Monday, July 28, 2014

Understanding and responding to corporate inversions

The last few days have seen a flurry of discussion about corporate inversions.  Examples include this Washington Post op-ed by Treasury Secretary Jacob Lew, and today’s NYT op-ed by Paul Krugman.

Corporate inversions are transactions in which a U.S. multinational transmutes itself into a foreign multinational by arranging to convert the U.S. entity into a mere subsidiary, rather than the company at the top of the chain.  Meanwhile, in such a deal, the internal corporate structure is rearranged so that any foreign affiliates that previously were subsidiaries of the U.S. company become instead its lateral siblings.  They are owned by the new foreign parent, and hence are outside any U.S. chain of ownership.

At the end of the day in an inversion, there is still a U.S. company conducting U.S. operations.  But there are two big changes on the ground.  First, unrepatriated foreign earnings of the foreign affiliates no longer face the threat of U.S. tax upon repatriation to the U.S. parent (since there is no U.S. parent).  In theory, the repatriation tax is merely being deferred while the money stays abroad.  And deferral does nothing to reduce the present value of the expected repatriation tax if it is certain to be incurred eventually and if the U.S. repatriation tax rate will always be the same.  But with an inversion, the company wages its magic wand and presto, the deferred tax completely disappears.  This not only causes a seemingly fixed tax burden (in present value terms) to disappear, but makes it a lot easier for the company to play around with retained earnings however it deems best, instead of needing to jump through hoops to keep deferral going.  (By the way, the fact that they are willing to jump through hoops to keep deferral going shows how unrealistic it is to base analysis of deferral on the assumption that repatriation is inevitable at some point at the currently applicable repatriation tax rate.)

Second, it becomes vastly easier to reduce taxes on one’s U.S operations once the U.S. company is merely a subsidiary rather than a corporate parent.  For example, the use of both intra-company and third-party debt to strip earnings out of the U.S. and make sure they will show up elsewhere instead can be a highly effective tax planning strategy post-inversion.  Pre-inversion, the use of intra-company debt to do this generally doesn’t work well at all (since it triggers passive income, currently taxable in the U.S., from the foreign affiliate that lends to the U.S. company), and loading third-party debt into the U.S. company can also fail to pay off due to our interest allocation rules.  For a fuller account, see Stephen Shay’s article in today’s Tax Notes.

An earlier flurry of inversions was shut down by the 2004 enactment of an anti-inversion statute in 2004 that basically prevents pure paper-shuffling transactions from working, as in the case where a U.S. company creates a Caymans affiliate that emerges at the end of the day as the parent on top even though nothing substantive has actually happened.  But the rules are now being beaten by transactions that have just enough economic substance to work - e.g., where there is an actual acquisition or merger of some kind, with an actual company located in a country where the U.S. group had some prior activity, but the whole thing is still in fact highly tax-influenced.  So the Obama Administration has been calling for legislation to address these transactions and prevent them from being tax-effective.

Yesterday I was on Arise TV, an Africa-based international news and entertainment station, to discuss inversions for a few minutes on a news show.  The host wanted to address whether inversions are immoral.  My response was, that’s not a very useful way to think about the problem.  Companies are going to do what they do (although it’s true that I myself would feel bad about spending my time doing this sort of deal), and the important thing is that we have rules in place that lead to the results we want.  More on what I mean by that in a moment.

But inevitably moralistic vocabulary is going to be a part of these discussions.  In 2004 there was talk of “corporate Benedict Arnolds,” and President Obama has been speaking of “corporate deserters.”  This is pretty much how discussion needs to proceed in general public debate if one accepts – as I do – the bottom line conclusion that allowing the transactions to be tax-effective is undesirable.

As summarized by Treasury Secretary Lew, the proposed legislation would cause inversions to be ineffective for tax purposes if the multinational company “is still managed and controlled in the United States, does a significant amount of its business here and does not do a significant amount of its business in the country it claims as its new home ….  [In addition, t]o make sure the merged company is not merely masquerading as a non-U.S. company, shareholders of the foreign company [that ostensibly acquired the U.S. company] would have to own at least 50 percent of the newly merged company – the current legal standard requires only 20 percent.”

I support this legislation because I see no reason why we should let it so be easy for U.S. companies to avoid the repatriation tax that ostensibly has merely been deferred, and because I also see no reason to make it easier for them to strip away U.S. earnings.  But the fact that these are the two problems has three broader implications worth noting here.

