Thursday, June 30, 2005

Tony Judt in the 7/14/05 New York Review of Books

"[T]here is a precedent in modern Western history for a country whose leader exploits national humiliation and fear to restrict public freedoms; for a government that makes permanent war as a tool of state policy and arranges for the torture of its political enemies; for a ruling class that pursues divisive social goals under the guise of national 'values'; for a culture that asserts its unique destiny and superiority and that worships military prowess; for a political system in which the dominant party manipulates procedural rules and threatens to change the law in order to get its own way; where journalists are intimidated into confessing their errors and made to do public penance. Europeans in particular have experienced such a regime in the recent past and they have a word for it. That word is not 'democracy.'"

Tuesday, June 28, 2005

Tax reform

Reportedly (a little birdie told me), some people more in the know than I am are betting that the Tax Reform Commission will endorse neither the X-tax, which I would favor, nor the Graetz model, on which I’ve made my views clear, but rather will propose making various changes to the current income tax system. Some of the main possible features that I have heard about (plus my comments on them) are as follows:

1) Exemption for capital income plus elimination of interest deductibility. Even if you like consumption taxation, as I do under the right circumstances, impossible to comment on this without seeing exactly how it would be done, as the details are all-important. David Bradford, although a consumption tax advocate, would have classified lots of “capital income” (in the formal sense) as in fact representing returns to work that he wanted to tax. So a key question would be whether the plan’s design worked properly in this regard. Note also that something akin to interest deductibility would remain for home mortgage interest (see #3 below), potentially leading to arbitrage problems. (Borrow more against your home and get a credit, invest the funds and exclude the income.)

2) Replace personal exemptions with a single, unified child tax credit. I would argue that the credit should be made refundable (i.e., allowable even if in excess of current-year income tax liability). Dream on.

3) Replace various itemized deductions, such as those for charitable contributions and home mortgage interest, with percentage credits. In illustration, if these items became 15% credits, a taxpayer with $10,000 of home mortgage interest would save $1,500 of tax no matter what her marginal rate bracket. There often are good arguments for such an approach where the aim of a tax benefit is not income measurement, but something else such as influencing behavior (my NYU colleague Lily Batchelder has work in progress that will discuss this point). The Bradley-Gephardt tax reform bill that helped inspire the Tax Reform Act of 1986 had this feature. Once again, there could be arguments for refundability that I am sure will have to be ignored.

4) A $10,000 cap on the exclusion for employer-provided health insurance. I would once again say: why not a refundable percentage credit (e.g., 15% on health insurance value up to $10,000)? But an important virtue of this proposal, even if not turned into a credit, is that it addresses the incentive to over-insure – an important cause of our country’s growing healthcare crisis – without eliminating the nudge in the direction of having some insurance, which many would argue is socially desirable.

All in all, the plan could certainly be worse – a tribute, perhaps to good people on the Commission and staff, notwithstanding the constraints under which they are operating. But I tend to doubt that it will go anywhere, or that the Democrats will want to have anything to do with it under present political circumstances. Indeed, I would expect them to demagogue even its good features given where we are today after 4-1/2 years of Republican gutter politics.

Why are we in Iraq?

This story was reported recently, but I don't think it's gotten as much attention as it deserves. It describes conversations between President Bush and a family friend:

"Two years before the September 11 attacks, presidential candidate George W. Bush was already talking privately about the political benefits of attacking Iraq, according to his former ghost writer, who held many conversations with then-Texas Governor Bush in preparation for a planned autobiography.

“'He was thinking about invading Iraq in 1999,” said author and journalist Mickey Herskowitz. “It was on his mind. He said to me: ‘One of the keys to being seen as a great leader is to be seen as a commander-in-chief.’ And he said, ‘My father had all this political capital built up when he drove the Iraqis out of Kuwait and he wasted it.’ He said, ‘If I have a chance to invade….if I had that much capital, I’m not going to waste it. I’m going to get everything passed that I want to get passed and I’m going to have a successful presidency.'”

In other words, Bush's reason for the war in Iraq was to build, in his characteristic phrase, his domestic "political capital." This really should rank, in terms of public attention, with the Downing Street memos.

Monday, June 27, 2005

"Smaller government"?

