Only at NYU Law School

Perhaps I can be forgiven for a spasm of institutional chauvinism.  There is no place like NYU Law School, in the U.S. or indeed around the world, for studying tax law and policy.  A case in point today came from an event that was organized pretty much on the fly, yet drew a strong audience response.

Professor Alfons Weichenrieder of the Economics Department at Goethe University in Frankfurt is a leading researcher in the field of international taxation.  Like several other excellent economists in this field in both the U.S. and Europe, he is interested in understanding the institutional details of how countries' tax systems work, recognizing that one can't otherwise do good empirical research about international taxation.  In addition, like some but not all of the economists whom I have met, he is interested in talking to lawyers.

He was in the U.S. for a conference that we both attended last Friday, and had asked me if, while in the area, he could present a paper at NYU Law School.  We thought that this would be great, the only question being whether we'd be able to deliver a proper audience, but we figured we'd do our best.

The event took place from 6 to 7 pm today.  He presented his paper (co-authored by Martin Ruf) "CFC Legislation, Passive Assets, and the Impact of the ECJ's Cadbury Schweppes Decision."  The background here is that in 2006, in the Cadbury Schweppes decision, the European Court of Justice, on grounds that many fair-minded people find considerably short of being persuasive, held that the U.K. could not use its controlled foreign corporation (CFC) rules to combat tax planning games that placed passive income (via foreign subsidiaries of a U.K. company) in low-tax Ireland, rather than high-tax England, unless the taxpayer was making use of a "wholly artificial" arrangement.

The decision undermined EU countries' ability to address income-shifting games through the use of subsidiaries in low-tax members of the EU.  A number of EU countries, I believe including Germany, responded to the Cadbury Schweppes decision by loosening their CFC rules in the interest of advance compliance.

Using a unique data set concerning German companies, the Weichenrieder-Ruf paper examines the question of whether there are empirical traces suggesting that German companies responded to the new opportunities afforded.  Although the response appears not to have been huge - in part, perhaps, because of uncertainty regarding how aggressively Germany would push on the decision's permitting the disallowance of tax benefits from "wholly artificial" arrangements - there nonetheless are discernible signs that companies responded by holding more passive assets through EU subsidiaries, albeit less through subsidiaries in outside tax havens such as the Cayman Islands.

OK, onto the NYU Law School chauvinism.  One point is simply that we had an event like this, and have many such in the course of a typical semester.  But another point is that, despite a late start on our part in promoting the event (basically because everyone is every busy), we got more than 20 people to show up (and then engage in lively discussion), on short notice, on a Thursday night from 6 to 7 pm, with no food available (other than a Cadbury chocolate bar that Alfons whimsically brought), on a rather specialized topic, for an empirical paper by an economist who is not from the U.S. and thus is not known to most people here, and on a night when many or even most of the tax students who might have come were unavailable because they were going to Washington for a job fair.  The audience included NYU students, NYU faculty, and tax people from outside the institution who are regularly participating members of our broader community.

I tend to doubt that all this could have happened at any other U.S. law school.

NYU Tax Policy Colloquium, week 6: Hines and Logue, Delegating Tax

Yesterday at the NYU Tax Policy Colloquium, Jim Hines and Kyle Logue presented their paper, “DelegatingTax.”  The paper’s main arguments are: (1) Congress does less delegation of lawmaking authority in tax than in other areas of law, such as environmental regulation, (2) the grounds for favoring significant delegation in other areas also apply to tax, and therefore (3) it might be desirable for Congress to increase the degree to which it delegates lawmaking authority in the tax area.

Possible examples of greater delegation that the paper discusses include (a) giving the Fed authority to make tax rate changes for countercyclical reasons, (b) giving greater discretion, with regard to the design of tax preferences either to the Treasury or to subject-matter experts, and (c) empowering a commission, a la the military base-closing commission of some years back, with the authority to make broad determinations with regard to which tax preferences might be eliminated to fund either lower rates (in a 1986-style reform) or else long-term deficit reduction.

