Rare moments in parenting

"Dad, what's the music you're playing?"

"Oh, it's a group called the Feelies."

"Really? It sounds pretty good."

Definitely atypical, despite a few past success stories such as Squeeze and Heatmiser.

Fred Thompson's bad idea

It's hardly worth mentioning Fred Thompson's recent tax proposals, although lauded in the Wall Street Journal the other day, given that the dang doggone ol' boy (as this Washington-Hollywood smoothie likes to style himself) is going nowhere fast. He makes my 16-year-old cat Shadow, who sleeps almost all the time, seem like a whirling dynamo by contrast. But I'll briefly discuss ol' Fred's tax plans anyway, as they raise broader points of interest.

What with proposing to end the AMT, extend the Bush tax cuts, and on and on, Fred appears to envision reducing Federal revenues by as much as 5 to 10 trillion dollars for 2008-2017 alone. (This is a wild guess, but the Bush tax cuts alone come in at $2.3 trillion according to the Congressional Budget Office.) This verges on the criminally insane given the overall U.S. fiscal picture and the political unlikelihood of commensurate outlay reductions.

The bad idea I want to emphasize here, however, is his proposal to add a simple flat tax system with fewer deductions to the Code, but not to replace the current system - he would instead make it elective: you get to use whichever system you prefer.

Tax Policy Rule # 12 (I don't have a list, it's just that this one isn't important enough to be Rule # 1): Taxpayer elections are almost always a bad idea. They add complexity while losing revenue, since taxpayers have an incentive to look at all the options and then pick the one under which they pay the least. Plus, the pattern of tax liability you get is bound to be incorrect, given its being a mix-and-match between different systems. No matter which system you prefer, the result is "wrong" for people who pick the other system.

The Wall Street Journal, in its Nov. 28 editorial lauding the plan, was characteristically ignorant and naive. They put it as follows: "Anyone who prefers the current tax code can stick with it. The rest of us can have a better choice."

Does the Journal really think that taxpayer elections will be based on personal affinity as opposed to which system enables one to pay less tax? That is not a very plausible or sophisticated view of taxpayer behavior.

Yes, as the Journal notes, providing the election may ease the politics of adopting a flat tax, which may seem good if that is the tax system you prefer. But it eases enactment by not really enacting the flat tax, given that the other system remains out there, influencing behavior and running up tax planning costs. Making something easier to adopt by not really adopting it is not a very brilliant strategy.

Okay, just for completeness, are taxpayer elections always bad? No. To over-simplify, suppose there were 2 kinds of elections: those that induced the taxpayer to choose whichever option reduced tax liability, and those that induced the taxpayer to choose whichever option lowered her tax planning and compliance costs. The latter type of election would be good, the former bad. In practice, of course, the two effects will generally be mixed together, so it's a question of how much you get of each. But the election Thompson proposes certainly seems likely to be the bad kind, as taxpayers would have strong reason to track, e.g., their home mortgage interest deductions and such (not all that administratively costly a thing to do) in deciding which option they want to use.

Inadvertent hilarity

In an op-ed in today's LA Times, Zev Chafets says that Bush is the "big winner" from today's Middle East shindig in Annapolis, notwithstanding that nothing is likely to happen there. Could be so, I suppose, as a statement about the U.S. opinion poll effects (though even this seems to me unlikely).

But then the LSD kicks in, and the spittle starts spraying from Chafets' mouth.

He asserts that, just because various countries and institutions came to the thing, "[i]t turns out that Bush, far from wrecking America's prestige and influence, has compounded it."

Then the true comedy payoff:

"In the past, there were foreign leaders who might have attempted to spoil the party. President Jacques Chirac of France, Chancellor Gerhard Schroeder of Germany, Canadian Prime Minister Jean Chretien and U.N. Secretary-General Kofi Annan were all publicly rude to Bush at one time or another, and perhaps they would have dissed him again this time. But guess what? None of them is invited. They are all gone from office -- a fact not lost on their successors, who are almost embarrassingly anxious to be friendly with the Bush administration."

Never mind Australia, or for that matter the fate of Tony Blair. The really important thing to keep in mind is that Bush can go over the heads of foreign leaders and appeal to the voters out there ANY TIME HE LIKES. Those foreign voters are nuts about him, and protective like a mother hen. Likewise, Bush's pull with the UN General Assembly rank and file is just INCREDIBLE. So none of these people would DARE stand up to him unless they had a political death wish.

Is Chafets living on the planet Zircon or something? Is he deranged enough to believe what he writes, or too crass to care?

