A sense of relief

Last Thursday I taught my last class of the semester.  I won't be back in the classroom until Tuesday, January 21, when Alan Auerbach and I will be doing the first session of the 2014 NYU Tax Policy Colloquium.

That makes this week the very week when I would have had ACL surgery, if I had decided to go under the knife for purposes of fixing my right knee.  The timing idea, had I gone ahead, was to finish fall classes, and then maximize the recovery time before I am next scheduled to teach a class.  I was told that I'd need at least four weeks to get back in the classroom, but the more the better.  I could also expect six grueling months before I'd be largely recovered as a matter of light daily activity, and probably twelve months before I could try anything as rigorous as tennis.

I suffered the injury at the tail end of April.  My first thought was that I definitely wanted the surgery, so I could be physically whole and (among other things) get back on the tennis court.  This was accompanied, however, by a queasy sense that getting surgery at my age just to play tennis (if that's how one thought of it) might be unwise.  Anyway, I'd need to finish my semester first and then do prehab.

I already had a couple of trips planned for the early summer, to Stockholm in May and Israel in June.  These, I determined, were still feasible, meaning that I couldn't have surgery until the end of June.  But one thing I absolutely did not want to do was ruin my summer, when I so vastly prefer it to winter.  There was simply no way that I wanted to spend my favorite months of the year lying in bed and then hobbling around on crutches, rather than enjoying the outdoors.  But once it was September, I'd need to wait for fall classes to end, hence the target date of sometime this week.

I met with three surgeons, decided which one I preferred, and started rehab (or at the time, apparently prehab).  But I hadn't definitely decided what to do.  I'm usually decisive about choices that I face, but this time I kept wavering, not that it mattered immediately, as the "go" decision still lay several months down the road.

By late July, my physical therapist was telling me that I was close to being able to go back on the tennis court.  But I didn't feel ready until late August.  My first time out, hitting with a pro, I felt as if I was a million years from ever actually playing tennis again.  All I could do was hit the ball if it was drilled right at me.

By late September I was actually playing matches, which I now have survived for more than two months, pretty much at my old level (as to both good days and bad).  I even run down a lot of balls - I'm almost as mobile as I used to be, if I'm on my toes and leaning the right way, though less able to change directions or manage a cold start.  I try to be careful in a couple of ways (including how often I play), but so far, mostly so good.  I also can rush to cross streets when the light is turning, as I always used to.  I simply don't do red lights, if I can help it, but early on this caused knee buckling if I even dared to try.

Meanwhile, I've been living my regular life, apart from the nuisance of having to keep up the regimen of daily knee exercise.  My current project (due January 15, but triaged until now behind other, more pressing obligations) is writing a short chapter called "The Economics of Taxation" (not my choice of title) for a forthcoming Oxford U. Press volume, the Oxford Handbook of Law and Economics.  Not as much fun for me, perhaps, as writing a more creative and original paper, but incomparably preferable to lying on my back with painkillers and an ice machine.

UPDATE: Great article about ACL tears, including why they happen.  I'd been noticing that, in the NFL, there seem to be a few every week, while in the NBA point guards have been falling from ACL tears like flies.  Also exactly my experience that it's a "mind-body" issue - ACL tears happen because you're surprised (which requires that you be playing with an opponent, even if there's no physical contact) - you change what you're doing at the last second and thus are awkwardly misaligned at the moment of injury.  Then you feel the  pop, and it's welcome to the world of diminished performance and (at least initially) pain.  The one difference between my experience and that described in the article is that, as merely an amateur / weekend athlete, I could get back to an adequate physical performance level without the surgery - obviously not possible for an NFL or NBA player.

Martin Sullivan on the Baucus international tax discussion draft and my work on foreign tax credits

In today's Tax Notes (12/9/13, 141 Tax Notes 1007-1012), Martin Sullivan is kind enough to offer an analysis of the Senate Finance Committee discussion draft that "draws heavily from the work of professor Daniel Shaviro of New York University School of Law," in particular my articles on foreign tax credits.  I gather that Sullivan has not seen my (still-unpublished) book on international tax policy, which offers a comprehensive broader framework, based in part on those articles.

