Start Making Sense

Tax Policy Colloquium on 2/14/12 - Heather Field on tax elections & federal-state conformity

2012-02-15T14:19:00.006-05:00

Yesterday at the Tax Policy Colloquium, Heather Field presented a draft of her paper, Tax Elections and Federal-State Conformity. The paper extends her earlier work regarding explicit tax elections in U.S. federal income tax law, by asking to what extent states with income taxes should seek to bind taxpayers to the elections that they have made for federal income tax purposes. The elections at issue might cover anything from married couples' choice between joint returns and married-but-separate filing, to claiming the standard deduction versus itemized deductions, to corporations' electing under Code section 338 to have a stock purchase of another company treated as if it were an asset purchase.

Once again, rather than writing a fresh comment on the issues raised by the paper, why don't I offer here an expanded version of the outline that I prepared to help guide discussion at the session:

2 topics: (1) What is electivity & why does it matter, (2) federal-state conformity, in light of broader issues of fiscal federalism.

1. What is electivity & what does it matter?

Paper rightly recognizes that you can have electivity without explicit elections.

E.g., realization of loss versus gain assets with sufficiently cheap financial engineering, no constructive sale rules, no loss nonrecognition rules.

I’d add: you can also have explicit elections that really aren’t what we have in mind.

E.g., consider standard vs. itemized deduction. Arithmetically equivalent to everyone gets the standard deduction, itemized only allowed above a floor that equals the standard deduction.

What do we really have in mind here? Call it taxpayer self-sorting. You choose between Regime A and B, want to minimize the sum of tax liability & deadweight loss (DWL).

Revised itemized deduction with floor still has an element of TP self-sorting if the question is whether to try to get above the floor. E.g., don’t bother with record-keeping or base charitable decisions on expecting to get the subsidy.

How should we analyze the merits of TP self-sorting? While taxpayers presumably aim to minimize the sum of taxes paid & DWL, suppose for simplicity it was JUST one or the other (though in practice, think in terms of ratio).

We’re glad if they self-sort to minimize DWL. But if to minimize tax liability, that’s often bad. In principle, a right amount to pay given relevant attributes (e.g., ability to pay).

Nonetheless, in some cases we might be OK with electing into lower tax liability.

Some examples:

--Federal married filing separately in practice (but a harder question if could elect single filing).

--§338 elections, given lack of a good rationale for treating stock & asset sales differently.

--Domestic check-the-box – Note lack of any evident purpose or rationale. But this reflects other rules in the area. E.g., C corporation status is unavoidable if shares are publicly traded, prior multi-factor test couldn’t impede individuals from using limited partnerships in tax shelters since the test had previously been rigged by the Treasury the other way (to block the self-employed from claiming self-paid fringe benefits), other means (such as the passive loss rules) are used instead to impede tax sheltering.

--International check-the-box – rightly controversial due to large tax stakes. But is it actually a bad thing? Distinguish U.S. MNE avoiding U.S. tax vs. German tax.

SO: ability to elect is good if mainly about DWL or higher taxes that we don’t like, much more questionable if avoiding taxes we might want to impose.

This is the same analysis that we should use for cheaper versus costlier electivity. E.g., how much economic substance, in terms of last week’s paper how hard we fight against regulatory arbitrage. And the fact that there’s so much of it reflects how much arbitrary line-drawing we have in our system.

E.g., in a pure Haig-Simons income tax, with no admin or compliance costs, household issues, etc., the only “elections” are how much to work & save, & how much to invest. Can only reduce income through a “costly” election (such as working less), though how costly determines optimal rates.

But in our actual system we have realization, the cubbyholes for different financial instruments, etc. – so costly vs. cheap electivity issues are pervasive.

Often don’t want electivity to be too cheap (e.g., the Miller equilibrium & debt; realization electivity and strategic trading). This is why, for lots of things, we wouldn’t think explicit elections make sense – their key feature may be cost of zero (apart from the need to decide and keep records).

But by even raising the question of whether state elections should have to follow federal, the paper demonstrates that, just because we have an explicit election, that doesn’t necessarily mean that zero is the right exercise price. One key argument for tying elections together, or requiring that they be consistent, is to make them costlier than otherwise.

The paper discusses cross-border tax arbitrage, which is semantic arbitrage or inconsistent effective electivity. E.g., dual resident companies.

U.S. rule against it in effect says, you can’t deduct affiliate’s losses in the U.S. unless you aren’t suspected of deducting it somewhere else.

Likewise, consider tax vs. accounting semantic arbitrage (e.g., the income measure or debt vs. equity). Separate systems, but may want to require consistency simply to make electivity costlier (my argument on the subject).

4 main propositions before we get to distinctive federal vs. state issues:

(a) Is the right category TP self-sorting, as per the point that an explicit election may be thought of otherwise. (Universal, even under H-S though not lump sum ability tax)?

(b) Is there indeed nothing special about explicit electivity other than its being at the low end, & potentially easier to avoid (by just repealing the election)?

(c) Is tax vs. DWL, & what we think about the tax, the right organizing principle?

(d) Is requiring consistent elections mainly about making elections costlier?

2. Federal-state conformity

As when considering federal-state conformity generally (rather than just re. elections), it’s worth considering 2 perspectives here: state residents acting unilaterally, & all states’ residents acting collectively.

State residents acting unilaterally – I want to distinguish this from “sovereignty” as sometimes used. Expressing political preferences (e.g., how high should taxes be, how allocate among residents) has value. But keep in mind the agency problem with state political actors.

E.g., state officials may value their ability to extract rents from lobbyists.

This makes me want to second-guess the value of state-level discretion, based on voter salience. E.g., cost recovery for particular assets vs. rules for allocating tax burdens between different kinds of households.

Paper notes a dilemma that state political actors face with piggybacking & costly adjustment. Congress imposes revenue externalities that may lead voters to misallocate responsibility. But properly assigning responsibility is already a huge mess, so unclear how much mileage we get from this.

Value of simplification vs. complexity: If just borne by voters, fine to have the state decide for itself.

Residents of all states acting collectively – Here we add externalities that all should in principle agree to eliminate. E.g., harmful state tax competition (incentives for football stadiums & factories, rather than taxes that are sufficiently linked to benefits that there is Tiebout competition).

Consider also complexity externalities. E.g., suppose a state with market power (such as California) had its own debt vs. equity rule, the complexity from which would be borne partly by out-of-staters.

Also tax exportation, such as the NYC hotel tax. One could imagine this being done through the income tax instead, & blocked by a federally imposed conformity requirement (or by a bribe, a la highway funds).

OK, let’s try some examples.

Standard vs. itemized deduction: Once we see this as a universal standard deduction that’s part of the federal rate structure, plus an itemized deduction floor, analysis is simpler. No reason for states to require consistency, apart from their own (internalized) interest in being able to free-ride on federal enforcement for itemized deductions claimed federally.

Joint versus separate marital filing: If state wants a different policy, this is salient to voters. No reason to mind joint filing even if federally separate (including, e.g., same-sex spouses). For separate when federal filing is joint, the only issue is the ability to free-ride on federal-level divisions of income.

Other: For a wide range of tax base things (338 election, sub S election, definition of debt & equity, business cost recovery rules, etc.), there will often be a reason for requiring or rewarding uniformity. E.g., if we think it’s state-level political agency costs & rent-seeking, or bad tax competition (e.g., lower tax rates for sports teams or companies with mobile capital), or tax exportation (e.g., hotel tax rules, even if not in the income tax), there may be good reason for Congress to do more to block states’ distinctive rules than it does under current law.

The Obama Administration's semantic pivot from tax-cutting to progressivity

2012-02-14T11:21:00.011-05:00

I've been too busy over the last couple of days to take a close look yet at the Obama Administration's budget proposals (though I hope to address this oversight shortly), but I gather that, in at least one key respect, they are using a budgetary baseline of current policy, rather than current law.

This baseline choice pertains to what people still commonly call the "Bush tax cuts" - rate cuts for individuals that were adopted in 2001 but officially scheduled to expire after 2010, and that more recently were extended two years so that they would expire after 2012. As the Administration's Budget says at page 201, their "adjusted baseline assumes that these tax rate changes are made permanent." The Congressional Budget Office, by contrast, assumes in its budgetary baseline that current law remains in force, meaning that all of the tax cuts are assumed to expire, and budgetary "changes" are measured relative to that.

One semantic consequence of the current policy baseline choice is that the Obama Administration cannot credit itself with "tax cuts" by reason of its support for extending the expiring lower tax rates for people who earn less than $250,000. A second is that the Administration is avowedly seeking to "raise taxes" on people earning more than $250,000, for whom the 36% and 39.6% rates that were ostensibly eliminated in 2001 would reemerge in 2013, rather than keeping those taxes the same (as would follow if one used a current law baseline). And a third is that the Administration can credit itself with deficit reduction by reason of permitting the high-end brackets to increase, rather than facing the question of how it proposes to pay for extending the lower-tier tax cuts.

The politics behind the semantics are clear enough, and to me not wholly unwelcome. The Administration is evidently less afraid than it used to be of Republican attacks based on the usual rhetoric about "job creators" and the supposedly endless need for enacting new tax cuts whether affordable or not. In a post-Occupy Wall Street political environment, it apparently does not entirely mind being charged with plotting a huge tax increase for the top 1 percent.

In addition, the Administration is trying to cut itself some budgetary slack so that it cannot be attacked as harshly on this front. Even this I quasi-welcome, because I believe that short-term budget policy ought to respond to our horrendous (even if very modestly improving) unemployment situation - though I remain very highly concerned about the long run picture (which the Administration when its performance is being evaluated, like the Republicans when they are discussing tax revenues, has a political incentive to sweep under the rug).

But it is not an enormously healthy thing when baseline choices have such a large effect on how fixed sets of policy options are described and (presumably) perceived.

Another customer review at Amazon for Getting It !!

2012-02-13T15:38:00.005-05:00

A writer whom I met and chatted with at a vacation resort several years back (about iguanas, as it happens) has just posted on Amazon the following review of my novel, Getting It:

"Getting It by Daniel Shaviro is a compelling read! His quirky, fully developed characters span the personality continuum; no two are alike, and whether or not you LIKE them, you are drawn to them. I might even say that several will elicit compassion. I also appreciate the way Shaviro frames the plot and subplots. Shaviro's unethical, revolting main character devises a brilliant scheme to cover his oversight on a project for a potential long-term deep-pocket client. Much happens -- psychologically and actually -- in the short span of time before the Who-Will-Make-Partner meeting. Finally, while Shaviro's work is fiction, the story leaves the reader pondering the reality of the inner sanctum of some law firms. My husband and I both loved the book and could not wait to see how it ended. We also agreed that Getting It reflects Daniel Shaviro's brilliant mind. Consider...this novel could be the basis of a fascinating one-week seminar on legal ethics in law schools nationwide."

Teaching assignment for the fall

2012-02-09T14:33:00.011-05:00

I was on sabbatical during the last two fall semesters at NYU (I did this in lieu of the more typical full-school-year sabbatical, as I wanted to keep on doing the Tax Policy Colloquium each spring). But this fall I will be back in action, teaching Tax I (Individual Income Taxation) to JD students at NYU Law School, on Tuesday and Friday mornings starting at 9 am, from the last day of August through early December.

When you don't have to teach, that's great because you have more time for all of the other things that you may want to do professionally. But you also start to miss it after a while. And though I've still been teaching the Colloquium in the spring, large lecture classes are a genre unto themselves, with a performance aspect and instant feedback from the students' responses.

Those who have taken, but never taught, a lecture class might be startled to learn how fully the person at the front of the room can read the students' general reactions. It's of course pretty easy to tell whether a given class went well or not - and if it was bad, you're eager for a shot at redemption the next time. You only feel you're as good as your last class.

But even more so, it's remarkably easy to see how different students are reacting to you and to the subject - who likes it more, who less, the interested versus the bored, the people who find you entertaining or insightful versus those who are less so inclined, and so forth. Hours in front of people turn their faces into an open book, at least on the question of how they are reacting to what's in front of them (though some may remain quite opaque in terms of who they are as people).

Anyway, I'm looking forward to it, and face a handful of basic structural questions. One is whether to use PowerPoint slides - I did the last two times I taught Tax I, but probably will not this time. Another is how much to aim at a specified rate of progress, as opposed to just seeing how it goes. A third is how to structure calling on people (this remains a common law school tradition, even if no longer done in the Professor Kingsfield manner, and I will probably go randomized).

One of the good things about teaching Tax I is that students tend to find it a much more engaging topic than they had expected. (Of course, this reflects in part that there is nothing easier to beat than low expectations.) I'll consider it a failure unless at least a few unsuspecting enrollees end up being recruited to "the life" (i.e., find themselves wanting to take more tax classes and perhaps even to practice in the area, when they had never expected any such thing).

Tax Policy Colloquium on 2/7/12 - Victor Fleischer on Tax and the Boundaries of the Firm

2012-02-08T12:26:00.003-05:00

Yesterday at the NYU Tax Policy Colloquium, Victor Fleischer presented an early draft of his paper, "Tax and the Boundaries of the Firm." The paper discusses an interesting set of issues pertaining to how the features of U.S. corporate taxation affect firm "size," such as with respect to the Coasean tradeoff between make-or-buy decisions.

Rather than writing a fresh comment on the issues raised by the paper, why don't I offer here an expanded version of the outline that I prepared to help guide discussion at the session:

1. Effects of current tax law, absent regulatory arbitrage

(a) What is firm size, and when is it a Coase story?

(i) Multi-dimensional (e.g., make-or-buy, assets inside or outside the firm, multi-industry conglomerates, full-time vs. part-time vs. independent contractors)

(ii) What relationship to issues of debt vs. equity choice?

(b) Significance of transfer pricing

(i) Only matters if the “pocket” does (firms, households) – e.g., international transfer pricing, domestic manufacturing deduction

(ii) Irrelevant to well-designed VAT or retail sales tax; can matter in domestic income tax due to the “cascading” tax on inter-firm transactions (from inclusion on one side, capitalization on the other) if not replicated by in-house capitalization rules

(iii) International: pure WW versus territorial (see example at the end of this document)

(c) Separate businesses (loss nonrefundability creates incentives for conglomeration)

(d) Agglomeration (i.e., excess firm size because earnings are retained to avoid the tax on shareholder distributions)

(i) Wouldn’t it be anticipated on the way in?

(ii) New view: uniform distributions tax does not induce lock-in

(iii) International new view: same as domestic, but permanently avoiding the tax may be more credible because the taxable “distributions” are intra-firm

(e) Full-time employees (vs. part-time, independent contractors) – note that companies often want to avoid having full-time employees despite the opportunity to give them tax-free, in lieu of taxable, compensation

(f) Choice of tax rate – any differences between the corporate and individual rates may affect firm or entity choice; the ease of taxable income-shifting through partnerships can be a reason for using them

(g) Debt versus equity

(i) Modigliani-Miller: choice is irrelevant apart from bankruptcy, tax, asymmetric information / agency cost issues

(ii) Tax shield vs. bankruptcy risk tradeoff

(iii) Tradeoffs from agency costs / asymmetric information: debt better in some scenarios, equity in others.

(iv) Miller equilibrium: debt vs. equity is simply an election to pay tax at the corporate rate (via equity) or at one’s own rate (via debt)

2. Regulatory arbitrage

(a) General issue is costly vs. cheap electivity

(b) Examples: check-the-box, anti-avoidance rules, debt vs. equity, rules constraining realization and recognition

(c) Transaction cost tradeoff: more/cheaper vs. fewer/costlier transactions

(d) Need to assess merits of the particular taxes that regulatory arbitrage permits one to avoid (e.g., for tax shelters, debt-equity under Miller, or domestic vs. international check-the-box)

3. Policy implications

Corporate integration? Lowering the corporate tax rate? International?

Make versus buy and the U.S. international tax rules
The U.S. tax rate is 35%, that in Ireland is 12.5%. A U.S. company will use parts made in Ireland (a decision that itself may reflect this tax rate difference) but is choosing between make and buy (i.e., subsidiary vs. arm’s length purchase).

Suppose that separately owned U.S. and Irish firms would earn $16 and $8, respectively. After paying national taxes, they collectively have $10.40 + $7 = $17.40.

(a) Territoriality as inefficiently encouraging “make”

Suppose merger reduced their combined income to $22, but that they could report this as $6 in the U.S. and $16 in Ireland. Now the after-tax is $3.90 + $14 = $17.90.

(b) Pure worldwide as inefficiently encouraging “buy”

Suppose merger increased their combined income to $26, all subject (after foreign tax credits) to U.S. tax. Transfer pricing is irrelevant, but now the after-tax is just $16.90.

(c) Deferral – In principle an indeterminate tradeoff between (a) and (b); in practice we can be confident that (a) is more significant.

The Zuckerberg tax

2012-02-08T07:59:00.008-05:00

David Miller has an op-ed in today's New York Times proposing what he calls the "Zuckerberg tax." David notes that Steve Jobs paid no income tax on the $2 billion of Apple stock he accrued in the last 15 years of his life - gain that will never be taxed at the shareholder level, since the stock gets a tax-free step-up in basis at death - and that the same is likely to apply to Larry Ellison of Oracle, who simply borrowed against his vast stock appreciation in order to start living it up, as well as to Mark Zuckerberg for the $23 billion (out of $28 billion total) in Facebook stock that he apparently does not plan to sell.

Then the punchline:

"Our tax system is based on the concept of 'realization.' Individuals are not taxed until they actually sell property and realize their gains. But this system makes less sense for the publicly traded stocks of the superwealthy. A drastic change is necessary to fix this fundamental flaw in our tax system and finally require people like Warren E. Buffett, Mr. Ellison and others to pay at least a little income tax on their unsold shares. The fix is called mark-to-market taxation.

"For individuals and married couples who earn, say, more than $2.2 million in income, or own $5.7 million or more in publicly traded securities (representing the top 0.1 percent of families), the appreciation in their publicly traded stock and securities would be “marked to market” and taxed annually as if they had sold their positions at year’s end, regardless of whether the securities were actually sold. The tax could be imposed at long-term capital gains rates so tax rates would stay as they were.

"We could call this tax the 'Zuckerberg tax.' Under it, Mr. Zuckerberg would owe an additional $3.45 billion when Facebook went public (that’s 15 percent of the value of the roughly $23 billion of stock he owns). He could sell some shares to pay the tax (and would be left with over $20 billion of Facebook stock after tax), or borrow to pay the tax.

"If his Facebook shares decline in value next year, he’d get a refund."

David has previously published an article more fully explaining the proposal's details.

This is probably not my first-best proposal. Working from scratch, I might be more inclined to go for something like a progressive consumption tax, plus an inheritance tax for reasons requiring fuller explanation than I have room for here. An example of the concerns that the "Zuckerberg tax" proposal raises is the fact that non-publicly traded stock, such as Facebook pre-IPO, would not be reached (reflecting the measurement problems that underlie the realization concept).

I also would feel less sympathetic to the proposal if the corporate-level tax were operating more effectively. There would be much less ground for concern about Jobs', Ellison's, and Zuckerberg's personal income tax bills if their profits were being effectively taxed at the entity level. (Indeed, the huge tax that Zuckerberg is going to pay on exercising his stock options worth $5 billion will be wholly offset, leading to a net tax of zero, if Facebook has enough taxable income to use all the offsetting deductions.) But in fact the companies in these types of examples (looking beyond just Apple, Oracle, and Facebook) often pay very little U.S. income tax, because it is easy to play games with the underlying intellectual property so that it yields taxable income in the Caymans or Bermuda rather than here.

As it happens, we are not in a political world where all of the options are on the table. And if you compare Miller's proposal to, say, the talk emanating from the Obama Administration about a "Buffett rule" that apparently would go off adjusted gross income and be a second alternative minimum tax on top of the first one, it looks pretty good. In particular, the aim is much better if our concern lies with people in the top 0.1 percent who appear to be paying very little tax, whether directly or indirectly - and indeed (as the Ellison case shows) who may be paying far less than they would under a well-designed consumption tax.

So here's hoping that this is not just a one-day story in the New York Times op-ed page, and that the proposal indeed gets serious consideration, including from the Obama Administration.

An illustration of the problem with average tax rate calculations

2012-02-02T13:26:00.015-05:00

In a couple of earlier posts, I've noted some of the conundrums posed by relying on effective or average tax rate computations, when used either for purposes of a Buffett rule (see here) or to assess Romney's degree of federal income tax burden (see here).

A fresh illustration comes from a recent Wall Street Journal blog posting, Laura Saunders' "What Was Mitt's Income in 2009?," available here.

Noting Romney's $4.8 million capital loss carryover to the 2010 tax year, along with other evidence (such as of estimated tax payments) on the 2010 return, Saunders cites Boston CPA Adam Gorlovsky-Schepp for the conclusion that "the Romneys’ 2009 adjusted gross income appears to have been about $6.47 million, with federal income tax of about $1.24 million," whereas "[i]n 2010 they paid nearly $3 million of tax on $21.6 million of income."

Saunders adds: "That would make their effective tax rate 19% in 2009, much higher than the nearly 14% rate they paid in 2010."

Ah, so Romney apparently paid a "fairer" tax rate in 2009 than 2010. Saunders doesn't say this, but may mean to imply that it is a logical conclusion.

Consider, however, that - unless tax planning incompetents were at the helm, which seems unlikely - Romney's 2009 capital losses must have reflected "loss harvesting," or systematically selling stocks that were worth less than their tax basis, while continuing to hold those that were appreciated. Now, despite the horrific stock market events of 2008 and 2009, it is entirely plausible that Romney's stock portfolio remained substantially appreciated on balance, given the massive overall stock market run-up over the two decades preceding 2008. There's certainly no reason to think it likely that he had purchased most of his stocks right at the end of the run-up, or just before the crash.

Given this set of issues, a tax rate computation that is based on Romney's adjusted gross income misses a large part of the picture. You have to think about economic income, not just taxable income, and about a long-term time horizon, not just the current year.

Tax Policy Colloquium on 1/31/12 - Alex Raskolnikov on tax versus non-tax law and economics

2012-02-01T15:53:00.017-05:00

Yesterday at the NYU Tax Policy Colloquium, Alex Raskolnikov presented his paper, "Accepting the Limits of Tax Law and Economics." The paper argues that, as law and economics in the law schools goes, that in tax has been generally less "successful" than that in other areas - say, antitrust law or studying and evaluating the Uniform Commercial Code - in two senses: less able to generate relatively clear and widely accepted right answers concerning particular issues, and less influential in guiding policymakers, in particular the courts.

In a sense, one could compare the paper to Fellini's 8½. Just as 8½ is a film about not being able to make a film, so this is to some extent a paper about the difficulty of writing a paper.

Alex and I appear to agree, however, that the reason for our lesser success (as the paper uses this term) is our having a tougher job. In particular, tax policy analysis requires considering distribution issues that the rest of law and economics typically brushes aside (and indeed expressly leaves to us), and, with lump-sum taxes ruled out, we are required to labor in the thickets of second-best analysis, which is never particularly clean or clearcut.

I suppose my ego is sufficiently bound up in the question of how our field has performed that I don't especially like reading about our lack of "success" - in particular, when I myself code it (without any substantive disagreement with what Alex says) as a laudable reflection of our having collectively taken on tough and interesting issues of great theoretical complexity and practical importance. And how important are answers and influence, as compared to advancing intellectual understanding? (Which I believe we have collectively done.) Tastes may differ about this.

Three books

2012-02-01T15:09:00.008-05:00

Though I continue to careen from one task to the next, a bit like a human pinball equipped with word processor, I wanted to pause here to briefly mention and praise three books that have crossed my desk recently.

1) Bruce Bartlett, THE BENEFIT AND THE BURDEN: TAX REFORM, WHY WE NEED IT AND WHAT IT WILL TAKE - This is an excellent, wide-ranging guide to what matters about the U.S. federal income tax system, its history and problems, and where it might go next. Bartlett, who has been a favorite commentator of mine for many years, does a really excellent job of providing a lucid review that deserves (and I think will get) broad readership. Well-designed for citizens and voters without special expertise, but I could also imagine suggesting that students, say in an introductory Tax Policy class, dip into it, as they would learn a lot.

2) Edward J. McCaffery, THE OXFORD INTRODUCTIONS TO U.S. LAW: INCOME TAX LAW, EXPLORING THE CAPITAL-LABOR DIVIDE - Some guy named Shaviro is quoted on the back cover as saying the following: "This is a really excellent guide to the U.S. income tax that combines a powerful theoretical scaffolding with attention to important practical details. Ed McCaffery has the flair to explain clearly and entertainingly both the forest and the trees of our ill-functioning system. I will definitely recommend it to my students." On further review, let me re-endorse these comments. For my students in Tax I the next time I teach it (which will very likely be this fall), I will definitely be asking the bookstore to stock it as recommended reading, and perhaps even taking the view on my syllabus that the time has come to last to give it pride of place as recommended side reading, relative even to the Marvin Chirelstein "blue book" that has been rightly considered indispensable for so many decades (including back when I was a law student).

3) Stephen Leeb, RED ALERT: HOW CHINA'S GROWING PROSPERITY THREATENS THE AMERICAN WAY OF LIFE - This book is out of my area of expertise, and came to my attention through friends. The argument is that natural resource scarcity is a huge threat to the economic future of our country. China enters into the equation in a sense indirectly, on the view that (a) its rising prosperity means that it will be using far larger quantities of scarce and depleting natural resources (such as rare metals) than previously - just as the rise of the Chinese and Indian economies may affect global carbon emissions - and (b) that China, unlike the U.S., is farsightedly taking steps to ensure its own long-term access to these resources, which necessarily comes at the expense of others' access. Leeb argues that China's economic rise is likely to be sustainable, and that its government has been serious and capable in pursuing its population's long-term interest in material betterment. (This is not a conspiracy-theory book about the Chinese, although it does portray their government as surprisingly capable, perhaps a la Singapore on a much larger scale.) With enough terrible things to occupy us already - e.g., global warming, the threats of nuclear weapons dissemination and terrorism, the risk of more financial crises, the long-term U.S. fiscal gap , concerns about whether the U.S. political system is still able to function, etc. - it is hardly welcome to learn that we might have something else to worry about as well. But Leeb makes a serious case that deserves attention, in particular from people who are probably better situated than I am to offer their own judgments about the underlying issues. He makes a powerful and lucid case for his views.

Financial arbitrage is fun when it actually works

2012-01-27T15:43:00.007-05:00

According to this article, one aspect of the New York Mets' financial problems is that they owe a huge amount of deferred income to former Mets players. Disastrous former Met Bobby Bonilla is the most famous example, as he is owed almost $1.2 million annually for each of the next 25 years, but there are others as well.

The article offers the following explanation for the Mets' willingness to accept huge deferred salary obligations:

"The Mets once were comfortable pushing salary obligations for their players into the future because the Wilpons were, Picard alleges, getting 18 percent average annual returns on money they invested with Madoff regardless of drastic market fluctuations. So why would it matter if they deferred a player's salary at 8 percent annual interest? They could pocket the sizable difference between the interest owed to the player and what Madoff could make for them."

For that matter, if you can keep on getting 18 percent annually no matter what, why ever pay cash for anything, and indeed why not run up all the debt that they evidently did?

Great financial minds, except for being fatally credulous?

Tax policy colloquium on 1/24/12 - Amy Monahan paper on healthcare

2012-01-26T13:33:00.005-05:00

This past Tuesday, Amy Monahan presented her paper, "Will Employers Undermine Healthcare Reform By Dumping Sick Employees?"

The basic argument is as follows. Under the recently enacted healthcare reform (HCR), employers have an incentive to seek the situation where employees who are likely to be high-cost health insurance customers opt NOT to be covered by the available employer-provided health insurance (EHI), but instead to opt out and seek coverage under the public insurance exchanges that HCR provided for. Employers can't, as a legal matter, directly tell their high-expected cost employees to go elsewhere, but perhaps they can push them in this direction indirectly (without also inducing low-cost or healthy employees to help out - after all, the preexisting tax subsidy for EHI makes this a good deal for employer and employee alike). An example might be not covering diabetes or AIDS at all, and being relatively stingy on hospitalization coverage, but being quite generous with regard to substituting gym memberships.

