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ABA Tax Times

ABA Tax Times Winter-Spring 2024

Point: Does More Procedure Produce Better Guidance?

David Andrew Weisbach

Summary

  • The author argues that Treasury substantially complies with the requirements of administrative law and that administrative law is flexible and should be applied to the particular circumstances of each agency. 
  • The author examines several recent studies on the effectiveness of notice and comment as it relates to tax.
  • The author also looks at court supervision of preambles, suggesting that a demand for longer preambles leads to gamesmanship without improving democratic accountability.
Point: Does More Procedure Produce Better Guidance?
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In a series of articles, Kristin Hickman has advanced the thesis that the Treasury consistently violates the requirements of administrative law as laid out by the Administrative Procedure Act (APA) and interpreted by courts. She argues that the Treasury is not, and should not be, exempt from those rules and, therefore, needs to come into compliance. Other commentators have taken up these views as well (known together under the rubric “anti-tax exceptionalism”), and a number of courts have followed their lead. The stakes are high because, under some versions of anti-tax exceptionalism, many guidance documents may be invalid.

Others, including me, have disputed the merits of these claims. On the positive front, I argued that the Treasury substantially complies with the requirements of administrative law. On the normative front, I argued that administrative law is flexible and should be applied to the particular circumstances of each agency.

The details of these debates are available in the relevant articles. Many of the doctrinal issues are before the courts, or soon will be, and we will likely see resolution of some of the issues. Moreover, some of the doctrinal ground may soon shift if the Supreme Court draws back on Chevron or otherwise asserts more court control over the executive branch.

I. The Role of Notice and Comment in Tax Guidance Development

Rather than repeating these debates, I will focus here on two issues. The first is what should we think about the role of notice and comment in developing tax guidance. A key recommendation of those who believe the Treasury violates many requirements of administrative law is the increased use of notice and comment. For example, in an influential article, Kristin argued that the use of temporary regulations is undesirable because Treasury commits to the substance of a regulation before getting public comment. The remedy would be to use proposed regulations, followed by notice and comment, and then (perhaps retroactive) final regulations rather than temporary regulations. In another article, Kristin expresses a concern that many subregulatory guidance documents have binding legal effect, in large part because of how they interact with the penalty rules for tax shelters. Fixing this (if it is indeed a problem) would also likely lead to greater use of notice and comment, because the other alternative, drawing back on the penalty rules for tax shelters, would likely have serious deleterious consequences. That is, a key theme of the anti-tax exceptionalism literature is a faith in the notice and comment process.

A key question, therefore, is whether an increased use of notice and comment would improve the tax regulatory process (again, leaving aside the question of how much the law mandates, a topic both Kristin and I have addressed elsewhere). There are two ways it might be helpful. First it might improve the substance of regulations by improving information flows to regulators. Second, it might increase the democratic legitimacy of the regulatory process because it gives people a chance to participate and to express their views. These two mechanisms overlap but are distinct.

If we find that neither is true, the arguments made by the anti-tax exceptionalism literature are much weaker. Administrative law is flexible enough that we can at least hope to interpret it to avoid waste. It is hard enough to get good guidance out on a timely basis. If notice and comment adds little or no value, why would we want to use whatever flexibility we find in administrative law to ask for more of it? To take one example, nobody knows the difference between legislative and interpretative guidance. If notice and comment adds value, we might be more inclined to draw the line between legislative and interpretative guidance to require more notice and comment, and vice versa if notice and comment does not add value.

As far as I can tell, notice and comment does not appear to be an effective method of gathering information. Some of what we know comes from people with experience in the Executive branch, largely outside of tax. For example, David Barron and Elena Kagan find that “notice and comment often functions as a charade.” Jody Freeman finds that notice and comment undermines the implementation of rules by failing to encourage dialogue and deliberation among the parties. Don Elliott famously argued that it was a kabuki show. And while it is surely the case that comments on proposed regulations sometimes provide useful information, it is far less clear that that same information would not find its way to regulators in any event in other ways.