This was an interesting paper and I am generally sympathetic to its line of argument.  To be sure, it is hard to pin down what exactly one means by greater versus lesser delegation (although there clearly is some underlying content there).  Moreover, if it could be defined crisply enough, one might want to try to examine empirically the relative delegation in tax versus other areas in the U.S., and as between the U.S. and other countries.

Further thoughts that I had upon reading the paper are contained in the following, which is an expanded and reorganized version of notes that I prepared for myself in order to be ready for the session:

1) What do we mean by delegation of tax lawmaking authority, and where do we tend to find it?

(a) It has something to do with the choice between rules and standards, where the latter might be viewed as involving greater delegation, but is not exactly the same thing.  (E.g., one could delegate either more or less under either a rules-based or a standards-based approach.)

(b) If we are talking about tax delegation, we should keep in mind delegation to the courts, not just to the Treasury Department.  Most judicial decisions on tax in the U.S. involve statutory interpretation, and thus not only could be overturned by Congress ex post, but in many cases could have been headed off ex ante if Congress had wanted to specify more precisely what it meant.  (Often it doesn’t, however – apparently preferring to delegate.)

(c) Congress appears highly inclined to delegate in cases where it is applying very broad legal concepts that have murky or unclear underlying economic content.  Examples include:

            (i) Section 482, which authorizes the Treasury to reallocate taxable income between related parties based on the principles of clear reflection of income and preventing evasion.  Under the regulations, this is generally done under an “arm’s length” standard.  One asks the counterfactual question: “What would the related parties have done if acting at arm’s length?” and tries as best as one can to finesse the problem that this question commonly lacks a coherent, much less discernible, answer.  My point here is not that doing this is a bad idea (not doing it would probably be even worse), but that the difficulty of devising workable principles has apparently induced Congress to punt / delegate.

            (ii) Debt versus equity – This is the re-delegation that failed.  As is well-known, there is no coherent basis on which the tax law can distinguish debt from equity, at least in close or mixed cases, and there also is no particular policy reason for treating them so distinctively.  Congress for decades delegated the whole issue to the courts.  However, in 1969, it passed Code section 385,  instructing the Treasury to issue regulations sorting out the mess.  The Treasury tried for a while, issuing two sets of proposed regulations (if I recall correctly) that it then decided not to finalize.  So delegating / punting the issue to the courts remained the prevailing norm.

            (iii) Economic substance requirement – Case law has long held that tax-motivated transactions will be ineffective if they lack requisite economic substance and/or business purpose.  This is of course a “standard” developed by the courts and for decades left alone by Congress.  When Congress finally codified the economic substance approach, for use in applying penalties, it bent over backwards to make clear that it was not adjusting or revising the prior common law approach in any way, apart from one distinct matter: it provided that taxpayers must meet both the “objective” and “subjective” aspects of the prevailing test, whereas case law had been divided as to whether one needed to satisfy both, or just either one.

2) Is there less tax delegation, and if so why?

(a) Presumably, Congress will only delegate lawmaking authority (or delegate “more” rather than “less” when it realistically has the choice) where the relevant decision-makers conclude that the political benefits of doing so exceed the political costs.

Making a consequential political decision often has both political benefits and costs.  One gets the credit but also the blame; one pleases the winners but also angers the losers.  Given, however, that politicians both often like to exercise power and benefit from doing so (e.g., reputationally and in fundraising), presumably “extra” delegation that was not practically necessary tends to reflect some particular motivation.

Here are 3 representative examples:

            (i) Public interest reasons for delegating: If, say, an independent agency can actually do a demonstrably better job than Congress, and members of Congress believe that on the whole this will be to their political benefit, they may delegate for entirely “good” reasons.  A classic example is delegation of power over monetary policy to the Fed.  (Admittedly, this example risks becoming obsolete in the era of Rand Paul.  I suspect that, if were necessary to pass new legislation retaining the Fed’s current authority over monetary policy, it would fail in the House and be filibustered in the Senate.)

            (ii) Symbolic politics: Here an example is the creation of the Environmental Protection Agency (EPA).  To be clear, I certainly agree that the creation of the EPA was important substantive policymaking, with real effects that I believe were on the whole decidedly good. But to legislators at the time, I would think that it had an important symbolic element: By creating a new agency, one takes the credit for “doing something” about environmental concerns.  But since the EPA is the party actually making decisions that involve tough tradeoffs (or winners versus losers), it gets the blame on the implementation end.

