenue while making the tax system more efficient and reducing deadweight loss. The inventory of the prior 64 shelf projects is found at http://www.utexas.edu/ law/faculty/calvinjohnson/shelf_project_inventory _subject_matter.pdf. Shelf projects follow the format of a congressional taxwriting committee report in explaining current law, what is wrong with it, and how to fix it.

Double or Nothing: A Tax Treaty for the 21st Century

Reuven S. Avi-Yonah et al. — Fri, 15 Feb 2013 11:06:47 PST

The current tax treaty network was developed in the 1920s and 1930s in order to prevent double residence/source taxation. This kind of double taxation rarely exists any more because most countries have adopted either an exemption system or a foreign tax credit regime in their domestic (non‐treaty) law, which effectively prevents residence/source double taxation even in the absence of a treaty. Instead, as Tsilly Dagan has pointed out, the current treaties serve mostly to transfer revenue from the source country to the residence country. This suggests that treaties may be unnecessary because exemption from withholding taxes by source countries can be done unilaterally. However, in the era of globalization (post 1980), the treaties have developed two new functions, both of which apply primarily to individual taxpayers: First, to prevent double non‐taxation by ensuring that withholding taxes are collected if there is no assurance of taxation by the residence country. Second, to enforce residence based taxation of individuals by having source countries provide information to residence countries about income derived by their residents in the source country. The paper proposes ways to update the US model treaty to reflect these new functions.

Contribution of a Built-In Loss to a Partnership

Douglas A. Kahn — Fri, 15 Feb 2013 10:25:12 PST

In 2004 Congress amended the code to prevent the use of a partnership contribution as a means of transferring a deduction for a built-in loss from one person to another. That amendment has undermined the application of the remedial method (and the traditional method with curative allocations) that the regulations provide for the allocation of a contributed built-in gain or loss, Kahn argues. He also asserts that the 2004 amendment distorts income reporting.

Sales Between a Partnership And Non-Partners

Douglas A. Kahn — Fri, 15 Feb 2013 10:16:24 PST

Kahn argues that a 1986 amendment to section 707 invalidated several regulatory provisions promulgated under section 267.

Essential Health Benefits and the Affordable Care Act: Law and Process

Nicholas Bagley et al. — Mon, 11 Feb 2013 06:41:07 PST

Beginning in 2014, the Affordable Care Act (ACA) will require private insurance plans sold in the individual and small-group markets to cover a roster of “essential health benefits.” Precisely which benefits should count as essential, however, was left to the discretion of the Department of Health and Human Services (HHS). The matter was both important and controversial. HHS nonetheless announced its policy on essential health benefits by posting on its website a 13-page bulletin stating that it would allow each state to define essential benefits for itself by choosing a “benchmark” plan modeled on existing plans in the state. On both substance and procedure, the move was surprising. The benchmark approach departed from the uniform, federal standard that the statute appears to anticipate and that many informed observers expected HHS to adopt. And announcing the policy thorough an internet bulletin arguably allowed HHS to sidestep orthodox administrative procedures, including notice and comment, White House review, and preenforcement review in the courts.

What are we to make of this? This chapter explores two questions. First, is the benchmark approach a lawful exercise of HHS’s authority under the ACA? Although HHS may have brushed up against the limits of its discretionary authority, we conclude that the approach likely will (and, in our view, should) be upheld in the event of a challenge. Second, did HHS’s announcement of the benchmark approach through an internet bulletin allow the agency to avoid the very administrative procedures that typically serve to constrain the exercise of agency discretion? The answer here is a flat no. The agency’s adroit use of guidance documents instead resulted in a process that was more open to public scrutiny and external oversight than conventional rulemaking would have been.

Employment Law and Social Equality

Samuel R. Bagenstos — Thu, 31 Jan 2013 06:40:21 PST

What is the normative justification for individual employment law? For a number of legal scholars, the answer is economic efficiency. Other scholars argue, to the contrary, that employment law protects against (vaguely defined) imbalances of bargaining power and exploitation. Against both of these positions, this paper argues that individual employment law is best understood as advancing a particular conception of equality. That conception, which many legal and political theorists have called social equality, focuses on eliminating hierarchies of social status. Drawing on the author’s work elaborating the justification for employment discrimination law, this paper argues that individual employment law is justified as preventing employers from contributing to or entrenching social status hierarchies—and that it is justifiable even if it imposes meaningful costs on employers.

