Wednesday, February 10, 2016

Tax policy colloquium, week 4: Donald Marron’s "Should We Tax Unhealthy Food and Drinks?"

This week’s colloquium, featuring Donald Marron of the Urban Institute, offered a neck-wrenching change of topic from recent past and future sessions (one of the things I like about our format).  This time around, rather than corporate inversions, the tax treatment of higher education, and public opinion regarding income tax rates, we discussed the question of whether tax instruments should address unhealthy food choices.

The paper (coauthored with Maeve Gearing and John Iselin) is part of a recent flurry of Tax Policy Center publications addressing corrective (often, but not necessarily, Pigouvian) taxes of various kinds.  Other recent entries address, for example, financial transaction taxes, carbon taxes, and how governments might use the revenues from corrective taxes.

As the paper is rooted in recent advances in nutritional science (and what these reveal about continuing uncertainty in the field), I was dismayed to learn of all the now-rejected science that I’ve followed – counseling, for example, avoidance of avocados and eggs (each actually a super-food) based on their fat content.   By reason of all the complexities in how our bodies mediate between inputs and outputs, there are often no straight lines of the sort that were presumed in earlier stages of the science.

For that matter, whom can I sue about the now-refuted claim that teenagers who eat chocolate get way more acne? No empirical relationship whatsoever, and I’ll never get back those lost chocolate-eating years.  But anyway.

The still-provisional nature of nutritional science is only one reason for caution about designing taxes on unhealthy food and drinks.  Even with certainty, one has to assess motivation and, if one wants to do it, issues of design.

Two classic examples of much easier problems pertain to carbon taxes and cigarette taxes.  Carbon taxes, of course, are an externality story.  The great thing about these taxes, from a design standpoint, is that each atom of carbon would have the same marginal effect on global warming as any other atom, if added to the atmosphere at a particular moment.  There are of course problems in measuring the marginal harm, as well as resolving issues of national versus global welfare and (given the immensity of the stakes) arranging multijurisdictional  cooperation, but at least one need not distinguish between, say, “good” carbon atoms and “bad” or neutral ones.

Also much easier than the unhealthy food tax scenario is that of designing cigarette taxes.  Here, despite passive and third-hand smoke, it is probably mainly an internalities story.  Smoking is extremely harmful, and there is evidence that people often want to quit but find this very hard.  Also, despite the Gary Becker-Kevin Murphy “rational addiction” model, there is reason to doubt that smokers should be viewed as having optimized correctly, from their standpoints, via consumption that merely happens to have highly front-loaded benefits.

Marron has elsewhere written about designing taxes to address internalities, and one of the points he makes, in distinguishing them from externalities, could be explained as follows.  Suppose your actions would impose a $5 cost on someone else, and markets plus tort law can’t succeed in making you internalize this cost.  Then a $5 Pigovian tax, designed purely on efficiency grounds, gets your decision metric just right, from the standard of social costs versus benefits.

Now suppose instead that, due to an internality (i.e., a flaw in your capacity to optimize your own choices from the standpoint of your own true self-interest, as you would judge it while being truly reflective), you under-value a cost that a given choice would impose on you by $5.  Assuming one is willing to accept the parallel – which admittedly, raises issues about “true” choice and valuation that are easier to dodge in the externalities setting – the efficient answer is just the same as before.  Even though only you are bearing the costs and benefits of your choice, once again a $5 tax will get things just right.  (BTW, among other problems with this set-up, it works better for consistent undervaluation – e.g., due to hyperbolic discounting – than it does for framing scenarios where we lack a good handle on your “true” preferences or welfare.)

A point that Marron adds is as follows.  Suppose our reason for considering the internalities tax is beneficence, rather than general social efficiency.  That is, we want to make YOU better off.  Then it is noteworthy that the internality tax, even if it improves your marginal decision-making, might leave you worse-off overall.  E.g., suppose you do some of the thing anyway (e.g., because in some instances the true net benefit to you exceeded $5).  Then you may be worse-off overall, despite improving your marginal decision-making, unless we can find a way to return the revenues to you (e.g., via a lump-sum transfer equal to your expected tax costs).

Turning at least to the idea of taxing unhealthy food and drinks, the paper argues that the strongest case offered by current nutritional science for a corrective tax pertains to sugar – and in particular, that which is added to sweetened soft drinks, such as sodas.  Here there may be both an externalities story and an internalities story.  The former mainly pertains to formal and informal health insurance (e.g., emergency room visits as an example of the latter).  For example, diabetes, which is linked to obesity that may result from drinking lots of sweetened soft drinks, may impose large external costs on other consumers and taxpayers.  But the internalities story may be important as well.

BTW, if I may digress, one thing for which I am grateful to my parents is that I never had Coke, Pepsi, etcetera, when growing up.  The first times I tasted such things, I found them disgusting.  I also never had beer until I went to college – the drinking age was 18, in those days – and I also initially found that disgusting.  But while I decided it would be worthwhile to develop a taste for beer, which didn’t take all that bloody long, I also decided NOT to do it for the sodas, which I therefore still find disgusting, and I’m happy to keep it that way.  So I personally have no internalities problem with respect to soft drinks.  (Don’t ask me about extra portions at dinner, however.)  Like Oscar Wilde, I can resist anything except temptation.