            (iii) Prisoner’s dilemma: Suppose there is broad consensus that we all lose overall from an array of parochial benefits.  But no one wants to give up his or her narrow benefit, unless enough others are doing the same.  Congress’s creation of a military base-closing commission (with Congress to vote the final recommendations up or down, with no amendments permitted) is a classic example.

(b) In practice, agreement to delegation appears to require broad underlying consensus regarding the general policy approach that Congress   However, while broad delegation’s reliance on the existence of underlying consensus appears clear empirically (at least based on casual observation), it is less clear why, as a theoretical matter, this should be so.  One could, for example, imagine political players who strenuously disagree but are mutually uncertain of success handing things over to an arbiter.  But my impression is that this doesn’t generally happen.

(c) The conditions for broad delegation are generally missing in current tax politics.  Politicians appear not to view the political benefit as exceeding the political cost, and an important reason is the lack of underlying consensus.  With respect to particular examples:

            (i) The Fed and tax rates – Even when there was greater consensus than we have today regarding countercyclical fiscal and monetary policy, why would Congress hand over tax rate authority to the Fed?  Isn’t it more fun to get the credit oneself for cutting taxes during recessions?  And while Congress could reasonably have anticipated that it would be less eager to clamp down when there was inflation risk, at least the Fed was still there as a backstop via monetary policy.

            (ii) Design of tax preferences – Here is where one could most readily imagine it happening.  Indeed, there are a couple of small areas in the law (e.g., with regard to low-income housing credits and state agencies) where delegation has indeed expanded a bit.

            (iii) Repealing tax preferences to fund a rate cut or reduce the fiscal gap – This would be just like military base-closing if there were sufficient underlying consensus, along with willingness to lose one’s own favored items so long as others shared in the haircut.  But there simply is no such underlying consensus. What is more, many of the underlying items are just too big for their proponents to be philosophical about losing them even if lots of other stuff is nicked as well.

3) Would more tax delegation be beneficial?

(a) Analogy between delegation to an independent agency and the existence of nonprofit firms – There is a rich law and economics literature concerning when and where we observe the use of nonprofit firms – for example, in charity work, higher education, and the fine arts.  The dominant account, for example from Henry Hansmann’s work, emphasizes that it is a response to the concern (by consumers and/or donors) that here, unlike in many other areas, the standard profit motive would be over-powered and partly misdirected.

Hansmann emphasizes, for example, the role of ambiguous outputs (e.g., higher educational quality, which may be hard to observe, apparently leading to the surmise that tamping down the profit motive may lead to better results.  In a very small piece that I once wrote in this area, I made the additional point that the substitute motivation is somewhat of a black box, which we fill in based on our empirical beliefs concerning the motivations and utility functions of likely nonprofit actors.  This may be why, for example, we don’t observe nonprofit auto repair shops.  Their being nonprofit might mitigate concern that they were using asymmetric information to fool us into overpaying for stuff we don’t need, but there is no theory of altruistically minded nonprofit auto repair workers who would love and respect the process as much as we academics try to respect effective teaching and good scholarship.

Substitute direct political accountability for the profit motive, and independent experts or professionals for nonprofit actors in a charity, and you get a parallel scenario analytically.

(b) Analogy to the Financial Accounting Standards Board (FASB) and the specification of generally accepted accounting principles (GAAP) – Suppose Congress instructed the Treasury to define taxable income, basing it on economic income but subject to reasonable administrative concerns, including use of the realization requirement where Treasury thought it appropriate.  Full stop, subject only to whatever provision Congress separately made for the design and use of tax preferences.

Would this be a good thing?  I am inclined to think so if the Treasury in turn delegated the task to an insulated professional agency.  But admittedly this is just a surmise – if Congress did this (which it won’t), then we would find out how well or poorly it worked.

One reason for thinking that it might be a good thing (leaving aside that it will never happen) is the analogy to FASB and GAAP.  FASB is a somewhat independent and politically insulated agency under the itself-somewhat-independent Securities and Exchange Commission, and it uses its GAAP rules to define financial accounting income.

