Collaborative Intent

Why do parties—even sophisticated ones—draft contracts that are vague or incomplete? Many others have tackled this question, but this Article argues that there is an overlooked, common, and powerful reason for contractual gaps. Using original interviews with dealmakers, it introduces a theory of “collaborative intent” to show that the bureaucratic deal-building process within companies can help explain why contracts are incomplete, vague, and otherwise seemingly irrational. The institutional details of dealmaking are important but understudied, and have wide-ranging implications for contract theory, design, and interpretation.

This Article makes three contributions to the literature. First, using original interviews with in-house dealmakers, it provides the literature’s first account of how deals are made within companies. Both economists and legal scholars have tackled the puzzle of incomplete contracting, but leading explanations overlook the critical influence of companies’ internal deal-building process. Unlike individuals who enter into contracts, sophisticated business parties do not have monolithic intent. Instead, even before taking a seat at the negotiation table, business parties engage in a complex, internal bargaining process that requires many intra-corporate constituencies to weigh in and sign off on the deal. The result is that sophisticated business parties bring multiple agendas to the negotiation table, and those agendas are reflected in the contract. Second, collaboration complicates intent, especially for sophisticated parties. Rather than being the result of rational, considered contract design, contractual gaps may be mere byproducts of the contract-shepherding process within the firm. Finally, this Article offers practical guidance to courts and contract designers about the overlooked and rampant intra-corporate bargaining and pork-barreling process. It helps them account for collaborative intent in ex ante contract design and ex post contract enforcement.

Introduction

Four weeks before Halloween in 2018, a Delaware Chancery Court decision spooked the corporate world. In an unprecedented move, the court released German pharmaceutical giant Fresenius from its $4.75 billion contract to buy U.S. generic drug manufacturer Akorn based on a contract term called the material adverse change clause.1.Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018).Show More The decision in Akorn, Inc. v. Fresenius Kabi AG was the first time Delaware courts had found that a company triggered a material adverse change clause, and it sparked a storm of anxiety and commentary.2.Many major firms issued client alerts, immediately digesting the landmark case for their clients. See, e.g., David Leinwand, James E. Langston & Mark E. McDonald, Akorn v. Fresenius: A MAC in Delaware, Cleary Gottlieb Steen & Hamilton LLP (Oct. 11, 2018), https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware [https://perma.cc​/43KW-C54E]; Chris Gorman & Lisa Richards, Akorn v. Fresenius: Important Practical Lessons from First-Ever Material Adverse Effect, Fenwick & West LLP (Oct. 24, 2018), https://www.fenwick.com/publications/pages/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect.aspx [https://perma.cc/9KPX-75MZ]; Peter A. Atkins & Edward B. Micheletti, ‘Reasonable Efforts’ Clauses in Delaware: One Size Fits All, Unless . . ., Skadden, Arps, Slate, Meagher & Flom LLP (Nov. 1, 2018), https://www.​skadden.com/insights/publications/2018/10/reasonable-efforts-clauses-in-delaware [https://p​erma.cc/JR7Z-FYAP]; Grant J. Esposito, David J. Fioccola & Robert W. May, Delaware Court of Chancery Finds a Material Adverse Event and Excuses Buyer from Obligation to Close in Akorn v. Fresenius Kabi AG, Morrison & Foerster LLP (Oct. 9, 2018), https://www.mofo.com/resources/insights/181009-delaware-material-adverse-event.html [htt​ps://perma.cc/FE72-NR7Q].Show More

In every merger and acquisition (“M&A”) deal, there is a material adverse change provision: a long-winded, heavily negotiated provision choked with exceptions and caveats. Material adverse change provisions almost always say the same thing: that if something huge and unexpected happens between the contract’s signing and the deal’s closing, one or both parties can back out of the deal.3.Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 854 (2010) [hereinafter Choi & Triantis, Strategic Vagueness](defining a material adverse change clause in a contract as one that “permit[s] the buyer to avoid the closing of a deal if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm”).Show More And, perhaps most surprisingly, despite the long negotiations and dense legalese, material adverse change provisions are vague.4.Id. at 853 (noting that material adverse change clauses are vague, but “among the most heavily negotiated nonprice terms”).Show More

Vague provisions like these are common but surprising. In M&A contracts, for example, parties routinely haggle over whether they will use “best efforts,” “commercially reasonable best efforts,” or “reasonable best efforts” to accomplish certain tasks—and each of these standards will be left unspecified and unquantified.5.See Scot Baker & Albert Choi, Contract’s Role in Relational Contract, 101 Va. L. Rev. 559, 565 (2015) (describing the common “best efforts” provisions as “a fault-based and open-ended standard”); Anthony J. Casey & Anthony Niblett, Self-Driving Contracts, 43 J. Corp. L. 1, 8 (2017) (“[Parties can choose to] use a vague standard that also requires a court to fill in the details after the fact. This could be a clause that requires something like ‘reasonable efforts,’ ‘best efforts,’ or ‘commercially reasonable efforts.’”); Victor P. Goldberg, In Search of Best Efforts: Reinterpreting Bloor v. Falstaff, 44 St. Louis L. Rev. 1465, 1465 (2000) (“When contracting parties cannot quite define their obligations, they often resort to placeholder language, like ‘best efforts.’”); Robert E. Scott, Contract Design and the Shading Problem, 99 Marq. L. Rev. 1, 20 (2015) (“[I]n the past fifty years, parties have increasingly inserted vague terms such as ‘best efforts,’ reasonable best efforts,’ or ‘commercially reasonable best efforts’ as modifiers that are combined with specific of precise performance obligations under the contract.”). The contracts law case Bloor v. Falstaff, 601 F.2d 609 (2d Cir. 1979), is another famous case about best efforts clauses.Show More In debt contracts, borrowers promise to let lenders conduct “routine” inspections, without specifying what is routine.6.In A. Gay Jenson Farms Co. v. Cargill, 309 N.W.2d 285 (Minn. 1981), the well-known agency law case, for example, large international conglomerate Cargill lent money to a small Minnesota grain elevator operator, in part on the condition that Cargill could conduct routine inspections of the grain elevator. The intrusive nature of the inspections became one of the reasons that the grain elevator operator’s other creditors later sued Cargill, arguing that the grain elevator operator was an agent of Cargill and that Cargill should be liable for the operator’s debts. Id. at 290–91.Show More In just about any corporate contract, parties promise “material” compliance or compliance that does not rise to a “material adverse effect,” again without specifying what those thresholds might mean.7.Robert Malionek & Jon Weichselbaum, Five Keys to Analyzing a Material Adverse Effect, N.Y.L.J. (Mar. 6, 2019), https://www.lw.com/thoughtLeadership/five-keys-analyzing-materia​l-adverse-effect-ny-law-journal [https://perma.cc/TM95-FQKH] (noting that “[m]ateriality is both qualitative and quantitative” and that in M&A contracts, representations can be made “that reasonably would be expected to result in [a material adverse change]”).Show More In each of these circumstances, sophisticated parties, who have both the technical sophistication and financial means to draft specific, complete provisions, choose instead to embrace vague, incomplete ones.

The persistence of vague provisions, incomplete contracts, and other such contractual oddities has long plagued both legal scholars and economists—and neither literature has a shortage of explanations. Economist and Nobel Prize laureate Oliver Hart famously notes that contracts are necessarily incomplete: there are no parties, no circumstances, where every contingency can be thought of and thought out ex ante.8.See Oliver Hart, The Nobel Prize, https://www.nobelprize.org/prizes/economic-sciences/​2016/hart/facts/ [https://perma.cc/E6MG-HZY4] (last visited Nov. 10, 2021) (“In the mid-1980s, [Hart] contributed to the theory of incomplete contracts. . . . These analyses have been significant for, among other things, governance of companies and the design of laws and institutions.”); Oliver Hart & John Moore, Foundations of Incomplete Contracts, 66 Rev. Econ. Stud. 115 (1999) [hereinafter Hart & Moore, Foundations of Incomplete Contracts](developing a model for the idea that contracts are incomplete); Oliver D. Hart, Incomplete Contracts and the Theory of the Firm, 4 J.L. Econ. & Org. 119 (1988); Oliver Hart, Dep’t of Econ., Harvard Univ., Incomplete Contracts and Control, Nobel Prize Lecture 372–73 (Dec. 8. 2016), https://www.nobelprize.org/uploads/2018/06/hart-lecture.pdf [https://perma.cc/7TK​E-49TD] [hereinafter Hart, Incomplete Contracts & Control](noting that, although economists spent many decades working on questions involving complete contracts, “[a]ctual contracts are not like this, as lawyers have recognized for some time. They are poorly worded, ambiguous, and leave out important things. They are incomplete.”).Show More Many scholars have argued convincingly that vagueness in contracts—especially in contracts between sophisticated business parties—is intentional and rational: provisions that are rarely litigated but expensive to negotiate, such as material adverse effect provisions, are particularly well-suited to vagueness.9.Choi & Triantis, Strategic Vagueness, supra note 3, at 852–53, 855 (arguing that parties can use vague contract provisions efficiently—for example, material adverse change clauses in acquisition agreements may remain vague because they are rarely litigated); Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 818–22 (2006) [hereinafter Scott & Triantis, Anticipating Litigation] (examining the efficiency of investment in the design and enforcement phases of the contracting process and arguing that parties can lower overall contracting costs by using vague contract terms ex ante and shifting investment to the ex post enforcement phase); Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 Case W. Res. L. Rev. 187, 195–96 (2005) (considering the role of litigation in motivating contract design).Show More Still others have argued that contracts do not need to be complete or specific. Community and industry norms can and do fill the gap where contracts are vague—and sometimes even when contracts do not even exist.10 10.See Ronald J. Gilson, Charles Sabel & Robert E. Scott, Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum. L. Rev. 1377, 1398–99 (2010) [hereinafter Gilson et al., Braiding] (discussing the “rivalry” between formal and informal enforcement for contracts and noting that the two can substitute for each other or complement each other); see also Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry, 21 J. Legal Stud. 115, 121–24 (1992) [hereinafter Bernstein, Opting Out] (describing trade association enforcement of contractual breaches); Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1725 (2001) (describing the cotton industry’s alternative system of enforcement to the typical legal system).Show More And, in those cases, it is the threat of informal sanctions, such as loss of reputation, that curbs bad behavior, even without a legally binding contract.11 11.Informal sanctions are particularly effective in small, tight-knit communities where parties have many points of contact. A robust literature has documented the role of norms and informal sanctions in a variety of interesting settings. See Robert C. Ellickson, Of Coase and Cattle: Dispute Resolution Among Neighbors in Shasta County, 38 Stan. L. Rev. 623, 628, 677 (1986) [hereinafter Ellickson, Of Coase and Cattle] (describing how rural cattle ranchers in Shasta County, California, abide by norms rather than rules and how animal trespass disputes are settled by self-help rather than formal legal enforcement mechanisms); Robert C. Ellickson, A Hypothesis of Wealth-Maximizing Norms: Evidence from the Whaling Industry, 5 J.L. Econ. & Org. 83, 84–85 (1989) (presenting evidence of informal enforcement—norms—overtaking formal enforcement in the whaling industry); Peter T. Leeson, An-arrgh-chy: The Law and Economics of Pirate Organization, 115 J. Pol. Econ. 1049, 1051 (2007) (describing the extralegal systems that pirates developed to provide checks on captain predation and to “create piratical law and order”); Bernstein, Opting Out, supra note 10, at 124 (describing how a diamond-merchant trade association in New York City helps to enforce contracts); Gillian K. Hadfield & Iva Bozovic, Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation, 2016 Wis. L. Rev. 981, 987, 1017 (describing the way in which commercial contracting parties across a variety of industries use a mix of formal and informal contracts to support their business relationships); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 562 (2015) (describing how original equipment manufacturers in the Midwest have used a mix of formal contracts, relational contracts, and other tools to build and support their business relationships); Jonathan M. Barnett, Hollywood Deals: Soft Contracts for Hard Markets, 64 Duke L.J. 605, 607 (2015) (discussing the use of non-binding agreements—or “soft contracts”—in modern Hollywood filmmaking).Show More

In many contexts, these explanations are convincing. Consider a simple apartment lease signed between one landlord and one tenant. Rather than spending a lot of time up-front discussing the specific condition in which the tenant needs to leave the apartment at move-out, the parties might simply decide to agree to the vague provision that the tenant needs to leave the apartment “clean.” The law and economics view explains this decision well: in most cases, the tenant leaves the place clean enough, and the parties will never have to haggle over the details upon move-out. Relational contracting theory also explains the vagueness well: the landlord doesn’t need to be too specific about cleanliness because the tenant relies on the landlord to give her a good reference for her next apartment rental.

But while existing explanations work well for simple, two-party contracts, and do some work in explaining sophisticated-party contracting, they fall short.12 12.In previous work, for example, I explored the puzzle of term sheets in M&A contracting. Term sheets—short, nonbinding precursors to a full-fledged M&A contract—are not contracts and are not legally binding or enforceable. Parties to term sheets do not operate in the tight-knit communities where informal sanctions are known to work. Nonetheless, once parties sign them, they behave as though bonded. Why do nonbinding term sheets have binding power? See Cathy Hwang, Deal Momentum, 65 UCLA L. Rev. 376, 380 (2018) (describing how deal lawyers use preliminary agreements in M&A deals); Cathy Hwang, Faux Contracts, 105 Va. L. Rev. 1025, 1056 (2019) [hereinafter, Hwang, Faux Contracts] (describing how M&A deals create small relational ecosystems in which both the contracting parties and their agents are incentivized to engage in consummate, rather than perfunctory, performance).Show More Certainly cost-benefit analysis and informal sanctions account for some contractual oddities—but not all. This Article offers a friendly addendum to those pathbreaking explanations: collaborative intent.

At its core, collaborative intent relies on a simple idea: businesses are not monoliths. They contain many divisions, departments, operational groups, and other constituencies. This idea is well-understood in the literature—even Ronald Coase’s seminal work on the boundary of the firm assumed that companies would contain multiple different groups within it.13 13.Ronald H. Coase, The Nature of the Firm, 16 Economica 386, 390 (1937) (posing and discussing the “boundaries of the firm” question: When should individuals be expected to form firms, and when should they be expected to cooperate through contract?).Show More Collaborative intent takes this idea a step further: it explicitly recognizes that each module within a company has its own purpose and, correspondingly, its own incentives, goals, limitations, and preferences. Internal constituencies often have a chance to veto—or at least weigh in on—both the substance and form of a proposed deal. By the time a company brings its intent to the negotiating table, that intent reflects the result of a consensus-building process within the company—in other words, the company brings what this Article calls its collaborative intent.

That collaborative intent in turn helps to account for many contractual oddities. Contracts that result from this kind of institutional collaboration are not necessarily rational, intentional, or carefully considered. Instead, they are amalgamations of many preferences within each deal party and result from the consensus-building process of getting the deal through a bureaucracy.

This Article provides a layered account of collaborative intent and its impact on deals and contracts, and proceeds as follows. Part I sets the stage. It shows how current contract theory does not account for the dealmaking process within firms. Part II presents the theory and evidence of collaborative intent. It uses two dozen original interviews with in-house dealmakers to show how the process of building consensus for a deal within the firm impacts contractual form and structure. Interview participants brought experience from a variety of industries, ranging from technology to hospitality to gaming, and uniformly reported that dealmaking within the firm is a collaborative exercise: it requires vote-whipping, pork-barreling, and balancing the needs of various constituencies into a coherent but multifaceted “intent.” Part III turns to implications. Existing literature overlooks the institutional details that impact contract design. Collaborative intent injects important and overlooked nuance and helps to build out a nuanced account of dealmaking that can help shape contract theory, enforcement, and design.

