A calm perspective on Irene

"Hurricane? What hurricane?"

UPDATE: It looks like Seymour was right to be so calm about it.

Another of my international tax articles comes out

My paper "The Rising Tax-Electivity of U.S. Corporate Residence," previously posted here, has now officially come out in the Tax Law Review. A link to the published version is available here.

The abstract is as follows:

"In an increasingly integrated global economy, with rising cross-border stock listings and share ownership, U.S. corporate residence for income tax purposes, which relies on one’s place of incorporation, may become increasingly elective for new equity. Existing equity in U.S. companies, however, is effectively trapped here, given the difficulty of expatriating for tax purposes absent a bona fide acquisition by new owners.

"Both the prospect of rising tax electivity for new equity and the very different situation facing old U.S. equity have important implications for U.S. international tax policy. This paper therefore explores three main questions: (1) the extent to which U.S. corporate residence actually is becoming elective for new equity, (2) the implications of rising electivity for the age-old (though often mutually misguided) debate between proponents of residence-based worldwide corporate taxation on the one hand and a territorial or exemption system for foreign source income on the other, and (3) the transition issues for old equity if a territorial system is adopted."

In addition to the discussion referenced in the abstract, the paper foreshadows and provides a brief exploration of a somewhat bigger topic: what (in my view) is fundamentally wrong with a lot of contemporary academic international tax policy analysis, and what the analysis should instead look like. Much more on this to come in my book in progress, Fixing the U.S. International Tax Rules.

Some of the building blocks of this analysis also appear in the two main versions of my recent article on foreign tax credits, available here and here. But in Fixing I hope to have it all nailed down more definitively and concisely.

A collective action / externalities rationale for Keynesian stimulus

I'm no longer surprised by the frequency with which good economists - of course, not all of them - fail to understand and apply basic economics reasoning. In the fields I write about professionally, I'd have to say I'm grateful, as it's good for business.

A key reason for these failures is that people get lost in the forest and can only see the trees. They play with models, use math, etcetera, but forget the basic underlying intuitions. Or, they become prisoners of simplifying assumptions that are often (but not always) useful, and forget that these assumptions should only be used conditionally and when appropriate.

Today's example is Robert Barro, who has a Wall Street Journal op-ed today (available outside the paywall here) claiming that Keynesian economics, unlike "regular economics," can't possibly make sense. Thus, with regard to the claim that Food Stamps or unemployment benefits could boost demand and help ease the recession, he concludes:

"There are two ways to view Keynesian stimulus through transfer programs. It's either a divine miracle—where one gets back more than one puts in—or else it's the macroeconomic equivalent of bloodletting."

And elsewhere he says of the at one time uncontroversial Keynesian idea that giving money to the cash-constrained can be stimulative:

"How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?"

David Glasner responds to Barro as follows:

"But wait a second. What does Barro mean by his query: 'Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?' Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

Glasner then asks whether Barro agrees with the real business cycle theorists who explained that the Great Depression merely reflected millions of workers' rational decision to take a nice long vacation until productivity and therefore wages were higher.

Paul Krugman jumps in as well, and mentions some of the standard points from Keynesian economics for which there is empirical evidence, such as sticky prices and wages.

But I have long thought it reasonably clear (as discussed somewhere in here) that a very familiar tool can do a lot of the work here - collective action problems. Economic models often simplify the world, and in the right setting with good reason, by taking people's preferences as given and assuming away interdependence. But suppose I am deciding whether to spend money on a nice vacation. Even in an entirely rational setting and with a flexibly responding price system, this may depend on how well I expect my business to do over the next few years. Suppose people who are considering whether to patronize my business have exactly the same thought in mind. Their willingness to buy goods and services depends importantly on their confidence that others will be buying their own goods or services. So, when everyone gets scared or anxious, there is a coordination problem. If only everyone could agree to shake hands and continue opening their wallets a bit, the problem would ease, but instead it feeds on itself, as belt-tightening here prompts responsive belt-tightening there.

To throw in another common buzzword, there's an externality here, as each individual's belt-tightening causes others to lean more towards belt-tightening, creating collectively self-fulfilling prophecies about low earnings potential.

Against this background, Food Stamps and unemployment benefits, by getting people to spend more (albeit perhaps more because they were cash-constrained than due to the vacation problem above) can get things moving in the other direction. People whose businesses start doing better change their estimats about how much it makes sense for them to spend, and things may start going the other way.