"I have supped full with horrors"

The title of this post is a quote from Macbeth - appropriately enough, since Macbeth is known to Bertie Wooster as the "cat chap" - reflecting that Jeeves had quoted to him the line where Lady Macbeth refers to "letting 'I dare not' wait upon 'I would,' like the poor cat in the adage."  The horrors of which I write here do indeed relate to a cat.

For the last 15 months, our household has been brightened by these two adorable little fellows, littermates whom we adopted in September 2012 at the age of somewhere between 6 and 8 weeks. In the picture, Sylvester is the one on the left, and Gary is on the right.  Among the rituals that they eagerly endorse (besides knocking things onto the floor, following us around the house if something fascinating, such as watering plants, is afoot, swatting at loose yarn, and playing vigorous rounds of Friskabout) is coming downstairs for breakfast, after having starved all night once their food from the evening was gone.

But yesterday, no Gary at breakfast or thereafter.  We didn't see or hear him, and couldn't find him anywhere.  We then recollected that we hadn't seen him the previous evening (which can happen with a cat - it's that air of mystery which they never entirely shed), and that there had been people in our house the previous day doing repairs, which the kittens hate (both the noise aspect and the strangers aspect).

Sherlock Holmes says somewhere that, when you have eliminated the impossible, whatever remains, however improbable, must be the truth.  We were struggling to apply this precept, the problem being that we couldn't distinguish the impossible from the merely highly unlikely.  Could he have gotten out of the house?  It didn't seem possible, but then again cats can have ways.  Had he found a hole somewhere (a radiator seemed to have one) and disappeared into the wall?  Were there human fist-sized openings and passageways behind the walls, which he might be able to navigate and then perhaps get lost or stuck?  Did he get sick or injured and hide?  If he was still in the house and conscious, why wasn't he scratching and meowing?

This went on all day, and it would be an understatement to say that there were long faces in the Shaviro et al household.  But then at around midnight, a family member heard some scratching and meowing sounds.  It turned out that he was in one of the drawers of a little-used dresser.  He is now out and about, and evidently none the worse for having spent perhaps as much as 30 hours there.  We, by contrast, remain a bit the worse for wear, our immense relief notwithstanding.

Remaining mysteries, which I don't imagine we will be able to solve, include (1) how did he get into the drawer, which one would have thought was closed, (2) how did it re-close once he was inside, and (3) why didn't he announce his presence sooner, especially once the workers had left.

But after spending a full day thinking we might never see him again, or that perhaps in a month we would detect a skeleton stuck behind the wall, we are not complaining.

The joke with three punchlines

It recently occurred to me that, in the last three weeks alone, I have attended two public sessions devoted to discussing fundamental tax reform.  And these are hardly the only two such sessions that I have attended in 2013 alone, or even since the start of the school year alone.

Fundamental tax reform remains a favorite topic even though, as I once remarked in the opening paragraph of some paper or other, "while frequently in the air, it is rarely to be spotted on the ground."  Indeed, I am admittedly a multiple offender in writing about the topic, which is why I can't remember offhand in which paper it was that I said that.

After a while, however, the topic grows sufficiently over-familiar that I am reminded of the joke (itself perhaps over-familiar by now) in which a bunch of comedians are gathered in a room.  One of them stands up and shouts "39!"  Everyone laughs.  Another one stands up and says "17!"  Everyone laughs.  A newcomer who has heard this going on for a few minutes asks the person next to him what they're doing, and is told that all the jokes are so familiar that each has a number, eliminating the need to recite the entire thing..

So the newcomer stands up and shouts "28!"  Dead silence.  Mortified, he asks the person next to him what he did wrong.  And here's the best thing about the joke, its own over-familiarity notwithstanding.  It has three alternative punchlines, and perhaps not everyone who is reading this blog entry has already heard all three of them:

(1) "You didn't tell it right."

(2) "They heard that one already."

(3) "They don't know that one."

Heard all three punchlines already?  Sorry about that, but perhaps this makes it all the more postmodern (over-familiar joke about over-familiar jokes).