The Roll Call (subscription required) has an article entitled "Republicans Warn MLB on Soros Bid," in which prominent Capital Hill Republicans, including Tom Davis, the Chairman of the Government Reform Committee who hilariously views his committee's subject matter as centering on the baseball steroid issue, warn baseball against allowing a group that includes George Soros to purchase the Washington Nationals even if they are the high bidder:

"Davis, whose panel also oversees District of Columbia issues, said that if a Soros sale went through, 'I don't think it's the Nats that get hurt. I think it's Major League Baseball that gets hurt. They enjoy all sorts of exemptions' from anti-trust laws."

Other leading Republicans suggest additional forms of harassment, including denying funding for a new D.C. baseball stadium that would otherwise have been made available. And, as the Roll Call article helpfully notes, quoting several other prominent Republican Congressmen, there are plenty of other things Congress could do and presumably would.

I'm so glad these guys believe in limited government.

UPDATE: And on the same theme, here is a story about an attempt by House Energy and Commerce Committee chair Joe Barton to threaten and harass scientists for producing a study confirming that there is a global warming problem.

There are thousands of these stories.

Sunday, June 26, 2005

U.S. exceptionalism

If you think about it, this is just amazing:

"The extraordinary decision by an Italian judge to order the arrest of 13 people linked to the Central Intelligence Agency on charges of kidnapping a terrorism suspect here dramatizes a growing rift between American counterterrorism officials and their counterparts in Europe. European counterterrorism officials have pursued a policy of building criminal cases against terrorism suspects through surveillance, wire-taps, detective work and the criminal justice system. The United States, however, has frequently used other means since Sept. 11, 2001, including renditions - abducting terror suspects from foreign countries and transporting them for questioning to third countries, some of which are known to use torture."

The fact that the United States, under the GW Bush Administration, should stand for lawlessness and torture, and against the rule of law that European countries continue to defend, is no small thing. While our foreign policy has, in the past 60 years, included such episodes as CIA assassinations, the Phoenix program in South Vietnam, participation in coups eliminating elected governments, etc., this is a step beyond in a certain sense. We are substituting kidnapping and torture for the rule of law where both are available options, and treating European allies as if they were not legitimate sovereigns whom we need to respect. And I will stick to my comment in an earlier post that, for the Bush Administration, torturing foreign suspects (including innocent ones accidentally included in some broader sweep) is not just a case of the ends justifying the means; to a considerable extent the torture is the end (otherwise why be so indifferent to possible innocence, lack of intelligence value, etc.?)

In terms of why this sort of U.S.-European divergence is taking place, well obviously 9/11 happened here. I was certainly up for torture of al Qaeda people in the days after I witnessed (from a mile away) the WTC attack. And also there is the old argument about the extent of American exceptionalism, sometimes given a positive spin about our leaving Europe behind but also capable of a negative spin that emphasizes the ugly side of American religious fundamentalism.

But a political science-type explanation about institutional structure might have a lot to say as well. I recently heard a talk by a colleague who is in the early stages of a sociological study concerning another recent instance of American exceptionalism - the political rise of the death penalty here, in contrast to its abolition in Europe. The history of the death penalty in the two places is, I gather, pretty much parallel through the point in the late 60s and early 70s when it became a "social issue" here - at first linked to law and order concerns and perhaps, on a symbolic level, the broader social unrest of the era. Now, of course, the death penalty is part of the Jeb Bush-style "culture of life" (save the unborn and brain-dead; kill, torture, and persecute the living).

Why did the death penalty disappear in Europe, however? Apparently public opinion there was as opposed to its abolition as it was here. The difference was that the political elites imposed it on the public there, and none of the competing political forces decided to use it as a wedge issue against the others. In other words, cartelization of the policy process by the elite resulted in forcing an unpopular policy change on the western European countries. (Whether this was good or not depends on what you think about the death penalty and about policymaking more generally. I am just trying to be descriptive here.) In the US, by contrast, while a portion of the political elite wanted to do this, others seized on the issue and forced the retention of the death penalty through democratic politics. At conferences where US and European criminal law types who opposed the death penalty would meet, apparently the latter would tell the former: "Your country is too democratic - that's why you can't do the right thing on this issue.")

If political institutions are the key here, what comes to mind is the difference between parliamentary systems and the US approach, including not just the separate Presidency but primaries, lack of top-down selection of candidates, etc.

