Googling a Free Lunch : The Taxation of Fringe Benefits

How should fringe benefits be taxed? Though fringe benefits are covered in every basic law school course on federal income taxation, no widely accepted economic framework has developed for thinking about their taxation. As a result, policymakers lack a clear picture of the benefits and costs of alternative tax regimes, when faced with situations such as the free luxurious meals provided by Google and Facebook to their employees. This Article fills this gap in the literature, by developing an economic theory of the provision of fringe benefits. Employing this economic framework, this Article considers different tax regimes for fringe benefits, using standard measures of a desirable tax policy, namely equity, efficiency, and revenue raising. This analysis provides three valuable implications. First, when labor markets are competitive, the choice of tax regime for fringe benefits has no effect on either horizontal or vertical equity. Second, the efficiency of the provision of fringe benefits depends on the marginal taxable income from these benefits. Third, non-taxation of fringe benefits generates a "double penalty" phenomenon, which results in a greater effect on tax revenue than scholars have realized. In light of these implications, this Article shows that policymakers choosing among possible tax regimes for fringe benefits face a tradeoff between efficiency and revenue raising. The two extreme tax regimes for fringe benefit often used, namely non-taxation and taxation at fair market value, lead to non-optimal outcomes both in terms of efficiency and in terms of revenue raising. Therefore, adopting intermediate tax regimes, such as the taxation of fringe benefits at half their fair market value, is desirable