My ideal

Someone once said the following about David Ricardo, the great classical economist, who developed all kinds of remarkable insights without any formal economic tools. (An example is what we now call Ricardian equivalence with respect to budget policy, an idea he both expressed and saw the problems with, in a couple of throwaway paragraphs, nearly two centuries before anyone else wrote about it.)

Anyway, this individual compared Ricardo to the guy you see at the end of a tough mountain climb, when you've gotten there with tons of special gear and burkah helpers, who you find out has ascended before you with nothing but a T-shirt, shorts, and sneakers.

That's my ideal in academic work, though I certainly make no pretense of comparability.

David Halberstam's The Coldest Winter

This widely noted book about the Korean War has been a very interesting read. The start is painful and hard to get through - a flash forward to the stage of the war where American soldiers, near the Chinese border, were being overwhelmed by Chinese forces for whom the sleeping MacArthur had totally failed to prepare despite more than ample warnings.

A lot that happened in the Korean War era is painfully recognizable today. Policy being driven by ignorance about the other side. People who knew something being ignored, as the "China hands" had been driven from influence for the sin of correctly predicting the outcome of the Chinese Civil War. People who knew better lying about what had happened in China to score political points against the Truman Administration. The overwhelming inclination in U.S. politics to be over-hawkish at all costs, without regard to rational pursuit of national self-interest. The arrogant disregard of local realities out there. Absurd worship of military figures, permitting them to exercise malign influence. Deliberate exploitation of patriotism themes by right-wingers determined to pursue nefarious ends, or in some cases well-meant but unrealistic ones. Knowledgeable civil servants being defamed and ignored. Insistence on reading every single situation in world politics as Munich revisited, with "appeasement" of a mythically monolithic adversary to be avoided at all costs, and with "appeasement" defined to include any exercise of sanity and common sense.

Interesting side-point: MacArthur's daring Inchon landing succeeded for a reason that no one fully understood at the time. It was guaranteed to fail if the North Koreans were at all prepared for it, highly likely to succeed (as it did) if it caught them completely by surprise. What we didn't know, before the archives opened abroad, was how close it came to failing. The Chinese knew from their intelligence sources in Japan that the U.S. was planning a landing somewhere. Being a lot savvier and more experienced than Kim Il Sung, they correctly guessed Inchon because they had studied MacArthur and knew his style. So they told Kim, a couple of weeks before the landing, to prepare for it. He wouldn't have had to do much - just put minimal resources there without greatly diverting from anywhere else. But luckily enough he arrogantly ignored them. So MacArthur's gamble worked because of Kim, but certainly was not bound to work given that the Chinese had figured it out. Being a racist, MacArthur had counted on "Asians" lacking the wit to foresee what he was up to.

Back to the main themes and how familiar they feel from the perspective of 2007. We really are reliving 1946 to 1954 in a lot of ways, albeit without responsible adults running the Executive Branch or the Republican Party. Let's hope we are lucky enough to emerge again. But I am not very confident that we will.

If Bush isn't stupid ...

... then why is he so laughably easy for sophisticated foreign leaders, such as Putin and Musharraf, to dupe?

Great new album

Glenn Mercer (previously of the Feelies), Wheels in Motion. So far as I can tell, the biggest difference between this album and his work with the Feelies is that this one is actually in print.

You could call it George Harrison on guitar with a Velvet Underground drone.

Cat pandering

Posts on international tax appeal only to a select audience. But I fail to see how anyone could resist my three cats.

This one is Shadow, aka The Big Fella.








This one is Ursula, aka The Lovely One.








And this one is Buddy, aka The Wascally Wabbit.

U.S. international taxation

Today at NYU Law School we held the session on international taxation mentioned in my blog entry from yesterday, with Jim Hines presenting his new paper, “Reconsidering the Taxation of Foreign Income,” followed by comments from Alan Auerbach, Mitchell Kane, and Stephen Shay, followed by general discussion. The following is a partial report and some very preliminary thoughts. (I am likely to publish about this topic at some point down the road.) But let me just mention up front that the event seemed (to my biased eyes at least) to be a big success - 70 attendees, lively discussion that could have kept right on going if people didn't have to leave, and most importantly it may have advanced people's thinking about the issues, as it certainly did mine.

Jim argues that U.S. (and other countries’) tax policy with respect to outbound investment should be guided by capital ownership neutrality (CON) rather than capital export neutrality (CEN), with the claimed implication in practice that the U.S. should exempt active business income earned abroad by U.S. corporations. Under CEN, the prescription would instead be to move towards full U.S. taxation of all worldwide income of resident corporations (and individuals), albeit subject to allowing foreign tax credits.

