Paul Caron blogs Lee Sheppard's coverage of the Columbia Roundtable on Narrowing the Tax Gap.  I was at the conference on Friday, which was superb.  Sheppard makes it sound like the conference was mostly about practitioners complaining about Circular 230.  That was only a small part of it.  Far more interesting, I thought, were the discussions about Chirelstein & Zelenak's quest to find a perfect (or imperfect) arrow to slay the tax shelter dragon, and Alex Raskolnikov's proposal for a self-adjusting tax penalty. 

Chirelstein & Zelenak proposed a new Code section to disallow (or suspend) noneconomic losses.  The proposal, like the 469 passive loss rules, would do a superb job of shutting down shelters.  What's less clear is what the collateral damage would be.  In effect, the proposal would create a strong presumption in favor of the government that noneconomic losses (even those sanctioned by a literal reading of the tax code) cannot be realized as tax losses unless you first get an advance ruling from the IRS or get a special carve out in the regs.  I think the proposal could work as a matter of sound tax policy, but I doubt it has the political appeal to get far.   I  imagine the real estate, oil and gas, and leasing industries could mount a healthy attack.  If it survived the political process, it would be so full of holes that it might end up adding complexity to the code without solving the shelter problem at all.  I personally favor a general anti-abuse rule, though C&Z's concerns about judicial discretion are certainly warranted.

Raskolnikov's paper on a self-adjusting penalty was fascinating.  He's definitely on to something.  Raskolnikov proposes that the size of a penalty for tax avoidance should vary according to how difficult it is for the government to find it.  So, for example, if I were to take a deduction for having a child, the penalty would be low, as it would be easy for the government to verify that I don't, in fact, have a dependent.  If, on the other hand, I took an extra $500 in charitable deductions on top of $1000 in legitimate deductions, the penalty would be high, as it would be hard for the government to discover the fraud.  I like the proposal, although the design problems may ultimately make it too unwieldy to implement.  I was struck by the harsh reaction that Alex's paper faced:  his paper really steps on our intuitions about the design of penalties.  I see no reason, however, why we should trust our intuitions rather than carefully thought out, rationally designed proposals that fit with economic theory. 

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