  1. Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018).
  2. Many major firms issued client alerts, immediately digesting the landmark case for their clients. See, e.g., David Leinwand, James E. Langston & Mark E. McDonald, Akorn v. Fresenius: A MAC in Delaware, Cleary Gottlieb Steen & Hamilton LLP (Oct. 11, 2018), https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware [https://perma.cc​/43KW-C54E]; Chris Gorman & Lisa Richards, Akorn v. Fresenius: Important Practical Lessons from First-Ever Material Adverse Effect, Fenwick & West LLP (Oct. 24, 2018), https://www.fenwick.com/publications/pages/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect.aspx [https://perma.cc/9KPX-75MZ]; Peter A. Atkins & Edward B. Micheletti, ‘Reasonable Efforts’ Clauses in Delaware: One Size Fits All, Unless . . ., Skadden, Arps, Slate, Meagher & Flom LLP (Nov. 1, 2018), https://www.​skadden.com/insights/publications/2018/10/reasonable-efforts-clauses-in-delaware [https://p​erma.cc/JR7Z-FYAP]; Grant J. Esposito, David J. Fioccola & Robert W. May, Delaware Court of Chancery Finds a Material Adverse Event and Excuses Buyer from Obligation to Close in Akorn v. Fresenius Kabi AG, Morrison & Foerster LLP (Oct. 9, 2018), https://www.mofo.com/resources/insights/181009-delaware-material-adverse-event.html [htt​ps://perma.cc/FE72-NR7Q].
  3. Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 854 (2010) [hereinafter Choi & Triantis, Strategic Vagueness] (defining a material adverse change clause in a contract as one that “permit[s] the buyer to avoid the closing of a deal if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm”).
  4. Id. at 853 (noting that material adverse change clauses are vague, but “among the most heavily negotiated nonprice terms”).
  5. See Scot Baker & Albert Choi, Contract’s Role in Relational Contract, 101 Va. L. Rev. 559, 565 (2015) (describing the common “best efforts” provisions as “a fault-based and open-ended standard”); Anthony J. Casey & Anthony Niblett, Self-Driving Contracts, 43 J. Corp. L. 1, 8 (2017) (“[Parties can choose to] use a vague standard that also requires a court to fill in the details after the fact. This could be a clause that requires something like ‘reasonable efforts,’ ‘best efforts,’ or ‘commercially reasonable efforts.’”); Victor P. Goldberg, In Search of Best Efforts: Reinterpreting Bloor v. Falstaff, 44 St. Louis L. Rev. 1465, 1465 (2000) (“When contracting parties cannot quite define their obligations, they often resort to placeholder language, like ‘best efforts.’”); Robert E. Scott, Contract Design and the Shading Problem, 99 Marq. L. Rev. 1, 20 (2015) (“[I]n the past fifty years, parties have increasingly inserted vague terms such as ‘best efforts,’ reasonable best efforts,’ or ‘commercially reasonable best efforts’ as modifiers that are combined with specific of precise performance obligations under the contract.”). The contracts law case Bloor v. Falstaff, 601 F.2d 609 (2d Cir. 1979), is another famous case about best efforts clauses.
  6. In A. Gay Jenson Farms Co. v. Cargill, 309 N.W.2d 285 (Minn. 1981), the well-known agency law case, for example, large international conglomerate Cargill lent money to a small Minnesota grain elevator operator, in part on the condition that Cargill could conduct routine inspections of the grain elevator. The intrusive nature of the inspections became one of the reasons that the grain elevator operator’s other creditors later sued Cargill, arguing that the grain elevator operator was an agent of Cargill and that Cargill should be liable for the operator’s debts. Id. at 290–91.
  7. Robert Malionek & Jon Weichselbaum, Five Keys to Analyzing a Material Adverse Effect, N.Y.L.J. (Mar. 6, 2019), https://www.lw.com/thoughtLeadership/five-keys-analyzing-materia​l-adverse-effect-ny-law-journal [https://perma.cc/TM95-FQKH] (noting that “[m]ateriality is both qualitative and quantitative” and that in M&A contracts, representations can be made “that reasonably would be expected to result in [a material adverse change]”).
  8. See Oliver Hart, The Nobel Prize, https://www.nobelprize.org/prizes/economic-sciences/​2016/hart/facts/ [https://perma.cc/E6MG-HZY4] (last visited Nov. 10, 2021) (“In the mid-1980s, [Hart] contributed to the theory of incomplete contracts. . . . These analyses have been significant for, among other things, governance of companies and the design of laws and institutions.”); Oliver Hart & John Moore, Foundations of Incomplete Contracts, 66 Rev. Econ. Stud. 115 (1999) [hereinafter Hart & Moore, Foundations of Incomplete Contracts] (developing a model for the idea that contracts are incomplete); Oliver D. Hart, Incomplete Contracts and the Theory of the Firm, 4 J.L. Econ. & Org. 119 (1988); Oliver Hart, Dep’t of Econ., Harvard Univ., Incomplete Contracts and Control, Nobel Prize Lecture 372–73 (Dec. 8. 2016), https://www.nobelprize.org/uploads/2018/06/hart-lecture.pdf [https://perma.cc/7TK​E-49TD] [hereinafter Hart, Incomplete Contracts & Control] (noting that, although economists spent many decades working on questions involving complete contracts, “[a]ctual contracts are not like this, as lawyers have recognized for some time. They are poorly worded, ambiguous, and leave out important things. They are incomplete.”).
  9. Choi & Triantis, Strategic Vagueness, supra note 3, at 852–53, 855 (arguing that parties can use vague contract provisions efficiently—for example, material adverse change clauses in acquisition agreements may remain vague because they are rarely litigated); Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 818–22 (2006) [hereinafter Scott & Triantis, Anticipating Litigation] (examining the efficiency of investment in the design and enforcement phases of the contracting process and arguing that parties can lower overall contracting costs by using vague contract terms ex ante and shifting investment to the ex post enforcement phase); Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 Case W. Res. L. Rev. 187, 195–96 (2005) (considering the role of litigation in motivating contract design).
  10. See Ronald J. Gilson, Charles Sabel & Robert E. Scott, Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum. L. Rev. 1377, 1398–99 (2010) [hereinafter Gilson et al., Braiding] (discussing the “rivalry” between formal and informal enforcement for contracts and noting that the two can substitute for each other or complement each other); see also Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry, 21 J. Legal Stud. 115, 121–24 (1992) [hereinafter Bernstein, Opting Out] (describing trade association enforcement of contractual breaches); Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1725 (2001) (describing the cotton industry’s alternative system of enforcement to the typical legal system).
  11. Informal sanctions are particularly effective in small, tight-knit communities where parties have many points of contact. A robust literature has documented the role of norms and informal sanctions in a variety of interesting settings. See Robert C. Ellickson, Of Coase and Cattle: Dispute Resolution Among Neighbors in Shasta County, 38 Stan. L. Rev. 623, 628, 677 (1986) [hereinafter Ellickson, Of Coase and Cattle] (describing how rural cattle ranchers in Shasta County, California, abide by norms rather than rules and how animal trespass disputes are settled by self-help rather than formal legal enforcement mechanisms); Robert C. Ellickson, A Hypothesis of Wealth-Maximizing Norms: Evidence from the Whaling Industry, 5 J.L. Econ. & Org. 83, 84–85 (1989) (presenting evidence of informal enforcement—norms—overtaking formal enforcement in the whaling industry); Peter T. Leeson, An-arrgh-chy: The Law and Economics of Pirate Organization, 115 J. Pol. Econ. 1049, 1051 (2007) (describing the extralegal systems that pirates developed to provide checks on captain predation and to “create piratical law and order”); Bernstein, Opting Out, supra note 10, at 124 (describing how a diamond-merchant trade association in New York City helps to enforce contracts); Gillian K. Hadfield & Iva Bozovic, Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation, 2016 Wis. L. Rev. 981, 987, 1017 (describing the way in which commercial contracting parties across a variety of industries use a mix of formal and informal contracts to support their business relationships); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 562 (2015) (describing how original equipment manufacturers in the Midwest have used a mix of formal contracts, relational contracts, and other tools to build and support their business relationships); Jonathan M. Barnett, Hollywood Deals: Soft Contracts for Hard Markets, 64 Duke L.J. 605, 607 (2015) (discussing the use of non-binding agreements—or “soft contracts”—in modern Hollywood filmmaking).
  12. In previous work, for example, I explored the puzzle of term sheets in M&A contracting. Term sheets—short, nonbinding precursors to a full-fledged M&A contract—are not contracts and are not legally binding or enforceable. Parties to term sheets do not operate in the tight-knit communities where informal sanctions are known to work. Nonetheless, once parties sign them, they behave as though bonded. Why do nonbinding term sheets have binding power? See Cathy Hwang, Deal Momentum, 65 UCLA L. Rev. 376, 380 (2018) (describing how deal lawyers use preliminary agreements in M&A deals); Cathy Hwang, Faux Contracts, 105 Va. L. Rev. 1025, 1056 (2019) [hereinafter, Hwang, Faux Contracts] (describing how M&A deals create small relational ecosystems in which both the contracting parties and their agents are incentivized to engage in consummate, rather than perfunctory, performance).
  13. Ronald H. Coase, The Nature of the Firm, 16 Economica 386, 390 (1937) (posing and discussing the “boundaries of the firm” question: When should individuals be expected to form firms, and when should they be expected to cooperate through contract?).

Frankenstein’s Baby: The Forgotten History of Corporations, Race, and Equal Protection

This Article highlights the crucial role corporations played in crafting an expansive interpretation of the Fourteenth Amendment. Exposing the role of race in the history of the constitutional law of corporate personhood for the first time, this Article argues that corporations were instrumental in laying the foundation of the Equal Protection Clause that underlies civil rights jurisprudence today. By simultaneously bringing cases involving both corporations and Chinese immigrants, corporate lawyers and sympathetic federal judges crafted a broad interpretation of equal protection in order to draw a through-line from African Americans, to Chinese immigrants, and finally to corporate shareholders. At the same time that corporate litigation expanded the umbrella of protected “persons,” however, it limited the capacity of the Fourteenth Amendment to address issues of substantive inequality.

This Article reveals that central to the argument in favor of corporate constitutional personhood was a direct analogy between corporate shareholders and racial minorities. This Article thus highlights the intersection of corporate personhood and race, a connection that has rarely, if ever, been explored. Corporate lawyers’ expansive interpretation of equal protection ultimately triumphed in the Supreme Court with the twin cases of Yick Wo v. Hopkins, a bedrock of modern civil rights doctrine, and Santa Clara v. Southern Pacific Railroad, a case credited with extending equal protection rights to corporations. This is the first Article to juxtapose these two seminal cases and to expose the deep and long-standing connections between them. In so doing, this Article uncovers a neglected history of the link between corporations and race, as well as a lost history of the Fourteenth Amendment.

Introduction

“Like Frankenstein’s baby, there was no end to its growing, and no limit to its voracity. And, like that wonderful child, it started in to devour its author.”

Records of the California Constitutional Convention (1878)

“The Fourteenth Amendment . . . stands in the constitution as a perpetual shield against all unequal and partial legislation by the states, and the injustice which follows from it, whether directed against the most humble or the most powerful; against the despised laborer from China, or the envied master of millions.”

– The Railroad Tax Cases (9th Cir. 1882)

Since the controversial cases of Citizens United v. Federal Election Commission1.558 U.S. 310 (2010).Show More and Burwell v. Hobby Lobby,2.573 U.S. 682 (2014).Show More which recognized the political speech and religious freedom rights of corporations,3.In Citizens United, the Supreme Court struck down a federal law, 2 U.S.C. § 441b (2006), that banned direct corporate spending on political campaigns. 558 U.S. at 372. Citizens United was part of a long line of cases in which the Court had recognized the First Amendment rights of corporations, including: NAACP v. Alabama ex rel. Patterson, 357 U.S. 449, 459 (1958) (freedom of association); NAACP v. Button, 371 U.S. 415, 428–29 (1963) (freedom of expression and association); New York Times Co. v. Sullivan, 376 U.S. 254, 264 (1964) (freedom of speech and the press); and First National Bank of Boston v. Bellotti, 435 U.S. 765, 784 (1978) (campaign expenditures as political speech). Hobby Lobby concluded that corporations were “persons” under the Religious Freedom Restoration Act, 42 U.S.C. §§ 2000bb–1, and held that Health and Human Services regulations requiring employers to provide insurance that covered contraceptives unconstitutionally burdened closely held corporations’ exercise of religion. 573 U.S. at 736.Show More respectively, activist groups have been lobbying for a constitutional amendment to eliminate corporate constitutional personhood.4.See Move to Amend, https://www.movetoamend.org/ [https://perma.cc/RH9L-2FZT] (last visited Aug. 19, 2020); United for the People, http://united4thepeople.org/ [https://perma.cc/XS9X-LZNR] (last visited Aug. 19, 2020).Show More Granting corporations constitutional rights, they argue, gives powerful mega-corporations even greater means to avoid regulation and manipulate elections, thus threatening “the democratic promise of America.”5.United for the People, supra note 4; Move to Amend, supra note 4. See Joanna M. Meyer, The Real Error in Citizens United, 69 Wash. & Lee L. Rev. 2171, 2198 (2012).Show More In 2019, Rep. Pramila Jayapal (D-WA) introduced a bill to provide that “the rights extended by the Constitution are the rights of natural persons only” and that corporations “shall have no rights under this Constitution.”6.H.R.J. Res. 48, 116th Cong. (2019) (proposing an amendment to the Constitution of the United States providing that the rights extended by the Constitution are the rights of natural persons only). Other bills introduced in both the House and the Senate have targeted specific constitutional rights, such as one “waiving the application of the first article of amendment to the political speech of corporations.” H.R.J. Res. 39, 116th Cong. (2019). See United for the People, http://united4thepeople.org/amendments/ (last visited Oct. 31, 2021) [https://perma.cc/QGU7-883U], for an up-to-date list of proposed amendments relating to corporate constitutional rights.Show More Supporters of this amendment showcase buttons and bumper stickers that proclaim: “Corporations are not People!”7.See Move to Amend, https://move-to-amend.myshopify.com/collections/frontpage [https://perma.cc/8JVP-CYAD] (last visited Dec. 28, 2021).Show More

