Friday, October 31, 2014

NYU event on Kleinbard book

Yesterday Ed Kleinbard presented his new book at an early evening session at NYU Law School.  Linda Sugin and I then offered comments.  Unfortunately, perhaps, for the intellectual diversity of the event, we both approached it more from the left, leaving viewpoints more from the right under-represented there.

My remarks went something like this:

The book is great, a tour de force and an important contribution to public debate.  I agree with the great majority of it.  But since that’s no fun to discuss, I’ll emphasize my main disagreement, which relates to high-end inequality, or the recent lift-off from everyone else of not of the top one percent, but rather the top one-tenth of a percent (which is where a recent paper by Emmanuel Saez and Gabriel Zucman finds that U.S. wealth gains since 1979 have been almost entirely concentrated).

I consider rising high-end inequality, in the top one-tenth of one percent, more important and broadly problematic than Ed does.  Now, this is at least partly an empirical question – what adverse effects, if any, does it actually have on everyone else? – but that is hard to evaluate.  So, while both Ed and I are open to evidence, we may have to continue to disagree about the importance of this issue, at least for the time being.

Because of this difference, at least in emphasis, I attach more importance than Ed does to distinguishing, both conceptually and empirically, between high-end and low-end inequality.  A measure like the Gini coefficient fails to do this, and not because of its particular tradeoffs or flaws, but because it’s a single overall measure.  When Ed says that even taxes that are regressive in isolation can create greater equality if they are spent right, he is emphasizing the effect on low-end inequality.  You can’t do much about high-end inequality, at least directly or in the short run, through greater social spending.

Given the greater importance that I ascribe to high-end inequality, I am more eager than Ed is to address it through the fiscal system, which really does mean the tax system.  Now, there may be important non-fiscal tools for addressing it – for example, regulations concerning intellectual property, the financial sector, corporate governance, and campaign financing.  But if we want to seriously address high-end inequality through the fiscal system, it has to be done through higher taxes at the top.

Now, this doesn’t necessarily have to mean higher graduated rates in the income tax, although it could.  Estate or inheritance taxes with fewer planning outs might play a big role as well, as might income tax reforms such as taxing asset appreciation at death, and perhaps finding a way to tax borrowing against appreciated property, so the likes of Larry Ellison can’t avoid tax on high current consumption.  (Ed says, by the way, that he supports the use of estate taxes to address dynastic wealth transfers – but he doesn’t emphasize it much, nor does he fully explain why it might be exempt from the political logic that he offers for steering away from greater high-end rate graduation.)

Although there are lots of different ways to skin the apple, I am more open than Ed is to having high income tax rates at the top, as Diamond and Saez have suggested.  By the way, they stop at 73 percent, including state and local taxes, under a low estimate of elasticity, because they are just trying to revenue-maximize at the top.  There’s an argument for going beyond that if you believe that high-end wealth concentration has net negative externalities, like pollution.

Raising the Social Security earnings cap would be a significant (12.4 percent) tax rate increase on people who are well above the median – but obviously it starts applying long before we reach the top tenth of a percent.  So, while that would be a progressive tax change, it wouldn’t be aimed where my special concerns lie regarding what’s happened since 1979.

Of course, there is more than I’ve acknowledged so far to Ed’s side of the argument against specially aiming higher up.  So let’s back up for a minute.

This is at least three books in one – perhaps more.  But it certainly includes at least the following three:

First, it’s a book about substantive policy analysis.  What are the issues, and what are the tools that we might use to address them?  A core argument is that, in addressing inequality through the fiscal system, we should focus on spending, not tax progressivity.  Again, while I agree with this, it addresses low-end inequality, to the relative exclusion of high-end inequality, and I would like to address both, while using Ed’s approach for the low end.

Second, it’s a book about morals and rhetoric.  The two are linked because appealing to people’s underlying moral beliefs is crucial to rhetorical success.  Here Ed does a great job of attacking market triumphalism. 

But I wonder if he is being either too optimistic about moral argument’s capacity to cajole people into caring more about the bottom end, or else too pessimistic about its doing the same at the top end.  In any event, I wonder about the substantial gap between his optimism and pessimism on these two scores.  And while he views addressing low-end inequality and high-end inequality as substitutes – in his view, pursuing one would undermine pursuing the other – it’s also possible that they could function as complements.

