Aftermath of the Columbia / Davis Polk panel on corporate inversions

Just back from the above panel, which was held under the Chatham House Rule, which provides that "participants are free to use the information received, but neither the identity nor the affiliation of the speaker(s), nor that of any other participant, may be revealed."

So I'd better not say whether I actually delivered the remarks in my prior post, or whether, if I did, I spoke fast enough (or the chair was lenient enough) for me to deliver the whole thing in five minutes.

But I will mention what I considered the most interesting thing I heard at the session.  It was suggested in some quarters that, even though the U.S. has what we label as a "worldwide" system, while Germany has what we label as a "territorial" system, it is not entirely clear which system bears more rigorously on its multinationals.  Germany, for example, has much tougher earnings-stripping rules than we do, perhaps even making it harder, in some circumstances for German than U.S. companies to strip earnings out of the domestic tax base.

The response offered to this was as follows: If the U.S. isn't much tougher on its multinationals than Germany, why is it that tax inversions are a U.S. phenomenon, not a German phenomenon?

Sounds convincing, right?  Actually, not so much.  The response offered to that was, at least my view, a game, set, and match refutation of the claim that inversions prove the U.S. tax regime to be more onerous.

The point is as follows.  Companies don't look to invert because their current tax rate is high - it's not based on the absolute pre-inversion level.  Rather, they consider inverting based on an assessment of before versus after.  The U.S. rules differ from Germany's in that they make the before vs. after analysis of an inversion potentially far more appealing for U.S. than German companies.

This, in turn, happens for two reasons.  First, given how much tougher the German than the U.S. earnings-stripping rules are, there's much less payoff to a German inversion.  You can't do as much great stuff afterwards, such as through intra-group loans.  Plus, in the U.S. setting, since we use our controlled foreign corporation (subpart F) rules to discourage the use of intra-group debt to reduce U.S. tax liability, you really give yourself a new tool here by inverting.

Second, because we have deferral, you get out from under the burden of having to play costly tax planning games to access the overseas earnings without incurring U.S. repatriation tax.  That reflects a stupid design element of our system, but again, it's about the before versus after, and doesn't prove anything about the overall relative levels.

My remarks in the previous blog post emphasized the importance, if we eliminate deferral, of imposing a transition tax on the pre-change foreign earnings that would now permanently escape the repatriation tax.  I would also consider applying such a tax to U.S. companies that invert, i.e., treat the transaction (even if very substantive) as a constructive repatriation of prior foreign earnings of the U.S. group.  Indeed, this cash-out of the deferred tax liability could apply even though the foreign earnings typically remain in the hands of subsidiaries of U.S. companies in the ownership chain, since having a foreign parent on top of the whole group generally makes it easier to avoid repatriation indefinitely than it would have been before.

Columbia Law School / Davis Polk panel on corporate inversions

Today, in just over an hour, I will be participating in a panel discussion regarding corporate inversions that is sponsored by Columbia Law School along with the law firm of Davis Polk.  My co-panelists will be Rosanne Altshuler, Richard D'Avino, Mihir Desai, and David Schizer.

We'll each be talking for 5 minutes near the start on assigned topics, before getting to general discussion.  My assigned topic is deferral.  Since I talk fast, I am hoping to use my 5 minutes to say something rather like this:

If there’s one U.S. international tax rule that everyone hates, with good reason, it’s deferral.  Proponents of a strong worldwide tax want to replace it with full accrual.  Proponents of a more territorial system want to replace it with exemption of foreign source income.

The reason they can’t agree to get rid of it is that each side hates the other side’s proposed system even more.  So deferral is the boundary line of an enforced political ceasefire in place between armed camps, like the trench lines between the German and Allied forces in World War I.

Deferral originally arose for purely formalistic reasons, via realization doctrine.  If you own GE stock and GE has profits, you don’t personally have taxable income until you get dividends or sell the stock.  But applying this concept to a company and its wholly-owned foreign subsidiaries is just silly.

So in 1962, when the Kennedy Administration proposed repealing deferral, U.S. companies did NOT primarily respond by making formalistic arguments, such as saying the income hasn’t been realized yet.  Instead, they talked policy, saying that the U.S. tax burden on their foreign operations would be too high if we adopted a worldwide system with full accrual.

OK, what’s wrong with deferral?  It’s not that it prevents U.S. companies from getting their hands on cash that they want to invest at home.  I wouldn’t gratuitously insult these companies’ tax directors by falsely suggesting that they are too lame or dense to figure out how to get around the rules.  But once a lot of money is nominally abroad – often, due to profit-shifting games – the tax planning games start getting costly, as Rosanne showed in a recent paper.

In practice, companies may pay less attention to the tax rule as such than to the associated accounting rule, under which all deferred U.S. taxes are a current expense unless you declare that the earnings have been permanently reinvested, in which case the deferred tax expense goes to zero.

