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Taxing Option Luck First to Printer_Nam.docx (Do Not Delete) 4/14/21 7:17 AM Taxing Option Luck Jeesoo Nam* As economic inequality reaches new heights every decade, academics stress the importance of the tax system in matters of equity. In contemporary winner-take-all markets, much of the massive income and wealth accumulated by the rich are the result of deliberate and calculated economic gambles that turned out in their favor. Yet theories of distributive justice such as Ronald Dworkin’s brute luck egalitarianism have committed themselves to the position that even if these market outcomes are the results of luck, the unequal outcomes are justified insofar as investors chose to take such risks. This Article argues, in contrast to the aforementioned theories, that inequalities resulting from option luck, the luck involved in deliberate and calculated gambles, remain unjust. This theory entails novel arguments in favor of imposing additional tax burdens on the most well-off members of our society and taxing capital income by demonstrating the extent to which unequal market outcomes are undeserved. Technological developments have led to winner-take-all markets in which even small amounts of option luck can lead to a wide divergence in results. A further tax imposed on the winners of such markets helps neutralize the economic inequalities resulting from luck. Differences in capital income are partly unjust because differential returns to investments are attributable, in large part, to chance. A tax on capital income compresses the distribution of these returns by lowering the returns to winning bets (by taxing such returns) and the losses of losing bets (by allowing deductions for such losses). * Visiting Assistant Professor of Tax Law, New York University School of Law. I would like to thank Anne Alstott, Joseph Bankman, Lily Batchelder, Greg Cui, Noël Cunningham, Steven Dean, William Eskridge, Mitchell Kane, Sarah Lawsky, Yair Listokin, Laurie Malman, Liam Murphy, Takayuki Nagato, Daniel Shaviro, John Steines, David Weisbach, Minkeun Woo, and participants in the NYU – Lawyering Scholarship Colloquium. Any errors are mine and mine alone. 1067 First to Printer_Nam.docx (Do Not Delete) 4/14/21 7:17 AM 1068 UC IRVINE LAW REVIEW [Vol. 11:1067 Introduction .................................................................................................................. 1068 I. Base and Rate as the Foundations of Tax Law .......................................... 1074 A. Progressive Tax Rates ........................................................................... 1074 B. Tax Bases: The Role of Capital ............................................................ 1076 II. Luck Egalitarianism ........................................................................................ 1082 A. Luck Corrodes Desert ........................................................................... 1084 B. Option Luck and Brute Luck ............................................................... 1085 C. Defining the Boundaries of Luck Egalitarianism ............................. 1092 III. Policy ................................................................................................................ 1094 A. Taxing the Rich ...................................................................................... 1094 B. A Tax on Capital Income and the Neutralization Thesis ................ 1098 IV. Taxpayer Responses to a Tax on Capital Income ..................................... 1103 A. A Critique of the Neutralization Thesis ............................................. 1103 1. An Illustration of the Critique with an Income Tax .................. 1103 2. An Illustration of the Critique with Consumption Taxes ......... 1106 B. The Critique’s Oversights ..................................................................... 1110 1. Rational Behavior ............................................................................ 1112 2. Broad Rationality and the Neutralization Thesis ....................... 1113 Conclusion .................................................................................................................... 1117 INTRODUCTION In September of 2016, just weeks after the Rio Olympics, Congress passed a bill exempting prizes awarded to athletes at the Olympic games from the federal income tax.1 The law, now I.R.C. § 74(d), is an exception to I.R.C. § 74(a), the general provision which explicitly includes “prizes and awards” as the recipient’s income. The bill passed the Senate unanimously and the House with near unanimous support (415 to 1).2 The massive support the bill received in Congress contrasted starkly with how tax policy analysts perceived the new legislation. The political rhetoric surrounding the bill—Chuck Schumer painting the Internal Revenue Service (IRS) as formerly “punishing” national heroes via taxation, for example—made little sense to tax scholars.3 The IRS, after all, is not 1. H.R. 5946, 114th Cong. (2016). 