CON focuses on not distorting ownership patterns, as would happen if a German firm rather than a U.S. firm owned a given investment in China, despite the U.S. firm’s expecting a higher pre-tax return from the investment, because the German company earns more after-tax by reason of Germany’s imposing less tax than the U.S. does on top of whatever China levies. CON advances worldwide efficiency by increasing pre-tax profitability, taxes being ignored for this purpose as they are a cost to the taxpayer but a transfer from the social perspective (since the taxing government gets the money and does something with it). CON is understood to matter a lot in a world where the theory of the firm, as pioneered by Ronald Coase, suggests that ownership arrangements are economically very important. (You have a firm instead of arm’s length market arrangements between partners in the productive process where this increases efficiency.)

CEN focuses on not distorting where investments are made. If Ireland has a lower tax rate than the U.S., investment will tend to shift from the U.S. towards Ireland, leading to the selection of some Irish investments that are more appealing after-tax than their U.S. alternatives despite having lower expected pre-tax returns. Same point about pre-tax profitability being the proper guide since taxes are a transfer not a social cost.

So why should we think the CON margin is more worth pursuing than the CEN margin? Not because it is inherently more important, which Jim doesn’t claim (noting only that CON is indeed important), but on the ground that the U.S. can benefit from unilaterally pursuing CON but not CEN. This is a part of the analysis that needs to be developed more.

Proponents of CEN usually define unilateral pursuit of national self-interest by invoking national neutrality (NN), under which the home country would fully tax outbound investment by its companies without foreign tax credits – permitting only deductibility for foreign taxes paid. The foreign tax credits then emerge either out of benevolence or (more plausibly) reciprocity between nations. As I argued in my recent Tax Law Review piece on international taxation, moving towards CEN by increasing the U.S. tax burden on multinationals is often defensible in terms of national self-interest because it also moves towards NN.

Jim rejects this nationalistic ground for moving towards CEN and NN via what I am inclined to call the “musical chairs” or “row of shops” hypothesis. NN is motivated by the concern that, if we tax outbound investment by U.S. companies less than their domestic investment, we lose revenue because their investments relocate from the US to abroad. But suppose the amount that will be invested in the U.S. is fixed so far as the U.S. tax regime for U.S. firms is concerned. If the U.S. tax rules induce a U.S. firm to invest abroad, someone else will make the investment here. Or the U.S. firm will raise more capital in worldwide capital markets and make both investments, not just one or the other. He invokes recent empirical research in support of this view, suggesting that home and foreign investment by U.S. multinationals seem to be complements rather than substitutes.

I call this the musical chairs theory because it’s as if the music is playing, and the companies are marching around all the chairs (i.e., investment choices), and everyone ends up getting a seat somewhere. If we induce the U.S. firm not to take the seat here, someone else will take it instead. This is of course the benign (or should I say progressive schools) version of musical chairs, where you have just enough for everyone rather than being one short.

The row of stores metaphor for this story is inspired by Bleecker Street, which I sometimes pass on my way from home to school, in which every storefront is bound to be rented by someone – it’s just a question of who ends up where. Bad theory so far as Bleecker Street is concerned, by the way – there are lots of boarded-up storefronts still seeking tenants, some of which have been there for years. (A puzzle: why are the rents apparently so high if so many stay vacant for so long?)

Again, Jim doesn’t deny that low taxes attract investment. The claim here is that, if the U.S. tries to move towards CEN, rather than everyone doing it, all it does is create clientele effects, whereby other nations’ firms replace U.S. firms as the makers of particular foreign investments. So no motivation for the U.S. to address CEN alone, and indeed we get a piece of the worldwide CON welfare loss if U.S. firms (still these days predominantly owned by U.S. individuals) make a bit less money due to the inefficient reallocations. Unclear how much we gain from following CON, however, even granting that in this model we have nothing to gain from unilaterally following CEN.

Jim rejects distributional or fairness-based reasons for taxing the worldwide income of U.S. firms by analogy to tax-exempt bonds. Say the interest rate on taxable bonds is 10%, the marginal tax rate (MTR) is 30%, and tax-free municipal bonds pay 7%. Then there is no distribution problem by reason of the preference (assuming the pre-tax interest rate is fixed), because muni bond holders pay a 30% implicit tax that is the same as everyone else’s explicit tax. All earn 7% after-tax. By analogy, investment in low-tax Ireland pays an implicit tax in the form of a lower pre-tax return (by reason of the CEN-violating shift of investment into Ireland), so there’s no reason for distributional concern about its being (to exaggerate relative to actual Ireland) tax-exempt.