First, Congress should consider enacting an “exit tax” when U.S. companies with unrepatriated foreign earnings cease to be U.S. companies – even in deals that would pass muster under the new proposed legislation.  The exit tax could be based on the amount of U.S. tax that the company would have paid had it repatriated all of its earnings just before the change in legal status occurred.  Then deferral for foreign earnings would truly be just deferral, at least so far as this particular escape hatch was concerned.  Under the simplest version, the tax due would be the amount of unrepatriated foreign earnings times the U.S. corporate tax, minus the amount of tax reduction that would have resulted from claiming foreign tax credits.  But one could also consider other approaches, such as providing “rough justice” in the form of a lower tax rate in lieu of counting up all the credits.

Second, so far as stripping income out of the U.S. tax base is concerned, it would be desirable to move towards having “residence-neutral” rules that applied similarly to U.S. and foreign multinationals.  In particular, there ought to be ongoing multilateral discussion (such as through the OECD) of causing information from the entire global corporate group to be available to countries that merely host subsidiaries, rather than the parents.  This, for example, would permit the U.S. to apply interest allocation rules neutrally as between U.S. and foreign multinationals, for purposes of measuring U.S. source income.

Third, in the tax policy literature, we ought to be operating from realistic, rather than unrealistic, assumptions.  I noted above that deferral does nothing to reduce the present value of the expected repatriation tax if it is certain to be incurred eventually and if the U.S. repatriation tax rate will always be the same.  The reason is that, with further standard assumptions, the amount of tax ultimately due grows at the discount rate, so its present value stays the same.

It’s important for people who are working in the field to understand this point, which often is called the “new view” of dividend repatriations but is in fact a provable theorem (aka a tautology) under the requisite assumptions.  But what they should NOT do is assume that the assumptions are true.  Inversions raise the issue of the deferred tax simply disappearing.  But consider as well the fact that the U.S. could change the repatriation tax rate – for example, by lowering it to zero through the adoption of a territorial system without enactment of a transition tax, or through the enactment of further tax holidays.  (I say “further” because a dividend tax holiday was enacted in 2004, and there has been lots of discussion of doing it again.)

A better way of framing one’s understanding of deferral is to say that it has option value.  By deferring, one gets the option to benefit from future disappearance of the repatriation tax and/or from a reduction in the repatriation tax rate.  This would be economically valuable even if that rate were as likely to go up as down – which almost surely is not the case, especially given that the company will generally control the timing of repatriations.

Friday, July 25, 2014

Cable TV appearance this Sunday

This Sunday (July 27), I'll be interviewed live, at 4 pm EST or so, on an international TV channel called Arise TV that is viewable domestically on-line (, on Time Warner Cable, and on Verizon Fios (481).  The subject will be corporate inversions to eliminate U.S. resident status, and President Obama's recent call for legislation combating them.

Monday, July 21, 2014

New article draft posted on SSRN

I have just posted a recently completed article draft on SSRN, entitled "Multiple Myopias, Multiple Selves, and the Under-Saving Problem."  It's available here.

It will be appearing in 2015 in volume 47 of the Connecticut Law Review, as the lead article in a special Commentary Issue.  (It will thus be accompanied by two or three papers by people in the field offering comments.)

The abstract goes something like this:

In both public policy debate and the academic literature, there is widespread, though not universal, agreement that millions of Americans are saving too little for their own retirements.  If this is true, we could potentially increase such individuals’ welfare through the adoption of policies that resulted in their saving more.  A key dilemma, however, is that, unless one understands why people are under-saving, it is hard to evaluate the likely responses to or merits of a given policy.
Possible explanations for systematic under-saving include at least the following: (1) na├»ve myopia, (2) sophisticated or self-aware myopia, (3) procrastination, or putting off any active decision because deciding is difficult or stressful, (4) mistake aversion, or not wanting to risk regret of an “active” decision that turns out poorly, and (5) acting as if one had multiple selves with distinct utility functions, causing decisions to depend on which is dominant at a given time.
These causal accounts differ predictively, with regard to how they suggest people subject to them would respond to a given policy.  They also differ diagnostically, with regard to whether the increased saving induced would be by the “right” people (i.e., those whom we believe are under-saving).  Yet they can be hard to tell apart in practice.  What is more, the same individual may be subject to several at once, or to alternative ones at different times.
The alternative explanations for systematic under-saving can have very differing implications for such issues in U.S. public policy debate as the following:
1) Should income tax benefits for retirement saving be reduced or even repealed?
2) Should the U.S. federal income tax be partly or fully replaced by a consumption tax?
3) Should “nudges” such as automatic enrollment be used to increase employee participation in employer-run retirement savings plans?
4) Should Social Security retirement benefits be scaled back for long-term fiscal plans, or alternatively expanded?
5) Should the design of Social Security be changed, such as by making the relationship between payroll taxes paid and benefits received both actually and optically clearer?
            The paper’s aim is not to offer definite answers to any of these questions, but simply to improve understanding of the likely relationship between leading theoretical explanations for under-saving and the above issues.

