[author: Rick Jones]
The way we regulate rarely works terribly well for the regulator or the regulated. Yet, we keep doing it the same way…a subspecies of insanity to be sure.
As an example, has anyone out there in CRE land taken a gander at the new Corporate Alternative Minimum Tax (CAMT) proposed rule? This little gem comes to us as part of the Inflation Reduction Act (a monicker of breathtaking misdirection) purports to impose a 15% alternative minimum tax on the Adjusted Financial Statement Income (ASFI) of a small number of corporations which have included ASFI of over $1 billion.
Now, one might ask why anyone who reads CrunchedCredit regularly would look at this, and indeed one should not, but I noticed it (do I have excess free time these days?) and what struck me was the fact that it was 602 pages long! We needed 602 pages to do whatever it’s supposed to do?
Why was 200,000 words of regulatory excreta necessary to implement the rather detailed statutory language of the Inflation Reduction Act dealing with CAMT? 200,000 words, give or take, is 50 words for every “a,” “the,” “joy” and “holistic” (there must be few “joys” and “holistic” in there somewhere) in the actual statute.
This is not an outlier. The Code of Federal Regulations weighs in at approximately 10 million words. In 1950, the CFR was a svelte 400,000 words. Did this explosion of locution result in our government functioning better? (Okay, there’s a lot more statutory law to deal with as well…and that’s perhaps also part of the problem here.)
I’m not against the notion that regulation is necessary to implement statutory language. In many cases, it’s critical. But in general, it’s how we do it that’s the problem. The desideratum of our regulatory structure appears to be prescriptive rules. Detailed, fidgety, overly mechanistic rules that show considerably more fascination with process, with documentation and reporting than the what. Our love of overly prescriptive rules is self-destructive. It results in wildly excessive compliance costs and fuels an entire industry whose sole purpose is the workaround. When intent is not the NorthStar of the regulatory process, workarounds abound.
When we regulate, we rarely seriously think much about costs. Oh, sure, there are constituencies out there, relegated by their critics to the status of fringe voices, who endeavor to raise questions about comparative value and ask the question of what each new regulatory missive would cost and whether it would deliver value for compliance cost, but those voices certainly don’t appear to amount to much of a restraint upon our rulemaking enthusiasm.
Here’s an example. I took a look back at one of my personal favorites, the Risk Retention Rule. I carry the damn Risk Retention Rule (which has been published in convenient pamphlet form) around with me, like Mao’s Little Red Book. When promulgated, the SEC estimated of the cost of complying with the Rule (which is something the regulator is obliged by statute to do) at a ludicrously low $12 million. How much have we actually spent complying with this Rule since its promulgation? How significantly have we torqued existing business practice to meet the obligations of this Rule? Certainly, a large multiple of the SEC “guesstimates.” This is not the place for me to castigate the actual statutory language, but let’s leave it by observing that the Rule does not really improve upon the statutory language and in many respects makes actually obeying the law less certain and more complex. Does anyone actually think that the dozens of pages in every offering document calculating with precision the boundaries of the 5% retention actually helps anyone make an intelligent investment? Silly question.
We could do better. The weakness of prescriptive rule-based systems is that it encourages the drafting of overly mechanistic commands which purport to, but fail to, provide the sort of clarity the regulators set out to achieve. It’s the difference between “go to the store and buy a loaf of bread” and dozens of pages of wordy text telling you how to go to the store, which particular road should be taken and which avoided in getting there, what to wear while doing so, the documentation to show what you did and how you did it (and probably require an environmental impact statement and an elaborate community outreach process before you go) because they can’t help themselves. The relevant regulations will probably also include several pages more about the definition of bread. Wouldn’t “go to the store and buy bread” work? Isn’t the intent of that clear enough as promulgated in the statute?
Our prescriptive approach is not the only way to make rules, and there is a better one. Consider the difference between IFSR with GAAP. IFSR is a principals-based regime which sets out high-level principals rather than prescriptive, specific rules. Most of the world seems completely fine with that. GAAP, which is perhaps the most extensive non-tax exemplar of our doctrinal devotion to prescriptive rules, makes financial statements almost unreadable. I remember an exchange I had with a member of the FASB staff on FAS166/167, the accounting for the transfer of financial assets. With considerable frustration, I suggested that much of the proposed new rule made financial statements opaque, if not misleading. My interlocutor snootily pointed out that GAAP is not designed to make financial statements clear, it’s designed to ensure the internal consistency of its rule-based system. Huh? Intent, clarity of purpose is subordinated to mechanistic precision. Intent can be lost in a cloud of picky and purposeless micro commands.