The paper uses the term "targeted dumping" to describe this strategy of getting the high-cost employees to opt out and use the public insurance exchanges instead. But despite the term's harsh tenor, this seemingly must be good for the employees who opt out, since they do it voluntarily. (Leaving aside scenarios in which the high-cost employees would have been better off still if the employer had designed its plan based on the fact that dumping was impermissible.)

So what could possibly be wrong with targeted dumping? Two groups in particular might be adversely affected: others on the public insurance exchanges if there is an influx of high-cost people whose risks are being pooled with those who are on the exchanges simply because they don't have EHI available, and taxpayers who must fund the subsidies for those exchanges.

My own view is somewhat as follows. Ex ante health insurance given your preexisting health status (high-cost or low-cost) is best accomplished by separating out the distinct expected-cost pools and not having cross-subsidization, in which the low-cost pay net transfers to the high cost. This would address adverse selection by the potential insured, as well as its flipside, favorable selection by the insurers.

As it happens, I also support transfers from low-cost to high-cost people, just as from high-ability to low-ability people through the fiscal system. Only, cross-subsidization is not, at least in theory, the best way to do this. Running it through employer plans is likely to have adverse efficiency consequences relative to financing it through general revenues. In addition, cross-subsidization may have odd and anomalous distributional effects on who ends up paying, relative to running it through general revenues. So targeted dumping may actually produce a better equilibrium - if one ignores the political economy problem of whether explicit taxpayer subsidies to the exchanges will be as close to the right level as the implicit and somewhat hidden ones that are delivered via blocking targeted dumping and thereby achieving greater rather than lesser cross-subsidization within EHI.

So I would offer at least one-and-a-half cheers for allowing targeted dumping, subject to the admitted political economy concern.

Further complications arise from the fact that HCR, for obvious political reasons, was constructed on top of the existing EHI system, with all of its horrendous defects. This makes everything more complicated. One of EHI's many defects is that, by carving out the covered employee group from everyone else, it greatly worsens adverse selection problems outside of its domain. So when you have these two somewhat segregated groups, the people in EHI and everyone else, shifting people around between them can worsen the problems in one sector or the other. Thus, for example, if targeted dumping shifts a significant high-cost population from the EHI to the non-EHI sector, then (with uniform premiums) cross-subsidization may actually become a bigger issue in the latter sector than it would otherwise have been.

The White House "Blueprint for an America Built to Last"

2012-01-25T14:08:00.012-05:00

In principle, I am in great sympathy with the White House's turn towards a stance of treating high-end wealth concentration as an important tax policy concern. But, like many commentators across the political spectrum, I am less than thrilled by what I know of the details of the White House plan that featured in the State of the Union speech.

Called the "Blueprint for an America Built to Last," it is available here. I guess that label must have beaten out "Making America Ford-Tough" in the focus group sessions. But let's go beyond snark to substance by covering most of the main tax suggestions (they are not quite yet at this stage proposals) in the document.

1. Buffett Rule - The White House favors "measures to ensure that everyone making over a million dollars a year pays ... at least 30%." But apparently this doesn't apply to people who make large charitable contributions to get below 30%.

The purist in me says that this is the wrong way to go about making our system more progressive, although I favor that end. When you start talking about what tax rates people pay, you get into all sorts of side issues that aren’t really of central interest.

The policy is based on a fraction, taxes paid over some measure of income. But for starters, what should be in the numerator? As per the WSJ column yesterday by Berlau and Kovacs that I commented on here, do we need to argue about the case for counting corporate taxes that one arguably indirectly paid as a shareholder? If so, do we have to try to measure them (rather than, like Berlau and Kovacs, conclusively adopting the false presumption that corporations actually pay tax at 35% on their economic income)?

And what should be in the denominator? Is it just adjusted gross income (AGI), which is taxable income prior to taking itemized deductions and personal exemptions? Suppose a hedge fund guy reports AGI of zero, because he wiped out the capital gain from his carried interest by harvesting tax losses through selective realization of the loss assets in his portfolio. Does Congress, as proved so wildly unsuccessful with the alternative minimum tax, need to enact a parallel tax base that is ostensibly broader but then will inevitably be targeted by interest groups for repeated narrowing?

Are we going to get multiple tax return computations - maybe this plus regular taxable income plus the existing alternative minimum tax - and create silly tax planning incentives for taxpayers to try to equalize their tax liability under each, while also having to maintain multiple tax attributes (such as basis) for each asset, one for each system?

OK, I realize that this is politically salient, and the best shouldn't be the enemy of the good, but without more I'm not even sure how good this is (again, despite favoring the goal of increasing high-end income tax liability).

2. Eliminate tax deductions for those making more than $1 million - This is listed aa separate item, and the items they mention (not all of which actually involve deductions, as distinct from exclusions) are housing, healthcare, retirement, and childcare. The last of these is pretty trivial in this income range. Retirement saving tax benefits are a big and complicated topic, and I'm not entirely sure what they have in mind. Phasing out home mortgage interest deductions and the exclusion for employer-provided healthcare at the high end has potential appeal, especially since these are bad items in a tax policy sense but are both politically sacrosanct and would be a bit economically disruptive to yank away for everyone else cold turkey. Again, one needs more details to really assess this.

3. Extend the payroll tax cut - Though this is far from the best stimulus design (since it is largest for people who are earning at least $110,000, and thus have less marginal propensity to spend an extra dollar than poorer individuals), it does appear to be the best and indeed only one that might currently be available from Congress.

4. Expanded "tax relief" for start-ups and small businesses - Yawn, sigh, groan.

5. Remove tax incentives to locate overseas through an international minimum tax - I suppose the idea is as follows. Compute global taxable income for U.S.-headed multinationals, meaning that we count all of the income of their controlled foreign subsidiaries that would be currently taxable in the U.S. if deferral were repealed. Unclear how foreign taxes play into this. Say the minimum global rate is 20%. I am guessing that the foreign taxes are treated as equivalent to U.S. taxes for this purpose - i.e., they are included in the numerator, taxes paid - but conceivably they might just be deductible (i.e., ignored in the numerator but deducted from the denominator, which is global taxable income).

In assessing provisions that would raise U.S. taxes on U.S. multinationals, I think it's helpful to break out 3 distinct issues:

First, at how high a level do we want to be taxing them, on their true foreign source income and/or as compared to non-U.S. multinationals on all of their global income? As I have discussed here, the correct tax "price" at this dimension is hard to determine, and depends in part on the value that both U.S. and foreign shareholders ascribe to U.S. rather than foreign incorporation. This includes a big transition component since existing U.S. companies are largely "trapped" here (subject to true purchases by foreign companies and keeping in mind that they need not be the ones to issue new equity).

Second, to what extent does the tax change target what we suspect of being disguised U.S. source income, classified as foreign source for tax purposes because the rules are so manipulable? I suppose there is a "proxy" argument here for firms with a significant U.S. presence - i.e., that if they are paying a low global rate that may well involve income-shifting outside of the U.S. tax base.

Third, how does the tax change affect the two awful rules that currently dominate U.S. taxation of outbound investment? These are deferral and the foreign tax credit. I have discussed how bad these rules are elsewhere, and I would distinguish this issue from whether one wants the tax rate on outbound to be low and high. After all, both a pure worldwide system under which foreign taxes are merely deductible, and an exemption system for foreign source income, eliminate both. The rule that the Administration suggests would make deferral less important (since a U.S. company faces some current U.S. tax even if it keeps its money abroad), but its effect on the foreign tax credits depends on whether it treats them as equivalent to U.S. taxes paid.

Here's my suggestion: issue the proposal with a fairly low rate but with foreign taxes merely being deductible. E.g., say we have a 5% or 10% minimum worldwide rate, in the above sense, with foreign taxes merely being deductible for this purpose.

6. Lower tax rates for companies that manufacture and create jobs in the U.S. - More specifically, lower tax rates for U.S. manufacturing, double the tax deduction for high-tech manufacturers, provide a tax credit for companies' "moving expenses" (that's what it says) when they "close production overseas and bring jobs back to the United States." This, I must say, sounds really stupid on all fronts.

A couple of last words on Romney's taxes

2012-01-25T07:59:00.002-05:00

As many people have said, the Romney tax return story is in the end less about him as an individual than about how it shows and dramatizes the workings of the current U.S. income tax system.

I considered the biggest revelation of his 2010 tax return to be the net capital loss carryover, showing that he had zero net income from capital gains (including carried interest) in 2009. I noted that no doubt he had a lot of genuine loss stocks given the stock market price drop, but that (even without tax sheltering to create fake tax losses) he may have engaged in "loss harvesting," or selling losers while holding winners.

Should one add the Seinfeld line, "Not that there's anything wrong with that"? Yes if one is evaluating Romney's behavior - why wouldn't anyone engage in perfectly legal loss harvesting when the system permits it to work. (Although again, the fact that it could work against carried interest income shows a second aspect of the favorable tax treatment - capital gain not only gets a lower rate than ordinary income, but can be offset by harvestable capital losses.) But it shows a big problem with our tax system. Suppose we even stipulate that Romney had an overall loss on his investment portfolio in 2009, not just losses on one side of the ledger that he was able to harvest. Income is a "net" rather than a "gross" concept, so of course he should be able to deduct losses against gains, all else equal. But suppose we are looking at the 1990s massive run-up in stock prices. In that scenario, Romney, along with any other sensible investor, would have had huge gains that he would have taken care to avoid realizing for tax purposes unless absolutely necessary.

Another issue: in yesterday's Wall Street Journal, John Berlau and Trey Kovacs argue that Romney's tax rate was actually as high as 44.75%. This is a pretty simple calculation. You take the 35% corporate tax rate, and then layer a 15% dividend or capital gain rate on top of it. Thus, $100 earned through a corporation drops to $65 after paying corporate tax, and then to $55.25 after paying a 15% shareholder level tax. So, if we ignore the myth of separate corporate personhood, we should realize that the whole thing is really paid by the shareholder.

Let's leave issues regarding the incidence of the corporate tax to one side, since they are actually equally raised by a tax that is levied directly on business owners. Berlau and Kovacs are entirely right to suggest that the corporate level tax matters to the analysis. I frequently noted this point in the carried interest debate a couple of years back. But they are of course wrong (in classic WSJ fashion) to simply assume that corporations are actually paying tax on 35% of their income. The average or effective rate, not the marginal rate, is what matters if one is thinking about distributional effects (although efficiency issues turn on the marginal rate, which may effectively be 35% in many cases even if the company's average rate is much lower).

Another point that I made in the carried interest debate, and that is relevant here (again, much more for assessing the broader issues than with regard to Romney himself) is that people realizing capital gains from selling corporate stock do not necessarily bear, even implicitly, the corporate tax. And this may be especially true for private equity, quick-turnaround firms like Bain (wholly aside from the issue of what one thinks of Bain's activities).

Let's take 3 cases in which a private equity firm swoops in, buys a company for a low price, and then reaps large profits by selling it for a high price.

Case 1: They figured out how to make the company more efficient and profitable. These increased profits will bear the 35% corporate tax (if the average or effective rate is actually at that level), so the Berlau-Kovacs analysis holds. (Note, however, that per the famous article by Shleifer and Summers, it's possible that this involved breaking implicit long-term employment contracts with the workforce, rather than generating true efficiency gains.)

Case 2: They figured out how to make the company more tax-efficient (i.e., to lower its tax rate), and thus it sells for more. This time their capital gain does not reflect income that has already been taxed at the corporate level. (The corporation is not taxed for the after-tax profit from lowering its tax rate.)

Case 3: They are smart traders, and figured out that the company was under-valued. Here the profit is a return to their labor in figuring out true value (or for that matter in skillfully playing the Keynesian beauty contest game), and it is not being double-taxed by reason of the 35% corporate tax rate, which was a constant.

One last point about all this: It is striking how many of the better commentators across the political spectrum draw one of the right lessons, which is that a well-designed progressive consumption tax could work far better than the current income tax. David Frum made this point recently, and I believe so has Matt Yglesias from time to time. But this point continues to lack any apparent political traction at any point in Washington political debate.

Death of Ursula

2012-01-24T21:23:00.018-05:00

One thing about cats, if you have a typical human lifespan and your norm is to have 3 cats in the house, you will repeatedly experience their mortality, which is not pleasant (although the journey is still very much worth it as a whole).

Today Ursula died of kidney disease. There's an element of relief to this, because for the last few days we had been operating a hospice. It was horrible to see how gaunt and skeletal she looked, and how inert she was becoming. By the last few days (though not before that) her quality of life appeared clearly to be approaching zero. But at least we had 9 good years with her first.

She first got kidney disease, from an infection, about 2 years ago. She was briefly at death's door, but we got her restored with antibiotics, IV fluid for a week, etc. Then she was fine for a while, until a more recent stint at the vet at which it became obvious that her time was growing short. But she still had a couple of good months after we took her back home - although I don't think she much enjoyed the water shots that we gave her nightly. Finally in the last couple of weeks she sank fast. She stopped eating a few days ago, stopped using the stairs shortly after that, and today, I suppose mercifully, her body completed its shutdown.

An extremely sweet-tempered animal, known (among other monickers) as Ursee, the Lovely One, Ursulina, Princesska, and the Little Gal. Spirited although small, and the much larger Seymour (who is a peace-lover) would let her shove past him to eat at his food bowl. She didn't much like people whom she didn't know, but when she decided you were OK, you would feel really honored by her trust, affection, and regard. Not much for being picked up, but she loved being petted while on the ground, and would purr loudly (as well as fluttering) and groom you back, at least if you were on her Special Friends list. I often used to say that I wished I could get her to write me a letter of recommendation that I could present to other cats, stating "This one's OK," as I knew that was how she felt. She was also a very clever little gal - remarkably astute, for example, in divining when we were planning to pack her up for an unwanted ride in the car.

Look at the markings. She had great stripes. We adopted her at a shelter, ostensibly as just another brown tabby, but she was a dead ringer for a breed we saw in a book, called the Wild Abyssinian. Very smooth and silky soft fur. So long as you were not a mouse, she was a friend worth making and cherishing.

Romney's 2010 and 2011 tax returns

2012-01-24T08:04:00.015-05:00

Last night, courtesy of a media organization that got some materials in advance, I was able to spend a short time looking at some of the information from Governor Romney's 2010 tax return, along with some tentative and preliminary 2011 items. As I will be colloquiumizing, so to speak, while this story is bright and fresh today, I am writing up my main preliminary reactions in advance and will post them when the story has gone public.

1) Roughly speaking, Romney shows annual adjusted gross income (AGI) in the range of just over $20 million per year, and is paying income tax on this at a rate of about 15% or perhaps a mite below. This is as expected, and raises a set of issues not about his compliance or tax planning activity, but about the merits of the underlying rules that yield this result. A key reason for the low average tax rate (computed relative to AGI) is that about half of his income comes from long-term capital gains that are presumably mainly or wholly Bain carried interest payouts. Taxing these as capital gains rather than ordinary income may have saved him about $2 million a year, all else equal. He also lowered his average tax rate through significant charitable contributions, in particular to his church and with a higher amount in 2011 than 2010. Obviously he can argue that paying less tax due to charitable contributions is different than doing so by reason of tax planning or favorable tax rules for what is classified as capital income.

2) He appears to have had the full measure of disallowed miscellaneous itemized deductions under the "2% of adjusted gross income" floor, and thus apparently did not use Caymans entities to avoid this problem, as David Miller's NYU Tax Policy Colloquium from last year suggested may be common practice in some circles.

3) Not to bury the lede, but the single most interesting thing I saw is that he had a $4.8 million capital loss carryover in 2010. In other words, for 2009, his capital losses exceeded his capital gains (including from the Bain carried interests) by $4.8 million. So he had zero net capital gains, and zero tax on his carried interest income, in 2009. I had speculated in an earlier post that the fact that the carried interest gives rise to capital gain might benefit him not only by lowering the tax rate on the income from 35% to 15%, but also by permitting it to be offset by capital losses, and now we see this confirmed.

The really interesting question is: What was the reason for these sizable capital losses? An obvious possibility that comes to mind is that 2009 was not exactly the greatest year ever in the history of the stock market. But it would be interesting to know more about this. It would also be interesting to know more about whether he had capital losses offsetting his capital gains in 2008, which of course is when the current financial crisis broke out, and for that matter in 2007 and earlier.

On the Democrats' (or even Gingrich?) side, I would be tempted to make a lot of this: "He didn't pay ANY tax on his Bain carried interest income in 2009 and perhaps earlier!" But of course our income tax employs a net rather than a gross concept of income. If you make $10 million here but lose $10 million there, your net is zero and you are supposed to pay tax of zero.

But - taxpayers can be quite artful about the losses that appear on their returns. Thus, suppose you have a stock portfolio with both huge gains on some stocks and huge losses on others - reflecting diversification and perhaps a willingness to take a wide array of risks. Then you sell the losers and hold the winners, and you get huge loss deductions (offsetting the carried interest income) that misrepresent the actual economic performance of your portfolio as a whole. This would involve entirely legitimate tax planning, which I might do as well if in Romney's tax position, but then it would indeed mean that he was paying zero tax on his carried interest income despite not actually having net losses from his portfolio holdings.

Another possibility is that one can create fake capital losses (or at least take a reporting position that one has done so) through aggressive tax planning tricks that, for example, create fake basis in assets to permit the deduction of fake losses. There is no evidence whatsoever that Romney did this, but the possibility underscores the point that one might really like to know more about the source and reality of the capital losses that Romney claimed or perhaps harvested in 2009.

If I were on the other side of this politically, I would use the 2010 capital loss carryover as grounds supporting the demand to see earlier years' tax returns, as well as perhaps non-tax return information that might shed light on what was really going on here economically. Again, it may just be a matter of having an exceptional year in which the recession and stock market collapse gave him large losses that he realized, but one can't tell for sure from the information that has thus far been released.

4) Romney has lots of PFIC investments on which he reports, and on which he takes the QEF election - but there's something baffling to me about what's reported. Oops, a lot of jargon in that last sentence. Let's explain. In general, passive foreign investment companies (PFICs) are foreign corporations in which one owns shares, and which are primarily engaged in passive portfolio investment rather than actively running controlled businesses. To prevent U.S. individuals from incorporating their stock portfolios abroad and avoiding current tax, the PFIC rules require current year taxable income inclusion of one's share of the income thus generated, or its deferred (but with interest) equivalent. The QEF election means that you elect to be taxable currently, since the deferred alternative is generally worse. Romney has lots of PFICs - some Bain, some Goldman Sachs, and others as well - that are incorporated all over the place: the Caymans, Ireland, Luxembourg, Switzerland, Germany, I believe the U.K., etcetera. But the odd thing about it is that the PFIC income he reports for 2010 tends to be really trivial amounts, like $2,000 here and $800 there. (I.e., not just trivial in his specialized sense, a la the $370,000 in speech fees that he mentioned.) What I don't understand is why this is. Were the PFICs doing poorly in the 2010 economic environment? Is most of his real money in tax-deferred IRAs, so we are only seeing a tiny piece in the taxable realm? Is there tax planning going on off-screen, at the PFIC level, such that he might have more economic income than taxable income from all these PFICs? Someone who knows more about practice in this area might have a better sense of it than I do.

5) For 2010, Romney filed several Form 8886, Reportable Transaction Disclosures with the IRS. These were generally for investments through a Goldman Sachs hedge fund. I couldn't see what the transactions were, since the forms stated that a full textual explanation was being provided on separate pages that were not available, at least in what I saw.

Reportable transaction disclosures generally pertain to transactions that the IRS and Treasury find suspicious as potentially improper tax shelters. They typically have a high ratio of tax benefits to cash invested and/or economic substance, and the government thus wants a chance to look them over more carefully. Or they may have triggered the disclosure requirement in other ways, such as by reason of being offered confidentially. The fact that you have reportable transactions doesn't by itself support any definite conclusions. For example, the IRS may end up agreeing that all of these transactions were reported properly and had the tax consequences that were claimed. Or it may disagree but lose in court. Or it may disagree and win in court, but you believed in good faith that your positions were valid.

So no definite conclusions of any kind can be drawn from Romney's having reportable transaction disclosures - especially since I don't even know what these transactions were or what tax benefits they may have produced. Nonetheless, the fact that his return includes these things is of interest, and raises the question of whether he was engaged (mainly through Goldman, it seems) in aggressive tax planning.

Romney's latest talking point about how policy should be directed by people who have had a "job"

2012-01-23T13:33:00.011-05:00

Romney appears to be doubling down on his talking point about how Obama and lots of people in the Administration have never had a "job," by which he means a private sector business job. Apparently that is what you need to decide, for example, on the merits of the case for Keynesian stimulus, or to evaluate global warming, or for that matter to set our policy towards Iran.

Back in the 1990s, I was once called as a witness at some sort of House sub-committee hearing on raising the minimum wage. The Republicans were in the majority, and I was one of their two witnesses. The other was Doug Holtz-Eakin. I had been called because of a recent article I had written in the U of Chicago Law Review, in which I skeptically compared min wage increases to their equivalent in explicit tax and transfer terms (i.e., a tax on low-wage employment that was used to fund a subsidy to people with low hourly earnings, and with no focus on household income over any longer period). The article was balanced, and I noted that some of labor markets' peculiar features made it plausible that modest minimum wage hikes would have genuinely ambiguous employment effects (as suggested by then-recent empirical work by Card and Krueger).

The background for the hearing was that the Republicans were not having any of it, so far as a minimum wage increase was concerned, but that they didn't feel they could just not hold the hearing. (Obviously they would never hold it today.) So it was a day for the Democrats on the sub-committee to beat up the Republicans a bit, since this was an issue on which the Dems would definitely poll better. They had their own witnesses, including I believe Jared Bernstein.

Anyway, at some point the Democrats started saying stuff like: What do we need these academics here for. Let's get some witnesses who actually know something about the minimum wage - minimum wage workers! Holtz-Eakin, while trying to tamp down his reaction, couldn't help being a bit sarcastic and irate. He suggested to the Democrats that, if that was how they defined expertise (rather than, say, by asking experts about the state of empirical knowledge), why not just fire their staffs and have all the issues decided by people who don't know anything.

Then we had to sit through some stuff about how "you people" just "don't get it," which was funny for me because I certainly do want to help low-wage and unemployed people but would not assume that they know the most about how to raise employment and wage levels.

When it was over, outside the hearing room a leading Democrat (I believe it was John Dingell) winked at me as if to say, hey, don't take it personally, it's all just show biz.

But now we have Romney basing an entire presidential campaign on essentially the same type of definition of expertise, only it relies on the perspective of the bosses rather than the workers.

Gingrich's tax planning trick

2012-01-23T08:33:00.025-05:00

According to Forbes (courtesy of the Tax Prof Blog), Newt Gingrich's tax return shows that he purported to avoid $50,000 of Medicare payroll taxes by using the so-called John Edwards Sub S tax shelter - a scam that Forbes says the IRS has "consistently and successfully attacked." The trick is to avoid the 2.9 percent Medicare payroll tax by forming a shell entity that supposedly employs you. Then, when others pay for your services, the money goes to the entity, which underpays you from a reasonable compensation standpoint. This ostensibly results in converting the lion's share of your compensation income into business profits, which do not face the Medicare payroll tax. If you actually need the cash, you can still ask the entity to pay it to you (and it will probably say yes to its 100% owner), but you label the payments as dividends, which also are exempt from the Medicare payroll tax (and indeed are tax-irrelevant, given that a subchapter S corporation is taxed as a flow-through entity whose profits accrued to you anyway).

Essentially, the trick is the same as if I were to make a deal with NYU whereby I formed a subchapter S corporation, charged NYU my entire salary, and then had my S corporation pay me just a pittance under the salary label. If this worked, I could avoid all payroll taxes (except on the pittance that I admitted was salary) - Social Security as well as Medicare. And I suppose NYU could avoid paying its half of the Social Security payroll tax. But needless to say this wouldn't actually work, in particular given the personal service corporation rules (Internal Revenue Code section 269A).

The John Edwards Sub S tax shelter typically comes closer to being legally defensible, avoiding the terms of section 269A and being contested by the IRS on "reasonable compensation" grounds, which in this setting is a version of substance over form. That is, if Gingrich the sub S owner were dealing at arm's length with Gingrich the star employee, he would have to pay himself pretty much the entire profits, since he is the asset. The IRS has had prominent recent wins lately in litigating this issue.

It's only fair to compare Gingrich's Sub S tax shelter to Romney's use of Caymans entities to avoid unrelated business income tax (UBIT) with respect to his pension investments. Romney's strategy appears clearly to work as a legal matter, and the tax he is avoiding (the imposition of UBIT on debt-financed exempt entity investments) has contested merits, which may be one reason why Congress has not revised the rules to defeat the strategy (an almost absurdly simple one, based on not "looking through" a meaningless blocker entity). Gingrich's tax planning trick strikes at the heart of taxing earned income under the rules that are supposed to apply to it. Like so many abusive tax shelters, it appears to be based on mischaracterizing actual transactions, rather than merely exploiting a legally relevant technical lacuna in the law. What is more, if audited, Gingrich (unlike Romney) might face a risk not just of losing the case, but of owing penalties.

New article on financial sector taxation

2012-01-20T17:24:00.002-05:00

I have now posted on SSRN a first draft of my just-completed article, "The Financial Transactions Tax Versus (?) the Financial Activities Tax."

It is available for download here.

The abstract reads as follows:

The 2008 financial crisis has provoked widespread interest in developing new taxes to apply to the financial sector. In particular, the Staff of the International Monetary Fund has suggested enactment of a financial activities tax (FAT), while the European Commission has proposed a financial transactions tax (FTT). This article discusses the FAT and FTT models that have featured in historical and more recent discussion, and evaluates them in light of the objectives stated by the European Commission, along with broader tax policy considerations. It concludes that there is a strong case for enacting an FAT, and that two alternative versions of this tax have competing pluses and minuses. With respect to the FTT, it concludes that the rationales advanced by the European Commission are unpersuasive, but that an argument could perhaps made for the tax – subject to concern about its clear inefficiency at certain margins – based on the goal of discouraging the socially excessive pursuit of trading profits (or if better instruments for raising revenue and increasing progressivity are politically unavailable).

But enough about taxes and politics, what about the weather?

2012-01-19T17:06:00.003-05:00

Every winter - even uncommonly mild ones, such as winter 2012 so far - I keep asking myself: Have we bottomed out yet? When does the average daily temperature stop falling and start to rise?

Today I finally thought to do an online search that would enable me to answer this question. According to the relevant link at weather.com, the average mean daily temperature in New York City declines from 34 degrees to 33 on January 1. Then on January 10, it drops another degree to 32. There it stays until January 24, when it rises back to 33. It goes to 34 degrees on February 4, 35 on February 11, and whee, up we go back towards ranges where human beings could biologically survive indefinitely even without clothing and shelter.

Bottom line, we are more than halfway through what is on average the very coldest stretch.

Romney Caymans tax planning follow-up

2012-01-19T16:24:00.012-05:00

A Wall Street Journal article suggests that Romney's use of offshore entities in the Caymans, permits him to avoid the unrelated business income tax (UBIT), which can kick in when tax-exempt entities (such as pension funds) have debt-financed portfolio income.

This raises the question of whether we should view Romney (a) as having been engaged in disreputable tax avoidance behavior, demonstrating how the rich and well-advised can avoid intended income tax liability - or instead (b) as merely avoiding traps for the unwary and/or structuring his investments rationally and in a tax-efficient manner, as any well-advised investor would.

The question has no clear answer. Those who would like to plunge into the thickets a bit should definitely consult the article on using overseas entities that David Miller presented at the NYU Tax Policy Colloquium last year, which you can find here. At pages 40 through 48 of the article (following the numbers on the bottom of each page, rather than the overall document numbering at the link), he explains in detail both (a) the underlying UBIT rules and how they might have created a tax liability but for the apparently standard strategy that I gather Romney followed (investing through Caymans "blocker entities"), and (b) how the strategy eliminates the UBIT liability (which is pretty simple - the US tax-exempt doesn't itself borrow, but just gets dividends from its Caymans creature which does the borrowing).

The paper also tackles the further question of whether we should think there is anything wrong with allowing the strategy to work. The suggested conclusion (see pages 47-48) is that (a) Congress really did intend to apply the UBIT in situations where Romney's tax planning strategy permits him to avoid it, but (b) the provision that he is avoiding "was crafted less by prudent tax policy and more by politics," and hence one might not object strongly to its being avoidable.