You don’t have to know anything about accounting to see what a stupid rule this is – it’s just too discontinuous.  Once companies get the PRE designation, that alone deters taxable repatriations, both to avoid an earnings hit and so the accountants won’t start questioning other claimed PRE.

While simply bad considered in itself, deferral also has important effects at two completely distinct margins.  First, in practice it effectively lowers the U.S. tax burden on U.S. companies’ foreign earnings.  This could be good or bad, depending on how the actual effective rate that U.S. companies face compares to the optimal effective rate, all things considered.  That is an issue on which serious people disagree. 

Second, deferral makes the allowance of foreign tax credits domestically tolerable, rather than intolerable.  Under a worldwide / foreign tax credit system without deferral, each dollar of foreign tax liability costs domestic companies precisely zero, until the foreign tax credit limit is reached.  But with deferral, U.S. companies generally are foreign tax cost-conscious – which is good, from a U.S. standpoint.

Suppose we adopted a worldwide minimum tax for U.S. companies with full foreign tax credits – unlike the recent Administration proposal, which limited them to 85%.  Even if the rest of the current system remained in place, that would be like partly repealing deferral.  A company that was currently paying zero worldwide would say: Hey, we might as well pay 19% to other countries and still pay zero to the U.S.  Why keep on bothering with all the extra overseas tax planning if it makes no bottom line difference anyway?

At that point, you’d have to ask exactly what the U.S. had accomplished by enacting the minimum tax.  Why should we be glad that other countries are getting more tax revenues from companies with U.S. shareholders?

In sum, it’s a great idea to get rid of deferral – everyone agrees.  But if we do it, we have to think about 3 things.  First, what should be the tax rate on foreign source income?  Definitely not zero, at least not for all foreign source income.  All of the major so-called territorial countries, such as Germany, the U.K. and Japan, agree.  They all have anti-tax haven rules of some kind, which can cause certain foreign source income of resident companies to face a domestic tax.

Second, without deferral and without full territoriality, it’s a big mistake to offer full foreign tax credits, which would eliminate the companies’ zero foreign tax cost-consciousness in certain ranges.  Now, there are ways of taxing foreign source income at a low though positive rate, and not granting full foreign tax credits, that might avoid formally violating any treaties with rules against “double taxation.”

Third, the word is deferral because taxes are just being deferred.  U.S. tax liabilities have been at least hypothetically accruing, and they are even effectively accruing interest as they naturally grow over time.  The most prominent Republican and Democratic international tax reform proposals that would repeal deferral both include a one-time transition tax on prior foreign earnings.  These wouldn’t be unfair retroactive taxes – they’d be fair, anti-windfall taxes.

Now, we can debate how high or low the transition tax should be.  But not imposing it would be a giveaway.  It also would be inefficient.  Companies that anticipated the giveaway would be even more anxious than under present law to avoid any taxable repatriations until the change in law occurred.  So it would be desirable if both parties committed today to enacting a transition tax when and if deferral is finally repealed.

NYU Tax Policy Colloquium, week 5: paper by Linda Sugin

We had a week off from the colloquium last week, as the usual Tuesday was a "legislative Monday" at NYU Law School.  But yesterday we were back in business, discussing Linda Sugin's article, Invisible Taxpayers.

The article discusses tax issues related to standing, and in particular to the difficulty of getting judicial review of IRS decisions that fall outside of the "traditional dyad," i.e., IRS versus taxpayer.

A taxpayer who pays "too much," due to an IRS decision that arguably misinterprets the law, or a legislative rule that arguably is unconstitutional, unmistakably has standing and thus can get it reviewed by the courts

But whenever a taxpayer pays "too little" for the same reasons, others may lack standing, and thus be unable to get it reviewed by the courts, potentially permitting legally incorrect or unconstitutional policies to keep right on going as there is no forum for raising the challenges.

The paper notes up front that we are all fiscally interconnected.  Given the intertemporal budget constraint for all US taxpayers considered together, anytime you pay a dollar less or get a dollar more that's bad for me in a certain sense, and vice versa.

This alone, of course, probably would not make it wise to grant universal standing to challenge others' tax outcomes (e,g., for me to sue the IRS on the ground that it gave GE an unduly favorable advance transfer pricing agreement), even if there were no constitutional restraints based on separation of powers, the need for a proper case or controversy within the ambit of the adversarial system, etc.