Most accountants whom I know – and there also are arguably supportive empirical studies – believe that GAAP, financial reporting, and the quality of the information provided to investors by reported earnings would be a lot worse if Congress meddled a lot more than it does in the process.  On the few occasions when Congress has intervened (e.g., when Senator Lieberman, in the late 1990s, successfully bullied them into dropping plans for treating executive stock options as deductible), there is a view that generally or typically it has made things worse.

This naturally inclines one to speculate that similar delegation with respect to defining taxable income would likely be a good thing, if it was done right.  But obviously we don’t know for sure, and an experiment permitting us to find out remains highly unlikely.  I could only see it happening if the U.S. federal income tax became far less important and prominent than it is today (e.g., as tariffs were once a central concern of Congressional policymaking and then ceased to be such).

Talk on my international tax book at Duke Law School

Last Wednesday (February 26), I  gave a talk at the Duke Law School's Tax Policy Colloquium concerning my newly published book, Fixing U.S. International Taxation.

My slides, which aim to present an overview of the book, are available here.  I've published somewhat similar slides, relating to similar talks, in the past, but I am hopeful that this time around the slides provide a somewhat improved quick tour of the book's main content.

It was a good session, and I enjoyed seeing a number of old friends on the Duke and UNC law faculties.

Let a hundred schools of thought contend

Reuven Avi-Yonah has posted a very brief review of my international tax book in which he states his disagreement with it, and his continued adherence to views that I criticize in the book.  That's certainly fine - how boring it would be if everyone agreed, and I was no more surprised to learn that he still disagrees with me than he will be to learn that I still disagree with him.

To be very picky, I should note that I do in fact extensively discuss in the book the well-known international tax policy welfare norm of "national neutrality," which he appears to say that I don't discuss.  More importantly, I do not agree with his central argument, which is that, in opposing foreign tax creditability, I ostensibly ignore the fact that "no country is an island."  To the contrary, I'd say that it's largely because no country is an island that unreciprocated foreign tax creditability is an ill-conceived national policy.

NYU Tax Policy Colloquium, week 5: Chris Sanchirico's "As American as Apple, Inc."

Last week the colloquium didn't meet, as Tuesday was a "legislative Monday" at NYU Law School.  But yesterday we resumed with week 5, featuring Chris Sanchirico's paper, "As American as Apple Inc.: International Tax and Ownership Nationality."

The issue raised by the paper is as follows.  "Home equity bias" is a well-known phenomenon in the capital finance literature.  That is, despite the existence of global capital markets, it appears that investors around the world disproportionately own home-country equity, rather than globally diversified portfolios.  At least in the simple case where, say, the only way to invest in the U.S. is via a "U.S. company," this appears to fly in the face of basic principles of optimal diversification, causing home equity bias to be a "puzzle" badly in need of explanation, and possibly also a problem to be addressed.

The paper's focus diverges from that of typical entries in the home equity bias literature in two respects. First, in an empirical examination of what we know about U.S. home equity bias, it focuses on the question of who (as between Americans and foreigners) ultimately owns the stock of big U.S. multinationals in particular.  Second, the underlying reason for being interested does not pertain to explaining or trying to address the puzzle if any.  Rather, the paper notes that various arguments that commonly are made in U.S. international tax policy debate - in particular, as it happens, by people on the pro-multinationals side - take it as given that home equity bias is an important fact concerning the ownership of stock in U.S. multinationals.

Suppose, for example, that we are looking at General Electric versus Siemens.  These are in some ways similar companies, but GE is legally an American company under our place-of-incorporation rule, while Siemens is legally a German company under their headquarters rule.  Perception perfectly matches legal status, however.  Most people would say that GE is an "American company" whereas Siemens is a "German company."  But in the absence of home equity bias, U.S. individuals (and likewise German individuals) might hold roughly the same ownership percentage in GE as in Siemens.