Depending on what you think about particular policies, it's possible that the US institutional design is better on some issues and the European design better on others. Going back to the Framers, both too little responsiveness and too much can be a problem.

This post is long enough already, so I will save for a subsequent post my political economy explanation of why US politics has gone so far astray in the last few years. The cause I have in mind is actually unrelated to all this.

Monday, June 20, 2005

Mysteries of the New York Mets

Although I remain a New York Mets fan, as I apparently have no psychic choice, I have now reached the point, as I do nearly every year, where I start rooting for them to lose so that they will not make more insanely self-destructive trades near the trading deadline. Since I am scarcely alone in viewing the Mets management this way – the entire vast army of Mets bloggers has the same view, and is proven right, while the management is repeatedly proven wrong, year after year after year - we have a puzzle on our hands, related to the “Moneyball” puzzles that have attracted much attention (including in the legal academy) lately. The question is why baseball owners, who have strong incentives to act rationally in terms of winning cost-effectively, are usually so much stupider than interested fans.

Briefly on the Mets, taking their set of player contracts as given, they have good reason to want to win. But while they treat their best pitcher (Martinez) as their #1, their second best pitcher (Heilman) is used strictly in mop-up situations where the game appears to be out of hand, even though he has a streak of shutout innings that’s been going on for several weeks. Their third best pitcher (Seo) is in the minor leagues. Yesterday, their philosophy of doing this was really tested, when they put Heilman in a game they were losing 6-1, but then scored 4 runs to make it close. Not to worry; manager Willie Randolph was equal to the challenge. He pulled Heilman and put in the team’s worst pitcher (DeJean), who promptly gave up 4 runs to put the game out of reach. It’s a good thing that pitchers who have been removed aren’t allowed back in, or Randolph might have reinserted Heilman once the game was safely out of reach. Meanwhile, he bats his best hitter (Wright) seventh, and has been quite vocal at times about his eagerness to bat Wright eighth. The reason for this, he says, is that Wright is still young and needs to earn a higher spot. (Never mind that in about a full season he has vastly outperformed everyone else on the team.) Meanwhile, the equally young Reyes is kept for months in the lead-off spot (he has finally been dropped to #2), notwithstanding that he has the lowest on-base average on the team and that on-base average is vital at the top of the order.

A couple of broader Mets-related (but not just Mets-related) mysteries are the following. One reason so many New York teams are persistently bad is that they are wildly impatient and grab at fading big names for too much money. They refuse to take the short-term hit and rebuild. The reason for this, we always hear, is that the New York fans are too impatient; you can’t make them wait. Leave aside for the moment that actually the New York fans, so far as I can tell, continually lament their teams’ not rebuilding properly. Taking it from a rational choice standpoint, the claim is that you need to have a higher discount rate in New York than, say, San Diego because success this year is more important and valuable. But if success NEXT year and the year after is also more important and more valuable, then the discount rate for owners in the two cities should be the same. The only explanation I can see is that myopia and hyperbolic discounting are harder to resist when the current year stakes are absolutely (albeit not relatively) higher. But baseball owners have a pretty strong incentive to get it right. Not only is there a lot of money at stake, but in a city like New York they get pilloried in the press if they fail to build a winning team.

A second, related mystery is baseball teams’ inability to grasp the admittedly counter-intuitive but fundamental economic idea that sunk costs are sunk. If you can’t do anything about them, you might as well move on and optimize given where you stand. Yet we always hear that teams can’t “afford” not to play the guys to whom they are paying huge salaries (e.g., Tom Glavine). Needless to say, they will be paying these guys huge salaries whether they play them or not (and in Glavine’s case they will owe him a way above value salary for next year if he pitches enough for his option to vest). So you would think it would make sense to use the players who give you the best chance to win, regardless of past mistakes in offering high salaries to the wrong people.

Michael Lewis’ “Moneyball” became a hot item in legal academic circles due to people’s interest in the limits of rational choice, since one of Lewis’ main points was that Billy Beane was succeeding with a low-budget team by exploiting market irrationalities, in particular under-appreciation of the importance of on base percentage. An interesting point here is that the Athletics seem at the moment to be failing, although maybe by the end of the year they will be moving back up again. To some extent this may be chance, but if enduring it can also be explained on two main grounds: that Beane’s financial disadvantage has grown even greater over the last couple of years, and that this particular market irrationality has narrowed because his success (and that of the book) has helped to correct the market’s under-appreciation of on-base average. The guys at Long-Term Capital saw their arbitrage advantages shrink, too, although frankly (Nobelists or not) I would expect Beane to show greater shrewdness in adapting than they did.

