Section of Taxation Publications
  VOL. 60
NO. 1
FALL 2006
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Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.


Professor William P. Kratzke*

*Cecil C. Humphreys Professor of Law, University of Memphis School of Law; University of Washington, B.A., 1971; Valparaiso University, J.D., 1974; Georgetown University Law Center, LL.M., 1977.


Through the Internal Revenue Code, Congress implicitly defines, by design or by accident, what the nature of the employment relationship is, or can be. Through a pattern of employer deductions for certain expenditures that benefit employees and exclusions of these expenditures from employees’ gross income, Congress subsidizes the procurement of certain benefits. Congress has tied some increments to a social safety net to the employment relationship. It also has made available other benefits ( e.g., certain fringe benefits, adoption assistance, education assistance, and employee achievement awards) to at least some employees at reduced costs. The Code is not Congress’s exclusive tool to shape the employment relationship. For example, Congress may mandate that employers provide certain benefits or pay a minimum wage. However, through the Code, Congress suggests in the employment relationship the outer parameters of a social safety net, the nature of compensation, and various not-so-inexpensive perquisites (“perks”). By subsidizing some purchases but not others, Congress encourages employees to seek these benefits from employers who, in turn, may be indifferent to their employees’ choice(s) and might even prefer to provide such benefits as a substitute for payment of cash wages. The Code’s provisions generate inequities among individual taxpayers and competitive inequities among employers because some employers and their employees can exploit these provisions and others cannot (or will not).

In an employment relationship, an employee receives from his employer a wage or salary comprised of readily exchangeable dollars on which he pays federal income tax. With the balance of his wages, an employee is free to make purchasing choices, exchanging dollars for a nearly limitless variety of goods or services when he feels such exchanges are to his advantage. Absent beneficial externalities flowing from the fact that some taxpayers have a particular benefit, free exchangeability is a necessary condition to the maximization of value. When Congress offers a tax subsidy to facilitate employer purchases of certain employee benefits, it limits, sometimes absolutely, their exchangeability—thereby generating (some) allocative inefficiency. Congress has somewhat ameliorated this inefficiency by allowing limited exchangeability among benefits. Employees’ voluntary structuring of benefits in different mixes creates more value than the benefit mix that would result if government provided particular benefits in kind. Nevertheless, if Congress fails to generate beneficial externalities of sufficient magnitude to overcome allocative inefficiencies when it offers a tax subsidy in an employment relationship, it should pursue the policy objective of that benefit by other means. Aside from generating beneficial externalities, Congress could utilize exclusions from employees’ gross incomes to make a not-very-progressive federal tax burden either more or less progressive.




Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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