Recently, Senator Chuck Schumer (D-NY) released a bill that would retroactively change interest deduction laws and ownership requirements for inverted companies going back to 1994. We’ve discussed how this is an attempt to fix a problem that only sound tax reform can solve, but the bill’s retroactivity is also bad policy.
Retroactive taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es can be harmful to promoting certainty and stability for taxpayers. As we have put it in the past, avoiding retroactive taxes is one of the most important principles of sound tax policy.
Retroactive taxes are sometimes unconstitutional; according to a Congressional Research Service report, retroactive tax laws could be ruled unconstitutional under several circumstances:
- If they fail the rational basis test, they may violate the Fifth Amendment right to due process.
- If they resemble the arbitrary confiscation of property more than legitimate taxation, they may violate the Takings Clause.
- If they are found to be punishment for past criminal behavior, they may violate the Ex Post Facto Clause.
- Finally, if they are designed to target specific individuals, they may violate the Equal Protection Clause or be considered bills of attainder.
The courts have found that the legislative power to tax is very broad, but in a few instances, retroactive taxes have been struck down. As the report states, “the Supreme Court has made clear that a modest retroactive application of tax laws is permissible, describing it as ‘customary congressional practice’ required by ‘the practicality of producing national legislation.’”
The court has applied a two-part test to these cases, upholding retroactive tax application if (1) the legislation has a rational legislative purpose and is not arbitrary; and (2) the period of retroactivity is not excessive.
A recent case involving the rational legislative purpose test was Armour v. Indianapolis, in which the city levied a tax to help fund a civic project. Taxpayers were given the option of paying the $9,278 tax upfront or over 10, 20, or 30 year periods. After a year, the tax was repealed and those paying incrementally were forgiven of payment, while those who paid upfront were not allowed even partial refunds. In other words, the rules of the tax were changed retroactively in a way that clearly treated taxpayers unequally. Those taxpayers who paid up front filed suit.
We filed an amicus brief arguing that the taxpayers should be refunded, but the court found that the city had a rational basis in avoiding what would be a “bureaucratic hassle.” Unfortunately for taxpayers, what constitutes a rational basis is relatively broad, as taxes go.
An example of a case involving the period of retroactivity would be Nichols v. Coolidge. In 1927, the Supreme Court struck down an estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. provision change that was twelve years retroactive. This signified that time is a significant factor in what can be considered due process. Schumer’s bill, which is retroactive for events of up to twenty years ago, may warrant some examination in this respect.
Even though retroactive taxes may be legal in most cases, it does not make them just. Retroactive taxes create complex codes and burdensome compliance cost, and lack the transparency and stability to allow taxpayers to make informed decisions. Most importantly, though, this case of retroactive tax policy turns a blind eye to the real driver of inversions: the high U.S. corporate rate and the worldwide system of corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es.
Follow Josh on TwitterShare