UPDATE: I discuss the UBIT tax planning angle in a Christian Science Monitor article by Ron Scherer, available here.

What is Mitt Romney's effective or average tax rate?

2012-01-18T15:34:00.009-05:00

He now says that it is 15%. But if that is his opening claim, I would say that the smart money is on an over-under that is considerably lower.

Romney appears to believe that he can get away with releasing only the 2012 return, which obviously is being prepared with current campaign circumstances in mind. I myself would regard it as preposterous if he is not compelled by political pressure to go several years back, in keeping with what is otherwise universal practice in presidential campaigns.

Would his tax returns for, say, 2007 through 2011 look about the same as that for 2012, given that he has been running for president (or preparing to) throughout this entire period? If he has made good decisions, clearly yes. But he appears so clueless about the difference between his circumstances and those of average voters that I suspect the answer is no. He may simply have figured: this (i.e., extremely aggressive tax planning) is how you do it, and how everyone does it.

But suppose he releases his tax returns. How should we interpret them? There will be a lot of discussion of what his average or effective tax rate is, and how that compares to that for more average taxpayers. Indeed, he himself engaged in this analysis by quasi-endorsing the 15% figure.

An initial question is whether to benchmark the number we end up with against average taxpayers' income tax liabilities, or their income plus payroll tax liabilities. And if we include payroll tax liabilities for average taxpayers, should that include the employer share? (This would require grossing up the income measure to which one's tax liability is being compared.)

There certainly is an argument for including payroll tax liabilities. But it is true that, when you earn wages that are subject to the Social Security portion of the payroll tax, you may also be earning expected retirement benefits from Social Security. (Technical note: you only pay Social Security tax on your first $110,000 of wages, and the formula for determining retirement benefits counts only your 35 highest-earning years, excluding amounts earned that were above the tax threshold.) So arguably your net payroll tax liability is lower than your gross payroll tax liability. Then there's also the lifetime perspective (Social Security and Medicare benefits versus payroll tax liabilities overall in present value, rather than current year). This is an important perspective but obviously well beyond what we can imagine focusing on here.

Now let's get to Romney's income tax return itself. One possibility would be to compare the bottom line income tax liability to his adjusted gross income (AGI). This may be the source of his 15% estimate, if he is paying mainly capital gains tax based on the highly controversial income tax treatment of "carried interest" paid to private equity managers.

But suppose he also has a bunch of tax shelter losses that reduce AGI. Then there would certainly be a strong case for grossing up AGI, for purposes of the effective rate measure, to reflect the noneconomic character of such losses.

Suppose further that, since so much of his income took the form of capital gains, he used an aggressive "strategic trading" strategy to generate offsetting losses. The basic trick is as follows. You hold a huge stock portfolio, figuring that some will go up in value while others go down. You then hold the winners and sell the losers, generating sizeable capital losses. In one sense, these are not fake - the stocks you sold actually did generate the losses claimed. But it may radically misrepresent your overall portfolio results.

Strategic trading has the potential to wipe out income tax liability for rich people with large stock portfolios. It is combated by the capital loss limitation, which limits individuals' net capital losses claimed to $3,000 per year. But this is not a constraint insofar as the income you want to shelter is taking the form of capital gains.

Thus, there would be an argument for grossing up Romney's income measure, for purposes of the effective tax rate computation, to disregard capital losses, insofar as we suspect that this is going on. But the right answer depends on the rest of his stock portfolio, which will not be directly observable from his tax return.

A related issue, which came up in public discussion of Warren Buffett's effective tax rate, pertains to unrealized asset appreciation generally. It's a bedrock rule in our tax system that this stuff generally isn't taxed. But it is a part of economic income, so if you are interested in tax liability relative to that, it oughtn't to be ignored.

Now let's take the unrealized appreciation issue one step further. Suppose Romney has huge unrealized gains that have accrued economically overseas, in particular in tax havens, without being currently taxable in the U.S. Suppose that his not including all this stuff in his income reflects the very aggressive, but (under current law) perhaps legally defensible, tax planning that reports I have seen on-line suggest is characteristic of Bain investments. This, like tax shelter losses, might be viewed as unrealized appreciation plus. Excluding it would give a false picture, making his tax liability seem higher than it really is as a percentage of economic income.

Finally, let's consider a deduction that would reduce taxable income but not AGI. I have seen reports suggesting that he gives millions of dollars in annual charitable donations to the Mormon Church. At least if they're done in cash rather than reflecting tax gimmicks such as the use of appreciated property, this really does reduce his remaining cash out of pocket. But on the other hand, it is a voluntary and discretionary outlay, best viewed as how he chose to spend his economic income rather than as a reduction thereto. And it does reduce his contribution to the public fisc. So arguably the income measure that we use to compute his effective tax rate should not be reduced (relative to AGI) by his charitable contributions. But on the other hand, the size of his charitable contributions may be relevant to the characterological conclusions that we would draw from getting to see his tax returns.

There are some complex issues here, not all of which have an absolutely clear right answer, and not all of which would be entirely illuminated if he consented to the level of disclosure that all other major presidential candidates have accepted for decades. But I say, release the returns and we can let the debate begin.

Tax policy colloquium on 1/17/12 - Michelle Hanlon paper on offshore investment

2012-01-18T13:34:00.014-05:00

Yesterday was the first session of the 17th (!) NYU Tax Policy Colloquium. I am doing it with Alan Auerbach again, for the 3-½th time, and we have 27 students (the max allowed). Our Week 1 guest was Michelle Hanlon, with respect to her paper (co-authored with Maydew and Thornock), Taking the Long Way Home: Offshore Investments in U.S. Equity and Debt Markets and U.S. Tax Evasion.

The paper seeks to get a handle empirically on the existence and magnitude of illegal tax evasion by U.S. individuals that takes the following form. You want to invest in U.S. securities without paying U.S. income tax, so you establish a corporation in a tax haven (say, the Cayman Islands) and have it invest in U.S. securities. But you ignore the fact that such "round-tripping" gives you current year tax liability (or its present value equivalent) under the passive foreign investment company (PFIC) rules, obviously counting on the prospect that the U.S. tax authorities will not learn of your ownership interest in the offshore company.

Since researchers, no less than the IRS, can 't directly observe this illegal activity, one needs an empirical strategy to try to estimate it. The Hanlon paper finds two main things. First, when relevant U.S. tax rates go up (such as for individuals' ordinary income or long-term capital gains), inbound investment to the U.S. from tax havens tends to go up. The suggested explanation is that the higher tax rate increased U.S. investors' incentive to engage in fraud, but did not directly affect investors from other countries. Hence the surmise that perhaps the increased inbound capital flow may actually reflect round-tripping, and associated tax fraud, by U.S. investors.

Second, when certain agreements are reached between the U.S. and a tax haven country that may indicate an increased probability of detection for fraudulent evasion of the PFIC rules, inbound capital flows to the U.S. from the haven tend to decline. Once again, the surmise would be that, if only U.S. investors are being affected, it is a decent surmise that they are responsible for the change.

The paper makes a nice contribution by shedding some light on this issue, but it remains hard to tell just how much fraudulent round-tripping is going on. For example, one could concoct a scenario in which the U.S. tax rate increase induces U.S. investors shift to municipal bonds and tax-favored housing. So they sell securities to non-U.S. investors, who may invest through tax haven entities if they have other reasons for doing it this way.

Also, a higher U.S. tax rate could lead to round-tripping that is not associated with tax fraud. A paper that David Miller presented at the colloquium last year explored the various reasons why U.S. investors may choose to use tax haven entities, even when fully complying with the law (including the PFIC rules). For example, this structure may enable them to avoid itemized deduction disallowance or limitation rules that only apply to individuals. So we could potentially have the round-tripping story that the paper shows, minus the implication that it is mainly about tax fraud.

Likewise, suppose that there are U.S. taxpayers who have figured ways to engage in legal tax avoidance with respect to the PFIC rules, rendering them inapplicable in circumstances where one might argue that as a matter of policy they ought to apply. Once again, we would have the round-tripping story without the fraud.

Insofar as the data do indeed show non-trivial levels of tax fraud, the issue of what to do about it remains. Open questions include what sort of revenue estimate one might get for particular crackdown measures, and how things will change when the Foreign Account Tax Compliance Act (FATCA) takes effect next year.

Still, the paper presents a suggestive initial look at an area where there have been large gaps in our empirical knowledge.

Martin Luther King Day

2012-01-16T18:07:00.011-05:00

Though I was only 10 years old at the time, I well remember my shock, dismay, and disbelief (sorry for the cliched word choice, but those are the ones that fit) when Martin Luther King was shot. I learned of it from my parents (who must have had the TV or radio on), I would think in the early evening.

Recently I was reading a very compelling book, Hampton Sides' "Hellhound on His Trail," about Dr. King's last days, the assassination, James Earl Ray, and the FBI's pursuit. When reading about the horrific deed itself, even all these years later, I found myself getting choked up as if it had just happened.

At the time of King's death, his primary mission of combating legal segregation was pretty much done. He was struggling to define and advance a secondary mission, pertaining to poverty and economic opportunity as well as to U.S. military involvement abroad, but in a much more fragmented political environment, with fewer allies or good choices, and with less of a clear sense of how (or towards what ends) to proceed. But he certainly didn't think he was done.

The issues in his secondary mission faded from politics for a while in the decades after his death, and probably he would have had a hard time changing that. But today they arguably are even more pressing than in 1968. Something to think about on a day devoted to his remembrance.

Financial sector taxation

2012-01-16T15:50:00.004-05:00

I have just completed a first draft of a paper, entitled "The Financial Transactions Tax Versus (?) the Financial Activities Tax," that I will be submitting within the week for inclusion in a conference volume to be published by the International Bureau of Fiscal Documentation (IBFD). The underlying conference is the one in Amsterdam that I attended last month, which I discussed in an earlier blog entry here.

Once I've looked it over a bit more, I'll be posting it (with an abstract) on SSRN. I may also consider publishing it in either U.S. or International Tax Notes, which the conference organizers have given me clearance to do.

Further details, including abstract and an SSRN link, to come shortly.

I'll also be presenting it (leaving aside the point that speakers don't actually present their papers) at the NYU Tax Policy Colloquium on Tuesday, February 28, as we had to make a change in our previously announced schedule.

Those quiet rooms where we can discuss tax policy

2012-01-14T08:50:00.013-05:00

"QUESTIONER: Are there no fair questions about the distribution of wealth without it being seen as envy, though?

"ROMNEY: I think it’s fine to talk about those things in quiet rooms and discussions about tax policy and the like."

I guess I should thank Mitt for this, what with the 2012 Tax Policy Colloquium starting in 3 days and all. We certainly plan on discussing distribution and tax policy in our quiet room in Vanderbilt Hall. This may be our first ever explicit endorsement by a leading presidential candidate.

Outside our quiet room, however, the comment has rightly attracted the mockery that it deserves.

Though it's shooting fish in a barrel, let me briefly explain why. Government economic policies matter because they can affect how well off people are. Each person might end up with more or with less, depending on what policy is adopted and on how it works out. It is analytically convenient to divide all this into issues of efficiency and distribution. Efficiency is the size of the pie. Distribution is how the slices are divided between different people. You're always facing distribution issues unless it is a pure Pareto (and hence efficiency) case in which someone could gain without anyone else losing. Those issues are pretty easy to resolve - it's not hard to like policies that would make someone better off and no one worse off. The rest of the time, distribution is a key part of the story, and often this is about richer individuals as opposed to poorer ones.

So there are two basic dimensions in economic policy, and one of them, which is involved almost single time, Romney says can't be discussed in public. Would he hire an architect to design his 11,000 square foot house, and say "We can only talk about the size of the house, and not about how we are going to divide up the space between the rooms"?

Another point, of course, is that the government cannot help but affect distribution. It's not a matter of deciding whether or not to simply retain the (wholly fictional) preexisting, non-government distribution. We aren't living in a state of nature, we're in an actual political and economic world with centuries of government policy and ongoing effects on everyone. The question isn't whether to address distribution or not, but what it's going to be, and how different distributional outcomes will be traded off given efficiency (size of the pie) differences between them.

Then of course we have Romney proposing huge tax law changes, not just for the quiet rooms but for the actual halls of Congress, that would include vast, unfinanced tax cuts for people like himself, and apparently tax increases for the bottom 50 percent. But he evidently thinks, from his political handlers, that the "envy" talking point will permit him to dodge discussion of what he wants to do distributionally.

And of course it's not just tax policy. The legal environment in which Bain Capital operated led to a set of transactions around the country that had various efficiency and distributional consequences, which are certainly fair game for discussion. Now, as it happens, I might agree with Mitt that allowing takeovers, refinancings, and plant closings is better than trying to ban them - although we should (a) seek to ensure well-functioning capital markets, without which all bets are off about the ability of a free market economy to yield value-increasing outcomes, (b) keep in mind the effects of tax biases that may have helped drive the transactions, such as that for debt over equity, and (c) consider what policies could help the people who are the casualties of the process. Is that envy too?

If you cannot defend your own policies in terms that have some connection to how you might actually rationalize them to yourself, and instead show the world that you can only defend them publicly in terms that are laughable and (since you must know better) insulting, then perhaps you are in the wrong business.

A critique of Bain Capital

2012-01-13T06:38:00.004-05:00

The film denouncing Mitt Romney's work at Bain Capital, which apparently is playing in South Carolina but is also available here via youtube, may appear at first glance to be longer on story than coherent critique. But in fact it makes a specific claim about Romney's private equity career that deserves broader attention and assessment.

The claim is that Bain's business model under Romney was as follows. They would buy a business and boost its short-term profitability through measures that did not actually increase, and might indeed reduce, its long-term profitability. A specific example mentioned is demanding swifter production at the cost of much lower quality, which could increase sales for the first six to twelve months but then destroy a product's reputation and longer-term sales. Another is slashing wages, where they were previously higher for "efficiency wage" reasons, generating immediate savings but over a longer period reducing workforce productivity (e.g., due to higher turnover costs, change in the quality of the workforce, and morale effects).

The short-term profit jump would immediately be cashed out via higher debt, in many cases accompanied as well by a public stock offering. Bain would then cash out, leaving the business to fail because profits, once they reverted to lower levels, couldn't handle the debt burden.

While I don't know for sure that this story is (at least generally) true, it hangs together and makes logical sense. Note that, in bankruptcy, it might make sense to break up the business rather than simply refinance and keep it going, even if before the arrival of Bain Capital this would not have made sense even with a high debt overhang. Once they have destroyed intangible value (goodwill, workforce in place, etcetera), the company they purchased is no longer optimally using resources.

Obviously, the story requires a healthy dose of asymmetric information and capital market gullibility to get off the ground. (The suckers, after all, are not just the workers but also the lenders and the public offering stock purchasers.) But this is entirely believable. Think of Goldman conning its customers, AIG offering what was effectively an insurance product that it would never be able to make good if the insurance was needed, or mortgage securitizations that offered sham diversification benefits and were priced based on credit ratings that they did not deserve. Bain, under this view, is simply one more member of the rogue's gallery of players that found ways to generate enormous profits by causing the U.S. economy to work worse, not better.

This of course would be a story not of capitalism's "creative destruction," but of destructive destruction and the use of information asymmetries (pertaining here to the short-term profitability jumps that apparently drove the ability to borrow and drain out cash) to undermine the sound functioning of capital markets. And the extent to which it is true certainly deserves serious scrutiny in the months ahead.

On the road again

2012-01-09T12:20:00.003-05:00

I am sitting in Charlotte Airport, en route to Gainesville, Florida and the University of Florida Law School, where I am scheduled to give a talk this afternoon on international tax policy. I will be using (as a handout) the slides from my talk in Brazil, which I posted here early last month, but for discussion purposes minus thr Brazil parts.

2012 NYU Tax Policy Colloquium schedule with paper titles

2012-01-05T16:31:00.003-05:00

Just 12 days from now, the 2012 NYU Tax Policy Colloquium will be getting under way. I'll be doing it this year with Alan Auerbach. I've previously posted the schedule with speakers and dates, but here for the first time I can do so with almost all of the paper titles (some of which, however, are still tentative). Anyway, it will go something like this:

1. January 17 – Michelle Hanlon, MIT Sloan School of Management. "The Effect of Repatriation Tax Costs on U.S. Multinational Investment Efficiency."

2. January 24 – Amy Monahan, University of Minnesota Law School. "Will Employers Undermine Health Care Reform by Dumping Sick Employees?"

3. January 31 – Alex Raskolnikov, Columbia Law School. “Not Close Enough: Accepting the Limits of Tax Law and Economics.”

4. February 7 – Victor Fleischer, University of Colorado Law School. "Tax and the Boundaries of the Firm."

5. February 14 – Heather Field, Hastings College of Law. "Binding Choices: Tax Elections & Federal/State Conformity."

6. February 28 – Dhammika Dharmapala, University of Illinois Law School. “Taxes and the Real Option of Delaying Incorporation.”

7. March 6 – Edward Kleinbard, USC Law School.

8. March 20 – Susan Morse, Hastings College of Law. “Worldwide Corporate Income Tax Consolidation and a Corporate Offshore Excise Tax."

9. March 27 – Stephen Shay, Harvard Law School. “Unpacking Territorial.”

10. April 3 – Jon Bakija, Williams College Economics Department.”Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data."

11. April 10 – Lane Kenworthy, University of Arizona Sociology Department. "Getting taxes right: What can we learn from the comparative evidence?"

12. April 17 – Yair Listokin, Yale Law School. “’I Like to Pay Taxes’: Lessons of Philanthropy for Tax and Spending Policy” (with David Schizer).

13. April 24 – William Gale, Brookings Institution. “Fiscal Therapy.”

14. May 1 – Rosanne Altshuler, Rutgers Economics Department, and Harry Grubert, U.S. Treasury Department. “A New View on International Tax Reform.”

New York Times article on corporate stock options

2011-12-30T11:45:00.025-05:00

In today's Times, David Kocieniewski has an article noting how the revival of stock prices has led to a new explosion of executive stock options offering huge payouts to high-ranking executives. The article emphasizes the entity-level tax angle, which is that, when the executives exercise their options - typically at a huge profit, even if their companies have failed to outperform the stock market - the companies get huge deductions that may zero out their taxable income.

The natural reply to make to this critique is that there is no tax angle after all, if the executive is taxed at the same marginal rate as the company. (And note that even a company facing a low average rate on its income, due to other tax planning such as causing its U.S. income from intangibles to be treated as arising in tax havens, may face a 35% marginal rate in the effective range.) Thus, if Steve Ballmer gets a $100 million stock option and both he and Microsoft face 35% marginal rates, then its $35 million tax saving is offset by his $35 million tax bill. Denying it the deduction but taxing the underlying income only once - by allowing him to receive it tax-free - would lead to an identical after-tax result on both sides of the transaction if it responded to the change in rule by paying him $65 million.

I doubt many readers of this blog entry will consider this either a novel or a hugely surprising point. Indeed, it is made repeatedly, and at times vituperatively, by readers of the NY Times article who posted comments discussing it. So let em just add two further lines of discussion here.

First, I would certainly agree that the executive comp discussed in the article is a huge problem, even if it isn't a tax problem. The issues it raises are twofold: distributional and corporate governance. As to the former, rising executive comp over the last 20 years is a huge contributor (both directly and indirectly) to rising U.S. income inequality during this period. Conventional economic theory would suggest that this merely reflects that the execs are adding more value, so even if you dislike the distributional result it would be gratuitously inefficient to attack rising executive comp as such. I happen to think that conventional economic theory is wrong in this case, but that would require a lengthy discussion of its own that doesn't really fit well here.

So let's move on to corporate governance. A large part of the appeal of stock options to inside players as an executive comp tool lies in the opportunity that the options offer to facilitate looting of publicly traded companies, if you want to put it as rudely and crudely as possible. Or. if you want to put it more politely, stock options are a really crucial tool for overpaying mediocre executives - not all of whom can be above-average, after all. Even without any tax angle at all, the options offer a wonderful excuse to compensate the mediocre as if they were geniuses, by allowing them to ride the overall rise in the stock market to claim huge payouts that they pretend reflect their own influence on the stock price. (And if the stock market goes down rather than up, no problem - the company simply reprices the options and gives the executives another chance. So it is rather like getting to place huge bets on the roulette wheel where it's someone else's money, and where if red doesn't come up this time you get to try again and again.)

While this is a serious corporate governance problem, to a degree one could argue that the tax system actually helps, rather than making things worse. High-ranking executives might be happier still if stock options were nondeductible, assuming that this meant that they would also be treated as tax-free to the grantee. Returning to the Ballmer-Microsoft example, in such a state of the world they could announce the value of the grant (at exercise) as only $65 million, yet it would produce the same end result as giving him $100 million under current law.

Indeed, taxpayers like this result so much that they are often apparently quite willing to risk paying MORE tax overall if this permits them to steer as close to it as present law permits. As a starting point for explaining this, note that options could in principle be taxed earlier still - when they are granted, rather than when they are subsequently exercised via a purchase of the company's stock at the option's strike price.

Why aren't executive stock options taxable when granted? After all, they may have significant option value even if they are not yet "in the money." The reason that they usually are not taxable when granted is that they usually remain subject to a "substantial risk of forfeiture" (rather than having irrevocably vested), rationalized on the ground that they represent contingent compensation for future services that might affect the stock price and thus the option value.

Under the relevant Code provision, however, employees can elect to have the options valued and included (as well as deducted by the company) in the year when they are granted. If they make this election, the option is valued as if the risk of forfeiture did not exist.

This in turn led for years to the following tax planning trick. I elect to have my option valued and included / deducted in the year when it's granted. But I claim that the option value is zero, reflecting that it is not yet in the money (i.e., the stock price doesn't yet exceed the exercise price). In fact, the claimed value is ludicrous, since the person claiming the zero value would very likely refuse to sell the option, if this were permissible, even if offered many thousands (or perhaps millions) of dollars for it.

The IRS was so upset about this trick that it issued a regulation providing that, if the option's value isn't sufficiently "ascertainable" (which basically requires that it have an observable market price), taxpayers can't go the election route here. So the IRS effectively forces many taxpayers, contrary to their preferences and an arguably fairer reading of the statute itself before the regulation was issued, to wait for taxable income at a later point.

The funny thing about this, in turn, is that, once the employee has recognized taxable income (and the employer a matching deduction), further appreciation is taxable to the employee (though generally at just the capital gain rate) without a matching employer deduction off any kind. So the low valuation "scam" that taxpayers prefer and the IRS prevents may actually be a route to higher, rather than lower, overall taxation.

What could possibly be going on here? Well, probably several things. For one, if the company has net losses (as may be common in the start-up period even without tax haven games and the like) then the employer deduction doesn't actually make up in full for the employee inclusion. For another, if you hold the stock until death then the deferred tax on post-taxability appreciation permanently disappears. Perhaps a few people are myopic and just want to defer the employee-side day of reckoning. Executives who are trying to hide the ball regarding how much they are actually getting paid don't want to pay tax sooner since it's inconvenient to have to rely on gross-up to make themselves whole.

Bottom line, without condemning today's article in the Times there are still some interesting angles to pursue, though it's possible that the editors would consider them too esoteric for a page 1 placement. But perhaps still worthy of page 1 in the business section?

Wonky teaser for my FAT versus FTT article

2011-12-20T12:55:00.002-05:00

Bruce Bartlett's newly posted Tax Notes column criticizing financial transactions taxes (FTTs) reminded me that, while James Tobin is often considered the FTT's grandfather due to his 1970s advocacy of a tax on currency exchange transactions, John Maynard Keynes offered a seemingly very similar rationale for a tax on securities trades. However, I may argue in my paper that, insofar as the rationales can be teased apart, Keynes' actually stands up better today than Tobin's.

As the year winds down ..

2011-12-20T11:58:00.005-05:00

I'll be spending a significant portion of the winter break writing a short article (based on my talk at the Amsterdam conference earlier this month) called "The Financial Transactions Tax Versus the Financial Activities Tax." I conclude, however, that the article's title states a false opposition, since a financial activities tax (FAT) should be passed in any event, whereas a financial transactions tax (FTT) might or might not be desirable on balance - whether or not there is an FAT - based on issues entirely distinct from the overall treatment of financial sector firms and the risk of another 2008.

The one time I baffled my Amsterdam audience with American slang

2011-12-10T17:03:00.003-05:00

In general, I thought my Amsterdam talk went smoothly and was well-received. But at one point, with reference to bankers who make bets that have positive expected returns for them because they don't bear the downside tail risk, I unthinkingly said something about how sometimes it comes up snake eyes. Alas, pretty much no one in the predominantly Dutch audience knew what this meant, and several asked me afterwards. But they agreed that the Americanism for rolling a pair of ones in craps is striking and apt.

Amsterdam conference on bank taxation

2011-12-10T08:30:00.017-05:00

Yesterday was the conference day in Amsterdam at which I delivered my talk on the FTT versus the FAT (see previous entry). The FTT, aka (in an absurd misnomer, whether one Iikes the tax or not) the "Robin Hood tax," did not, for the most part, receive a lot of love. Not surprisingly, representatives of banks and hedge fund-type asset managers were, shall we say, restrained in their enthusiasm for the measure. But academics were mostly skeptical as well, for good reason, notwithstanding the contrarian instincts that a couple of us had.

By the way, although for convenience I'll continue calling the European Commission's proposal an FTT, it is really an STT, or securities transaction tax, as stock trading (other than primary issuance) is the core item covered, and things such as currency exchange (the original Tobin tax target) and debt transactions are excluded.

An FTT is potentially extremely avoidable. For example, as is well known, geographically. A telling example arose when Sweden enacted an FTT a few years back, even though all the financial actors that would have been charged with collecting the tax said they would avoid it by going to London. This of course is a standard taxpayer threat, not always fulfilled in practice, but lo and behold, when the tax was enacted 60 percent to 80 percent (depending which estimate you take) did indeed go to London virtually overnight.

Then of course there is the issue of using derivatives. Why sell stock, for example, if you can use a swap instead. So a modern day FTT is a joke unless it can reach derivative transactions, by interpreting them as versions of some underlying "primary" transaction.

The Commission's response to this problem has been to try to pitch the proposal broadly. While it can't reach transactions that wholly leave the European tax net (e.g., say an American pension fund would have used German bankers to purchase developing world equities, but decides instead to use a U.S. broker), but the design tries to push having some sort of European connection as hard as it can.

Likewise, derivative transactions ostensibly are reached by basing the tax (though at a lower rate than for other transactions) on the highest (in effect) notional principal amount one can come up with in defining the direct transactional equivalent. (Unclear, of course, whether this is coherent or feasible.)

Exceptions for debt and insurance, which are excluded from the reach of the tax, would likely offer fertile tax planning grounds for avoidance efforts, especially if some EU countries decided to compete with each other for the hosting privilege by, say, broadening their state law definitions of insurance.

The Commission's STT would reach a lot of inter-bank transactions (often taxing both sides), and ostensibly would thus apply even to deemed transactions between branches of the same company or corporate group. Indeed, the Commission may regard this as a strength of the proposal, as it ostensibly counters the critique that customers rather than the banks themselves are being taxed. Some pointed out that this sort of cascading tax within the productive process is exactly what the VAT was supposed to end. (And it is of course contrary to any well-informed economic view about how to make business taxation less rather than more inefficient.)

As the next to last speaker on a long day, I was able to modify and fill out my commentary (from the previous blog entry) a bit, such as by noting that what I see as the best case for some sort of an STT (to discourage socially excessive pursuit of zero sum trading gains) would face many of the same problems but require a very different design. I might want to emphasize taxing trades with customers rather than internal cascading, but then again, what is a "customer" for this purpose? Surely it should include people who are seeking trading gains through a business entity (whether via share ownership or compensation arrangements), which potentially brings back the cascading issue. (And, just because integrated businesses, as distinct from those dealing with each other at army's length, are engaged in zero sum battles over division of the surplus, does that mean we want to comparatively tax-favor them? That wholly contradicts the Coase principle of hoping they will pick the arrangements that are best on a pretax basis.) So perhaps I have to settle for an STT just on sales to customers, though including some legal entities such as shells and pension funds, and without here affirming that it would actually be worth doing in the end.

A financial activities tax or FAT on banks, using a VAT-like design but perhaps with rising marginal rates to address bigness, rents, or suspected hidden tail risk (with the choice importantly affecting key design features) seems considerably easier both to design and to rationalize persuasively.