But in some instances, third parties may have a stronger claim than this for invoking the judicial process.  For example, consider the Sklar case, which the paper discusses.  Here what happened is the following.  First, the IRS won a favorable Supreme Court ruling (in a case called Hernandez) regarding the non-deductibility of supposedly charitable gifts by Scientologists to their church that arguably were quid pro quos for goods and services.  Second, the IRS decided to unilaterally concede the issue that it had won in the Supreme Court, arguably to call off aggressive harassment of IRS auditors who were attempting to enforce the Hernandez rule.  This meant that people practicing Scientology were arguably getting charitable deductions despite the quid pro quo.  Third, in Sklar itself, Orthodox Jews that their free exercise rights would be violated if the IRS enforced against them rules that it had expressly agreed not to enforce against Scientologists.  Here there literally was standing for the Sklars to contest their own tax liability, but the court arguably declined to give due heed to the issue of equal treatment

More generally, First Amendment rights to equal treatment of different religions are hard to vindicate when the members of one religion are treated unduly favorably, rather than unduly unfavorably (in which they will probably be able to bring a challenge).

In a more recent case, the lamentable ACS v. Winn, the Supreme Court held as follows  Even if it is unconstitutional for a state to fund people's private religious school tuition directly, the very same policy is beyond judicial review if the state instead provides a 100% tax credit for such tuition.  This rested on a childishly - though probably deliberately - naive view of clearcut tax expenditures as mere "inaction" from not taxing, whereas direct spending is reviewable stat "action."

One could say a lot more about why this is so wrongheaded a view.  Treating clearcut tax expenditures as equivalent to direct outlays does NOT rest on some notion that your money belongs to the government whether they tax it or not. I have addressed this canard, for example, here.  And you don't need to be a constitutional lawyer to realize that it is idiotic to permit constitutional requirements to be evaded through purely nominal changes in form.  (The question of whether direct outlays for religious school tuition should generally be unconstitutional is separate.  But if one views this as unconstitutional, it's unconscionable to let states dodge the rule by playing silly semantic games.)

It's easy to conclude that ACS v. Winn was wrongly decided, and that the Supreme Court should have treated that particular state program exactly as they would have treated a direct outlay.  Other issues involving tax expenditures might, admittedly, be more ambiguous, since the category doesn't have absolutely clear boundaries.  But that is certainly something that the courts could deal with.

With regard to "invisible' taxpayer issues more generally, I would say that one needs a theory of standing.  Why limit it, given that there may be social value to having ambiguous legal issues addressed publicly by the courts, and to correcting misinterpretations of the law and instances of unconstitutional decision-making.  Presumably, the values on the other side of the ledger include not just avoiding over-burdening of the courts, but also upholding the bona fide adversarial structure (if one thinks it is a good thing) and perhaps limiting the courts' ability to throw their weight around, even when they can at least claim to be merely performing their normal interpretive function.

Despite those concerns, it is plausible that current standing doctrine is far too narrow in some settings.  One could argue, for example, for more regularly granting standing based on equal treatment claims that have a specific constitutional basis (e.g., pertaining to religion or race).

Suppose Congress enacted a s"White People's Tax Credit," offering white people a tax credit that equaled $X outright, or say a 100% credit for food outlays up to $X.  Could this be challenged in court under current standing doctrine?  White taxpayers wouldn't have standing to challenge it since they are the direct fiscal beneficiaries, and other taxpayers would  face doctrinal and precedential impediments to their being allowed to challenge it.

I find it hard to believe that the provision wouldn't be somehow reviewable and struck down.  But apparently those who have read the relevant case law carefully (in particular, ACS v, Winn, along with various cases denying taxpayer standing) don't universally share my perhaps naive confidence on this point.

Current projects list

For some reason, the embarrassing weakness of the badly over-written yet under-baked The Godfather, Part III, (despite a great plot idea: ruthless American gangster finds that he's out of his league dealing with sharpies from the Vatican) has not prevented its most famous quote from being widely remembered: "Just when I thought I was out, they pull me back in."

My version of this quote would be: "Just when I think I'm starting to run out of ideas to write about, they give me new ones."  For me, of course, it's good rather than bad, and "they" refers to people who are holding conferences, compiling edited volumes, etc.

My main project these days is writing a book on the super-rich in selected works of literature (great and otherwise) from the last two centuries.  Tentative title: "Visions and the Versions of the Point-One Percent."  However, I don't think this title quite captures what the project is actually about, so I am probably going to feel compelled to change it.

This book, which I am quite enthusiastic about and finding fun to write when I can find the time, is a byproduct of the Piketty conference that we held at NYU last October, and of the paper for that conference that I co-authored with Joe Bankman.

Due to further conference and book invites, I'm probably also going to write short papers on:

(1) How the framework that I develop in my book on international tax policy suggests thinking about recent developments in the international tax field (e.g., OECD BEPS, the UK Google tax, and recent US international tax reform proposals).  Tentative title: "Getting a 'Fix' on Recent Developments in International Tax Policy."  Play on words here, since "Fixing" is the first word of my book title.

(2) The current US practice, which no other country follows, of imposing at least some degree of worldwide income taxation on nonresident citizens.

(3) For a book (without conference) that will consist of invited articles discussing timing and legislation from various perspectives, I have a piece in mind that's tentatively called "On Beyond Indexing."

