Costly Mistakes: Undertaxed Business Owners and Overtaxed Workers
Mary Louise Fellows
University of Minnesota School of Law
Seattle University School of Law
July 6, 2012
George Washington Law Review, Forthcoming
Seattle University School of Law Research Paper No. 12-33
This article advocates for fundamental changes in the federal income tax base by systematically challenging conventional understandings of consumption and investment. As signaled by our title, “Costly Mistakes,” our thesis has to do exclusively with the deductibility of expenditures by business owners and workers. Where the current tax law treats a business owner’s expenditure as investment, we sometimes find consumption and question why the law should allow the expenditure to be deducted. Where the tax law treats a worker’s expenditure as consumption, we sometimes find investment and question why the law does not allow at least a partial deduction. Through an historical analysis of the development of the modern tax law with special attention to Justice Cardozo’s 1933 U.S. Supreme Court opinion in Welch v. Helvering and a review of Welch’s judicial and legislative progeny, the article demonstrates that the deference the tax law traditionally has accorded business owners results in their being undertaxed. Through an analysis of the tax law’s treatment of workers, it further shows how its structural and substantive rules treat workers primarily as consumers, rather than as producers, and why that results in their being overtaxed. The article then investigates the economic inefficiencies produced by the tax law’s generous treatment of business owners’ outlays and its unduly restrictive treatment of workers’ outlays. It goes on to suggest an analytical framework for scrutinizing and reforming the tax treatment of workers and how that same framework could be extended to business owners with far-reaching implications. Finally, the article relates the undertaxation of business owners and the overtaxation of workers to the broader social policy discussions concerning the high rate of unemployment in the private sector and the escalating deficits in the public sector. It concludes that the success of the U.S. economy in the twenty-first century requires the tax law to treat both business owners and workers as producers. It further concludes that the tax law’s continuing failure to acknowledge that business owners and workers are both consumers and producers undermines the goals of efficiency and fairness.
Number of Pages in PDF File: 77
Keywords: Federal Income Tax
JEL Classification: H24, J24, K34Accepted Paper Series
Date posted: July 5, 2012 ; Last revised: February 14, 2013
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