Friday, May 25, 2007

My talk last week at the International Tax Policy Forum

Last Friday, I gave a talk on my worldwide welfare paper at the International Tax Policy Forum. This is a group, organized and funded by U.S. multinationals, that sponsors and disseminates research on international tax policy issues. Needless to say, there is a particular point of view that they strongly prefer, not entirely unrelated to the interests of the funders. But they are a high-brow group that takes an interest in good quality research, rather than hackery. Making this easier is a belief that the empirics, properly understood, genuinely favor them.

When I present a paper there that they don't agree with, as happened this time, the aim is to influence the author to think differently, not to attack. Certainly a savvy strategy, and I have to admit not entirely unsuccessful this time. Perhaps all the more successful here because my paper has the structure, in my mind, of "If A, then B," whereas they are arguing not A, and hence not challenging the paper's argument, which rests on saying: Let's assume A for present purposes, as it is a widespread and potentially plausible view, and see where it leads.

A, in this case, is the traditional view of international tax policy, dating back at least to Peggy Musgrave's work more than 40 years ago, in which the normative guideposts are:

(1) national neutrality (a country acting unilaterally benefits from merely allowing deductions for foreign taxes paid, and should address double taxation of cross-border investment only if other countries are willing to do so as well), and

(2) possible mutual welfare gains from cooperating to address double taxation, via the efficiency enhancements achieved by promoting capital export neutrality or capital import neutrality, which unfortunately counsel very different policies in particular settings.

Given this structure, my paper discusses how the choice between (1) and (2) involves a prisoner's dilemma, and what implications this has. Normally, prisoner's dilemmas require that the players can't witness each other's behavior, but I argue that it applies to setting international tax policy even though it takes place in broad daylight.

This is unambiguously the right way to look at the issues, I would argue, if we had a worldwide residence-based tax on individuals who were fairly immobile. But once you have entity-level taxation that turns on the fiction of corporate residence, the argument I was getting at ITPF was that the normative framework may radically shift. I agree with the logic of these arguments, and again one could view them as orthogonal to my paper except that, if universally and unambiguously true enough in practice, the logic discussed in my paper might not even be worth exploring. This is something I mean to take up more in the future.

A core empirical question, we agreed, is whether outbound investments by resident taxpayers that the home country is considering how to tax are substitutes or complements for investing at home. In the (counter-factual) case of a worldwide residence-based tax on individuals, they have to be substitutes. I have $X to invest, and unless I respond by saving more (which is probably not to be much expected in this setting), then every dollar I invest abroad is thereby not invested at home.

By contrast, a U.S. multinational that is trying to raise funds from people who can invest it anywhere and with anyone may well be in the world of complements not substitutes. A good cross-border investment opportunity may simply mean that they can raise more capital to play with. If the country in which the company is deemed a resident increases the tax, those who are ultimately the sources of the capital may simply respond by investing via another company in another country. And this in turn may affect the next move made by whichever company got the investment dollar. So the complementarity scenario becomes a plausible alternative to the substitution scenario.

These guys at ITPF are good. They've got me thinking. Or rather, since I was already familiar with the general intellectual landscape here, they've got me thinking a bit more.

Why do people become teachers?

This is not a question about academics such as myself. We're a different kettle of fish, as stuff happening outside the classroom, in particular scholarly and other writing, is so central to our career choice.

Rather, I'm ruminating here about K through 12 teachers, only slicing off the upper and lower ends. Those who work with very young children are also a distinctive group, while high school teachers remain as yet outside my experience as a parent.

For those who remain in the grouping, I have noticed three basic types. The first are the people who actually want to be teachers. Motivations may vary, but sometimes I discern a sense of "I'm going to be the sort of person I wish had been there for me, but wasn't." Obviously, this is the type one wants one's children to have. There are plenty of them, but they are unfortunately not as common as one would like - certainly below 50 percent, in my experience as a parent.