Third, this is a book about political economy.  Ed believes that some approaches to addressing inequality might succeed, while others will surely fail.  Here I’d make the same point about whether addressing high-end and low-end inequality have (a) such different prospects and (b) are necessarily substitutes rather than complements.

Okay, more about the first book, concerning substantive policy analysis.  Ed notes that recent increases in inequality have been driven by the rise of the top 1 percent.

In support of his nonetheless focusing almost exclusively on low-end inequality, the case for addressing it admittedly is much more clear-cut than that for addressing high-end inequality.  When we think about helping the poor, the idea is to make them better off.  That’s not hard to endorse.  But when we think about addressing extreme high-end inequality, is the idea just to make those people worse off?  Why would we want to do that?

The answer is that there are reasons for thinking that extreme high-end inequality may indeed be bad for everyone else.  It’s not just a matter of the declining marginal utility of consumption, which merely suggests that others would get more utility out of a dollar than people at the top do.  Extreme high-end wealth inequality can potentially have directly adverse effects on the bottom 99.9 percent.

But let’s start with declining marginal utility, since Ed disparages it as a ground for wanting to level down as well as up. In the book, he notes that his former clients loved money so much that the theory of declining marginal utility seemed not to apply to them.  But I have two responses.

First, that example does not concern the marginal utility of consumption, but rather of the income and wealth amounts that they get to see reported on pieces of paper.  Neither Ed’s super-rich former clients nor their heirs are likely to spend all of that money any time soon.  So a large part of what they love is the abstraction – gross dollar numbers that they see reported to them.

Among the key elements of this may be keeping score against their peers.  But if you tax all of them at the same high rate, their relative ranks stay the same.  And if what they like is the power and status that it brings them relative to everyone below, that is a mainly zero sum phenomenon.  More power and status for them means less for others.

I also question the admittedly standard practice in welfare economics of taking preferences as given.  I would argue that some combinations of people’s preferences can lead to higher total utility than other combinations.  Suppose one person enjoys hurting or oppressing others.  The standard utilitarian answer to why we shouldn’t let this happen is that surely the victims’ pain is greater than the inflictor’s pleasure.  But what if it isn’t? 

Well, probably it is.  But even if it isn’t, it seems obvious that we could get to a greater overall welfare level if the oppressor’s utility function instead had inputs that were at least neutral regarding whether others were suffering.  And preferences may be socially malleable over time, even if not for a given individual whose ways are set.

It makes sense for us to think about the long run, not just feelings that are based on expectations today.  Say I’m a hedge fund manager who believes that making me pay tax on my labor income at ordinary income rates, rather than capital gains rates, is on a par with Kristallnacht.  A billionaire actually said something like that recently.  And while his comment could not easily have been more ludicrous and offensive than it was, it certainly testified to his genuinely strong feelings.  Does that mean his marginal disutility of paying the same tax rate as the rest of us is really, really strong?  To me, even if so, that means he has preferences that shouldn’t be encouraged, and that over time, with habituation to a better system, could change.

In sum, I think that focusing on the marginal utility of consumption has more juice than Ed attributes to it, insofar as justifying a response to high-end inequality is concerned.  But it’s only a small part of the argument for concern about the takeoff in recent decades by the top tenth of a percent.  Other important points include the following:

--First, the fact that high-end inequality makes other people feel worse than they would in a more equal society.  There is extensive behavioral research evidence confirming this.  People say they’d prefer to have somewhat less in a more equal society, rather than somewhat more in a society where they are far below everyone else.  Utility comes not just from own consumption, but relative consumption.  This reflects that we are a competitive social animal.

--Second, political economy.  I see lots of evidence that a shift towards plutocracy is choking our political system’s capacity to respond to most people’s interests and concerns.  Consider the work of Princeton political scientist Martin Gilens, showing that policy preferences below the very top appear to have almost no influence on policy outcomes.

Case in point, I think it’s in good part because of rising plutocracy that there has been so little interest among policymaking elites in stimulating demand to address high unemployment still lingering from the Great Recession.  You might have to challenge the concentration of power at the very top in order to make the government more responsive to other people’s interests.

Now, campaign finance law might be part of the response, if there weren’t 5 Supreme Court justices asserting that the right to give a billion dollars to a candidate is sacred, while it’s perfectly fine to disenfranchise millions of voters through the equivalent of poll taxes.  But even if the Supreme Court majority actually respected our country’s best traditions, rather than being eager to trample on them, campaign finance reform might not be enough.  When things are so unequal, the power imbalance is going to seep through one way or another.  So you may actually have to address high-end inequality in order to preserve meaningful democracy.