Amsterdam slides: The Financial Transactions Tax Versus the Financial Activities Tax

2011-12-06T16:35:00.004-05:00

My slides on the FTT versus the FAT, to be presented this Friday at the Amsterdam Centre for Tax Law's conference on taxing the financial sector, are available here.

One topic I don't address in the slides, because I didn't think it was within my topic assignment, concerns the question of FTT feasibility. An FAT is pretty much feasible. The only really troubling question (and I admit it's a significant problem) is defining the set of financial sector firms to which it would apply. In particular, what does one do about the issue of financial firms that are in effect embedded in non-financial firms?

With respect to the FTT, one problem is international considerations, which are likely to be a lot more troubling than those presented by the FAT. Domestic banking activity, which the latter tries to reach, is a more stable and less elusive category than the former's reach of domestic financial transactions (or even those conducted by domestic taxpayers).

But in addition, the wonderful world of derivatives presents a huge challenge for the FTT. I know people are aware of this, and contemplate taxing derivative transactions under the FTT equivalently to the "primary" (or whatever one calls it) transactions that they replicate. But it may often be impossible to determine this equivalence, since there may be multiple renderings of what is equivalent to a given derivative transaction. This is likely to be a big problem even if regulators are able to observe everything that is happening, which is a big question in itself. I believe that other panels at the Amsterdam conference may be directly addressing this issue, but it did not appear to be the focus of the more bigthink-oriented panel on which I was asked to participate. It is certainly important, however.

Part of my responsibility in connection with the proceedings is to write (by the middle of January) a short article that will be published in a conference volume that the Amsterdam Centre for Tax Law is planning. I will of course post it on SSRN, and I also have permission to do something with it in the U.S., such as submitting it to Tax Notes. But I don't know yet if I will consider this suitable. (I'd have to see what I write in order to evaluate this - the issues being both how happy I am with it and whether it seems sufficiently in-context for U.S. publication.)

That photo surfaces again

2011-12-06T16:10:00.015-05:00

A number of friends and acquaintances have mentioned to me, over the last couple of days that this 1992 photo of me with (now)-Justice Elena Kagan has surfaced again, this time in the latest issue of New York Magazine.

Someone was kind enough to say that I don't look much different today despite the nearly twenty year interval. But I suppose that, if only the photo were doing all of the aging for both of us, Dorian Gray-style, perhaps I would feel better still. As it is, I can certainly tell the difference between then and now, even if it doesn't all show.

If it's Friday, this must be the Netherlands

2011-12-06T08:30:00.015-05:00

Okay, I admit to having overextended myself a bit these past couple of months. But I am hoping my body will accept the last few insults (such as time zone changes and overnight flights) without getting too angry at me.

Although I returned from Brazil only yesterday (Monday, December 5), an evening flight on Wednesday, December 7, will take me to Amsterdam early on Thursday, thus giving me a day to time zone-adjust before I present a talk on Friday at the Amsterdam Centre for Tax Law's Conference on Taxing the Financial Sector. This time, I am just one voice in the crowd, rather than the headliner.

Why did I accept, notwithstanding the events' close proximity? Well, for a few reasons, even apart from my being generally more temperamentally inclined towards yes than no. One is that the conference looks interesting and has a good group of people that is different from those I have been seeing lately at other conferences. Another is that the topic is quite interesting, and different from international tax, which has been my main focus in recent months. Plus, I haven't been in Amsterdam since 1983, and wouldn't mind seeing the Van Gogh Museum and Rijskmuseum again, as well as the Anne Frank House for the first time, not to mention having some rijstaffel and strolling around the canals and all that, even in what is likely to be fairly dismal weather.

The background for the conference is that people in Europe are debating various tax instruments for the financial sector. Unlike in the U.S., such taxes can actually be enacted, at least here and there. The International Monetary Fund Staff advocated a financial activities tax (FAT), which is essentially an excess profits tax on banks (reaching high-end employee compensation as well as profits that remain after paying all that swag). But the European Commission has endorsed a financial transactions tax (FTT) in lieu of the FAT. An FTT is a tax on securities transactions (other than initial stock issuance).

It's unclear to me, even after reading the European Commission's work on the subject, exactly why they prefer the FTT to the FAT. There is probably a political backstory, at which I can guess, but as an American (and thus an outsider to the European debates) I certainly don't know anything about this firsthand.

My own prior work, as well as blog posts, explain why I consider the FAT a better choice than the FTT. But, as my slides will show when I post them here in the next couple of days, I actually do see a decent rationale for enacting a modest FTT in addition to (not instead of) an FAT - or more precisely, independently of whether or not an FAT is enacted. Only, this rationale for an FTT has nothing to do with those offered by the European Commission, or with addressing past or expected future financial sector defalcations, or indeed with responding in any way to the threat of future bank failures reflecting undue risk-taking incentives that are likely to lead in the future either to costly bailouts or to further macroeconomic catastrophes (or perhaps, like last time, to both).

More on this shortly.

Reprieve

2011-12-05T13:16:00.011-05:00

Today I flew back from Sao Paulo to engage, among other things, in the grim task of going to the veterinarian in order to assess how my favorite little gal, Ursula, is doing.

The state of the play when I left for Sao Paulo was: Not so good. A couple of years ago, she just barely survived a kidney infection that left her with damaged but still for the most part functioning kidneys. But she had worsened again from a new infection, needing to be hospitalized and placed on IV, which in turn had transitioned to no-heroic-measures. Here is how she looked in the vet's office a few days ago.

So when I went to see her today (with spouse), having pretty much just gotten off the plane from a redeye flight, my understanding was that it was not impossible that we would need to be saying goodbye to her very soon. To my relief, however, she looked pretty good - there is plenty of energy and fight left in the little gal yet, at least for now. So she has returned back home, where she is eating and rubbing her head against people while purring loudly in the accustomed manner. No telling how long this will last, however, and she will be needing daily water shots.

I hope Ursula wouldn't mind if she knew that I was cozying up with some other animals while I was in Sao Paulo. Kind of burying my sorrows, I suppose.

Deborah Paul comments on Avi-Yonah dividend deductibility proposal for corporate integration

2011-12-05T12:51:00.011-05:00

Some time back (on October 4 of this year), I was a commentator, along with Deborah Paul of Wachtell, Lipton, Rosen, and Katz, on a paper by Reuven Avi-Yonah of U. Michigan Law School concerning dividend deductibility as a corporate integration method. A link for Reuven's paper is available at my blog entry here, and my comments at the session are available here.

Debbie Paul, whose comments I thought were quite good, has now published a written version on SSRN. It is available here.

Conference in Sao Paulo, Brazil

2011-12-04T17:09:00.006-05:00

I'm in the Sao Paulo airport, awaiting my overnight flight back to the U.S. after a very enjoyable few days here.

My talk, from the PPT slides posted in my previous entry, appeared to go well apart from the obvious distress that I caused the live-simultaneous translators. It took three of them to handle my talk (of perhaps about an hour?). They were dropping like horses on the Pony Express overnight delivery run, and seemed to think I was talking a bit fast. Not the first time I've heard this critique, but the live audience, which was 99 percent listening in English, appeared to be getting it fine. I later observed that quite a few of the Portuguese speakers at the conference, who were likewise being translated live (I believe, just for me), spoke every bit as fast as I do. But the translators told me afterwards (between shudders at the memory of the exhausting experience) that, for every 10 words or so of English speech, you on average need 13 or 14 words to say the same thing in Portuguese.

Anyway, people seemed interested in the talk. Brazil is an interesting case. At one time in the past a territorial country in re. outbound multinational investment, they have gone opposite to much of the rest of the world by shifting to a fairly tough worldwide system, with no deferral, tough formulaic transfer pricing rules, and anti-tax haven rules for foreign tax credit use (cross-crediting). They also have a 34 percent corporate rate, and are asking some of the same questions as people in the U.S. re. what to make of trends elsewhere.

Apparently, their shift in the other direction reflected that the government was looking for tax revenue and acted, whether for better or worse, without a lot of political debate about the usual set of international tax policy issues. But now Brazilian academics and civil society are getting interested, not in a particular change that they've already picked out, but in thinking about the issues more.

I offered the sort of analysis I've been arguing for in international tax policy lately, but without purporting to say "you should definitely do X." Rather, in addition to the structure of the analysis I noted some empirical issues that might help in evaluating what was best.

I also ended up commenting on a couple of other panels, first more on international taxation and then concerning transparency. I also participated in an informal seminar at a very nice separate location (on Ihla Bella, an accurately named island 3-plus hours from Sao Paulo), on issues of how the Internet et al has affected legal issues such as those pertaining to intellectual property. I suppose you could say I took somewhat of a modified Frank Easterbrook "law of the horse" type position.

I can't really say enough about what a warm and hospitable reception I received from the Brazilian and other (such as Argentinian) participants in these various events. I got a cultural impression of greater personal warmth and also taste for having a good time (such as with live music and very late evenings) than one would expect in a get-together of, say, North Americans or Europeans.

Slides for my talk in Sao Paulo on international tax policy

2011-11-29T10:18:00.005-05:00

A pdf of the slides for my keynote lecture at the NEF's Third Annual Colloquium in Sao Paulo, entitled "Rethinking International Tax Policy," is available here.

Upcoming talk this week

2011-11-28T22:33:00.014-05:00

This Wednesday morning, at the horrifying time of 4:45 AM, I will be heading to the airport en route to Sao Paulo, Brazil, where I will be the keynote speaker on Thursday, December 1, at the Third International Colloquium, to be held at the Center for Fiscal Studies (called the NEF due to its name in Portuguese), which is affiliated with the University of Sao Paulo Law School. The NEF is a think tank that aims to bring together academics, government representatives, the private sector, and civil society organizations to advance public thinking about tax reform.

A Portuguese-language schedule for this colloquium is available here. Prior keynote speakers were Richard Bird in 2009 and Vito Tanzi in 2010.

My talk will be called "Rethinking International Tax Policy," which I consider adequately descriptive, albeit not, as titles go, especially original or inspired. (How many "Rethinking ..." papers have there been on various legal subjects in the last 20 years?) But I am hoping that the content will be more original than the title.

Brazil is an interesting country, and also has fairly distinctive international tax rules, which I will mention in passing, although I certainly would not claim any more than a very general and superficial familiarity with them.

I have PowerPoint slides for the talk, and will post a pdf of them here on Thursday, if my iPad and wireless access cooperate. I've completed them and thus, I suppose, could post them now, but in general I don't like scooping my own talks at conferences in this way.

Cruel practical jokes

2011-11-27T12:24:00.003-05:00

I would never actually do this, but when I see one of my cats sniffing the seat of a soft chair while turning slowly around, preparatory to curling up for a nap, it occurs to me: What if some cruel practical joker had sprayed coyote scent (at a level undetectable by humans) on the spot?

NTA Annual Meeting in New Orleans, part 4

2011-11-21T14:17:00.015-05:00

The final panel in which I participated in New Orleans was one at which I presented my article on rising U.S. corporate residence electivity.

Since this article is verging on old and cold (i.e., it's based on a talk that I gave in September 2010, and appeared in the Tax Law Review earlier this year), I decided to use the talk as a vehicle for pushing forward a bit, and including thoughts that I have been developing in the last few months while working on my international tax book in progress. Hence, I called my talk "The Rising Tax-Electivity of U.S. Corporate Residence (... and Beyond)," and used the last couple of slides to push farther than I have thus far in print (other perhaps than earlier powerpoint slides that I have posted at this blog) on how I am thinking these days about how we should tax U.S. multinationals' foreign source income.

The slides are available here. I should note one difference between the version that I am posting and the one that I actually used in New Orleans. The latter included a slide asserting that Desai and Hines are "in error" insofar as they assert that the asserted national welfare norm of national ownership neutrality (NON) supports exempting U.S. companies' foreign source income. But, as Jim Hines noted at the session, there is no error either in identifying NON as a relevant margin at which distortion is undesirable (all else equal), or in asserting that NON supports exemption.

What I would regard as in error is saying that U.S. national efficiency would be maximized by basing our international tax policy on NON. I would argue that this, by over-focusing on one margin when in fact there are many to consider, would affirmatively diverge from minimizing the overall economic distortion caused by the U.S. federal income tax system. Even given this point, however, Desai and Hines are only in error if they do in fact assert that NON establishes that exemption is the most efficient international tax policy for the U.S. to follow.

Now, some may feel that they do effectively assert this, but the articles in which they introduced NON to the literature acknowledge that there are broader efficiency issues to consider. Thus, I decided to remove the "error" claim before posting the slides.

NTA Annual Meeting in New Orleans, part 3

2011-11-21T09:42:00.011-05:00

As noted in earlier blog entries, I wanted to offer a brief account of the other two panels in which I participated at the NTA Annual Meeting in New Orleans. Herewith the first additional entry, concerning a panel at which I commented on two empirical papers on international taxation.

The first paper on which I commented was Eric Allen & Susan Morse, "Firm Incorporation Outside the U.S.: No Exodus Yet," which is available here. Allen and Morse use hand-collected data (a phrase in general usage that I nonetheless find charmingly antiquarian, since I would assume people mostly do it with computers) to make a very useful rifleshot finding that contributes to our understanding of U.S. incorporation practices.

As I noted in my residence electivity article, if the U.S. pushes worldwide taxation of U.S. companies especially hard, one might expect rising foreign incorporation by U.S. start-ups. The article notes anecdotal evidence, offered to me by leading practitioners, explaining why in their experience home incorporation remains the norm in most business sectors, even for the potential multinationals of the future. Home incorporation turns out to have significant advantages in the start-up phase. Plus, so long as one places one's valuable international property abroad for tax purposes, the U.S. regime generally is not all that onerous anyway. But I noted suggestive evidence from an article by Mihir Desai and Dhammika Dharmapala that tax haven incorporations have risen in recent years. Might this be the start of a trend? Both I and the authors of that article stroked our chins (metaphorically speaking) and said yes, it's just possible that it might be.

Allen and Morse lay this to rest, however, by finding that the recent tax haven incorporation boomlet appears to reflect almost exclusively action involving start-ups from China and Hong Kong. U.S.-headquartered companies are not contributing to it at any significant level.

Good to know this. Now, I noted that this finding doesn't rebut the possibility that rising tax-elasticity of overseas investment by U.S. companies might still be a current trend and a problem, operating along other margins (e.g., new equity issuances, and clientele effects regarding who ends up investing where). Nonetheless, Allen and Morse have made a very nice contribution by making this new finding about tax haven start-ups, and I imagine that they will be cited regularly for this (certainly by me).

The second paper on which I commented was "Taxes and the Clustering of Foreign Subsidiaries," by Scott Dyreng, Brad Lindsey, Kevin Markle, and Douglas Shackelford, which is not yet available on-line. This paper notes that the empirical literature to date on how U.S. (and other) multinationals (MNEs) shift income between affiliates has generally operated under the assumption that all company choices regarding where to place an overseas affiliate are made independently.

For example, if Acme Products U.S. decides to place a controlled subsidiary in the Netherlands, this is assumed to have absolutely no effect on whether it will also put one, say, in Belgium, France, Germany, Ireland, or the Bahamas (to name just a few where we know that in fact there might be interacting causation). The literature adopts this view, not because anyone actually believes that affiliate choices are independent, but because we don't know how they interact with each other.

The Dyreng-Lindsey-Markle-Shackelford paper attempts to figure out relationships by coming up with "expected" correlations between where one has an overseas affiliate in the absence of a tax motivation, and then comparing this to the actual correlations that are found. E.g., if one found lots and lots of MNEs with affiliates in Germany plus the Caymans, this might suggest that the pairing is tax-motivated unless there are other grounds for expecting it.

The difficulties in deriving findings on this very interesting topic (which potentially would help inform policymakers), include the following:

--It's hard to say what correlations would be expected absent tax considerations. For example, should companies be expected commonly to have affiliates in neighboring countries? Leaving tax aside, one could imagine that a Netherlands sub is either a substitute or a complement for one in Belgium. On the one hand, the MNE is active in the area and thus might want to go to more countries that are nearby. On the other hand, perhaps the Netherlands is close enough to Belgium to reduce the need for a specifically Belgian sub if one starts being active there.

--Likewise, tax-induced relationships between affiliates may turn on either substitution or complementarity. E.g., being in one tax haven may either make a second tax haven less needed than otherwise, or else make the second one all the more valuable, as in "Double-Dutch-Sandwich" type schemes that require laundering profits through several successive locations. In addition, by going to one tax haven, a company may provide evidence that it is the type of company that likes to use tax havens. So, if it was also in other tax havens at "unexpected" levels, this might reflect endogeneity rather than complementarity.

--The real action may involve multi-jurisdictional clustering, not just two-country pairings. But that makes testing for empirical relationships even harder.

--Suppose that having a sub in Bermuda is a substitute for having one in the Caymans for companies following Strategy A, but a complement for those that are following Strategy B. Then one might fail to find net correlations that reflect tax planning, but it would still be going on in case after case.

The authors are quite aware of all these problems, and are struggling ingeniously to refine their empirical strategy. I look forward to the end result, as it could be both interesting and useful. But in the interim, virtue (choosing an interesting project even though it is hard) may serve as its own unfair punishment.

Great news for NYU Law School

2011-11-21T09:30:00.003-05:00

We at NYU Law School will be adding a new member to our tax faculty next year, David Kamin, a recent grad who is currently working on tax and budget policy at the White House. Details here. David is going to be an outstanding academic as well a great colleague, and I'm very excited that he will be joining us.

Nudge nudge, wink wink

2011-11-20T11:52:00.003-05:00

No, that can't be. Is demure little Ursula actually winking at the camera?

NTA Annual Meeting in New Orleans, part 2

2011-11-19T15:24:00.008-05:00

Herewith some quick notes on one of the three panels in which I participated at NTA New Orleans. I guess you could call me a triple threat, as I moderated once, presented once, and was a commentator once.

The moderating gig was for a panel on corporate tax reform, with Rosanne Altshuler, Peter Merrill, and Martin Sullivan. As background, at a session the day before, it became clear to me that Rick Perry jokes have not yet reached their sell-by date, although I would imagine it won't be much longer. There are only so many changes you can ring on the theme of having three things to say and forgetting the third.

But it occurred to me at that prior day's session that I had a fairly good Rick Perry joke in mind that I could use at the corporate tax reform panel. I won't try to re-create it word for word here, but suffice it to sketch out the basic idea, which was that, if Rick Perry, rather than Herman Cain, had been the candidate who was pushing the 9-9-9 plan, he would have forgotten the third 9.

Anyway, at the discussion panelists noted that international is really the key issue even if we are thinking about domestic corporate tax reform. At least for now, Congressional Republicans, no less than the Administration, are committed to revenue neutrality if they lower the domestic corporate rate (say, to 25 percent) and also so if they enact some version of a territorial system that exempts at least a substantial swathe of foreign source active business income. But international looms at center stage even just with respect to the first of these ideas.

In this connection, I mentioned a central conundrum that I gather has been baffling policymakers from both parties. On the one hand, we keep hearing about corporate tax avoidance, such as in newspaper articles about the likes of Google and GE. On the other hand, the revenue estimators and those conversant with them keep telling the policymakers that it is extremely difficult to finance a lower corporate rate through base-broadening. How can both of these propositions be true? Shouldn't we be able to make the "headline babies" pay more through base-broadening?

The answer, of course, is that base-broadening, as conventionally conceived in terms of explicit tax preferences, has only a very limited overlap with multinationals' (MNEs') modern tax avoidance techniques. They mainly exploit structural weaknesses in the income tax, and above all the ease of transferring economic value that arises from people's activity in the US (such as when Google-bots create valuable IP in California, or wherever it is they work their magic) so that the resulting taxable income will appear in someplace low-tax and far away, such as Bermuda.

Thus, aggressively addressing problems with the source rules - or enacting worldwide taxation without deferral for suspect classes of foreign source income - is crucial to revenue neutrality here, as well as to ensuring that the domestic US corporate tax base - which vitally backstops the income tax on individuals for high-flying owner employees - is not entirely gutted with respect to MNEs, leaving it to fall just on domestic businesses (which might then become takeover targets by reason of the tax synergies).

One last point worth noting here, before I adjourn to the next post to discuss the other other panels I was on, is that it's extremely misleading to hear the constant refrain about how the US is "out of step" because everyone else has shifted to exemption. This statement is only true if one is extremely simplistic in using a one-zero scale to classify each international tax system as either US-style or territorial.

What such a classification misses is that most "territorial" countries make some effort to address the Google-style problems that many U.S. advocates of territoriality appear eager to embrace or at least ignore. In other words, the putatively territorial countries impose tax on a lot of "foreign source income" as to which there are grounds for suspecting that it is actually domestic source.

For example, a number of territorial countries limit exemption to foreign source income that is earned in other high-tax countries. The rationale arguably is not what it seems - that one wants domestic companies to pay more rather than less tax abroad - but rather that income which shows up in a tax haven probably wasn't actually earned there, and thus may well have been earned at home.

In my view, limiting exemption to investment in other high-tax countries is the wrong response to the problem, for the same reason that I question the foreign tax credit. From a national welfare standpoint, there is nothing wrong, and indeed it is affirmatively desirable, for one's companies (if owned by domestic individuals) to pay less tax abroad rather than more. Thus, I would counsel alternative means of in effect "tagging" the ostensibly foreign source income that is relatively likely to represent game-playing that erodes the domestic tax base. For example, rules concerning intangibles and intellectual property, as well as interest expense, may be able to serve the tagging function without incentivizing resident companies to pay "just enough" tax abroad to avoid the rule and consequent full domestic taxation.

More on this in due course as I try to advance my still not-entirely-formed thinking about source issues.

NTA Annual Meeting in N'Awlins, part 1

2011-11-19T15:11:00.005-05:00

I spent the last two days, and indeed all day both days, at the National Tax Association's annual meeting, which was held this year in New Orleans. All told, I participated in three sessions and attended (depending on how you count) as many as nine others, including an award session for lifetime accomplishment honoring Alan Auerbach, as well as a lunch on Friday in which Peter Diamond gave a keynote address on how policymakers ought to assess the current macroeconomic situation.

Diamond made, to my mind, a compelling and verging on unanswerable case for the proposition that policy makers ought to be VERY concerned about persistent cyclical unemployment, and not, under current circumstances, at all concerned about the immediate prospects for inflation. OK, this is a very familiar point to anyone who reads the New York Times. But in addition to making it well he explained his view, which I largely share, that the long-term fiscal gap, while a significant long-term problem, is not an immediate crisis.

In the course of doing this, he focused on the projected path of the U.S. publicly-held debt to GDP ratio, which is not projected to get really hairy for at least 15 years.

This led to a question after his speech by a well-known (at least within the field) and somewhat idiosyncratic economist who has done important work relating to how we should think about long-term budgetary issues, but who has not previously been named in this blog post (hint hint). This individual strongly holds the view that public debt is an entirely, and I mean 100 percent, meaningless measure and that only the infinite horizon fiscal gap has any economic meaning whatsoever. Hence, in his view, if the infinite horizon fiscal gap, under our best forecasts of current Medicare, Social Security, & Medicaid policy et al, indicates fiscal unsustainability, then it is utterly irrelevant how fast the public debt rises. In his view, if there is a present value of, say, $20 trillion for expected 22nd century unfunded Medicare outlays, the fiscal problem this represents is literally indistinguishable from the case where the U.S. issues (for zero cash) $20 trillion of additional public debt today. If you say: Ah, but we could change Medicare policy before the 22nd century actually gets here, he will answer: So what, it is equally true that we could renounce $20 trillion of explicit debt. Only naive formalists, he is certain, could see any difference whatsoever between the two. (What is more, to him this is a matter of logic or science, not empirics. He alternates between saying that the empirics MUST match up with the economic logic, and that if they don't, then so much the worse for them.)

Diamond, who is familiar with these arguments by this individual, gave them somewhat short shrift. This brought to my mind e-mail debates that I have had with this individual on exactly this topic. In these debates, he repeatedly, and one could almost say a bit indelicately or even tactlessly, told me that the only reason I don't realize that he is correct is because my training as a lawyer has left me cognitively unable to see past mere semantics and form. This struck me as not just ad hominem but affirmatively incorrect, given that (I am pretty sure) at least 99 out of 100 economists would agree with me and not with him. (Indeed, perhaps all 100 unless he was included in the group.)

Anyway, I saw this individual afterwards, and could not resist noting that Diamond shares my view rather than his. I said, while this doesn't prove that we are correct, surely it does suggest that my view doesn't just rest on my being a lawyer.

"Oh, Diamond isn't very serious about the economics of this," he replied - perhaps not quite breezily, which in any case would be clichéd writing on my part, but certainly dismissively.

Speak of non-falsifiable propositions ...

Today's Occupy Wall Street developments

2011-11-15T17:19:00.012-05:00

I was distressed to learn today of Mayor Bloomberg's ugly and under-handed quasi-military police action in Zuccotti Park last night. It is exactly the sort of arrogant, sneaky, bad-faith, and self-pleasing venture, complete with police violence and concerted efforts to muzzle live press coverage, that one would expect of such colleagues of his in the media and government businesses as fellow oligarch Silvio Berlusconi. I am hoping that mayoral recall petitions (if there is such a procedure in NYC) will start to circulate.

That said, while I was disappointed by the ruling just issued by the New York State Supreme Court to the effect that, while OWS people must be allowed back into the park, they cannot reestablish a permanent encampment with tents and such, I did feel upon reading the ruling that it appears legally reasonable.

The OWS people need to be very smart now about how best to keep public attention focused on the issues of wealth distribution, rigged crony capitalism, and government policymakers' indifference to the interests of the "99 percent" that I gather motivate them - and how to retain broader public sympathy for themselves and their issues when the other side is just looking for excuses to demonize them - in a tough situation and when they no doubt are upset. Played correctly, it could end up having given them the perfect exit strategy from having to stay in Zuccotti Park (perhaps with ever-dwindling forces) all through the winter. But the next step is crucial, and it's unclear how well their collective decision structure can handle it.

Slides from prior post

2011-11-13T22:17:00.002-05:00

In case you saw my last post (on the University of Chicago Tax Conference, where I discussed foreign tax credits) while the link to (a pdf version of) my slides was still broken, I've fixed it, but you can also find them here.

Foreign tax credit discussion in Chicago

2011-11-11T18:25:00.010-05:00

I flew to Chicago last night in order to appear on a foreign tax credit panel this morning at the 64th Annual University of Chicago Tax Conference. As I said at the start of my remarks this morning, I was glad to appear there, not just because it's an excellent conference (though it is - surely the best practitioner-led tax conference that I know of anywhere), and not just because I saw many old friends and acquaintances all around the room (although I did, some going back more than 25 years and whom I don't see regularly), but also because the conference was originally inspired and led by the great Walter Blum, whom I had the privilege to know when I started teaching at the University of Chicago Law School in 1987, and who was kind enough as to serve as a mentor (as well as being a friend) back in those days.

Less than 24 hours in Chicago, and I dodged a couple of bullets - first yesterday, when my flight to Chicago was canceled shortly before I was going to leave for the airport. I was re-booked to get there today, long after my session had ended, but I was able to scramble and find another flight. Then today I came extremely close (in distance terms, perhaps a couple of millimeters) to losing a contact lens down the sink in my hotel room. This could have left me a bit like Piggy in Lord of the Flies, albeit in a much friendlier setting.

But then I was able to catch an earlier flight home and was even upgraded to first class (the fruits of just how much travel I have been doing on United and Continental over the last year). I feel so much less like a head of cattle when I get an upgrade.

But perhaps of more interest was the session itself. Phil West of Steptoe & Johnson (a leading international tax practitioner, and former International Tax Counsel at the Treasury) was the main presenter on the subject "The Future of the Foreign Tax Credit." Lowell Yoder of McDermott Will & Emery chaired and organized the panel, as well as whipping it into shape over Giardano's pizza, and the other commentator was Michael J. Caballero, who is currently the International Tax Counsel.

Phil gave a very useful overview of where the foreign tax credit has been, and where it might be conceivably be heading, with a particular eye on a number of recent and ongoing controversies, enactments, and proposals, on many of which Michael commented. But my assigned task, which Phil very kindly gave the audience highly favorable word about, was to shed a different light on discussion of the foreign tax credit (and international tax issues generally) than perhaps one generally hears.