In terms of why the Mets and so many teams would be so persistently irrational, despite the market forces pushing towards rationality, I would offer two main explanations. The first is the weakness of competitive market forces. With barriers to entry, a cartel making it harder for anyone to go out of business, and the difficulty of buying a team (especially with owners having non-economic reasons for ownership), the forces instilling discipline are not very strong. (Although perhaps strong enough to create very slow movement towards more accurately valuing on base average.) Corporate governance types in the Chicago school like to emphasize the takeover market, but I personally would put greater relative weight on the fact that really bad businesses fail or at least experience enormous reduction in their market share and economic significance. Second, rightly identified by Michael Lewis, especially in his afterword in the paperback version, is agency costs. The insiders in baseball have a stake in self-perpetuation and much less stake than the owners in whether a given team succeeds, and owners who lack expertise have a hard time overcoming this.

Still, it’s hard to explain why Willie Randolph, after thirty years in baseball, lacks the elementary sense that a nine year old with Strat-o-Matic cards would almost certainly have. Call it the New York Mets’ special mojo.

Friday, June 17, 2005

Mea culpa, subject to the Nuremberg defense

A reporter was asking me today why we have such a terrible problem with the alternative minimum tax (AMT), which is on the verge of being bigger rather than the regular tax, leaving most people (at least in a few years) in the position of having to deal with both systems. "Why" meaning, not how is it a problem, or even how as a technical matter did it become a problem (which is a consequence of the failure to index its exemption amount for inflation), but why was it permitted to become such a problem?

Once the system, with its unindexed exemption amount, was in place, no one had a short term political interest in fixing it. The Clinton Administration pursued other priorities. The George W. Bush Administration has affirmatively relied on it for Iraq war-style budgeting deception, since the rise of the AMT greatly lowered the revenue estimates for the 2001 and 2003 tax cuts without people realizing that the (relatively) low estimates relied upon widespread denial of the tax cuts via the AMT. So there is a politically satisfying (from a cynical standpoint) story of negligence rising to malignance as the problem approached and nothing was done.

But I'm convinced that a sheer element of accident played a role as well. Now for the mea culpa and the Nuremberg defense. I was on the Congressional staff that worked on designing the AMT during the 1986 tax reform process. Needless to say, my colleagues and I were only following orders. We certainly knew about indexing, which had recently been introduced for regular tax purposes. So I was wondering recently why we didn't index the AMT exemption amount. I don't remember for sure, but here is what I think. We probably were not allowed to index it within the five-year window for which revenue estimates were being done, since this would have required more money to be raised from rich people or business in some other, presumably more visible and politically painful, way. So why didn't we try to get it indexed to inflation beginning after the 5-year period? That would probably have been easy to do. The answer, I think, is that no one thought of it or realized it would be necessary. We weren't used to enacting such deferred changes. And presumably we figured Congress would get around to fixing the problem long before it became serious.

Suppose the AMT exemption had been indexed to inflation, beginning, say, in 1992. It's possible that politicians would have eliminated the indexing to pay for something else, putting us back where we now stand. But this is far from certain. Had we gotten to 2001 with indexing, it certainly would have been harder for the Bush Administration to eliminate indexing as a way of disguising the size of the tax cuts than to simply rely on the AMT in place. So accident was probably very important.

This is hardly unique to recent tax policy. In the same conversation with the reporter, it occurred to me that the 1986 tax reform probably wouldn't have happened if there hadn't been a Treasury Secretary in 1984 (Donald Regan) who happened to be willing to let the staff design an ambitious tax reform plan. Suppose James Baker, who took over Treasury the next year and helped pass tax reform, had already been there in 1984. It's hard to believe that he would have let the staff develop such a plan. Yet Reagan Administration personnel decisions may not have reflected any intention regarding the encouragement of tax reform by having Regan rather than Baker there in 1984. This was simply a by-product of other forces determining the personnel decisions.