Returning to sweetened soft drinks, a big problem that the paper discusses is the lack of a clear dose-response relationship.  Again, for carbon and externalities, it’s the same for all units of carbon.  For cigarettes and internalities, it may be variable, but at least it’s pretty darned high every step of the way.

For sugar – in common with alcohol, another target of corrective taxes that may reflect both externalities and internalities – the variability of the dose-response relationship makes it far harder to figure out how one should implement and design the tax, even assuming good information about average marginal costs (and undervaluation of internal costs).  For some people and at some usage levels, it’s relatively fine; for others and at different usage levels, considerably worse.  But if all possible approaches, including doing nothing, are imperfect, then certainly this instrument belongs on the tastes-good, not-too-filling table of possible revenue options.

Monday, February 08, 2016

Idiocy in the defense of extremism is no virtue

Just on the substance, it's interesting to note the actual content of Rubio's "defense" of Obama as highly competent, albeit anti-American (or at least, anti-America as it has always been).  The bill of particulars appears to consist mainly of the following:

1) Enacting the stimulus bill, which economists almost unanimously agree reduced the severity of the Great Recession, and which reflected standard U.S. macro policy, in response to economic downturns, since the 1930s.

2) Enacting Obamacare, which implemented a Heritage Foundation plan that Mitt Romney previously enacted at the state level and made the centerpiece of his 2008 Republican presidential campaign.

3) Supporting modest limitations on gun ownership, in accordance with the views of perhaps 70 percent of the American public.

4) Deliberately weakening the U.S. abroad, pursuant to a supposed view of U.S. power as evil.  This claim by Rubio is paranoid conspiratorialism - the sort of thing that led William F. Buckley to expel John Birchers from the mainstream conservative movement.  But now it is the credo of one whose claim to the "moderate" or "mainstream" slot among Republican presidential candidates is endangered only by the rising doubts that he can pass the Turing test.

Sunday, February 07, 2016

Campaign spin wars

I'll admit it; I quite enjoyed Marco Rubio's epic (whether or not electorally consequential) meltdown yesterday, in which he responded to Chris Christie's accusation that he was just parroting pre-memorized talking points by re-parroting the very same pre-memorized talking points.  "Show it, don't say it" is the advice that writers always get, and Christie was able to do this, by reason of Rubio's unwitting connivance.

While I have nothing unique to add about this little drama, I was interested by some of the follow-up today, which I think actually relates in an odd way to the topic of my last blogpost here (how the "paradox of voting" affects voters' belief formation).

Rubio today naturally tried to spin his constantly repeating the same thing about Obama ("He knows exactly what he's doing") as reflecting that he Cares So Deeply about the argument he was making. The point being, professing deep conviction sounds less pathetic than fessing up to a panicky meltdown.  He even said that this deep belief is why he is running for president (I guess, long-held ambition had nothing to do with it).  But there actually is a reason he was saying it - well, not four times - and whoever's idea this was (perhaps, just that of his handlers), it's an interesting example of being too clever by half, rather than just not clever enough.

The underlying argument that Rubio apparently was making aimed to rebut an argument against him.  Christie was saying: Obama was a bad president (in the Republican view) because he was so inexperienced.  Rubio is also inexperienced.  Hence, let's not make the same mistake again, by picking Rubio.

Note that there's a bit of an ambiguity here.  Christie needn't choose between saying (a) he's an inexperienced candidate so he'll lose the general election, versus (b) he's inexperienced so he'll be a bad president.  On its face, the argument is mainly (b), but inevitably, in an election campaign where the two parties' voters hate each other so much, those on either side are going to care a lot about the potential truth of (a), not just (b).

Yet obviously, no matter what one thinks of Obama as to (b), it's clearly he did pretty well in 2008 and 2012 as to (a).  So Republicans who only believed (b) would face a dilemma, if they rejected (a) and still thought Rubio the strongest November candidate.  This might reduce the overall force of the offered syllogism.  But the Rubio camp evidently wanted to respond anyway.

Someone, and I honestly don't know whether or not Rubio has the wit to think of this (or even understand it) himself, but in any case someone in the Rubio campaign evidently thought: Suppose we say Obama was a good president, not a bad one, by his own ideological lights.  Then seemingly Christie's syllogism is rebutted.  If Obama was good for his side despite being inexperienced, then what the precedent suggests is that Rubio will likewise be good for our side despite being inexperienced.

This is actually terrible political reasoning.  It's an example of what Jeeves in the Wooster books, called being "too elaborate," when he questioned the scheming of the "brilliant but unsound" Catsmeat Potter-Pirbright.  In effect, Rubio is arguing: Obama and I indeed ARE alike in a particular way - but that's good, not bad, in terms of its predictive value, because Obama is actually a good president from his ideological perspective.

Problem #1 - if one side hates a political leader, those on the other side should probably avoid arguing that they're like him in any way.  Embracing the analogy, even just implicitly and to turn it around, is probably not the way to go.

