Tuesday, May 21, 2013
Sweden and the Supreme Court's PPL decision (not meant to imply, however, that these two are in any way linked)
Today the U.S. Supreme Court decided the PPL case, its first decision concerning foreign tax credits for 75 years (and it would certainly be fine if they don't decide another one for 75 years). The taxpayer won, in one of those 9-0 opinions which reads like a brief for one side. Any sophisticated reader, even knowing nothing about the issue, will recognize upon reading it that the issues can't possibly be as simple, straightforward, and clear as the opinion would have it, or else there would have been no need for the Supreme Court to take the case.
Hope for the future (if the Supreme Court takes enough tax cases for it to matter): the case is decided on economic substance grounds. This is usually a good thing for the sound development of the tax law, relative to the Court's deciding to be rigid and formalistic. Of course, one wonders if the fact that it was a corporate taxpayer, in this instance benefited by "economic substance," made at least the opinion's author (Justice Thomas) so eager to embrace economic substance this time around.
The government clearly blundered, given the role that economic substance generally plays in the tax cases, in claiming that this was a case in which formalities should control. But (as I have discussed the case in earlier posts), it was reacting to the fact that the UK government made the "mistake," in terms of making foreign tax credit claims easier for US taxpayers, of describing the tax as something other than a (creditable) income tax, thus requiring the taxpayer to show that, in the main, it was economically equivalent to an income tax.
The problem, which I've discussed in earlier posts, is that creditable income taxes are, at least in the main, economically equivalent to non-creditable non-income taxes. (For example, if property earns 5% a year, then a 40% income tax is a whole lot like a 2% property tax.) Hence the government's formalistic argument, to the effect that you have to call it an income tax in order for it to be creditable as one - a point that might actually be reasonably consistent with the arguable "intent" of the enactors (notwithstanding that they of course never thought of this issue).
Also of concern is the fact that the creditable tax was in effect retroactive. Now, I have written a book about retroactivity in taxation, and I am not exactly knee-jerk about how terrible it supposedly is. But if another country can pass an effectively retroactive tax that is creditable, then potentially they can dig a scoop into the US Treasury, by hitting US companies with a levy that the companies won't mind insofar as it's creditable (i.e., reimbursable).
But this issue, which ought to have been clear, appears to have gone well over the head (or under the feet) of the Court's opinion in PPL. So if it becomes a problem, the Treasury will have to try to deal with it on the fly next time.
Monday, May 13, 2013
So on Sunday night I will be flying to Stockholm, Sweden, in order to spend a week there, during which I will guest-lecture at two Stockholm University Law School classes on international taxation, as well as giving a talk based on my Henry Simons paper to Stockholm University faculty. I also plan on enjoying my first-ever visit to a Scandinavian country.
Friday, May 10, 2013
Ten days ago I experienced an unpleasant knee injury while playing tennis. It appeared to have been on the outside of my right knee, where (I determined from about 30 seconds of on-line research) the lateral collateral ligament (LCL) is located.
I couldn't get in to see my sports doctor (yes, at my age those of us who are still playing sports tend to have sports doctors, whom we have seen multiple times) until this past Monday. And I couldn't get an MRI for the knee until today.
He said on Monday that he thought the LCL was fine. But there was a lot of swelling, possible meniscus (cartilage) damage, and possible anterior cruciate ligament (ACL) damage.
I was skeptical on the ACL front, since my understanding is that it's in the back of the knee, and I had thought the trauma was on the side. I was also really hoping that it wouldn't be the ACL. Say ACL and I think: Derrick Rose, Iman Shumpert, major setback, surgery, arduous one year rehab. In a word, ouch.
Well, you can probably guess the punchline. Today I had my MRI, and within an hour my sports doctor called to say I have a complete ACL tear. I guess this confirms once again that actual doctors, equipped with actual information, can do a better diagnostic job than lay people who are looking things up on Google.