Likewise, I've been told that it is to some degree an accident of personnel in place that led the current Administration to be as honest as it has been about the fact that private accounts are not a free-lunch solution to the Social Security financing gap. Karl Rove may have permitted the senior economic staff in place to commit the Administration to a non-free-lunch stance out of post-election hubris that he wishes he could take back, but he would not even have faced the issue had free-lunchers from the first term senior economic staff (and I don't mean Glenn Hubbard or Paul O'Neill) still been there.

Thursday, June 16, 2005

Another conference

I’ve been silent here lately due to a just-completed trip to La Jolla, first to attend a rather unusual conference and then for a brief family vacation.

The conference, entitled “Taxation, Economic Prosperity, and Distributive Justice,” was run by the Social Philosophy and Policy Center out of Bowling Green, Ohio, with support from the Liberty Fund, which I gather is a very active funding organization. I gather that both the Center and the Fund have a strong libertarian focus, although it appears with considerable open-mindedness and willingness to talk to non-like-minded people.

The conference had about 15 active participants. Three were public economics types (Michigan economist Joel Slemrod, USC law prof Ed McCaffery, and me). One was a tax historian (Elliot Brownlee of UC Santa Barbara), one a legal scholar with general interests (Kevin Kordana of Virginia), and the rest were conservatives or libertarians (including Jonathan Macey of Yale Law School and Richard Wagner of George Mason Economics) who do not accept welfare economics.

I remember once attending a Critical Tax Conference in Buffalo in which there were just a few public economics types and the rest were mainly in critical legal studies. The interplay was similar, except that the dialogue was with people who rejected our approach from the left rather than from the right. Both occasions were quite civil, however, which is more than one can always say of conferences that are limited to tax professors from law schools.

This time around, I attracted considerable (albeit courteous) flak for taking an openly utilitarian perspective in analyzing household tax and transfer issues (e.g., treatment of married couples versus singles, secondary earners, households with and without children, etc.). To many of the other attendees, utilitarianism and Rawls both lead straight to Sweden, a destination to be regarded with great distaste, partly on empirical grounds (via high estimates of government malevolence and incompetence), but mainly on the view that the rights of the individual to his [no women at this conference] talents and labor and the currently observed pre-tax market return thereto are paramount.

One of the pro-libertarian papers wrestled with the problem of (1) agreeing that a traveler facing death from starvation or exposure (in peril through no fault of his own) could violate property rights by breaking into an empty cottage, without (2) embarking on the road to Sweden via generalization of the point that need may outweigh property rights. Another paper posited that justice consists of people getting what they deserve, with symmetrical distaste for the case where good people get less than they deserve and that where bad people get more. I noted that this is not a very beneficent standard, especially given that none of us is perfect. The author, who just the previous day had been pressing me on the tensions between utilitarianism and our moral intuitions, replied that, yes, he completely rejects beneficence as a moral principle. (As for me, I’ll take mercy over justice any day of the week.)

Jonathan Macey’s paper mentioned that Robert Nozick argues for the primacy of property rights - “rather convincingly, I might add” - an aside on which he does not elaborate. He then argues for a constitutional amendment expanding the takings clause of the Fifth Amendment so that taxation, just like seizing someone’s house, requires “just compensation.” Unclear what this is supposed to mean given the problem of pricing public goods, not to mention evaluating the effects on property values of the basic legal system (police, enforcement of contracts, etc.), or for that matter national defense. I would not expect this proposal to get very far.

