The Case Against the Debt Tax

April 1, 2023

Americans are increasingly agitating for debt relief.  In the last decade, there have been national campaigns to cancel student debt, credit card debt, and mortgage debt.  These national campaigns have paralleled local efforts to cancel taxi medallion debt, carceral debt, and lunch debt.  But as the public increasingly pursues broad-scale debt relief outside bankruptcy, they face an important institutional obstacle:  canceled debt is generally taxable.

The taxability of canceled debt is often raised by opponents as an objection to broad debt cancellation and potentially discounts the value of any debt relief.  The conventional account for why we tax canceled debt is that debt incurred in one year and canceled in a later year reflects an accession to wealth that ought to be taxable.  The conventional account naturalizes the tax in a way that obscures its present function and history.  This Article seeks to clarify its present function and recover its history.

Modern credit markets grew, in part, because of policy decisions in the 1970s and 1980s to manage distributional conflict with credit.  As Professor Abbye Atkinson has argued, easy access to credit and a shrinking welfare state meant that credit replaced direct transfers of cash as our primary form of social provision.  One consequence of these decisions is that the modern tax on canceled debt functions less as a measure of wealth and more as a punitive tax on excessive debt.  This Article situates this shift within the context of larger political changes.  In the 1980s and 1990s, Congress made changes to tax administration that operationalized the tax in a way that would primarily affect individual debtors.  These changes corresponded to a broader shift in the policymaking landscape toward the redistribution of burdens and risk in society.

This Article suggests that the tax on canceled debt is the product of these broader political forces and not just the internal logic of tax.  This reorientation enriches and deepens existing critiques of our tax and financial systems by revealing how the tax on canceled debt contributes to the regressivity and racial inequity of our federal income tax and contributes to what some scholars term the acoustic separation of credit and debt in federal policy.  It also suggests that it is time to reconsider the wisdom of taxing canceled debt.  And this Article concludes by proposing changes to tax administration and the tax code that would circumscribe the scope of the tax.

April 2023

No. 5