Indeed, in this non-home equity bias scenario, U.S. individuals might even hold a lower percentage in GE than in Siemens, if holding the latter but not the former helped them to diversify against risks of the U.S. economy that they already bear by reason of working, living, consuming, etc. in the U.S.  But then again, since both companies are multinationals with investments around the world, we might well be pushed back, in the absence of home equity bias, towards expecting comparable ownership percentages for U.S. individuals.

It is widely assumed, however, that surely home equity bias does hold here, with the consequence that U.S. individuals are assumed to hold a MUCH higher percentage of GE than Siemens.  Just to capture what I am guessing might be the standard guess, perhaps the common view would hold that GE is, say 80% owned by American individuals, and Siemens, say, less than 5%.  But the paper says: "Not so fast - how confident should we actually be about this empirical claim?"

While the paper's main point concerns the lack of data that is actually reliable (despite multiple data sources), let's start by looking behind the data for a moment.  Suppose that, for all U.S. corporate equity, as defined by state incorporation statutes and including everything that is closely held, you could figure out the percentage that is owned by U.S. individuals.  Reflecting that some people who live in the U.S. incorporate in order to own and operate their own businesses, one would come up with evidence that appeared to show "home equity bias" but that actually conflated that phenomenon with the distinct one of what people do with their investment portfolios.  Now, just as a silly thought experiment, suppose we passed a law requiring all restaurants, fast food places, billiards parlors, and dry cleaning establishments to incorporate.  "Home equity bias" would seem to have increased, whereas in fact nothing of substance would actually have changed at the margin that interests us here.

It's one thing, already, to say that we're interested in publicly traded companies (which at least some of the data sources that the paper discusses generally don't break out as a separate category).  But the paper notes that multinational companies in particular are the poster child for those as to which you might expect LESS home equity bias, under most of the more credible explanations of the phenomenon in the literature.  So the paper argues, after going through the soft spots in one data source after another, that we really don't have any convincing evidence that stock in prominent U.S. multinationals is disproportionately owned by U.S. individuals.

A small additional word in furtherance of the paper's skeptical view of what we actually know about this: Suppose we actually knew who literally owns all the stock - including indirectly, by reason of looking through mutual funds and all such other intermediate entities to the ultimate individual level.  Even so, in a world full of derivative financial instruments (options, swap contracts, forward contracts, repo agreements, etc.), this might fall well short of telling us who really bears the economics associated with ownership of a particular company's stock.  For example, if you own the stock but we use a swap to transfer most of the economics of the share's performance to me, the data about legal ownership will be getting it wrong.  Derivatives, side bets, and all the rest make it even harder to figure out the underlying fundamentals than the paper's detailed and skeptical critique of the various leading data sources already suggests.

OK, why might all this matter?  The main reason I think  that it matters who "owns" (in the relevant economic sense) the stock of U.S. as compared to foreign multinationals, from the standpoint of U.S. international tax policy debate, is that (a) the entity-level corporate tax is a mechanism for indirectly imposing income taxation on the ultimate owners, and (b) we both do and should think very differently about taxing (whether directly or indirectly) resident individuals as opposed to foreign individuals.

For resident individuals, the main aim is to allocate tax burdens on the basis of some measure of some measure (e.g., income) that at least proxies for some underlying attribute such as ability or material wellbeing.  Hence, if we could, we would like to include, say, all of Bill Gates' income in the tax base, whether he earns it at home or abroad, and/or through a corporation or directly.

For foreign individuals, the idea is that it would be nice from, a domestic national welfare standpoint, to get $$ from them if we can.  So if we impose taxes on their activity in the US or through US corporations, and they bear this tax as a matter of economic incidence, then we are ahead of the game unless the associated cost to U.S. individuals (deadweight loss, decline in positive externalities from transactions with foreigners, etc.) is disproportionately high.  But this is a very different proposition from that for resident individuals, and in practice it may call for being resolved differently.  (For example, we probably don't want to tax the foreign individuals at all, in settings where we, not they, bear the economic incidence of the tax.)

Anyway, that's why I think the ownership data would be of interest, as one more potential input into evaluating all the issues in international tax policy.  (It's also of interest, of course, as a puzzle or non-puzzle in the capital finance literature.)  The main angle pursued in the Sanchirico paper, however, is somewhat different - not reflecting any particular disagreement, but merely because he is hunting different prey.