I welcomed this (as who wouldn't, in my shoes) in part because, as I have tediously yammered here from time to time, I really do believe that I have rethought the international tax field in an important way, previewed to some extent in recent articles that I have published but not to be fully laid out until my international tax book comes out (and I would be lucky to finish writing it by, say, mid to late 2012, what with the welter of conflicting obligations that I've either been handed or deliberately accepted).

One doesn't always feel that way about one's work (except perhaps if one is only loosely tethered to reality), even if one likes it, because it is hard to pull off that sort of thing very often, or indeed perhaps at all. But given that I do believe that I've done it this time around, it felt very good to get a strong confirmatory feeling from a lot of the audience - not that anyone there is necessarily chargeable with agreeing with me, but that people seemed to see the significance and, at least, plausibility of viewing the whole field rather differently than in the traditional international tax policy literature.

The first time I previewed these ideas, at a conference in North Carolina back in January 2010, I was distressed not to feel that what I had to say had gone over. But I've thought it through better, learned to say it better, and perhaps people have had more of a chance to think about it.

I also felt like I was in pretty decent form today. Just as NBA players (these are people who used to play something like "professional basketball" back in the distant past when there was such a thing) have good days and bad, so I felt like my jump shot was connecting a bit today. But not to worry, one can always count on worse days as well as better ones.

Anyway, here are the slides from my talk, which in many cases (I hope readers, like the conference attendees, can tell which ones) are borrowed from Phil West's talk, with my comments just added at the bottom to express my response to the standard approach that Phil was very ably laying out.

I should be able to post a fuller PPT version of what I have to say in early December, after giving a 45-minute talk on international taxation as a headliner at a conference in Sao Paulo, Brazil.

English-Al Jazeera story on corporate tax loopholes

2011-11-04T22:38:00.004-04:00

I appear more prominently in this one; wish they could have edited out the inadvertent grimace, but I guess that's on me.

CNN Situation Room corporate tax story in which I briefly appear

2011-11-04T14:07:00.002-04:00

The CNN story from last night discussing corporate tax avoidance, in which I briefly appear, is available on-line here. I appear near the end, and am quoted in relation to the political prospects for corporate tax reform.

My tax reform talk at yesterday's AAA-CPA Fall Meeting

2011-11-04T08:41:00.005-04:00

As kindly linked by the Tax Prof Blog, my talk at the AAA-CPA Fall Meeting yesterday had the following description:

"Dissatisfaction with the U.S. federal income tax has led to widespread discussion of fundamental tax reform including the possibility of replacing it with a consumption tax. What different forms could such a reform take? What are the best arguments for it and against it? And what are its political prospects for enactment? Among the alternatives that Professor Shaviro will discuss are a national retail sales tax, X-tax or flat tax, and a consumed income tax, and he will consider how these proposals’ chances might be affected both by Congressional politics and by the long-term budgetary problems facing the U.S."

This was not a new paper, as I've written extensively on this subject before, such as here. But a pdf version of my slides for the talk, offering a handy if somewhat condensed outline, is available here.

TV update

2011-11-03T16:42:00.005-04:00

In addition to taping a short interview with CNN's Situation Room show regarding the Citizens for Tax Justice report on corporate tax dodgers, I also ended up going to the Al Jazeera English studio in midtown to do a short TV interview with them on the same subject. (Each will apparently be used, probably a short snippet only, in a feature story on the CTJ report.)

Extra bonus, while leaving the Al Jazeera studio I met the German film director Werner Herzog, who introduced himself to me while we were both waiting for the elevator. I told him that I am very eager to see his 3-D film on the Lascaux cave paintings, and he noted that it is still playing in Greenwich Village.

The CNN and Al-Jazeera interviews followed somewhat different paths. For CNN, the main question was, is the bottom line of the CTJ report (showing massive though varying levels of U.S. tax avoidance by U.S, companies) accurate and credible? I said yes, and that the CTJ findings are no surprise to knowledgeable people, although no doubt there would be plenty to quibble regarding how they did the measure and in particular cases. On Al Jazeera, same bottom line reason for interviewing me (seeking independent expert assessment of the main CTJ findings), but more interest in questions such as, how does this pattern relate to the concerns of the "Occupy Wall Street" movement.

UPDATE TO THE UPDATE: I haven't been able to determine what ran on English Al-Jazeera. But I've seen the CNN story by Mary Snow (which ran tonight at 5:36 pm EST). I only made it on-screen for a very short soundbite saying that the politics of the 1986 Act can't be replicated today because compromises between the parties are dead. But the producers may also have viewed me as validating that the CTJ study is intellectually respectable (although they ran a he-said she-said on CTJ vs. GE, the latter of which used counter-argument rather than denial).

Perhaps the most interesting aspect of the CNN coverage was how Occupy Wall Street has changed the narrative frame that a major network uses in approaching a story like this. I view this as evidence that OWS is having a significant (whether or not lasting) impact on the framing of public debate, of a sort that companies such as GE are unlikely to welcome.

TV appearance today?

2011-11-03T12:02:00.002-04:00

I'll shortly be leaving my office to give a talk this afternoon at a meeting of the American Association of Attorney-Certified Public Accountants, entitled "Can, Should, and Will the Federal Income Tax Be Replaced by a National Consumption Tax?" While my slides are fairly skeletal in proportion to the length and coverage of the talk, I will post them here tomorrow, time permitting.

On the way there, I am stopping by at CNN headquarters for a short interview, a snippet from which may appear this evening on CNN's The Situation Room. The topic will be the newly issued Citizens for Tax Justice report, "Corporate Taxpayers and Corporate Tax Dodgers, 2008-2010."

Just as a preview, I believe that, while one could (and in the right setting should) nitpick and question various aspects of the report's analysis, the bottom line claims are important and have a significant degree of truth.

NYU-UCLA Tax Policy Conference on Tax Law and Healthcare Reform

2011-10-27T11:42:00.003-04:00

This afternoon, weather permitting (the East Coast will be rainswept all day), I am flying to Los Angeles, in order to participate in tomorrow's NYU-UCLA conference concerning tax policy and healthcare reform.

I'll be chairing the fourth and final panel, entitled "Health Care Reform and the Long-Term Fiscal Outlook." The papers, which will eventually appear in the Tax Law Review, are (1) Howard Gleckman, Healthcare and the Long-Term Fiscal Outlook, (2) Daniel Kessler, "Reforming Medicare," and (3) Mark Pauly, "The Real Burden of Tax-Financed Medical Care in the United States."

I won't have slides or a formal presentation, so there will likely be nothing to post here on Monday. During the session, however, I will be offering quick comments and reactions after the three presentations, mainly to focus and jump-start the broader discussion.

Everyone knows that the projected path of healthcare growth is at the heart of the grim long-term U.S. fiscal situation, and the question is what to do about it. I suspect that a central issue throughout the panel will relate to the basic fundamentals of why there is such a large government role (around the world) with respect to healthcare provision and financing, and how one should think about the relative defects of government provision on the one hand and market provision on the other. Plus, what happens when you mix them in different ways.

Healthcare's unique characteristics (especially when, but not only because, we decide that everyone should get basic care) inevitably will play a central role in this conversation. It hasn't been seriously disputed in economic circles for decades that, in a whole lot of consumer areas (say, cars or shoes or breakfast cereral), markets generally do better than government provision from the standpoint of efficiency and responsiveness to consumer demand. But is healthcare different, and if so then to what extent and in what ways? And if a critique of how markets work in the healthcare sector does not necessarily rebut pessimism about the informational and incentive issues raised by government involvement, then how do we navigate between various competing problems?

A few quick points about Perry's tax plan

2011-10-25T19:16:00.005-04:00

Perry's tax plan is in many ways the usual nonsense, not really worth addressing seriously. For example, it's clearly a huge revenue-loser, is a huge tax break for the wealthy, etcetera.

This is all par for the course. But here are a few particular points about his plan's distinctive quirks that are worth emphasizing.

First, the idea of an election between the simple system and current law is simply nonsense. Goodbye simplicity. People with tax planning capacity are going to be running the numbers to see which is better. Does anything with the slightest bit of common sense really think a well-advised taxpayer going to opt for the postcard return even if, due to base-broadening, it turns out this would increase his or her tax liability by several thousand dollars a year? Adding elections adds complexity, it generally doesn't reduce it.

Second, why even bother having a flat tax if you are going to retain big itemized deductions, such as for home mortgage interest, charitable contributions, and (if I am reading the under-specific language correctly) state and local tax deductions?

Third, how can he purport to combine a flat tax (and simplification) with phasing out the itemized deductions for people who earn more than $500,000? True, this increases the progressivity of the plan, at least relative to providing the deductions and not phasing them out. But this effectively adds higher tax rates to people in the phase-out range, albeit eventually declining back to 20% once all the deductions are gone. And with this feature, that is going to be some postcard.

Fourth, can anyone seriously doubt that the exemption for dividends and capital gains will be exploited by tax planners, on behalf of owner-employees, to avoid paying even 20% on what is effectively wage income?

Fifth, how exactly is he going to broaden the base of the corporate tax to pay for lowering the corporate rate to 20%? Note that some of the key items often called corporate tax preferences disappear under a consumption tax - and at the individual level the so-called flat tax is in fact a consumption tax. Is he going to get rid of accelerated depreciation and LIFO accounting for inventory? Under a consumption tax, the purchase price of items such as equipment and inventory would be expensed. So, unless he wants to confine the shift from an income to a consumption tax to the individual level, and still inexplicably apply income tax-style accounting just to the corporate tax, I certainly don't see what sort of base-broadening he has in mind at the corporate level. To the contrary, it seems likely that he would want to make changes that would reduce corporate taxable income at the same time that he wants to lower the corporate rate.

So the Perry plan in many ways makes less sense than Cain's 9-9-9 plan.

Talk at University of Louisville Law Review Symposium on Deficit Reduction

2011-10-24T13:52:00.024-04:00

This past Saturday (Oct. 22), during a lightning appearance in Louisville to participate in a conference on federal deficit reduction that was sponsored by the University of Louisville Law Review, I presented my paper, previously linked and available here, entitled "Tax Reform Implications of the Risk of a U.S. Budget Catastrophe." This is a kind of short interplanetary grand tour through previous work I've written that has a bearing on how concern about the long-term fiscal gap might affect our thinking about tax reform. It also briefly addresses why we face a long-term default risk. I use the analogy (also in several previous talks that I have linked here, but not previously in any of my published work) to the nesting Russian "Matryoshka" dolls, one inside another. I posit that, while the outermost doll is the fiscal impact of rising life expectancy plus the baby bust plus the current path of healthcare technology, the fact that this could in principle easily be addressed means one has to look to the next doll inside (U.S. political economy problems), and then to the doll inside that (potentially malfunctioning and discontinuously responding financial markets).

For a pithy overview of the already somewhat pithy paper, a pdf version of the PowerPoint slides that I used for my talk is available here.

Among the things I'm sorry to have missed at the conference, which I had to leave early, were the afternoon talks by Daniel L. Thornton, who is Vice President and Economic Advisor at the Federal Reserve Bank of St. Louis, and UNC law prof Greg Polsky. Although I suspect I would have disagreed with a lot in Thornton's talk (addressing how we have arrived at the current fiscal situation), I am sure it was interesting and provocative. And Polsky's talk on cutting tax expenditures is certainly a topic of interest to me (and I suspect I would have agreed with a lot of his analysis).

Another interesting talk that I missed was by GW law prof Neil Buchanan, arguing against ever fully paying off the U.S. national debt. Once again I suspect I would have agreed a lot, although I'm not convinced we'll be dealing with this problem any time soon. Buchanan and I appear to agree more than we used to about budgetary issues. He might argue that I've moved a bit towards him, and maybe he'd have a point. But I might respond that current events have pushed me towards a terrain where we always agreed to a considerable extent. I probably remain more favorably inclined than he is to adopting (under appropriate circumstances) policy changes that curtail the rate of growth of existing entitlement programs, with these changes to be announced ASAP and to begin being implemented as soon as the macroeconomic climate permits. I believe in "smoothing" expected long-term changes to the entitlement programs, based on the best available fiscal estimates of what will be necessary, and I am quite willing to reduce expected benefits to the better-off members of current retirees - again, subject to the macroeconomic climate and to this being part of a good overall package that includes, e.g., needed tax increases.

I did get to hear Penn State law prof Sam Thompson's interesting paper, arguing that Social Security and Medicare benefits should be phased out fairly rapidly for high income retirees, whose capital income might suggest that they have substantial wealth. Thompson had a powerful rhetorical point to the effect that, if you give retirement benefits to an individual who will be leaving a bequest, and if this means that the bequest ends up being larger than it would have been otherwise, one could view this as something not far from a federal match or supplement to the bequest. I could imagine this point being politically significant, and it is also reasonably intellectually defensible.

One concern I had with Thompson's proposal was that, by rapidly phasing out retirees' Social Security and Medicare benefits as their income increases, it operates as a powerful work disincentive. Even people who have retired from their prior full-time jobs and begun claiming retirement benefits often do some work on the side, and the empirical evidence suggests that they are quite tax-responsive. Such individuals do not necessarily have the wealth and expected bequest profile that Thompson assumes when arguing for his proposal, and I see no good reason, even with high unemployment, to discourage work by seniors. But in the limited time we had, we didn't get to discuss this issue more fully.

In response to my paper and talk, Berkeley law prof David Gamage argued that what he called my "let's preserve revenues" model for evaluating how concern about the fiscal gap should affect tax reform thinking - a fair enough label, I'll concede - doesn't take the next step that one ought to take in thinking about these issues. He proposes analyzing much more fully than I as yet have the question of how a given change (even a small one) that is adopted today might influence the likely long-term political equilibrium, assuming that the political chicken games do indeed eventually give away to a negotiated solution. Two examples he noted: (a) 1986-style tax reform, with base-broadening plus rate reduction, might grease the skids for raising the rates again in the future, (b) once a VAT is enacted, Congress's ability to raise revenue easily by boosting the rate becomes much enhanced, compared to when one doesn't have a VAT in place. I suppose there might be analogues for entitlements changes as well.

This may be a good next-stage framework for thinking about tax reform in relation to the long-term fiscal situation, albeit going beyond the relatively modest tasks I set for myself in recent writing about the issue, but certainly worth consideration. (Whether or not by me depends on where my interests take me over the next few years.)

Unauthorized activity

2011-10-23T19:38:00.004-04:00

I would assume that Seymour is eyeing the chicken, not the lettuce.

From 9-9-9 to 9-0-9?

2011-10-21T12:34:00.009-04:00

In response to criticism of 9-9-9's low-end regressivity, Herman Cain has apparently partially dropped one of the 9's. He is quoted by CNN as saying the following:

"If you are at or below the poverty level, your plan isn't 9-9-9 it is 9-0-9. Say amen y'all. 9-0-9."

This appears to refer to putting a zero bracket into the personal income tax (or wage tax?) portion of the 9-9-9 plan. However, three thoughts about this are the following:

(1) Poor people who are unemployed will get no benefit, since they already are earning zero. An 18 percent federal tax rate is a huge hike for them, compared to present law.

(2) Once you agree to a zero bracket, haven't you surrendered the entire supposed logic (whatever it is) of having a flat tax? This, of course, is also an issue for the so-called flat tax that Rick Perry is expected to endorse shortly. That proposal has historically had two brackets, one of them at zero percent, and I gather that the Perry proposal is expected to share this feature. So it isn't actually a flat tax.

Once you agree to a zero bracket, in a certain sense the flat tax game is over. As the old saying goes, from there on in we're just haggling over the price. Is there some natural law holding that having exactly two brackets is best? That strikes me as even more peculiar than insisting that there must only be one.

(3) Once Cain has agreed to put a zero rate in one of his three taxes, why not in the other two? Obviously, as an administrative matter one can't have a retail sales tax, or a quasi-VAT that has been mislabeled as a "business income tax," apply multiple brackets based on the income level of the individuals who purchase consumer goods. But doesn't the zero-rate feature that has now been added to Cain's personal tax imply that this is a defect one might want to address?

The so-called FAIR tax does so through what is effectively a demogrant, rather than a rate bracket. I've seen indications that Cain would like to have something of that nature in his 9-9-9 plan as well, but he hasn't made this entirely clear, and it would have significant budgetary / revenue implications unless its scope was trivial.

Cain also claims to add progressivity to his plan through an "opportunity zone" proposal. The idea, as described by CNN, is that "in cities facing high unemployment ... businesses could also deduct a certain amount of payroll expenses from their corporate taxes."

Enterprise zone features of income taxes generally have not received a hugely favorable write-up in the literature. In addition, if we can imagine Cain's proposals being adopted by Congress - and I certainly can't imagine this, even if he were to become president - it's hard to see why this special feature would be adopted and no others. Mightn't it open the floodgates? It's also fun to think about how the set of qualifying cities at any given time would be compiled, and whether businesses would be able to use this as a ground for deducting, say, high-end Wall Street salaries if New York qualified as an opportunity zone. Sure, one could start writing rules to address these problems, but by then (if not sooner) the 9-9-9 tax would be starting to look like a very different and more complicated animal.

They're calling the wrong tax the "Robin Hood tax"

2011-10-20T10:03:00.018-04:00

A report on the web suggests that Occupy Wall Street protestors may coalesce on a specific policy demand: the enactment of the so-called "Robin Hood tax" on financial transactions.

Although I have considerable sympathy for what I deem to be the OWS political economy critique of U.S. policy and institutions, I fear that they are being misled by labels into supporting the wrong tax. It's understandable. After all, how could they resist something that proponents call the "Robin Hood tax" and that would be collected from banks and other such financial institutions, given what the OWS protestors (and we) know about the U.S. financial sector and its grip on the U.S. economy and government, as well as that sector's responsibility for the last few years' disasters and the evident possibility that they will soon be doing it to us again?

The problem is, the wrong instrument has been labeled the "Robin Hood tax," apparently because some enterprising policy entrepeneurs, undoubtedly acting in good faith, took the initiative thus to label what those of us in the biz call the "financial transactions tax" or FTT.

The so-called Robin Hood tax - which I will now switch to calling the FTT - would be levied at a very low rate (say. 0.05%) on a wide range of financial asset transactions - for example, the sale of stocks, bonds, commodities, unit trusts, mutual funds, and derivatives such as futures and options. Thus, if you buy Microsoft stock for $10,000, the tax at 0.05% would be $5. Despite the low rate, enough financial assets in face value are sold that it could add up to a lot of money. For the thing to work, it obviously would have to address the problem of people, say, using swap transactions to replicate the economics of a debt-financed purchase of stock without actually doing the literal sale. That's a big problem, but let's put it to one side for present purposes.

Presumably your broker will actually remit the $5 sale proceeds to the tax authorities. I would guess that he'd list it as a separate charge that you had to pay, and would simply add it on to the other fees he was charging you. In principle, this could exert a mite of downward pressure on broker fees, raising the economic incidence question of who bears the tax, along with the possibility that, with sales being costlier, there'll be a small bit of exit from the broker industry. But it might be a good first approximation to say that you are likely to bear the tax, whether the broker separately states it or simply charges you $5 more than he would have otherwise.

Now let's consider Goldman Sachs, which presumably would be remitting a whole lot of fees to the government from the deals it does. (Leaving aside the fact that they would no doubt be at the forefront of figuring out, at least for their large customers, how to structure deals so as to avoid the tax.) Is this a tax "on" Goldman Sachs - or more specifically, on the firm's owners and highly compensated employees? I am a bit skeptical, as a matter of economic incidence. Come to think of it, if they do figure out how big players can avoid the tax they will be well-compensated for that, but even in other cases I suspect the incidence issue might play out a bit like the retail sales tax that the guy in the candy store collects from you and then remits to the local authorities.

The broader academic debate about the FTT - on which I will be presenting a short piece at a conference in Amsterdam in early December - emphasizes the efficiency question. Will the FTT have desirable economic effects? With perfectly functioning financial markets, the answer would obviously be no. Why burden trades that conventional economic reasoning suggests make the transactors better off while hurting no one else. But I would agree that we have reason to be very unhappy about a lot of what goes on in financial markets, so the FTT has a fighting chance.

What among the things that might be wrong with financial markets might the FTT address? The main argument is about volatility, which some types of trading may make worse. This is basically an externalities argument. By running computer programs that, say, go SELL-SELL-SELL as soon as the price of Zircon stock falls below $X, one can prompt runaway market panics. But the problem is that the FTT is not well-designed to address a specific externality. Trading can also reduce volatility. And if I want to buy or sell a given stock then it's good for me that someone else is actually willing to do so at a given price. FTT studies suggest that the tax might well make volatility worse rather than better. More generally, a well-designed instrument would have to target the types of trading that were worth discouraging.

A second point is sometimes called "internalities." Suppose people trade too much from the standpoint of their own welfare because they over-rate their ability to out-smart or correctly time the market. Once again, we're only in a subcategory of the overall trading that would be subject to the FTT. I have doubts about how strongly this line of reasoning can support the so-called Robin Hood tax, and it is certainly light years from the rationale and assumed incidence.

Now here's what I not only prefer to the FTT but think is far more entitled to the label of "Robin Hood tax" - a financial activities tax or FAT, such as that recently proposed by the staff of the International Monetary Fund.

The FAT would be a tax on extra-normal returns earned by financial institutions, with the potentially taxable returns including high-end compensation paid out to the big hitters. The FAT has two main rationales, other than the fact that the financial industry may generally be both over-large from a normative standpoint and widely under-taxed under VATs and income taxes.

The first rationale is that extra-normal returns may be rents, or opportunities that they have, in effect, to get free money not available to others. Taxing rents is efficient because it won't discourage activity that still has an extra-normal after-tax return. Plus, a tax on rents is borne by the party that is earning the rents.

The second rationale is that observed extra-normal returns in the financial sector are in a sense fake. They represent risky bets, the expected return from which is merely normal, but where the bettors earn an above-market rate in most states of the world, subject to downside "tail risk" if things go badly wrong. We don't want the financial sector making these bets due to their "heads I win, tails you lose" character, in which first they get extra-normal returns, then we have to bail them out so as to mitigate the degree of global macroeconomic collapse.

Once again, we would expect the financial sector to bear the incidence of this tax, because they'd be pushed back in the direction of a merely normal return by the mechanism of in effect taxing them for the suspected transfer of tail risk to the rest of us.

The FAT truly is a Robin Hood tax that would address the problems with the financial sector and likely be borne by the bankers themselves. Why tax Goldman Sachs' customers under the FTT, with no clear efficiency gain, instead of taxing Goldman Sachs itself under the FAT (leaving aside the most recent quarter, in which they reported losses) and addressing the costs that it may be imposing on the rest of us?

Virtually there

2011-10-19T07:58:00.011-04:00

Zocalo Public Square, a website devoted to "connecting people to ideas and each other" that also has actual, in-the-flesh public events, usually in Los Angeles, is having a session today on economist Robert Frank's new book, The Darwin Economy: Liberty, Competition, and the Common Good.

On to the personal plug for a moment, then back to the more substantial topic of Frank and his new book. In connection with this session, Zocalo has posted 4 short sets of comments on the topic "Taxes Hurt So Good: Levies Can Be Painful, But the Right Ones Bring Big Gains." The question for discussion was whether taxes can promote good behavior. Available here. As you may have guessed by now, I am one of the commentators; the others are Daniel Markovits, Timothy Hackenberg, and Annette Nellen.

Bob Frank, in his book, "argues that the man who best understood how economics works was not an economist at all [such as Adam Smith with his theory of the invisible hand], but renowned naturalist Charles Darwin. Darwin's understanding of competition held that favored traits were the ones that best served the individual, whether they benefited the group or not -- a theory Frank says explains the modern system much better than Smith's [invisible hand theory]."

To my mind, it risks being a bit cute to deploy Darwin as actually an economist. But Frank's basic point is quite sound. Smith's invisible hand theory derives a lot of powerful results from the fact that, under certain conditions, the possibility of mutual gain through trade can cause people to have interests in common and to behave cooperatively. But - as Smith certainly recognized but perhaps downplayed a bit - when these conditions don't hold, there is no general reason to expect cooperative rather than socially damaging beggar-your-neighbor behavior.

In this regard, evolution at least provides an analogy, and perhaps can even be described as directly operative in economic behavior (although people's battles over wealth, success, and power play out in arenas not limited to gene transmission). Cooperative group behavior has to pay off at the individual level (which depends on the specific environment and the odds it presents for various things) in order to be sustainable. And there is certainly no reason to assume that compatible incentives and cooperative behavior are the dominant features in a modern economy, any more than it makes sense to assume that "nature red in tooth and claw" is the dominant model in biological evolution. "Cooperation or competition - which prevails?" is a silly question, to which the only good answers are "both," "it depends," and "they're likely to be complexly intertwined."

I am definitely a fan of Bob Frank, who, through his work on positional goods and status competition, has made a very important contribution to modern thinking about GDP, technological progress, tradeoffs between equity and efficiency, and yes, tax policy. As it happens, he was a speaker at the NYU Tax Policy Colloquium many years ago. Our main criticism (I was still doing the colloquium with David Bradford at the time) was that his important insights didn't necessarily translate into thinking about income versus consumption taxation as he thought they did, since the two are arguably the same insofar as the points of interest to him are concerned. (Income and consumption taxation differ in how they treat present versus future consumption, either of which one might want to tax-discourage on the ground that people are competing over positional goods, and thus imposing disutility on others, to a greater extent when they choose work and thus present or future market consumption, than when they choose leisure.)

Frank was also a very pleasant guest and speaker at the colloquium. In person, he turned out (I had worried about this) to have no objection whatsoever to such things as having a nice dinner and accompanying it with a nice bottle of wine.

Does it matter how many separate taxes are in 9-9-9?

2011-10-14T10:16:00.013-04:00

Short answer: No, it does not matter at all in substance, although it evidently matters quite a lot optically.

By the way, Grover Norquist, who is no fool when it comes to assessing optics, understands this, and has apparently criticized 9-9-9 for permitting taxes to look lower because they appear to come in separate bundles. There is an ironic jujitsu to all this: so much of Cain's momentum on this issue reflects the fact that, to the conservative base, 9-9-9 looks lower than 27. But holding constant what the taxes actually are, Norquist is right that, if they look lower, this may grease the wheels for letting them go higher than otherwise.

But enough about the optics - why, as a matter of substance, doesn't it matter if there are three 9% taxes, or an 18% tax and a 9% tax, or one 27% tax?

Let's start with the point that Ed Kleinbard and I have been making, and that others such as Ezra Klein have picked up on, which is that 9-9-9's "business tax" and its sales tax are basically the same tax (a few odd details aside), since they are both flat-rate consumption taxes where the tax base is consumer purchases. So we have at a minimum just two taxes, 18% on consumption plus the possibly separate (or not?) 9% personal income (?) tax.

When I made this point in a previous blog post, a commenter made the point that what I called the business-level VAT is in some ways not that far from an income tax. Basically, all you have to do in order to make it an income tax is the following:

(a) allow wages to be deducted by the business. In the standard VAT setting, deducting wages or not is a wash - it doesn't matter in the end - if (i) they are made includable by the worker only if they are made deductible by the business and (ii) the worker and business tax rate are the same. After all, if my business pays me $100 and both its tax rate and mine are 35%, then deduction and inclusion, instead of neither, saves the business $35 of tax and costs me $35 of tax. By the way, even if I don't own the business, then if the net tax on wage payments is zero one would expect wages to adjust, reflecting real market conditions and people's responding to their actual incentives from after-tax returns, so it wouldn't matter (once everything had time to adjust) whether the wages were includable and deductible or neither - apart from in the situation where the worker's marginal tax rate differs from that of the business.

The Cain plan screws this up, of course, by making wages includable by the worker but not deductible by the business. Is this an evil example of that odious crime, "double taxation"? As an optical matter, I suppose you could argue that it is. But in reality, all it does is cause workers who are paid wages to be taxed, in effect once, at 27%. The problem here, as I have noted in prior posts, is that paying observable wages is tax-discouraged, so owner-employees with sufficient liquidity to fund their personal consumption expenses will tend to avoid it and lower their overall tax rates to 18%.