Corporate constitutional rights have been debated since the early years of the American Republic.8.For early cases debating the constitutional rights of corporations, see Bank of United States v. Deveaux, 9 U.S. (5 Cranch) 61, 63–64 (1809); Hope Insurance Co. of Providence v. Boardman, 9 U.S. (5 Cranch) 57, 58 (1809); Terrett v. Taylor, 13 U.S. (9 Cranch) 43, 46–47 (1815); Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheaton) 518, 556 (1819); Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, 36 U.S. (11 Peters) 420, 421 (1837); and Louisville, Cincinnati & Charleston Railroad Co. v. Letson, 43 U.S. (2 Howard) 497, 499 (1844). See also Adam Winkler, We the Corporations: How American Businesses Won Their Civil Rights, at xxi (2018) (describing how the country’s most powerful corporations have persistently tried to use the Constitution to evade unwanted government regulations); Margaret M. Blair & Elizabeth Pollman, The Derivative Nature of Corporate Constitutional Rights, 56 Wm. & Mary L. Rev. 1673, 1680 (2015) (explaining how the Supreme Court was tasked with determining the applicability of constitutional provisions to corporations in an 1809 case involving the first Bank of the United States).Show More Missing from histories of corporate personhood, however, is the central role that race played in the development of corporate constitutional rights.9.Legal historians of corporate personhood have discussed corporate Fourteenth Amendment cases in some detail but have neglected the role that race played in the development of these cases. For representative writings on corporate personhood and constitutional rights, see Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. Va. L. Rev. 173, 174 (1985); Blair & Pollman, supra note 8, at 1677; Reuven S. Avi-Yonah, Citizens United and the Corporate Form, 2010 Wis. L. Rev. 999, 1033–34; Gregory A. Mark, The Personification of the Business Corporation in American Law, 54 U. Chi. L. Rev. 1441, 1443 (1987); Herbert Hovenkamp, The Classical Corporation in American Legal Thought, 76 Geo. L.J. 1593, 1640–41 (1988); David K. Millon, Theories of the Corporation, 1990 Duke L.J. 201, 205–07; Elizabeth Pollman, Reconceiving Corporate Personhood, 2011 Utah L. Rev. 1629, 1630; Margaret M. Blair, Corporate Personhood and the Corporate Persona, 2013 U. Ill. L. Rev. 785, 796–97; Kent Greenfield, In Defense of Corporate Persons, 30 Const. Comment. 309, 310–12 (2015); Tamara R. Piety, Why Personhood Matters, 30 Const. Comment. 361, 362–63 (2015); Turkuler Isiksel, Corporations as Rights-Bearers, J. Pol. (forthcoming) (manuscript at 1–2) (on file with the author).Show More This Article uncovers this link by highlighting the strategy of a group of corporate lawyers and Ninth Circuit10 10.At the time, the Circuit Court for the District of California, where the cases discussed in this Article arose, was located in the federal circuit encompassing California and Oregon. This court exercised both original and appellate jurisdiction and was staffed by one Supreme Court Justice (Stephen Field), one circuit court judge (Lorenzo Sawyer), and one district court judge (Ogden Hoffman), any two of which could hear a case. Christian G. Fritz, Federal Justice in California: The Court of Ogden Hoffman, 1851–1891, at 29–30 (1991). To avoid confusion, this Article follows contemporary scholarship that refers to these cases as occurring in the Ninth Circuit. Id. at 29; Howard J. Graham, Everyman’s Constitution: Historical Essays on the Fourteenth Amendment, the “Conspiracy Theory,” and American Constitutionalism 573 (1968); Winkler, supra note 8, at 153–54. However, this should not be confused with the modern-day U.S. Court of Appeals for the Ninth Circuit, which was not created until the federal appellate system was redesigned in 1891. Joshua Glick, On the Road: The Supreme Court and the History of Circuit Riding, 24 Cardozo L. Rev. 1753, 1826 (2003).Show More judges to expand the Fourteenth Amendment using cases involving both corporations and race. As this Article reveals, modern ideas about corporate personhood are predicated on a historical analogy between corporate shareholders and racial minorities.11 11.A growing area of scholarship explores the connections between corporations and race. See, e.g., Cheryl L. Wade, Attempting to Discuss Race in Business and Corporate Law Courses and Seminars, 77 St. John’s L. Rev. 901 (2003); Alfred Dennis Mathewson, Race in Ordinary Course: Utilizing the Racial Background in Antitrust and Corporate Law Courses, 23 St. John’s J. Legal Comment. 667, 685 (2008); Cheryl L. Wade, Introduction to Symposium on People of Color, Women, and the Public Corporation: The Sophistication of Discrimination, 79 St. John’s L. Rev. 887, 890 (2005); Thomas W. Joo, Corporate Hierarchy and Racial Justice, 79 St. John’s L. Rev. 955 (2005); Thomas W. Joo, Race, Corporate Law, and Shareholder Value, 54 J. Legal Ed. 351 (2004); Juliet E.K. Walker, White Corporate America: The New Arbiter of Race? in Constructing Corporate America: History, Politics, Culture, 246, 253, 260 (Kenneth Lipartito & David B. Sicilia eds., 2007).Show More Yet racial analogies not only helped corporations gain constitutional rights; corporations themselves created constitutional guarantees that ultimately protected racial minorities. This neglected history shows that corporations have been crucial players in shaping rights guarantees—particularly an expansive interpretation of equal protection under the Fourteenth Amendment—that apply to individuals as well. In revealing these complex interconnections, this Article exposes the multifaceted legacy of litigation over corporate personhood in the development of modern equal protection jurisprudence.

This Article juxtaposes two seminal cases, decided on the same day in 1886 and brought by the same lawyers: Santa Clara County v. Southern Pacific Railroad,12 12.118 U.S. 394 (1886).Show More credited with establishing corporate Fourteenth Amendment rights,13 13.See Horwitz, supra note 9, at 173; Blair & Pollman, supra note 8, at 1694–95; Avi-Yonah, supra note 9, at 1033–34.Show More and Yick Wo v. Hopkins,14 14.118 U.S. 356 (1886).Show More a touchstone of modern civil rights jurisprudence.15 15.See 2 Encyclopedia of American Civil Rights and Liberties 482, 1055 (Kara E. Stooksbury, John M. Scheb, II & Otis H Stephens, Jr. eds., rev. and expanded ed. 2017); Peter Irons, Jim Crow’s Children: The Broken Promise of the Brown Decision 53 (2004); see also infra notes 327–35 (noting early civil rights cases citing Yick Wo).Show More This Article uncovers the conjoined history of these two Fourteenth Amendment cases, one involving a corporation and the other a Chinese immigrant, and their antecedents.16 16.Scholars have studied the connection between Fourteenth Amendment claims of Chinese immigrants and the Supreme Court’s desire to protect economic rights. See Thomas Wuil Joo, New “Conspiracy Theory” of the Fourteenth Amendment: Nineteenth Century Chinese Civil Rights Cases and the Development of Substantive Due Process Jurisprudence, 29 U.S.F. L. Rev. 353, 354–55 (1995); Thomas W. Joo, Yick Wo Re-Revisited: Nonblack Nonwhites and Fourteenth Amendment History, 2008 U. Ill. L. Rev. 1427, 1428; Charles McClain, Jr., In Search of Equality: The Chinese Struggle Against Discrimination in Nineteenth-Century America 83 (1994); Graham, supra note 10, at 15; Daniel W. Levy, Classical Lawyers and the Southern Pacific Railroad, 9 W. Legal Hist. 177, 211, 216 (1996); Paul Kens, Justice Stephen Field: Shaping Liberty from the Gold Rush to the Gilded Age 209 (1997); Winkler, supra note 8, at 153. However, no prior scholarship has specifically examined the intersection of Fourteenth Amendment claims by corporations and by Chinese immigrants.Show More Drawing on little-known archival sources, it traces how the same coterie of corporate lawyers simultaneously brought Fourteenth Amendment cases involving Chinese and corporate litigants before the sympathetic Ninth Circuit in order to strategically craft a broad interpretation of the Equal Protection Clause that applied to all “persons,” natural and artificial alike.17 17.See In re Ah Fong, 1 F. Cas. 213, 213 (C.C.D. Cal. 1874) (No. 102); Ho Ah Kow v. Nunan, 12 F. Cas. 252, 252 (C.C.D. Cal. 1879) (No. 6,546); In re Ah Chong, 2 F. 733, 737 (C.C.D. Cal. 1880); In re Tiburcio Parrott, 1 F. 481, 482 (C.C.D. Cal. 1880); The Railroad Tax Cases, 13 F. 722, 727 (C.C.D. Cal. 1882); In re Quong Woo, 13 F. 229, 233 (C.C.D. Cal. 1882); County of Santa Clara v. S. Pac. R.R. Co., 18 F. 385, 386, 397 (C.C.D. Cal. 1883), aff’d, 118 U.S. 394 (1886); In re Yick Wo, 9 P. 139, 139 (Cal. 1885), rev’d sub nom. Yick Wo v. Hopkins, 118 U.S. 356 (1886); In re Wo Lee, 26 F. 471, 475 (C.C.D. Cal. 1886).Show More Although in the Slaughter-House Cases the Supreme Court had suggested that it would read the Fourteenth Amendment narrowly,18 18.Slaughter-House Cases, 83 U.S. (16 Wall.) 36, 80–81 (1873).Show More in Yick Wo and Santa Clara the Court changed course and adopted the Ninth Circuit’s expansive interpretation of equal protection, a doctrinal shift with lasting effects today.

This is not a story of unintended consequences. By expanding the scope of the Equal Protection Clause to include Chinese immigrants, corporate lawyers were able to use the Chinese cases to draw a through-line from African Americans—the original beneficiaries of the Fourteenth Amendment—to Chinese immigrants, to corporate shareholders.19 19.The social and political connections of Chinese “coolies” with railroad and mining corporations in the context of Greater Reconstruction debates over the meaning of “free labor” and “equality” are explored in Evelyn Atkinson, Slaves, Coolies, and Shareholders: Corporations Claim the Fourteenth Amendment, 10 J. Civ. War Era 54 (2020).Show More This comparison was made possible because corporate lawyers and federal judges intentionally portrayed the corporation as simply an aggregate of rights-bearing shareholders who did not forsake their constitutional rights when they joined the corporation. In this framing, shareholders were members of a persecuted group, the same as racial minorities.

This view of the corporation as solely an aggregate of rights-bearing shareholders was at odds with an older common law vision of the corporation as both an aggregate of individuals and a separate legal person with special rights and duties distinct from those of “natural” persons.20 20.See John Dewey, The Historic Background of Corporate Legal Personality, 35 Yale L.J. 655, 656 (1926); 3 The Collected Papers of Frederic William Maitland 307 (H. A. L. Fisher ed., 1911).Show More In Part I below, this Article exposes a contour of common law corporate personhood that has not previously been noted: incorporation was a status in which corporate legal persons existed in a hierarchical relationship with the public, akin to master-servant or parent-child.21 21.See discussion infra Part I.Show More The common law view of the corporation as a “child” or “servant” of the public justified more stringent state regulation of corporations than of individuals: the state was the benevolent parent, overseeing its corporate child to ensure the corporation acted in the public interest.22 22.William Novak discusses the extensive power of state legislatures to regulate in the “public interest” in William J. Novak, The People’s Welfare: Law and Regulation in Nineteenth-Century America 19–20 (1996).Show More

Yet as Part II discusses, throughout the nineteenth century, corporate lawyers challenged this view, arguing that corporations were not “children” who owed a special duty of obedience to the parental state but private, profit-making entities whose interests were unrelated or even potentially opposed to those of the public. In this view, the corporation was a naturally arising market phenomenon, akin to any other private market actor, with no special obligation to the public welfare.23 23.This has been called the “natural” or “real entity” theory of the corporation, that corporations are naturally emerging market entities controlled by their managers. See Avi-Yonah, supra note 9, at 1000–01; Blair, supra note 9, at 805; Pollman, supra note 9, at 1642; Arthur W. Machen, Jr., Corporate Personality, 24 Harv. L. Rev 253, 262 (1911).Show More In support of this argument, corporate lawyers reframed the corporation not as a group of individuals authorized to act as one “artificial,” “legal person” for certain purposes, but as solely an aggregation of constitutional-rights-bearing shareholders.24 24.This is called the “aggregate” or “associational” theory. See Horwitz, supra note 9, at 182; Mark, supra note 9, at 1462; Hovenkamp, supra note 9, at 1597–98; Pollman, supra note 9, at 1662. Morton Horwitz argues that the aggregate theory was short-lived because of the increasing separation of management and control and that the “entity” theory replaced the aggregate theory in the early twentieth century. Horwitz, supra note 9, at 182. However, Citizens United, Hobby Lobby, and other recent cases have invoked an aggregate view of the corporation to justify extending freedom of speech and religion to corporations. See Citizens United v. FEC, 558 U.S. 310, 356 (2010) (“Yet certain disfavored associations of citizens—those that have taken on the corporate form—are penalized for engaging in the same political speech.”); Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 720 (2014) (attributing the religious beliefs of the shareholders of a closely held corporation to the corporate entity itself). But see Avi-Yonah, supra note 9, at 1040 (arguing that “both the majority and the dissent [of Citizens United] adopted the real entity view of the corporation”). Actually, the Court tacked back and forth between different conceptions of corporate personality.Show More By framing the corporation simply as a collection of private, rights-bearing individuals, corporate lawyers were able to argue that the rights and duties of corporations were simply the rights and duties of the natural persons who composed them, and no more.25 25.See infra Part I.Show More

This debate over whether the corporation was a state creation granted legal personhood in certain contexts for the purpose of furthering the public interest, or simply a group of private, rights-bearing individuals pursuing their own economic gain, was central to the cases involving corporate Fourteenth Amendment rights. While Morton Horwitz, Gregory Mark, and others have shown that key to the Ninth Circuit’s reasoning in Santa Clara was a view of the corporation as an aggregate of shareholders,26 26.Horwitz, supra note 9, at 223; Mark, supra note 9, at 1464.Show More they have not examined the equally viable, alternative vision of the corporation as a “child of the state” presented by opposing counsel and reflected in public opinion. More importantly, they have overlooked the racial analogy underlying the precedents to Santa Clara on which the doctrine of corporate constitutional personhood was built.27 27.Mark and Horwitz have explained the reliance on the aggregate theory of corporate personhood as primarily rooted in property protection. Mark, supra note 9, at 1464; Horwitz, supra note 9, at 177.Show More This Article reveals the background and reasoning behind this significant judicial reframing of corporate personhood: the aggregate theory of the corporation allowed corporate lawyers and judges to analogize shareholders to racial minorities as similarly persecuted groups targeted by discriminatory legislation.

This analogy, of course, disregarded the immense power discrepancy between corporate shareholders and persecuted racial groups. By holding that the Equal Protection Clause applied to “the despised laborer from China” as much as the “envied master of millions,”28 28.The Railroad Tax Cases, 13 F. 722, 741 (C.C.D. Cal. 1882).Show More the Ninth Circuit endorsed an interpretation of the Amendment as treating all persons alike, regardless of their social and economic power. This reasoning bolstered a “formal equality” interpretation of the Fourteenth Amendment, in contrast to claims that the Amendment embodied a commitment to “substantive equality” or anti-subordination—part of a trend towards limiting the Amendment’s ability to address long-standing inequalities that continues today.29 29.“Substantive equality,” or “anti-subordination,” consists not only in eliminating discrimination but also in “alter[ing] the circumstances that are identified as giving rise to equality questions in the first place.” Catharine A. MacKinnon, Substantive Equality: A Perspective, 96 Minn. L. Rev. 1, 11 (2011) [hereinafter MacKinnon, Substantive Equality]; see also Ruth Colker, Reflections on Race: The Limits of Formal Equality, 69 Ohio St. L.J. 1089, 1090 (2008) (contrasting a “formal equality” with an “anti-subordination” perspective); Kimberlé Williams Crenshaw, Race, Reform, and Retrenchment: Transformation and Legitimation in Antidiscrimination Law, 101 Harv. L. Rev. 1331, 1336 (1988) (contrasting “equality as a process” with “equality as a result”). For an extensive analysis of “formal” versus “substantive” concepts of equality, see generally Catharine A. MacKinnon, Sex Equality (2007) [hereinafter MacKinnon, Sex Equality].Show More

This is not a case of manipulation by corporate lawyers of disempowered minority litigants. Chinese litigants were willing partners in the strategy to join forces with corporations to expand the Fourteenth Amendment. As this Article reveals, the economic and social connections between industrial corporate magnates and the elite Chinese mercantile and political community were long-standing. Both relied financially on the continued immigration of Chinese laborers, and both had long been represented by the same corporate lawyers. They were also both the target of discriminatory regulations that aimed to simultaneously curb corporate power and stem Chinese immigration. The Fourteenth Amendment provided a valuable tool for corporate lawyers to advocate on behalf of both sets of clients. By eliding the difference between Chinese immigrants and shareholders in these interrelated lines of cases, corporate lawyers cemented an interpretation of equal protection that culminated in the success of the twin cases of Santa Clara and Yick Wo.