Senate Finance Committee international "Option Z" follow-up

In an earlier post on the Senate Finance Committee's international tax staff discussion draft, I said that Option Z, in which certain foreign source income (FSI) would be 60% taxed at the full U.S. rate but with foreign tax credits for 60% of foreign taxes paid, and 40% treated as exempt but with the remaining 40% of foreign taxes paid being ignored, may be a "treaty-compatible version of what I discuss in my book. To wit, the U.S. taxes FSI at a rate that is somewhere between 0% and the full U.S. rate, and foreign taxes are deductible-plus, but not fully creditable, thus retaining a degree of foreign tax cost-consciousness."  I attributed the possible treaty compatibility to the argument that "you don't literally 'double-tax' any given dollar of foreign income, by virtue of breaking it into two distinct pieces, each of which is formally 'taxed once.'"

Idiotically formalistic though this might be, I viewed it as just deserts for the formalistic legal norm that income must be taxed only once, a norm under which being taxed ten times at a 1% rate each time would be a horrid injustice, whereas being taxed once at 35% would be unobjectionable.

However, Fadi Shaheen, in a message that he has authorized me to quote (I don't otherwise spill the beans here on private communications), says the following:

"1. Wouldn't Option Z keep, if not increase, the complexity the FTC has been causing, which would be better addressed by deductibility? I thought that was the main advantage of deductibility over partial creditability ...

"2. Couldn't one make the argument that if under a substance over form approach two proposals (Option Z and yours) could effectively be the same and one is treaty-compatible, then the other would be too? I understand the formalities involved, but I really don't see much difference in substance."

Some quick responses: On Point 1, agreed that the arcane complexity of the foreign tax credit regime would still be on the books if we adopted Option Z, as distinct from simply making foreign taxes deductible (or deductible-plus in some fashion, but short of 100 percent reimbursement).  I was only thinking about the marginal incentive effects on paying higher rather than lower foreign taxes when I wrote the blog entry.  But on the other hand, with the marginal reimbursement rate on foreign taxes effectively reduced from 100% (in the scenario where deferral has been repealed and foreign tax credit limits do not apply), maybe one could ease up on the existing FTC rules a bit, as their attempted rigor responds to the total lack of cost-consciousness re. foreign taxes that a 100% credit can induce.

On Point 2, agreed as well.  When you have a formalistic rule, evaluating wholly formalistic questions of when it is or isn't being breached is not going to be a very intellectually edifying (or stimulating) exercise.  Hard to say how this would play out in practice.  The underlying question is whether U.S. treaty partners would get upset or not, and what role formal legal arguments would play in making them more tolerant of the end result. I was speculating that creating a decent formal argument that there is no "double tax" might help ease the way to limiting controversy, even though it means that equivalent systems get classified differently.

The one bit of substance that avoiding "double taxation" via the Option Z DOES have is that it requires equivalence between (a) the ratio between the "true" statutory tax rate for a full dollar of FSI and that for domestic source income, and (b) the marginal reimbursement rate for foreign taxes.  It's hard to see why the foreigners, in deciding whether to be outraged or not by U.S. adoption of Option Z, should care about this equivalence one way or the other.  But, then again, formalistic legal exercises have this way of making distinctions that matter little for their own sake potentially dispositive.

Lunch talks at the 2013 NTA Annual Meeting

Every year at the NTA Annual Meeting, we have two "General Session" lunches, usually with hundreds of people in the audience, with an invited speaker to give a talk.  One problem you face, as a Program Chair, is that lots of the people you might have considered inviting already did an NTA lunch recently. Great minds (in this case, past and current program chairs) think alike, and thus the pool of prospects keeps thinning unless the replenishment rate can keep pace.  I am not sure that it does.

Nonetheless, this year we we were able to do pretty well.  Thursday's lunch featured Peter Orszag, and Friday's Raj Chetty.  Each had substance and broad interest (if not that many jokes), so I felt good from the standpoint of an organizer who has attended mostly good NTA lunches but also a couple that were less successful and/or substantive.