Okay, that more than covers the first important difference between a business VAT and an income tax. On to the next two:

(b) In a business income tax, financial flows such as interest would tend to be deducted by the business that pays them and included by the recipient. (In the present income tax, of course, dividend payments, unlike interest, are not deductible.) In a VAT, all of these financial flows are typically ignored on both sides of the transaction, leading to problems in figuring out how to tax financial institutions (which embed service fees in the spread between the low interest rates they pay and the high interest rates they charge). Once again, however, leaving aside the double taxation of dividends problem in the existing income tax, both including and deducting or doing neither is a wash if the tax rates on both sides of the transaction are the same.

(c) And now for the big difference, applying even when all cash flows are taken into account (or not) reciprocally and when all tax rates are the same. In an income tax, business outlays that create durable assets or lasting value or income expectations beyond the current year are not deducted. Instead, they are capitalized, creating an asset that has a tax "basis," and are only recovered against gross proceeds, such as through depreciation deductions or by only taxing net gain on an asset sale (amount realized minus basis). An income tax, therefore, unlike a consumption tax style VAT, burdens saving and investment.

Suppose Cain altered the business tax in the 9-9-9 plan to be some sort of an income tax version of the VAT, with business outlays potentially being capitalized rather than immediately deducted. This would make the "business tax" component meaningfully different from the sales tax component. At the cost of economic distortion (i.e., discouraging saving and investment), it would burden the business owners and thus presumably increase progressivity.

But to say that there were now two separate 9s, while in a sense optically true, would in a sense be pure semantics. By making the two taxes a bit more different, we would be burdening some people a bit more and others a bit less. But if rates were adjusted to raise the same revenue either way, there would just as much taxation going on from the two taxes that now were somewhat distinct than there would have been if they were the same.

This brings us to the next element of major confusion in the 9-9-9 plan. The campaign website proudly trumpets that dividends will be deductible, so as to avoid present law's double taxation. But what about interest? Is that deductible as well? It is under the current income tax, but again, a VAT generally ignores it. But of course, to understand what would make sense here, we need to consider the last (or first?) of the three 9's, the tax on individuals.

Surely that must include dividends if deducting them at the company level is necessary to avoid double taxation. But surely interest has to be treated symmetrically as well, and the plan says nothing about it.

What is the base for the individual tax? The website says it's "gross income." But what is that? In the existing Internal Revenue Code, "gross income" includes all receipts (except that basis is deducted from the amount realized, so that only the net gain from an asset sale is included) but has no business deductions whatsoever. But everyone seems to agree that the "personal" tax here will not apply to the gross proceeds of, say, a neighborhood candy store, but is only for salary plus apparently some other gross income items - dividends and (despite the hiccup in the business tax) presumably interest, and perhaps all the other stuff that under present law leads you to get a W-2 or 1099. (Though not capital gain, as the plan purports to exempt this.) By the way, if we are including all this gross income, then I don't entirely understand how Cain is repealing the entire existing Internal Revenue Code, since parts of it are surely needed to figure out what income is.

For example, if interest is included by individuals, and is meant to be deducted by the business even though the plan does not say so, then might we need the original issue discount (OID) rules for interest that has accrued economically but not yet been paid? To be sure, if the treatment is symmetric and all the rates are the same, then perhaps this doesn't matter as much.

What the Cain campaign presumably does mean by "gross income" is that there will be none of the deductions that the Internal Revenue Code allows against "adjusted gross income" or AGI. By AGI, it means net rather than gross income, but without itemized deductions such as home mortgage interest, and without personal exemptions or the standard deduction.

Incidentally, I assume that fringe benefits that aren't currently included would be taxed in the Cain plan. Most would agree that the exclusion for employer-provided health insurance is no less a special tax expenditure than the home mortgage interest deduction. So does he mean to make it nondeductible at the business level as part of the wage (although it's currently deductible), AND includable at the individual level on the same rationale? Inquiring minds would like to know.

Okay, suppose we were to conclude that the personal income tax really is an income tax while the other two parts are consumption taxes. This probably isn't right, as it appears to be more of a wage tax plus perhaps a tax on interest and dividends (which of course are includable in "gross income" under present law). But suppose that one of the 9's is an income tax while the other two 9's are consumption taxes. Does this mean we have two taxes of 18 and 9 rather than one at 27?

This question really has no correct answer, or at least none that is meaningful, as it's a matter of optics and semantics. Let's consider instead substance. Suppose we had a single 27% tax but it was one-third income tax and two-thirds consumption tax. (E.g., suppose returns to capital that were income but not current consumption were two-thirds deductible, or alternatively were taxable, in the manner of capital gains today, at a special rate that happened to be 9% instead of 27%.) This would in a sense be the same as 9-9-9 if one of the bits is an income tax and the other two are consumption taxes, yet it would clearly be one instrument.

Bottom line: counting separate tax instruments is a fool's game. What matters is the overall tax being levied. And here, 9 + 9 + 9 = 27. Since this is an equation, the left side equals the right side, and no one should think it matters which side you are looking at.

Busy travel schedule

2011-10-13T11:05:00.018-04:00

I appear to have signed myself up for quite a lot. Here's how the next two months are looking for me at the moment:

Saturday, October 22 – At the University of Louisville Symposium on on Federal Budget and Debt Reduction, I will present my paper on the tax reform implications of the risk of a U.S. budget catastrophe.

Friday, October 28 – At the NYU-UCLA Tax Policy Conference on Healthcare Reform, to be held this year at UCLA, I'll be moderating a panel on Healthcare Reform and the Long-Term Fiscal Outlook. The panel will include papers, on which I may briefly comment, by Howard Gleckman, Daniel Kessler, and Mark Pauly.

Thursday, November 3 – At the annual meeting of the American Association of Attorney-Certified Public Accountants (AAA-CPA), to be held in NYC (east midtown), I'll offer a talk entitled "Fundamental Tax Reform: Can, Should, and Will the U.S. Federal Income Tax Be Replaced by a National Consumption Tax?"

Friday, November 11 – In Chicago at the University of Chicago Tax Conference, I will comment on a paper by Phil West concerning foreign tax credits.

Thursday, November 17 through Saturday, Nov. 19 – On to New Orleans for the National Tax Association's 104th (!) Annual Conference on Taxation. Here I will present my paper on corporate residence electivity, moderate a panel on corporate tax reform, and comment on a couple of international tax papers.

December 1-2 – On to Sao Paulo, Brazil, where I will be the keynote speaker (discussing international tax issues) at a conference held by the Center for Fiscal Studies at Sao Paulo Law School.

December 9 – Heading east for a change rather than west or south, I will fly to Amsterdam and present a short paper on the relative merits of financial transaction taxes (FTTs) and financial activities taxes (FATs) at a conference on taxing the financial sector that will be held at the Amsterdam Centre for Tax Law.

While I expect to get the rest of the year off, no doubt for good behavior, on January 6, 2012, I will be presenting work on international taxation at the University of Florida College of Law in Gainesville.

The New York Times is as confused about 9-9-9 as everyone else

2011-10-13T10:22:00.011-04:00

From today's front-page NYT article on the 9-9-9 plan:

"From that exchange emerged the plan that Mr. Cain calls 9-9-9: a flat 9 percent individual income tax rate, a 9 percent corporate tax rate and a 9 percent national sales tax."

Again, the "corporate tax" here is in fact a sales tax, no less than the sales tax in the plan is a sales tax. These things matter.

By the way, suppose that we didn't have an income tax - say, because Congress had replaced it with a progressive consumption tax, such as either the David Bradford X-tax or a "consumed income tax" on individuals. BTW, as I've discussed in various places, such as here, I would strongly prefer this to the existing income tax, at least if we could make optimistic assumptions about how Congress would actually implement it. (This is a problem that these plans admittedly would share with 9-9-9.)

If that happened, then we wouldn't need a "corporate tax." The main purpose that the corporate income tax serves today is to backstop the income tax on individuals, which would become a joke if people could avoid it by earning their income through corporate entities. Thus, suppose I could hire myself out to "Shaviro, Incorporated," a newly formed corporation to be entirely owned by myself and close family members, and arranged for it to contract with NYU for my teaching services. It would then pay me (to meet current consumption expenses) only a fraction of my actual salary. Unless we either taxed this company directly or made the income currently taxable at the worker or owner level, we would have shot a huge and pointless whole in the income tax.

Many people nonetheless seem to want a "corporate tax" as an end in itself, not just to backstop the income tax if we have one. This appears to reflect the "pathetic fallacy" of personifying corporate entities. As it happens, concern about this way of thinking was an important reason why David Bradford came to prefer the X-tax to a purely individual-level consumed income tax - he thought it would be more salable politically because corporations would literally be taxpayers (i.e., they would be remitting VAT-like payments to the government).

9-9-9 fails to use its "corporate tax" as a proper backstop to the individual tax, given that nonpayment of owner-employees' salary reduces tax liability at the full 9% individual rate. And it gestures towards the public sentiment for a "corporate tax" by doing something that is entirely misleading - although, again, I see no reason to doubt that the proponents are themselves misled. It would be nice if the New York Times could do more to help public understanding on this front.

Follow-up on Cain's 9-9-9 plan and fiscal self-delusion

2011-10-12T14:06:00.020-04:00

The more I think about the level of confusion that appears to underlie the 9-9-9 proposal, and to be shared by proponents and skeptics alike, the more extraordinary I find it. This is really Exhibit 1 for teaching some basic economics ideas in high school.

A key part of 9-9-9's intuitive appeal is the idea that, not only is 9 a low number, but the plans three 9's appear to be spread out. 9 percent on the worker, 9 percent on the business, 9 percent on retail sales.

But as I noted in my prior post, the latter two 9's are effectively THE SAME TAX (a few details aside). Only ignorance and naive folk notions of incidence could make them look like two different taxes that are pointed at different players.

Again, the "business tax" is a VAT, which is basically just another way of collecting sales tax. Most experts would say that you can have either a VAT or an RST (retail sales tax), and that the choice should depend on enforceability and administrability issues, but that it's nuts to have both. And if for some crazy reason you do have both, you still shouldn't fool yourself into thinking that you have two distinct taxes in any meaningful economic sense.

OK, time for a simple illustration to make the point. Say I own some land where I grow timber. I cut down a tree, turn the salvageable parts into a nice log, and sell it for $40 to Rawlings Sporting Goods. They turn it into a baseball bat and sell it for $100 to the parents of little Johny and Janey Smith, who will use the bat in their Little League games. Suppose we have a 9% business tax, Cain-style, and a 9 percent sales tax. How does each treat it?

The sales tax ignores the inter-business sale from me to Rawlings. It hits up the sale from Rawlings to the Smiths for $9.

The business tax generates a net tax of zero on the sale from me to Rawlings. More specifically, I owe tax of $3.60 and Rawlings gets a refund / tax reduction of $3.60. In a fuller account I'd build this in as changing the pre-tax price, but let's ignore that complication here. Net result: no tax on the inter-business sale, and once again a tax of $9 on the sale from Rawlings to the Smiths.

In short, these two taxes are the same, except that in the VAT (i.e., the "business tax") there is a paper trail. I might get in trouble if I don't remit the $3.60, since the tax authorities could cross-check the paperwork and note that Rawlings is claiming a $3.60 credit or refund. And if Rawlings claims the refund, but then pretends that the sale to the Smiths didn't happen so it doesn't have to remit $9 to the government, the tax authorities will say: If you bought timber and claimed a refund and you don't have a bat in your showroom, what exactly happened? Why don't you have inventory on hand from the goods you bought and claim not to have sold?

The underlying problem, again, is naive or folk notions of incidence. We think of the retail sales tax as paid by the Smiths, in part because, under common U.S. practice with sales taxes, it's separately stated. Rawlings could have sold the bat for $109 without ever mentioning the tax. It is going to owe the proper RST to the authorities no matter what. But we think of the tax as paid by the Smiths, in part because Rawlings is likely to flag it as a distinct item.

The business tax only looks different for trivial reasons that have nothing to do with economic incidence. Everyone would understand that this, too, was a tax on the Smiths if it was similarly separately stated, e.g., by having a pre-all-taxes price of $91.74. But presumably Rawlings wouldn't do this. In addition, perhaps everyone would understand that it was really on the Smiths, even without such separate statement if, as is the case with VATs around the world, its character as a consumption tax (and effectively an RST substitute) were better understood. The existence of cross-border VAT rebates may help with this as well. But because the tax part isn't separately stated AND people apparently don't realize that it's a VAT, it ends up getting vulgarly conceptualized as a tax on the business.

So two of the 9's in the Cain plan are simply redundant versions of almost the same thing. But what about the 9 that ostensibly falls on wages? That, as per my prior post, is a tax on being among the poor slobs who can't avoid using an explicit wage payment in order to get the compensation they have earned. So it's a tax on not being self-employed and, among the self-employed, on not having enough cash on hand for personal consumption expenses to simply leave all net cash proceeds in the business.

With all due respect to the late Steve Jobs, recall his famous $1 per year salary. Given his wealth-financed personal consumption, he would be paying 18 percent per year. No need to face the 27 percent rate given that he earned it through his Apple stock, on which 9-9-9 would permit him to earn tax-free capital gain whenever he liked.

But isn't it also true under present law that Jobs was untaxed on salary that effectively was earned but not paid? Yes, but that's not the whole story. By not paying the salary, Apple lost a deduction. So, if both Jobs and Apple faced a 35 percent marginal rate on the next dollar included or deducted, there was no net federal income tax benefit from the under-payment. Thus, current law does not favor the wealthy self-employed to anything approaching the same degree as 9-9-9.

In sum, one could think of 9-9-9 as having 3 tax rate brackets. Poor people without a job are taxed at 18 percent, including on the necessities that they can barely afford. The employed poor and middle class people, along with the non-self-employed rich, pay tax at 27 percent. But the wealthy self-employed get their tax rate back down to 18 percent again.

Herman Cain's 9-9-9 tax plan

2011-10-11T09:50:00.037-04:00

When Cain surged to a more prominent place in the Republican field and discussion of his "9-9-9" tax plan began surfacing, I, along with various others in my field, started getting phone calls from the press about it.

To be honest, I found it hard to focus seriously on the plan. With finite time available, a book I am trying to write, etcetera, I am often reluctant to spend a lot of time learning the details of tax proposals - not just by temporarily high-flying candidates, but also by presidential administrations and Congressional leaders - when I suspect, as frequently and with good justification I do, that they are neither well-designed enough to be of any intellectual interest nor likely enough to be enacted to have any real practical interest.

Nonetheless, I suppose a mea culpa is in order on this score, given that those of us in the tax policy biz have professional responsibilities to communicate with the public when issues in our domain reach the front burner. Thus, I am grateful to Ed Kleinbard for thoroughly analyzing the 9-9-9 plan here, and to Bruce Bartlett for doing so here.

One thing I hope I can contribute here, however, is a more succinct version of some of their key conclusions - Kleinbard's in particular, as Bartlett focuses much of his attention on Cain's apparent long-term plan to replace "9-9-9" with a national sales tax, a proposal that Bartlett has done an excellent job critiquing, such as here.

The really comical thing about Cain's 9-9-9 plan is how much it is a product of silly optics. As Kleinbard shows, it essentially amounts to a 27 percent flat tax on wages that is reduced to 18 percent for owner-employees who have enough liquidity not to need to pay themselves an explicit and observable arm's length wage.

There often is debate about whether, if we went the national consumption tax route, a value-added tax (VAT) or retail sales tax (RST) would be better. I regard the two taxes as in principle identical except that a VAT has better enforcement potential. Cain, however, has both in his plan. The business tax, his second "9," is in the main a VAT, apart from a few odd features such as its making dividends deductible. And Cain's third "9" is explicitly an RST.

Why on earth would you have both a VAT and an RST? I think the reason is that 9-9 sounds better than 18. You get the illusion that the taxes are more different than they actually are. Moreover, each, considered in isolation, seems low.

Along these lines, I have a great idea to eliminate the 35 percent individual income tax rate without losing progressivity or revenue. Here's the plan: replace the 35 percent annual income tax with a 3-3-3-3-3-3-3-3-3-3-3-3 monthly tax on annual income. After all, who's counting if the 12 monthly taxes actually add up to 36 percent annually?

Cain's first "9," of course, is the wage tax on individuals. Again, this is only for people who have to take their labor income in the form of wages because they are not owner-employees who can simply omit the step of paying a wage from their left pocket (the business) to their right pocket (the self-employed worker) - an omission that presumably requires sufficient liquidity to pay one's consumer bills with cash already on hand. But since (as Kleinbard shows) a wage tax is in the long run equivalent to a consumption tax apart from the undermeasurement of owner-employees' true economic wages, we end up with what is really a 27 percent / 18 percent consumption or wage tax, with the lower rate going to the self-employed, but, again, only insofar as they have the liquidity not to need to extract from their businesses the full economic wage. And this is not merely deferral, since in the long run you can simply sell the business and derive capital gain that the 9-9-9 plan would exempt.

As Kleinbard notes, Cain would impose a huge tax increase on lower-income and middle-class Americans, who would lose the benefit of lower income tax rate brackets, including the effective zero bracket that results from personal exemptions and the standard deduction. (To be sure, the payroll tax is first-dollar, but its rate is well below 27 percent even if one counts all of the employer / employee and Social Security / Medicare pieces.) So on the bottom end Cain's plan is shockingly regressive. Even his beau ideal the FAIR tax generally has a universal "prebate" in the amount of estimated poverty-level consumption expenditures.

As for imposing a lower tax rate on highly liquid owner-employees than on those whose work situation requires the payment of an observable arm's length wage, this in practice means that we don't even have a flat rate system, but one in which the rich will frequently pay a lower rate than anyone else. Although the high-end lower rate may in part reflect mere confusion and inadvertence, I am reminded of the gabelle - that is, the salt tax in pre-French Revolutionary France from which nobles and the clergy were exempted.

New publication

2011-10-06T12:21:00.004-04:00

My co-authored (with Kimberly Clausing) article, A Burden-Neutral Shift from Foreign Tax Creditability to Deductibility?, has now officially appeared in print. It was previously available as an SSRN working paper. The citation is 64 Tax Law Review 431-452 (2011).

The abstract is as follows: "Observers of international tax rules have long conflated two distinct effects of the foreign tax credit on multinational firms: the effect on the incentive to invest abroad and the effect on foreign tax sensitivity. With national welfare as the policy objective, we discuss how a burden neutral shift from foreign tax credits to deductibility could be designed to improve distortions associated with insensitivity to foreign taxation without raising aggregate burdens on outward foreign investment. We also provide new evidence suggesting that the tax sensitivity of outward foreign direct investment is indeed reduced for OECD countries using foreign tax credits, in comparison with other OECD countries. Finally, we discuss policy considerations surrounding a possible burden-neutral shift from foreign tax creditability to deductibility."

It's available for download here.

Corporate integration via dividend deductibility

2011-10-04T14:32:00.009-04:00

As promised in my prior post, here is the text of my talk at NYU today regarding Reuven Avi-Yonah's co-authored article, The Case for Dividend Deduction. (See prior post for my link to Reuven's article.)

The text refers to a chart I had distributed to attendees, demonstrating that allowing corporations to deduct dividends paid is potentially identical to the seemingly very different system where they are taxed, but dividend distributions to shareholders get the benefit of "imputation" (i.e., corporate-level tax is in effect treated as an advance payment by the shareholders of their taxes on the corporate income). Imputation is or at least was a very common corporate integration system around the world, whereas dividend deductibility is not. I argue that the paper over-distinguishes between the two and that they can be made identical. Anyway, the chart, which offers a simple illustration of the potential equivalence between the two methods, is available here.

Perhaps the most novel point in my talk is one that I under-developed in the text because it would have taken too long to explain it. So here goes. Reuven argues that dividend deduction would be more effective than imputation in encouraging the managers to pay dividends, on the ground they often don't especially care about shareholder taxes but love to get company-level deductions. Thus, even if the two methods of dividend deduction and imputation are in fact economically equivalent, the former will in fact induce greater payouts.

One could certainly challenge this view on multiple grounds, but the one I emphasized, in particular because I thought it was more of a new point, reflects accepting the basic premise (at least arguendo) but then asking what the managers really care about. A common answer, with considerable real world empirical support, would be that they appear to care more about financial accounting income than about income tax liability. So the entity-level tax benefit of dividend deductibility won't affect their behavior as strongly as Reuven anticipates unless there is an accounting benefit. But would there be?

I am not an accountant, but I've played in or near their waters often enough to realize that this is a trickier question than it may initially seem from a lawyer or economist standpoint.

Presumably the financial accounting rules would NOT be revised to allow dividend deductions against financial accounting income, even if newly made deductible against taxable income. But wouldn't financial accounting income reflect the benefit of reducing federal income tax liability through dividend payouts?

Not necessarily. An initial point to keep in mind is that financial accounting often ignores the mere deferral of federal income tax liability. In principle, under dividend deduction, the ultimate corporate tax is zero as all earnings get paid out (or at least an amount equal to taxable income, which is often less than the tax measure of earnings for dividend purposes). So it would seem that the accounting rules in the dividend deduction scenario should either (a) ignore federal taxes on the ground that they're merely temporary, at least until they escape the possibility of being reversed through net operating losses created by dividend deductions, or at least (b) ignore the difference between paying out deductible dividends this year or next year. I'm not in fact sure how it would all end up playing out, but we should recognize that (a) there would be a tricky issue for the accountants to work out and (b) there wouldn't necessarily be a straight accounting benefit for the tax liability effect.

By analogy, consider the accounting rules for the foreign earnings of U.S. companies' foreign subsidiaries. These get the U.S. tax benefit of deferral - that is, they aren't subject to U.S. tax until they actually are repatriated for tax purposes. But companies get no accounting benefit from deferral - they are treated as if the U.S. repatriation taxes were being fully paid on a current basis - unless they solemnly declare to their accountants that the funds are being "permanently" reinvested abroad. Once this happens, the potential future U.S. repatriation taxes are discounted by 100% (i.e., to zero) rather than by zero percent.

Anyway, if the timing of repatriation is effectively ignored in financial accounting on the view that it doesn't matter exactly WHEN it happens (despite the potential effect on the present value of U.S. tax liability, then the same idea might apply, albeit in a somewhat different and (at least to me) unpredictable fashion, with regard to the effect of current versus future dividend payouts on entity-level, purely domestic U.S. income tax liability.

Any accountants out there, your thoughts on this admittedly esoteric issue (either in the comments page here or by e-mail to me) would be of potential interest.

UPDATE: The following is hoisted from the first comment on this blog entry (by Elijah):

"As you suggest (directionally at least), corporations would presumably book a deferred tax asset for undistributed dividends, much in the same manner as they currently book a deferred tax liability for the (non-permanently reinvested) unrepatriated earnings of their foreign subsidiaries. In this manner, they would "ignore" the actual timing of the (tax) deduction and the tax rate (on U.S. earnings) would move towards zero.

"I say 'move towards' because capital needs will prevent corporations from ever truly distributing everything prior to liquidation, which itself may be too remote a possibility for the corporation to consider for financial accounting purposes. Rather, corporations would undoubtedly get into the usual arguments (with their auditors) about how much of the the deferred tax asset could really be realized, and whether some amount of offsetting valuation allowance would be appropriate. This would ultimately be reflected in the (book) tax rate.

"The more interesting question, I think, is whether any of this would influence managers to pay dividends. My initial thought is that it would not. Managers would, theoretically at least, not be able to influence the book tax rate (year to year) by paying dividends in year 1 versus year 2 (or 3, or 4, etc.)."

Corporate tax reform talk

2011-10-04T10:15:00.008-04:00

Today at 12:30 in Greenberg Lounge at NYU Law School, I will be participating in a panel discussion (with Deborah Schenk, Reuven Avi-Yonah, and Deborah Paul), of Reuven's recent co-authored paper, "The Case for Dividend Deduction." Reuven argues here for achieving corporate integration by making corporate dividends deductible at the entity level (and fully taxable to shareholders if they are U.S. taxpayers).

I do not entirely agree with the analysis or conclusions, for reasons that I'll explain. I actually wrote out my remarks in full, including some broader observations about corporate tax reform, so that I would be able to post them here after the session. I'll try to do that this afternoon.

A partially intellectually purist take on the Buffett Rule

2011-10-03T13:50:00.017-04:00

President Obama has lately been urging the enactment of tax legislation to implement the "Buffett Rule," which, according to his reelection campaign website, "would require the wealthiest Americans to pay a tax rate at least as high as the middle class."

The basic idea appears to be mathematical, or at least arithmetical. For each individual, you can make an equation where taxes paid are the numerator and some measure of income is the denominator. The Buffett Rule posits that the amount thus computed should be at least as high for the wealthiest Americans as it is for those individuals who are defined as representing the middle class.

Thus, if a middle-class individual earns $50,000 and pays $12,500 in relevant taxes (i.e., one-quarter), then a wealthy individual who earns $100 million should also pay at least 25 percent (i.e., $25 million).

The underlying computation, often called the average tax rate (as compared to the marginal tax rate that applies to your last dollar) is familiar. A number of conceptual problems emerge in trying to use it this way, however.

What's in the numerator? - Presumably not just income taxes, which is the usual Republican ploy to ignore the less progressive levies in our fiscal system. Thus, payroll taxes to finance Social Security and Medicare would presumably be included. But what about the benefits from those programs? Note, for example, that while Social Security taxes, considered in isolation, are extremely regressive, going from 12.4% to zero at around $100,000 of annual earnings, the program as a whole is progressive on a lifetime basis unless high-earners live significantly longer.

Likewise, what about non-federal taxes, which generally are less progressive but may vary significantly? Or the corporate tax, which is indirectly paid by the shareholders? While it has uncertain economic incidence, this issue would exist even if the shareholders paid it directly. What about the expected present value of future taxes on current earnings? This, by the way, is a huge issue in thinking about income tax versus consumption tax progressivity.

What's in the denominator? - Here we presumably don't mean taxable income, or else a system with graduated rates would automatically satisfy the Buffett Rule. But how far are we going towards a measure of economic income? Does all unrealized economic gain count? That would be a huge change, and perhaps a good one, but it would go way beyond anything the Buffet Rule could seriously be thought of as aiming at.

And once you start thinking about items that might be added to the denominator, you may realize that you need to think more about the numerator. Thus, suppose tax-exempt municipal bonds pay 3%, while taxable bonds pay 4%. A high-bracket municipal bondholder is effectively paying an "implicit tax" of 25%. Thus, suppose Warren Buffett holds $100 million in municipal bonds, on which he earns $3 million of tax-exempt income. In performing the computation, rather than adding zero to the numerator and $3 million to the denominator, shouldn't we add $1 million to the numerator and $4 million to the denominator? For a wide range of tax-favored assets, however, these computations will be very difficult to make, and once again far beyond the Buffett Rule's apparently intended scope.

Okay, enough. I understand that this somewhat crude and simplistic idea is in fact a potentially clever marketing device that may serve both (a) to support changes in the direction that I favor, which is increasing the relative tax burdens of the wealthiest Americans in an era when we have massive long-term budgetary shortfalls and they have shot away from the rest of us economically as if propelled by a nuclear rocket launcher, and (b) to dramatize the fact that our current system's progressivity is nothing close to what it may seem if you naively consult the income tax rate tables.

In that sense, the Buffett Rule could have some good effects, relative to the status quo, both on political debate and on the state of the tax law if it leads to some enactment. But it encourages a host of distracting debates about side issues so far as the true points of interest are concerned. And it may discourage focusing more directly on the real issues of tax preferences and after-tax income distribution. And it could lead to the enactment of Rube Goldbergish, alternative minimum tax-style rules, as compared to more straightforwardly broadening the base and increasing high-end marginal rates. Just like the AMT since 1986, moreover, it might be subject to slow-motion unwind, such as legislation removing a particular tax preference from the Buffett tax computation so that the ostensibly wonderful reasons for enacting the item could be fully realized.

So while the Buffett tax may be a clever rhetorical initiative in some respects, I wish they could have come up with something that was substantively more coherent and better. But I suppose that's just one more reason why I'm here (in academics) and they're there (in politics).

Can we forget about the 2007 Mets now?

2011-09-29T14:35:00.006-04:00

From Nate Silver:

“The following is not mathematically rigorous, since the events of yesterday evening were contingent upon one another in various ways. But just for fun, let’s put all of them together in sequence:

• The Red Sox had just a 0.3 percent chance of failing to make the playoffs on Sept. 3.

• The Rays had just a 0.3 percent chance of coming back after trailing 7-0 with two innings to play.