Back in January 2009, Barro had a WSJ op-ed that was almost as skeptical about stimulus, in which he said:

"[Keynesian theory] implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system."

Seen through the above lens, however, the price system in a recession or depression may be getting it exactly right so far as revealed preferences are concerned. Resources are idle because there isn't enough demand for the production that is being forgone. And given all that the price system is working just fine.

But the seemingly efficient equilibrium is far inferior in human welfare terms to the alternative one that would result if people could coordinate shifting to a higher-expressed demand, higher-output equilibrium.

This presumably is what Glasner means when he says: "Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

And this is why the view that the Great Depression was just a nice long holiday, as people awaited higher productivity that would increase their willingness to swap leisure for work, has never seemed very intuitively persuasive.

But the use of collective action problems and externalities that I suggest here lies outside conventions that economists are accustomed to allowing in their models (which commonly take revealed preferences as given rather than conditional and interdependent, and assume away externalities unless clearly demonstrable like that from pollution). Also, the use I suggest is admittedly a bit informal and ad hoc, which economists may rightly be on guard against. But it is coherent logically, plausible intuitively, and permits one to make more sense of the world. Barro's apparent inability to see that it might be relevant, and thus his entirely misplaced sarcasm about whether Keynesian economics could possibly make sense outside the realm of "divine miracle," is more disappointing than surprising.

A quick comment on corporate tax incidence

Lee Sheppard has an article in today's Tax Notes that riffs off Mitt Romney's "corporations are people" comment last week to address corporate tax incidence.

Lee criticizes economic models suggesting that labor bears the main burden of the corporate tax, in part by stating:

"It has even become fashionable to say that labor bears something like 40 to 80 percent of the economic burden of the corporate income tax. This defies common sense. We know that because if labor bore such a significant share of the corporate income tax, corporate managers would not devote so much time and effort to fighting it."

Here's why I believe Lee is wrong about this. The incidence claims are about the long-term difference between equilibria. For example, suppose a country raises its corporate tax rate, within a couple of years this reduces the amount of capital that would otherwise have been invested in the country, and this in turn causes wages to be lower than they would otherwise have been. Proof of the causation in this sequence would demonstrate that labor was bearing some of the corporate tax increase via the wage effect.

In politics, however, people mainly care about short-term transition effects. Thus, suppose that today (without any prior anticipation of this happening) we simply repealed the corporate tax. Ignoring the deficit problems that this would cause, along with the rampant avoidance of the individual income tax that it would empower, who would be the big transition winners? Obviously, shareholders at the moment that the change occurred (or rather was announced) would get a huge increase in share value from eliminating all company-level income tax liability. Managers no doubt would win big-time as well. Meanwhile, wages for the most part would not change immediately.

This not only explains the observable political alignment on corporate tax issues, but is entirely consistent or reconcilable with the long-term incidence story that focuses on labor and wages.

Lee also complains in her article about a recent vote by the American Economic Association not to require disclosure of funding sources. She believes that private funding has undermined the objectivity of research, along with intellectual balance in the corporate and international tax fields. Treading carefully here, as I am on friendly terms both with her and with some of the people whom she might conceivably have in mind, let me just say that I agree this is a serious problem, which cannot be dismissed simply by defending people's good faith and/or incentive to preserve their own intellectual reputations. What is more, from conversations I have had with a variety of people, I can definitively say that many in the field share Lee's concern, including people who do academic research and/or are not fully on her side in the underlying debates.

Death of Bernard Wolfman

I'm saddened by the death of emeritus Harvard tax law prof Bernard Wolfman, whom I had gotten to know at HLS conferences, and whom I always enjoyed seeing again.

On the academic side of things, the two articles of his that I know best - both diatribes, but in each case justifiably so - are (1) an attack on the Supreme Court's egregious Frank Lyon decision (which upheld a sale-leaseback tax shelter, based on a silly list of 23 factors and a bizarre insistence that 3-party deals are inherently better than 2-party deals), and (2) a critique of Justice William Douglas' tax jurisprudence, which bizarrely switched, I believe it was in 1948, from being routinely pro-government to anti-government (except for one subsequent case, called P.G. Lake, in which Douglas apparently decided that he hated oil company executives even more than the IRS).