--Third, social solidarity.  The reason you have all these billionaires complaining about Kristallnacht, the moment anyone even looks at them funny, is that such radical inequality as we have today undermines the sense of shared membership and enterprise that you may need for a successful democratic society.  These people end up living lives completely separated from the rest of us, and they grow accustomed to receiving enormous deference most of the time.  They start to find democratic politics and manners unacceptable, and they get paranoid that the voters will take it all away.  I don’t entirely blame so many of the super-rich for feeling this way, even though they appear to have immense political power, with fealty from the leaders of both major parties.  It goes with the territory to feel paranoia.  But the fact that they feel so threatened reflects the destruction of cohesion and social capital.

Let me turn briefly now to Ed’s second and third books – the ones on morals and rhetoric, and on political economy.

On morals and rhetoric, Ed believes that progressives need to focus more on the old-fashioned virtues, including basic human decency, and on saying “social insurance” rather than “redistribution.”  I agree about those rhetorical choices.

But I am not so sure that “we are better than this.”  For example, our country’s racial history makes it difficult to motivate helping people at the bottom.  Ed appeals to altruism, and to the appeal of being a mensch, not a jerk.  But altruism often takes the form of loyalty to one’s own racial, ethnic, or other social group, with an accompanying lack of compassion for, or even hatred of, other groups.

Politics is also importantly driven by economic interests.  And it’s not clear why those who are in the driver’s seat would share Ed’s concern about low-end inequality, even if high-end inequality is allowed to stand unchecked.

Jared Bernstein, in a review of Ed’s book that was extremely favorable, nonetheless made the following comment, based on the book’s title, “We Are Better Than This”:

“Just who is this ‘We’ he keeps talking about? More than any time in our recent history, we are balkanized by income, class, ideology, religion, politics, race, and pretty much every other dimension you can think of. And if there is no coherent ‘we’ then there can be no clear path for ‘us’ to take together that will make us ‘better than this.’"

One of the book’s important themes is combating market triumphalism.  But discrediting it could motivate addressing inequality at the top, as well as the bottom.  If the market’s losers don’t deserve contempt for having lost, then perhaps the winners don’t deserve quite so much genuflection for having won.  And if you can’t counteract the moral influence of market triumphalism, then addressing inequality at both ends is difficult.  The two might be tightly linked.

Finally, let’s turn to the political economy book.  Ed makes a number of judgments that are contestable – which is not to say wrong.  Opposing judgments would also be contestable, as this is a murky area.  To give an example, Ed argues that, if you advocate highly graduated income tax rates, you get into a class war, zero-sum framework where you inevitably lose.  An opposing view would be that you need to weaken the grip of plutocracy at the top before you can achieve anything at the bottom.  I find it hard to tell who’s right.

Plus, there’s the question of why some increases in high-end taxes (such as from base-broadening or making the estate tax more effective) won’t generate the same political backfire as raising high-end rates.  Ed may have specific distinctions in mind, but it’s bound to be debatable.

Insofar as the aim is to avoid angering the rich, the book employs what I call the “Mongo” theory, derived from the movie Blazing Saddles.  Mongo is the gigantic brute who can punch out a horse, and who initially is working for the bad guys.  Gene Wilder tells the good guy sheriff, played by Cleavon Little, “Don’t shoot Mongo – it only makes him angry.”  Likewise here, Ed fears that if you use steeply progressive rates to go after the super-rich, they will oppose the rest of your agenda.  But what if they’ll oppose it anyway?

In the movie, the sheriff tricks Mongo with an exploding Candygram, and Mongo then changes sides.  I’m not sure how we can exploit that insight here.  But leaving the very top alone may do less to placate the opposition, than to leave hostile forces still in control of our political and economic system.

In sum, I agree with Ed that addressing low-end inequality depends much more on revenue adequacy and spending levels than on tax rate progressivity at the top.  But there are distinct reasons for addressing inequality at the top, not just the bottom.  And, as a matter of morals, rhetoric, and political economy, it is hard to be sure whether addressing the two kinds of inequality is more a case of substitution – you can only do one, at most, as Ed believes – or of complementarity, where they are best seen as parts of the same enterprise.

Thursday, October 30, 2014

A concern for the 99.9 percent?

According to a recent paper posted by Emmanuel Saez and Gabriel Zucman, "the rise of wealth inequality [in the U.S. in recent decades] is almost entirely due to the rise of the top 0.1% wealth share, from 7% in 1979 to 22% in 2012."