• The Red Sox had only about a 2 percent chance of losing their game against Baltimore, when the Orioles were down to their last strike.

• The Rays had about a 2 percent chance of winning in the bottom of the 9th, with Johnson also down to his last strike.

"Multiply those four probabilities together, and you get a combined probability of about one chance in 278 million of all these events coming together in quite this way.”

Nate speculates that the outcomes might have been correlated rather than independent, although this might have to depend on statistically hard-to-support claims about systematically "clutch" and "un-clutch" behavior. But he also offers an amusing stick figure illustration, entitled "All Sports Commentary," in which the first person says: "A weighted random number generator just produced a new batch of numbers."

The second one replies: "Let's use them to build narratives."

Tales from (near) the Vienna Woods

2011-09-24T12:34:00.014-04:00

Last Tuesday night I flew to Vienna to teach a 4-day, 3 hours per day International Tax Policy class to students in a new doctoral program at a tax institute among the economics and business programs at Vienna University. The students are mostly lawyers, but also include people with degrees in economics, business administration, and someone with accounting as well as law. We're halfway done now, with a break for the weekend.

One of the best things about teaching this class is that there's no exam. Instead, the students will write papers. And while it's true that writing exams and grading them are the two worst tasks in a law professor's job, that's not even the main reason it's so incredibly refreshing not to have to do it.

I've assigned a bunch of readings (all by me, including unpublished book chapter drafts, except for the Tax Notes versions of Kleinbard's Stateless Income), but I don't feel I have to lecture on them. If on a given day I think it would be more instructive or fun to discuss X, Y, or Z (provided they are pertinent to the class's topic), that's just fine. No one is wondering about whether that's on the test, or whether stuff in the readings that I'm not discussing is on the test.

Obviously, the danger in such a situation is that the students will be unmotivated. But apart from the fact that they have to write papers, they're only in this program (3 years, but they're just starting) because they're interested in international business taxation, and in some cases possibly in academics or government policy jobs. They all have good work experience and would be insane to do this unless they were highly motivated.

When I teach the Tax Policy Colloquium at NYU, I get the same benefit of students who can take an interest without having to worry about the exam. (I of course don't blame students for worrying about exams when given; it just makes the experience much worse both for me and for them, and makes it much less genuinely educational apart from the admittedly important motivation it provides to take a class seriously.)

Of course, the colloquium is 14 weeks long, and the students have lots more going on, including other classes, family life, and job search. Plus, their opportunity cost is much lower, taking as given that they've decided to go to law school (or to add an LLM degree). Thus, the average level of commitment in the colloquium is bound to be less. But this is not to complain - I've been very happy with my colloquium students over the years, and I believe I've had some success, via various measures, in getting enrollees to self-select for being genuinely interested. It's been a true pleasure to get to know all these students (as one does a bit more in the colloquium than the lecture hall setting), and to learn from as well as teach them.

Meanwhile I've been touristing up a storm, so to speak, in Vienna, to the extent that I am feeling run-down and borderline sick. On Wednesday, after arrival, I went to the Schlossburg Palace & its grounds, including the Vienna Zoo, followed by 3 modern art museums in a complex called the Museum Quarter, topped off with dinner at one of the stalls in a place called the Naschmarkt (best translated as Nosh Market).

On Thursday after class, Demel's and Hotel Sacher's pastry shop followed by the delightful Albertina Museum (also with lots of modern stuff). I may go to an obscure American film there tomorrow (George Ray Hill's The Driver).

On Friday after class, the Kunsthistorische Museum (main Vienna art museum for the Renaissance and surrounding periods) followed by the Natural History Museum, then dinner with my host at a very non-touristy and authentic Vienna restaurant right on the edge of the Vienna Woods.

Today I took a train (1 hour each way) to Bratislava, Slovakia for a day trip. Charming town now that it has recovered from the horrid drabness and failure that the Communists imposed on it. Lots of charming and deliberately whimsical town squares, a few museums, a castle, some towers, coffee and a pastry on the town square, etcetera. Bratislava also has the Danube flowing through it, though it looked green rather than blue. At lunch, a very good Slovakian meal that (along with the pastry that followed) will also serve as my dinner.

As it was sunny and nice and everyone around was having a beer, I decided to do so at lunch as well, although that's certainly not my usual practice (too much the puritanical American, I suppose). Pilsener Urquel was prominently listed on the menu, but I was wondering (since I've heard of it in the US) if it is below the top local standard. I asked the waitress if it was good, and she frowned and said "It's Czech." So I got a Slovakian dark beer instead.

Tomorrow, another art museum & park called the Belvedere, then maybe that George Roy Hill movie. This leaves only Monday and Tuesday after class (I leave early on Wednesday).

I've brought work here, and I certainly could use the time doing it, but somehow when one's away from one's usual places and also has touring opportunities (cue the Puritanical sense of duty again, I suppose, although I really do enjoy it & find it interesting), I just can't find the motivation to do any of it.

"Go big" letter on deficit reduction

2011-09-13T12:02:00.010-04:00

I am one of the more than 60 signers (or, if you prefer, signatories) of a letter to the Joint Select Committee on Deficit Reduction that urges the Committee to "'go big' and develop a large-scale debt reduction package sufficient to stabilize the debt as a share of the economy."

With the studied generality that was needed to get so many signatures, which range across the ideological spectrum from about the medium left to the medium right, the letter continues:

"We believe that a go big approach that goes well beyond the $1.5 trillion deficit reduction goal that the Committee has been charged with and includes major reforms of entitlement programs and the tax code is necessary to bring the debt down to a manageable and sustainable level, improve the long-term fiscal imbalance, reassure markets, and restore Americans’ faith in the political system.

"While we have differences of opinion about the specific policies that should be included in any plan, we all agree that a large-scale, multi-year debt stabilization package is necessary to deal with the fiscal challenges facing the nation."

I was willing to sign the letter because it doesn't contradict (although it also doesn't endorse) the view I share that in the short run we need to boost consumer demand. Also, I certainly agree about the need for entitlement reform and tax reform, although (as discussed here) I would not include rate reduction in the latter.

And while I am very skeptical that anything good is likely to come out of the current political environment in which the Joint Select Committee on Deficit Reduction is operating - requiring me to swallow some qualms about the "go big" advice in signing the letter - I concluded as follows:

(1) waiting for the political environment to improve is not very promising, as it may just keep on getting worse, and

(2) as I discuss here, the threat of fundamental political dysfunction leading to default is great enough that it wouldn't be prudent (as Bush Sr. might have put it) to favor sitting tight and waiting for a more propitious time.

Tax planning by video game developers

2011-09-12T15:37:00.025-04:00

Interesting NY Times article about how video game developers such as Electronic Arts have combined aggressive tax planning with equally aggressive lobbying to pay no U.S. tax on $1.2 billion of global earnings, which I would guess were as a fundamental economic matter nearly all generated by talented employees who were living and working in the U.S.

One supplementary fact, not included in the article (reflecting that the information would be hard to find), but of interest substantively, is what taxes were paid on the owner level, given that one of the main tax provisions employed by Electronic Acts (according to the article) was deductions for employee stock options.

Still, even looking at both levels of tax, I rather suspect that Electronic Arts did pretty well.

The article spends quite a lot of time discussing the "architect" of Electronic Arts' strategies in recent years, "Glen A. Kohl, a tax lawyer colorful enough to publicly compare himself to Bruce Springsteen and to joke in the pages of The Wall Street Journal that his dog, Rubin, shared the name of the Treasury secretary under whom he served (Robert E. Rubin).

"After working in the Treasury Department during the Clinton administration, Mr. Kohl entered the private sector and became head of E.A.’s tax department in 2004, leading the company as it aggressively lobbied for a federal tax break on domestic production and set up a matrix of offshore subsidiaries, many in low-tax countries."

Kohl appears not to have been interviewed on the record for the article, but he is also discussed at length later on. It mentions that, before joining Electronic Arts in 2004, he "co-authored a widely-cited proposal urging the federal government to crack down on corporate tax avoidance, warning that 'the tax shelter problem is simply too detrimental to the tax system not to act.' As head of tax at Electronic Arts, he became a noted expert in using foreign subsidiaries to legally, and sharply, cut a corporation’s United States tax bill. As a co-chairman of the Silicon Valley Tax Directors Group, he also moderated a seminar in 2010 that showed technology companies how to use offshore subsidiaries to reassign the licensing of their intellectual property and, in some cases, reduce their effective federal tax rate substantially from 35 percent."

So it's a classic praise / pan, in some ways making him look great (smart, important, influential, creative, effective) but also no doubt prompting invidious musings from many readers about what might underlie the change in persona that appears to have taken hold around 2004 or so.

I should put my own cards on the table here and note that Glen and I are old law school classmates, and that I consider him a friend (hopefully, notwithstanding my topic choice here). Few if any in my law school class were so charismatic, energetic, or widely known and liked. For that matter, he was (and no doubt remains) far less self-important than Bruce Springsteen. Closer in intellectual outlook to Stephen Malkmus minus the diffidence, and coming from me that's high praise.

But the story of his evolution pre-2004 versus post-2003 certainly reflects the sort of incentives people face in the tax and business world - not just financially, although that's obviously very important, but in other ways as well. There are only so many ways to hit the really big leagues, develop and showcase your professional talents, and express your intellectual creativity, especially if you don't choose (or it isn't quite your thing) to toil in the obscure groves of academe, laboring to develop what you consider insights that maybe 300 people will download and 40 or so truly appreciate. And there may be unfortunate social byproducts to how talent thus ends up being directed.

Call it a cautionary tale, with an individually but not socially happy ending.

New article published on SSRN

2011-09-09T09:18:00.003-04:00

I have just published on SSRN an article draft that I prepared over the summer, entitled Tax Reform Implications of the Risk of a U.S. Budget Catastrophe.

The link for downloading the article is here.

The abstract is as follows:

"Despite the demographic causes of the long-term U.S. fiscal gap, only severe dysfunction in our political system, abetted by malfunctioning and discontinuously responsive global financial markets, could lead to a U.S. budget catastrophe. Unfortunately, the risk of disaster appears to be alarmingly high. The rising danger has implications both for income tax reform and for the possible adoption of new tax instruments.

"For income tax reform, the main implication is that base-broadening should be undertaken without accompanying 1986-style tax rate reduction. The threat of a fiscal catastrophe also raises concern about otherwise desirable but potentially revenue-losing reforms, such as to the rules for corporate and international taxation.

"A number of tax instruments not currently used in the U.S. might be appealing even if the reform that included them was revenue-neutral overall. These include a value-added tax (VAT), a carbon tax, and a financial activities tax (FAT), although in my view a financial transactions tax (FTT) would not have comparable merit. All of these instruments potentially gain appeal if they could be used to ease the political prospects for raising overall U.S. tax revenues, and thus for reducing the risk of a budgetary catastrophe."

A few words in further description: I prepared this short article draft pursuant to my obligations as a speaker at the University of Louisville Law Review Symposium on Federal Budget and Debt Reduction, which will be held at the University of Louisville Law School on Saturday, October 22, from 10 am to 4 pm. A link to this conference is available here. The rule for article submissions was 25 pages tops, so my article tries to cover a lot of ground very fast, and inevitably a bit superficially (or at least relying on conclusions from elsewhere that are not substantially defended in the text). That said, it does offer a general perspective on tax reform issues (pertaining to both the existing income tax and possible new instruments) in light of the fiscal dangers that we face.

Is Social Security a Ponzi scheme?

2011-09-08T10:04:00.012-04:00

Since Rick Perry keeps calling Social Security a Ponzi scheme, let's examine the accuracy of this characterization.

A true Ponzi scheme has two main elements. First, new investors' contributions are used to pay old investors' benefits. Second, an exploding or unsustainable growth rate is needed to keep the promised or expected benefits coming. (A chain letter where you ask six people to send you a dollar, and they then each ask six people to send them a dollar, is a classic example.)

Social Security has the first of these two elements, reflecting program cash flows and the initial decision, made when the program was started during the Great Depression while millions of seniors faced ineradicable poverty, to start paying benefits to retirees who had not significantly contributed to the program.

This alone, however, is not problematic in the way that the term "Ponzi scheme" inevitably suggests. If you think it is problematic and thus justifies the label, here's another non-exploding and seemingly Ponzi-like scheme for you. My family, like many others, has for countless generations been running this incredibly Ponzi-like scheme called "parenting." As a baby you get these free benefits, paid by your parents via their labor in raising you. Then when you grow up you pay in to the plan (if you have children) by raising your kids.

Surely this is even worse than Social Security. After all, at least in Social Security you pay your taxes before you get your benefits. Here, you get your benefits first! But there's still the key feature that you don't self-finance, i.e., raise yourself from infancy. Instead, each cohort relies on an adjoining one to pay it. Yet somehow this audacious scheme has proved sustainable over time.

So there really is no Ponzi scheme unless an exploding or unsustainable growth rate is needed to keep the promised or expected benefits coming. How does Social Security rank in this regard?

As it happens, the program does not have a well-defined relationship between taxes paid in and benefits that are promised. This depends on how the payroll tax rate and base on the one hand, and the benefit formula on the other hand (each subject to statutory modification at any time), happen to play out given birth rates, life expectancies, wage growth, employment levels, etcetera.

But in Paul Samuelson's famous conceptualization of Social Security in a classic 1958 article, we can think of the program as one in which everyone would get back exactly the amount they paid in if, among other simplifying abstractions, wages and population were constant over time and everyone's life consisted of a fixed "work period" followed by a "retirement period." Throw in population growth and rising real wage levels, and Samuelson foresaw a positive rate of return to Social Security retirees (possibly exceeding the real interest rate, in a Peter Diamond extension of the model) that depended on those two factors. That is, if we imagine payroll taxes being handed over to retirees in a strict pay-as-you-go system, the amount available to be paid over rises if the workforce grows along with wages that are subject to the payroll tax.

There's nothing Ponzi-like about that; it's entirely sustainable. But in actual Social Security, two things went "wrong." One was the baby bust after the baby boom, while the second, more important change was rising post-retirement life expectancies. Having retirees live longer was equivalent to having more of them, and had adverse effects on worker to retiree ratios even if each demographic cohort was larger than the one that came before.

Does this mean that Social Security became a Ponzi scheme after all? Strictly speaking, absolutely not. If we think of Social Security retirement benefits as being adjusted to reflect changing payroll tax revenue levels (even though this is only true, if at all, over the long run), then we'd say that retirees hold an implicit financial instrument, the payoff on which depends on wage and demographic trends. So all that rising life expectancies does in this scenario is cause the payoff to be lower rather than higher than it would otherwise have been. But that's in the nature of the implicit financial instrument - a built-in feature that does not cause Ponzi-like collapse, but merely affects the actual payouts from a program that can keep on running anyway.

This brings us to the point that comes closest to justifying Perry's angry braying about Social Security. The program's retirement benefits do not automatically adjust for these demographic changes. Instead, barring Congressional legislation, they proceed on statutory autopilot (albeit depending in practice on demographic and macroeconomic outcomes). So if adverse demographic changes do not lead to immediate tax or benefit changes, you get a program shortfall that emerges over time, and currently promised benefits become eventually unsustainable without new financing.

That, however, is merely lag in adjusting the actual rules on the books to keep on track with the Samuelson structure that is implied by having a largely pay-as-you-go scheme. And it does not mean that the program will collapse - merely that benefits will need at some point to be adversely adjusted (say, to the tune of 20 or 30 percent) in the absence of increased financing.

Perry is right (words that I must confess I hate typing) insofar as his point is that the current scheme requires adjustment, and that people won't get the full benefits promised by present law unless there is extra financing. But he is very substantially wrong in comparing this to a Ponzi scheme in which, as we well know, the investors (except for the lucky ones who got out fast) end up with nothing.

It would be more accurate to compare Social Security to an investment that has historically produced one rate of return, but which in fact appears likely to offer you a lower rate of return. E.g., suppose stock prices have historically appreciated, over a long period of time, at about 2% annually in real terms. You now hold stocks and are hoping to earn that rate of return. But suppose we can see the future well enough to anticipate that, in fact, you will end up learning less than that (and perhaps even a zero or modestly negative rate of return). That's too bad, but it doesn't make stock market investment a Ponzi scheme.

The negative adjustment to expected returns also obviously does not make mandatory retirement saving (a key feature of Social Security) a bad idea, given that lifetime consumption smoothing is necessary unless you're happy to have two houses and two dinners a day now, followed by none of either when you're old.

In sum, "Ponzi scheme" is really out of place as a description of Social Security, even though the program has financing problems. It's true that there have been some negative shocks to expected returns from the program, and that since it doesn't automatically self-adjust there will be a rising expected long-term program deficit until Congress gets around to adjusting things. But this is way out of Ponzi territory.

What about Medicare? That program is best described as Samuelson-plus. Program participants "bet" not only on economic and demographic trends, but also on the trend in healthcare expenditure relative to GDP. (When that rises, the program becomes costlier under constant benefit design.) What makes Medicare far more fiscally unsustainable than Social Security is the fact that healthcare expenditure levels have been significantly rising relative to GDP - and unsustainably so whether there is a government financing role or not.

Medicare is closer to Ponzi territory if we posit an implicit commitment, not just to the current statutory design, but to covering so large a percentage of seniors' healthcare outlays under a system where they so frequently can get the best procedures that are technologically available at a given moment. The built-in unsustainability comes from purporting to guarantee something that is itself growing at an exploding rate. But that is a piece of the broader healthcare problem that we face, more than an aspect of Medicare as such. So calling Medicare a Ponzi scheme (which even Perry does not seem inclined to do) is less illuminating than saying that healthcare generally is on an unsustainable growth path in our society, that we will need to address in one way or another.

UPDATE: Looking at Perry's statement more closely (although in this post I was more interested in the pervasive "Ponzi scheme" meme than in his murky mental processes), I see that his operating definition appears to be that, if the system is going to go kaput and pay you zero, then from your standpoint it is a Ponzi scheme. That is certainly a reasonable way to define Ponzi schemes. But of course it is wildly inaccurate as applied to Social Security, which is projected to be able (based on expected future Trust Funds) to pay about 75 percent of future retirees' benefits. So he is using what we will charitably call his own facts, rather than the actual ones, in calling Social Security a Ponzi scheme.

Interesting point about Perry: While he obviously feels entitled to his own facts, rather than the actual ones, on global warming, evolution, Keynesian stimulus, Social Security, etcetera, he apparently caused his last two gubernatorial campaigns to run very serious empirical tests regarding how alternative types of campaign expenditures and activities actually contribute to electoral success. See the NY times blog article here. In other words, this would appear to be a guy who (contrary to so much evidence from his cheap talk) actually knows and cares about expertise and empirical proof, in cases where there is something in it for him. But if there is no direct personal benefit to him, then he evidently doesn't care.

What would Nixon do?

2011-09-07T14:49:00.028-04:00

The opening of today's New York Times article on President Obama's forthcoming jobs package really turned my stomach:

"The centerpiece of the job creation package that President Obama plans to announce on Thursday — payroll tax relief for workers and perhaps their employers — is neither his first policy choice nor that of many economists. But it is the one that they figure has the best chance of getting Republicans’ support."

So typical of this Administration. They decide up front to advocate what they agree is very far from being the best available, policy - in order to give themselves "the best chance of getting Republicans’ support."

All this notwithstanding that the Administration's actual chance of getting that support is zero. Not 0.00001%. Zero. At least, leaving aside the payment of substantial ransom such as extending the high-end tax cuts. With or without payroll tax relief as a core feature, the Republicans will not agree to pass this legislation. So why would the Administration proceed as if winning their votes was the core design question? (Actually, I'll suggest a rationale below, but it isn't good enough.)

Let's turn our minds back to early 2009 and the big (such as it was) stimulus package. This included lots of tax breaks that the Administration, through its economists, knew would be less effective than alternative programs. They put these in to get Republican support. They got zero Republican support. They kept the tax breaks in anyway, and then of course grossly oversold an inadequately sized package as providing enough to get the economy back on track. Then, when the recovery fell far short of the rhetorical expectations that had been created, the Administration had encouraged the retort that stimulus just doesn't work (as opposed to its having been too small).

Now once again we have a flurry of proposals that are going to be too small in aggregate and deliberately poorly designed, in the hope of getting Republican support, which they have zero chance of getting.

But why did I title this post "What would Nixon do?" OK, I have keen memories of the old Trickster, though I realize that he is ancient history to anyone under the age of 45. But bear with me. One thing we know that Nixon absolutely for sure would have done (because he did it) is use every possible tool he had to push the Fed towards a more stimulative policy. Obama utterly failed to do this, whether through appointments or private sit-downs or public jawboning.

But there is also another standard Nixon trick that, sleazy though it was in context, the Obama Administration ought to think about. Nixon was a big fan of proposing legislation that he knew couldn't be passed, specifically because if it wasn't passed he would get a campaign issue. E.g., supposedly in 1970 he was disappointed by his success in getting the Democratic Congress to pass a tough crime bill that contained provisions that, under the quaint standards of the time, were considered odious by civil libertarians. Nixon had deliberately put these things in the proposed legislation, although they were largely symbolic and expected to have little actual impact on crime, because he wanted the Democrats to refuse to pass the legislation, whereupon he would make it a campaign issue and blame rising crime levels on them. They took the issue away by acceding.

How would such a scenario play out today? If Nixon faced Obama's current political circumstances, he would not be trying actually to enact stimulus legislation. He would know that he had zero chance of getting anything that would make a significant difference. He would want to propose something that the opposition WOULDN'T pass, and that he could then campaign on. (And it is clear this time around, unlike with the 1970 crime legislation, that the Congress won't accede in order to take away the issue.)

We could use a bit of that thinking today. Why not propose something that is actually big, dramatic, and well-designed? And why not make reasonable, economically supportable arguments about why and how much it might actually help? Then Obama could rightly criticize the Republicans and blame the labor market on them when they fail to pass it.

This would not just be Nixon-style maneuvering. It would also help make the correct point that, since at least mid-2009, we have actually been following Republican budget policies and they haven't worked. As things stand, by repeatedly acceding to them, even in what he proposes, he accepts a state of affairs in which they actually set the policy yet he takes the blame.

Meanwhile, Obama is collaborating in basic miseducation of American voters, by adopting all kinds of false or grossly overstated Republican claims about how regulatory burden and budget deficits are responsible for the jobs situation.

If people want Republican policies, they will pick Republicans to implement them. An abler, more courageous, and more farsighted politician than Obama would recognize the importance of laying the intellectual groundwork for good policy over many years.

OK, time is short and it's a bit late for all that now. So admittedly there is one clear political calculation that might explain how Obama is proceeding in his jobs proposal. If he proposed big infrastructure and public spending ideas to hire lots of workers and help get us out of the doldrums, and the Republicans refused to enact it, at least they would have a very strong case that they were acting in good faith. Rather than inviting the campaign charge that they are deliberate economic saboteurs, they would be following their own long-enunciated policy preferences in opposing the legislation. (McConnell has already previewed this by saying they won't enact failed policies, harvesting the legacy of Obama's 2009 overclaiming for the stimulus legislation.)

But even if the Republicans convincingly argued good faith in opposing such a proposal, Obama could still reply that they are wrong, and that they shouldn't be elected in 2012 because they will follow the wrong policies.

Don't call it stimulus, of course - call it creating jobs by hiring lots of people to build things that we need. Don't rely in public rhetoric on Keynesian multipliers that are counter-intuitive. Force the Republicans to argue that there will be no net job creation due to indirect effects - a freshwater economists' claim that is counter-intuitive wholly apart from whether it is right or wrong (and with the collapse of consumer demand I would say that it is clearly wrong).

By instead proposing watered-down, maldesigned, too-small Republican-style jobs legislation, Obama may hope to strengthen the claim that the Republicans are acting in bad faith when they inevitably reject it. But accusations of bad faith, which he will of course make extremely decorously if at all, will only go so far with the voters - especially once he has conceded that in general we need Republican-style policies, which they of course are the better-situated party to keep on providing.

And the reality is even worse. One lesson that voters might very well draw is that, if Republicans engage in bad faith obstructionism whenever a Democrat is president, we'd damn well better put them in charge so that they will have the right incentives. It doesn't make them nice people, but if they will make sure that things go worse when they are not officially in power than when they are, voters could very rationally view this as a good reason for electing them.

The New York City subway system is way too metaphysical for me

2011-09-03T11:48:00.002-04:00

Apologies if I offered approximately this entry a year or two ago - I had the same experience and it struck me the same way, and I don't recall if I posted about it. But anyway.

Last night I had to take the F train all the way out to Coney Island for a Brooklyn Cyclones minor league baseball game. Today I had to take the F in the other direction, to Roosevelt Island for some early morning tennis.

Each time, a train that was NOT labeled an F train approached on the F track - a D train yesterday, and an E train today.

Each time the garbled PA system said something like the following: "This is a [D/E] train traveling on the F track." I had to make a snap decision: do I take the train or not? The trains that they were labeled as would potentially take me to the wrong place (actually, the D might have worked yesterday, but definitely not the E today). In each case time was of the essence. So should I board the train or not?

Each time I did and it worked out for me. But my view was that, if these trains were traveling on the F track and making F stops, then they were F trains. They were not, at least for the duration of the journey, D or E trains traveling on the F track. A train is defined by the stops it makes.

The MTA, by contrast, appears to be essentialist (is that the right word here?) about train definitions. It thinks of a train as a D train or an E train, if that is its nature or how it is labeled, even while it is traveling on the F track and making only F stops.

Perhaps they could have clarified things a bit, without necessitating the metaphysical dispute, had they said that the trains were "traveling on the F track and making all F stops." Then I would still disagree with them about what the trains really were, but it would have been immaterial instead of causing initial anxiety.

Then again, perhaps I am over-thinking the whole situation a bit.

Alice in Wonderland riddles solved

2011-09-03T11:43:00.005-04:00

In Alice in Wonderland, as Alice falls down the giant rabbit hole at the start, she keeps asking herself "Do cats eat bats?" And, since she can't answer it anyway, also "Do bats eat cats?"

A definitive evidence answer to the first of these two questions is now available right here.

Another famous riddle from Alice is the Mad Hatter's query, "Why is a raven like a writing desk?" Though both he and the March Hare profess to have not the slightest idea when Alice gives up, some decades later a Lewis Carroll fan (I forget who it was), gave what strikes me as the best possible answer: "Because there's a b in both."

A calm perspective on Irene

2011-08-27T13:41:00.004-04:00

"Hurricane? What hurricane?"

UPDATE: It looks like Seymour was right to be so calm about it.

Another of my international tax articles comes out

2011-08-26T17:24:00.009-04:00

My paper "The Rising Tax-Electivity of U.S. Corporate Residence," previously posted here, has now officially come out in the Tax Law Review. A link to the published version is available here.

The abstract is as follows:

"In an increasingly integrated global economy, with rising cross-border stock listings and share ownership, U.S. corporate residence for income tax purposes, which relies on one’s place of incorporation, may become increasingly elective for new equity. Existing equity in U.S. companies, however, is effectively trapped here, given the difficulty of expatriating for tax purposes absent a bona fide acquisition by new owners.

"Both the prospect of rising tax electivity for new equity and the very different situation facing old U.S. equity have important implications for U.S. international tax policy. This paper therefore explores three main questions: (1) the extent to which U.S. corporate residence actually is becoming elective for new equity, (2) the implications of rising electivity for the age-old (though often mutually misguided) debate between proponents of residence-based worldwide corporate taxation on the one hand and a territorial or exemption system for foreign source income on the other, and (3) the transition issues for old equity if a territorial system is adopted."

In addition to the discussion referenced in the abstract, the paper foreshadows and provides a brief exploration of a somewhat bigger topic: what (in my view) is fundamentally wrong with a lot of contemporary academic international tax policy analysis, and what the analysis should instead look like. Much more on this to come in my book in progress, Fixing the U.S. International Tax Rules.

Some of the building blocks of this analysis also appear in the two main versions of my recent article on foreign tax credits, available here and here. But in Fixing I hope to have it all nailed down more definitively and concisely.

A collective action / externalities rationale for Keynesian stimulus

2011-08-26T09:25:00.026-04:00

I'm no longer surprised by the frequency with which good economists - of course, not all of them - fail to understand and apply basic economics reasoning. In the fields I write about professionally, I'd have to say I'm grateful, as it's good for business.