(4) I may also take a chapter from my book-in-progress on the super-rich in literature, and use it aas a standalone piece (for a conference on tax & philosophy), entitled something like "The Social Sciences and Beyond in Evaluating High-End Wealth Inequality."  Inside the book, this chapter serves to explain the possible relevance of reading literature to how one might think about the issues raised by high-end wealth inequality.  But this makes it potentially suitable for separate use as a standalone piece on how to frame the relevant normative issues. E,g., what do conventional economic approaches leave out.

I suppose all this should keep me off the streets (and often on the road), for the rest of 2015 and probably well into 2016.

Lee Sheppard at NYU Law School

Today Lee Sheppard appeared at NYU Law School to give a talk on a paper that she is writing - evidently not intended to be a Tax Notes column - entitled "Beyond Tax Avoidance: Managing Multinationals' Tax and Contractual Relationships With Developing Countries."

The session had excellent comments from Rebecca Kysar and Michael Schler.  But as usual, I view the session as having been off-the-record, and hence I can't comment specifically here about any of the speakers' comments, as opposed to the issues that Lee addresses in the paper.

The underlying idea that Lee's paper expresses is that, while the developed countries have their own set of issues with multinationals (MNEs) that they are dealing with (or not) through the OECD BEPS initiative and the like, developing countries have their own set of problems.  But these aren't confined to tax.  For example, a country with mineral wealth that MNEs want to extract and sell on world markets really needn't care whether it's getting better royalties or more taxes paid to it out of the deal - leaving aside the fact that the taxes may qualify for home country foreign tax credits (a point that I of course have elsewhere emphasized from a developed country perspective).

Lee's paper urges developing countries to consider capital controls, cherry-pick good tax base protection ideas from the OECD, verify mineral extraction quantities that determine royalties due, and be smart / only sign good contracts to begin with.

It further argues that developing countries should not: sign OECD model tax treaties, sign US model bilateral trade agreements, sign treaties with tax havens, sign arbitration clauses (at least if the arbitrators are likely to be biased), borrow from the IMF, or listen to economists.  It suggests that economists not only are sometimes being paid by big companies, but are too anti-tax and too blind to the downsides of free trade ideology (recall, for example, the rise and fall of the 1990s "Washington consensus").

This critique of economists is similar to what Joe Stiglitz or Paul Krugman, themselves economists, might say.  Note also that the IMF, or at least its staff, has recently changed course on questions such as whether austerity makes any sense these days.  And while economists may often be anti-capital controls, consider that decades ago James Tobin wrote about the dangers small countries face from rapid, speculation-driven global capital flows, Jagdish Bhagwati has more recently been writing about this.

 The core issue, from the standpoint of developing countries that encounter MNEs that want to engage in inbound activity of some kind, is how much market power the countries have.  Despite global economic forces, the paper suggests that these countries - even when short of the scale of China, India, and Brazil, which stand up for their own economic interests quite effectively - often have more market power than they apparently realize or have exercised.  E.g., if you have a national sales market or workforce or natural resources that the companies want to tap, that is worth something.

Now, part of the question goes to such countries' ability to arrange cooperation among themselves, rather than competing to mutual detriment in a prisoner's dilemma scenario.  But the paper suggests that, to a considerable extent, ignorance, naivete, and misplaced trust in outside professionals or experts have led developing countries to demand less than they have the power to extract.  And you don't have to be a non-economist or anti-economist to agree that, if this critique is correct,then developing countries would benefit from addressing it.

The Monty Hall problem: bungling probability theory versus engaging in strategic thinking

When the Monty Hall problem was first brought to my attention a few years ago, I didn't get it right either.

But here's the thing: perhaps because I hadn't seen the show for decades, or else because I was taking the reference to Monty too literally, I was thinking about him as a strategic player who wants to trick you, because it's fun for the TV audience to laugh at you as they play that "wah-wah-wah-wah" music once you've switched from the new car to the smelly goat (or whatever).

So I figured, he is more likely to show you a door that is the wrong answer, and then to ask you if you want to switch to the third door, if the door you initially picked was the right one.  Hence I hadn't accepted the (often unstated) premise of the Monty Hall problem, which is that, no matter what, he will show you a door that is the wrong one.

Once you introduce the possibility of situation-specific strategic play by Monty, rather than his doing the same thing every time, there is no right answer to the puzzle until we know more about his decision function.

This causes me to think of the Monty Hall problem as demonstrating, not just our difficulties in thinking clearly about probability theory, but also our inclination for strategic thinking (and imputing it to others).  That surely is highly adaptive as a general matter, whereas tending to bungle probability theory is presumably more about heuristics and cognitive shortcuts.