Saez presented this paper yesterday (Wednesday) at the University of British Columbia in Vancouver.  I was actually in Vancouver at the start of the day, by reason of my having presented my Piketty paper (coauthored with Joe Bankman) on Monday, but a change to my flight time prevented me from attending the session.

Here are the slides for my talk from my prior presentation of the paper at Virginia - all that changed in the interim was the title page.  And the photo here was taken right after the talk - I am only actually, not figuratively, backed up against a fence.

World Series note

I was rooting for the Royals, but obviously had to admire Bumgarner's performance.  (Plus, extra bonus points from me because he's left-handed.)

The interesting thing was that he appeared to realize, within a few batters, that he simply didn't have his usual command or velocity, so he adapted.  Rather than throwing nothing but strike after strike (to all four corners of the strike zone), he kept on moving the ball around, but frequently missed the strike zone on purpose - especially high.  The Royals, knowing his usual style by now and presumably over-anxious as well, couldn't adapt and kept swinging at pitches a foot out of the strike zone.

Monday, October 27, 2014

Avi-Yonah reviews Kleinbard

Speaking of Chicago-style legal writing, at least in the sense of frequency as opposed to scope of enterprise, Reuven Avi-Yonah has posted a very short book review of Ed Kleinbard's We Are Better Than This.

The style, as in Avi-Yonah's book review a few months back of my Fixing U.S. International Taxation, is to say, in 6 pages or less: "The author says ABC and DEF.  I agree with ABC but disagree with DEF.  Therefore, the author is to be commended for saying ABC, but criticized for saying DEF."

Actually, in my case, I don't think there was an ABC - just a DEF, but, as I noted at the time, we are all entitled to our own opinions.

In Kleinbard's case, Avi-Yonah defines "ABC" as being concerned about the overall progressivity of the fiscal system but not being too concerned about the super-rich.  This matches Avi-Yonah's views.  In the abstract, Avi-Yonah includes an odd putdown of Thomas Piketty for having an "obsession" with taxing the rich.  The only follow-through in the text of the article is a statement that an "obsessive focus" with raising top marginal tax rates is "misguided," since historical data from Elliott Brownlee suggest that we have not, as a historical matter, actually redistributed more from the top when we had higher (but generally more porous) top income tax rates.  I rather think there is more one could say on this topic.

"DEF," for Avi-Yonah in his review of Kleinbard, is not adopting Avi-Yonah's proposals - in particular, a VAT.  The book review does not explore what might be the similarities and differences between a VAT on the one hand, and Kleinbard's proposing to lift the annual earnings cap on the Social Security tax, on the other hand.  Clearly (and needless to say), these two are very different proposals in quite a few dimensions.  Yet there is enough general economic similarity between them - since a wage tax can resemble a consumption tax, when both are operating prospectively (and subject to tax rate differences, important administrative details that affect their reach, etc.) - that addressing it wouldn't have been out of place, at least in a more ambitious book review effort.

In Avi-Yonah's review of my book, although I tried at the time to put this delicately, it was not entirely clear that he had actually read it before writing his review.  For example, the review found it  surprising that Fixing U.S. International Taxation ostensibly hadn't discussed "national neutrality."  In fact, however, this had actually been a main subject of my book's chapter four, although I hadn't specifically mentioned my extensively discussing it in either the introductory chapter or the conclusion.

Then again, you know the old joke in which a writer says: "I never read the books I am reviewing.  I fear it should prejudice me."

As noted in an earlier post here, I'll be commenting on Kleinbard's book at an NYU book event later this week, and I will probably then post my comments here.  For me, ABC is most of the book, but DEF is the fact that I'm more concerned about rising high-end wage and wealth inequality than Ed is.  One thing I'll discuss, however, is that I recognize reasonable people can disagree about this.

UPDATE: It is fair to note here that Reuven Avi-Yonah takes exception to the suggestion about how carefully (or not) he read my book.  He regards it as an attack on his integrity, which goes beyond any suggestion that I meant to make, and I apologize insofar as it can be taken that way.

"Are you a Chicago-style (Quantity) or a Harvard-style (Quality) scholar?" - I try to be both at the same time

The other day, the TaxProf Blog linked to an Orin Kerr blogpost rightly noting two distinct styles in legal academia: the Chicago style, which involves writing a lot, and the Harvard style, which involves trying to make fewer but more significant, comprehensive, and well-thought-through statements.