For years, scholars have pondered Chief Justice Morrison Waite’s famously blithe comment at the outset of oral argument in Santa Clara that the Justices did not wish to hear argument on whether the Fourteenth Amendment applied to corporations, as they were “all of [the] opinion that it does.”30 30.Santa Clara County v. S. Pac. R.R. Co., 118 U.S. 394, 396 (1886); see, e.g., Howard Jay Graham, The Waite Court and the Fourteenth Amendment, 17 Vand. L. Rev. 525, 530 (1964) (“Nowhere in the United States Reports are there to be found words more momentous or more baffling than these.”); Horwitz, supra note 9, at 173 (“[The decision] has always been puzzling and controversial”); Pollman, supra note 9, at 1644 n.92 (“[T]he unusual circumstances of this case have evoked skepticism and debate.”).Show More Gregory Mark has pointed out that Waite expressly avoided addressing the constitutional question and argued that his statement indicated that the Court merely intended to accept the argument that the corporate property in this case was protected as property of the shareholders.31 31.Mark, supra note 9, at 1464.Show More Elizabeth Pollman has also explained Waite’s statement as concerned with protecting the shareholders’ property interests.32 32.Pollman, supra note 9, at 1644–45.Show More Howard Graham, dismissing the claim as “dictum,” went so far as to contend that “the recording of this statement was a fluke––the Court reporter’s after-thought!”33 33.Graham, supra note 30, at 530.Show More Adam Winkler has likewise claimed that Waite never intended his quote to become part of the opinion, but that it was intentionally misrepresented in the case report by a perfidious court reporter.34 34.Winkler, supra note 8, at 153.Show More

J. Willard Hurst even posited that, given late nineteenth-century law’s general embrace of economic activity, extending the Fourteenth Amendment to corporations “provoked no significant contemporary controversy.”35 35.James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States 1780–1970, at 68 (1970).Show More

This Article offers a novel interpretation of this puzzle. By reading Santa Clara in light of Yick Wo and the preceding line of corporate and Chinese Fourteenth Amendment cases, this Article illuminates the context of equal protection jurisprudence surrounding Waite’s enigmatic statement—specifically, the interplay between corporate personhood and race. As this Article reveals, the definition of equal protection that the Court adopted in Yick Wo had been developed in Ninth Circuit corporate and Chinese Fourteenth Amendment cases throughout the preceding decade and was central to the arguments of counsel in both Yick Wo and Santa Clara. By the time the Waite Court heard Santa Clara, the link between racial minorities and corporate shareholders had become well established in equal protection jurisprudence.36 36.Elizabeth Pollman notes the precedential effect of the Ninth Circuit’s equal protection jurisprudence but does not explore the explicit connections to race. Pollman, supra note 9, at 1644.Show More Although the Court announced its expanded interpretation of equal protection in Yick Wo rather than Santa Clara, its reasoning had long been applied equally to corporate litigants. This Article suggests that one reason why the Court declined to hear arguments on whether the Fourteenth Amendment protected corporations was because the combined precedent of Chinese and corporate cases had already established that it did.

The success of corporations at claiming constitutional rights has produced a forked legacy. Critics of Citizens United and Hobby Lobby have contended that corporate personhood has been used to trump the rights of individuals37 37.As Justice Ruth Bader Ginsburg argued in Hobby Lobby, the majority prioritized religious rights of employers over the reproductive rights of female employees. Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 740 (2014) (Ginsburg, J., dissenting); see also Jessica L. Waters & Leandra N. Carrasco, Untangling the Reproductive Rights and Religious Liberty Knot, 26 Yale J.L. & Feminism 217 (2014).Show More and to subvert the democratic process.38 38.One outcome of Citizens United has arguably been to permit dark-money groups to sway elections. See Heather K. Gerken, The Real Problem with Citizens United: Campaign Finance, Dark Money, and Shadow Parties, 97 Marq. L. Rev. 903, 905 (2014); Danny Emmer, Shedding Light on “Dark Money”: The Heightened Risk of Foreign Influence Post-Citizens United, 20 Sw. J. Int’l L. 381, 382 (2014).Show More In contrast, supporters of the decisions have argued that corporations are collections of shareholders who do not lose their fundamental rights simply because they do business as a corporation.39 39.Citizens United v. FEC, 558 U.S. 310, 339–40 (2010); Hobby Lobby, 573 U.S. at 706–07; see, e.g., Richard A. Epstein, The Defeat of the Contraceptive Mandate in Hobby Lobby: Right Results, Wrong Reasons, 2014 Cato Sup. Ct. Rev. 35, 45; Paul Horwitz, The Hobby Lobby Moment, 128 Harv. L. Rev. 154, 162–63 (2014).Show More Yet even those who oppose corporate constitutional personhood must acknowledge the discomfiting reality that corporate rights litigation has been, and continues to be, an important means of expanding rights protections for natural persons. Today, corporations play an important role in protecting civil rights in other contexts, such as by bringing claims for racial discrimination on behalf of their members under the 1866 Civil Rights Act.40 40.42 U.S.C. § 1981(a). Because corporations are typically the contracting party in these cases, not the natural persons against which the actual discrimination is directed, under common law principles of contract law the corporation is the only “person” that has standing to sue. See infra note 342.Corporate litigation has also laid the groundwork for individual claims regarding religious freedom. Hobby Lobby has been invoked by smaller corporations, nonprofits, individuals, and partnerships claiming freedom of religion rights in similar contexts. See, e.g., Brief for Petitioners at 38 n.6, Masterpiece Cakeshop, Ltd. v. Colo. C.R. Comm’n, 138 S. Ct. 1719 (2018) (No. 16-111); Reply Brief for Petitioners in Nos. 14-1418, 14-1453 & 14-1505, at 7–8, Zubik v. Burwell, 578 U.S. 403 (2016) (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191); Brief for Petitioners in Nos. 15-35, 15-105, 15-119 & 15-191, at 2, Zubik, 578 U.S. 403 (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191). The wealth and institutional knowledge of large corporations like Hobby Lobby and their lawyers make them ideally suited to pursue impact litigation that establishes precedent for non-corporate claims of religious freedom violations.Show More This does not mean we should rehabilitate constitutional-rights-bearing corporate persons; but we must admit that a blanket condemnation of corporate personhood ignores the important historical legacy of corporate rights litigation and the continued interconnection—even interdependency—of corporations and racial minorities.

The Article proceeds in three Parts. Part I addresses the common law vision of the corporation as both an aggregate of individuals and a “child of the state” with rights and duties different from those of natural persons and traces the continued viability of this vision throughout the period in which Santa Clara was decided. Part II concerns corporate challenges to this traditional view in Fourteenth Amendment litigation, examining the strategy of corporate lawyers’ and Ninth Circuit judges’ reliance on the aggregate theory of corporate personhood to analogize Chinese immigrants to corporate shareholders in order to support a broad reading of the Equal Protection Clause. Part III examines the background of Santa Clara and reveals how the meaning of equal protection established by the Chinese and corporate Fourteenth Amendment cases informed the Court’s ultimate rulings in Santa Clara and Yick Wo, laying the groundwork for modern equal protection doctrine today.

  1. * Postdoctoral Teaching Fellow, University of Chicago. Ph.D, University of Chicago; J.D., Harvard Law School. Many thanks to Amy Dru Stanley, Laura Weinrib, Alison LaCroix, Jonathan Levy, Ajay Mehrotra, Christopher Schmidt, Naomi Lamoreaux, Gregory Mark, Adam Winkler, Paul Kens, Nikolas Bowie, Naama Maor, Lael Weinberger, and the American Bar Foundation Doctoral Fellows Workshop (2018–2020) for their comments and insights. Thank you also to the editors of the Virginia Law Review for their deep engagement with this text, as well as their technical prowess.
  2. 558 U.S. 310 (2010).
  3. 573 U.S. 682 (2014).
  4. In Citizens United, the Supreme Court struck down a federal law, 2 U.S.C. § 441b (2006), that banned direct corporate spending on political campaigns. 558 U.S. at 372. Citizens United was part of a long line of cases in which the Court had recognized the First Amendment rights of corporations, including: NAACP v. Alabama ex rel. Patterson, 357 U.S. 449, 459 (1958) (freedom of association); NAACP v. Button, 371 U.S. 415, 428–29 (1963) (freedom of expression and association); New York Times Co. v. Sullivan, 376 U.S. 254, 264 (1964) (freedom of speech and the press); and First National Bank of Boston v. Bellotti, 435 U.S. 765, 784 (1978) (campaign expenditures as political speech). Hobby Lobby concluded that corporations were “persons” under the Religious Freedom Restoration Act, 42 U.S.C. §§ 2000bb–1, and held that Health and Human Services regulations requiring employers to provide insurance that covered contraceptives unconstitutionally burdened closely held corporations’ exercise of religion. 573 U.S. at 736.
  5. See Move to Amend, https://www.movetoamend.org/ [https://perma.cc/RH9L-2FZT] (last visited Aug. 19, 2020); United for the People, http://united4thepeople.org/ [https://perma.cc/XS9X-LZNR] (last visited Aug. 19, 2020).
  6. United for the People, supra note 4; Move to Amend, supra note 4. See Joanna M. Meyer, The Real Error in Citizens United, 69 Wash. & Lee L. Rev. 2171, 2198 (2012).
  7. H.R.J. Res. 48, 116th Cong. (2019) (proposing an amendment to the Constitution of the United States providing that the rights extended by the Constitution are the rights of natural persons only). Other bills introduced in both the House and the Senate have targeted specific constitutional rights, such as one “waiving the application of the first article of amendment to the political speech of corporations.” H.R.J. Res. 39, 116th Cong. (2019). See United for the People, http://united4thepeople.org/amendments/ (last visited Oct. 31, 2021) [https://perma.cc/QGU7-883U], for an up-to-date list of proposed amendments relating to corporate constitutional rights.
  8.  See Move to Amend, https://move-to-amend.myshopify.com/collections/frontpage [https://perma.cc/8JVP-CYAD] (last visited Dec. 28, 2021).
  9. For early cases debating the constitutional rights of corporations, see Bank of United States v. Deveaux, 9 U.S. (5 Cranch) 61, 63–64 (1809); Hope Insurance Co. of Providence v. Boardman, 9 U.S. (5 Cranch) 57, 58 (1809); Terrett v. Taylor, 13 U.S. (9 Cranch) 43, 46–47 (1815); Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheaton) 518, 556 (1819); Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, 36 U.S. (11 Peters) 420, 421 (1837); and Louisville, Cincinnati & Charleston Railroad Co. v. Letson, 43 U.S. (2 Howard) 497, 499 (1844). See also Adam Winkler, We the Corporations: How American Businesses Won Their Civil Rights, at xxi (2018) (describing how the country’s most powerful corporations have persistently tried to use the Constitution to evade unwanted government regulations); Margaret M. Blair & Elizabeth Pollman, The Derivative Nature of Corporate Constitutional Rights, 56 Wm. & Mary L. Rev. 1673, 1680 (2015) (explaining how the Supreme Court was tasked with determining the applicability of constitutional provisions to corporations in an 1809 case involving the first Bank of the United States).
  10.  Legal historians of corporate personhood have discussed corporate Fourteenth Amendment cases in some detail but have neglected the role that race played in the development of these cases. For representative writings on corporate personhood and constitutional rights, see Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. Va. L. Rev. 173, 174 (1985); Blair & Pollman, supra note 8, at 1677; Reuven S. Avi-Yonah, Citizens United and the Corporate Form, 2010 Wis. L. Rev. 999, 1033–34; Gregory A. Mark, The Personification of the Business Corporation in American Law, 54 U. Chi. L. Rev. 1441, 1443 (1987); Herbert Hovenkamp, The Classical Corporation in American Legal Thought, 76 Geo. L.J. 1593, 1640–41 (1988); David K. Millon, Theories of the Corporation, 1990 Duke L.J. 201, 205–07; Elizabeth Pollman, Reconceiving Corporate Personhood, 2011 Utah L. Rev. 1629, 1630; Margaret M. Blair, Corporate Personhood and the Corporate Persona, 2013 U. Ill. L. Rev. 785, 796–97; Kent Greenfield, In Defense of Corporate Persons, 30 Const. Comment. 309, 310–12 (2015); Tamara R. Piety, Why Personhood Matters, 30 Const. Comment. 361, 362–63 (2015); Turkuler Isiksel, Corporations as Rights-Bearers, J. Pol. (forthcoming) (manuscript at 1–2) (on file with the author).
  11. At the time, the Circuit Court for the District of California, where the cases discussed in this Article arose, was located in the federal circuit encompassing California and Oregon. This court exercised both original and appellate jurisdiction and was staffed by one Supreme Court Justice (Stephen Field), one circuit court judge (Lorenzo Sawyer), and one district court judge (Ogden Hoffman), any two of which could hear a case. Christian G. Fritz, Federal Justice in California: The Court of Ogden Hoffman, 1851–1891, at 29–30 (1991). To avoid confusion, this Article follows contemporary scholarship that refers to these cases as occurring in the Ninth Circuit. Id. at 29; Howard J. Graham, Everyman’s Constitution: Historical Essays on the Fourteenth Amendment, the “Conspiracy Theory,” and American Constitutionalism 573 (1968); Winkler, supra note 8, at 153–54. However, this should not be confused with the modern-day U.S. Court of Appeals for the Ninth Circuit, which was not created until the federal appellate system was redesigned in 1891. Joshua Glick, On the Road: The Supreme Court and the History of Circuit Riding, 24 Cardozo L. Rev. 1753, 1826 (2003).
  12. A growing area of scholarship explores the connections between corporations and race. See, e.g., Cheryl L. Wade, Attempting to Discuss Race in Business and Corporate Law Courses and Seminars, 77 St. John’s L. Rev. 901 (2003); Alfred Dennis Mathewson, Race in Ordinary Course: Utilizing the Racial Background in Antitrust and Corporate Law Courses, 23 St. John’s J. Legal Comment. 667, 685 (2008); Cheryl L. Wade, Introduction to Symposium on People of Color, Women, and the Public Corporation: The Sophistication of Discrimination, 79 St. John’s L. Rev. 887, 890 (2005); Thomas W. Joo, Corporate Hierarchy and Racial Justice, 79 St. John’s L. Rev. 955 (2005); Thomas W. Joo, Race, Corporate Law, and Shareholder Value, 54 J. Legal Ed. 351 (2004); Juliet E.K. Walker, White Corporate America: The New Arbiter of Race? in Constructing Corporate America: History, Politics, Culture, 246, 253, 260 (Kenneth Lipartito & David B. Sicilia eds., 2007).
  13. 118 U.S. 394 (1886).
  14. See Horwitz, supra note 9, at 173; Blair & Pollman, supra note 8, at 1694–95; Avi-Yonah, supra note 9, at 1033–34.
  15. 118 U.S. 356 (1886).
  16.  See 2 Encyclopedia of American Civil Rights and Liberties 482, 1055 (Kara E. Stooksbury, John M. Scheb, II & Otis H Stephens, Jr. eds., rev. and expanded ed. 2017); Peter Irons, Jim Crow’s Children: The Broken Promise of the Brown Decision 53 (2004); see also infra notes 327–35 (noting early civil rights cases citing Yick Wo).
  17. Scholars have studied the connection between Fourteenth Amendment claims of Chinese immigrants and the Supreme Court’s desire to protect economic rights. See Thomas Wuil Joo, New “Conspiracy Theory” of the Fourteenth Amendment: Nineteenth Century Chinese Civil Rights Cases and the Development of Substantive Due Process Jurisprudence, 29 U.S.F. L. Rev. 353, 354–55 (1995); Thomas W. Joo, Yick Wo Re-Revisited: Nonblack Nonwhites and Fourteenth Amendment History, 2008 U. Ill. L. Rev. 1427, 1428; Charles McClain, Jr., In Search of Equality: The Chinese Struggle Against Discrimination in Nineteenth-Century America 83 (1994); Graham, supra note 10, at 15; Daniel W. Levy, Classical Lawyers and the Southern Pacific Railroad, 9 W. Legal Hist. 177, 211, 216 (1996); Paul Kens, Justice Stephen Field: Shaping Liberty from the Gold Rush to the Gilded Age 209 (1997); Winkler, supra note 8, at 153. However, no prior scholarship has specifically examined the intersection of Fourteenth Amendment claims by corporations and by Chinese immigrants.
  18. See In re Ah Fong, 1 F. Cas. 213, 213 (C.C.D. Cal. 1874) (No. 102); Ho Ah Kow v. Nunan, 12 F. Cas. 252, 252 (C.C.D. Cal. 1879) (No. 6,546); In re Ah Chong, 2 F. 733, 737 (C.C.D. Cal. 1880); In re Tiburcio Parrott, 1 F. 481, 482 (C.C.D. Cal. 1880); The Railroad Tax Cases, 13 F. 722, 727 (C.C.D. Cal. 1882); In re Quong Woo, 13 F. 229, 233 (C.C.D. Cal. 1882); County of Santa Clara v. S. Pac. R.R. Co., 18 F. 385, 386, 397 (C.C.D. Cal. 1883), aff’d, 118 U.S. 394 (1886); In re Yick Wo, 9 P. 139, 139 (Cal. 1885), rev’d sub nom. Yick Wo v. Hopkins, 118 U.S. 356 (1886); In re Wo Lee, 26 F. 471, 475 (C.C.D. Cal. 1886).
  19. Slaughter-House Cases, 83 U.S. (16 Wall.) 36, 80–81 (1873).
  20. The social and political connections of Chinese “coolies” with railroad and mining corporations in the context of Greater Reconstruction debates over the meaning of “free labor” and “equality” are explored in Evelyn Atkinson, Slaves, Coolies, and Shareholders: Corporations Claim the Fourteenth Amendment, 10 J. Civ. War Era 54 (2020).
  21. See John Dewey, The Historic Background of Corporate Legal Personality, 35 Yale L.J. 655, 656 (1926); 3 The Collected Papers of Frederic William Maitland 307 (H. A. L. Fisher ed., 1911).
  22. See discussion infra Part I.
  23. William Novak discusses the extensive power of state legislatures to regulate in the “public interest” in William J. Novak, The People’s Welfare: Law and Regulation in Nineteenth-Century America 19–20 (1996).
  24. This has been called the “natural” or “real entity” theory of the corporation, that corporations are naturally emerging market entities controlled by their managers. See Avi-Yonah, supra note 9, at 1000–01; Blair, supra note 9, at 805; Pollman, supra note 9, at 1642; Arthur W. Machen, Jr., Corporate Personality, 24 Harv. L. Rev 253, 262 (1911).
  25. This is called the “aggregate” or “associational” theory. See Horwitz, supra note 9, at 182; Mark, supra note 9, at 1462; Hovenkamp, supra note 9, at 1597–98; Pollman, supra note 9, at 1662. Morton Horwitz argues that the aggregate theory was short-lived because of the increasing separation of management and control and that the “entity” theory replaced the aggregate theory in the early twentieth century. Horwitz, supra note 9, at 182. However, Citizens United, Hobby Lobby, and other recent cases have invoked an aggregate view of the corporation to justify extending freedom of speech and religion to corporations. See Citizens United v. FEC, 558 U.S. 310, 356 (2010) (“Yet certain disfavored associations of citizens—those that have taken on the corporate form—are penalized for engaging in the same political speech.”); Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 720 (2014) (attributing the religious beliefs of the shareholders of a closely held corporation to the corporate entity itself). But see Avi-Yonah, supra note 9, at 1040 (arguing that “both the majority and the dissent [of Citizens United] adopted the real entity view of the corporation”). Actually, the Court tacked back and forth between different conceptions of corporate personality.
  26. See infra Part I.
  27. Horwitz, supra note 9, at 223; Mark, supra note 9, at 1464.
  28. Mark and Horwitz have explained the reliance on the aggregate theory of corporate personhood as primarily rooted in property protection. Mark, supra note 9, at 1464; Horwitz, supra note 9, at 177.
  29. The Railroad Tax Cases, 13 F. 722, 741 (C.C.D. Cal. 1882).
  30.  “Substantive equality,” or “anti-subordination,” consists not only in eliminating discrimination but also in “alter[ing] the circumstances that are identified as giving rise to equality questions in the first place.” Catharine A. MacKinnon, Substantive Equality: A Perspective, 96 Minn. L. Rev. 1, 11 (2011) [hereinafter MacKinnon, Substantive Equality]; see also Ruth Colker, Reflections on Race: The Limits of Formal Equality, 69 Ohio St. L.J. 1089, 1090 (2008) (contrasting a “formal equality” with an “anti-subordination” perspective); Kimberlé Williams Crenshaw, Race, Reform, and Retrenchment: Transformation and Legitimation in Antidiscrimination Law, 101 Harv. L. Rev. 1331, 1336 (1988) (contrasting “equality as a process” with “equality as a result”). For an extensive analysis of “formal” versus “substantive” concepts of equality, see generally Catharine A. MacKinnon, Sex Equality (2007) [hereinafter MacKinnon, Sex Equality].
  31. Santa Clara County v. S. Pac. R.R. Co., 118 U.S. 394, 396 (1886); see, e.g., Howard Jay Graham, The Waite Court and the Fourteenth Amendment, 17 Vand. L. Rev. 525, 530 (1964) (“Nowhere in the United States Reports are there to be found words more momentous or more baffling than these.”); Horwitz, supra note 9, at 173 (“[The decision] has always been puzzling and controversial”); Pollman, supra note 9, at 1644 n.92 (“[T]he unusual circumstances of this case have evoked skepticism and debate.”).
  32. Mark, supra note 9, at 1464.
  33. Pollman, supra note 9, at 1644–45.
  34. Graham, supra note 30, at 530.
  35. Winkler, supra note 8, at 153.
  36. James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States 1780–1970, at 68 (1970).
  37. Elizabeth Pollman notes the precedential effect of the Ninth Circuit’s equal protection jurisprudence but does not explore the explicit connections to race. Pollman, supra note 9, at 1644.
  38. As Justice Ruth Bader Ginsburg argued in Hobby Lobby, the majority prioritized religious rights of employers over the reproductive rights of female employees. Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 740 (2014) (Ginsburg, J., dissenting); see also Jessica L. Waters & Leandra N. Carrasco, Untangling the Reproductive Rights and Religious Liberty Knot, 26 Yale J.L. & Feminism 217 (2014).
  39. One outcome of Citizens United has arguably been to permit dark-money groups to sway elections. See Heather K. Gerken, The Real Problem with Citizens United: Campaign Finance, Dark Money, and Shadow Parties, 97 Marq. L. Rev. 903, 905 (2014); Danny Emmer, Shedding Light on “Dark Money”: The Heightened Risk of Foreign Influence Post-Citizens United, 20 Sw. J. Int’l L. 381, 382 (2014).
  40. Citizens United v. FEC, 558 U.S. 310, 339–40 (2010); Hobby Lobby, 573 U.S. at 706–07; see, e.g., Richard A. Epstein, The Defeat of the Contraceptive Mandate in Hobby Lobby: Right Results, Wrong Reasons, 2014 Cato Sup. Ct. Rev. 35, 45; Paul Horwitz, The Hobby Lobby Moment, 128 Harv. L. Rev. 154, 162–63 (2014).
  41. 42 U.S.C. § 1981(a). Because corporations are typically the contracting party in these cases, not the natural persons against which the actual discrimination is directed, under common law principles of contract law the corporation is the only “person” that has standing to sue. See infra note 342.