As the paper notes, pro-U.S. multinational proponents sometimes argue that the presumed predominantly American share ownership of U.S. multinationals provides support for (a) lessening the companies' U.S. tax burdens on competitiveness grounds and (b) viewing foreign dividend repatriation tax holidays as likely to increase U.S. investment.  The argument on (a) is that U.S. individuals are the shareholders who putatively are getting enriched.  The argument on (b) might go as follows: Suppose a foreign repatriation tax holiday is expressly permitted to fund domestic dividends and share repurchases.  Shareholders who were U.S. individuals ostensibly would be more likely to plow the money received back into the U.S. economy.

The paper says, in effect: Let's accept these contentions arguendo and ask if the underlying factual premise is true: Are the U.S. multinationals' shareholders disproportionately American.  We really don't know this, and people therefore shouldn't just assume it, thereby weakening the underlying arguments.

I myself, while recognizing that these arguments are being made in the U.S. international tax policy debate, don't regard them as strong ones - no matter how one comes out overall on the underlying issues.  Thus, I would be skeptical of their value and weight even if I were to accept (as I previously had been inclined to) the asserted fact of predominantly American share ownership of U.S. multinationals.

For example, I note that the "competitiveness" argument is not easily translated into a compelling claim that people who own U.S. multinationals' stock will earn extra-normal returns if, but only if, the U.S. doesn't tax the companies' foreign source income.  And I consider tax holidays a horrible idea because they give companies and investors the lesson that you should just wait for the next holiday.  Moreover, I would not expect the holidays to boost the U.S. economy unless we were to accept a not very compelling story in which liquidity constraints (at the shareholder level and/or the domestic firm level) are the big problem that is holding back national macroeconomic performance.

Overall, however, the paper offers a nice lesson in the merits of learning that perhaps you know less than you thought you knew.

Foreign travels

It looks like, over the rest of this year, I will be teaching or going to conferences or giving talks in Luxembourg, Italy, Brazil, Austria, and Canada.  Have United premier account, will travel.

Another winter storm

According to the online edition of today's New York Times, the West Side Highway "looks like rural Maine." Well, if that's true, I'm heading out there to pick blueberries.

NYU Tax Policy Colloquium, week 4: Thomas Brennan's Smooth Retirement Accounts

On Tuesday, Tom Brennan took the train down for Columbia (where he is visiting for the semester, from Northwestern), to present Smooth Retirement Accounts.

The paper discusses traditional and Roth IRAs from two perspectives: utility to the saver, and federal budgetary optics.  It then sketches out an alternative (the "smooth" retirement account) that would have Roth economics but different budgetary optics.

To explain: In a traditional IRA, your contribution is deductible, but your withdrawals are taxable (with tax-free inside build-up in between).  A Roth IRA contribution is not deductible, but the withdrawal is tax-free.

These two alternatives are economically equivalent if you simply earn the "normal" rate of return and if the tax rate is fixed.  E.g., say the tax rate is 50%, 1 year investment with a 10% return.  Under traditional, you might spend $200 out-of-pocket, which costs you $100 after-tax, and the account grows to $220, of which you retain $110 after-tax.  In the Roth, you simply deposit $100 of after-tax income and get $110, all of which you keep.

One key assumption that's needed for the two methods to be equivalent is that the investment be "arm's length" rather than, say, in your own business with labor income built in, so that you can only earn the normal rate of return.  E.g., if you can turn the first $100 you have into $100M because you're Zuckerberg and it's Facebook (but you can't keep going at that rate), then obviously you do better under Roth (at least, if you couldn't have parlayed $200 into $200M), reflecting that in effect labor income or rents or whatever you want to call it has been layered on top of the normal rate of return.

All this is familiar stuff in the biz.  Returning to the more particular analysis in the paper, a big difference in practice is that in Roth, the only tax rate that matters is the current one, so you're locked into it (assuming Congress doesn't renege down the line).  But in a traditional IRA, the future tax rate may differ from the current one, causing the investment to be tax-favored vs. Roth (or immediate consumption) if the rate declines, and taxed unfavorably if the rate goes up.  This could happen due either to changes in statutory tax rates or because of the progressive rate structure (e.g., you are in a lower rate bracket during your retirement years when you withdraw).