Problem #2 - it mistakes the nature of emotional partisan belief.  From a Republican perspective, one could imagine a debate: is Obama inept, or merely serving goals we detest?  Logic suggests that it can't really be both.  If he likes where we are, then he didn't blunder by getting there.  But when emotionally involved partisans  on one side hate someone on the other side, they have no reason to value being logically consistent in the criticisms they applaud.  They are expressing their feelings.  For whatever broader reasons, which I won't try to explain here, they hate Obama and think he has done terrible things.  So it's emotionally satisfying to hear him being insulted, be it as feckless or as deliberately, effectually "evil."

In the nature of the enterprise - by which I mean, having political beliefs and being invested emotionally (but from the sidelines) in the great game - there's absolutely no reason to choose.  "Gee, he's doing it on purpose, so maybe he's actually smart."  Or, "Gee, he's incompetent, so perhaps he actually means well."  No - recall the voting paradox again.  Audience members who get involved emotionally in politics are not engaged in staking real resources that will affect their personal wellbeing on correctly understanding an individual who is on the other side.  They're not being irrational or stupid - rather, they're acting like sports fans, which is often a good analogy for political belief, when they decline to subject their angry disdain for someone on the other side to rigorous logical parsing.

By contrast, Republicans in Congress who are deciding how to interact strategically with the Administration, or the people in the McCain campaign in 2008 and the Romney campaign in 2012, DO need to evaluate Obama accurately and dispassionately.  They are actually playing against him, in a game that they want to win, and it's useful to understand your foe.  But voters are just spectators.

So the thought, by whomever in the Rubio camp, that praising Obama's skill was a smart political tactic, via the logical impact on the implied analogy between Obama and Rubio, appears not to have as good an understanding of real world politics and voter psychology as I might have expected of someone in the biz.

Again, who's to say whether or not any of this will actually matter politically in the end.  But it's still amusing as an apparent micro-illustration of political actors outsmarting themselves.

Wednesday, February 03, 2016

Tax policy colloquium, week 3: Lucy Martin’s “The Structure of American Income Tax Policy Preferences” (co-authored with Cameron Ballard-Rosa and Kenneth Scheve)

Yesterday, Lucy Martin of the UNC Political Science Department presented the above paper, discussing survey evidence regarding how Americans think about tax progressivity.  The paper addresses an apparent puzzle: the fact that rising high-end inequality, plus stagnant real income growth for everyone outside the top 0.1 percent, has not yielded greater high-end tax progressivity.

Is this lack of an offsetting tax policy response to rising high-end inequality actually surprising? I’m not all that surprised by it, but it clearly is surprising if one’s baseline assumptions reflect (1) the median voter hypothesis, which holds that the median voter’s policy preferences tend to be enacted, plus (2) a view of voting as being based on narrowly defined economic self-interest.  Under such a view, the median voter should want higher tax rates at the top under these circumstances, and should be expected to succeed in getting it – wholly independently of the question of whether or not this would be a good policy choice – unless she is sufficiently concerned about the efficiency costs on her of the high-end rate increase (or believes that it wouldn’t actually raise revenue).

The two main explanations for the “puzzle” that political scientists have offered are (1) the rich have too much political power for the sentiments of the median voter to carry the day, and/or (2) voters actually aren’t strongly supportive of increasing high-end redistribution – perhaps because they don’t just focus on narrowly defined economic self-interest.

The paper mainly comes out in favor of explanation #2.  It concludes from survey evidence (gathered on yougov, with sampling to replicate characteristics of the general voting population) that, while there is widespread support for mildly progressive tax rates, these sentiments are relatively tepid, and support a progressive rate structure rather like the one that we currently have – rather than one with much higher marginal rates at the top.

However, explanation #1 is not refuted, except insofar as one interprets it as involving affirmative elite override of strongly held popular sentiments.  The fact that the public does not care intensely can plausibly be viewed as leaving the elite free to decide.  The evidence in the paper might come closer to supporting a strong version of explanation #1 if the 2016 election were to lead to the election of a Republican president, along with continued Republican Congressional control in both houses, and this in turn led to the enactment of a flatter rate structure – promised by all leading Republican candidates – that actually would be at variance with the paper’s findings regarding voter sentiment, including that among Republican voters.

Among the paper’s features that I particularly like are its (1) disaggregating between high-end and low-end inequality issues, (2) disaggregating between the issues under study and those of views on government spending and/or the “size of government,” and (3) offering a gauge on voter sentiments’ intensity and elasticity (defined as the rate of change, for one’s preferences regarding tax rates, as the income level that is under consideration changes).

In preparing for the session, I divided my thoughts into two main topics: (1) political science issues, focusing on survey design and one’s theory of voting, and (2) the tax policy takeaways one might glean from the evidence in the article.


A) Research design – Here I see four main issues:

(i) Tax base – Marginal tax rates don’t mean much until we know to what they apply. Given the limitations on how much one can lay on the plate of survey respondents, we don’t know what (if anything) they had in mind if they liked, say, a 35% or 40% top rate. How might this relate to – and what would they think about – say, the use of tax shelters, the capital gains rate, or the general non-taxability of unrealized appreciation. These are techie issues, but surely they might have some actual or potential state of mind regarding the relevance (and high likelihood) of significant divergence between taxpayers’ taxable income and their economic income.

For that matter, what about average rate versus marginal rate?  For a top bracket of, say, 35%, were they assuming that this was also the average rate that taxpayers with income in that bracket actually faced as to their taxable income as a whole?