2. Id.; H.R.5946 – United States Appreciation for Olympians and Paralympians Act of 2016, CONGRESS.GOV, https://www.congress.gov/bill/114th-congress/house-bill/5946/all-actions?overview =closed#tabs [https://perma.cc/Y6ZA-ARWR] (last visited Nov. 29, 2020). 3. See, e.g., Adam Chodorow, Olympians Don’t Need a Tax Break, SLATE (Aug. 26, 2016, 5:34 PM), http://www.slate.com/articles/business/moneybox/2016/08/giving_olympians_a_tax_break_ is_bad_for_america.html [https://perma.cc/HQN2-SVZ5]; Ira Stoll, Pols Deserve Olympic Medal in Sport of Fiscal Hypocrisy for the Latest Tax Scheme, N.Y. SUN (Aug. 15, 2016), http://www.nysun.com/ national/pols-deserve-olympic-medal-in-fiscal-hypocrisy/89686/ [https://web.archive.org/web/202011 06084105/https://www.nysun.com/national/pols-deserve-olympic-medal-in-fiscalhypocrisy/89686/]. First to Printer_Nam.docx (Do Not Delete) 4/14/21 7:17 AM 2021] TAXING OPTION LUCK 1069 a penal institution, and the imposition of tax is not an imposition of punishment.4 If anything, it seems that carving out this exception to the income tax is the injustice, given that Olympic victories involve a substantial amount of luck. 5 Winning a gold medal at the Olympics requires almost everything to go right. Part of what needs to go right is unending effort on the part of the athlete—the claim that luck is involved is analytically distinct from the claim that effort is not involved—but the athlete must likewise be the winner of several lotteries. The athlete is greatly helped if he or she wins the genetic lottery, guaranteeing the physical attributes necessary to perform at the highest levels, and the parenting lottery, which gives athletes access to high levels of professional training at young ages. These are brute luck lotteries: lotteries for which the participants never chose to “play the odds,” so to speak.6 Children do not choose which genes to be born with or, for the most part, the qualities of their parents.7 And there are other lotteries that influence the outcome as well. Who could forget the darling of the Rio Olympics, Chinese swimmer Fu Yuanhui, revealing in an interview that her performance sunk after her period began?8 One’s day-to-day physical condition matters and is to a large extent outside of one’s control. There is similarly luck in the quality of one’s coach or training program. Given the fact that there is always less than full information about the different coaching options available, it makes it a gamble as to who can really provide the most value-added. However, such option luck differs from brute luck in that the participant chose to play the lottery.9 A coach might turn out to be good or bad, but insofar as the athlete was aware of the risk, he cast the die. Given the massive amount of brute and option luck involved, we may question to what extent it is effort that divides a gold medalist from a fourth-place finisher going home empty-handed.10 There is no doubt that a gold medal winner worked hard to stand on the podium, but surely so has the fourth-place finisher. And if the difference is largely a matter of luck, then common-sense fairness dictates that government should work to close the gap between the economic 4. See LIAM MURPHY & THOMAS NAGEL, THE MYTH OF OWNERSHIP: TAXES AND JUSTICE 31–37 (2002). 5. Stoll, supra note 3. 6. RONALD DWORKIN, SOVEREIGN VIRTUE: THE THEORY OF PRACTICE AND EQUALITY 73 (2000). 7. I take it as prima facie plausible that the quality of one’s parents is partly influenced by decisions children make. For instance, the decision of a child to fight with his parent may make the parent more tired and, thus, worse at parenting. In such a case, the resulting parent qualities would not be a matter of brute luck, but rather option luck. 8. Tom Phillips, ‘It’s Because I Had My Period’: Swimmer Fu Yuanhui Praised for Breaking Taboo, GUARDIAN (Aug. 15, 2016, 11:27 PM), https://www.theguardian.com/sport/2016/aug/16/ chinese-swimmer-fu-yuanhui-praised-for-breaking-periods-taboo [https://perma.cc/KAN6-BXK6]. 9. DWORKIN, supra note 6. 10. For an extensive discussion of causation from both a legal and metaphysical perspective, see generally MICHAEL S. MOORE, CAUSATION AND RESPONSIBILITY: AN ESSAY IN LAW, MORALS, AND METAPHYSICS (2009). First to Printer_Nam.docx (Do Not Delete) 4/14/21 7:17 AM 1070 UC IRVINE LAW REVIEW [Vol. 11:1067 outcomes of the lucky and unlucky. Yet I.R.C. § 74(d) does quite the opposite. By exempting Olympic award income from taxation, lucky winners get an even greater reward from their luck than they otherwise would have. The proposition
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