Each has some apparent back story. In the Frank Lyon article, I believe one can discern that Wolfman was unhappy on ethical grounds about the behavior of the renowned Erwin Griswold, a tax prof who had been his colleague (and the Harvard Law School Dean) not to mention Solicitor General of the U.S., and who thus carried some clout when he represented the taxpayer before the Supreme Court. In this case, Griswold seems not to have done his best to inform the Supreme Court accurately of the tax stakes in the case (which pertained to tax rate differences, since one of the parties had tax losses that made depreciation deductions unusable). In the Douglas article, Wolfman does not try to explain the reason for the 1948 change of heart, but I wouldn't be surprised if he knew a story that the late Walter Blum once told me, to the effect that Douglas changed sides in tax cases after he was audited, apparently in relation to reimbursements for his wife's travel expenses when he gave speeches. I've never tried to check out this story, but Douglas actually has a somewhat foolish dissent in a case involving this issue that is in my co-authored Tax I casebook. If true, however, bad move by the IRS but not very edifying so far as Douglas is concerned.

One part of Bernie's career that may not be well-known, but that he once told me about at dinner, pertained to his service in World War II. He was in an infantry division on the German front after D-Day, and apparently would have been right at the spot where the Germans attacked in the Battle of the Bulge, except that he was evacuated a few days beforehand due to severe frostbite in his feet. This he attributed to the fact that the U.S. Army, trying to be thrifty, gave its soldiers on the German front - in the middle of what was apparently one of the coldest winters there in the 20th century - footwear that had been designed for fighting in the scorching deserts of North Africa.

Warren Buffett on taxing the rich

Warren Buffett has drawn considerable attention with his op-ed in Monday's NYT suggesting that tax rates be increased for people at the top of the income distribution:

"Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent....

"But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.

"My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice."

Some on the right gibe that, if Buffett wants to pay more to the federal government, that's fine; he can do so any time he likes by making a voluntary donation. But Buffett wants people in his income tier generally to pay more tax, not just himself personally, so the critique is wide of the mark. He can't unilaterally achieve the social effects of a higher tax rate on rich people generally all by himself, and it's not especially selfish to ask "Why should I be the only one to pay more?" Perhaps it's equally wide of the mark on the same ground, however, when people on the left complain that those on the right shouldn't take advantage of government subsidies that they argue should be repealed.

As I discussed in my recent Tax Notes article, the policy Buffett advocates of imposing significantly graduated rates at high income levels is in tension with what long was the predominant view suggested by the optimal income tax or OIT literature (which takes distributional concerns into account, not just efficiency). But that consensus is increasingly vanishing, even within the OIT framework. I noted this (and some reasons for the change in views) in my article, and since then the Peter Diamond and Emmanuel Saez's have further spelled out some of the main arguments in The Case for a Progressive Tax: From Basic Research to Policy Recommendations.

Before one swoon too much over Buffett's nobility (though I do indeed find his stance praiseworthy), a caustic comment from David Miller may be in order. David notes that Buffett's "Berkshire Hathaway stock appreciated by $3 billion last year and, unless he is extraordinarily patriotic, there will never be any income tax paid on his unrealized appreciation. So his tax rate on the economic income he earned last year is more like 0.22% ($6.9/$3.039.9). Even if his tax rate on recognized income was increased to 100%, the tax on his economic income would be a little more than 1% ($39.9/$3.039.9). A mark-to-market tax on appreciation at a 15% rate would have raised $450 million in 2010 from Warren Buffett alone!"

David is the author of A Progressive System of Mark-to-Market Taxation, under which current year mark-to-market taxation of publicly traded securities such as Berkshire Hathaway stock would indeed be required, so this is no idle or random suggestion. Buffett presumably will never pay tax on the appreciation due to Code section 1014, which gives assets a tax-free basis step-up at death.

On the other side of the ledger, it is certainly fair to note that Berkshire Hathaway appears to pay tax at something like a 30 percent rate on its financial accounting income, if I am correctly interpreting this. I myself would count this as paid by Buffett, to the extent of his stock ownership. While there are disputes about the economic incidence of the corporate tax, similar questions could be raised about non-corporate business taxes that the owners pay directly.