The paper argues that the social equality theory can help us critique, defend, elaborate, and extend the rules of individual employment law. It illustrates the point by showing how concerns about social equality, at an inchoate level, underlie some classic arguments against employment-at-will. It also shows how engaging with the question of social equality can enrich analysis of a number of currently salient doctrinal issues in employment law, including questions regarding how the law should protect workers’ privacy and political speech, the proper scope of maximum-hours laws and prohibitions on retaliation, and the framework that should govern employment arbitration.

A Proposed Replacement of the Tax Expenditure Concept and a Different Perspective on Accelerated Depreciation

Douglas A. Kahn — Thu, 24 Jan 2013 12:25:53 PST

The thesis of this article is that the tax expenditure concept is grounded on an erroneous vision of the structure of an income tax system. The tax expenditure concept adopts a binary view of income taxation. It posits that there is an ideal or pure income tax system whose provisions are elements of the normal structure of that system without any influence from non-tax policy considerations. Tax provisions are described either as falling within those core provisions or outside of them. There are no other categories. To the contrary, this article contends that tax provisions lie on a continuum in which some are in the core and some are at different distances from the core. The author contends that virtually all tax provisions, including those within the core, reflect policy considerations. The decision whether to adopt or retain a provision takes into account both its proximity to the core and also the economic and societal consequences (both positive and negative) that the provision will cause. There is no universal tax system for all times. Tax laws are (and should be) constructed to coordinate with the needs and values of society as they change over time. The article also contends that there is not just one proper method of depreciation, and that accelerated depreciation is as consistent with neutral tax principles as is straight line depreciation.

And Yet it Moves: A Tax Paradigm for the 21st Century

Reuven S. Avi-Yonah — Thu, 13 Dec 2012 11:44:20 PST

A central premise of tax scholarship of the last thirty years has been the greater mobility of capital than labor. Recently, scholars such as Edward Kleinbard have recommended that the US adopt a variant of the 'dual income tax' model used by the Scandinavian countries, under which income from capital is subject to significantly lower rates than labor income because of its supposedly greater mobility. This article argues that the premise upon which this argument is built is mistaken, because for individual US taxpayers (as opposed to corporations), there are significant limitations on their ability to avoid tax by moving their capital overseas. Moreover, if we focus on those taxpayers that pay the bulk of the income tax (i.e., the upper middle class and the rich), the data suggest that their ability to legally avoid taxation by expatriation is not significantly lower than their ability to evade it by moving capital, and lower income taxpayers are able to avoid both the income tax and the payroll tax (as well as a VAT) by emigration. The article will then develop the policy implications, suggesting that income from labor and capital should be subject to similar rates, but that these rates should be congruent with the price the US population is willing to pay for public services.

International Taxation and Competitiveness: Introduction and Overview

Reuven S. Avi-Yonah et al. — Tue, 27 Nov 2012 08:40:49 PST

The debate about whether to abolish deferral or to adopt territoriality has been going on ever since the Kennedy Administration first proposed ending deferral in 1961. The problem is that neither side has factual support for their argument about whether the U.S. tax system, including Subpart F, as currently enacted or with any of the proposed reforms, in fact negatively impacts the tax burden of US-based MNEs. Even the concept of competitiveness itself is unclear. Despite numerous claims, there has been no rigorous attempt that we are aware of to determine whether MNEs based in our major trading partners in fact have a tax advantage or disadvantage because of Subpart F or other rules.

In October, 2011, the American Tax Policy Institute sponsored a conference organized by Reuven Avi-Yonah and Jane Gravelle on 'International Taxation and Competitiveness'. This conference was designed to address these issues in a systematic way, and to form the basis for a better informed policy debate going forward. The articles included in this volume were first presented at this conference.