    Corporate litigation has also laid the groundwork for individual claims regarding religious freedom. Hobby Lobby has been invoked by smaller corporations, nonprofits, individuals, and partnerships claiming freedom of religion rights in similar contexts. See, e.g., Brief for Petitioners at 38 n.6, Masterpiece Cakeshop, Ltd. v. Colo. C.R. Comm’n, 138 S. Ct. 1719 (2018) (No. 16-111); Reply Brief for Petitioners in Nos. 14-1418, 14-1453 & 14-1505, at 7–8, Zubik v. Burwell, 578 U.S. 403 (2016) (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191); Brief for Petitioners in Nos. 15-35, 15-105, 15-119 & 15-191, at 2, Zubik, 578 U.S. 403 (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191). The wealth and institutional knowledge of large corporations like Hobby Lobby and their lawyers make them ideally suited to pursue impact litigation that establishes precedent for non-corporate claims of religious freedom violations.

Taxing Nudges

Governments are increasingly turning to behavioral economics to inform policy design in areas like health care, the environment, and financial decision-making. Research shows that small behavioral interventions, referred to as “nudges,” often produce significant responses at a low cost. The theory behind nudges is that, rather than mandating certain behaviors or providing costly economic subsidies, modest initiatives may “nudge” individuals to choose desirable outcomes by appealing to their behavioral preferences. For example, automatically enrolling workers into savings plans as a default, rather than requiring them to actively sign up, has dramatically increased enrollment in such plans. Similarly, allowing individuals to earn “wellness points” from attendance at a gym, redeemable at various retail establishments, may improve exercise habits.

A successful nudge should make a desired choice as simple and painless as possible. Yet one source of friction may counteract an otherwise well-designed nudge: taxation. Under current tax laws, certain incentives designed to nudge behavior are treated as taxable income. At best, people are ignorant of taxes on nudges, an outcome that is not good for the tax system. At worst, taxes on nudges may actively deter people from participating in programs with worthy policy goals. To date, policymakers have generally failed to account for this potential obstacle in designing nudges.

This Article sheds light on the tax treatment of nudges and the policy implications of taxing them. It describes the emergence of a disjointed tax regime that exempts private party nudges, but taxes identical incentives that come from the government. What is more, an incentive structured as a government grant may be taxable while an economically identical tax credit is not. The Article then proposes reforms that would unify the tax treatment of nudges and enhance their effectiveness. Specifically, lawmakers should reverse the default rule that all government transfers are taxable, and instead exclude government transfers from income unless otherwise provided by the Tax Code.

Introduction

Imagine that every ten years, a flood decimates the banks of a river, destroying homes and other buildings in its wake. Each time, the flood causes millions of dollars of damage and leaves some people homeless or jobless. The local government incurs enormous costs in the aftermath to clean up damage and provide subsidies to victims.

Now imagine that experts determine that a measure can be taken to “flood proof” homes and other buildings. The measure costs several thousand dollars per building, but this pales in comparison to the cost of cleaning up flood damage. Naturally, policymakers would be eager to encourage residents along the riverbank to undertake the improvements. But people tend to be present-biased and discount future harms, and the residents are unmotivated to make the improvements.1.See infra Subsection I.B.6.Show More What can policymakers do?

One option would be to mandate flood proofing and penalize those who do not do it. But this would be politically unpopular and entail enforcement costs. Another option would be simply to pay for the flood proofing for each resident; but this may be cost prohibitive.

There may be a third option, however. Suppose that lawmakers decide to offer a small carrot—a “nudge”—to encourage people to flood proof their homes. They might, for example, offer a modest cash reward—say $300—for doing so. Or they might offer to provide a warranty for any flood damage incurred after the improvement is made. The small nudge may be enough to motivate people to flood proof their homes. If the nudge is effective, the government might succeed in protecting its residents’ homes at a fraction of the cost of using penalties or paying for the improvements outright.

Nudges are an increasingly popular policy tool in many contexts. Insights from behavioral economics reveal that people’s irrational tendencies may lead them to make suboptimal decisions, such as failing to flood proof their homes, opting not to save for retirement, or not applying to college. For example, people’s failure to save for retirement is often just due to sheer inaction—what researchers call “status quo bias,” 2.See infra note 15 and accompanying text.Show More rather than any rational decision about how to spend one’s money. Making retirement savings easier by defaulting people into savings plans is an example of a simple nudge that achieves a desired policy at a low cost.

The term “nudge” was famously coined by Professors Richard Thaler and Cass Sunstein to describe an intervention that “alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives.”3.Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness 6 (2d ed. 2009).Show More Nudges might make a desired choice easier or simpler for people, they might help people overcome bad habits like procrastination, or they may simply provide people with better information.4.Cass R. Sunstein, Misconceptions About Nudges, 2 J. Behav. Econ. for Pol’y 61, 61 (2018).Show More Governments around the world have increasingly used nudges to enact cost-effective policies to improve the welfare of their citizens.

Nudges come in many forms: shifting defaults, like in the case of savings plans; sending people text message reminders to apply for college financial aid; or simplifying instructions on forms. Other nudges provide small incentives, like cash rewards or “wellness points” one might earn for achieving health goals. Regardless of the form of a particular nudge, it should make a desired choice as simple and painless as possible.

Yet one source of friction may counteract an otherwise well-designed nudge: taxation.

Under current tax laws, certain incentives aimed at nudging behavior are treated as taxable income. While nudges like defaults or text message reminders do not have tax consequences, nudges that provide an economic benefit to the recipient may be taxable. This is true regardless of whether the benefit comes in the form of cash, property, or services. For example, if a local government offers its citizens a $300 reward for flood proofing their homes, that grant would be subject to federal income taxation.

At best, people are ignorant of taxes on nudges, an outcome that is not good for the tax system. It may be particularly counterintuitive to people that government grants would be subject to tax. At worst, taxes on nudges may actively deter people from participating in programs with worthy policy goals. For example, homeowners may decide to forego a cash reward for flood proofing their home because they do not want to deal with the hassle of reporting it or because they do not want to attract scrutiny from the IRS. To date, policymakers have generally failed to account for this potential obstacle in designing nudges.

This Article sheds light on the tax treatment of nudges and the policy implications of taxing them. It first describes the emergence of a disjointed tax regime that often exempts nudges that come from private parties, but taxes identical incentives that come from the government. As a default, the tax law generally treats all economic benefits as taxable income. However, broad exceptions exist for certain incentives provided by employers to their employees, which are often classified as nontaxable fringe benefits. Similarly, incentives paid by nonprofits to individuals are likely to be treated as nontaxable gifts. Nudges provided by businesses to paying customers are also exempt from tax under the judicially created “purchase price adjustment” doctrine.

When it comes to identical incentives provided by governments, however, none of the fringe benefit, gift, or purchase price adjustment exclusions apply. Furthermore, while many government transfers are exempt from tax under other exclusions—for example, welfare assistance, veterans’ benefits, Social Security, and Medicare—those rules do not cover most nudges. Without a special exclusion, incentive-based nudges provided by governments are generally subject to tax under current laws. This regime does not appear to be a product of design, but is more likely the result of a piecemeal system of tax exemptions that has developed over time. Perhaps even more confounding is that an incentive structured as a government grant may be taxable, while an economically identical tax credit is not.

After examining the tax treatment of the most common types of nudges, this Article proposes reforms that would unify the tax treatment of nudges and enhance their effectiveness. It argues that lawmakers should reverse the default rule that all government transfers are taxable, and instead provide a rule that government transfers are excluded from income unless otherwise provided by the Tax Code. This would ensure that nudges designed to promote worthy policy goals would be exempt from tax as a default matter, unless Congress specifically decides otherwise. As an alternative to this broad proposal, the Article also proposes legislation that would exempt specific nudges from tax in the areas of health and environmental protection. Under either approach, exempting nudges from tax will make them more effective and should not pose serious revenue consequences.

This Article proceeds in four parts. Part I describes the concept of a nudge and categorizes the most common types of nudges. Part II provides an overview of the tax system and discusses the current tax treatment of nudges. Part III discusses policy implications of the current tax regime, including proposals to reform the tax treatment of nudges. Part IV concludes that the simplest, yet most effective, way to unify the tax treatment of nudges would be for Congress to provide a default of nontaxability for government transfers.