Those in Type 2 want a white-collar job, no hard physical labor, that sounds good when you tell people you're doing it. And they want something that doesn't take too much hard-core professional training, and that doesn't require specialized skills of a kind that are too easy to test for objectively. Their chief goal professionally is advancement with as little challenge and trouble as possible.

Type 3 wants inferiors, in size, age, and knowledge, from whom to demand admiration. This type is potentially even worse than Type 2.

Needless to say, Types 2 and 3 attempt to masquerade as Type 1. The best diagnostic I know is that Types 2 and 3 are generally humorless.

Saturday, May 19, 2007

Ruminations of an anti-Yankee fan

In all of sports, my anti-Yankee sentiments are second only, and barely, to my pro-Mets sentiments. The two are of course tightly linked, and go back to 1964, when a pint-sized version of the person now typing this was the only Mets fan on his Bronx block. So the sentiments are pretty foundational; even the Mule from Asimov's Foundation series might have a hard time modifying them now.

The Yankees have certainly had some bad luck this year. Do I feel sorry for them? Well, first of all, they need at least 10 or 15 more years of luck this bad before I will say it's evened out. Second, they've ended up on top too many times for me to be convinced they are really scotched for this year. In fact, for all I know they may win their next ten. Third, as of this April their payroll stood at $195M, versus $143M for the Red Sox and $117M for the Mets. They have since added Roger Clemons, which even with his late start should add $20M or so. So they are more than $70M ahead of the Red Sox in spending, and nearly $100M ahead of the Mets. To put it another way, there are more than 20 teams whose payrolls, added to the Mets', are still less than theirs. One certainly ought to be able to buy a bit of insurance that way. So no, I am considerably short of feeling sorry for the Yankees.

Wednesday, May 16, 2007

Nixon Frost

Last night I saw Nixon Frost, the play about the famous interviews, starring Frank Langella as the Trickster (updating his performance as Dracula?). Most enjoyable; Nixon is the gift that just keeps giving, and I feel sorry for those too young to have experienced him. The current parallels are of course unavoidable, e.g., the scandals and the view of Presidential power, but one can't stop thinking about how vile, stupid, uncomplicated, uninteresting, and unworthy current pretenders to the Nixon throne are compared to the man himself. Nixon had a lot in him, and some of it (like some of his presidency) was actually quite good. The rest may have been bad but was fascinating. None of this is true today, when we have venomous little scorpions instead of Macbeth.

Despite the innate appeal, I thought the playwright's recent movie, The Queen was in some ways more illuminating. Nixon is of course one of the all-time great real world characters, and has been taken in all sorts of directions involving varying degrees of poetic license. Here it was a bit linear, and the payoff was the famous moment in the Frost-Nixon interview on Watergate where he breaks down a bit into an on-camera catharsis, which the play suggests he at least half-wanted to do. This verged on being a bit too much of a typical final-scene chew-the-scenery Big Moment, although Langella did it well and I gather it actually happened. (I saw the interviews back when, but would have to see the big scene again to evaluate whether or not the play over-milked Nixon's emotional level here.)

Not to sound too harsh, though, and highly recommended, at a minimum to all Nixon fans.

Tuesday, May 15, 2007

Tax break for managers of private investment funds

There's been much controversy lately about the tax break for managers of private investment funds that is currently under review by the Senate Finance Committee. The basics, first brought to general public attention (and certainly mine) by U of Illinois law prof Victor Fleischer, who presented his paper on the subject at the 2006 NYU Tax Policy Colloquium, are as follows. Managers of these funds typically get a standard return equaling 2% annually of the money they are managing plus 20% of the capital gain they eventually generate. The former is taxed as ordinary income, but the latter is taxed as capital gain. As Victor pointed out, this means that much of the managers' labor income is being taxed at 15% rather than 35%, even though these are some of the highest-paid people in the U.S. today.

