No Taxation Without . . . Notice and Comment

Over the past several years, the International Budget Partnership (IBP) has increasingly emphasized the importance of governments providing reasons for their budget decisions and actions (here, here and here). Government reasons sit at the nexus of two of our core beliefs about open budgets: that governments must be transparent, and that they must engage the public meaningfully in their budget choices. When government agencies provide public reasons, they are legitimating public debate about those choices and signaling a willingness to accept criticism and revisions. This is the essence of democracy.

In part, standards for public reasons about government decisions are set by law and by the courts. In the United States, the Administrative Procedures Act (APA), and subsequent case law, require all government agencies to follow certain minimum practices for providing reasons for their actions, and for engaging the public in decision-making. Falling short of the APA is considered “arbitrary and capricious” behavior by government and can invite litigation.

Failure to follow these rules has been at stake in important court cases against the Trump administration in the last few years, on issues as varied as the environment, the census, immigration and health insurance (see for example the U.S. Census case, and the Keystone Pipeline case). Other countries ranging from Germany, Kenya, Hong Kong, and South Africa also have legislation and/or case law that lays out similar requirements for agency administrative action.

While these standards are usually not thought to have much to do with budgeting, they do in fact relate to rules and regulations issued by national treasuries or ministries of finance. These kinds of rules are often not budgetary in nature, but they can be. For instance, rules for calculating tax liabilities have a direct bearing on revenue collection and therefore on the size of the annual budget.

It so happens that this has emerged as an evolving area within administrative law in just the last decade in the United States, with courts in recent years beginning to adopt a stricter review of the U.S. Treasury’s tax regulations. An important source of arbitrary action by the U.S. Treasury has been the use of temporary rules that are legally binding and that are issued either without any notice and comment period, or with a request for comment issued at the same time as the binding temporary rule. A “notice and comment period” is one mechanism of inviting the public to offer its views on a new government policy before it is introduced. By failing to invite comment, or by only inviting comment when a rule is put into effect, the Treasury denies the public a chance to comment and tips the scales in favor of acceptance of the rule.

Treasury has typically claimed that much of its rulemaking is exempt from the APA, allowing it to avoid notice and comment rules, but it has not normally justified the need for such exclusions. One estimate suggests that the U.S. Treasury has eschewed standard APA procedure in about 40 percent of recent rulemaking. The failure to follow the APA, and to provide reasons for doing so, ultimately promotes arbitrary and undemocratic behavior.

Things are beginning to change.  In 2011, the U.S. Supreme Court found that tax issues should be treated like other regulatory issues, in a case that the Treasury Department actually won (requiring medical residents to pay taxes). This decision made it clear that Treasury regulations should fall under the APA and standard doctrines of deference.

Following this precedent, in 2015, the courts duly overturned a Treasury regulation under the “hard look” doctrine, which is a type of scrutiny that is routinely applied to other federal agencies. The regulation in question concerned the taxability of compensation issued in the form of stock. The courts found that Treasury failed to identify a factual and reasoned basis for taxing such compensation.

Then again in 2017, the courts overturned another Treasury rule, this time on the tax treatment for stock in so-called “inversions,” where large US companies merge with smaller foreign companies and shift their residence to the foreign country (often to avoid taxes, as discussed briefly in a previous blog). In this case, the courts found that Treasury acted within its statute and reasonably. However, it also found that its practice of issuing temporary binding rules without prior notice and comment periods violated the standards for public participation in the APA.

Interestingly, in 2019, the cumulative weight of these decisions spurred the U.S. Treasury to issue a public statement affirming its commitment to follow the APA. Among other promises, the Treasury recognized the need to be more forthcoming about the reasons for issuing temporary rules with immediate effect: “the Treasury Department and the IRS will make their reasons for issuing such immediately-effective regulations clear by including a statement of good cause in the preamble.”

This brief history indicates the ways in which broadly accepted legal standards for public justification across government can and increasingly do apply to fiscal issues. While the scope for the application of such standards to expenditure may be less clear, there is a considerable amount of expenditure policy that is also made through agency action, such as determination of eligibility for social programs. Indeed, the courts specifically took on the expenditure issue in a recent APA case on Medicaid (a public health insurance program), finding (among other things) that cost savings alone would not constitute an adequate public justification for a government agency decision to change eligibility rules.

The writing is on the wall: we are going to see more and more government action subjected to scrutiny on grounds of reasonableness and participation in line with evolving legal standards. This is good news for budget advocates, although much work remains to be done to set reasonable standards for what counts as adequate justification and what amounts to sufficient public participation.

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