Very sad news (re. Marvin Chirelstein)

I was greatly saddened to hear today of the death of Marvin Chirelstein.  Marvin was my tax (and Corporate Finance) professor at Yale Law School back in the day – I never took a course with Bittker, who was reputed to dislike having to deal with students’ vastly lesser state of intellectual attainment (both in tax and generally) than his own.

My intellectual inspiration in tax didn’t really come from Marvin – mainly through my own fault; at that stage I wasn’t very receptive to the Yale law professors’ intellectual interests.  Combination of burnout (I had gone straight through from nursery school to law school without a break) with disdain, at that callow stage in my personal development, for non-Ph.D. academic disciplines (I had planned until late junior year to go to history grad school).  But he had very few peers at the time in tax law scholarship.

Marvin was, however, by far my favorite professor at YLS.  I (along with all of my best friends among the students there) admired his humor, personality, and panache as a performer (if panache, rather than anti-panache, is the word for his brilliantly low-key comic style).  We all thought he was extremely cool - not an accolade that we extended, at the time, to many YLS faculty members, or, for that matter, to many people who were older than, say, John Lennon and Bob Dylan.

Word had it that he had been associated with the people in the Second City Theater Group in Chicago during the Nichols and May era, but didn’t formally join the troupe due to stage fright.  I honestly don’t know if that was true.  But he used to pace around nervously before class, sucking on a cigarette and narrowing his eyes, very much in his own head like a performer getting ready.  And, true or not, it was credible, because he was so hilarious in his distinctive style.  I thought of him, at the time, as a combination of Humphrey Bogart and Rodney Dangerfield.  I might now add, also with a touch of Stephen Wright.

Here is another story I heard about Marvin at the time, which I doubted was true but actually did later confirm.  Supposedly, when he was a student at the University of Chicago Law School, taking tax with my own subsequent mentor Walter Blum, two things became clear to Walter.  The first was that Marvin was intellectually gifted, and the other was that he was cutting a lot of classes, apparently because he detested the early morning meeting time.  Walter called Marvin into his office to discuss this, and Marvin made him the following offer: “How about you let me attend or not as I see fit, and if I get at least an A- on the exam you give me an A, but if I don’t, you fail me / lower my grade to a C” [I forget which].  I assumed that this story couldn’t actually be true, but when I asked Walter about it years later, he confirmed it.

Here are a few examples of Marvin’s comic style in class.  Disclaimer: You had to be there, it was a totally personal style that worked via his delivery and the character he played.

1) Marvin: “Feldman, this case says something about ‘old and cold.’  What’s the opposite of ‘old and cold’?

Student: “Uh, hot and fresh?”

Marvin.  “Hot and fresh … hot and fresh … I would have said young and warm.  Shame on you, Feldman.  You’re thinking about bagels.”

2) Student in the back: “Can you speak up?  We can’t hear you.”

Marvin: “Sometimes people don’t speak softly because they’re unaware.  Sometimes it’s because they’re so ashamed of what they’re saying.”

3) [To a student]: “Would you be able to defend this transaction?  … For a fee, of course.”

4) [Discussing a case that was decided in 1935.]  “Ah, 1935.  The best year of my life.  The Cubs won the pennant, and a boxer from my hometown became middleweight champion.”  He followed this with a toneless little laugh.  What made this funny, to Chirelstein aficionados such as myself, was the implicit suggestion that the point wasn’t that these things were so great, but rather that the rest of his life was so completely lacking in anything better.  But I should note that we didn’t think he was actually unhappy - rather, it was the character he played, like Jack Benny pretending to be cheap.  Indeed, if anything we figured he had to be confident and secure in his life, in order to be willing to pretend that he felt pathetic.

5) [Explaining why he wasn’t using Bittker’s casebook, in a year when Bittker was on leave and out of town.]  “He’ll never know.  He’s currently sailing down the Nile with a rose between his teeth.”

Whenever I saw Marvin in subsequent years, he would make a point of commenting on how awful my handwriting was on the exams I took in his classes.  He complained that it had permanently worsened his vision, and that surely I must have a physiological problem.  He also called me “young Shaviro,” well past the point when it was descriptively accurate.  And he would complain that I was publishing too much, pretending to demand that I stop so he wouldn’t look bad.

Early in my time at the University of Chicago Law School, I got a handwritten card from Marvin in which he suggested that I visit Columbia Law School.  He assured me that the head of the Appointments Committee, “Smiling Jack Coffee,” would be happy to extend a visiting offer.  Why not try New York, he wrote.  It has crime, dirt, and vermin – what more could you want? 

I’ll greatly miss Marvin Chirelstein, a brilliant and wonderful man whom I admired and wish I could see again.

NYC Tax Policy Colloquium, week 4: paper by Eric Toder et al

Yesterday, we had our Week 4 session at the Colloquium, featuring Eric Toder’s Lessons the United States Can Learn From Other Countries’Territorial Systems for Taxing Income of Multinational Corporations (co-authored by Rosanne Altshuler and Stephen Shay).  The following is an expanded version of a much shorter outline that I prepared to guide my portion of the discussion.