Tuesday, June 07, 2005

AEI tax reform panel

Yesterday (Monday, June 6), I appeared at an AEI tax reform panel related to the rollout of a new tax reform book AEI is publishing, with chapters by lots of the main contributors to the tax reform debate.
The speakers on the first panel were Bob Hall of flat tax fame and Michael Graetz, discussing his plan that I have had a couple of posts about. Hall, interestingly, disclaimed the "flat tax" label, since his tax, after all, has two brackets (zero plus the positive rate). He called the flat tax label brilliant but inaccurate marketing of the plan, attributable to certain other individuals who co-designed it. He also expressed great sympathy for the David Bradford X-tax idea of having yet more brackets and thus more progressivity. Rabushka is not with him on this, however.
I asked Graetz a question reflecting the viewpoint in my last post on his plan, i.e., why would you give low-wage workers freedom from having to file any tax return rather than several thousand dollars of tax saving from a zero bracket. His reply was civil and in a good spirit, but I will admit I was not persuaded. The two main points I recall him making were (a) his payroll tax credit will address the low-end distributional problems, and (b) he has other compelling reasons for favoring his plan, e.g., avoid treaty problems that more radical breaks with current US tax practice might lead to. On (a), I continue to believe he is stuck with a dilemma resulting from the basic tradeoff between good distributional results and low-end simplification. You need information about people to treat them properly in a distributional sense, and that means, I think, that you are roughly back where you started in terms of the complexity they face. I can't say that I am sure exactly where he stands on the spectrum between more simplification and better modulated distribution. On (b), I just would say that I regard this as less of an important constraint. In principle one can renegotiate treaties (especially if one is the US and the changes don't hurt other countries in any way), and it would be nice to get a better system going in the long run.
Big consensus from everyone in the room was that the biggest problem facing tax reform is not defining a good tax base; it is the political economy problem of getting a decent plan enacted and then protecting it from the politicians and lobbyists. Death by a thousand cuts, to quote a recent Graetz title. Unfortunately, no one knows how to do this. Political economy is much harder and less determinate than straight economics.
Panel 2, which I moderated, had Kevin Hassett describing David Bradford's plan since David could not do so, and Casey Mulligan of the U of Chicago Economics Dept presenting his contrarian view that inefficient taxes are better because they constrain inefficient spending. My comment to Kevin was that I wasn't entirely sure David had found the right balance between good optics and handling transition problems. David tilted towards the latter in his last few years of working on the X tax, but perhaps too much at the expense of the former, e.g., through the use of income tax style depreciation timing plus interest on basis to make it the present value equivalent of expensing. This is an issue that I would have liked to discuss with David in this setting. Casey's point I objected to in a way that I couldn't, without unduly taking time from audience questions, make sufficiently clear. It was that he unduly treats "government spending" as a stand-in for "allocative effects of government policy." This is one of the main things I am writing about in my book in progress, tentatively called "The Use and Abuse of Fiscal Language."
Panel 3 was Ron Pearlman, noting the problems with going piecemeal towards a consumption tax without cutting back interest deductions, and Bill Gale with a general overview of these and other problems with all of the plans. By then I guess I was flagging (the sessions went straight through with no break), so I have nothing particular to add although both talks were good.

Friday, June 03, 2005

Cause for anxiety

One of our three cats is missing. Buddy, aka Budzo, aka Spud, aka Spudringo, aka Buddy Von Beastingham, a brown tabby with a pointed snout and impressive stripes, got out into our enclosed backyard two days ago, went over the fence into a neighboring yard, and has not been seen (at least by us) since. He is a very active one year old "fixed" male who doesn't sleep much by species standards and has one of the great cat swaggers, as if to say "I'm not looking for trouble, but if it finds me that's okay." Very sweet-tempered and affectionate (he is a face-licker), although I wouldn't want to be the mouse that met him.
We're hoping that he's okay, and also that he will come back. Even cats that purr loudly while shoving their heads against their owners' hands are not always averse to accepting better offers, defined presumably in terms of food. Perhaps Scott Boras is advising him. Then there is the possibility of house arrest, although we have been spreading posters in the hope that he will be recognized and returned. Other possibilities are best not thought about.
I gather cats sometimes come back weeks or even months later. But tough times in the interim, for adults as well as kids.
UPDATE: He's back, after an evidently excellent 5-day adventure that culminated with his meowing loudly to us from a neighbor's balcony several houses away. The balcony seemed impossible to enter or exit other than through the house, where no one was home. He agreed that it was impossible to exit, and is not telling how he got there, but with help from inside the house he is back.
After eating and drinking for perhaps the first time in days, he's asking us to let him out again.
This is related, I think, to why Social Security should offer a fixed real life annuity without portfolio choice.

Thursday, June 02, 2005

Fun headline

From the New York Times: "North Korea Calls Cheney a 'Bloodthirsty Beast'."
Of course, it takes one to know one.

Watergate redux

It was, of course, comical to read about convicted Watergate felons piously condemning Mark Felt for whistle-blowing. But hearing from the various conspirators reminded me of one of the most interesting aspects of the afterplay, which is how surprisingly Haldeman and Ehrlichman (not among the commentators because they have died) became sympathetic figures after the whole thing was over, showing more detachment and greater humanity than I, at least, expected. Indeed, absurd though it seemed back in April 1973 when Nixon called them two of the finest public servants he had known, Haldeman turns out to have deserved at least a dollop of such commendation for his sense (revealed in the diaries that came out afterwards, although I have only read about them) of the importance of knowing when to ignore Nixon when Fearless Leader was flying off the handle, as often he was.