Brennan doesn't like this feature of traditional IRAs for two reasons.  It subjects the taxpayer to tax rate risk, and progressive rates can distort portfolio choices by reducing the relative payoff for investment with variability but high upsides relative to those that are relatively fixed.  So he prefers the Roth approach of avoiding downstream tax rate variability, though he wouldn't mind having the tax paid at the end (a la traditional IRAs) if it was locked in and equal to the deduction rate up front.

OK, the issue of progressive rates and portfolio choice is a broader one in the income tax (or in a progressive-rate consumption tax), though clearly he has a point.  Also a legitimate broader concern is the issue of tax rate variability distorting consumption choice between periods.  (A standard model consumption tax such as a VAT or retail sales tax creates this problem, of course, if there may be tax rate changes between years.  And suppose you are  faced, upon making your tax-free Roth withdrawals, with a newly enacted VAT.  Then you have indeed been "taxed twice," although it might not be viewed the same way as explicitly reneging on tax-free Roth withdrawal under the income tax.)

On the subject of tax rate risk, clearly it would increase people's utility if, in response to future tax rate risk, they could purchase, for a suitable price, private insurance locking in the current rate for them.  Under such a hypothetical insurance system, I'd pay, say, 35% no matter what, and the government would collect based on the actual future rate no matter what, but the insurance company would pay the extra on my behalf if the rate went up, and take the difference out of my hide if the rate went down.  This of course is just a thought experiment, not real life or a practical proposal.  Presumably one reason such insurance doesn't exist is that the insurer would have difficulty reinsuring or spreading the risk.  And there would also be moral hazard issues if the payments depended in part on how much income I actually had in the later period.  But I mention it just to make the point that, while such insurance presumably would be a good thing for consumers if feasible, that doesn't mean that it's optimal for the government to allow people to lock in their future tax rate.  That leaves other taxpayers as the "counterparty" without any insurance premium.

Example 1, you lock in the current rate in June 1941, then on December 7 it turns out that taxes will have to go way up to pay for a million-soldier, two-front world war.  Taxpayers who locked in the earlier rate have concentrated the revenue risk on everyone else.  Case 2, President Romney imposes low rates, then the following year President de Blasio enacts high rates.  So it's a change in political preferences, not "objective" needs, but here it's at a minimum unclear whether or not we should view allowing an earlier-year opt-out as socially beneficial.

Anyway.  As Brennan agrees, it's a complicated question to what extent we should want tax rates to be locked in, despite the clear benefits at one particular margin to enabling this.  The point, of course, is that these are complex and interesting issues, not that the paper is "wrong" to use correct analysis of one of the relevant margins to show an advantage to locking in the rate.

Issue 2 is budgetary accounting.  With a short-term budget window, traditional IRAs look costlier than they actually are, since the deductions are counted but the later year inclusions are outside the budget window.  Roths look cheaper than they actually are, since Congress is only giving away the out-year revenue (plus the tax on inside build-up within the budget window, but that may be just a small part of the whole).  Worse still, as Congress showed through budgetary shenanigans in 2010, you can lose long-term revenue by "bribing" people to switch from traditional to Roth IRAs, yet score it as a revenue gain within the budgetary window that you use to pay for other tax cuts.  In that scenario (which, again, actually happened), tax cuts (from the bribe that is offered to prompt Roth conversions) are used to "pay" for other tax cuts.

Brennan has an intricate plan in mind that could work as follows.  You use a traditional IRA, in the sense that there is an up-front deduction.  But as in a Roth IRA, there is no tax rate risk, because you are guaranteed that the withdrawal will be taxed at the same rate that applied to the deposit.  But to improve the budgetary accounting, each year a suitable fraction of the accruing future tax liability would be counted as current revenue gain for budgetary accounting purposes.  The deemed tax revenues for budgetary accounting purposes are the source of the adjective "smooth," but, as this is already a long blog entry, I will refer you to the paper itself (see the link above) for the precise mechanics.