The good news is that I can still walk, and don't need immediate surgery. My upcoming trips, to Stockholm later this month and Jerusalem next month, appear to be safe. But it does look like I will be having surgery and rehab starting later this summer, since otherwise my knee stability and lateral movement capacity would be too low for me ever again to play sports such as tennis.
Further good news, relative to the torn-ACL baseline that I had in mind, is that I gather I should be walking in less than a week after the surgery, and back on the tennis court within 3 months.
The difference in this regard between a casual athlete like me, and a professional like Rose or Shumpert, is as follows. All of us are projected to be 80% recovered after three months, 90% after six months, and 95% after a year. But I can play tennis at 80%, whereas if you are driving to the basket and/or defending against the likes of LeBron James, you had better reach at least 95% before you even think about it.
Wednesday, May 08, 2013
Tax policy colloquium, week 14: Raj Chetty's "Active vs. Passive Decisions and Crowd-Out in Retirement Savings Accounts: Evidence from Denmark"
Our final speaker of the semester was Raj Chetty, presenting the above-titled paper, which has already (deservedly) received enormous attention, both within the field and from policymakers, even though it hasn't been officially published yet. (Of course, it's not as if all that many people, at least in the field, really do read much in the way of published versions of papers, since the working paper versions may appear years earlier.)
Chetty's paper takes advantage of some stunningly complete data from Denmark, providing information about people's income, savings within retirement accounts, and overall wealth-holdings (at least of financial assets), and extending over a long period when Danish policy changes created the equivalent of large-scale natural experiments. The idea is to test the effects on people's overall financial wealth - not just that which they hold in employers' retirement savings accounts - when the rules for the accounts change in either of two respects. The first is either (i) requiring mandatory contributions to the accounts or (ii) changing the amount that one invests through them, out of one's paycheck, as a default (i.e., unless one specifically opts to change the contribution amount). The second is changing the amount of any tax incentives for investing in the accounts.
A couple of preliminary notes: First, mandating contributions can be a lot more like merely defaulting them in than one might initially think. If you are required to contribute more, thus reducing your currently available cash flow and increasing your retirement savings, then, so long as you are not in a corner, you can respond by reducing your outside saving. In such cases, the only real difference between a mandate and a default is that reversing out the latter may be easier (as well as more precise, if the mandated saving has different characteristics than the outside saving you can reduce).
Second, when we say that retirement saving through employer accounts is tax-subsidized, we are describing it relative to an income tax framework. From a consumption tax perspective, exempting returns to saving (or the equivalent thereto) is "normal" treatment, not a tax subsidy. This can be important for certain purposes when we are thinking about the significance of the Chetty paper's findings - something that I may be writing about this summer, although I will not address it here and now.
A theoretical apparatus that the paper uses to make predictions about the data, which then are strongly confirmed, posits that there are two types of savers: "active" savers and "passive" savers. The former act like neoclassical utility maximizers. In other words, they have some sort of preference for the split between current consumption and saving, and if you change where they stand through mandates or defaults they will simply steer back towards where they wanted to be to begin with. If you give them tax incentives for retirement saving, a key response will be simply to redirect saving that they were already doing to the tax-favored accounts. They will only respond by saving more insofar as the incentive sufficiently affects the relative payoffs to create a slight change in the overall balance.
Passive savers, by contrast, are inattentive and easily steered. There actually are several different explanations of what they might be doing and why, and the paper doesn't try to choose between these explanations, although for some purposes it is quite important. They are posited not to respond to tax incentives because they aren't paying attention. They also don't deliberately offset any changes in retirement saving from their facing mandates or a change in the default.
It is theoretically indeterminate, in the paper's model, whether mandates and defaults will actually cause them to save more. Suppose that they start getting smaller paychecks due to larger contributions to their employer retirement accounts. Possibility (a) is that they go on consuming just as much as before, only they run their bank balances lower, perhaps have to borrow more, etc. So there is no change in their net saving, not because they are deliberately undoing the induced saving, but because their behavior is so entirely fixed. Possibility (b) is that they consume less in response to having smaller paychecks. E.g., suppose they are rule of thumb consumers who don't just go blindly on with the same consumption activities no matter what, but rather they treat their current checking account balances as telling them how much they have to spend for the month.
