The Law, in its Majesty, Allows Rich and Poor Alike to Keep Their Private Jets While Waiting to Declare Bankruptcy

This, from Ars Technica, is pretty extraordinary:

In the early 2000s, William “Trip” Hawkins—founder of video game publisher Electronic Arts—was living the good life. … Hawkins had a peculiar way of keeping his cash flow up; he wasn’t paying all the taxes connected to the proceeds of some of his stock sales. Instead, he participated in a tax sheltering setup designed to produce on-paper “monetary losses” to offset the gains. The scheme was all done through accounting firm KPMG, which used convoluted Swiss and Cayman Islands deals that eventually raised the eyebrows of Internal Revenue Service (IRS) tax auditors. The IRS and the California Franchise Tax Board eventually cried foul. In 2002, the IRS notified Hawkins’ lawyers that the tax shelters, accounting for about $60 million in claimed losses, wouldn’t be allowed for the tax years 1997 to 2000. This meant that Hawkins would be on the hook for millions in back taxes on all those EA stock profits. Still, Hawkins continued living a jet setter’s life until around the time he filed for bankruptcy protection in 2006. For instance, a government legal filing said that Hawkins’ private jet had cost $11.8 million in 2000 and had an “operating” cost of $1 million annually.

Hawkins did eventually pay more than $10 million toward his tax debt, but $26 million still remained. Because of Hawkins’ continued high spending, a federal bankruptcy court refused to give him the usual bankruptcy benefit of wiping his tax burden. … But Hawkins appealed this ruling—and he doesn’t have to pay those taxes, at least not for now. A recent decision by a three-judge panel for the 9th US Circuit Court of Appeals in San Francisco sided 2-1 with Hawkins despite objections from a dissenting appellate judge who said that Hawkins didn’t deserve a break because he was engaged in “profligate spending.” The appeals court concluded that it didn’t matter whether Hawkins bought a private jet or lived the high life, so long as he wasn’t willfully scheming to evade his tax burden. The majority opinion concluded that the law was on Hawkins’ side and that “bankruptcy law must apply equally to rich and poor alike.”

The key quote from the majority’s ruling is below:

[A] mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took the action with the specific intent of evading taxes. Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable. Such a rule could create a large ripple effect throughout the bankruptcy system. As to discharge of debts, bankruptcy law must apply equally to the rich and poor alike, fulfilling the Constitution’s requirement that Congress establish “uniform laws on the subject of bankruptcies throughout the United States.”

On the one hand, there might in principle be a sort of logic to this. US bankruptcy law has been revised to the great benefit of creditors in recent years. Stripping away another set of protection for debtors could be problematic, given that most debtors in need of protection are not Trip Hawkins. You could read the first part of the argument as referring to this possibility. On the other hand, the second part of the judges’ decision seems to be guided by exactly the opposite fear. They seem, very literally to be arguing that the laws which protect poor people from adverse judgments that they are spending above their income, should also give carte blanche to a rich dude with creative accountants and a massive tax judgment hanging over his head to keep his jet, his Giants season tickets etc without any adverse implications being drawn about his willingness to settle his tax affairs. And they made this judgment despite (as a dissenting judgment points out) the fact that Hawkins’ tax attorney “testified that Hawkins’ intent was not to pay the tax debt, but to discharge it in bankruptcy.” I don’t imagine that the judges realize that they are unconsciously recapitulating Anatole France, with the satiric effect surgically removed. But the incentive effects on rich people in temporary financial difficulties will be interesting, if the judgment stands.

[Title stolen from David Moles, with a small modification]

[Cross-posted at Crooked Timber]

Henry Farrell

Henry Farrell is an associate professor of political science and international affairs at George Washington University.