(ii) Taxes only, without direct regard to the use of the funds – In principle, one should always think about tax changes in a long-term balanced budget sense. However, since money is fungible and there are many different possible uses of say, increased high-end revenue, the survey design did not offer any indication regarding how marginal revenues might be used (or ceased to be used).  Instead, to avoid encouraging complete disregard of budgetary considerations, the survey informed respondents when particular choices would affect or greatly affect net revenue levels.

This probably was a better survey design than proposing particular uses of the funds – especially since, if one used too many alternatives, one would both be degrading the results’ statistical significance and requiring respondents to slog through more.  But it did mean that respondents weren’t offered the possibility of taxing the rich more in order to fund something they might like.  Obviously, a savvy politician might make earmarking claims of this kind (like NYC Mayor Di Blasio campaigning for higher taxes on the rich that he said could fund universal pre-K).  It also may have caused revenue-raising higher tax rates at the top to look as if they merely would have imposed burdens on one group without conveying benefits to any other group.

(iii) $375,000 of income and above as the top group – In order to keep the rate brackets similar to those under actual U.S. income tax law at the time that the survey was being designed – which had advantages in terms of figuring out net revenue effects – the study’s top group was people with income of $375,000 or more.  Insofar as actual voter concern today focuses on plutocracy and/or the super-rich – say, the top 0.1%, as opposed to just the top 1% - this meant that one did not learn what the respondents thought about tax rates for people earning at least, say, $1 million or $10 million a year.

(iv) Anchoring – What should we make about the fact that the tax rate structure getting the most support looked rather like what we actually have right now?  Does this mean public sentiment is being honored?  Alternatively, might the causal arrow run the other way, with people taking cues from what is actually on the books?  What would happen if we could run the same test with U.S. voters 60-odd years ago, when the top rate was over 90%?  And if we found that people liked that top rate then, once again we’d have to ponder the direction of the causal arrow, i.e., do the rates reflect preferences or anchor them?  More feasible, of course, would be doing a similar survey in, say, an EU country with higher marginal rates for individuals at the top of the distribution.

B) Theory of what drives voter preferences

The paper identifies three main explanations for voters’ tax policy (and other) preferences: (mainly economic) self-interest, fairness norms, and partisan identity.  Herewith some thoughts on each:

(i) Economic self-interest – Assertions that voters should be expected to vote in their self-interest, generally defined economically, have long struck me as hard to reconcile with the voting paradox.  Here I mean not the range of Condorcet, etc., phenomena, but rather the fact that voting itself is not an economically way of promoting narrowly self-interested outcomes.

Everyone knows the basic issue here.  I once heard (perhaps apocryphally) about a prior-generation professor who apparently told his students that he never voted, even though he cared about political outcomes, because the chance that his vote would alter the outcome was effectively zero.  Therefore, the benefit certainly wasn’t worth the cost, defined in terms of the time he would have to spend on voting.  “What if everyone thought that way?” he was asked.  “Well, then I’d certainly vote,” he replied.

While awareness of the voting paradox surely does reduce turnout, obviously millions of people vote anyway.  But the paradox is still, to my mind, of primary importance in understanding and explaining voter behavior.  Since voting is so irrational, if defined as seeking to realize the dollar value one places on a desired election outcome, divided by the likelihood that it will actually change the outcome, obviously something else is going on.  Consumption? Self-expression? Sense of obligation?  Cooperating rather than defecting with regard to like-minded voters, who face a prisoner’s dilemma insofar as each would rather not bother to vote but they’ll only win if enough of them vote?

Once one is voting based on any of those motives, it is no longer irrational not to vote based on economic self-interest, even if one otherwise acts pursuant to it.  Suppose you just like voting for the candidate with whom you’d hypothetically rather have a beer.  It’s not personally irrational to vote for this person, even if he or she would be bad for one’s economic interests, if this feeling sufficiently flavors one’s enjoyment of the voting act.

More important still, it is now affirmatively irrational – and people damn well know it – to invest significant effort in figuring out which candidate would best serve one’s interests, unless one happens to enjoy the investigative process.  How much time would you spend figuring out what car you ought to buy, if the decision wasn’t up to you but instead would be made by a multi-million person electorate?

Given this point, it verges on being paradoxical that people pay as much heed as they do to the question of which candidates would favor their interests and those of people like them.  I would presume that this reflects feelings of affinity that in turn reflect our having evolved to internalize sincere belief in arguments in favor of our own interests.

But one still doesn’t get a strong prediction that the median voter will respond to high-end inequality in the manner presumed by standard political science models.

Fairness norms – The paper notes that people who favor higher tax rates at the top tend to believe that the most economically successful were mainly lucky, while those who oppose such rates tend to believe that merit and hard work play larger roles.  Likewise – though the issues are somewhat independent – those who favor high tax rates tend to have a lower valuation of the likely efficiency costs than those who oppose such rates.

While this does not contradict the paper, which looks at correlations without proposing specific causal theories, I tend to wonder which way the causal arrow runs.  I would suspect that there is a widespread tendency to take the “progressive” view on both issues as a consequence of one’s (for other reasons) favoring higher rates, and the “conservative” view on both issues as a consequence of one’s (for other reasons) opposing such rates.  In other words, I think people often start with biases and then develop the needed rationalizations, although certainly one ought to aspire to the reverse.