1.  International tax policy at a crossroads

(a) International tax policy is arguably at a crossroads.  It has been there for a while, and may stay there for a while.  But changes on the ground have important implications for current regime’s workability.  This comes from 2 related but distinct types of changes: rising actual global capital mobility, and advances in tax planning technology that create greater mobility for reported income, even if just from paper-shuffling.  The latter reflects not just ongoing innovation by tax planners, but also rule changes – e.g., U.S. adoption of check-the-box rules and these rules’ disregard of transparent single-owner entities (leading to the effective quasi-repeal of our CFC rules).  All this has fueled the newspaper headlines we see about Apple, Google, GE, corporate inversions, etc.  It also has influenced the U.K. & Japan to change their international tax systems in ways that have been described as replacing “worldwide” systems with “territorial” ones.

(b) Many argue that the U.S. should do this too.  But there has also been pushback, as per calls in the U.S. for tougher rules and the OECD BEPS initiative.  Overall, our options could be classified as “retreat” versus “advance” versus “do something different entirely” (such as replacing the corporate income tax, and/or the entire U.S. tax system, with something very different – there are several alternatives that would eliminate the current dilemmas of international tax policy, which rest on the problems associated with entity-level income taxation).

(c) The paper’s main takeaways are twofold.  First, the “worldwide vs. territorial” framework is not a useful way of describing our choices.  Second, a simplistic narrative holding that the U.S. must become territorial because otherwise we will be “out-of-step” is wrong on two grounds: in some respects we aren’t actually that out-of-step, and neither Japan’s nor the U.K.’s reasons for adopting changes apply to us.

2.  What’s wrong with the “worldwide versus territorial” framework?

(a) As I discuss at length in my 2014 book, Fixing U.S. International Taxation, this is not a well-posed choice, because it conflates 2 distinct margins.  The first is what tax rate a given country applies to resident companies’ foreign source income (FSI).  The second is what marginal reimbursement rate (MRR) the country offers with respect to resident companies’ foreign income tax liabilities.

(b) Statutory tax rate on FSI: It’s often assumed that this must either be the same as the domestic rate (under “worldwide”) or else zero (under “territorial”).  Refreshingly widening the options, however, the Obama Administration recently proposed a 19% tax rate on resident companies’ FSI.

(c) MRR: In a worldwide system without foreign tax credit limits and without deferral (which I discuss below) the MRR is 100%, thus completely eliminating resident companies’ foreign tax cost-consciousness. A territorial or exemption system provides implicit deductibility of foreign taxes, in that the MRR equals the marginal tax rate or MTR, inducing resident companies to seek to maximize after-foreign-tax foreign income.

(d) In Fixing, I argue that, assuming our distortionary system for taxing business income will generally remain in place, an intermediate tax rate on FSI (i.e., between zero and the full domestic rate) is likely to be optimal if we have some market power over corporate residence.  The MRR should equal the MTR – the deductibility result – if (i) there is no reciprocity (e.g., we aren’t agreeing with other countries to credit each other’s taxes – and we aren’t if they are generally territorial AND (ii) there are no other issues to consider here.  As I discuss below, it’s plausible that there are other issues, supporting better-than-deductible (albeit worse-than-creditable) treatment for foreign taxes in the tax that the MRR should actually exceed the MTR, at least in certain settings.  But even so, the MRR shouldn’t be 100%.  When I wrote Fixing, I was concerned that this might require violating bilateral tax treaties (which address “double taxation”), albeit not actually to the disadvantage of other countries, relative to treaty-compliant things that we could do.  But since then, both the Baucus staff tax reform plan and the recent Obama Administration budget proposal have shown how one might be able to combine an intermediate rate for FSI with an intermediate MRR, without formally violating the anti-“double tax” requirement of our tax treaties.

(e) Toder et al Case Study, point 1: So-called “territorial” countries do indeed tax certain FSI of their corporate residents, in particular if it is passive income or associated with tax havens.  (These are effectively the same thing, as passive income tends to show up in tax havens.)   Such countries may also have tougher rules for the U.S. for defining domestic source income.  In practice, this can have very similar effects to taxing FSI that shows up in tax havens, especially if the tougher source rules apply distinctively to resident companies.

(f) Toder et al Case Study, point 2: Widespread anti-tax haven rules, yielding a positive tax rate on certain FSI of resident companies, effectively extend better-than-deductible treatment to foreign tax liability.  After all, a company that reduces its foreign tax liabilities by shifting income to tax havens ends up paying more domestic tax, effectively causing the extra foreign taxes that one pays by reason of not going to tax havens (and thus not incurring domestic tax liability) to be better-than-deductible at the margin.

