Michael Love (Columbia), Taxing Complexity:

Complex business structures have overwhelmed U.S. tax enforcement, leaving trillions of dollars of business activity beyond the reach of meaningful oversight. This article develops a new theoretical framework to understand and address the social costs of this complexity, identifying two distinct channels of harm. Not only does complexity shield a firm by making it harder to detect or challenge its own aggressive tax positions, but there is also a novel “dilution” channel: even if the firm is fully compliant, its complexity drains government resources because enforcement becomes especially costly. This dilution effect cannot be corrected with higher penalties or stronger enforcement, because the source of the harm is complexity itself, not wrongdoing. The article develops an optimal policy response centered on a “complexity fee,” a Pigouvian tax instrument that causes complex firms to internalize this dilution cost.

The paper discusses how this instrument, used in combination with other policy tools, such as enhanced reporting or penalties, can optimally address the costs of complexity. The article also offers a case study and proposal to address dilution in the setting where complexity has proven most intractable: complex partnerships (LPs, LLCs, etc.).

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