The big problem with the muni bond argument is that it only works with a single MTR for all investors. So, if in actuality we taxed corporate income on outbound investment at the individual level, so we could apply Bill Gates’ MTR to his investments and a lower rate to yours and mine, exemption for foreign source income would involve sacrificing this potential to apply the desired MTR to each investor. But since we generally tax outbound corporate equity investment purely at the flat corporate rate, we aren’t getting that rate differentiation anyway under the current system or even one revised to accord more with CEN.

There is lots more one could say (and that I perhaps will say) about the paper and the topic – including details of excellent comments by Auerbach, Kane, and Shay – but given the length of this post I will omit them at least for now. But one last point concerns passive income, earned through portfolio investment. Jim agrees that the U.S. should tax all worldwide income of U.S. residents. This is potentially a big concession, making one wonder about the broader principle. It has a rationale, relating to the point that passive income doesn’t have a meaningful location in the same sense as active business investment (e.g., there is no limit to the funds that could be described to the tax authorities as deposited in Caymans banks). So the musical chairs hypothesis does not apply. But still, it might have big implications for the overall analysis – especially considering the murkiness of the active-passive distinction (which Jim conceptualizes as, “does ownership or control matter here?” – a matter of degree, of course) – and considering as well the murkiness of the source concept.

Source is not an economically well-defined idea. Consider, for example, the synergies obtained by operating as a multinational rather than through arm’s length dealings between firms in different nations. Where exactly does the synergy income arise? And this is not just an implementation question – it undermines the underlying idea on which source-based taxation ostensibly rests.

International tax session at NYU Law School

On Wednesday, November 14 (tomorrow as I write this), from 12 to 2 pm, we will be having a really interesting session at NYU Law School on international tax issues. Jim Hines of the University of Michigan Business School and Law School will be presenting a new and as yet unpublished (perhaps even unposted?) paper entitled "Reconsidering the Taxation of Foreign Income." Commentators will be Alan Auerbach, Mitchell Kane, and Stephen Shay. If I do say so myself despite having arranged the event, this is a really strong group of people with diverse backgrounds and viewpoints.

I am expecting a very lively and enjoyable session. Jim argues for significantly changing the policies and policy benchmarks that have prevailed for several decades in U.S. international tax policy. The panelists' level of agreement may well top out at 50 percent while in some cases being significantly lower. But all agree about seeking light not heat.

Interested individuals who will be in the area and who were not previously aware of the event (or at least have not previously responded) should let me know, and I can offer fuller information about it.

Budget hypocrites threaten to strike again

Courtesy of Paul Caron's TaxProf blog, I note that the White House is threatening to veto the one-year AMT patch being considered by Congress. Specifically:

"The Administration does not believe the appropriate way to protect 21 million additional taxpayers from 2007 AMT liability is to impose a tax increase on other taxpayers. Accordingly, if H.R. 3996 were presented to the President in its current form, the President’s senior advisors would recommend he veto the bill."

How exactly does the White House rationalize counting AMT revenues towards its multi-year deficit forecasts, under this view? They're counting net revenues that they insist must be lost, not replaced.

UPDATE: Stan Collender, in his "Budget Battles" analysis of the AMT squall, puts it a bit more crisply:

"On one hand, the White House says that paying for a one-year "patch" on the AMT is unnecessary, so an offsetting tax increase isn't needed. As he has done with everything else Congress is considering that he doesn't like, the president is threatening to veto any AMT fix that is revenue neutral.

"On the other hand, congressional Republicans have been insisting that the Democrats maintain their pledge to live up to pay-as-you-go budget rules by offsetting the AMT fix so that it has no impact on the budget.

"The Republican positions clearly are not defensible.... [given] the glaring, inherent conflict between saying that the AMT fix doesn't have to be paid for and demanding that PAYGO, which applies to taxes, be maintained."

Collender notes as well how utterly (and I would add characteristically) incompetent the Congressional Democrats have been in letting the Republicans paint them into this corner, and in failing to explain why the AMT fix isn't a tax cut but the offsets are somehow tax increases.

Could those guys win a poker hand if they had four aces and the other side had face-up junk? I am starting to think not.

Newly published or forthcoming

My article "Why Worldwide Welfare as a Normative Standard in Tax Policy?", 60 Tax L. Rev. 155-178 (2007), has now been published. Hard-copy reprints are available to anyone who still wants so old-fashioned a thing.

Another forthcoming article of mine, "Beyond the Pro-Consumption Tax Consensus," should be appearing very shortly in issue 4 of Volume 60 of the Stanford Law Review.