3.  Deferral

(a) As is well known, deferral for FSI that is earned through one’s CFCs does not lower the present value of the deferred taxes under new view assumptions, which are twofold: (i) there is permanently fixed repatriation tax rate that will be paid at some point, (ii) convergence of all the after-tax rates of return one might earn, even with different source-based tax rates.  But the first of these assumptions clearly does not hold in practice, and the second may not either.

(b) Under new view assumptions plus a couple of extra ones (including the inapplicability of foreign tax credit limits), deferral does not reduce the 100% MRR that a “worldwide” system offers via foreign tax credits.  However, once we recognize that the new view assumptions do not generally hold in practice, deferral may and does lower effective MRRs, pushing towards (and possibly even all the way to) a deductibility result.

(c) For this reason, repealing or reducing deferral in favor of a more accrual-style worldwide system requires rethinking foreign tax credits.  The Obama Administration apparently recognized this.  Their 19 percent “minimum tax” proposal would have led U.S. companies to face zero after-tax cost from increasing their foreign tax liabilities, say, from 0 percent to 19 percent of FSI, if not for the fact that the proposal offers what are only, in effect, 85 percent foreign tax credits (i.e., a dollar of foreign tax liability effectively reduces one’s U.S. tax liability, within the range of potential application, by only 85 cents).

(c) Toder et al Case Study, point 1: Why did the U.K. & Japan even bother to go territorial?  After all, their deferral rules were so weak – since the domestic parent could borrow from CFCs without its being treated as a taxable repatriation – that it is unclear why the companies even cared.  I think an important part of the answer is that making the systems (more) territorial served as protection against possible tightening of the existing rules.

(d) Toder et al Case Study, point 2: As noted in the paper, the burden of avoiding the repatriation tax is much higher for U.S. firms than it was for U.K. and Japanese firms, recently estimated as akin to a 7% tax rate albeit taking the form of deadweight loss rather than U.S. revenue-raising.  This helps to explain U.S. inversions and support for territoriality?  Is this a helpful “friction” in any way?  The “yes” argument would hold that it deters U.S. companies from engaging in even more profit-shifting to the detriment of the U.S. domestic tax base. 

(e) The fact that U.S. companies have deferred tax on more than $2 trillion of foreign earnings provides strong grounds in favor of enacting a “transition tax” if the repatriation tax is eliminated, whether by a shift towards territoriality or an accrual-based worldwide system.  There is some bipartisan support for this.  For example, both the Camp plan and the Obama Administration’s budget proposals provide transition taxes, although the latter has a higher rate than the former.

4.  The paper’s response to claims that the U.S. is “out-of-step” unless it adopts a territorial system

(a) Despite our system’s distinctive (and often ill-chosen) features, we are not out-of-step if “territorial” countries are actually similar.  Apparently, one thing that German CFOs and company tax directors have in common with their American counterparts is that each group is convinced that its home country international tax system is the more rigorous of the two, thus placing their companies at a competitive disadvantage relative to the other country’s companies.

(b) Japan and the U.K. don’t offer us much in the way of relevant lessons.  Japan’s system appears to operate very differently than ours – for example, the companies are far less willing to engage in aggressive tax planning.  It’s very plausible that this has less to do with cultural differences (other than peer pressure that can support either equilibrium) than with Japanese firms’ having more reason to want to please government counter-parties, and also facing worse prospects if they try litigation.  Also, the Japanese government seems to have thought that formally eliminating the already trivial repatriation tax would help counter economic stagnation and recession.  This was not convincing as a matter of economic theory – especially given how easy it was to repatriate funds tax-free.  As for the U.K., its being a small island nation and one that was severely constrained by the European Court of Justice put it under pressures that the U.S. does not currently face to the same degree.

(c) Admittedly, one can’t do a case study of the future.  The paper agrees that competitive pressures on the ability of the U.S. to depart from international norms (insofar as it is even doing so) seem likely to increase over time.

5.  Conclusions

(a) Ought we to broaden the menu of choices? Australia’s full-imputation approach to shareholder-level taxation, the Toder-Viard plan to replace the corporate income tax with a shareholder-level mark-to-market tax, the Auerbach plan to replace the corporate income tax with a destination-based VAT-style approach, and progressive consumption tax models such as the X-tax, would eliminate certain of the dilemmas that one inevitably faces when engaged in entity-level corporate income taxation.

 (b) Assuming that we retain entity-level corporate income taxation , I would say that the approach I advocated in Fixing – involving an intermediate tax rate on FSI, an intermediate MRR, and the repeal of deferral – is looking pretty good, and has been gaining support, as reflected by the embrace of all three of these concepts in recent proposals by the Senate Finance Committee majority staff (under Senator Baucus) and the Obama Administration.

Addressing inequality from the right?

