Taxing political donations: the case for corrective taxes in campaign finance.

• Author: Gamage, David S.

Campaign finance lives in a time warp, untouched by the regulatory revolution of the past generation. --Bruce Ackerman and Ian Ayres (1) INTRODUCTION

Incentive-based regulations are generally more efficient than command-and-control measures. (2) One of the primary categories of incentive-based regulations--and one that has gained significant support of economics scholars over the past few decades--is corrective taxation. (3) Corrective taxes, under various guises, are used in numerous areas of the law: (4) "Sin taxes" are the method of choice for regulating goods such as cigarettes and alcohol, (5) pollution taxes are familiar tools of environmental law, (6) and liability rules play a central role in tort law. (7) Nevertheless, the potential of corrective taxes has been overlooked in the debates over campaign finance reform. (8)

The equivalent of command-and-control measures in campaign finance law are contribution ceilings, which lie at the heart of the American approach to regulating campaign finance. (9) Current law places a $2000 ceiling on donations from individuals to political candidates. (10) This limit is supplemented by a $5000 ceiling on donations from individuals to political action committees, (11) a $25,000 ceiling on donations from individuals to national party committees, (12) and an assortment of additional ceilings on numerous other forms of political donations. (13) Contribution ceilings have become an enduring component of our system of campaign finance regulation. (14)

There are critics of this reliance on contribution ceilings. (15) Some argue that caps on campaign contributions violate First Amendment rights, (16) help incumbents against challengers, (17) and lead donors to divert their contributions through regulatory loopholes. (18) The (mostly conservative) adherents of this position favor allowing donors to contribute unlimited sums to political campaigns. Meanwhile, others argue that permitting even moderately sized donations is incompatible with true political equality. (19) The (mostly liberal) adherents of this position would replace private donations with government-financed campaigns or a regulated system of public debates.

This Note is not directed at either of these positions. (20) Instead, I begin with the premise that political donations are neither categorically harmful nor categorically benign. I accept the underlying purpose of contribution ceilings: to limit the size of political donations without completely banning them. In order to achieve such an end, this Note applies the logic of corrective taxes to the problem of campaign finance. Specifically, I argue for replacing contribution ceilings with "contribution taxes." (21) Rather than capping the size of political donations at a specified dollar level, I propose taxing donations based on a schedule of graduated rates--the larger the size of a contribution, the higher the rate of taxation. (22) The argument proceeds on a highly theoretical level; questions about design variables are largely outside the scope of this Note. (23) Instead, I present an economic argument for why contribution taxes are superior to contribution ceilings.

My argument stems from a single observation: As compared to contribution ceilings, contribution taxes affirmatively select for donors with a greater willingness to pay taxes on their donations. To demonstrate this point, imagine that donors were required to obtain government permits before contributing any given amount to a candidate. Under this hypothetical, a contribution ceiling would grant every donor a permit to contribute up to the amount of the ceiling. In contrast, contribution taxes would distribute permits based on a donor's willingness to pay the tax. Donors with greater willingness to pay taxes would receive permits allowing them to donate larger amounts, while donors who were unwilling to pay the taxes would be allowed to donate only small amounts. (24) Instead of capping all donors at the same level, contribution taxes allow donors to contribute up to the maximum amount at which they are still willing to pay the associated tax.

There are two advantages to allowing donors with greater willingness to pay taxes to contribute larger amounts. First, in a sense, these donors derive greater value from contributing. According to microeconomic theory, the value someone receives from purchasing a good or service can be measured by the amount the person would be willing to pay for the good or service. (25) The difference between the amount a consumer would be willing to pay for a good and the cost of producing the good equals the economic surplus created by the transaction. (26) In the case of campaign donations, a donor's economic surplus equals the maximum level of contribution taxes the donor would be willing to pay for the privilege of making a donation. As compared to contribution ceilings, contribution taxes create more total surplus by affirmatively selecting for donors with greater willingness to pay taxes--donors who derive greater surplus from contributing. (27)

The second advantage comes from the possibility of donors diverting their contributions through "regulatory loopholes" when prevented from contributing directly. (28) The regulatory system has proven unable to block all of the ways in which donors can spend money on behalf of a candidate. When prevented from contributing directly, some donors divert their funds into independent expenditures or other methods of indirectly aiding their favored candidates. Diversions of this sort are an endemic problem of campaign finance regulation. Still, not all donors will divert their funds when prevented from contributing directly. Ideally, a system of campaign finance regulation would only block donations to the extent they can be limited without causing donors to divert their funds. (29) Contribution taxes come much closer to this goal than contribution ceilings. Contribution ceilings prevent all donors from contributing more than a fixed amount, regardless of the likelihood that donors will divert their funds in response. In contrast, contribution taxes only block donors who are unwilling to pay the tax. All else being equal, we can expect a strong correlation between donors who are willing to pay large taxes and donors who are likely to divert their funds. Hence, when the two policies are set based on the same goals, contribution taxes should cause less diversion than contribution ceilings.

My argument proceeds on two levels. Part I models the advantages of contribution taxes in greater detail. As compared to contribution ceilings, contribution taxes generate more total surplus and less overall diversion. The Introduction has already explained the basic intuitions behind these two advantages. Part I demonstrates that these intuitions are robust in the face of more rigorous economic analysis.

Part II relaxes some of my assumptions to argue that contribution taxes remain superior to contribution ceilings in the real world. Hence, Part II discusses questions that my model assumes away: Would contribution taxes exacerbate the problems of corruption or inequality? Are contribution taxes constitutional? Can we actually quantify the harms caused by donations? This Part does not attempt to fully resolve these questions nor to respond to all possible objections, but merely aims to show that contribution taxes do not generate any disadvantages serious enough to overpower the two advantages demonstrated by Part I.

1. A COMPARATIVE MODEL OF CONTRIBUTION CEILINGS AND CONTRIBUTION TAXES

   I begin with the premise that private donations are neither categorically harmful nor categorically benign. Both contribution ceilings and contribution taxes are mechanisms for limiting the size of private donations without completely banning them. Either policy mechanism can place more or less severe restrictions on private donations. Just as a $20,000 contribution ceiling is less restrictive than a $200 contribution ceiling, a 9% marginal tax rate is less restrictive than a 90% marginal tax rate. Whereas contribution ceilings reduce the size of large donations by capping the donations at a specified dollar level, contribution taxes reduce the size of large donations by the amount of the tax. Some donors may increase the amount they contribute in order to offset the effects of the tax, but taxes will still tend to reduce the after-tax size of political donations. A sufficiently high tax rate can reduce the average size of political donations by the same amount as any contribution ceiling.

   The question, then, is whether contribution ceilings or contribution taxes are a better method of limiting the size of private donations. If the two policies are set to reduce the average size of political donations to the same level, which policy option preserves the most benefit while reducing the most harm? To answer this question, this Part builds a model based on three simplifying assumptions:

   1. Neither the externalities generated by a contribution, nor the transaction costs associated with diverting a contribution, are directly correlated with donor willingness to pay contribution taxes (Assumption of No Correlation).

   2. Contribution taxes are a constitutionally acceptable method of regulating campaign donations (Assumption of Constitutionality).

   3. Policymakers can and will set the tax rates at their socially optimal levels (Assumption of Perfect Implementation).

      When combined with the basic maxims of microeconomic theory, these assumptions allow me to model the choice between contribution ceilings and contribution taxes using a simplified form of cost-benefit analysis. The model assumes that the harms and benefits of campaign donations can be quantified--that there is a direct relationship between the amount a donor contributes and the level of harm and benefit generated by her donation.

      We can express this relationship through a set of functions; for any...