A key reason for these failures is that people get lost in the forest and can only see the trees. They play with models, use math, etcetera, but forget the basic underlying intuitions. Or, they become prisoners of simplifying assumptions that are often (but not always) useful, and forget that these assumptions should only be used conditionally and when appropriate.

Today's example is Robert Barro, who has a Wall Street Journal op-ed today (available outside the paywall here) claiming that Keynesian economics, unlike "regular economics," can't possibly make sense. Thus, with regard to the claim that Food Stamps or unemployment benefits could boost demand and help ease the recession, he concludes:

"There are two ways to view Keynesian stimulus through transfer programs. It's either a divine miracle—where one gets back more than one puts in—or else it's the macroeconomic equivalent of bloodletting."

And elsewhere he says of the at one time uncontroversial Keynesian idea that giving money to the cash-constrained can be stimulative:

"How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?"

David Glasner responds to Barro as follows:

"But wait a second. What does Barro mean by his query: 'Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?' Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

Glasner then asks whether Barro agrees with the real business cycle theorists who explained that the Great Depression merely reflected millions of workers' rational decision to take a nice long vacation until productivity and therefore wages were higher.

Paul Krugman jumps in as well, and mentions some of the standard points from Keynesian economics for which there is empirical evidence, such as sticky prices and wages.

But I have long thought it reasonably clear (as discussed somewhere in here) that a very familiar tool can do a lot of the work here - collective action problems. Economic models often simplify the world, and in the right setting with good reason, by taking people's preferences as given and assuming away interdependence. But suppose I am deciding whether to spend money on a nice vacation. Even in an entirely rational setting and with a flexibly responding price system, this may depend on how well I expect my business to do over the next few years. Suppose people who are considering whether to patronize my business have exactly the same thought in mind. Their willingness to buy goods and services depends importantly on their confidence that others will be buying their own goods or services. So, when everyone gets scared or anxious, there is a coordination problem. If only everyone could agree to shake hands and continue opening their wallets a bit, the problem would ease, but instead it feeds on itself, as belt-tightening here prompts responsive belt-tightening there.

To throw in another common buzzword, there's an externality here, as each individual's belt-tightening causes others to lean more towards belt-tightening, creating collectively self-fulfilling prophecies about low earnings potential.

Against this background, Food Stamps and unemployment benefits, by getting people to spend more (albeit perhaps more because they were cash-constrained than due to the vacation problem above) can get things moving in the other direction. People whose businesses start doing better change their estimats about how much it makes sense for them to spend, and things may start going the other way.

Back in January 2009, Barro had a WSJ op-ed that was almost as skeptical about stimulus, in which he said:

"[Keynesian theory] implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system."

Seen through the above lens, however, the price system in a recession or depression may be getting it exactly right so far as revealed preferences are concerned. Resources are idle because there isn't enough demand for the production that is being forgone. And given all that the price system is working just fine.

But the seemingly efficient equilibrium is far inferior in human welfare terms to the alternative one that would result if people could coordinate shifting to a higher-expressed demand, higher-output equilibrium.

This presumably is what Glasner means when he says: "Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

And this is why the view that the Great Depression was just a nice long holiday, as people awaited higher productivity that would increase their willingness to swap leisure for work, has never seemed very intuitively persuasive.

But the use of collective action problems and externalities that I suggest here lies outside conventions that economists are accustomed to allowing in their models (which commonly take revealed preferences as given rather than conditional and interdependent, and assume away externalities unless clearly demonstrable like that from pollution). Also, the use I suggest is admittedly a bit informal and ad hoc, which economists may rightly be on guard against. But it is coherent logically, plausible intuitively, and permits one to make more sense of the world. Barro's apparent inability to see that it might be relevant, and thus his entirely misplaced sarcasm about whether Keynesian economics could possibly make sense outside the realm of "divine miracle," is more disappointing than surprising.

A quick comment on corporate tax incidence

2011-08-22T14:50:00.019-04:00

Lee Sheppard has an article in today's Tax Notes that riffs off Mitt Romney's "corporations are people" comment last week to address corporate tax incidence.

Lee criticizes economic models suggesting that labor bears the main burden of the corporate tax, in part by stating:

"It has even become fashionable to say that labor bears something like 40 to 80 percent of the economic burden of the corporate income tax. This defies common sense. We know that because if labor bore such a significant share of the corporate income tax, corporate managers would not devote so much time and effort to fighting it."

Here's why I believe Lee is wrong about this. The incidence claims are about the long-term difference between equilibria. For example, suppose a country raises its corporate tax rate, within a couple of years this reduces the amount of capital that would otherwise have been invested in the country, and this in turn causes wages to be lower than they would otherwise have been. Proof of the causation in this sequence would demonstrate that labor was bearing some of the corporate tax increase via the wage effect.

In politics, however, people mainly care about short-term transition effects. Thus, suppose that today (without any prior anticipation of this happening) we simply repealed the corporate tax. Ignoring the deficit problems that this would cause, along with the rampant avoidance of the individual income tax that it would empower, who would be the big transition winners? Obviously, shareholders at the moment that the change occurred (or rather was announced) would get a huge increase in share value from eliminating all company-level income tax liability. Managers no doubt would win big-time as well. Meanwhile, wages for the most part would not change immediately.

This not only explains the observable political alignment on corporate tax issues, but is entirely consistent or reconcilable with the long-term incidence story that focuses on labor and wages.

Lee also complains in her article about a recent vote by the American Economic Association not to require disclosure of funding sources. She believes that private funding has undermined the objectivity of research, along with intellectual balance in the corporate and international tax fields. Treading carefully here, as I am on friendly terms both with her and with some of the people whom she might conceivably have in mind, let me just say that I agree this is a serious problem, which cannot be dismissed simply by defending people's good faith and/or incentive to preserve their own intellectual reputations. What is more, from conversations I have had with a variety of people, I can definitively say that many in the field share Lee's concern, including people who do academic research and/or are not fully on her side in the underlying debates.

Death of Bernard Wolfman

2011-08-22T12:53:00.019-04:00

I'm saddened by the death of emeritus Harvard tax law prof Bernard Wolfman, whom I had gotten to know at HLS conferences, and whom I always enjoyed seeing again.

On the academic side of things, the two articles of his that I know best - both diatribes, but in each case justifiably so - are (1) an attack on the Supreme Court's egregious Frank Lyon decision (which upheld a sale-leaseback tax shelter, based on a silly list of 23 factors and a bizarre insistence that 3-party deals are inherently better than 2-party deals), and (2) a critique of Justice William Douglas' tax jurisprudence, which bizarrely switched, I believe it was in 1948, from being routinely pro-government to anti-government (except for one subsequent case, called P.G. Lake, in which Douglas apparently decided that he hated oil company executives even more than the IRS).

Each has some apparent back story. In the Frank Lyon article, I believe one can discern that Wolfman was unhappy on ethical grounds about the behavior of the renowned Erwin Griswold, a tax prof who had been his colleague (and the Harvard Law School Dean) not to mention Solicitor General of the U.S., and who thus carried some clout when he represented the taxpayer before the Supreme Court. In this case, Griswold seems not to have done his best to inform the Supreme Court accurately of the tax stakes in the case (which pertained to tax rate differences, since one of the parties had tax losses that made depreciation deductions unusable). In the Douglas article, Wolfman does not try to explain the reason for the 1948 change of heart, but I wouldn't be surprised if he knew a story that the late Walter Blum once told me, to the effect that Douglas changed sides in tax cases after he was audited, apparently in relation to reimbursements for his wife's travel expenses when he gave speeches. I've never tried to check out this story, but Douglas actually has a somewhat foolish dissent in a case involving this issue that is in my co-authored Tax I casebook. If true, however, bad move by the IRS but not very edifying so far as Douglas is concerned.

One part of Bernie's career that may not be well-known, but that he once told me about at dinner, pertained to his service in World War II. He was in an infantry division on the German front after D-Day, and apparently would have been right at the spot where the Germans attacked in the Battle of the Bulge, except that he was evacuated a few days beforehand due to severe frostbite in his feet. This he attributed to the fact that the U.S. Army, trying to be thrifty, gave its soldiers on the German front - in the middle of what was apparently one of the coldest winters there in the 20th century - footwear that had been designed for fighting in the scorching deserts of North Africa.

Warren Buffett on taxing the rich

2011-08-16T10:42:00.032-04:00

Warren Buffett has drawn considerable attention with his op-ed in Monday's NYT suggesting that tax rates be increased for people at the top of the income distribution:

"Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent....

"But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.

"My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice."

Some on the right gibe that, if Buffett wants to pay more to the federal government, that's fine; he can do so any time he likes by making a voluntary donation. But Buffett wants people in his income tier generally to pay more tax, not just himself personally, so the critique is wide of the mark. He can't unilaterally achieve the social effects of a higher tax rate on rich people generally all by himself, and it's not especially selfish to ask "Why should I be the only one to pay more?" Perhaps it's equally wide of the mark on the same ground, however, when people on the left complain that those on the right shouldn't take advantage of government subsidies that they argue should be repealed.

As I discussed in my recent Tax Notes article, the policy Buffett advocates of imposing significantly graduated rates at high income levels is in tension with what long was the predominant view suggested by the optimal income tax or OIT literature (which takes distributional concerns into account, not just efficiency). But that consensus is increasingly vanishing, even within the OIT framework. I noted this (and some reasons for the change in views) in my article, and since then the Peter Diamond and Emmanuel Saez's have further spelled out some of the main arguments in The Case for a Progressive Tax: From Basic Research to Policy Recommendations.

Before one swoon too much over Buffett's nobility (though I do indeed find his stance praiseworthy), a caustic comment from David Miller may be in order. David notes that Buffett's "Berkshire Hathaway stock appreciated by $3 billion last year and, unless he is extraordinarily patriotic, there will never be any income tax paid on his unrealized appreciation. So his tax rate on the economic income he earned last year is more like 0.22% ($6.9/$3.039.9). Even if his tax rate on recognized income was increased to 100%, the tax on his economic income would be a little more than 1% ($39.9/$3.039.9). A mark-to-market tax on appreciation at a 15% rate would have raised $450 million in 2010 from Warren Buffett alone!"

David is the author of A Progressive System of Mark-to-Market Taxation, under which current year mark-to-market taxation of publicly traded securities such as Berkshire Hathaway stock would indeed be required, so this is no idle or random suggestion. Buffett presumably will never pay tax on the appreciation due to Code section 1014, which gives assets a tax-free basis step-up at death.

On the other side of the ledger, it is certainly fair to note that Berkshire Hathaway appears to pay tax at something like a 30 percent rate on its financial accounting income, if I am correctly interpreting this. I myself would count this as paid by Buffett, to the extent of his stock ownership. While there are disputes about the economic incidence of the corporate tax, similar questions could be raised about non-corporate business taxes that the owners pay directly.

I myself, if generally empowered to specify tax code changes, would opt both for corporate integration (so that Buffett wouldn't be taxed at two levels on BH's income - though, as it happens, I would prefer to concentrate the tax liability at the shareholder level, without regard to the payment of dividends) and for greater high-end rate progressivity.

Another point well known to those who have been following the budget debate, but perhaps worth mentioning here, is that solving the long-term U.S. fiscal gap realistically requires not just revenue increases from the top end of the income distribution, but extending significantly down the income scale to at least the middle-middle. With an aging population and retirement programs that serve important social purposes (and also are baked in to people's behavior and expectations), raising taxes just at the top will not be sufficient. But raising them at the top as part of the short-term budgetary response (if anything happens from the Gang of Twelve deliberations) would certainly be a start.

If Obama were shrewd ...

2011-08-08T13:31:00.005-04:00

... then, instead of denouncing the S & P downgrade (tempting though that must be given their embarrassing track record and the $2 trillion computational blunder), he would have said "Yes, it's terrible that the Republicans have caused this. This shows how right I was about not endangering our credit, about the need for more revenue and a balanced grand bargain, etcetera."

As things stand, he risks making himself the downgrade's sole owner in the U.S. public mind, without necessarily having any effect on market confidence (downgraded debtors are expected to complain).

But the heading of this post makes it alternative history, along the lines of "What if Lee had won the battle of Gettysburg?".

Middle Earth alternative history

2011-08-07T14:33:00.003-04:00

I've been greatly enjoying Kirill Yeskov's The Last Ringbearer. This is an alternative history / sequel to Lord of the Rings, written from a pro-Mordor, anti-Gandalf/Aragorn/elves viewpoint that is actually highly persuasive (if one can say this about a fictional world). It reviews what we thought we knew but didn't (due to our having only a biased winners' history) about the end of the Third Age, followed by a quest that aims to restore the balance that Gandalf et al had destroyed.

More information, including what I gather are legal downloading options, is available here.

Standard & Poor's expected Treasury bond downgrade

2011-08-05T20:46:00.007-04:00

I agree with the S & P downgrade (if advance reports are accurate) in substance. That is, the U.S. has a significant chance of default because of political dysfunction, in particular the Republicans' recently demonstrated callousness about our credit standing and their unwillingness to increase tax revenues under (apparently) any circumstances.

But it's certainly not obvious that the market should care about the downgrade. When major U.S. companies issue bonds, S & P actually has some inside information if they've been consulted during the rating process. There may be conflicts of interest and the smart guys on the other side may snow them, but at least they get to see things that aren't publicly available. As I noted in an earlier post, this is not true in the government bonds setting.

Here's a somewhat farfetched theory as to why the market may care. S & P's willingness to downgrade, as a bid to enhance their "brand," is evidence that they think people in the audience for their performance will consider the downgrade credible. So if I am in the bond market, it is a bit of a Keynes beauty contest thing - someone with a real (reputational) stake has decided that others who are in the bond market will view this as a credibility-enhancing play. Note that pessimists may not directly participate in the market as much as optimists if the market is incomplete because it is costly to go short.

Nonetheless, I'd be unsurprised if there is no market response to the downgrade.

Obama's next two chances to capitulate

2011-08-03T12:40:00.010-04:00

Both are set for September 30, when House Republicans can both cause a government shutdown (as Stan Collender explains) and force the gas tax to expire unless whatever demands they can think of are met.

By the way, there is no need to limit these demands to spending cuts. There will probably lots of unrelated demands as well. (Healthcare, oil drilling, reversing other regulations they don't like, any tax changes such as a dividend holiday that they happen to favor, etcetera.)

Given what happened the last time around, what would be the argument within Republican circles against playing these to the hilt? After all, neither involves threatening to destroy the full faith and credit of the U.S. government. And even if Obama genuinely plans to stick to his guns this time (not that I'd actually expect him to, closer to zero hour, even if he sincerely believes that he will), how could he possibly communicate this credibly to the Republicans?

Three mistaken views contrary to blaming White House incompetence for the debt debacle

2011-08-02T19:35:00.013-04:00

It's much more fun to be counter-intuitive than to repeat the obvious. So, when we see overwhelming evidence of egregious and pathetic political failure by the Obama White House, there is no shortage of theories defending them (or at least saying that their political ineptitude was, as an appeals court might say in affirming a trial court judgment, harmless error).

Theory One is that he wanted more spending cuts than Democrats are comfortable with. So the Republicans gave him cover. As in: "See what they're making me do?"

Verdict: True that he had this motivation. Perhaps even true that it influenced his feckless negotiating "strategy." But surely he did not want to get rolled, and so publicly and humiliatingly rolled, by the utter failure of his oft-repeated insistence on getting revenues as well as spending cuts. So bottom line: False.

Theory Two is that he simply had a weak hand to play. Sure, he might not have played it well, but even a competent politician and negotiator wouldn't have done much better.

Verdict: 100% false. The public supported his preference for "balanced" cuts and tax increases. Now, admittedly, public opinion is often close to irrelevant in Washington. But he had a decent hand and failed to play it. Point one: the constitutional option and related gambits, all of which would have gained support from Washington's beloved "strong leadership" meme. Point two: skillful politicians can do much better with hands that are much worse than what he had here. Think Clinton in 1995 after he lost the 1994 election. Or for that matter consider the Republicans taking him on in 2009. If either had performed as abysmally as he did, people would have said: "They just had a bad hand. Nobody could have won with that."

Just because he lost doesn't mean he had an inevitably losing hand. In many ways it was a good hand.

Theory Three is that he's cleverly positioning himself in the center, and letting the Republicans be seen as extremists.

Verdict: Mostly false. People also respect strength, commitment, self-confidence, and success. His pathetic showing is not going to win him the 2012 election. He's disheartened his base, millions of whom will likely stay home. Clinton positioned the Republicans as extremist (when they weren't nearly as far around the bend as they are today) without making himself look like a pathetic loser.

The evidence that Obama has very little understanding of the most basic political tactics and strategy is pretty overwhelming. This is a guy who believes that you start a negotiation by offering LESS than you want, not more so that you can give ground and still do well overall.

Jon Stewart had some rather obvious fun with the December press conference clip where he said that of course the Republicans wouldn't risk the full faith and credit of the U.S. government, so there was no need to negotiate a debt ceiling deal back then. And for the past 6 months his minions have apparently been telling reporters that of course the Republicans will agree to new revenues, because reasonable people can't disagree that it's part of the problem.

He also appears to be strangely arrogant and uneducable about his woefully naive view of political competition. The Bourbons famously "learned nothing and forgot nothing." Obama will evidently learn nothing and forget everything.

Recent talk at Oxford summer symposium

2011-08-02T15:45:00.008-04:00

I recently noted here my trip to Oxford in early July to present a paper and otherwise participate in an international tax conference. But in the press of events (even my summers are busy these days), I forgot to create a link to the slides from my talk.

At this year's Oxford conference, I presented a talk based on my forthcoming Tax Law Review article, The Rising Tax-Electivity of U.S. Corporate Residence, using revised and condensed slides. A link to the new slides is available here.

I have recently (and FINALLY, after months of intervening obligations, for the most part voluntarily if in some cases ambivalently self-imposed) gotten back to working on a completed revised version of my long-in-progress book on U.S. international taxation. At this point, I think I finally have it conceptualized properly. And I believe that this time, unlike in Decoding the Corporate Tax, which I admittedly like but which was basically (and avowedly) an accessible literature review, I'm making significant new contributions to how people should think about the field. The tax-electivity piece is one of the detours that I voluntarily set for myself because I felt that I needed to get my ideas in better shape first, and (along with my recent foreign tax credit work) it offers in passing some, though by no means all, of the ideas that I plan to detail in the new book.

Obama at the car dealership

2011-08-01T13:29:00.008-04:00

"There's one thing you should understand before we start talking price. I need this car, and I know you want to be fair to me. We're both better off if we're both happy afterwards.

"I don't have transport - I sent the cab away, and I didn't bring my cellphone. So I promise you right here and now that, no matter what happens, I am not going to another dealership. Again, I need this car, and I know you want nothing more than a satisfied customer.

"So here's what I'm going to do. The sticker price is $24,995? Great. I am offering you $26,000. That's fair, so there's no need for you to hold out for more. Why bargain when we can go right now and just sign the papers?

"What do you say? Deal?"

If we had a parliamentary system ...

2011-08-01T12:55:00.004-04:00

... then not only would the party in power after the 2008 election have been able promptly to pass legislation that it wanted, and not only would we have avoided the perverse incentive structure whereby one of the parties has veto power without responsibility, and no incentive whatsoever to cooperate on anything (a point brilliantly grasped by Senator McConnell), but the Democrats would now be able to kick out their leader and elect a new one via party caucus.

Perhaps my mood on this is too dark, but I am thinking that it's about time for people in the Obama Administration who don't want to be associated with its cowardice and ineptitude to start resigning.

A prediction

2011-07-31T23:07:00.009-04:00

Obama's next abject surrender is only months away, if that. When the trigger in the plan comes due, he will agree with the Republicans that there can't be big defense cuts, and they will get their way on the rest once again. Meanwhile, there will presumably be a government shutdown surrender on his part before the end of the year.

Even if he wins the 2012 election, it seems obvious that he will capitulate again on the Bush tax cuts (and of course he ostensibly wants to extend all but the top bracket cuts, although that too I take simply to be timorous advance surrender dating all the way back to 2008).

Two points on which Krugman is clearly right: it will hurt the economy, which now will be viewed as entirely Obama's fault; and rewarding blackmail like this is exceptionally dangerous. Sometimes you need to bite the bullet or it will only get worse (even leaving aside the clear alternatives to surrender or default that he ruled out from the start). That would take courage, however, a quality that (along with foresight) Obama appears entirely to lack.

This is why we're risking macroeconomic disaster

2011-07-28T08:52:00.005-04:00

Commentators are increasingly recognizing that the Reid and Boehner plans are similar, and that both would be significantly recessionary. David Frum recognizes why the difference is apparently worth fighting over:

"The Boehner plan promises to identify big cuts in discretionary spending over the next nine years. But wait a minute. Discretionary spending is appropriated spending. Congress can cut appropriations through the budget process anytime it wants. Why not just … do it? How is it a big win to declare a commitment to do it over a decade to come?

"The answer to that last is that the ordinary budget process requires some cooperation with the Senate and the president. And it was that cooperation that stuck in House Republicans’ craw. The big benefit of the Boehner plan is that it is seen to be imposed – and the current GOP mindset is that it’s better to gain less by show of force than to get more by negotiation."

This is what it comes down to. The Republicans' core goal has very little to do with policy, but rather is to impose a humiliating surrender on Obama and the Democrats. Meanwhile, the Democrats are more than willing to surrender in policy terms, even though the American public (unlike the Democrats themselves) takes the Democrats' side substantively (e.g., with regard to the mix between tax and spending changes). But the Democrats don't want to accept crushing humiliation in the form (as opposed to the content) that the final agreement takes.

Over this dispute - whether the Republicans should be allowed to openly humiliate the Democrats - we face the threat of an economic disaster that could be ten times worse than what happened in 2008.

Shorter John Boehner

2011-07-26T10:40:00.001-04:00

Lindbergh guilty of the child's death because he dragged his feet paying the ransom.

Sleeping in high places

2011-07-24T15:39:00.004-04:00

Ursula is owling again, as we call it, and also having a nap. The beauty sleep strategy appears to be working.

I am not thrilled by the "Gang of Six" tax plan

2011-07-20T16:19:00.030-04:00

The Gang of Six plan is unlikely to go anywhere anyway. But, while I realize that political constraints mean one must lower one's standards pretty severely in reaching a judgment, and while I recognize that there may be some good people involved with this who are trying to be constructive, I am unimpressed.

Herewith is the tax portion of the Gang of Six plan in its current form, with comments from me in caps.

"Simplify the tax code by reducing the number of tax expenditures and reducing individual tax rates, by establishing three tax brackets with rates of 8–12 percent, 14–22 percent, and 23–29 percent." I SEE ABSOLUTELY NO REASON FOR LOWERING MARGINAL INCOME TAX RATES WHEN WE HAVE A HUGE FISCAL GAP AND RISING HIGH END INCOME INEQUALITY. SEE MY DISCUSSION HERE OF THE 1986-STYLE TAX REFORM MODEL'S OBSOLESENCE. AND NEEDLESS TO SAY, NO BRAVE WORDS HERE ABOUT WHICH TAX EXPENDITURES TO CURTAIL.

"Permanently repeal the $1.7 trillion Alternative Minimum Tax." ONCE AGAIN, HOW BRAVE THEY'RE BEING - TAX CUTS ARE TRUMPETED, TAX INCREASES DISCUSSED ONLY IN THE MOST GENERAL TERMS.

"Tax reform must be projected to stimulate economic growth, leading to increased revenue." MEANINGLESS IN CONTEXT, AND LIKELY TO BE RELATIVELY TRIVIAL, UNLESS THEY ARE TALKING, AS I DON'T THINK THEY ARE, ABOUT SOMETHING LIKE SHIFTING TO A CONSUMPTION TAX. NOTE THAT REDUCED PROGRESSIVITY MIGHT TEND TO INCREASE ECONOMIC GROWTH, BUT THAT'S A TRADEOFF, NOT UNAMBIGUOUSLY GOOD. IT'S ALSO HARD TO EVALUATE THE GROWTH EFFECTS WITHOUT REFERENCE TO THE "SPENDING" SIDE OF THE PACKAGE.

"Tax reform must be estimated to provide $1 trillion in additional revenue to meet plan targets and generate an additional $133 billion by 2021, without raising the federal gas tax, to ensure improved solvency for the Highway Trust Fund." ONCE AGAIN, WHO NEEDS DETAILS?

"If CBO scored this plan, it would find net tax relief of approximately $1.5 trillion." INSIDE-THE-BELTWAY CODE FOR LOSING REVENUE RELATIVE TO SIMPLY LETTING THE BUSH TAX CUTS EXPIRE. BUT WHY EXACTLY WOULDN'T WE JUST LET THEM EXPIRE? (I REALIZE THAT THIS IMPLICATES THE OBAMA ADMINISTRATION, NOT JUST THE REPUBLICANS.)

"To the extent future Congresses find that the dynamic effects of tax reform result in additional revenue beyond these targets, this revenue must go to additional rate reductions and deficit reduction, not to new spending." WHY WOULDN'T THE TAX SYSTEM'S HYPOTHETICALLY ENHANCED EFFICIENCY SUGGEST USING IT MORE, NOT LESS? THIS IS JUST A VACUOUS SOP TO REPUBLICANS, WHO I DON'T THINK WILL BE IMPRESSED.

"Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families." ALREADY BACKING OFF THEIR SUPPOSED KEY REVENUE SOURCE. ONCE AGAIN, THE WAY THEY STRESS THE EXTENT TO WHICH THEY'RE NOT CUTTING, RATHER THAN WHAT THEY WOULD CUT, WHILE POLITICALLY UNDERSTANDABLE, HELPS SHOW THE HOPELESSNESS OF THE ENTERPRISE.

"Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries." I AGREE, BUT ONCE AGAIN THIS IS A DESCRIPTION OF WHERE THE BUDGETARY IMPROVEMENT ISN'T COMING FROM.

"Maintain or improve the progressivity of the tax code." MIGHTN'T THIS SUGGEST NOT REDUCING THE TOP INDIVIDUAL RATES? IF RATES ARE FLATTER BUT TAXES STILL RISE JUST AS SHARPLY WITH INCOME AS BEFORE, THEN (A) EFFECTIVE MARGINAL TAX RATES HAVEN'T ACTUALLY DECLINED, AND (B) PERHAPS PHASE-OUTS ARE BEING USED TO CREATE HIDDEN MARGINAL TAX RATES.

"Establish a single corporate tax rate between 23 percent and 29 percent, raise at least as much revenue as the current corporate tax system, and move to a competitive territorial tax system." ONCE AGAIN, ALL THE DETAIL IS ABOUT TAX CUTS, FROM REDUCING THE CORPORATE RATE AND ELIMINATING THE TAX ON U.S. COMPANIES' FOREIGN SOURCE ACTIVE BUSINESS INCOME. WHAT ABOUT THE U.S. MULTINATIONALS' TRANSITION GAIN FROM SHIFTING TO EXEMPTION GIVEN THEIR $1.2 TRILLION OR MORE OF FOREIGN EARNINGS THAT ARE ALREADY OUT THERE? AND AGAIN, WHERE ARE THE TAX INCREASES? FOR EXAMPLE, DO THEY PLAN TO COMBINE MAKING CORPORATE DEPRECIATION LESS GENEROUS AS A PAY-FOR WITH BEING MORE PRO-GROWTH? AND WHAT ABOUT U.S. COMPANIES' ABILITY TO REPORT U.S. PROFITS AS ARISING IN TAX HAVENS? NO WORD OF ADDRESSING THAT.

To some extent, I think the disingenuous gobbledygook here (to put it unkindly) reflects a deliberate, well-meaning, and not entirely foolish strategy. E.g., the thought may be that if Republicans were to agree in principle to raising revenues relative to the baseline in which the Bush tax cuts are extended, one huge obstacle to the revenue-raising changes would have been eliminated. But I consider it naive to think that this would actually work. Once the rubber hit the road, the Republicans would go right back to their anti-tax absolutism. And even if they didn't, the taxpayers affected by particular revenue-raising proposals would continue to make the task impossible.

Hard though it might be - and I admittedly don't think that ANYTHING will work politically; our system is just too dysfunctional - I think you have to try to lead with a bit more of the bad news, rather than leaving it all for later. If today, against the urgent backdrop of potential August 2 default, you can't even say what you'd be willing to do to raise some people's taxes, what exactly is supposed to make it easier down the road?