A blog with regular entries, like this one, is clearly a Chicago-style enterprise.

But in my academic writing, I try to be both at the same time: closer to Chicago than Harvard frequency, but (apart from a few quick commissioned pieces and such) with the aim of putting more into each project than the Chicago approach deems necessary.

Friday, October 24, 2014

They're not happy

One argument we sometimes hear concerning U.S. international taxation is that, whereas the current U.S. system is "out of step" with world norms, other major OECD nations have figured out what to do.  Just enact a territorial system, exempting foreign source active business income, perhaps with some moderate anti-tax haven rules, and you're done / good to go / insert bland bromide of choice.

One good thing about these other systems, as I emphasize in my book, is that adopting territoriality happens to rid you of both deferral and the foreign tax credit - but not because the tax rate on designated foreign source income.  You can have a positive rate (preferably low for a bunch of other reasons) at that margin and be "full worldwide" in the sense of taxing foreign source income, at whatever rate you do, immediately and with foreign taxes only being actually or implicitly deductible.  (Anti-tax haven rules, however, may effectively make them worse than deductible, a move that might itself have good rationales, as I discuss in the book.)

Anyway, back from the detour to the main point.  If everyone else has gotten it right, and they are now doing so great, why aren't they happy?  The whole OECD / BEPS (base erosion and profit-shifting) issue shows that they do not think they have gotten it right.  Note that a zero rate for foreign source income does indeed increase the temptation for profit-shifting, even relative to the dysfunctional U.S. system (in which resident multinationals with billions stashed abroad may at least find that this reduces the appeal of further income-shifting).

One answer I've heard to this point is that they are only unhappy about income-shifting by foreign multinationals, not their own (e.g., Starbucks in the UK, since it isn't a UK company).  But even if this is true of the domestic politics, try finding an economist who will agree that a "national champions" strategy actually makes sense.

A second answer I've heard is that countries like to let foreign multinationals do some income-shifting, so that they will be more interested in inbound investment.  An example might be the U.S. having no qualms about Toyota using debt to strip the income out of its U.S. plants, since this permits them to invest here without actually facing our 35% statutory rate on much of the profits they derive from U.S. production.  They can only do this successfully because they aren't a U.S. company, and hence don't have to worry about generating taxable passive income via the interest outflows to foreign affiliates (or deduction disallowance against U.S. source income under our interest allocation rules).

The funny thing about this story is that it's the opposite of the first one.  Now we're told that countries want to tax foreign multinationals less than domestics, rather than more.

I do believe this story has some truth, however.  But what's happened in the BEPS controversy, is that the income-shifting has simply gone too far, from the standpoint of various countries including the U.S. (at least in the view of some people here).  In effect, I see the countries thinking: "We were fine with you lowering your effective tax rate from A to B, which is why we didn't enact rules to stop you, but instead you've raced far past that point and lowered them all the way to C, which is less than we think we can and should get from you on domestic economic activity."

This is not to say whether the countries are right or wrong about this, from the standpoint of domestic national welfare - clearly a tough judgment to make, and one that depends in part on your normative inputs.  But I do think it explains why they're not happy.  And if they're not happy, we shouldn't be so quick to conclude that they have made life easy for us by showing us how best to tax income from cross-border investment.

Thursday, October 23, 2014

My remarks at this afternoon's Fordham session on corporate inversions

The panel today, which I mentioned in my previous blog post, was off the record, so I can't address any of the particulars of the session.  But here is the written version of my remarks there:

One of the hazards of being asked regularly to comment on things is that you start wanting to be known as a sage who has made great predictions in advance.  So you get football prognosticators who keep picking the upset special, on the view that no one will remember when they’re wrong, but that they’ll be able to crow about it when they’re finally right.

Insofar as I predicted something in this area, it definitely wasn’t the upset special.  If anything, it was more like predicting that the Mets wouldn’t make the playoffs this year.

And anyway, I didn’t specifically say that we’d be back in the inversion soup so soon after Congress addressed the issue in 2004 (if ten years later is indeed soon).  What I said, with a kind of confirmation from the current inversion controversy, is that a really crucial attribute, in assessing what sort of international tax regime the U.S. should have, is what I call the effective degree of our system’s corporate residence electivity.  If we attach potentially adverse tax consequences to being a U.S. company, then it is important to know how avoidable that status is, or isn’t.