  1. * George R. Ward Term Professor of Law, University of North Carolina School of Law. I am grateful to Andrew Benton for excellent research assistance, and to helpful comments from Ellen Aprill, Peter Barnes, Fred Bloom, Michelle Drumbl, Heather Field, Brian Galle, Brant Hellwig, Andy Hessick, Carissa Hessick, Ed McCaffery, Pat Oglesby, Leigh Osofsky, Gregg Polsky, Katie Pratt, Rich Schmalbeck, Ted Seto, Jay Soled, Sloan Speck, Manoj Viswanathan, Larry Zelenak and workshop participants at University of Colorado Law School, Duke Law School, Loyola Law School, Washington & Lee University School of Law, and UC Hastings College of Law. For Tessie DeLaney.
  2. See infra Subsection I.B.6.
  3. See infra note 15 and accompanying text.
  4. Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness 6 (2d ed. 2009).
  5. Cass R. Sunstein, Misconceptions About Nudges, 2 J. Behav. Econ. for Pol’y 61, 61 (2018).
  6. See, e.g., George Loewenstein & Nick Chater, Putting Nudges in Perspective, 1 Behav. Pub. Pol’y. 26, 29 (2017) (“Traditional economic interventions include taxes, subsidies and mandatory disclosure of information . . . .”).
  7. See, e.g., David Halpern, Inside the Nudge Unit: How Small Changes Can Make a Big Difference 4 (2015).
  8. See, e.g., Bruno S. Frey, A Constitution for Knaves Crowds Out Civic Virtues, 107 Econ. J. 1043, 1044–45 (1997).
  9. Cass R. Sunstein, Nudging: A Very Short Guide, 37 J. Consumer Pol’y 583, 583 (2014) (Nudges “generally cost little and have the potential to promote economic and other goals . . . .”).
  10. Halpern, supra note 6, at 22.
  11. Brian Galle argues that, in some circumstances, nudges are the most efficient choice of instrument. See Brian Galle, The Problem of Intrapersonal Cost, 18 Yale J. Health Pol’y, L., & Ethics 1, 32–50 (2018).
  12. Sunstein, supra note 8, at 585. However, for a critique of savings defaults, see Ryan Bubb & Richard H. Pildes, How Behavioral Economics Trims Its Sails and Why, 127 Harv. L. Rev. 1593, 1607–37 (2014).
  13. Thaler & Sunstein, supra note 3, at 110–11.
  14. Id. at 111.
  15. See, e.g., id. at 111–13 (automatic enrollment increased employee participation in savings plans from 65% to 90%, and could notably increase per-capita contribution percentages); Loewenstein & Chater, supra note 5, at 27.
  16. Daniel Kahneman, Jack Knetsch & Richard Thaler, Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias, 5 J. Econ. Persp. 193, 197–98 (1991).
  17. See About SBST, SBST, https://sbst.gov/#report [https://perma.cc/S3YM-35MC] (last visited June 14, 2019).
  18. William J. Congdon & Maya Shankar, The White House Social & Behavioral Sciences Team: Lessons Learned from Year One, 1 Behav. Sci. & Pol’y 77, 83 (2015), https://behavioralpolicy.org/wp-content/uploads/2017/05/BSP_vol1is2_Congdon.pdf [https://perma.cc/EXF9-RWMV].
  19. Id.
  20.  See About Us, Behavioural Insights Team, https://www.bi.team/about-us/ [https://perma.cc/6BUF-95PA] (last visited Nov. 7, 2020) (“We have run more than 750 projects to date, including 400 randomised controlled trials in dozens of countries.”).
  21. See Christopher Larkin, Michael Sanders, Isabelle Andresen & Felicity Algate, Testing Local Descriptive Norms and Salience of Enforcement Action: A Field Experiment to Increase Tax Collection, 2 J. Behav. Pub. Admin. 1, 9–10 (2019); Dominic King et al., Redesigning the “Choice Architecture” of Hospital Prescription Charts: A Mixed Methods Study Incorporating In Situ Simulation Testing, 4 BMJ Open 1, 8–9 (2014); Peter John, Elizabeth MacDonald & Michael Sanders, Targeting Voter Registration with Incentives: A Randomized Controlled Trial of a Lottery in a London Borough, 40 Electoral Stud. 170, 175 (2015).
  22. See Zeina Afif, William Wade Islan, Oscar Calvo-Gonzalez & Abigail Goodnow Dalton, World Bank Group, Behavioral Science Around the World: Profiles of 10 Countries 6 (2019), http://documents.worldbank.org/curated/en/710771543609067500/pdf/132610-REVISED-00-COUNTRY-PROFILES-dig.pdf [https://perma.cc/JDX2-R9UK].
  23. See, e.g., Congdon & Shankar, supra note 17, at 84 (finding that letters sent to physicians comparing their prescribing rates with those of their peers had no measurable impact on prescription rates).
  24. See Afif et al., supra note 21, at 8–9.
  25. See, e.g., Thaler & Sunstein, supra note 3, at 12, 85.
  26. See, e.g., Johan Egebark & Mathias Ekström, Can Indifference Make the World Greener? 11–13 (Rsch. Inst. of Indus. Econ., IFN Working Paper No. 975, 2013).
  27. Eric J. Johnson & Daniel Goldstein, Do Defaults Save Lives? 302 Science 1338, 1338–39 (2003).
  28. See, e.g., Sunstein, supra note 8, at 585.
  29. Eric P. Bettinger, Bridget Terry Long, Philip Oreopoulos & Lisa Sanbonmatsu, The Role of Simplification and Information in College Decisions: Results from the H&R Block FAFSA Experiment 1 (Nat’l Bureau of Econ. Rsch., Working Paper No. 15361, 2009), https://www.nber.org/papers/w15361.pdf [https://perma.cc/XBV6-DL2U].
  30. Id. at 26–27.
  31. Cass R. Sunstein, Empirically Informed Regulation, 78 U. Chi. L. Rev. 1349, 1372–73 (2011).
  32. Id. at 1373.
  33. See, e.g., New Text Message Reminders for Summons Recipients Improves Attendance in Court and Dramatically Cuts Warrants, Ideas42, https://www.ideas42.org/new-text-message-reminders-summons-recipients-improves-attendance-court-dramatically-cuts-warrants/ [https://perma.cc/5SMM-PPFH] (last visited June. 17, 2019) (finding that text message reminders in New York City reduced “failure to appear” rates by 26%).
  34. See Congdon & Shankar, supra note 17, at 83.
  35. See, e.g., Raj Chetty, Adam Looney & Kory Kroft, Salience and Taxation: Theory and Evidence, 99 Am. Econ. Rev. 1145, 1165 (2009).
  36. Lisa L. Shu, Nina Mazar, Francesca Gino, Dan Ariely & Max H. Bazerman, Signing at the Beginning Makes Ethics Salient and Decreases Dishonest Self-Reports in Comparison to Signing at the End, 109 Proc. Nat’l Acad. Sci. 15197, 15197–98 (2012), http://www.pnas.org/content/109/38/15197.full.pdf+html [https://perma.cc/436E-DGL2]
  37. Id. at 15198.
  38. See, e.g., Sunstein, supra note 30, at 1381; Kate Phillips, Applying Behavioral Science Upstream in the Policy Design Process, Behav. Scientist (Sept. 17, 2018), https://behavioralscientist.org/applying-behavioral-science-upstream-in-the-policy-design-process/ [https://perma.cc/UWJ5-BBC7] (describing new laws implemented in Australia, requiring graphic images on cigarette labels, to reduce smoking rates).
  39. Michael Hallsworth, John A. List, Robert D. Metcalfe & Ivo Vlaev, The Behavioralist as Tax Collector: Using Natural Field Experiments to Enhance Tax Compliance 4 (Nat’l Bureau of Econ. Research, Working Paper No. 20007, 2014), https://www.nber.org/papers/w20007 [https://perma.cc/W7LN-F2T2].
  40. Hunt Allcott, Social Norms and Energy Conservation, 95 J. Pub. Econ. 1082, 1082–83 (2011).
  41. Sunstein, supra note 4, at 61 (distinguishing between nudges, which “must preserve freedom of choice,” and subsidies or other interventions, which “impose[] significant material costs on choosers”).
  42. This is assuming economically rational decision making on behalf of the homeowner, without factoring in other (realistic) costs, such as hassle costs and present bias.
  43. Sunstein, supra note 4, at 61.
  44. See Robert Münscher, Max Vetter & Thomas Scheuerle, A Review and Taxonomy of Choice Architecture Techniques, 29 J. Behav. Decision Making 511, 518 (2016) (defining micro-incentives as “changes of the consequences of decision options that are insignificant from a rational choice perspective”).
  45. Id.
  46. The small size of the payment makes it particularly less likely to function as a true subsidy, although it could. For example, if paying for bus fare to a local clinic was the impediment to a person obtaining a free flu shot, the $5 may operate as an economic subsidy free of behavioral considerations. For further discussion of the distinction between nudges and subsidies, see Brian Galle, Tax, Command . . . or Nudge?: Evaluating the New Regulation, 92 Tex. L. Rev. 837, 854–56 (2014) (explaining that “surprising and asymmetric incentives” are one factor distinguishing nudges from subsidies, and using a five-cent tax on plastic bags as an example of a financial consequence that is most likely a nudge, given that alternatives are generally more costly than the bag tax).
  47. Bronwyn McGill, Blythe J. O’Hara, Anne C. Grunseit & Philayrath Phongsavan, Are Financial Incentives for Lifestyle Behavior Change Informed or Inspired by Behavioral Economics? A Mapping Review, 33 Am. J. Health Promotion 131, 131 (2019) (“Since the 1960s, financial incentives (FIs) have been used in behavior change interventions, targeting a broad spectrum of health issues such as blood donation, medication adherence, and health and wellness programs.”).
  48. Soeren Mattke et al., Workplace Wellness Programs Study: Final Report, at xiv (Rand Corp. ed. 2013); see also Laura A Linnan, Laurie Cluff, Jason E. Lang, Michael Penne & Maija S. Leff, Results of the Workplace Health in America Survey, 3 Am. J. Health Promotion 652, 655 (2019) (over 46% of worksites surveyed had wellness programs).
  49. See Ha T. Tu & Ralph C. Mayrell, Employer Wellness Initiatives Grow, But Effectiveness Varies Widely, Nat’l Inst. for Health Care Reform, July 2010, at 2 (concluding that employers offer wellness programs to contain medical costs, to improve productivity, and to “position themselves as ‘employers of choice’”).
  50. Id.
  51. Id. at 2–3.
  52. Id. at 3–4.
  53. Mattke et al., supra note 47, at xv.
  54. Tu & Mayrell, supra note 48, at 5; Bahaudin G. Mujtaba & Frank J. Cavico, Corporate Wellness Programs: Implementation Challenges in the Modern American Workplace, 1 Int’l J. Health Pol’y & Mgmt. 193, 194 (2013) (mentioning gym reimbursements as a part of corporate wellness programs).
  55. See, e.g., Mujtaba & Cavico, supra note 53, at 194 (listing seminars as a part of corporate wellness programs).
  56. These wellness program incentives are regulated by several laws. For example, the Health Insurance Portability and Accountability Act (“HIPAA”) imposes multiple nondiscrimination requirements. See Tu & Mayrell, supra note 48, at 6.
  57. Mattke et al., supra note 47, at 73 fig.5.3.
  58. Tu & Mayrell, supra note 48, at 5; see also Mujtaba & Cavico, supra note 53, at 196 (referencing “[h]ealth insurance discounts and reimbursements for employees who meet health standards and maintain a healthy lifestyle”).
  59. One report found that “[m]ost benefits consultants and wellness vendors believed that $100 is the ‘sweet spot’ for an incentive for a ‘single instance of behavior,’ such as HRA completion or participation in a specific wellness activity.” See Tu & Mayrell, supra note 48, at 5.
  60. John Cawley & Joshua A. Price, A Case Study of a Workplace Wellness Program That Offers Financial Incentives for Weight Loss, 32 J. Health Econ. 794, 795 (2013).
  61. Mattke et al., supra note 47, at xxi.
  62. But see Katherine Pratt, A Constructive Critique of Public Health Arguments for Anti-Obesity Soda Taxes and Food Taxes, 87 Tul. L. Rev. 73, 77–94 (2012) (discussing economic, externality-based justifications for anti-obesity taxes and subsidies).
  63. Present bias describes the tendency to value immediate rewards over future rewards, even if the future rewards are larger. See, e.g., Richard Thaler, Some Empirical Evidence on Dynamic Inconsistency, 8 Econ. Letters 201, 201 (1981). In the context of weight loss, it is hard for people to forego immediate benefits (a tasty meal, for example) in exchange for a future benefit (lower weight).
  64. See Cawley & Price, supra note 59, at 794 (“[P]eople may want to do what is in their long-run interest (lose weight), but consistently succumb to the temptation to eat and be sedentary.”).
  65. Id.
  66. Tu & Mayrell, supra note 48, at 5.
  67. Id.
  68. Sahil Gupta, Opinion, Earning Prizes for Fighting an Addiction, N.Y. Times (Mar. 12, 2019), https://www.nytimes.com/2019/03/12/opinion/earning-prizes-for-fighting-an-addiction.html [https://perma.cc/58CN-DT45].
  69. Id.
  70. Id.
  71. Id.
  72. Scott D. Halpern et al., Randomized Trial of Four Financial-Incentive Programs for Smoking Cessation, 372 N. Eng. J. Med. 2108, 2108 (2015). Another intervention explored in the study was a deposit program in which participants would put up their own funds and earn them back if they successfully quit. Although the deposit was very effective for those who chose it, the cash incentive was more successful overall at reducing smoking, because significantly more participants opted for the cash intervention over the deposit. Id. at 2114.
  73. See, e.g., Kevin G. Volpp et al., A Randomized, Controlled Trial of Financial Incentives for Smoking Cessation, 360 New Eng. J. Med. 699, 707 (2009) (finding that a group who received financial incentives to refrain from smoking had “significantly higher” rates of “prolonged abstinence” than did a control group, who did not receive the same incentives).
  74. See, e.g., Jody Sindelar, Opinion, Should We Pay People to Stop Smoking?, CNN (Oct. 5, 2011), https://www.cnn.com/2011/10/05/opinion/sindelar-smoking-medicaid/index.html [https://perma.cc/C3Y6-39H8].
  75. Thaler & Sunstein, supra note 3, at 236.
  76. Joshua Rhett Miller, North Carolina Program Pays Girls a Dollar a Day Not to Get Pregnant, Fox News (June 25, 2009), https://www.foxnews.com/story/north-carolina-program-pays-girls-a-dollar-a-day-not-to-get-pregnant [https://perma.cc/L6JJ-7CVW]. The payment was contingent on attending a ninety-minute lesson each week, where the women learned about abstinence and contraception use. Id.
  77. Id.
  78. Dyan Zaslowsky, Denver Program Curbs Teen-Agers’ Pregnancy, N.Y. Times, Jan. 16, 1989, at A8.
  79.  Economic Incentives, Environmental Protection Agency, https://www.epa.gov/‌environmental-economics/economic-incentives [https://perma.cc/UCT5-4JJB] (last visited Dec. 21, 2020) (explaining that market-based incentives, like taxes and subsidies, are “becoming increasingly popular as tools for addressing a wide range of environmental issues”).
  80. Christian Schubert, Green Nudges: Do They Work? Are They Ethical?, 132 Ecological Econ. 329, 329 (2017).
  81. See Howard Kunreuther & Elke U. Weber, Aiding Decision Making to Reduce the Impacts of Climate Change, 37 J. Consumer Pol’y 397, 397–98 (2014).
  82. See, e.g., Schubert, supra note 79, at 330 (defining green nudges as “nudges that aim at promoting environmentally benign behavior”).
  83. Id.
  84.  See Hunt Allcott & Dmitry Taubinsky, Evaluating Behaviorally Motivated Policy: Experimental Evidence from the Lightbulb Market, 105 Am. Econ. Rev. 2501, 2501–02 (2015) (exploring the phenomenon and finding that moderate subsidies for energy-efficient lightbulbs may be effective in addressing this underinvestment).
  85. Free LED Program, Duke Energy, https://www.duke-energy.com/home/products/free-leds [https://perma.cc/FY93-D5L5] (last visited June 19, 2019); see also Commercial Retrofit, Puget Sound Energy, https://www.pse.com/rebates/business-incentives/commercial-retrofit-grants [https://perma.cc/R578-FS72] (last visited July 5, 2019) (providing coverage for up to 70% of the cost for energy efficient upgrades).
  86. Smart $aver: Home Improvement Rebate Program, Duke Energy, https://www.duke-energy.com/home/products/smart-saver [https://perma.cc/GAT6-GC5L] (last visited June 19, 2019).
  87. HVAC Install, Duke Energy, https://www.duke-energy.com/home/products/smart-saver/hvac-install [https://perma.cc/BE7P-YTJQ] (last visited June 19, 2019).
  88. Insulate & Seal, Duke Energy, https://www.duke-energy.com/home/products/smart-saver/insulate-and-seal [https://perma.cc/RC5K-V89W] (last visited June 19, 2019).
  89. Toshio Fujimi & Hirokazu Tatano, Promoting Seismic Retrofit Implementation Through “Nudge”: Using Warranty as a Driver, 33 Risk Analysis 1858, 1873 (2013).
  90. See id. at 1859–60.
  91. Id. at 1863.
  92. Id. at 1859.
  93. Id. at 1873.
  94. See supra note 62.
  95. See Kathleen DeLaney Thomas, The Modern Case for Withholding, 53 U.C. Davis L. Rev. 81, 124 (2019).
  96. See id. at 114.
  97. See Loewenstein & Chater, supra note 5, at 29–30.
  98. See Fujimi & Tatano, supra note 88, at 1872.
  99. Earthquake Brace + Bolt, https://www.earthquakebracebolt.com [https://perma.cc/‌5WPS-7X73] (last visited June 20, 2019).
  100. See, e.g., Cesarini v. United States, 296 F. Supp. 3, 4 (N.D. Ohio 1969) (“The starting point in determining whether an item is to be included in gross income is, of course, Section 61(a) of Title 26 U.S.C.”).
  101. I.R.C. § 61(a). The statute goes on to provide a non-exclusive list of items of gross income, such as compensation for services, interest, rents, royalties, and dividends. Id.
  102. 348 U.S. 426, 431 (1955).
  103. See, e.g., Cesarini, 296 F. Supp. at 4 (holding that cash found in a used piano constituted taxable income under I.R.C. § 61(a)); Turner v. Comm’r, 13 T.C.M. 462, 463 (1954) (holding that cruise tickets received as a prize from a radio station constituted taxable income, with the only issue being valuation); see also Treas. Reg. § 1.61-14 (as amended in 1993) (expanding § 61(a) definition of gross income to include illegal gains and treasure troves, while clarifying that “[i]n addition to the items enumerated in section 61(a), there are many other kinds of gross income”).
  104. See I.R.C. § 74 (a).
  105.  See Topic No. 420 Bartering Income, IRS, https://www.irs.gov/taxtopics/tc420 [https://perma.cc/4XMQ-EASH] (last visited June 20, 2019).
  106. The discussion omits other exclusions not relevant for this purpose, such as the non-taxation of imputed income under the Code, the realization requirement (§ 1001), and statutory exclusions like § 101 (life insurance proceeds) and § 103 (interest on state and local bonds).
  107. I.R.C. § 102.
  108. 363 U.S. 278, 285 (1960).
  109. Id.
  110. Id. at 280, 291–92 (The transfer was “at bottom a recompense for Duberstein’s past services, or an inducement for him to be of further service in the future.”).
  111. Specifically, Code section 139 and the general welfare doctrine, both of which are discussed below. Rev. Rul. 2003-12, 2003-1 C.B. 283–84.
  112. Rev. Rul. 2005-46, 2005-2 C.B. 120.
  113. See, e.g., Rev. Rul. 2003-12, supra note 110, at 283.
  114. The exception is that certain employee achievement awards are excludable under I.R.C§ 74(c) (2018).
  115. Rev. Rul. 2003-12, supra note 110, at 284–85.
  116. Id. at 283–84.
  117. Rev. Rul. 99-44, 1999-44 I.R.B. 549–50. The matching contributions were gifts even though the savings accounts were established pursuant to a federal government program, which was administered by the charitable organization.
  118. See I.R.S. Priv. Ltr. Rul. 200442023 (Oct. 15, 2004).
  119. I.R.S. Priv. Ltr. Rul. 200529004 (July 22, 2005). Although payments from charities to individuals are likely to receive gift treatment in most situations, the Duberstein standard must still be satisfied for the gift exclusion to apply. For example, the IRS has stated in informal guidance that if a charity makes a payment to a for-profit business, “[t]he IRS will evaluate whether . . . . the payment was made out of a moral or legal obligation, an anticipated economic benefit or in return for services . . . .” Internal Revenue Service, Disaster Relief20, https://www.irs.gov/pub/irs-pdf/p3833.pdf [https://perma.cc/CQ2W-R83D]. Generally, payments made to individuals that are part of a “charitable class” (i.e., “large enough or sufficiently indefinite that the community as a whole, rather than a pre-selected group of people, benefits when a charity provides assistance”) should qualify for gift treatment. Id. at 9. I am grateful to Ellen Aprill for bringing this limitation to my attention.
  120. See, e.g., I.R.C. § 132.
  121. See Jay A. Soled & Kathleen DeLaney Thomas, Revisiting the Taxation of Fringe Benefits, 91 Wash. L. Rev. 761, 770 (2016).
  122. See id. at 766–68.
  123. Id. at 769–70.
  124. I.R.C. § 132(d), (e).
  125. See Soled & Thomas, supra note 120, at 770.
  126. However, if an employee is a shareholder or owner of the employer, payments made to employees may be treated as dividends rather than as compensation. See, e.g., Andrew W. Stumpff, The Reasonable Compensation Rule, 19 Va. Tax. Rev. 371, 377 (1999).
  127. I.R.C. § 132(a)(4), (e).
  128. In a similar context but outside the employment setting, a court allowed for exclusion of an all-expenses-paid business trip to Germany because the payment was made for the convenience of the payer, rather than for the recipient’s benefit. United States v. Gotcher, 401 F.2d 118, 119, 122 (5th Cir. 1968). Neither courts nor the IRS have explicitly extended the line of reasoning in Gotcher to other settings, particularly to non-business settings. However, the line of reasoning in the case could arguably apply to exclude many nudges from income. The argument would be that payments made primarily for the payer’s benefit (e.g., a government grant program) are not taxable income to the payee. Thanks to Ted Seto for this observation.
  129. See, e.g., Pittsburgh Milk Co. v. Comm’r, 26 T.C. 707, 717 (1956); Freedom Newspapers, Inc. v. Comm’r, 36 T.C.M. (CCH) 1755, 1758–59 (1977); Rev. Rul. 76-96, 1976-1 C.B. 23.
  130. See Rev. Rul. 76-96, 1976-1 C.B. 23. The taxpayer must reduce his basis in the property purchased by the amount of the rebate, resulting in a basis of $19,000 in this example.
  131. Freedom Newspapers, 36 T.C.M. (CCH) at 1756–57. But see I.R.S. Priv. Ltr. Rul. 201004005 (Jan. 29, 2010) (ruling that grants paid by a third party were not excludable from income, even when the net effect was to reduce the buyer’s cost on a purchase transaction). In the private ruling, the IRS distinguished payments involving broker commissions, which are dependent upon the sales transactions, from third-party grants that are independent of the transaction. Id.
  132. The taxpayer received “Thank You Points” that were redeemable for airline miles. Shankar v. Comm’r, 143 T.C. 140, 148 (2014). The court also noted that the miles were not earned during business travel, which the IRS has singled out for non-enforcement in Announcement 2002-18, 2002-1 C.B. 621.
  133. Shankar, 143 T.C. at 148.
  134. See I.R.S. Priv. Ltr. Rul. 201027015, at 3 (July 9, 2010) (ruling that cash-back rebates are excluded from gross income as purchase price reductions).
  135. For taxpayers that are corporations, Code § 118 historically exempted “contributions to capital,” which covered many government grants to corporations. However, section 118 was amended in 2017 and currently does not exempt contributions to capital made by “any governmental entity.” I.R.C. § 118(b). Regardless, this Article is concerned with incentives provided to individual taxpayers, not corporations.