I myself, if generally empowered to specify tax code changes, would opt both for corporate integration (so that Buffett wouldn't be taxed at two levels on BH's income - though, as it happens, I would prefer to concentrate the tax liability at the shareholder level, without regard to the payment of dividends) and for greater high-end rate progressivity.

Another point well known to those who have been following the budget debate, but perhaps worth mentioning here, is that solving the long-term U.S. fiscal gap realistically requires not just revenue increases from the top end of the income distribution, but extending significantly down the income scale to at least the middle-middle. With an aging population and retirement programs that serve important social purposes (and also are baked in to people's behavior and expectations), raising taxes just at the top will not be sufficient. But raising them at the top as part of the short-term budgetary response (if anything happens from the Gang of Twelve deliberations) would certainly be a start.

If Obama were shrewd ...

... then, instead of denouncing the S & P downgrade (tempting though that must be given their embarrassing track record and the $2 trillion computational blunder), he would have said "Yes, it's terrible that the Republicans have caused this. This shows how right I was about not endangering our credit, about the need for more revenue and a balanced grand bargain, etcetera."

As things stand, he risks making himself the downgrade's sole owner in the U.S. public mind, without necessarily having any effect on market confidence (downgraded debtors are expected to complain).

But the heading of this post makes it alternative history, along the lines of "What if Lee had won the battle of Gettysburg?".

Middle Earth alternative history

I've been greatly enjoying Kirill Yeskov's The Last Ringbearer. This is an alternative history / sequel to Lord of the Rings, written from a pro-Mordor, anti-Gandalf/Aragorn/elves viewpoint that is actually highly persuasive (if one can say this about a fictional world). It reviews what we thought we knew but didn't (due to our having only a biased winners' history) about the end of the Third Age, followed by a quest that aims to restore the balance that Gandalf et al had destroyed.

More information, including what I gather are legal downloading options, is available here.

Standard & Poor's expected Treasury bond downgrade

I agree with the S & P downgrade (if advance reports are accurate) in substance. That is, the U.S. has a significant chance of default because of political dysfunction, in particular the Republicans' recently demonstrated callousness about our credit standing and their unwillingness to increase tax revenues under (apparently) any circumstances.

But it's certainly not obvious that the market should care about the downgrade. When major U.S. companies issue bonds, S & P actually has some inside information if they've been consulted during the rating process. There may be conflicts of interest and the smart guys on the other side may snow them, but at least they get to see things that aren't publicly available. As I noted in an earlier post, this is not true in the government bonds setting.

Here's a somewhat farfetched theory as to why the market may care. S & P's willingness to downgrade, as a bid to enhance their "brand," is evidence that they think people in the audience for their performance will consider the downgrade credible. So if I am in the bond market, it is a bit of a Keynes beauty contest thing - someone with a real (reputational) stake has decided that others who are in the bond market will view this as a credibility-enhancing play. Note that pessimists may not directly participate in the market as much as optimists if the market is incomplete because it is costly to go short.

Nonetheless, I'd be unsurprised if there is no market response to the downgrade.

Obama's next two chances to capitulate

Both are set for September 30, when House Republicans can both cause a government shutdown (as Stan Collender explains) and force the gas tax to expire unless whatever demands they can think of are met.

By the way, there is no need to limit these demands to spending cuts. There will probably lots of unrelated demands as well. (Healthcare, oil drilling, reversing other regulations they don't like, any tax changes such as a dividend holiday that they happen to favor, etcetera.)

Given what happened the last time around, what would be the argument within Republican circles against playing these to the hilt? After all, neither involves threatening to destroy the full faith and credit of the U.S. government. And even if Obama genuinely plans to stick to his guns this time (not that I'd actually expect him to, closer to zero hour, even if he sincerely believes that he will), how could he possibly communicate this credibly to the Republicans?

Three mistaken views contrary to blaming White House incompetence for the debt debacle

It's much more fun to be counter-intuitive than to repeat the obvious. So, when we see overwhelming evidence of egregious and pathetic political failure by the Obama White House, there is no shortage of theories defending them (or at least saying that their political ineptitude was, as an appeals court might say in affirming a trial court judgment, harmless error).

Theory One is that he wanted more spending cuts than Democrats are comfortable with. So the Republicans gave him cover. As in: "See what they're making me do?"