Economically speaking, the managers' 20% return is a mix of labor income and a risky return to saving. The reason they get compensated so richly for playing with other people's money is that they are at least believed to have the ability to make big bucks, such that the investors are happy even after giving away the "2 and 20." It would be pure labor income if the managers could lock in and be paid the expected value of the 20% interest right up front. (This is of course unfeasible on measurement and liquidity grounds along with its incentive effects on what the manager does.) But even for the true investment component keep in mind that they are getting the tax benefit of deferral until sale.

What are these funds doing, exactly? While I know nothing first-hand, I gather that they run the gamut from (a) the straight hedge fund that figures out clever strategies to exploit market inefficiencies and generate above-market risk-adjusted returns to (b) takeover firms that find under-performing companies and restructure them to be more profitable, and thus rapidly salable for a big turnover profit.

Economically speaking, (b) is generally more valuable to the economy than (a). While (a) may increase market efficiency, the private return from figuring out how to beat out other investors by buying and selling at just the right time exceeds the social return. Not that I have any problem with such activity, but it definitely doesn't need to be subsidized.

By contrast, (b) may have some broader social payoffs, although the question here, from the standpoint of incentives, is whether there are positive externalities - i.e., gain beyond that captured by the entrepeneurs who sell for a big turnover profit. Note also that one would be less bullish about this activity if the improved performance came, say, from improved tax planning strategies or the one-shot gain from implicitly reneging on deferred compensation arrangements with rank and file workers, rather than from, say, rationalizing production and marketing processes.

I raise these broader issues of the social value associated with particular types of economic activity, although often one can and should ignore such issues in setting tax policy, because incentive arguments are important to the debate concerning the taxation of the 20% carried interest. The incentive case for giving managers a low tax rate is limited to some portion of the activity in category (b), although even for the best case scenario it is unclear why we should expect substantial positive externalities, i.e., social returns that aren't captured by the remake artists who make so much money for having done such a good job. I'd certainly like to think that I create value when I publish or teach. And lots of other workers in our economy can say the same. But presumably I'm paid for the value I create, and I am sadly unconvinced that I can make a powerful case for applying a lower tax rate to myself than the one that everyone else bears.

A week or two ago, the Wall Street Journal published an editorial, unless it was an op-ed (what's the difference most of the time in the WSJ these days?) arguing against making the managers pay the ordinary 35% rate. What a surprise. No comment needed. But today the Los Angeles Times published an editorial to the same effect. I figure that this is a bit more noteworthy since it wasn't as crushingly obvious that the Times would take this tack. Hence, worth a response.

I did not find the editorial very persuasive. After inaccurately describing the tax break as for takeover firms, rather than for the broader category of private investment firms, it rolls out the usual hardware about enterpeneurship and risk-taking and creating jobs and how crucial all this is to the health of the economy. The main problem with this argument, other than the poor fit between the affected firms and the claimed external social benefit, is the poor fit between the capital gains preference and the aim of addressing risk-taking.

A flat rate tax system with full loss refundability at the generally applicable marginal rate would not discourage risk-taking. Even the positive expected tax on the risk premium could be offset by investing on a riskier pre-tax basis in order to get where one wants after-tax. Since we don't have such a system, the tax system actually does discourage risk-taking, which is unfortunate, even without an externalities story, as it imposes deadweight loss beyond that implicit in taxing productive economic activity. For the big-time entrepeneurs, graduated marginal rates, although they discourage risk-taking, are not very important. These guys are way into the top bracket anyway. What matters a lot more is loss nonrefundability, in particular at the business (as opposed to the investor) level. That is, companies pay tax on profits, but do not get any tax benefit from net losses if they don't at some point have sufficient profits from other operations. A recent paper by Alan Auerbach, presented at the 2007 NYU Tax Policy Colloquium (see here) suggests that this problem is growing increasingly important.

The obvious solution to that problem is greater loss refundability. But this involves a dilemma. The one good reason for nonrefundability is to limit the tax benefit from phony tax losses. But if you can't measure income accurately, then distinguishing between the real losses that we want to allow and the phony ones that we still want to limit is tricky indeed. So, while we may not be at the optimum today, especially if (as Auerbach's paper suggests) the problem of real losses is growing more important due to a change in business dynamics, it's unclear exactly where we ought to go.