Orszag gave a talk about where healthcare in the U.S. appears to be headed - a matter of huge interest for U.S. federal budgetary purposes, not to mention otherwise as well.  He offered good news for everyone except for the people (and there are many of them in budgetary politics) who prefer bad news. Time will tell if he is right or not, but the viewpoint certainly ought to be more widely known.

Here, for starters, is the part that's absolutely clear.  The rate of growth in annual per capital healthcare expenditure has declined very sharply in the last few years.  If this decline in annual growth rate is sustained, then the long-term fiscal picture is much better than people have been assuming for many years.  The official estimates still don't assume that it will be sustained, since it still looks a bit like an outlier.  But, to assess whether it is a fluke or the new normal, the key question to ask is what's been causing it.

Orszag convincingly rebutted the view that the last few years' economic slowdown is responsible for the reduced growth rate.  A key piece of evidence is that healthcare for people on Medicare who are largely insulated from the state of the economy (especially if they have Medigap plans to deal with their copayments) has been slowing like all the rest.

The slowdown is from the quantity services being rendered, not because healthcare prices are no longer rising.  Orszag attributes it, admittedly tentatively, to changes in financial incentives for healthcare providers.  Medicare is now much less a fee for service system (which encourages rising service intensity).  Instead, it tends to base payments on the medical condition, and where not doing so yet is apparently expected by many to start doing it shortly (so they are preparing).  This means that the hospital or other provider is the one bearing marginal costs of extra patient care.  Similar things are happening, he says, in private healthcare plans.

In effect, he says, there is a transition going on that resembles that in private annuity plans, which switched over the last couple of decades from "defined benefit' (where what you will get at retirement is specified) to "defined contribution" (where the pay-in is specified, and the market determines what it yields).  That shifted risk onto the employees.  Here, to a degree it's the healthcare providers that are facing the shifted risk, and this in effect makes them insurance companies (on behalf of the consumers) even if they are hospitals or doctor groups.  This in turn may have problems of its own, including issues of care being denied or of them mismanaging risk or being forced to band together in huge organizations that have the scale needed for insurance.  But it does potentially bend the cost curve, indicating (if Orszag is right, and he admitted that this is merely his speculation at this point) that our long-term fiscal situation under current policy may be far less dire than most people, including me, have been assuming.

Hard to say when the political system will take note of this, even if one is wholly convinced that it's correct.  After all, falling budget deficits in the last few years have gone almost completely unnoticed by the general public and also the Washington political class.

Chetty's talk was based on the landmark pension savings study, using Denmark data, that he presented at my colloquium earlier this year and that I am actually writing about (in an article that I had to put on the shelf a couple of months ago, and won't be getting back to for a couple months more at the least).  So I won't say anything particular about it here.  The subject was taxpayer inattention, and the implications for being defaulted into retirement savings plans versus getting "incentives" (from an income tax standpoint) for greater contributions.  As you'd expect from Chetty, sober and fair, no undue claims, and careful noting of all the problems in deciding what to make of the research findings for policymaking purposes.

2013 National Tax Association Annual Meeting

The NTA Annual Meeting ended a few hours ago, and (as per my last blog post) I am stranded in my hotel lobby, because that is better than being stranded in the airport.  My flight is just over two hours away, but no need to leave yet.  We are so close to the airport that, when playing tennis on the hard courts here - as it turned out, without injuring my ACL-deficient right knee, although there is always next time to worry about - I could almost have imagined I was playing at the U.S. Open.  All those giant jets taking off and landing right next to you.  Circling birds of prey as well.  I was hoping that they didn't know something about me that I didn't.

Anyway, the conference appears to have been a big success.  At least, this was my own sense of it, and people kept telling me so, in connection with my role as co-Program Chair (with Tracy Gordon). Our main strategy was to be inclusive and accept as many of the submitted papers and panels as we could.  This has a downside, since 4-paper sessions are potentially more jumbled and scattered than those with just 3, and since having lots of parallel sessions at the same time risks thinning out the audience.  But it also means that more people attend, more people get to present, that attendees have more choices, and we thought it would create a richer conference experience.  Inclusive is good.  Plus we just hated having to say No any more than we had to.  (Unfortunately, resource constraints meant that we'd be saying this to dozens of people in any event - but no reason to make it even worse.)