    There are other special exclusions applicable to businesses not discussed in detail here. For example, Code § 48(d)(3) excludes grants made to developers and producers of renewable energy, pursuant to the American Recovery and Reinvestment Act of 2009.

  136. Greisen v. United States, 831 F.2d 916, 918 (9th Cir. 1987). The Alaska Permanent Fund is funded by the state’s mineral royalties; it distributes earnings in the form of dividends to each resident of the state on an annual basis. Id. at 916–17; see also About Us, Alaska Department of Revenue: Permanent Fund Dividend Division, https://pfd.alaska.gov/Division-Info/About-Us [https://perma.cc/QHG2-M67C] (last visited July 1, 2019) (explaining the Alaska Permanent Fund eligibility and dividend calculation functions).
  137. Greisen, 831 F.2d at 919–20 (“According to the statement of purpose, the 1980 Act was intended: (1) to allow equitable distribution of part of the state’s wealth to Alaskans; (2) to encourage people to remain Alaska residents; and (3) to encourage awareness and interest in the management of the fund.”).
  138. See, e.g., Graff v. Comm’r, 673 F.2d 784, 785 (5th Cir. 1982). For a comprehensive discussion of the doctrine, see Theodore P. Seto & Sande L. Buhai, Tax and Disability: Ability to Pay and the Taxation of Difference, 154 U. Pa. L. Rev. 1053, 1106–14 (2006); see generally Robert W. Wood & Richard C. Morris, The General Welfare Exception to Gross Income, 109 Tax Notes 203, 204–08 (2005) (describing the development of the General Welfare Exception and the prongs of the test determining whether a payment qualifies).
  139. Rev. Rul. 2005-46, 2005-2 C.B. 120; see also Rev. Rul. 74-205, 1974-1 C.B. 20 (ruling that housing payments to displaced families qualified under the general welfare exception, and were not includible in gross incomes of the recipients); Rev. Rul. 98-19, 1998-1 C.B. 840 (ruling that a relocation payment made to an individual moving from a flood-damaged residence qualified for the general welfare exception).
  140. I.R.S. Notice 99-3, 1999-1 C.B. 271, 272.
  141. Rev. Rul. 2005-46, supra note 138.
  142. Rev. Rul. 2003-12, 2003-1 C.B. 283; Rev. Rul. 76-144, 1976-1 C.B. 17. However, the IRS has ruled that payments to businesses do not qualify for the doctrine, because the need must be “individual or family” based. See Rev. Rul. 2005-46, supra note 138.
  143. Rev. Rul. 74-74, 1974-1 C.B. 18.
  144. Rev. Rul. 76-395, 1976-2 C.B. 16.
  145. 88 T.C. 1293, 1301 (1987), acq. 1989-2 C.B. 1. The court excluded the grant from income on other grounds, however, finding that the taxpayer “lacked complete dominion” over the funds, which were paid directly to the contractor who did the work.
  146. Id. (noting that the only requirements to receive the grant “were ownership of the property and compliance with the building code”).
  147. The exclusion applies to “qualified disaster[s],” which also includes events involving terrorism or common carrier accidents. See I.R.C. § 139(c). For a critique of limiting the exclusion to qualified disasters only, see Ellen P. Aprill & Richard Schmalbeck, Post-Disaster Tax Legislation: A Series of Unfortunate Events, 56 Duke L.J. 51, 95 (2006).
  148. I.R.C. § 139(g).
  149. I.R.C. § 401(k).
  150. I.R.C. § 61.
  151. I.R.C. § 132(e).
  152. I.R.C. § 106(a).
  153. Rev. Rul. 2002-3, 2002-1 C.B. 316 (“Under §106(a), an employee may exclude premiums for accident or health insurance coverage that are paid by an employer.”).
  154. I.R.C. § 105(b).
  155. See, e.g., Office of Chief Counsel Internal Revenue Service Memorandum 201622031, at 1 (Apr. 14, 2016) [hereinafter “IRS Memo 201622031”].
  156. I.R.C. § 61.
  157. Treas. Reg. § 1.132-6(c) (as amended in 1992).
  158. I.R.C. § 132(e).
  159. Treas. Reg. § 1.132-6(c) (as amended in 1992). The exception to this rule is cash for occasional overtime meals or transportation fare can be excluded as de minimis. See Treas. Reg. § 132-6(d)(2) (as amended in 1992).
  160. Treas. Reg. § 1.132-6(e)(1) (as amended in 1992) (“Benefits excludable from income”).
  161. IRS Memo 201622031 at 4.
  162. Id. at 4.
  163. See Treas. Reg. § 1.132-6(e)(1)–(2) (as amended in 1992).
  164. See supra notes 51–53 and accompanying text.
  165. See Treas. Reg. § 1.61-2(d)(1) (as amended in 2003).
  166. I.R.C. § 132(e)(1).
  167. Treas. Reg. § 1.132-6(e)(1)–(2) (as amended in 1992).
  168. See IRS Memo 201622031 at 2, 4–5. “Medical care” is defined in section 105(b) by reference to section 213(d) of the Code, which provides that medical care includes amounts paid “for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” I.R.C. § 213(d)(1)(A).
  169. See IRS Memo 201622031 at 2, 5.
  170. See id. For examples of medical care under section 213, including smoking cessation programs, see IRS Publication 502, Medical and Dental Expenses, https://www.irs.gov/‌pub/irs-pdf/p502.pdf [https://perma.cc/3GGF-RMV3] (last visited Mar. 10, 2021).
  171. Medical expenses include payments for a weight-loss program “for a specific disease diagnosed by a physician,” so it is unlikely that a weight-loss program would qualify in the absence of a diagnosis. See IRS Publication 502, supra note 169.
  172. See Treas. Reg. § 1.132-6(e)(1) (as amended in 1992) (citing examples of “occasional” events, such as sports games or cocktail parties, as ones that qualify as de minimis).
  173. In an analogous context, it appears many service-type benefits offered by Silicon Valley companies, such as free dry cleaning, haircuts, or yoga classes, are likely not reported as taxable by those employers. See Soled & Thomas, supra note 120, at 779–86.
  174. Treas. Reg. § 1.132-6(e)(2) (as amended in 1992). However, onsite gyms operated by the employer qualify for exclusion. See I.R.C. § 132(j)(4).
  175. See IRS Memo 201622031 at 4–5.
  176. I.R.C. § 132(a)(2).
  177. I.R.C. § 132(c)(4).
  178. It follows that a private gym could offer discounted gym services to its own employees.
  179. See supra note 57 and accompanying text.
  180. See supra note 128 and accompanying text.
  181. See supra note 152.
  182. See IRS Memo 201622031 at 5.
  183. See id. at 2–5.
  184. See Rev. Rul. 2002-3, supra note 152.
  185. See supra note 73 and accompanying text.
  186. See supra notes 75–77 and accompanying text.
  187. See supra notes 67–70 and accompanying text; 75–77 and accompanying text.
  188. See supra note 140 and accompanying text.
  189. See supra notes 141–43 and accompanying text.
  190. See IRS Publication 502, supra note 169. However, the deduction is only available to itemizers (those who do not claim the standard deduction) and is limited to the excess of 10% of the individual’s adjusted gross income. I.R.C. § 213(a).
  191. I.R.C. § 105(b).
  192. I.R.C. § 104(a).
  193. Another exception, which would be irrelevant in this circumstance, is section 102, which would exclude from income medical care paid for by family members or friends. See I.R.C. § 102(a).
  194. See supra notes 84–87 and accompanying text.
  195. See, e.g., supra note 87.
  196. See supra note 129 and accompanying text.
  197. For example, in Freedom Newspapers v. Commissioner, 36 T.C.M. (CCH) 1755 (1977), the Tax Court held that even a payment received by a third party broker several years after the original purchase “was sufficiently tied to the purchase that its characterization must be made by reference to the original transaction.”
  198. I.R.C. § 139(g).
  199. See supra note 141 and accompanying text.
  200. See supra note 98 and accompanying text.
  201. I.R.S. Priv. Ltr. Rul. 201816004 (Jan. 11, 2018). See also I.R.S. Priv. Ltr. Rul. 201815005 (Jan. 11, 2018) (describing similar facts).

    One theory that the IRS did not appear to consider is the purchase price adjustment doctrine. See supra Subsection II.A.2. Arguably, a state grant paid to a state taxpayer could be considered a non-taxable adjustment to the amount of taxes owed to the state by the grant recipient. (This assumes the grant recipient earns enough income to owe state taxes in excess of the grant.) While it is hard to distinguish a state grant from a seller rebate on economic grounds, it appears neither courts nor the IRS have extended the purchase price adjustment doctrine to this context. I am grateful to Heather Field for this observation.

