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An Efficiency Analysis of the Line Drawing in the Tax Law

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  • Weisbach, David A

Abstract

The tax law frequently distinguishes or draws lines between economically similar activities. For example, the tax law draws lines between selling and holding, debt and equity, corporations and partnerships, and independent contractors and employees. Policy makers typically have discretion to shift the boundaries between these categories but cannot eliminate the categories or make the treatments of the categories consistent. Where a given line is drawn will have efficiency effects. This paper provides a model of efficient line drawing and gives several applications. The model shows that, generally, lines should be drawn so that a transaction or item is taxed like its closest substitutes. Moreover, the benefit of keeping substitutes together often outweighs the negative effect of raising an inefficient tax. For example, if a new financial instrument is a better substitute for equity than for debt, it should be classified as equity notwithstanding the resulting increase in the inefficient corporate tax. Copyright 2000 by the University of Chicago.

Suggested Citation

  • Weisbach, David A, 2000. "An Efficiency Analysis of the Line Drawing in the Tax Law," The Journal of Legal Studies, University of Chicago Press, vol. 29(1), pages 71-97, January.
  • Handle: RePEc:ucp:jlstud:v:29:y:2000:i:1:p:71-97
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    File URL: http://dx.doi.org/10.1086/468064
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    1. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, vol. 50(1), pages 97-109, January.
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    3. Chung, Tai-Yeong, 1996. "Settlement of Litigation under Rule 68: An Economic Analysis," The Journal of Legal Studies, University of Chicago Press, vol. 25(1), pages 261-286, January.
    4. Jennifer F. Reinganum & Louise L. Wilde, 1986. "Settlement, Litigation, and the Allocation of Litigation Costs," RAND Journal of Economics, The RAND Corporation, pages 557-566.
    5. Lucian Arye Bebchuk, 1984. "Litigation and Settlement under Imperfect Information," RAND Journal of Economics, The RAND Corporation, pages 404-415.
    6. Anderson, David A, 1994. "Improving Settlement Devices: Rule 68 and Beyond," The Journal of Legal Studies, University of Chicago Press, vol. 23(1), pages 225-246, January.
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    Cited by:

    1. Warren, Alvin Jr, 2004. "US income taxation of new financial products," Journal of Public Economics, Elsevier, pages 899-923.

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