Economists with NTA-related interests presumably already tend to know about the Annual Meeting.  In addition, many of them know about the advantages of going, especially if one is junior.  You get exposure for your own work, feedback on it, you get to meet and talk with other people in the field, etcetera.  But tax law professors, and tax practitioners with broad policy interests, don't participate at the levels that the NTA wants.  (That said, there were at least twenty law profs here this year.)  Equally or more importantly, lots of junior tax people in the law schools may not be aware of the extent to which they may benefit from attending NTA annual meetings.  One of the great things about the NTA, especially for lawyers given the predominance here of economists, is the inter-disciplinary element.  Lots of panels are deliberately designed to include both groups.  But there is also a sufficiently large cadre of tax law professors who already come to the NTA with some frequency that you get to see plenty of your kind, which is good as well (networking, feedback, exchange of ideas, etcetera).

The next NTA Annual Meeting will be held in Santa Fe, at some point in November 2014.  Certainly a nice town in which to spend a few days, by all reports. But here are a few practical tips regarding how to get a paper accepted, based on my experience this year as a program chair.

Tip #1 - Start thinking about it before the Call for Papers goes out next year.  When it does go out, by the way, then even if you have not already joined the NTA (though why wouldn't you do that, especially if reimbursable as a professional expense), you ought to be able to get word, e.g., via the Tax Prof Blog.

Tip #2 - If possible, form the entire panel for a proposed session.  This would consist of either three or four papers, a couple of discussants, and a moderator or organizer (presumably, one of the authors or discussants).  This year, we accepted all of the proposed sessions.  I can't speak for next year's program chairs, but for a couple of reasons forming an entire panel gives you a leg up.  One, we hated to turn down people who had done this much work and put that degree of thought into it.  Two, it made our lives easier, since otherwise we had to accept individual papers and then start grouping into multi-paper sessions, where fit was important but not always easy to provide (and it took a LOT of time).

Tip #3 - Only if you have enough live prospects on your desktop, submit several papers, not just one.  I personally hated turning down ALL of someone's multiple submissions, plus there is a diversification advantage.  If one paper didn't seem like a great NTA fit to us, then maybe another one seemed better suited.  So don't submit sheer dogs, if you have just one good paper at hand and nothing else that's really suitable, but if you do have more than one live prospect, then by all means submit them all rather than choosing.  (Easy for me to say, of course, given that I won't be the one who has to read all of the submissions next year.)

Time for the airport - I will try to post, once I'm there or shortly afterwards, on one of the highlights (unless one calls it two of the highlights): the lunch talks at this year's NTA meeting, which were given by Peter Orszag and Raj Chetty.  (Perhaps with a mention as well of the session honoring Michael Graetz, who was this year's Holland Medal winner at the NTA, this award being one that is granted for lifetime achievement.)

Senate Finance Committee cost recovery draft

I'm sitting around the hotel lobby at the Tampa Bay Grand Hyatt, almost as if I had nothing better to do, because the National Tax Association Annual Meeting ended at 11:45 am and my flight isn't until 5:15 pm.  I had been reluctant to shave it too close, which put me initially on a 3 pm flight, but then they pushed me back to 5:15, so here I am.

The upside to being on such a deferred and unpopular flight (Saturday night the weekend before Thanksgiving) is that my United miles have proven sufficient, for the first time in a while, to get me upgraded to first class.  I am not sure whether my being very pleased about this has more to do with the objective conditions (bigger seat, probably better entertainment options, free dinner and drinks) or with the fact that airline travel is such a crazily status-demarcated activity today, making it a relief to be an aristocrat rather than a plebe/sheep, even if just for one day.  (I am the type who's mildly uncomfortable being High-Status compared to the low-status, but who really hates being low-status compared to the High-Status.)  But one way or the other, airline travel is not a very egalitarian experience these days (and of course the high end aren't in first class - they are in their own planes, where at least we don't have to see them.)