The Denmark data finds that the population was about 15% active savers and 85% passive savers. The latter used possibility (b) above - that is, they did reduce consumption when mandatory or default saving reduced the size of their paychecks. Unsurprisingly, the active savers tended to be people who are wealthier, older, save more in general, etc.
The paper finds that each dollar of increased tax incentives for saving produced only about 1 cent (!) of additional saving. This reflected the passive savers' inattentiveness and the active savers' mainly shifting saving from outside to tax-favored accounts.
The paper also funds that each dollar of increased mandated or default saving produced about 90 cents of additional saving. This reflected the predominance of passive savers in the population.
Lots more to say about this in due course. But for now I'll just say that it's interesting and has important implications for both theory and policy. (Not just this paper, of course, but also others in the same literature that reach similar findings albeit generally less far-reaching and conclusive ones because the U.S. data, say, simply isn't as rich.)
Monday, May 06, 2013
What does "fundamental tax reform" mean here? I suppose it could mean anything or close to nothing. But, as I recently discussed here, for several decades it has meant 1986-style tax reform, in which one lowers the rate and broadens the base, with the aim of achieving overall budget neutrality, and in some versions also maintaining distributional neutrality against prior law.
So here's the idea: the U.S. will have to default unless we enact massive tax changes that have no net budgetary impact. That makes a lot of sense, in relation to the debt limit problem.
I should note that Republicans and Democrats not only don't agree with each other regarding what fundamental tax reform should look like, but they don't even agree with themselves. Neither side has, or could easily develop, a budget-neutral fundamental tax reform plan that its own people would generally support. And few on either side have been willing to specify sufficient base-broadening to make such a plan budget-neutral (let alone distribution-neutral, which is probably impossible today for a significant 1986-style package for individuals).
Perhaps the Congressional Republicans should instead demand something that is more feasible, albeit equally unrelated to achieving long-term fiscal sustainability. For example, they could demand de-extinction through cloning of the woolly mammoth, a goal that may soon be feasible and that - unlike 1986-style tax reform - I fervently support.
Thursday, May 02, 2013
Tax policy colloquium, week 13: Itai Grinberg's "Emerging Countries and the Taxation of Offshore Accounts"
The U.S. share of this problem is relatively small, since a far lower percentage of U.S. wealth is held offshore than that from most other countries. Note that U.S. individuals generally cannot lawfully avoid U.S. tax by holding their portfolio assets offshore. The income from foreign bank accounts, stock trading accounts, etceteram is currently taxable, and even if you do your portfolio investment through a company that you incorporate abroad it is likely to face current U.S. tax (or worse-than-equivalent treatment to current taxation) under the passive foreign investment company or PFIC rules.
But there are of course some U.S. individuals who commit tax fraud through the use of secret overseas accounts. Moreover, the problem can extend past investment income to labor or active business income, as in the scenario where a fraudster tells people to pay for his services (say, as a contractor) via deposits in the secret accounts. This leaves only the problem of getting spending money out of the accounts, such as via overseas trips or the use of credit cards. And then the IRS, unless it can trace the cash or find the accounts, can only use "lifestyle audits" to prove that the fraud is occurring.
As further background to all this, in 2010 Congress passed FATCA (the Foreign Account Tax Compliance Act), almost overnight and without advance notice but leading to huge controversy ever since even though it is not scheduled to take effect until 2014. FATCA seeks to require foreign financial institutions around the world to identify their U.S. account holders and report on them to the IRS. (For convenience, I'll call them "foreign banks" although they can be other types of financial entities as well.) Foreign banks that don't cooperate may face huge withholding taxes that are meant to be a punitive rather than an indirect collection mechanism.