There are multiple margins at which you need to think about corporate residence electivity.  One involves new incorporations, and the extent to which tax considerations affect their occurring in the U.S. rather than abroad.  A second margin involves existing companies, both U.S. & foreign, and the question of which of them are the ones to issue new equity and/or make overseas investments.  And inversions involve a third margin: changing the corporate residence of the company at the top of an existing multinational group, as when a U.S. multinational becomes a foreign one.

When I was doing research for an NYU Tillinghast Lecture discussing corporate residence electivity that I delivered in 2010, I was surprised to hear from leading New York practitioners that, even just for new incorporations, effective electivity appeared to be lower than I had expected.  That is, while they typically told their clients to incorporate abroad for tax reasons, they often didn’t win these arguments.  Data about new incorporations actually seem to bear this out (there’s a paper, for example, by Eric Allen and Susan Morse).  But I thought that corporate residence electivity was likely to rise over time, with adverse long-term implications for the extent to which we can benefit from following policies that seek to impose distinctive tax burdens on U.S., as compared to foreign, multinationals.

At the time of my Tillinghast lecture, the pre-2004 inversion fever had abated, because those deals were generally self-inversions with zero economic substance, making them easy to address legislatively.  What we have now are deals with some economic substance, although often very strong tax planning considerations as well, making the design of rules that will block at least some of them, if that’s what you want to do, more challenging than it had been in 2004.

There are several ways we could address inversions like the ones that we are seeing today, involving actual mergers between foreign and U.S. companies that are not pure cases of a minnow swallowing a whale.  One is just to let them happen.  Another is to change the rules by requiring somewhat more economic substance than we do under current law.  A third, emphasized by the Treasury in recently issued regulations, is to reduce the expected tax advantages of these deals.  And a fourth is more generally to address the differences in U.S. tax treatment of U.S.-headed, as compared to non-U.S.-headed, multinationals.

Before saying more about that, I want to address two half-truths that purport to explain why U.S. companies may engage in these deals.

According to the first half-truth: “U.S. companies want to invert because the U.S. tax rate is just too high.” 

Now, it’s true that the U.S. corporate tax has a 35 percent statutory rate, even disregarding state-level corporate income taxes, and that peer countries have lower statutory rates.  But first, the average or effective tax rate matters more for many taxpayer decisions than the statutory rate applying at the margin, and U.S. companies’ overall effective rates do not appear to be out-of-line with those that foreign companies pay.

Second, the U.S. source income of foreign as well as U.S. companies is, at least on its face, generally taxable by us at 35 percent.  If that rate is too high, this goes more to the domestic corporate tax rate question than to inversion issues.

So why isn’t it wholly false to say “U.S. companies want to invert because the rate is too high,” instead of the clearly true statement: “Companies will be more interested in shifting their investments and claimed profits abroad if our rate is high, than if it is low”?  The reason the first statement isn’t wholly false is that there actually is a practical link between inversion and the effective domestic tax rate.

A major reason why U.S. companies want to invert is the hope that this will make it easier for them to reduce reported U.S. source taxable income, even if their true economic activities around the world remain the same.  This reflects what I’d call existing anti-base erosion features of the U.S. international tax rules – involving, for example, interest allocation and subpart F.  These rules, at least when they’re working effectively, can make it harder for U.S. companies than foreign ones to lower their U.S. tax bills through such planning steps as assigning lots of debt, including intercompany debt, to the U.S. affiliates in a global group. 

The second half-truth about inversions goes as follows: “U.S. companies want to invert because we, unlike most other countries, tax our resident companies’ foreign source income.”  Well, perhaps this is even a two-thirds truth.  But it does require amplification and correction, potentially changing its apparent implications a bit, if we actually want to understand it.

Now it’s formally true that we have a “worldwide” system, in which U.S. companies’ foreign source income, even if earned through foreign subsidiaries, is eventually supposed to be taxable here.  Most of our peer countries have territorial systems, in which at least active business income that’s earned abroad is domestically exempt, albeit potentially subject to the reach of anti-tax haven rules.

For three particular reasons, however, the statement can misleading if one doesn’t say a bit more about it.