But anyway.  Might as well blog, having already done most of the work that I can do before getting back to my desk, and in a moment I'll post something about NTA 2013 (and 2014).  But for now, I thought I'd say something about the Senate Finance Committee draft on cost recovery even though, to be brutally honest, by reason of being on the road I haven't read it yet, though I hope to do so by Monday.  (But at that point I will be back in full triage mode re. multiple responsibilities.)  I believe I know the basic content of the draft - a very thorough and comprehensive effort at moving towards economic cost recovery, so I'll say something about that.

I gather that the draft covers, not only things like asset depreciation, but even advertising, which has been expensed for decades despite its typically creating long-term value.  I think it's great to have this sort of a benchmark out there, whether or not it's likely to be enacted (and I would think not, even if packaged with a corporate rate cut).

In addition, while I am not a vehement advocate of entity-level income taxation, as compared to a more consumption tax-style expensing-driven approach, two advantages of doing this sort of thing are: (a) it is one way of increasing inter-asset neutrality relative to that in the existing income tax system, although across-the-board expensing can get there as well, and (b) consumption tax-style expensing deductions within what's otherwise an income tax can have bad effects if taxpayers can effectively arbitrage them against realization-based deferral of economic gain on the inflow side, with the mismatch being enhanced via interest deductibility.  So this sort of approach can have desirable second-best features even if one would prefer across-the-board consumption tax-style business taxation.

But there is a problem with going full economic depreciation from where we stand today, especially if the change is paired with rate cuts in a revenue-neutral package.  Shifting to slower depreciation, plus lower rates on new investment, results in economically retroactive transition gain for old assets.  In effect, past decisions that were made under the current structure get rewarded, even though the taxpayers apparently didn't need the lower rate to invest (leaving aside the possibility that they were betting on it and that new investors will anticipate similar retroactive gain in the future).  Moreover, taxpayers who enjoyed faster-than-economic depreciation deductions under the 35% rate would then get to include the future income produced by those investments at the lower rate.  Meanwhile, in an overall revenue-neutral setting, new investments may be less appealing on an after-tax basis than they were before.

In general, if you like the new system better and believe you can first enact and then keep it, the transition price may be worth paying.  But the effect on new investment might be expected to worsen the short-term revenue estimates from the cost recovery scale-back.  OK, once again in theory that might be a small point, albeit in budget politics potentially a big one.  But it's an especially strong concern when we seem endlessly stuck in "secular stagnation," with a down economy and unacceptably low employment levels that just won't go away.  Not the best time for negative stimulus, especially when it is politically impossible to consider any positive stimulus.

Again, props to the Senate Finance Committee staff for working hard on a broad and ambitious proposal that I suspect will rightly remain a benchmark to be consulted in the future.  But these other concerns do merit mention.

Senate Finance Committee international business tax reform discussion draft: Part 3

So what is the long-term significance of the Senate Finance Committee discussion draft on international tax reform?  Interesting and ambitious tax reform plans, international and otherwise, get promulgated every couple of years, and nothing much ever seems to happen.  Here, as usual, we can expect the Washington partisan divide, interest group politics, etcetera, to stand in the way.  Senator Baucus and House Ways and Means Chairman Camp, who appear much readier than most of their colleagues to consider engaging in a 1986-style bipartisan process, will both be leaving their posts, and that might well be that.

But even proposals that get put on the shelf can matter, if someone in the future is possibly going to reach onto the shelf and pick out whatever is on top.  As per my prior two posts, I see three big takeaways from the Senate Finance discussion draft.

The first is its proposing to address rampant tax avoidance by U.S. companies.  Now, this is a trend that already has been gathering political momentum over the last few years, from all of the Apple, Google, etc., stories in the newspapers.  Whether it gets anywhere depends partly on U.S. politics - the companies have plenty of friends in Washington, both Republicans who hate all taxes, and Democrats who are friends with particular industry groups.  And whether it gets anywhere also depends on developments outside the U.S., such as the "base erosion / profit shifting" (BEPS) initiative that is being pursued by countries multilaterally.  Much easier for the U.S. to act effectively if not going to alone.  In this broader story, the discussion draft is admittedly just one more grain of sand on top of the dune.