Within the tax realm, there have been three recent studies of notice and comment. One study, by Shu-Yi Oei and Leigh Osofsky, looked at the process of issuing regulations under section 199A. Because this section was both novel and affected many taxpayers, it attracted more attention than many regulation projects. Oei and Osofsky found significant participation in the notice and comment process but also found that a large volume of useful information made its way to the Treasury outside of that process.

Clint Wallace studied participation in the notice and comment process for all proposed regulations during the period between 2013 and 2015. Unlike the 199A regulations examined by Oei and Osofsky, Wallace finds little engagement with the notice and comment process, with a full 25% of regulations receiving no comments whatsoever and the median regulation receiving three comments. Some regulations, not surprisingly, received many more comments; but we cannot determine from the study how much information was in those comments and whether that information would otherwise have found its way to the Treasury.

Finally Wallace and Jeffrey Blaylock look at regulations going back to 1986, focusing on three periods: immediately after the 1986 reform, the 2001 and 2003 tax cuts, and the 2017 reform. They find that over this period, Treasury reduced its use of temporary regulations, consistent with the recommendations by Kristin and others. They found, however, that this change actually reduced the flow of information to the Treasury because guidance documents became longer and the comment periods shorter. That is, “better” compliance with the APA (with the scare quotes to indicate that at least in my reading fewer temporary regulations is not better compliance) and more notice and comment led to less information making its way to the Treasury.

A different source of information about notice and comment comes from our collective experience. Many of us have either worked in government or worked with clients trying to influence the regulatory process. While my experience may be unique (though I do not think so), what I found working in the Treasury many years ago is that we constantly sought out information because we wanted to get the regulations right. The notice and comment process was helpful but not a big part of that picture. We would speak at bar association or industry meetings, bring in taxpayer or bar groups, meet with people in other agencies, read articles and bar association reports (most of which were not part of the formal notice and comment process), meet with IRS staff and field agents, and so forth. Working at Treasury was a process of constantly seeking information and learning, but only a modest fraction of that came from formal comments on regulations. Nobody knows what they don’t know, but the terrifying prospect of being responsible for a stupid regulation generates incentives to try to find out.

To be sure, there are some benefits to notice and comment. I think the most important benefit is what we academics think of as getting comments on a draft. It is useful not only to exchange vague ideas about what might go into a guidance project, but to also put words on a page and let people comment on those words. Notice and comment does not, however, replicate the give and take of a panel at a bar association meeting or an in-person meeting at the Treasury where one can ask pointed questions. Bar associations often write reports before regulations come out, rather than merely reacting to proposals, because the reports can better shape regulations at the earlier stage. It is hard to see how attempting to channel more information flows through the formal notice and comment process would help.

One interesting non-tax angle on improving information flows is the July 19, 2023 memorandum from the Office of Information and Regulatory Affairs on broadening public participation and community engagement in the regulatory process. It suggests that agencies engage in outreach to affected communities, that they focus on pre-proposal engagement (i.e., information flows outside of notice and comment), provide forums for interaction such as webinars, and similar items. OIRA’s goal is functional—to find ways to improve engagement—rather than formal—to dot i’s and cross t’s to conform to a particular vision of administrative law. To the extent information flows are a problem for the tax guidance process, we should seek a similar functional approach, finding where the information gaps are and seeking to close them.

The second way that notice and comment might help is if it increases the democratic legitimacy of the tax regulatory process. There may be legitimacy problems with the tax system, though it is not easy to distinguish politically-motivated attacks on the IRS from genuine grievances. Notice and comment can occasionally promote broad public participation. The net neutrality regulations received 21.7 million comments. Most tax regulations, however, receive few, if any, comments, and most of the comments are from insiders, people who can make their views known through many methods. Widespread acceptance of the legitimacy of the IRS and of the tax process is of great importance, but more notice and comment for guidance documents would not be near the top of the list of ways to address this.