Tuesday, July 08, 2014

Jotwell post on Piketty book

I have published a very brief essay on Jotwell concerning Thomas Piketty's Capital in the Twenty-First Century.  You  can find it here.

As you can perhaps see from reading it, it's less of an actual response to or full assessment of Piketty's book (unlike, say, Neil Buchanan's Jotwell piece on Piketty, which you can find here), than a preliminary statement of what I actually do want to write about at greater length.  This reflects that I will actually be doing so.  Further details to be available shortly.

Thursday, June 26, 2014

What I'm doing on my summer vacation

Gad, but I love the summer.  First of all there's the weather.  So long as the AC in my house doesn't break, I say bring on the heat.  I like a real summer, and we've had bits of it although at times it's been too cool and wet.  The only thing I really don't like about this time of year is mosquitoes.

The horrible winter and early spring are still exacting their price re. one my favorite parts of the summer - fresh produce at the Union Square Farmers' Market.  Generally you get strawberries by mid-May, then by the start of June it goes full Technicolor.  Blueberries, red and black raspberries, apricots, soon after that peaches and blackberries, etcetera.  This year is different.  Blueberries and red raspberries were both 2 + weeks late, no black raspberries yet, and apricots and peaches may simply not happen in the Northeast this year.  That's a shame as they're way better than the stuff that gets shipped here from far away.  So I am still waiting for full Technicolor, and may have to wait until June 2015 (assuming the next winter is less awful).

OK, back to the summer positives. Weeks that aren't jammed full with appointments are one nice feature - even leaving aside classes, my calendar is never so open during the rest of the year.  And as it happens my summer travel (in the school calendar sense) has been scheduled just for May and August, so open time yawns in front of me.  But that's a good thing, and I wish there were more.

On the work front, I've just finished a draft of an article entitled "Multiple Myopia, Multiple Selves, and the Under-Saving Problem."  The piece will end up being the headline piece in a spring 2015 "Commentary Issue" of the Connecticut Law Review, where there will also be invited commentators.  I will post a draft of the article in SSRN at some point well before that, but I want to sit on it at least briefly first.  After all, while there are second bites at the apple (aka revisions before publishing), I suspect that the first SSRN draft is the one that gets read by the greatest number of people.

I've now started work on a piece that I will be co-authoring with a friend that addresses Piketty's Capital in the Twenty-First Century.  More on that in due course, including on the underlying event at which we'll be presenting the paper.

In the fall, I'll be writing a short Tax Notes piece for a conference to which I've been invited concerning certain of the perennial tax reform issues that are always on the table.  More on that in due course, after that event has been publicly announced.

And after that, I guess I'll have to see, though there are several possible candidates.  But I don't think I'll be writing much in international tax in the immediate future (as I like doing new things and changing my focus as needed to feel fresh).

Monday, June 23, 2014

Alternative (or complementary) theory to CEO narcissism

In an earlier post, I noted recent corporate governance literature suggesting that narcissist CEOs, who are identified by criteria that include their pay relative to that of other company officials, tend to perform worse in various ways, such as by reason of their taking undue risks.

There's also a recent paper suggesting that high-paid CEOs tend to perform worse than other CEOs through an entirely different mechanism.  According to the abstract:

"CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay.  For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%.  The effect is stronger for CEOs who receive higher incentive pay relative to their peers.  Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as over-investment and value-destroying mergers and acquisitions."

Some are born narcissistic, others achieve narcissism, and yet others have narcissism thrust upon them.  And no doubt, to paraphrase Joseph Heller's line in Catch-22 about Major Major Major and mediocrity, for some CEOs it is all three.

Sunday, June 22, 2014

I let him go right afterwards

Let's hope he's still out there, happily catching mosquitoes.