Finally, within the next few weeks my article "Disclosure and Civil Penalty Rules in the U.S. Legal Response to Corporate Tax Shelters" should be appearing in Wolfgang Schon (ed.), Tax and Corporate Governance, to be published by Springer Science. This volume contains the papers from a conference that was held in Munich in December 2006, and other authors whose papers should be in the volume include, e.g., Reuven Avi-Yonah, Steve Bank, and Mihir Desai.

Radiohead redux

They're not a natural band for me to espouse. I'm a bit suspicious of the popularity, although the Beatles model says that in the ideal world the best band is also the most popular. But then there's the U2-ish, prog-rock sound and the keening mournfulness of Yorke's lead vocals, neither to my typical taste.

Still, in varying degrees I like most of their albums, previously OK Computer best of all, and to date I would call In Rainbows the best album of 2007.

UPDATE: I've also come to like the new Fiery Furnaces album, after initial skepticism. Eval of Jens Lekman, highly touted by pitchforkmedia.com and others, remains open.

Buffoon in chief

A stopped clock is right twice a day, but not Cheney - he is wrong 100% of the time, defying the law of averages. Latest bit is that he has apparently demanded 100% loyalty by the Bush Administration to Musharraf, in lieu of any thought of steering an independent course.

State of the play academically on wealth transfer taxation

Yesterday I went to a session at Columbia Law School where my colleague, Lily Batchelder, was presenting her paper, "How Should an Ideal Consumption Tax or Income Tax Treat Wealth Transfers?" Lily is doing excellent and important work in this area, ranging from her actual policy proposal as part of the Hamilton Project to the more theoretical inquiries she is pursuing now. But even apart from any one individual's distinctive view of the area, I think it's important to say something about the current state of the play, which Lily helps make her clear both through her own contributions and through the prior empirical literature she cites.

Ten years ago, I would have said the jury is out in the academic and tax policy literature, so far as the merits of wealth transfer taxation are concerned. E.g., there is no particular reason one should favor wealth transfer taxation just because it's progressive, given that in principle equal progressivity could be obtained with or without it, through adjustments to other tax instruments.

From a 2007 perspective, however, I think the case for wealth transfer taxation has pretty much been made. A key point that Lily's work makes clear is that inheritance taxation - where the tax depends on the circumstances of the recipient - is theoretically superior on informational grounds both to estate taxation - where it depends on the size of the bequest - and to no tax at all on wealth transfers. The inheritance tax option uses more distributionally relevant information than do the other mechanisms. E.g., my wellbeing clearly depends on the wealth transfers I receive, plus other stuff I have or can earn, so the tax system is depriving itself of distributionally relevant information if it ignores the wealth transfers or fails to interact them with what else I have.

Now for a refinement, potentially reversing the seeming import of what I just said. The clear superiority, on informational grounds, of inheritance taxation over the alternatives does not tell us that the inheritance tax rate should be positive. This depends on a whole raft of relevant inputs, including (as Lily's work makes clear) the case for subsidizing gratuitous transfers due to the "altruistic externality" that Louis Kaplow may have been the first to emphasize. So to say we should have an inheritance tax isn't to say we should burden inheritance relative to not having a wealth transfer tax - just that in theory it ought to be taken into account somehow, which straight exemption fails to do.

But here is what I would argue is the clincher in terms of a positive inheritance tax rate (again, recognizing that there are complicated multiple inputs). Recent empirical research concerning bequest motives and practices, including, e.g., work by Wojciech Kopszuk of Columbia University, suggests that "accidental bequests" (those reflecting imperfect lifecycle saving and annuitization rather than bequest motives) are a sufficiently large piece of the whole to suggest that the distortionary effects of taxing wealth transfers, e.g., the discouragement of work and saving by future decedents (which we all are), are likely to be substantially lower than they would be if bequest motives were doing more of the work. So there are likely to be substantial efficiency advantages to this device for taxing work and saving, relative to the use of standard annual income or consumption taxation.

All this is not just high theory, of course. The estate tax is actually scheduled to disappear in 2010 and then re-appear in its pre-2001 form in 2011. This is a crazy and implausible sequence of rule changes, leaving aside the fascinating "throw momma from the train" research opportunities that it would offer empirically minded economists. So something is bound to be done. It thus is well worth knowing how strong the academic case for some type of wealth transfer taxation, especially an inheritance tax, now appears to be.

I myself would combine inheritance taxation in some form with a progressive consumption tax in lieu of the current income tax, but this is a topic for another day (actually for a past not a future day as I have written about income and consumption taxation quite a lot in recent years).