  202. I.R.S. Priv. Ltr. Rul. 201816004 (Jan 11. 2018).
  203. See Earthquake Mitigation Incentive and Tax Parity Act of 2017, H.R. 1691, 115th Cong. (2017); Earthquake Mitigation Incentive and Tax Parity Act of 2017, S. 2104, 115th Cong. (2017).
  204. See Henry C. Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy 50 (1938); Robert Murray Haig, The Concept of Income–Economic and Legal Aspects, in The Federal Income Tax 1, 7 (Robert Murray Haig ed., 1921). The definition is commonly referred to as the Haig-Simons definition of income. See, e.g., John R. Brooks, The Definitions of Income, 71 Tax L. Rev. 253, 262 (2018); Boris I. Bittker, A “Comprehensive Tax Base” as a Goal of Income Tax Reform, 80 Harv. L. Rev. 925, 932 (1967). For a comprehensive discussion of the difficulty of defining income and a description of several other approaches, see generally Brooks, supra; see also Victor Thuronyi, The Concept of Income, 46 Tax L. Rev. 45, 47 (1990) (describing the Haig-Simons definition vis-à-vis the general difficulty in defining income).
  205. See, e.g., Bittker, supra note 203, at 935; Jonathan Barry Forman, The Income Tax Treatment of Social Welfare Benefits, 26 U. Mich. J.L. Reform 785, 799 (1993).
  206. Bittker, supra note 203, at 935–37.
  207. The legal scholarship on this point is too voluminous to cite, but for some of the earliest work, see, e.g., id. at 932; R. A. Musgrave, In Defense of an Income Concept, 81 Harv. L. Rev. 44 (1967); Joseph A. Pechman, Comprehensive Income Taxation: A Comment, 81 Harv. L. Rev 63 (1967); Charles O. Galvin, More on Boris Bittker and the Comprehensive Tax Base: The Practicalities of Tax Reform and the ABA’s CSTR, 81 Harv. L. Rev. 1016 (1968). For a discussion of the debate over the use of a “comprehensive tax base,” see Brooks, supra note 203, at 270–74.
  208. See, e.g., Dep’t of Treasury, Office of Tax Analysis, Tax Expenditures (2017), https://www.treasury.gov/resource-center/tax-policy/Documents/Tax-Expenditures-FY2019.pdf [https://perma.cc/8UVR-9ZKJ] [hereinafter “Tax Expenditures].
  209. Id. at 9, 18.
  210. Although the tax-free receipt of a gift by the donee is not labeled as an expenditure, the carryover basis provided by section 1015 for appreciated gifts is considered a tax expenditure. See J. Comm. on Tax’n, Estimates of Federal Tax Expenditures for Fiscal Years 2018–2022, 26 (Oct. 4, 2018), https://www.jct.gov/publications/2018/jcx-81-18/ [https://perma.cc/33XY-P3EB] [hereinafter “JCT Tax Expenditures”].
  211. See Tax Expenditures, supra note 207, at 3 (“The normal tax baseline also excludes gifts between individuals from gross income.”).
  212. See, e.g., Richard Schmalbeck, Gifts and the Income Tax—An Enduring Puzzle, 73 Law & Contemp. Probs. 63, 65 (2010) (arguing that “although it is intuitively appealing to regard value received by gift as an element of the income of the individual receiving it, it is completely unappealing to regard value received by gift as an increment to income in the aggregate”).
  213. Id. This of course assumes that the donor and the donee have the same tax rate. In reality, donors likely have higher tax rates than donees, in which case the net effect would be revenue loss to the government. For example, if the donor had a 30% marginal tax rate and the donee had a 10% marginal tax rate, the donor’s deduction for a $100 gift would be worth $30 (30% of $100), while the donee’s tax liability would be $10 (10% of $100), resulting in a $20 revenue loss.
  214. For income tax purposes, the gift is a non-event and need not be reported. However, the gift may need to be valued and returns filed if the gift tax applies. Currently, transfers under $15,000 are exempt from the gift tax. See, e.g., Frequently Asked Questions on Gift Taxes, IRS, https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes [https://perma.cc/23XD-GDZC] (last visited July 11, 2019).
  215. E.g., Schmalbeck, supra note 211, at 65.
  216. The counterargument is that the gift represents consumption purchased by the donor. For a discussion of this theory, see id. at 68–69.
  217. See supra Subsection II.A.2.
  218. For a similar argument, see Charlotte Crane, Government Transfer Payments and Assistance: A Challenge for the Design of Broad-Based Taxes, 59 SMU L. Rev. 589, 611–12 (2006) (pointing out that government transfers do not create new value).
  219. See, e.g., supra notes 134–135 and accompanying text.
  220. See supra note 154 and accompanying text.
  221. Either way, the payment is deductible under Code section 162.
  222. JCT Tax Expenditures, supra note 209, at 27. The characterization of an exclusion as an expenditure depends on how Congress defines the tax base, and this has changed over time. See, e.g., Julie Roin, Truth in Government: Beyond the Tax Expenditure Budget, 54 Hastings L.J. 603, 608–10 (2003) (providing an overview of the development of the federal tax expenditure budget).

    The characterization of scholarships depends particularly on varying definitions of the tax base, and Treasury has noted that:

    From an economic point of view, scholarships and fellowships are either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus, under the baseline tax system of the reference law method, this exclusion is not a tax expenditure . . . . The exclusion, however, is considered a tax expenditure under the normal tax method, which includes gift-like transfers of Government funds in gross income (many scholarships are derived directly or indirectly from Government funding).

    See Tax Expenditures, supra note 207 at 13.

  223. See, e.g., Joseph M. Dodge, Scholarships Under the Income Tax, 46 Tax Law. 697, 698–99 (1993) (examining arguments for excluding scholarships from the tax base and for making them a tax preference); Charlotte Crane, Scholarships and the Federal Income Tax Base, 28 Harv. J. on Legis. 63, 113 (1991) (same).
  224. The exclusion in section 117 only covers scholarships paid for tuition and related expenses. Although some scholarship funds are conditioned on the performance of services like teaching or research, those funds are explicitly excluded from section 117 and are taxable. I.R.C. § 117(c)(1).
  225. The value of the educational benefit likely exceeds the cost of tuition because higher educational institutions receive substantial funding from other sources besides tuition, including government subsidies. See, e.g., Crane, supra note 222, at 71.
  226. See generally sources cited at note 222 (observing the difficulty of assessing educational value as justification for exempting academic scholarships from taxable income under the federal tax code).
  227. See supra note 221; see also Dodge, supra note 222, at 701–02.
  228. See Dodge, supra note 222, at 711.
  229. See Freedom Newspapers v. Commissioner, 36 T.C.M. (CCH) 1755, 1758–59 (1977).
  230. JCT Tax Expenditures, supra note 207, at 27–28.
  231. Because retrofit grants and similar payments must be applied towards the specified property improvements, they are better viewed as the provision of property, rather than as a receipt of cash by the taxpayer. There is precedent for this approach, although it is not the approach the IRS has taken specifically with retrofit grants. For example, in Bailey v. Commissioner, the taxpayer wasn’t taxed on an urban renewal grant for his property because the grant went directly to the general contractor, and the court found the taxpayer never had sufficient control over the funds to warrant taxation. See 88 T.C. 1293, 1301 (1987), acq., 1989-2 C.B. 1.

    Arguably, any time an individual receives an incentive-based nudge or BBS in the form of cash that must be spent on specified property or services, the taxability of such funds should be based on the ultimate purchase, rather than on the temporary receipt of cash.

  232. For example, if a taxpayer owns an asset that appreciates in value (e.g., a stock or a house), she has a positive change in net wealth. However, the Code will not tax her until she “realize[s]” a gain, such as by making a sale. See I.R.C. § 1001.
  233. For a discussion of the legislative history behind the section 132 fringe benefit rules, see infra notes 261–67 and accompanying text.
  234. See Scott Greenberg, Reexamining the Tax Exemption of Municipal Bond Interest, Tax Found. Fiscal Fact No. 520 (July 2016), https://files.taxfoundation.org/legacy/‌docs/TaxFoundation_FF520.pdf [https://perma.cc/ZY7A-QS3M]. (observing that state and local bonds are justified as a basis for incentivizing investments in projects that benefit nonresidents, but concluding that “[a] tax exclusion is an unideal policy design for subsidizing state and local debt”).
  235. In that case, 20% or $250 would be tax, and $1,000 would remain.
  236. If the federal government increases a federal subsidy from $1,000 to $1,250 to account for federal income tax, it will pay $250 more for the subsidy and collect $250 in tax.
  237. See, e.g., Christopher C. Fennell & Lee Ann Fennell, Fear and Greed in Tax Policy: A Qualitative Research Agenda, 13 Wash. U. J.L. & Pol’y 75, 79 (2003) (“A functional definition of . . . tax aversion . . . is the amount by which one’s aversion to a tax exceeds the economic cost of the tax.”); Edward J. McCaffery & Jonathan Baron, Thinking About Tax, 12 Psych., Pub. Pol’y & Law 106, 117 (2006); Abigail B. Sussman & Christopher Y. Olivola, Axe the Tax: Taxes Are Disliked More than Equivalent Costs, 68 J. Mktg. Rsch. S91, S91 (2011).
  238. See, e.g., Sussman & Olivola, supra note 236, at S93 (describing experiments that found people change their behavior to avoid taxes, but not reacting in a similar manner to comparable non-tax costs).
  239. McCaffery & Baron, supra note 236, at 117–18 (recounting an experiment the authors conducted where individuals were confronted with a policy labeled as a tax or comparable economic policy not labeled as a tax, which “found that labels mattered”); David J. Hardisty, Eric J. Johnson & Elke U. Weber, A Dirty Word or a Dirty World? Attribute Framing, Political Affiliation, and Query Theory, 21 Psych. Sci. 86, 91 (2010) (finding in an experiment that “framing the cost increase as a tax differentially affected the structure and content of thoughts generated by Democrats and Republicans, leading to different preferences”).
  240. Sussman & Oliviola, supra note 236, at S94–96, S100.
  241. Id. at S95.
  242. Id.
  243. Id.
  244. Id.
  245. Id. at S95–96.
  246. Id. at S94.
  247. One source of variation appears to be political affiliation. Studies show that Republicans and Independents are sensitive to “tax” labels in decision making, but Democrats generally are not. See id. at S96–97; Hardisty et al., supra note 238, at 91 (finding “that the power of a framing manipulation can depend on participants’ preexisting individual differences”).
  248. Of course, tax aversion will not deter participants who are unaware of the tax, which may be the case when there is no information reporting required. For incentives subject to information reporting (discussed more below), participants will likely have to provide tax information at the outset (e.g., a Form W-9), and are more likely to be aware of tax consequences. Other programs may disclose tax consequences on their website or in related materials, as is the case with California’s Earthquake Mitigation program. See infra note 272.
  249. See generally Kay Blaufus & Axel Möhlmann, Security Returns and Tax Aversion Bias: Behavioral Responses to Tax Labels, 15 J. Behav. Fin. 56, 63–65 (2014) (finding that people have tax aversion bias toward infrequent, unfamiliar financial decisions).
  250. See I.R.C. § 6041(a).
  251. I.R.S. Priv. Ltr. Rul. 201816004 (Apr. 20, 2018); I.R.S. Priv. Ltr. Rul. 201815005 (Apr. 13, 2018).
  252. Marianne Bertrand, Sendhil Mullainathan, & Eldar Shafir, Behavioral Economics and Marketing in Aid of Decision Making Among the Poor, 25 J. Pub. Pol’y & Mktg. 8, 16 (2006).
  253. Id.
  254. Saurabh Bhargava & Dayanand Manoli, Psychological Frictions and the Incomplete Take-Up of Social Benefits: Evidence from an IRS Field Experiment, 105 Am. Econ. Rev. 3489, 3490 (2015).
  255. Id. at 3524.
  256. Id. at 3492.
  257. See Kathleen DeLaney Thomas, User-Friendly Taxpaying, 92 Ind. L.J. 1509, 1512 (2017).
  258. Tax withholding is required on payments of employee compensation, but not for other payments. See I.R.C. § 3402(a).
  259. See, e.g., Thomas, supra note 94, at 84.
  260. See supra note 249 and accompanying text.
  261. Penalties are up to $270 per information return (up to $550 in the case of intentional disregard) and may be assessed separately for both failure to issue to the payee and failure to file with the IRS. For a summary of these penalties, see Increase in Information Return Penalties, IRS, https://www.irs.gov/government-entities/federal-state-local-governments/‌increase-in-information-return-penalties [https://perma.cc/F2NZ-K4CL] (last visited July 17, 2019).
  262. Deficit Reduction Act of 1984, Pub. L. No. 98-369, 98 Stat. 494, 499 (codified as amended in scattered sections of 26 U.S.C.).
  263. See Staff of J. Comm. on Tax’n, 98th Cong., General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 840 (Comm. Print 1984).
  264. Id.
  265. Id. at 841.
  266. Id.
  267. Id.
  268. Id. at 843.
  269. Equally important, but beyond this Article’s scope, are potential federalism and comity concerns that may arise when the federal government seeks to tax state programs, to the extent the tax hinders the state’s ability to implement the program.
  270. See Earthquake Mitigation Incentive and Tax Parity Act of 2017, H.R. 1691, 115th Cong. (2017); Earthquake Mitigation Incentive and Tax Parity Act of 2017, S. 2104, 115th Cong. (2017).
  271. Id.
  272. Press Release, Senator Dianne Feinstein, Feinstein and Harris Introduce Legislation to Protect Earthquake Loss Mitigation Incentive Ahead of Senate GOP Tax Bill Release (Nov. 9, 2017), https://www.feinstein.senate.gov/public/index.cfm/press-releases?ContentRecord_‌id=78BD9E69-4090-4E62-AE1A-08A01870F3AB [https://perma.cc/L7UZ-BY8G].
  273. The Brace + Bolt program mentions potential consequences in an FAQ on its website, stating, “The homeowner of a retrofit House under the Program will receive an IRS Form 1099, if applicable, reporting the amount of incentive payments as taxable income to the homeowner for federal income tax purposes.” See Earthquake Brace+Bolt FAQs, https://www.earthquakebracebolt.com/FAQ [https://perma.cc/GXF5-HMEU] (last visited July 24, 2019).
  274. Although state tax credits are generally not taxable, to the extent they reduce a taxpayer’s state tax liability, the refundable portion (if any) of a state tax credit is taxable. See, e.g., Ginsburg v. United States, 922 F.3d 1320, 1322 (Fed. Cir. 2019) (holding that the refundable portion of a New York State tax credit was includible in income for federal income tax purposes).
  275. See supra notes 134–35 and accompanying text.
  276. I.R.C. § 85. However, prior to the enactment of section 85, the IRS treated unemployment payments as excludable. See Rev. Rul. 70-280, 1970-1 C.B. 13.
  277. Failing to tax unemployment compensation also favors such compensation over wages, which may distort decisions to work.
  278. See I.R.C. § 86. Previously, the IRS treated all Social Security benefits as exempt from tax. See Rev. Rul. 70-217, 1970-1 C.B. 13.
  279. See, e.g., Forman, supra note 204, at 795. But see Brian Galle, How to Save Unemployment Insurance, 50 Ariz. St. L.J. 1009, 1062–64 (2018) (arguing for repeal of taxes on unemployment benefits).
  280. Professor Charlotte Crane has observed that this appears to have been the IRS’s historical approach prior to the evolution of the general welfare doctrine. Crane, supra note 217, at 594.
  281. Examples include current exclusions for educational grants, veterans’ benefits, and worker’s compensation payments. See, e.g., I.R.C. § 104(a)(1) (worker’s comp), I.R.C. § 117 (scholarships), 38 U.S.C. § 5301 (veterans’ benefits). Similarly, Medicare benefits, which are not specifically excluded by statute but are treated as such by the IRS, would continue to be excluded. See Rev. Rul. 70-341, 1970-2 C.B. 31–32.
  282. See supra note 167.
  283. See supra notes 261–67 and accompanying text.
  284. See supra note 172.
  285. See Soled & Thomas, supra note 120, at 763–64, 776.
  286. Id. at 814–15.
  287. While section 132 contains a list of specific exclusions in the statute, section 132(o) does delegate authority to Treasury to implement the statute and numerous regulations exist, such as those clarifying what types of benefits qualify as de minimis fringes. See Treas. Reg. § 1.132-6 (as amended in 1992).
  288. Cf. Crane, supra note 217, at 612–13 (discussing the exclusion of transfer payments that do not create new value, regardless of source).
  289. Withholding could be set at a default rate (e.g., 5%), or taxpayers could fill out a form that would determine their withholding rate. These possibilities are discussed in Thomas, supra note 94, at 131–34.
  290. See id. at 111.
  291. Id. at 128.