Wednesday, June 01, 2005

Tax shelters

According to the May 30 Tax Notes Magazine, Eric Solomon, the acting Treasury Deputy Assistant Secretary for Tax Policy, suggests that Congress, with respect to anti-tax shelter legislation, "take a moment, take a breath, and take a look at what has happened, what is going on, and what the effect is of the legislation and the enforcement initiatives." In other words, no more legislating in the area, please, for now.
Solomon, a truly public-spirited public servant (under both Clinton and Bush, no less) whom I greatly admire, has a point. Congress has a way, when an issue is on the public agenda, of passing a flurry of responses without much overall deliberation or coordination.
The one disagreement I have with Solomon on this concerns the idea of putting the economic substance/business purpose requirement for tax shelters in the Internal Revenue Code, rather than having it just be case law. This is a problematic issue, and both the Treasury and tax practitioners have tended to oppose doing this. One reason I think it is nonetheless a good idea is that several court decisions recently have suggested a lack of understanding or acceptance of the requirement, and indeed I am told that a couple of recent decisions have cited Congress's non-enactment of the statutory rule as indicating that they shouldn't rely on it. (This is bad statutory interpretation, by the way, since non-enactment both need not indicate dislike of the requirement and is not a legislative act.)
Note, moreover, that Justice Scalia's increasingly influential "textual" and anti-purposive approach to statutory interpretation suggests that the Supreme Court might throw out the economic substance line of cases at some point if there is no hook in the Internal Revenue Code indicating that Congress wants it to stay.