But second, the discussion draft adds credence to the idea of levying a "transition tax" on U.S. companies' unrepatriated foreign earnings, as part and parcel of ending the repatriation tax along with deferral.  This is not only a good idea, if done properly, but one that politicians could potentially love (if they think of it as a one-time pot of "free money").

And third, the 60% / Option Z plan, discussed in my previous post, points the way to taxing resident companies' foreign source income at a rate that is between zero and the full domestic rate, while also rendering foreign taxes less than fully reimbursable, without violating tax treaties via formally defined "double taxation."  Given the arguments for such an approach that I develop in my book, this could end up being a major contribution.

Senate Finance Committee international business tax reform discussion draft: Part 2

OK, just very briefly on some added details of the Discussion Draft.

It's pretty aggressive in expanding U.S. taxation of U.S. companies' foreign source income (FSI), relative to present law that of course reflects the companies' large advances over the last 15 years in perfecting their avoidance of the U.S. tax.  (This in turn has resulted both from technological advances in tax planning, and from changes in the U.S. rules, such as the introduction of "check-the-box" rules for foreign entities that make subpart F, imposing current U.S. tax on suspected tax haven income, close to a joke or a relic.)

That's potentially fine, substantively if not (one suspects) politically, subject to two caveats.  One is the extent to which companies would use creditable foreign taxes to pay more foreign tax, rather than more U.S. tax.  But the other is the U.S. corporate residence electivity question: if we make it too tax-costly to be a U.S. company, increasing numbers of U.S. companies will opt out, via transactions that permit them to take foreign affiliates out of the U.S. chain of direct ownership.  No reason, perhaps, to set the U.S. tax price too low, but one also doesn't want to set it too high.

Among the key features of the Discussion Draft is a choice between "Option Y" and "Option Z," which are two alternative means by which the U.S. tax on resident companies' foreign source income is expanded.  Under Option Z, some FSI of U.S. companies would be fully taxed, with foreign tax credits.  But other FSI, generally I think that which is deemed to carry less of a smell of being "really" U.S. source or of having been artificially shifted through tax planning, is in effect 60% taxable in the U.S. with foreign tax credits, and 40% exempt without foreign tax credits.

Suppose, for example, that the U.S. corporate tax rate is still 35% (although I think the plan is to use the Discussion Draft to help finance lowering the U.S. corporate rate), and that a U.S. company earns $100 of FSI that is subject to the 60% rule under Option Z.  60% of the income is U.S.-taxable but gets foreign tax credits, and 40% is exempt but gets no foreign tax credits.  So the U.S. tax rate on this income, pre-foreign tax credits, would be $21, but the FTC would only reimburse 60% of the foreign taxes paid.

Say that the company pays $20 of foreign tax on this $100 of income.  The foreign tax credit is 60% of this amount, or $12, leaving an overall U.S. tax liability of $9 (i.e., $21 minus $12).  Increase the foreign tax fby $10 to a total of $30, and the FTC increases by $6, or to $18, reducing the U.S. tax to $3 (i.e., $21 minus $18).  So a $10 increase in foreign taxes reduces the U.S. tax from $9 to $3 (illustrating the 60% MRR).

I am starting to think that Option Z is a treaty-compatible version of what I discuss in my book.  To wit, the U.S. taxes FSI at a rate that is somewhere between 0% and the full U.S. rate, and foreign taxes are deductible-plus, but not fully creditable, thus retaining a degree of foreign tax cost-consciousness.  But it appears to be treaty-compatible, because you don't literally "double-tax" any given dollar of foreign income, by virtue of breaking it into two distinct pieces, each of which is formally "taxed once."

I wish I had thought of that!  But I didn't, and the book has gone final.  That petty personal regret aside, kudos to the Senate Finance staff (and their colleagues on other staffs) for filling in this gap.  I still need to spend more time on the proposed legislation, in order to understand the definitional attributes of the income that they would treat this way under Option Z, but it looks like they've actually proposed something that I have been calling for (although, again, not to be vainglorious on the subject of who gave them the idea).