II. Court Supervision of Preambles

The second issue I would like to examine is court supervision of preambles. (Although this essay is styled as a back-and-forth with Kristin, I’m not aware that she has taken a position on this issue, and nothing below should be read to imply that she has.) The doctrinal debate is about what the “concise general statement” requirement of APA section 553(c) means, particularly as interpreted by State Farm and related decisions.

The issue has gained prominence because a number of courts, most importantly a number of judges on the Tax Court have taken an aggressive view that regulations should be scrutinized and invalidated for insufficient preambles. We saw this most vividly in Altera, Valley Park Ranch, and in some of the dissents in 3M. It seems evident that litigants see an avenue to invalidating regulations by challenging preambles.

This strikes me as a terrible development. Preambles are important for democratic accountability: reason giving by those who govern our lives is important. But judges second-guessing preambles many years, often decades, later is not likely to improve things. It is all too easy to fall into the trap the Supreme Court identified in Vermont Yankee:

[A]dministrative proceedings should not be a game or a forum to engage in unjustified obstructionism by making cryptic and obscure reference to matters that “ought to be” considered and then, after failing to do more, to bring the matter to the agency’s attention, seeking to have that agency determination vacated on the ground that the agency failed to consider matters “forcefully presented.”

We can see the problem by comparing the reasoning in Hewitt to that in Oakbrook Land Holdings. The Eleventh Circuit in Hewitt found that Treasury failed to respond to a number of significant comments on a 40-year-old regulation. Looking at precisely the same regulation, the Sixth Circuit found that in fact the Treasury had responded to all significant comments. Two circuit courts, same law, same facts, opposite conclusions. The reason this can happen is that there are few clear standards as to what is required. While I believe that most preambles attempt to explain the content of the regulation and address the most important comments, it is almost certain that many preambles would fail with sufficiently close scrutiny. There will be a comment that a judge, ex post, may find was not considered appropriately. We should not play “robed roulette” with the tax system, particularly if the roulette wheel is weighted in only one direction, toward invalidating regulations.

Moreover, the level of scrutiny we are now seeing in cases like Hewitt, Valley Park Ranch, and 3M is new. While one can claim that Treasury should have known its preambles would be closely scrutinized, realistically that is not the case. The Treasury Department doing its best to gather information and engage with affected taxpayers 20, 30, or 40 years ago could not have imagined that it needed encyclopedic preambles. Even if one thinks that close scrutiny of preambles by judges is a good idea, raising the preamble standards ex post puts a large body of existing guidance at risk. Redoing that guidance would be a massive effort, taking away resources from far more important needs.

For future regulations, Treasury can and does know of the potential for close scrutiny of preambles. What we have seen in other areas of the administrative state, however, is that a demand for longer preambles leads to gamesmanship without improving democratic accountability. Regulated parties, anticipating future challenges to regulations, have an incentive to issue comments so massive in length and number that the agency cannot feasibly respond to them all. A cottage industry in generating invalidation-motivated comments has developed. The agency is then forced to respond to meaningless comments with meaningless preambles that give up on explaining the regulations and instead become litigation defenses. Nothing is gained except legal and consultant fees and delay, and much is lost because preambles become less meaningful. This cannot be a good way to proceed. The Tax Court, or at least some of the judges on that Tax Court, have gone in a dangerous direction. They should stop. In what world do they think they are improving tax administration?

In sum, I do not see the case for channeling more tax guidance through the notice and comment process. It will not lead to improved information flows, at least compared to other methods, and it will not lead to increased democratic accountability. Increased scrutiny of preambles is not only not a promising direction for improving the tax administrative process, it is in fact positively dangerous to the effectiveness of that process. Tax administration needs improvement. The additional funds provided to the IRS in recent years, if well spent, is likely to help. I do not think, however, that more attention to the niceties of the Administrative Procedure Act is a good method for pursuing those improvements.

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