But a special capital gains rate for some set of investment fund managers is very poorly focused indeed on this underlying problem.

The L.A. Times op-ed admits that the effectiveness of using capital gains rates to encourage socially valuable entrepeneurship is "open to some debate." However, the only response it deems appropriate is "a simpler tax code that defines clearly the behavior it is trying to encourage." Big internal contradiction here. A simpler tax code would not result from trying to define the true value-creating entrepeneurs, e.g., those who are enough by way of making companies more profitable rather than merely outguessing the market by five minutes. That would undoubtedly be a complicated rule, inevitably drawing various objective bright lines about control percentage, ownership period, etc., that would further distort economic behavior and benefit mainly the accountants and lawyers who were in charge of making sure that particular investments qualified for the low rate. Almost certainly a bad idea.

There actually is one good rationale for the capital gains preference. It relates to lock-in, or the tax discouragement of selling appreciated capital assets, given that one can avoid the current tax by continuing to hold them. In view of this problem, a capital gains preference can actually raise revenue relative to full taxation, although I gather (from my memory of disputes and dueling revenue estimates from the time of the Bush I Administration) that the revenue-maximizing rate is more likely to be in the range of about 30% rather than 15%. (Although note that the optimal rate is likely to be lower than the revenue-maximizing rate.)

Anyway, this rationale seems singularly inapplicable to the investment fund managers if the stuff their firms hold is generally likely, in keeping with their business model, to be turned over quickly in any event, and if the investors in the funds, who get the remaining 80% of the turnover profits, are indeed getting the capital gains rate.

Bottom line: the Senate Finance Committee should press ahead with some version of its proposal, although I suppose Bush will just veto it anyway.

Nobody likes a whiner

The above is a quote from Bill Murray's character in the delightful, though I gather little-known, "Quick Change."

Brought to mind by the release of the new Wilco album. Jeff Tweedy can indeed be a whiner. But worse, based on the admittedly limited evidence of 30-second samples on iTunes, his new release sounds downright boring. Which is just as, though not, would have it. It's hard to tell this way, but 30 seconds a song was enough to sell me on Yankee Hotel Foxtrot, back in the day.

By contrast, the new Elliott Smith release, New Moon, is excellent even though one would ordinarily be suspicious of multiple posthumous offerings.

Saturday, May 12, 2007

These guys are good

That didn't take long. Today, the day after my 50th birthday, I got a letter from AARP, with membership card already printed in my name and dues card ready to go. What, they couldn't get it to me yesterday?

They bring to mind the Chinese restaurant a couple of blocks away. Order from them and the doorbill rings almost as soon as you hang up the phone. One wonders if they wiretap their customers' homes so they can have the orders ready.

If I do join AARP, which is unlikely at the moment, I wonder how much extra it would cost to get them to send the AARP Magazine in a plain brown paper bag. Don't want the neighbors seeing it & such.

Friday, May 11, 2007

Some random TV notes

Now that the summer has truly come in the main sense that matters to an academic - graduation was earlier today - I am plugging away on my tax & accounting article, which I feel is going well, but one needs to just do it for a while before stepping back and applying perspective. Between sections, or when a new part is thrashing around a bit before taking its proper shape, distractions, including self-created ones if nothing else comes up, are always welcome. So herewith a couple of notes prompted by TV viewing last night.

First, it's just amazing what the Pistons did to the Bulls in game 3 of their second round series. Detroit started the series with two unexpected blowouts, then the Bulls seemed to be making a counter-statement by pushing to a 19 point lead early in the third quarter, and it just didn't matter. The Detroit team of the last few years, along with the one that won two championships before Michael Jordan's breakthrough, is the best basketball team I've ever seen with no superstars. Or, they're the best I've ever seen at overcoming long stretches where they are pitifully unable to score. Somehow it just doesn't matter when they start to clamp down.