Perhaps more intriguing is the paper’s finding that those who favor high rates at the top tend to lean towards being “reciprocators,” as tested separately within the survey, while those on the anti side tend to lean more towards being “free riders.”  But given this point , along with the voting paradox, it is interesting that conservatives, whom the survey suggests lean towards being on the “free rider” side, have nonetheless done a better job of countering their own internal group prisoner’s dilemma, by maintaining higher voter turnout levels even in non-presidential election years.

Partisan identification – Not surprisingly, this proves to have the strongest predictive value, arguably supporting the observation that following politics is a lot like picking sports teams to root for.


Given the structure of the U.S. political system – in particular multiple branches, status quo bias, and partisan entrenchment, frequently yielding gridlock – it’s no surprise that the system hasn’t grown significantly more progressive at the top.  This would require (a) Republicans to lose their veto power at all levels, plus (b) Democrats to support as a bloc enacting a more progressive rate structure.  (The 2013 budget deal did a bit of this, but only by restoring the Clinton-era top rate.)

So it’s not clear what extent we need to look to voter preferences to explain the “puzzle” of limited change to high-end rates.  But nonetheless, because Knowledge is Good (in the words of Emil Faber, but I actually mean it), one does not need policy or outcome relevance in order to find the paper’s analysis interesting.

In any event, however, I see the following three main takeaways for people who favor greater high-end progressivity:

(a) Suppose one favors raising tax rates at the top – even if not to 1960s levels, then at least to something approaching Diamond-Saez-advocated levels on the order of 70%.  The information provided is not encouraging, and suggests that the indicated change would most likely have to reflect intra-elite opinion movements, rather than the empowerment of widespread public sentiment.  While it’s not clear why the elite should be expected to favor higher tax rates, to some extent on itself, note that the conservative movement, unlike its counterpart on the left, has spent the last 4 decades building a powerful policy advocacy infrastructure in Washington.

(b) Efforts to increase high-end progressivity can try to take advantage of earmarking the net revenues for widely supported functions, although the public is far from being wholly naïve regarding the relevance of earmarking given that money is fungible.

(c) Otherwise, efforts to increase high-end progressivity should focus on the tax base and/or the choice of tax instrument.  For example, advocacy of taxing appreciated assets at death and strengthening the taxation of gratuitous transfers might be more fruitful than focusing on the top rate – although clearly these ideas as well could not be expected to benefit from mass movements in their support.

They're sometimes there when you need them, they're sometimes there when you call them

To get through the slog of elliptical machine sessions at the health club, I periodically rediscover old musical favorites that I can use for a few days, until I once again need something fresh. Most recently it's been early Talking Heads, and especially my favorite of their albums, Fear of Music. I consider this a great comedy album, except that it's also lifted into something stranger and more unnerving by its weird intensity.

Great disquisitions, for example, on:

--Air ("Air can hurt you too / Some people say not to worry about the air / Some people haven't had experience with air")

--Cities ("London ... dark in the daytime / People sleep in the daytime / If they want to")

--Heaven ("Heaven is a place where nothing ever happens / There is a party, everyone is there / Everyone leaves at exactly the same time")

--And of course, animals ("Animals are laughing at us / Don't even know what a joke is / They're never there when you need them / They're never there when you call them / They think they know what's best / They're making a fool of us / They ought to be more careful / They're setting a bad example").

David Byrne is the only rock lyricist in history who would worry about someone needing to be more careful or setting a bad example.

Anyway, this got me to thinking about cats, as they are certainly among the main species as to which his  charges might ring true more broadly (although they certainly don't live on nuts and berries).

People less crazy than Byrne's character in Fear of Music might say that cats don't care about their "owners" (or should I say caretakers), but this is not true, certainly as to friendly and socialized cats. They can be very affectionate, want attention, and find what you are doing very interesting.

What they almost always don't have, in the slightest, is a desire to please you, or any concept of doing something because you want them to do it.  And it's not that they don't understand intention.  They can learn all too well, for example, that you don't want them on the counter, or grabbing items of your food that they like. So they won't do it if you are nearby, and will jump down if you approach.

This gap in their social schema, relative to that of humans and dogs, can be frustrating if you actually need them to do something in particular.  (The Coen brothers apparently vowed, after Inside Llewyn Davis, never to use cats again, even though they had three with distinct temperaments available to play the one role.)  But perhaps this makes it seem all the more an honor when they show affection - you know that it's sincere, perhaps I should even say disinterested, in the sense that they aren't trying to get you to reciprocate so as to boost their own self-regard (a potential motivation that I'd attribute to dogs as well as people).

Sunday, January 31, 2016

Mitchell Kane's "A Defense of Source Rules in International Taxation"

My colleague Mitchell Kane has recently published a quite interesting article on source rules in international taxation, taking a view that differs more from mine on the surface than I think it does in underlying substance.

