Tax Elections & Private Bargaining

Focal points for private bargaining occur every instance the tax law provides a tax election that directly affects multiple taxpayers. These elections explicitly enable, and actually incentivize, the taxpayers to cooperate in order to reduce their aggregate tax burden. For example, divorced parents of a dependent child can negotiate about which parent will be entitled to take the dependency exemption for the child. If the parents work together, they can identify the parent for whom the dependency exemption will have the most value. By electing to allocate the dependency exemption to that parent, they can reduce their aggregate tax burden and share in the tax savings. Yet transaction costs, cognitive biases, and sheer irrationality can impede taxpayers’ abilities to bargain effectively. Thus, in order to facilitate bargaining and reduce bargaining costs, this article analyzes how impediments to negotiation should affect the design of two key election parameters: (1) the allocation, among the affected taxpayers, of the power to make the election, and (2) the default rule that will apply if no election is made. As examples, this article examines tax bargaining focal points in three settings where the negotiating dynamic can differ significantly: divorce, employment, and corporate acquisitions. In addition to making a few specific proposals for modifying these elections, this article provides generalizable recommendations about how to design tax election parameters in order to facilitate effective and efficient bargaining