Prescriptive rulemaking often does not actually make it easier to understand what one is supposed to do. Intent can be lost. It also sets up the certainty of gamesmanship. Anytime there is a complex and detailed rule architecture which prescribes so many things, there’s always, always things that are not prescribed and therein lies the opportunity for the workaround. Prescriptive rule-based systems are the happy homes of lawyers, accountants and consultants beavering away at such workarounds. Consider the numerous non-evasion and economic substance provisions in the Internal Revenue Code where the Service really wants to constrain…creativity. Isn’t that telling? Isn’t it evidence, an admission, that mechanistic, prescriptive rules often don’t work?
In a principal-based system, intent is the NorthStar. The regulated make judgments and if the government fundamentally disagrees with those judgments, that’s what the courts are here for.
The principal-based rules do work. Certainly, the IFSR is an example, but for a more mundane example which one can see on any Sunday in the fall, think about the NFL’s new rule on helmet-to-helmet contact. The rule doesn’t mechanically describe the dimensions of the “crown” of the helmet, the impermissible angle of contact and the minimum G-force at the point of contact or any other such nonsense. It simply says, “using the crown of the helmet to intentionally hurt another player will get you tossed out of the game.” That seems to work; that seems to leave reasonable discretion to the referees and generally speaking has produced outcomes that most people find acceptable. Would a bunch of prescriptive rules, perhaps running two dozen pages, improve the outcomes? Clearly not.
I don’t want to set up a false dichotomy here between principals and prescriptive rules, because there is clearly room in a good set of regulations for both, but we have simply gone way too far away from principals to the land of the mechanistic, the steampunk. This is not helpful. (And by the way, it’s incredibly not helpful for the Congress to not do its job and boot many important questions about how the law works to the regulators. Such heedless delegations are an attractive nuisance for the regulatory clerisy. Congress should do its job.) Regulators should be obliged to exercise reasonable judgment and respect the intent of the underlying legislation to get to the right answer.
Given the recent unlamented (or deeply lamented depending on where you sit) death of Chevron, which had transformed bureaucratic opinion into ex-cathedral dictates, we now can reset the table. The law is the law. People have to obey the law. Parties can take a view and when disputes arise, the courts, who interpret the law and interpret the intent of the lawgivers, can provide guidance.
That’s not perfect, but it is simply wrong to suggest that a prescriptive rule-based system if sufficiently detailed, thorough and particular will produce real clarity. No system of prescriptive mechanistic rules will ever answer all the questions and indeed, an argument can be made that it raises as many questions as it settles. Think of many of our current rules as a little bits of dry lands, scattered across the billions of acres of the Pacific Ocean. Tiny bits of land, or in our case, tiny bits of mechanical clarity, in a great sea of uncertainty. That uncertainty is functionally infinite. It cannot be eliminated. No matter how fine the rulemakers grind, no matter how many words are used, no matter how many mechanistic choices are made, the total amount of uncertainty will never actually be materially diminished. That’s what make the cost of our approach to rulemaking so insane. If you can’t actually provide real clarity, the type of clarity that might exist in the architecture of a computer chip, then the cost of chasing this sort of precision and failing, will always exceed its value.
Our laws are not wiring diagrams. In the regulatory arena, we’ve run away from intent; we’ve run away from judgment and have little to show for it. Okay, I know, I am tilting at windmills here, but it would be so much better if we could embrace, at least in some cases, a principals-based system. It would be so much better if we could make Congress do its job and not leave so many gaping holes in proposed statutory law for unelected bureaucrats to fill in.
Maybe there’s hope because of the death of Chevron? If our regulators were required to hew more closely to legislative intent and to tie significant regulations more directly to that intent, perhaps it would mediate this wrong-headed devotion to false precision. Have we arrived at a better place, in a backhand sort of way with the death of Chevron? Perhaps.
I’m not sure if that’s a view or a hope.