At least since the 2012 presidential campaign, when I periodically discussed the Romney candidacy, I have generally stayed away from partisan politics.  "A plague on both your houses" is my preferred stance, reflecting that I understand the imperatives of politics will lead people (even when of good faith) away from being able to consider consistently adopting analyses or policies based purely on their actual merits.

But my distress over the turn Republicans have often taken since 1994 (although I didn't really get distressed about it until about 2002) risks leading me into rants if I pay too close attention to daily politics, even though I am no more thrilled about the Democrats than, say, Bruce Bartlett is.  This not only strikes the wrong tone but can lead me astray.  I have been told, for example, that sitting here in New York (outside the Washington circle of debate, and also not knowing a whole lot of Republicans in NYC, as there aren't many) I have viewed the party as more monolithic than it actually is.  (Yes, I am aware of the Tea Party vs. the establishment, but if the establishment is Boehner, McConnell, and Ryan, that doesn't do much for me.)

It's of interest, therefore, to see the newfound discussion of inequality - both high-end and low-end, which I regard as distinct phenomena - among Republicans.  Now, when Romney or Ryan does it, I am inclined to dismiss it as just a cynical rhetorical ploy.  I assume that what Romney (like Ryan) wanted to do for the poor, had he graced us with a third presidential campaign, was simply to take away all their benefits, on the theory that this would force them to straighten up and fly right.  And I would assume that both of those individuals are not just unworried by, but fervent supporters of, rising plutocracy.

But then there's Senator Mike Lee.  I really don't know enough about him to comment knowledgeably.  And I note that he is identified with the Tea Party, which I'll admit to not regarding as a recommendation.  But I'm also aware that he recently proposed a tax reform plan that, while surely not perfect - for example, it lost a lot of revenue - offered lots more aid at the bottom and retained a 35 percent rate at the top.

And here are some quotes from Mike Lee, courtesy of a column in today's New York Times by Thomas Edsall:

"Today, the United States is beset by a crisis in inequality .... The underprivileged are trapped in poverty, sometimes for generations ....  At the top of our society, we find political and economic elites increasingly exempted and insulated by law from the rigors of competition and the consequences of their own mistakes."

Joe Stiglitz, I think, would agree.

Likewise, Edsall notes self-styled "reformicons" such as Reihan Salam, who has argued that "a well-designed safety net and high-quality public services are essential parts of making entrepreneurial capitalism work."

I am still extremely skeptical that a post-2016 Republican government (e.g., if they win the White House while keeping both branches of Congress) would follow policies outside of the Romney-Ryan playbook.  But then again, Hillary Clinton, according to Larry Summers, apparently believes that the most important thing, when addressing inequality, is to avoid embracing a "politics of envy."  When you start there, one can kind of guess where you are going to end up.

An interesting fact that became clear to me a couple of years ago, when I wrote an article on Henry Simons, is how free market viewpoints can be consistent with surprisingly egalitarian preferences - at least, when shorn of arrogant and anxious Ayn Randian chest-beating about Success and hatred of those who fail.  Simons, as I discuss in the piece, was a self-proclaimed libertarian and "extreme conservative" - and a close ally of Hayek - who endorsed "drastic progression" in income tax rates because (as I put it) he "viewed concentrated economic and political power as ugly and offensive, and... thought no group, profession, or class should be allowed too much superiority or sway in either realm."

Simons thus took a "horizontal, or even a leveling, vision of both economic and political power. He [did] not like plutocrats rising far above the peasants (even if the latter, as a formal legal matter, are entirely free), any more than he like[d] Washington bureaucrats telling private economic actors what to do."

I further asked: "Is this 'liberal' in the classical sense [and thus conservative in modern terms]? That depends on how one defines the tradition. In any event, however, emotionally no less than intellectually, it is certainly no Ayn Rand or Paul Ryan version of the laissez-faire creed. Simons does not yearn for a world in which the great are permitted to thrive, but for one in which the small do not have anyone too far above them, either politically or economically."

My aim here is not to discuss the merits of Simons' views, but simply to note the existence at one time of a self-styled libertarian, classical liberal, "extreme conservative" viewpoint that could very interestingly mix things up, both politically and ideologically, if it regained any purchase on the right.

Comments on Eugene Steuerle's new book

Today Eugene Steuerle came to the law school for a discussion of his new book, Dead Men Ruling: How to Restore Fiscal Freedom and Rescue Our Future.  I was the designated commentator.

As a long-time admirer of Steuerle, from his work on 1986 tax reform through his writings over the last few decades, I was delighted to see him, and to get to discuss his book.  I am in considerable agreement with his analysis, but more regarding what I called the "treatment" than the "diagnosis."  That is, while we have large areas of agreement regarding how the current path of taxes and spending should change, I didn't view the issue that he calls "fiscal democracy" (relating to the default path of federal taxes and spending from laws on the books) as being as important as defects in our substantive politics.

A pdf version of my Powerpoint slides is available here.