A commonly quoted line about determining the source of income, from Hugh Ault's and David Bradford's piece on the subject more than 25 years ago, says that the notion of "source" lacks coherent economic content. I recall Bradford frequently noting that, while there is an intellectually coherent Haig-Simons income concept, there is no such benchmark for source. I've frequently quoted this line, as it's seemed both (a) clearly right and (b) related to the difficulties that source-based taxation presents in practice.  But I've also been aware that (a) it's easy to determine source in some cases, and (b) in other cases it depends on how you define it - e.g., origin basis vs. destination basis (more on this shortly).

Kane agrees at least arguendo that there may be no coherent economic definition of source, but then says: Why would the definition have to be an economic one?  "Household" or "family," for example, can't be satisfyingly defined for tax or other transfer system purposes unless one informs it with ideas taken from somewhere else that express one's underlying purposes.  For source, he sees the purposes as relating to how countries try to divvy up income tax bases between themselves.  He approaches this as a multilateral cooperative process, whereas - just as a matter of taste or interest; either approach can be fine - I tend to think about it more in terms of unilateral processes that may be conducted in the shadow of particular strategic interactions.

Then comes an important point that I've been thinking of writing about, although at the moment I'm engaged in my literature book - origin-based vs. destination-based income concepts. Say I sit at my desk in New York and write a book in Bengali that I will sell for large profits to people on the Indian subcontinent. Under the origin concept, the income is U.S.-source because that's where I did the work.  Under the destination concept, the income is sourced in India and Bangladesh because that's where the sales occurred.

In the context of, say, a retail sales tax or value-added tax, we often hear about the point that they can use either the destination basis (which is the universal norm) or the origin basis (as under some progressive consumption tax models that would use a VAT as part of their structure).  It's a familiar point that, in the consumption tax environment, one can use either, and in the long run it doesn't matter which one uses, leaving aside some extremely important issues pertaining to transition and administrability.

Income is commonly called an origin concept, and I've written about the difficulty of trying to run an income tax off the destination basis.  Absent some very fancy footwork, the equivalence from the consumption tax context is undermined by the fact that how long one saves before consuming (e.g., the time between exports to earn $$ and imports to spend it) affects income tax liability, whereas it hypothetically doesn't affect the present value of consumption tax liability using constant rates across time.

But in fact there are plenty of destination-based source concepts in existing income taxes.  For example, the U.S. income tax sources labor income based on where the work occurs, but it sources royalties based on where the property is used. So what if you use labor to create royalties? Then formalism determines the source of income.

The mix between origin and destination concepts in the income tax creates various tax planning opportunities, but that's not to say, at least right off, that a given country isn't better off using both in different places rather than just one.

Now let's consider source in the taxation of multinational enterprises.  Using transfer pricing between affiliated entities is apparently an origin based concept, but doesn't work too well.  Shifting to one-factor formulary apportionment that was based solely on sales would make it a destination concept.  But as Jerry Seinfeld and George Constanza would say, not that there's (necessarily) anything wrong with that.  When Reuven Avi-Yonah, Kim Clausing, and Michael Durst propose replacing transfer pricing with formulary apportionment, they are surely not "wrong' by reason of urging the use of a destination concept in a mainly origin-based system. After all, suppose the switch has predominantly good effects, whether adopted just by the U.S. or more generally. And the assessment of that depends on all sorts of wholly separate things (e.g., how manipulable would the sales factor be) that are quite distinct from the theoretical choice between income and consumption taxation.

Anyway, back to Kane's article.  The fact that one can use either origin or destination concepts to define the source of income has figured in my thinking as evidence for the prosecution in calling the source concept incoherent. Kane instead views it as evidence for the defense, showing that there are two ways one can actually do the thing, and it is simply a question of deciding which is better.  He mainly comes out pro-origin, because of the points that make it a better fit with the income concept.

Is the choice "really" evidence for the prosecution, as I have thought, or for the defense, as he argues? Once again this is really a matter of perspective - it's not a case where reasoning logically from required premises leads to one conclusion or the other.

Kane has one other main point in defending the coherence (whether it's economic or not) of the source concept.  He notes the problem of, say, deciding where interest should be deducted, when a multinational has both interest expense and gross income that presumably was produced by using the borrowed funds.  (But of course we don't really know what income this "really" is, given that the fungibility of money makes it quite meaningless where the particular loan proceeds were directly sent.)  But he notes that this is simply a broader difficulty of applying the income concept which applies even in the context of one-country taxation where there is no source issue.

Let me broaden that a bit.  Consider the "synergy" problem in transfer pricing. Standard example: U.S. and French company, if separately owned, would have earned $1M each. But they're co-owned by a multinational enterprise, leading to synergies that increase their combined net income to $2.5M. Where did the extra $500,000 of synergy income actually arise? I see it as in principle a bilateral monopoly bargaining problem - one could imagine the U.S. and French entities negotiating over it, if we posit that neither could realize it separately.  But since we can't really say anything about bilateral monopoly bargaining outcomes in the abstract, there's seemingly no good answer here.

So source might be viewed as an economically (and otherwise?) incoherent concept with respect to the $500,000 - though not as to the underlying $1 million that "should" be the minimum reported in each jurisdiction.

Once again, however, Kane's argument, to the effect that this is not a "source" problem as such, can be made here.  Suppose you have related entities in the U.S. that are taxed at different rates - e.g., because we have a special tax rate for the finance industry as compared to the electrical generating industry, and a given conglomerate entity or set of entities does both.  Now it matters which entity has how much income, but there is comparably no coherent answer to the bilateral monopoly bargaining issue that's raised by the synergy income.  So the transfer pricing problem isn't so much a source problem as a related-parties problem.