Option Y is a global minimum tax system, under which one must pay 20% somewhere, or else the U.S. will make up the difference.  It therefore results in zero cost-consciousness with respect to foreign taxes, as one's foreign tax liability increases from 0% to 20%.  So not a great idea from a U.S. standpoint, even if we agree that current law is worse overall.  The point once again is that, even insofar as you don't change the foreign tax credit, repealing deferral makes its real world incentive effects worse.

Nonetheless, hurrah for Option Z - which, at a minimum, appears to contain the seeds of a very interesting implementation approach that potentially improves on just about everything else that is currently out there.

Senate Finance Committee international business tax reform discussion draft: Part 1

Today Senator Baucus, the chairman of the Senate Finance Committee, released a staff discussion draft on international business tax reform.  You can find a New York Times description of it here, as well as an official description of it here, not to mention a one-page staff summary here and even detailed statutory language here.

I myself have looked at all of the above except for the statutory language, which I have printed out with the hope of getting to read it during my airplane flight to Tampa tomorrow.  (I will be attending the National Tax Association's 106th Annual Meeting, at which Tracy Gordon and I are the program co-chairs.  If you can tolerate one more link, the conference program is available here.)

One key feature of the discussion draft is its imposing a one-time transition tax on U.S. companies' unrepatriated foreign source earnings.  I gather that these earnings would face a one-time 20 percent U.S. tax, which could be paid over 8 years.  This is an idea that I promoted in my article on corporate residence electivity (available here), not having previously heard anyone propose it, although I honestly don't know if I'm the source of the idea given that sometimes multiple people think of the same thing.

Not surprisingly, I consider this a generally meritorious idea, in part because its anticipation effects, if people think it might be enacted even before it actually is, push towards reducing the incentive to keep funds abroad indefinitely.  However, there is one important question to keep in mind, if it is used as a "pay-for" in a broader international or business tax reform package that also contains revenue reductions, such as from lowering the corporate rate.  Since this is a one-time tax, one wouldn't want to rely on claims of overall revenue neutrality that reflected ignored continuing revenue loss outside of a finite, such as ten-year, budget window.

A second feature of the proposal is its making U.S. companies taxable on their foreign subsidiaries' sales into the U.S. market.  Assuming that tax planners cannot game this rule too easily - a question that I obviously can't evaluate at this point - I'd view this idea as having considerable merit.  Roughly speaking, and despite major formal and substantive differences, it has some potential economic commonality with (a) making the U.S. corporate tax system destination-based rather than origin-based (as Alan Auerbach has proposed), and/or (b) using formulary apportionment, with primary or even exclusive emphasis on the sales factor (as Reuven Avi-Yonah and Kim Clausing have proposed).  In practice, this will often be income that actually was created economically in the U.S., even if the magic of tax planning causes it to be classified as foreign source income.  And in addition, there are efficiency benefits, including but not limited to reducing tax planning games, to causing U.S. tax liability, in one of these ways, to be in part a function of domestic sales.

I presume that this inclusion would be subject to the allowance of foreign tax credits with respect to the sales income.  If I am right about this (and I will correct this posting promptly if informed that I'm wrong), then there is a problem.  U.S. companies would have zero incentive to reduce foreign taxes up to the point of the foreign tax credit limit, given creditability.  OK, but isn't that already true today under the foreign tax credit?  Ah, but there's a difference.  As I discuss in my book - and I think this is an important point - deferral for unrepatriated foreign earnings, which the Discussion Draft would eliminate, is bad in almost all other ways, but it does have the virtue of making U.S. companies foreign tax cost-conscious under most of the realistic scenarios.  The foreign tax credit becomes worse, even if you don't directly change it, when you repeal deferral.  And this, to my mind, calls at a minimum for scaling back the 100 percent reimbursement percentage that the foreign tax credit generally offers when applicable.

More in subsequent posts, I hope - although subject to multiple claims on my time - first on other important features in the Discussion Draft, and then on its potential significance as a marker in the ongoing debate even if we posit that no significant Congressional tax legislation is likely to be imminent.