The budgetary optics problem has a straightforward solution, which is simply to do infinite horizon budgetary accounting rather than artificially truncating the out years that are deemed to be within the budgetary window.  Obviously, this raises issues of its own that a large literature has examined.  Next best might be coming up with ad hoc budgetary rules that replace pure cash accounting, for both Roth and traditional IRAs, with something that is the same for both of them and also closer to economic accrual than the cash flow treatment of either way.  The paper offers one way of moving in that direction.  But once you are not going all the way to accrual, by eliminating the budget window, it comes down to a choice between imperfect alternatives.  Brennan, who at all times is extremely and indeed completely fair-minded, agrees with this analysis.

Column in local paper

One of the nice features of my neighborhood in the West Village is a local paper that comes out every month, called Westview, which covers local issues, such as the loss of St. Vincent's Hospital (leaving much of lower Manhattan without a nearby hospital or emergency room), along with cultural news and the like from our area.

I write occasional short pieces for Westview, which also was nice enough, a few years ago, to run a feature relating to my novel, Getting It.

Anyway, in this month's issue, I wrote a short op-ed called "Mayor De Blasio's Plan To Increase Taxes on High-Earners."

I encourage those who are interested to click on the link and also to look at other features in Westview.  However, here are some highlights from my piece (which overall is only about 500 words):

In the recent mayoral campaign, then-candidate Bill de Blasio’s signature proposal was to address New York’s “tale of two cities” – the extremely rich versus everyone else – by increasing the City’s income tax rate for people with incomes over $500,000, from 3.9 to 4.4%. ... [D]oes the tax policy literature (in which I write professionally) support viewing the proposed tax increase as a good idea? I believe that it does ...

The literature on state and local taxes strongly suggests that, as a general rule, it’s wise to leave progressive taxes to the national level, rather than imposing them sub-nationally (such as in a given city or state). The reason is potential exit from the taxing jurisdiction by high-earners. For example, if one town raised taxes on high-earners while all of its identical neighbors did not, it’s a fair bet that many of the intended targets of the tax would simply leave. Exiting the entire country, if federal income taxes go up for the wealthy, is a lot costlier for taxpayers to execute, and thus is not as much of a problem (Facebook’s Eduardo Saverin notwithstanding).

However, New York is not just one in a sea of identical towns. It has genuine market power these days, as a global destination city like London and very few others.... Clearly, high-earners are willing – at least, up to a point – to pay a premium to live here.

Thus, even if you don’t share Mayor de Blasio’s (and many voters’) discomfort with rising high-end inequality, it would be foolish for New York City not to take advantage of its privileged, albeit not quite impregnable, position. So long as we can secure significantly more tax revenues, with only relatively modest behavioral responses (such as exit by high-earners), it would be like leaving money on the table for the City not to try to extract a bit more.

Obviously, this argument – like that for increasing the minimum wage – can only be pushed so far. Overdo it, and you shoot yourself in the foot. The more the tax on high-earners goes up, the more tax base is likely to be lost per dollar of revenue raised. At some point, one would even run into the Laffer Curve, where raising the tax rate actually loses revenue. In my view, however, we are still well short of that point.

Suppose the de Blasio plan is enacted, and it proves a success. How much will it do to address our “tale of two cities?”  ... [T]he answer is: Not all that much. New York City is a cork bobbing on the waves of the global economy. Overall global trends pertaining to high-end inequality will accentuate – or else not – depending on factors that the City cannot control or even much influence. Yet so long as those trends do continue, and so long as we continue to be a favored global destination city – an asset that we must assiduously preserve – taking modest advantage is not wild-eyed radicalism, but simply sober common sense.

UPDATE: A comment that I received offline from a correspondent has persuaded me that I should not be so certain of the accuracy of my assumption in the above piece that NYC is below the peak of the Laffer Curve for the super-rich.  For example, if the City raises their income tax rates, they don't have to sell their pied a terres but can be more careful to beat the NYC residency rule.  Meanwhile, if they are in town less for this reason, it's conceivable that NYC-area consumption will fall, leading to adverse multiplier effects on NYC even if not national tax revenue.  I would certainly welcome any studies or good empirical assessments of this issue that anyone may have available.