Verdict: True that he had this motivation. Perhaps even true that it influenced his feckless negotiating "strategy." But surely he did not want to get rolled, and so publicly and humiliatingly rolled, by the utter failure of his oft-repeated insistence on getting revenues as well as spending cuts. So bottom line: False.

Theory Two is that he simply had a weak hand to play. Sure, he might not have played it well, but even a competent politician and negotiator wouldn't have done much better.

Verdict: 100% false. The public supported his preference for "balanced" cuts and tax increases. Now, admittedly, public opinion is often close to irrelevant in Washington. But he had a decent hand and failed to play it. Point one: the constitutional option and related gambits, all of which would have gained support from Washington's beloved "strong leadership" meme. Point two: skillful politicians can do much better with hands that are much worse than what he had here. Think Clinton in 1995 after he lost the 1994 election. Or for that matter consider the Republicans taking him on in 2009. If either had performed as abysmally as he did, people would have said: "They just had a bad hand. Nobody could have won with that."

Just because he lost doesn't mean he had an inevitably losing hand. In many ways it was a good hand.

Theory Three is that he's cleverly positioning himself in the center, and letting the Republicans be seen as extremists.

Verdict: Mostly false. People also respect strength, commitment, self-confidence, and success. His pathetic showing is not going to win him the 2012 election. He's disheartened his base, millions of whom will likely stay home. Clinton positioned the Republicans as extremist (when they weren't nearly as far around the bend as they are today) without making himself look like a pathetic loser.

The evidence that Obama has very little understanding of the most basic political tactics and strategy is pretty overwhelming. This is a guy who believes that you start a negotiation by offering LESS than you want, not more so that you can give ground and still do well overall.

Jon Stewart had some rather obvious fun with the December press conference clip where he said that of course the Republicans wouldn't risk the full faith and credit of the U.S. government, so there was no need to negotiate a debt ceiling deal back then. And for the past 6 months his minions have apparently been telling reporters that of course the Republicans will agree to new revenues, because reasonable people can't disagree that it's part of the problem.

He also appears to be strangely arrogant and uneducable about his woefully naive view of political competition. The Bourbons famously "learned nothing and forgot nothing." Obama will evidently learn nothing and forget everything.

Recent talk at Oxford summer symposium

I recently noted here my trip to Oxford in early July to present a paper and otherwise participate in an international tax conference. But in the press of events (even my summers are busy these days), I forgot to create a link to the slides from my talk.

At this year's Oxford conference, I presented a talk based on my forthcoming Tax Law Review article, The Rising Tax-Electivity of U.S. Corporate Residence, using revised and condensed slides. A link to the new slides is available here.

I have recently (and FINALLY, after months of intervening obligations, for the most part voluntarily if in some cases ambivalently self-imposed) gotten back to working on a completed revised version of my long-in-progress book on U.S. international taxation. At this point, I think I finally have it conceptualized properly. And I believe that this time, unlike in Decoding the Corporate Tax, which I admittedly like but which was basically (and avowedly) an accessible literature review, I'm making significant new contributions to how people should think about the field. The tax-electivity piece is one of the detours that I voluntarily set for myself because I felt that I needed to get my ideas in better shape first, and (along with my recent foreign tax credit work) it offers in passing some, though by no means all, of the ideas that I plan to detail in the new book.

Obama at the car dealership

"There's one thing you should understand before we start talking price. I need this car, and I know you want to be fair to me. We're both better off if we're both happy afterwards.

"I don't have transport - I sent the cab away, and I didn't bring my cellphone. So I promise you right here and now that, no matter what happens, I am not going to another dealership. Again, I need this car, and I know you want nothing more than a satisfied customer.

"So here's what I'm going to do. The sticker price is $24,995? Great. I am offering you $26,000. That's fair, so there's no need for you to hold out for more. Why bargain when we can go right now and just sign the papers?

"What do you say? Deal?"

If we had a parliamentary system ...

... then not only would the party in power after the 2008 election have been able promptly to pass legislation that it wanted, and not only would we have avoided the perverse incentive structure whereby one of the parties has veto power without responsibility, and no incentive whatsoever to cooperate on anything (a point brilliantly grasped by Senator McConnell), but the Democrats would now be able to kick out their leader and elect a new one via party caucus.

Perhaps my mood on this is too dark, but I am thinking that it's about time for people in the Obama Administration who don't want to be associated with its cowardice and ineptitude to start resigning.