Costly Mistakes: Undertaxed Business Owners and Overtaxed Workers

73 Pages Posted: 7 Jul 2012 Last revised: 28 Jun 2013

See all articles by Mary Louise Fellows

Mary Louise Fellows

University of Minnesota School of Law

Lily Kahng

Seattle University School of Law

Multiple version iconThere are 2 versions of this paper

Date Written: February 4, 2013


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.

Keywords: Federal Income Tax

JEL Classification: H24, J24, K34

Suggested Citation

Fellows, Mary Louise and Kahng, Lily, Costly Mistakes: Undertaxed Business Owners and Overtaxed Workers (February 4, 2013). George Washington Law Review, Vol. 81, 2013, Minnesota Legal Studies Research Paper No. 12-27, Available at SSRN:

Mary Louise Fellows

University of Minnesota School of Law ( email )

229 19th Avenue South
Minneapolis, MN 55455
United States

Lily Kahng (Contact Author)

Seattle University School of Law ( email )

901 12th Avenue
Seattle, WA 98122
United States

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