First, we don’t do a great job of taxing U.S. companies’ officially reported foreign source income.  More than $2 trillion of that income is currently reported for accounting purposes as “permanently reinvested abroad” – which means that the companies have successfully argued to their auditors that they will NEVER have to pay the U.S. repatriation tax.  The reason those companies may be interested in inverting is to make it easier for themselves to access the funds that they have stashed abroad, without as much concern about triggering a taxable U.S. repatriation.  This can reduce their tax planning costs even if they would never have paid the U.S. tax anyway.  Now, this is potentially a pro-taxpayer point, since no one wins except for the lawyers when the companies incur extra tax planning costs, but it does show that we’re not overtaxing as such.  The conclusion might be, not that we are taxing U.S. companies’ foreign source income too much, but that we are doing it the wrong way.

Second, a lot of the foreign source income on which U.S. companies want to avoid paying U.S. tax may actually, as an economic matter, have been earned here.  Again, this goes to the U.S. base erosion and profit-shifting opportunities that are greater here for foreign than U.S. multinationals.  Now, this does mean that the U.S. companies can truthfully say that they are trying to put themselves on more of a par with their foreign rivals, although the issue here is actually U.S. rather than foreign investment.  But we may not be entirely happy about it in either case.

Third, some of the motivation for inversions relates to the past, not the future.  Suppose you are a company with $10 billion of foreign earnings.  If you repatriated the funds today, you would pay $3.5 billion of U.S. tax on this income, minus the amount of any foreign tax credits (which may be trivial if you have stashed most of the profits in tax havens).  The only reason the U.S. doesn’t make you pay that tax is that we have deferral, permitting you to postpone the payment until you actually repatriate the funds.  Deferral is a realization rule.

In theory, deferral – unlike realization in some other cases – doesn’t reduce the present value of your U.S. tax liability.  After all, the amount that’s waiting to be repatriated presumably is growing annually at your after-foreign tax rate of return.  Thus, in terms of my earlier example, in theory you’ll eventually pay $3.5 billion plus interest on earnings of $10 billion plus interest, eliminating the present value benefit of deferral.  So, again in theory, allowing deferral to U.S. companies is like granting them a loan – and not an interest-free loan, but a true loan with a floating market rate that automatically depends on actual rates of return.

As soon as you invert, however, this may change.  Even if the U.S. company’s prior foreign subsidiaries remain below it on the ownership chain, with the new foreign parent standing above both, it may now become much easier in practice to avoid ever paying the U.S. repatriation tax.  You may have more ways than you had pre-inversion to actually access the funds while you sit and wait for the next corporate tax rate cut, or foreign dividend tax holiday, or the enactment by Congress of a territorial system, all of which might potentially reduce or even eliminate the deferred tax bill.

So allowing U.S. companies to invert without triggering realization of the deferred gain is a bit like allowing them to increase the likelihood of default on a loan.  This is why there has been some talk of an exit tax – a deemed taxable repatriation – when U.S. companies invert, even if the U.S. company’s foreign subsidiaries still stand below it in the ownership chain.

“Exit tax” is an ugly-sounding term.  It brings to mind Soviet-era harassment of dissidents.  So let me propose a term that sounds better and yet is metaphorically accurate: loan repayment acceleration.  When you own your home subject to a mortgage, and you sell the house and buy a new one, they generally make you repay the loan.  I think we should consider applying such an approach to deferral, via deemed repatriations when U.S. companies expatriate, on the view that the loan’s “credit risk” – i.e., the chance that it will never be repaid, has likely increased.  This doesn’t mean that the special tax rate here should be as high as 35 percent, even in the absence of foreign tax credits – but perhaps a zero tax rate on deemed repatriations when you invert, by reason of not deeming them at all, is too low.

Now, companies that invert are typically looking forward as well as back.  They want to ease profit-shifting and their access to foreign earnings for the future, not just retroactively for the earnings that already are stashed abroad.  So the tax motivations for a given deal are likely to go beyond easing the company’s full access to permanently reinvested earnings.

Given that issue, I would like to see us move in the direction of adopting what I call more residence-neutral rules for determining the source of income – and in substance, not just formally, although this is tricky when the methods used to address base erosion include treating resident companies’ claimed foreign source income as currently taxable, rather than re-defining it as actually U.S. source.

I also agree that we have to accept that we are living in a world in which corporate residence electivity, genuine capital mobility, and inevitable source tax reporting flexibility mean that it’s going to be growing ever harder to hold the line.  Indeed, some retreat from relying on entity-level corporate income taxes, and income taxes more generally, is surely in order – perhaps even a large retreat, depending on what else is on the tax reform table.  But that requires a much bigger conversation, and in the interim I believe that we should take some steps to hold the line a bit longer, both on the corporate inversions front and with regard to base erosion and profit-shifting generally.

