Thinking Through OIRA Review of Tax Regulations

Last week, the U.S. Department of Treasury released a draft of its first major regulation implementing the tax legislation—known as the Tax Cuts and Jobs Act—enacted in December 2017. The proposed rule addresses some aspects of a new “pass-through” deduction, which allows some taxpayers to reduce their taxable income by as much as 20 percent.

The proposed pass-through regulation is the first “economically significant” tax regulation to be subject to centralized review by the Office of Management and Budget’s (OMB) Office of Information and Regulatory Affairs (OIRA) under a memorandum the Treasury Department and OMB released earlier this year. Before the memorandum, tax regulations were generally exempt from OIRA oversight under a 1983 agreement, as well as through years of practiced mutual disregard: OIRA had no interest in reviewing tax regulations, and tax administrators at the Treasury Department and the Internal Revenue Service (IRS)—along with tax practitioners and academics, with a few exceptions—had little interest in treating tax regulations in the same manner as regulations from other agencies.

The prospect of centralized review of tax regulations raises a number of tricky issues for the tax regulatory process: What tax regulations should be subject to review? What should OIRA review include? What sort of experts should be involved in the review?

Centralized review of tax regulations can be valuable: It has the potential to provide greater political accountability by making the incumbent administration take responsibility for tax regulations; it can allow for coordination across the executive branch; and it can be used to introduce analytical rigor to the sometimes slapdash regulation-writing process.

But centralized review also has the potential to act as a cudgel for the most powerful and politically connected taxpayers to use the regulatory process to get their way—by blocking or slowing down regulations they oppose, for example. Over decades, the Treasury Department has generally seemed to be effective at avoiding this sort of capture, and it is important that centralized review not create new problems with regulatory capture.

Although the recent memorandum between OIRA and the Treasury Department seeks to address some of these concerns, it raises even more issues. Echoing the language of Executive Order 12,866, the memorandum states that any tax regulation having “an annual non-revenue effect on the economy of $100 million or more” will be treated as “economically significant” and subject to plenary review, including review of a regulatory impact analysis prepared by the Treasury Department as part of the rulemaking process. But why is a “non-revenue effect” the relevant gauge for a tax regulation?

In an article forthcoming in the Alabama Law Review, I propose an alternative framework to help answer the question of which tax regulations should be reviewed and how that review should proceed. I argue that disregarding the revenue effect of proposed tax regulations is ill-considered, both practically and conceptually. From a practical standpoint, the Treasury Department is well prepared right now to produce revenue estimates of proposed tax regulations: The agency often prepares revenue estimates for proposed legislation, and in the past it has prepared revenue estimates of tax regulations for internal use—that is, not to be released publicly. That means that revenue is a well-practiced metric for determining whether intensive centralized review would be appropriate. Unfortunately, the pass-through regulation included no revenue estimates, despite the Treasury Department making decisions—such as taking a lenient approach to guardrails that could have limited the reach of the deduction—that will affect billions of dollars of revenue each year.

Conceptually, disregarding revenue seems downright bizarre. Obviously, the core purpose of the tax system is raising revenue; it should be uncontroversial that important tax rules—the ones that should receive increased scrutiny—are generally those that raise more revenue. On the other hand, a compliance cost threshold of $100 million—like that in the memorandum—may bear little relationship to the significance of a proposed rule. This is especially true when 150 million people file an individual tax return each year, spending around 2 billion hours and costing about $30 billion annually. It may be easy to concoct $100 million in compliance costs. A proposed rule could result in each taxpayer needing a few minutes extra to complete their tax return, which opens the door to playing around with the numbers to ensure or avoid OIRA review. Indeed, the Treasury Department estimated that the proposed pass-through regulation will result in $1.3 billion in compliance costs each year. It is critically important that the criteria for triggering review are clearly prescribed in advance so that there is no room for manipulation or individual discretion over when the Treasury Department must prepare a regulatory impact analysis for OIRA. Focusing on revenue is a straightforward approach that will provide a consistent barometer for review.

Once OIRA review is triggered, the oversight cannot be one-size-fits-all: Not all tax regulations are the same. I distinguish among different aspects of tax rules: the “private allocation function,” which affects private behavior; the “public allocation function,” which raise revenue; and the “implementing function,” which simply implements policy established by Congress. Each is important, but each warrants a different type of review. The private allocation function can be illuminated and improved through traditional regulatory impact analysis—weighing costs and benefits—and through a robust interagency review process that engages experts and stakeholders from outside the Treasury Department and the IRS to weigh in on the effects of rules. For example, having economists and policymakers from the U.S. Department of Commerce and the U.S. Department of Labor weigh in on aspects of the pass-through regulations seems like a good idea. Full cost-benefit analysis of tax regulations is thorny—the costs are somewhat clear, but what are the benefits, and can those benefits be quantified?—and academics have begun to offer suggestions.

On the other hand, for the public allocation function, the key considerations should be the amount of revenue raised and the distributional consequences. How much money does the proposed regulation bring into the fisc, and who is the revenue coming from? In addition to revenue estimates, the Treasury Department is well suited to prepare distributional analyses. Indeed, tax regulations provide an avenue for OIRA to begin to respond to recent pressure to assess and address distributional effects of regulatory actions more generally.

The recent memorandum gives OMB and the Treasury Department one year—until April 2019—to figure out what regulatory impact analysis of tax regulations should consist of. The analysis of the proposed pass-through regulation—which consists of vague descriptions of the benefits of “certainty,” questionable cost estimates, and no revenue or distributional analysis—shows that the agencies have a lot to figure out.

In any event, these questions will linger, and they will remain extremely important, because additional pass-through regulations and other regulations that the Treasury Department is currently drafting will be critically important to how the tax system functions. In fact, one of the defining features of the 2017 tax legislation is how much of the nitty-gritty details Congress avoided getting into. With OIRA oversight, there are more cooks in the tax regulatory kitchen than there were in the past. Whether this is good or bad for tax administration depends on how OIRA’s review of tax regulations takes shape.

Clint Wallace is an assistant professor of law at the University of South Carolina School of Law.