Plugging Tax Loopholes with... Fine Art?

To coincide with the fact that taxes have been on everyone’s minds like a neurological fungus for the past week, media outlets have been publishing pieces left and right about the intersection of taxes and more interesting levels of life - which is to say, practically any of them. Art has been no exception. Two pieces in particular caught my attention. Although each is interesting on its own, considering them together led me to some ideas about how the arts and the IRS might be able to help each other. 

On Saturday the New York Times ran a story by Graham Bowley and Patricia Cohen about one of the cavernous tax loopholes available to art collectors: By immediately loaning a new acquisition to a non-profit institution in one of the five states (Oregon, Alaska, New Hampshire, Delaware, Montana) which charges neither sales nor use tax, a collector can escape having to pay either one in the name of cultural exchange. The loans must last at least 90 days, and the institution must be the work’s first destination after sale. Meet those criteria and you can, in the case of Elaine Wynn’s record-setting $142.4M purchase of Three Studies of Lucian Freud, give your home state’s tax man the middle finger instead of $11M.

A day earlier, The Atlantic published a story by Eva Hershaw about a more crowd-pleasing tax policy - not in the US, but in Mexico. There, a program called Pago en Especie (“Payment in Kind,” for gringos like myself) permits visual artists to donate works to the government in lieu of paying income tax. I’ll let Hershaw tell it: 

The program is simple—donations are made according to reported sales. If an artist sells between one and five pieces of art in a given year, he or she donates one piece to the federal government. If the artist sells between six and eight pieces, he or she donates two, and so on, with an annual cap of six donations… A committee of artists and curators oversees the donations process to ensure that the art received meets certain quality standards. If the art is of a particularly high caliber, it becomes part of the “national-heritage collection,” which is displayed in a permanent exhibit in Mexico City. All other pieces are divided up and shipped across the country to fill public museums and administrative buildings. Certain pieces are also sent abroad as part of exhibitions coordinated with museums across the world.

So in the case of the Oregon loophole, state governments are getting stiffed on tax revenues that should arrive from fine art sales. In the Pago en Especie scenario, the Mexican federal government basically decided that they would rather receive art as tax payment than nothing at all. (Hershaw notes that Mexico has lost an estimated $872B to tax evasion and money laundering in the past 40 years, 80% of its population either lives in poverty or via the informal economy, and its annual tax revenues rate near the bottom of all Latin American countries.) Seems like an opportunity for synergy, no?

Anish Kapoor, “Temenos” (2010). Image credit: Awakening Arts Network.

In plain speech: Assuming the Oregon loophole is closed, why not allow American collectors to pay their use tax in artwork? The idea would be for the states to trade a use tax exemption to a collector in exchange for one or more pieces from her collection whose total appraised value equals the use tax burden of her new acquisition(s). This could benefit all sides. Instead of a handful of scattered, out of state museums’ being privileged with short-term loans of blue chip works while the owner’s home state receives a ball of lint in an envelope, the state would receive actual assets - and the collector wouldn’t have to pay a dime. Most collectors also churn their holdings in the same way that fashion conscious men and women churn their wardrobes. Few serious collectors ever have enough space to actually exhibit everything they own. Rather than entomb their less-prized works in art storage units, many prefer to try to resell them to clear room for their newly acquired favorites - a process that can be lengthy and frustrating. By swapping the “use tax value” artworks for an exemption, collectors would be given a fair-play alternative that also solves their overflow problem efficiently. 

Off the cuff, I could see two scenarios:

1. The collector donates the “use tax value" work to a non-profit institution chosen by an impartial third party. This would provide a superior version of the (eyelash thin) cultural exchange justification used to justify the Oregon loophole. Instead of quarantining the offered artwork in select venues in one of five states, it could become a part of the permanent collection (or perhaps a very long-term loan) of whatever home-state institution is deemed most suitable by experts - for instance, the Association of Art Museum Directors. This would prevent a "rich get richer” scenario whereby prominent collectors might only choose to donate to either major museums least in need of good work… or smaller institutions with which the collectors maintain close philanthropic ties. Since so many collectors are concentrated in glamour states like California and New York, the practice could also be expanded so that the rest of the country benefits.

2. The collector transfers the “use tax value” work to the state for subsequent sale. This could be executed in any number of ways: sale to private clients or gallerists/dealers; consignment to a reputable auction house for inclusion in an appropriate sale; even a self-made public auction, more refined but similar to the ones held by municipal governments for seized property. In all cases, the proceeds would go directly into the state’s coffers, just as they would if the collector had paid cash to cover the use tax in the first place. Value protections could be easily built into the system by applying the auction house concept of a reserve price to each work. (For the uninitiated, the reserve is a price floor that must be met or exceeded during the bidding process in order for the sale to actually go through. If I consign an Ed Ruscha print to Christie’s with a reserve price of $15,000.00, but bidding tops out at $13,500.00, I retain ownership because the high bid came in below the reserve.)

Ed Ruscha, “OOO” (1975). Image credit: Sotheby's.

Now, there are caveats and procedural challenges to both of these ideas. First and foremost, the states would have to employ appraisers and experts who could insure that any “use tax value” works being offered were indeed valuable and marketable enough to be worthwhile; the program would make no sense if any mustache-twirling, art-hoarding ne'er-do-well could dump a bucket of sewage onto the state capitol and call it his half of a fair exchange. The “donation/exhibition” option would require the creation of a bureaucracy which, if poorly managed, could actually run the state(s) deeper into the red than if they did nothing. And even if executed efficiently, no actual revenue materializes from this option anyway - a fact that would drive revenue hawks to hysterics. The “subsequent sale” option would have to contend with liquidity risks, too. There is no guarantee of finding buyers willing to meet the asking price for every work that arrives, especially not in a timely fashion. Yet this is a risk inherent to art dealing as a whole, not a unique deficiency of this particular hypothetical program. Questions would also have to be answered about who gets to execute the different aspects of the process - appraisal, negotiation, sales management. But the moral hazard involved there is no more extreme than on any other job subcontracted out by a state government. 

Above all, huge acquisitions that incur huge use tax bills are still going to incent certain collectors to be be as sneaky as they’re able to be. For instance, Elaine Wynn probably would not want to churn $11M worth of her collection to Nevada to import the Bacon triptych even if the option were available to her. But any system can be gamed by actors with enough motivation; that’s why this problem exists in the first place. If thoughtfully constructed, though, something like what’s outlined in this (admittedly wonkish) thought exercise might at least provide fewer exploitable opportunities than the status quo - and greater benefit to those of of us outside Oregon, Alaska, New Hampshire, Delaware, and Montana.