Even if we are in retreat with regard to taxing corporate income at the entity level, there is a difference between an orderly withdrawal and a rout.  Making it too easy to escape the U.S. tax net, especially when that means that you can get a kind of retroactive windfall gain from reducing the expected tax burden on foreign earnings that you accumulated in the past, would in my view make the retreat too much of a rout.

Tuesday, October 21, 2014

Yet another upcoming event at which I'll be a speaker

On Thursday, October 30, from 6:30 to 8:30 pm, NYU Law School will be hosting a book event for Ed Kleinbard's We Are Better Than This: How Government should Spend Our Money.  At this session, Ed will speak for a while, then Linda Sugin and I will both offer, say, 10 minutes each of commentary, followed by open discussion in the room.  A link for the event that includes a further registration link is available here.

The book is great - important, convincing, highly informative, entertaining, both erudite and sure-footed on a wide range of topics, and a major public service.  I'll make more particular comments at the session, and then post something about them here.

Roundtable discussion on corporate inversions

This Thursday, October 23, from 12 to 2 pm at the Fordham School of Law, I will be participating in a roundtable discussion on tax inversions.  Details are available here, and you can register for free on-line.

The other panelists will be David Shakow (a fellow academic, although he is also in practice), John Samuels (from General Electic), Paul Oosterhuis (from Skadden Arps), and Harry Grubert (from the Treasury Department).  These individuals are all aptly described as heavy hitters, with plenty of Washington connections and Treasury or Capital Hill experience in addition to field knowledge.

I might possibly be one of the more pro-government and anti-inversion of the panelists (so far as allowing the deals to have full intended effects is concerned), but I am certainly not doctrinaire, and it's possible that others will say things I'm not expecting.

I'll post something here afterwards, perhaps including a rough version or outline of my remarks.

Monday, October 20, 2014

New project

I've been reluctant to mention this here, for fear of jinxing a still inchoate new thing, but I appear to be moving towards (and into) a new book project, inspired by one of the small sidelights in the Piketty article that I coauthored with Joe Bankman (and that we will soon be posting on SSRN).

There's a short section of that article, representing one of my parts of this true joint project, in which we discuss Piketty's much-noted discussion of literature to help illuminate past rentier societies that he believes may tell us something about the future.  In particular, he discusses Austen and Balzac.  We quibble with his use of Balzac (who describes not just rentier society but more particularly the struggles of would-be arrivistes), and then briefly note other 19th and 20th century literature that is also about adventurers and arrivistes, before briefly commenting on Wodehouse's Bertie Wooster, who is the true comic embodiment of rentiers' decline amid the mid-20th century Great Easing.

This may, I am hoping, end up inspiring a book that, if it meets its objectives, will be fun both to write and to read, discussing the wealthy and the arrivistes, along with underlying social attitudes about both and their evolution over time, in fiction of my choice over the last two-plus centuries (e.g., Austen, Balzac, and Wodehouse, among others).  I'll be looking at the fictional worlds in these books, not in any close detail at the actual contemporaneous societies, and with no presumption that the books I choose to write about are the "right" ones in any sense other than that I personally find them fun and interesting (and usually, though not always, of high literary merit).

More travel and recent travel

I will be reprising my talk on the Piketty book in a talk at the University of British Columbia Law School in Vancouver on Monday, October 27.  Details here.

Good session in Charlottesville last Thursday when I last presented this paper, although the air travel aspect was not as much fun.  (Five-hour delay heading out, including a flight that returned to NYC after many minutes in the air, due to mechanical problems; one-hour delay heading back.)

The main comments I got in Virginia concerned the likely virtues of spelling out, a bit more thoroughly than the current draft does, the implications for tax instrument design of (a) different normative concerns about rising high-end inequality, and (b) different sources of rising wage inequality that one might to address, if one modifies Piketty's assumption that r > g is doing most of the work.

I also got an interesting sidebar comment on my blog, generally praising it but saying that, when I discuss politics, I am (a) too ungenerous to Republicans, (b) at least implicitly too generous to Democrats who often are equally in bed with plutocracy (I say "implicitly" because I don't actually praise them much here), and (c) insufficiently mindful of the sharp divides within the Republican camp - as shown by the populist and anti-rent-seeking passions that helped to retire Eric Cantor to a life where he will have to accept multimillion-dollar paychecks in lieu of being an inside player.  Point taken; I will try to do better.