Foreign banks and their U.S. allies or representatives have been screaming bloody murder ever since FATCA passed, and they make several good points. One is that it may be very difficult for them to determine who are their U.S. account-holders, since U.S. individuals may invest in them via foreign entities. (E.g., I incorporate in Bermuda, and my Bermuda company invests through a Luxembourg bank.) Another problem is that complying with FATCA may require one to break home country laws aimed at protecting confidentiality, and on the same ground may violate contracts with one's clients and customers.
A sophisticated defense of FATCA would hold that it was simply a device to require foreign banks and other countries to start negotiating with the U.S. with regard to the offshore wealth problem - which again, is in comparative terms a far worse problem for many other countries than for us. And indeed there has been significant movement along those lines since FATCA was enacted, which likely would not have taken place otherwise.
Grinberg's UCLA article takes stock of all this, and makes a couple of main points. One is that there has been enormous movement towards global acceptance of the proposition, which would have been thought absurd pre-FATCA, that financial institutions acound the world should serve as "tax intermediaries" that act on behalf of the home country taxing authorities, just as U.S. banks do domestically by issuing Form 1099s to account-holders and the IRS. But he describes the battle between two competing models: that of information reporting to the home country authorities, and that of anonymously collecting a withholding tax (with respect to dividends, interest, etc.) that is paid over to such authorities in lieu of any reporting.
The second of these two options appears to have been the brainchild of some very clever Swiss banks that figured they could push back against the pressures for full reporting by making selective withholding tax deals with a couple of influential countries (the U.K. and Germany). Grinberg argues in the UCLA piece that the reporting approach is better than the withholding approach - a view that has considerable merit if withholding is sufficiently feasible. The basic point is that only information reporting can lead to fully effective home country worldwide taxation of individuals' passive income, which clearly is how one would like to go if the home country has an income tax that it wants to apply effectively. Reporting also can address, as withholding taxes on interest and dividends cannot, the fraud problem of not reporting one's earnings or business receipts to the home country authorities by reason of having them secretly paid abroad.
One objection to universal information reporting, assuming it to be feasible, concerns bad people getting information about resident individuals' foreign holdings, in settings where it is not simply a matter of anodyne tax enforcement. Consider Putin wanting as much information as possible about people who might oppose him, or corrupt officials who would sell the foreign wealth information they procure to prospective kidnappers who want to know whom they should victimize and how much they should demand. But certainly the system has great appeal, if feasible, not just for countries like the U.S. and those in the EU, but also for what Grinberg calls "emerging countries" that have decent governance. Indeed, those countries might actually benefit the most, so FATCA, if it plays out as Grinberg hopes, might actually be seen as a generous act that leverages U.S. financial market power in favor of a global cause that has bigger winners than us.
Before we start getting all choked up about U.S. generosity, however, it is worth noting that FATCA, at least on its face, is mainly unilateralist. The idea is that other countries should tell us what we want to know, whereas we don't necessarily want to tell them anything. The U.S. is indeed a kind of tax and reporting haven that wealthy people in other countries use to escape the scrutiny of home country authorities. I gather that Miami, for example, is an offshore global financial haven (or heaven) for wealthy people in Central America and South America. Miamians who are getting rich off this business are not exceptionally eager to face FATCA-type obligations towards foreign governments. So FATCA can play out in the direction of U.S. hypocrisy, rather than of providing the benign global leadership that Grinberg favors.
"Emerging Countries and the Taxation of Offshore Accounts," Grinberg's follow-up paper for the colloquium, tries to take stock of fast-moving current developments, which in the last month have been unremitting (e.g., at G-20 meetings). It argues that we are in a "punctuated equilibrium" type moment in which a system that might persist for decades is still fluid and being set up. Moreover, it discerns grounds for optimism that there are enough players with common interests for the information reporting model to really take hold. The two detours that the paper argues against are withholding in lieu of information reporting, and narrow special deals between just a few countries (with everyone else left out) in lieu of broader and more widely applicable deals. The main reasons offered for optimism are (a) lots of countries would benefit - this is not a rich country versus poor country issue, although it is a "countries with substantial resources versus tax haven countries" issue, and (b) financial institutions might prefer a single and consistent system of global reporting than having to comply with 50 different rules from countries that are going it alone.