Second note pertains to Survivor, still the only network TV series that I have watched regularly in the past twenty-five years. My wife and I would have quit a few years back except that our kids wanted to keep watching, so it became a family thing to do. But after several years in the doldrums, it's actually taken on new life, whether or not anyone has noticed. The producers have made the tactical elements more complicated and tricky, for example by adding a hidden immunity item that one has to decide whether to play before knowing whether one needs to or not, and this has paid off dramatically at least twice this season. They've also managed to induce more fluid, less stable alliances. And the cultural norms of the contestants have evolved to accept greater opportunism towards alliance partners. Finally, the last two seasons have had greater racial and ethinc diversity in the cast, and this as well has paid off in terms of the range of interesting characters. So, while it's too late for this season if you're not already watching, and while who knows if next season will be any good, the current one (ending Sunday) has actually been one of the best ever.

Thursday, May 10, 2007

Major landmark

Tomorrow I turn, ahem, 50 years old. This is a pretty big landmark, reached by most individuals no more than once. It's strange to have been young all one's life, strongly conditioning one's self-image, and then increasingly to find that one is no longer so. That being said, I weigh the same and am in better aerobic shape than when I was a college or law student. I also would make short work of my past self if we played, say, racquet sports against each other. But alas, all this requires eating a lot less and exercising a lot more. I also increasingly get all sorts of aches and pains that I didn't know as well back then. Some days you just don't feel that good, once you reach this stage. I now have to do regular exercise and stretching routines for nearly every body part that is potentially injurable in sporting activities. I also need reading glasses unless the print is large and/or the lighting great. And dessert now often inspires something of the same mute horror that I assume mice bring to thinking about cats.

"Youth is wasted on the young" may be trite, but that doesn't mean it's true. (It's not.) Certainly it would have helped me, back in the past, to know some of the things I know now, but then again my tolerances have changed so as to remain age-appropriate. (Being a student was okay back then, but I'd hate to relive it now.) I'd say I'm a lot more contented now, albeit more careworn because I have more responsibilities. At and to this point, various life issues (personal and career) that were unpredictable thirty years ago have gone in what I feel were good directions. Who knows if this would still be true if one could turn back the clock and play it out again. If offered that deal, I would definitely say no and keep what I have.

I was lucky not to experience much death among people I was close to, for a very long time. Lately, not so lucky, as is inevitable when you keep going. Still, I'm hoping for a respite, and also for a very long time before my own decay gets too advanced. And with that cheerful thought, accompanied by a lot of genuine gratitude for so much of the past and present, I will close these reflections.

Thursday, May 03, 2007


Yesterday afternoon, at about 2 pm, I finally got the chance to start my summer research & writing. No exams to grade, as I spent a good part of the semester grading weekly papers in my colloquium, but lots of underbrush that I had to clear before finally getting started.

My first project for the summer & fall (when I'll be on sabbatical but in residence here at NYU) concerns the issue of book-tax differences, permitting publicly traded companies to report low taxable income and high accounting income, in each case potentially through dubious manipulation. Many have proposed requiring book-tax conformity, a notion that has some real problems despite its appeal. Rather than just taking a particular stance, I am hoping to bring a bit more analytical depth to the issues that are raised.

Other topics on my agenda include penalties for taking ex post erroneous tax positions (I have an SSRN-posted paper on this, but hope to dig deeper), possibly something on the estate or inheritance tax/generation-skipping tax set of issues, and possibly something on generational equity, a topic on which I've heretofore focused on measurement issues while putting off consideration of the philosophical merits. That might even turn out to be a book, but then again it might not even end up being an article. On vera.

But all this may have to wait a bit. I'm off today to Chicago, where tomorrow at a tax practice-related conference (at Chicago Kent Law School) I will be discussing the economic substance doctrine in tax law, in terms likely to be more encouraging to the IRS people in attendance than to some of the Chicago practitioners, who I recall as a bit Wild West-style and anti-government compared to the New York practitioners.