How much does all this matter in the end?  The issues of ultimate importance really turn on the consequences of alternative rule designs, as judged based on some underlying set of metrics.  So I'm not substantially more (or for that matter less) sanguine on the question of how well or poorly one can use source concepts in practice than I was before reading the Kane article.  But it provides very useful clarification regarding a set of conceptual issues that interest me, and on which I may still write a bit (in light of this article) at some point down the road.

Wednesday, January 27, 2016

Tax policy colloquium, week 2: Michael Simkovic's The Knowledge Tax

Yesterday, we discussed the above paper, which builds on Mike's co-authored empirical work on the economic value of a law degree, along with other empirical work that Mike and others have done suggesting that higher education degrees (college and up) offer highly favorable pre-tax (and to a lesser degree, after-tax) rates of return, even taking into account of opportunity costs (foregone earnings while one is in school).

The underlying research reaches two main conclusions.  The first is that lifetime earnings are sufficiently higher for those who get higher education degrees (despite the time away from being more than part-time in the workforce) to offer an above-market rate of return on tuition, etcetera.  The  comparison here is to investment returns on different forms of capital other than human capital.  The second is that a causal arrow runs from higher education to higher earnings - in other words, that it's not just selection bias, as in the case where those motivation and abilities will tend to produce higher earnings in any event also happen to pursue higher education.

Both of these conclusions, perhaps the second in particular, are controversial in the literature. Based admittedly on just superficial inquiry, Simkovic's work on these issues strikes me as plausible and well-reasoned, but I admittedly don't know enough to form a definite opinion.

In reading The Knowledge Tax for our session, I thought it reasonable to accept the empirical conclusions for argument's sake (which again, is not to suggest skepticism about them), because the main issue presented by the paper concerns their further implications. The paper argues that part, though not all, of the higher pre-tax return associated with higher education reflects that human capital investment is treated less favorably by the U.S. fiscal system (and in particular, though not exclusively, the U.S. federal income tax) than other investment. It thus argues that more favorable treatment of higher education would increase tax neutrality, economic efficiency, and long-term growth, due not only to the standard efficiency arguments for tax neutrality between particular alternatives, but also positive externalities.

There is of course a difference between devising "neutral" rules, at some particular margin, and those that are aimed at inducing particular behavioral responses, but if the rules are currently biased against something with positive externalities, then up to a point the two modes of analysis may have some tendency to travel together.

I thought the paper made a good case that we should mainly think of higher education expenses as investment, rather than as consumption (an old debate, of course).  But it's harder to draw firm conclusions about the current degrees of relative bias.  Obviously, the question of how favorably the U.S. federal income tax system actually treats non-human capital investment of varying kinds is quite complicated.  And one tax benefit of pursuing higher education, in lieu of working currently, is that the opportunity cost isn't taxable.

E.g., say I could have earned $50,000 this year, but instead I earn zero and rely on loans, savings, or family resources to spend an additional $50,000 going to law school.  I get implicit expensing of the $50,000 foregone earnings, even though the law degree may have future value that goes forward for decades.  This is highly favorable treatment from an economic standpoint.  On the other hand, I never get cost recovery for the $50,000 of tuition, even though it may reasonably be viewed as a cost of generating earnings.  There is of course no general answer to the question of how alternative investment choices would have been treated by the tax system, given the crazy quilt of possibilities.  So figuring out what's treated better or worse than what is quite tricky.

It's also fair game to ask how we think people who are considering higher education actually decide, and to what extent they are focusing on the long run, and sophisticated aspects of it such as the tax treatment of alternative types of future income.  As I discuss in my recent paper on behavioral economics and retirement saving, people often act as if they are myopic, even if that is not exactly the internal mental process. Now, when one decides to pursue higher education, evidently there is some sort of departure from the blinkered, short-term focus of the classic myope.  But still, even if people are taking account (or act as if they are taking account) of long-term earnings potential, it is possible that some aspects of the myopic or as-if-myopic frameworks will continue to influence them.  And this is potentially relevant to how they respond to reasonably expected after-tax earnings under alternative choices, and to tax rules that would change the overall treatment (especially down the road).

There are also important institutional issues to think about, e.g., does the education sector respond to demand (e.g., given that much of it is nonprofit), and how do relevant labor markets function - e.g., those for lawyers and doctors.

So it's a rich topic, to which the paper makes an interesting (if inevitably inconclusive) contribution.

Behavioral economics and retirement saving

My recently published Connecticut Law Review article, "Multiple Myopias, Multiple Selves, and the Under-Saving Problem," is now available on-line here.  It joins the fray regarding the reasons for apparent under-saving for retirement, with particular reference to the "nudges" debate, the well-known Chetty et al Denmark study, and the sometimes under-appreciated links between income tax "incentives" for retirement saving, fundamental tax reform, and Social Security reform.