On the first of these two points, one would have to rely on the ability of the non-haven countries to pressure all (or enough) of the haven countries - there can be no Pareto improvement here that would make everyone eager to cooperate. Providing accommodation services for foreign wealth is a nice business model for a small country that is sufficiently well-governed. On the second point, it's clear that uniform global financial reporting would not be the banks' first choice, so getting them to play ball (including in the sense of not opposing it politically) depends on their assessment of the likely alternatives.
If Grinberg is right about the timing, we will know within a couple of years how it all came out.
Monday, April 29, 2013
The legal dispute reflects the fact that economically identical taxes may be creditable or not, depending on how they are formally described. For example, if you had a $5 perpetuity and the pre-tax interest rate is 5%, so it is worth $100, a 40% "income tax" is hard to tell apart from a 2% "property tax," since either one will cost you $2 per year. Yet only foreign "income, war profits, and excess profits taxes" qualify for the foreign tax credit.
The IRS has raised a few eyebrows, along with a legal challenge that generated a circuit split and Supreme Court review, by taking an apparently formalistic stance here, and saying that the U.K. tax is not creditable because it was not called or expressly structured as an income tax. More often, the IRS wants to look at economic substance, while taxpayers rest their cases on self-selected form that supports favorable tax results.
But here, saying that "substance" should control runs into the problem that the underlying law on its face rests on arbitrary and formalistic distinctions. Should any tax that can be shown to be equivalent to an income tax be creditable, even though it's clear that some such taxes are not meant to be creditable? If so, then how exactly is one supposed to draw the fantastical line between taxes that win due to income tax equivalence and those that lose despite it (and thus that are also equivalent to the ones that win)?
In today's Tax Notes, Alan Viard has a very nice piece exploring PPL's conundra. Rather than argue that the case should come out one way or the other, he uses it as a vehicle to expose the fundamental problems with foreign tax creditability and the related illogic and arbitrariness of efforts to draw lines between taxes that are creditable and those that are not. In addition to agreeing with his analysis, I'll admit to having been personally gladdened by his references to some of my recent work on foreign tax credits (to be further developed in my forthcoming book on international tax policy). A few samples of the article's discussion include the following:
"Reiterating a point made a half century ago by Peggy Musgrave, Daniel N. Shaviro of the New York University School of Law recently emphasized that from the standpoint of American well-being, U.S. taxpayers’ foreign income tax payments are no different than their other foreign tax payments, nontax foreign business costs, and reductions in foreign income. The credit reduces American well-being by artificially and inefficiently diluting U.S. taxpayers’ incentives to minimize foreign income taxes, because those taxes can be offset by the credit. The credit prompts American companies to operate in high-tax countries, to be less zealous in challenging foreign tax assessments, and to enter transactions that reallocate other parties’ foreign income tax liabilities to them in exchange for other benefits. Statutory and regulatory restrictions on the credit cannot satisfactorily combat those incentives....
"Despite its unusual generosity, the FTC has enjoyed almost unanimous support" [For example, to bring out the lack of coherent - or any - analysis more bluntly than Viard does, it's not classified as a tax expenditure because it's not classified as a tax expenditure. That is to say, it has not been defined as a tax expenditure because it has been defined as not a tax expenditure.] ....
"Empirical evidence recently presented by Kimberly Clausing and Shaviro confirms that a country’s provision of an FTC prompts its investors to direct their overseas investments toward high-tax countries. Clausing and Shaviro found that OECD countries with credits placed a larger share of their foreign direct investment in high-tax countries (statutory corporate tax rate above 30 percent) and a smaller share in low-tax countries (statutory rate below 15 percent) than the OECD countries that exempt overseas income or have a hybrid credit/exemption system. The difference persisted in a statistical analysis that controlled for countries’ GDP levels, geographical distance, and other relevant variables.