Estimating Gender Disparities in Federal Criminal Cases

Sonja Starr — Tue, 27 Nov 2012 08:40:48 PST

This paper assesses gender disparities in federal criminal cases. It finds large gender gaps favoring women throughout the sentence length distribution (averaging over 60%), conditional on arrest offense, criminal history, and other pre-charge observables. Female arrestees are also significantly likelier to avoid charges and convictions entirely, and twice as likely to avoid incarceration if convicted. Prior studies have reported much smaller sentence gaps because they have ignored the role of charging, plea-bargaining, and sentencing fact-finding in producing sentences. Most studies control for endogenous severity measures that result from these earlier discretionary processes and use samples that have been winnowed by them. I avoid these problems by using a linked dataset tracing cases from arrest through sentencing. Using decomposition methods, I show that most sentence disparity arises from decisions at the earlier stages, and use the rich data to investigate causal theories for these gender gaps.

Facebook, the JOBS Act, and Abolishing IPOs

Adam C. Pritchard — Tue, 27 Nov 2012 08:40:47 PST

The market for initial public offerings (IPOs) — the first sale of private firms’ stock to the public — is notorious for its swings from peaks to valleys. This paper argues that these swings reflect serious flaws in the IPO scheme, and that U.S. capital markets should move toward a more stable alternative. Specifically, this paper argues for a two-tier market system in which new stock issuers initially participate in a less-regulated private capital market of accredited investors and then, if they choose, they can move to a more regulated, broader public market. Likewise, firms currently participating in the public market can choose to move to the accredited investor market. Such a scheme would harness private markets to promote the public good while simultaneously eliminating the public bad of IPOs.

SEC Investigations and Securities Class Actions: An Empirical Comparison

Stephen Choi et al. — Tue, 27 Nov 2012 08:40:45 PST

We compare investigations by the SEC with securities fraud class action filings involving public companies. Using actions with both an SEC investigation and a class action as our baseline, we compare SEC-only investigations with class action-only lawsuits. We find evidence that the stock market reacts more negatively to the class actions relative to SEC investigations. We also find that institutional ownership and stock turnover decline more for class actions compared with SEC investigations. Lastly, the incidence and magnitude of settlements, as well as the incidence of top officer resignation, are greater for class actions relative to SEC investigations. This evidence is consistent with private class actions pursuing more egregious securities law violations than SEC investigations and imposing greater sanctions against companies. At least for the metrics employed here, our findings are consistent with the private enforcement providing at least as much deterrent value, if not more, than public enforcement.

"Perpetual Trusts: The Walking Dead" and "Congress Should Effectively Curb GST Exemption for Perpetual Trusts."

Lawrence W. Waggoner et al. — Tue, 27 Nov 2012 08:35:52 PST

In separate but complementary letters to the editor of Tax Notes, Calvin Johnson (University of Texas School of Law) and Lawrence Waggoner (University of Michigan Law School) respond to an article by Dennis Belcher and seven other practicing attorneys that defend the GST exemption for perpetual trusts. In Federal Tax Rules Should Not Be Used to Limit Trust Duration, 126 Tax Notes 832 (Aug 13, 2012), the attorneys argue that the duration of a trust is a state law issue. Their article is actually a response to a Shelf Project article: Lawrence W. Waggoner, Effectively Curbing the GST Exemption for Perpetual Trusts, 125 Tax Notes 1267 (June 4, 2012), Doc 2012-9442, 2012 (TNT 110-14, available electronically at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2083804).

In Perpetual Trusts: The Walking Dead, 126 Tax Notes 1215 (Sept. 3, 2012), Johnson argues that the harm to the national wealth done by perpetual trusts is a federal responsibility. Trusts reduce the value of wealth, and settlors could figure that out if they were not seduced by the tax exemption. Specific settlor instructions get out of date and become an impediment after a generation. Delegating to trustees accountable to no one means trusts are managed primarily for the benefit of the trustees. Perpetual trusts become monsters, the walking dead. The federal exemption is motivating the harm; federal law is responsible for the harm that perpetual trusts cause.

In Congress Should Effectively Curb the GST Exemption for Perpetual Trusts, 126 Tax Notes 1216 (Sept. 3, 2012), Waggoner reaffirms his Shelf Project proposal and his criticism of the Treasury Department’s proposal for dealing with perpetual trusts. The Treasury Department’s proposal would leave many trusts and much wealth GST exempt for much longer than Congress originally intended. The Waggoner proposal, if enacted, would be much more effective. Belcher and the other attorneys argue that Congress should do nothing (a position refuted by Johnson), but if Congress is to do something, the attorneys essentially embrace the Treasury proposal.