Wednesday, January 20, 2016

Tax Policy Colloquium, week 1: Eric Talley's "Corporate Inversions and the Unbundling of Regulatory Competition"

Yesterday we began Year 21 of the NYU Tax Policy Colloquium. It occurred to me that I have been doing the Colloquium for more than half of the adult portion of my life, whether we date if from my first being eligible to drive (other than on a learner's permit), to vote, or to drink. At least we haven't yet reached the point where the age of the colloquium exceeds that of any student in the class (given that we don't have undergraduates). But that is not so many years off.

My co-convenor this year is Chris Sanchirico, and the speaker for Week 1 yesterday was Eric Talley, We discussed his recently published U Va Law Review piece on corporate inversions.

Because the sessions are off the record (although it is not as if a lot of Page Six-worthy stuff happens at them), my procedure here is to focus just on the paper and my reactions to it, as opposed to discussing what happened at the session.

Talley's paper takes advantage of his expertise in corporate governance and securities law to offer an insight that was not, so far as I know, familiar to tax people who have been thinking, talking, and writing about corporate inversions. Certainly it was new to me. He notes that recent moves towards the effective federalization of U.S. corporate governance law have potential implications for taxpayers' interest in engaging in corporate inversions that cause a given multinational to have a non-U.S., rather than a U.S., parent.

Federalization in this context refers particularly to the enactment of Dodd-Frank and Sarbanes-Oxley. Whether these laws are good, bad, mixed, or indifferent, one effect they have is to move legal provisions that are relevant to corporate governance, managerial discretion, etcetera, from the state level (such as Delaware corporate law) to the federal level.

The reason this matters to inversions is as follows. Suppose the relevant choosers (be they the managers who direct corporate planning, or the shareholders and other investors, if their preferences constrain or influence management) like Delaware corporate law. An inversion that makes, say, Dutch, Swiss, U.K., or Irish corporate law the relevant body will have the disadvantage, to the choosers, of supplanting Delaware law.

But so long as the company's stock is still traded on U.S. markets post-inversion, the federal regimes, such as Dodd-Frank and Sarbanes-Oxley, continue to apply.  So one doesn't opt out of them by inverting, even though one does effectively opt out of Delaware.

To get Delaware corporate law, you have to be incorporated in Delaware, with the inevitable consequence that the company is a U.S. tax resident. But if you want Dodd-Frank and Sarbanes-Oxley (which is not to say whether companies DO generally want them), you don't have to be U.S.-incorporated.  In short, in the paper's lingo, we have unbundled them from the requirement that one be treated as a resident U.S. company.

It is possible that this change, by allowing U.S. companies to invert without as fully exiting U.S. corporate governance law, has made inversions more attractive to some companies than they would otherwise have been. Of course, the magnitude of this effect is unclear. But I'm less sold on the paper's analysis of bundling corporate governance services with makng one accept resident taxpayer status. Under the paper's basic model, this functions as the means of (a) funding the costly provision of corporate governance services and (b) permitting corporate tax revenues to be collected, up to the value that choosers place on those services.

Some particular points I might make, in questioning the bundling model, include the following:

1) How costly is it to provide governance services? Of course they don't cost zero, but are they significant enough to make a model that emphasizes them especially useful?

2) Even if governance services are costly and funded by choosers, why fund it this way? The residence-based aspect of corporate income taxation presents a rather odd funding model for corporate governance services.  Note that companies that act in the U.S. are taxable here on a source basis anyway. So what I mean by the "residence-based aspect of corporate income taxation" is (a) the issues around deferral for profits stashed abroad and (b) the greater difficulty in some respects of profit-shifting out of the U.S., if one is a resident U.S. company.

3) Note that corporate governance services are not currently funded by choosers in the manner that the model envisions. Extra corporate income tax revenues to the federal government don't pay for Delaware's corporate law regime, and (as the paper notes) U.S.-listed companies don't distinctively pay for Sarbanes-Oxley and Dodd-Frank.

4) Suppose you have a public goods argument for the federalized corporate governance rules, e.g., based on systemic risk to the economy or the general benefits of having well-functioning and transparent corporate securities markets. These aspects can't be funded via value provided to the choosers, given the public goods aspect. So they can only be funded through general revenues or some other dedicated source that relies in some different way on the governance jurisdiction's market power.

BTW, what would I do about inversions, at a more general level than simply tightening the inversion rules? I think the key elements are (1) addressing the $2.3 trillion buildup in public companies' "permanently reinvested earnings" abroad, such as via mandatory deemed repatriations of some kind, (2) changing the U.S. rules' current relative over-reliance, in combating profit-shifting by multinationals, on (a) CFC rules that only apply to resident companies relative to (b) rules that apply comparably to all multinationals (e.g., thin capitalization rules), and (3) perhaps broadening the grounds on which a given company will be deemed a U.S. company (e.g., headquarters location in addition to place of incorporation).

But the paper makes a nice contribution by raising the issue of governance-federalization's effects. It also argues that the inversion wave is likely to exhaust itself faster than many have been assuming, due to the relative scarcity of suitable foreign "dance partners" for U.S. companies.  This, in turn, reflects both (1) the substantive requirements for tax-effective inversions that have been put in place since the last corporate inversions wave, and (2) companies' apparent preference, at least so far, in confining inversions to those that are at least arguably strategic (i.e., involving companies in the same industry - such as Burger King and Tim Horton's, or Pfizer and Allergan.