Update on Graetz tax reform plan

Michael Graetz let me know he was offended by the tone of my admittedly snarky earlier post on his tax reform plan. Without meaning to make our little dispute any worse, since it’s probably better for both of us (not to mention our many mutual friends) to retain civil relations, here is a fuller critique, overlapping a bit with my earlier one but offering a different emphasis.
I feel that Michael’s plan, although presented as major tax reform, does too little to justify its worsening distribution in the zero to $100,000 range.
Michael’s replacement of an income tax by a consumption tax for people earning under $100,000 has only minor significance. People at those income levels don’t save much anyway. The really important change is his eliminating individual or household-level taxation for people in that range. He puts them purely in a business-level tax that fails to adjust for personal circumstances, other than through a sketchy proposal involving employer-administered payroll tax credits.
The income tax today has an effective zero bracket amount. And it taxes people earning $90,000 at significantly higher marginal and average rates than people earning $20,000. The opportunity to do this is why all prior tax reformers I am familiar with, other than the national sales tax proponents who don’t like progressivity to begin with, have considered retention of individual-level taxation to be essential. Are all of the other tax reform proponents, going back at least to Nicholas Kaldor in 1955, wrong? I really don’t think so.
Michael trumpets the claimed benefit of getting the IRS out of lower earners’ lives by eliminating their need to file. But just how important is this, weighed against the distributional benefits of retaining individual-level taxation?
Suppose the VAT rate is 14 percent, as Michael says it might be, but that we would like to have a zero bracket for up to $20,000 of earnings, which the flat tax but not Michael’s methodology makes possible. Consider a low-wage worker without children earning $20,000, for whom the zero bracket would eliminate $2,800 of tax liability. Michael would rather eliminate this individual’s filing requirement, even if we are just talking about W-2s that report earnings, than save him $2,800 of tax by having a zero bracket. I wonder how many people earning $20,000 would thank Michael for this. Note, by the way, that he proposes to offset the tax increase on poor people for those with children – but, not apparently, other poor people.
Unless Michael’s payroll tax credit can sufficiently do the job, he is effectively taking the position that there would be no case for tax progressivity if the top income in our society were $100,000. Given the huge economic difference between earning $100,000 and earning zero, this should rightly be questioned by anyone who believes in progressivity.
It seems to me that Michael cannot deal properly with the low-end distribution problem unless he brings back the very income measurement ideas, on an individual or household basis, that he claims to be throwing out. If he puts the measurement function in some other part of the fiscal system, then he has given up the simplification.
He suggests that employers could provide payments to low earners (as part of the regular paychecks) that are related to family size. I find this suggestion problematic. Outsourcing the distributional work of the tax system to private businesses that are not going to want to bother with it strikes me as a recipe for mischief. Are they supposed to check on the childen’s Social Security numbers? Will they be reluctant to hire workers with lots of children unless the child benefits are foregone, even if the IRS at some point would pay them back? By the way, I gather that relatively few eligible people seek monthly EITC benefits today, even though allowed under the law, in part because they don’t want to share personal information with their employers. Yet Michael seems to assume that periodic, employer-administered payments to low-wage workers will be feasible under his system.
Michael also makes a serious error to the extent that payroll tax credits do not depend on the worker’s overall circumstances apart from the claimed number of children. Once you have issues such as people with several part-time or successive jobs, or college kids working over the summer, you risk either having a badly misdirected subsidy or else being right back where you started, in terms of simplification. And if he proposes to have the government cross-check it all so that workers don’t have to file returns (although they might, depending on his plan, get letters in the mail saying that they have to pay something back), again one wonders about the feasibility. Is it really that important to eliminate filing based on simple W-2s, which would permit distributional adjustments to be made much more easily?
But let’s suppose Michael offers simplification at the low end, albeit potentially at a big equity cost in the portion of the income distribution where a dollar matters the most. Even so, I believe he has misdirected his simplification efforts, and missed 95 percent of the problem.
On the high-income and business end, he mainly limits himself to a bit of hand-waving about partial book-tax conformity, a nice idea in theory but one that is unlikely to work well in practice. I have said nice things about book-tax conformity myself recently, more or less offhand, but I do think it is hard to push this idea very far. For example, the marketplace pressure to state book income high might change if the tax system started relying on it more. And what about Congress monkeying with the tax rules so as to create ever greater divergence - or, for that matter, monkeying with the accounting rules?
So it looks as if Michael basically leaves us with the same old system, with all of the problems he decries, for everything and everyone above the $100,000 level.
Where are the dominant administrative, compliance, and tax planning burdens of the income tax? The answer is that they overwhelmingly relate to high-earners and businesses. Here people not only face complicated issues, but can throw enormous resources at them.
A properly directed tax simplification effort would focus on the billions of dollars that are being spent, but in a social sense wasted, by those groups both on lawful tax planning and on questionable tax shelters. Under Michael’s plan, you’d still have all the game-playing and line-drawing that we see today, drawing on such tax rules as the realization requirement, the myriad interest expense rules, the distinction between debt and equity, the treatment of contingent convertible bonds as opposed to debt plus a separate option, etcetera. So the billions of dollars that are being wasted today on tax planning, compliance, and administration, and the stories about outrageous scams, would continue. [To give Michael a bit of credit, he has in the past been associated with a “CBIT” proposal for corporate tax reform that would wash away the main implications of the debt-equity distinction. That doesn’t seem to be a part of his current plan.]
A progressive consumption tax, unlike Michael’s plan, would greatly simplify the taxation of business and high-earners, while also retaining equity at below $100,000 of income. It also could easily be more progressive at the high end, when we consider the tax planning opportunities that a realization income tax offers. The only virtue that Michael’s plan offers against all this is the greatly overstated benefit he ascribes to filing no tax return instead of simplified returns based on W-2s.
To suggest that progressive consumption taxes are politically unrealistic, Michael notes the failure of the Nunn-Domenici plan. But that example proves little. Although there were good progressive consumption tax prototypes out there, Nunn and Domenici, for some reason, decided to reinvent the wheel, and got it wrong. Their unfortunate detour from a sensibly designed progressive consumption tax does not establish his broader claim that such a tax is unrealistic.
Michael notes that no other country has a progressive consumption tax. That is true, and sobering for advocates of such a system. But he fails to note that no other modern, economically advanced country has his plan either. While nearly all such countries have an income tax/VAT mix, I do not know of any that comparably restricts the reach of individual or household-level taxation. Other countries, like other tax reform proponents, recognize the need to individualize tax burdens based on personal circumstances.
Michael closes his chapter by suggesting that perhaps his proposal is politically impossible. This leaves me wondering even more about his stated ground for rejecting progressive consumption taxation, since he’s now pleading guilty to the same problem.
So I don’t believe that Michael’s plan belongs on the roster of those that are seriously worth considering.