New York Times article on corporate stock options

In today's Times, David Kocieniewski has an article noting how the revival of stock prices has led to a new explosion of executive stock options offering huge payouts to high-ranking executives. The article emphasizes the entity-level tax angle, which is that, when the executives exercise their options - typically at a huge profit, even if their companies have failed to outperform the stock market - the companies get huge deductions that may zero out their taxable income.

The natural reply to make to this critique is that there is no tax angle after all, if the executive is taxed at the same marginal rate as the company. (And note that even a company facing a low average rate on its income, due to other tax planning such as causing its U.S. income from intangibles to be treated as arising in tax havens, may face a 35% marginal rate in the effective range.) Thus, if Steve Ballmer gets a $100 million stock option and both he and Microsoft face 35% marginal rates, then its $35 million tax saving is offset by his $35 million tax bill. Denying it the deduction but taxing the underlying income only once - by allowing him to receive it tax-free - would lead to an identical after-tax result on both sides of the transaction if it responded to the change in rule by paying him $65 million.

I doubt many readers of this blog entry will consider this either a novel or a hugely surprising point. Indeed, it is made repeatedly, and at times vituperatively, by readers of the NY Times article who posted comments discussing it. So let em just add two further lines of discussion here.

First, I would certainly agree that the executive comp discussed in the article is a huge problem, even if it isn't a tax problem. The issues it raises are twofold: distributional and corporate governance. As to the former, rising executive comp over the last 20 years is a huge contributor (both directly and indirectly) to rising U.S. income inequality during this period. Conventional economic theory would suggest that this merely reflects that the execs are adding more value, so even if you dislike the distributional result it would be gratuitously inefficient to attack rising executive comp as such. I happen to think that conventional economic theory is wrong in this case, but that would require a lengthy discussion of its own that doesn't really fit well here.

So let's move on to corporate governance. A large part of the appeal of stock options to inside players as an executive comp tool lies in the opportunity that the options offer to facilitate looting of publicly traded companies, if you want to put it as rudely and crudely as possible. Or. if you want to put it more politely, stock options are a really crucial tool for overpaying mediocre executives - not all of whom can be above-average, after all. Even without any tax angle at all, the options offer a wonderful excuse to compensate the mediocre as if they were geniuses, by allowing them to ride the overall rise in the stock market to claim huge payouts that they pretend reflect their own influence on the stock price. (And if the stock market goes down rather than up, no problem - the company simply reprices the options and gives the executives another chance. So it is rather like getting to place huge bets on the roulette wheel where it's someone else's money, and where if red doesn't come up this time you get to try again and again.)

While this is a serious corporate governance problem, to a degree one could argue that the tax system actually helps, rather than making things worse. High-ranking executives might be happier still if stock options were nondeductible, assuming that this meant that they would also be treated as tax-free to the grantee. Returning to the Ballmer-Microsoft example, in such a state of the world they could announce the value of the grant (at exercise) as only $65 million, yet it would produce the same end result as giving him $100 million under current law.

Indeed, taxpayers like this result so much that they are often apparently quite willing to risk paying MORE tax overall if this permits them to steer as close to it as present law permits. As a starting point for explaining this, note that options could in principle be taxed earlier still - when they are granted, rather than when they are subsequently exercised via a purchase of the company's stock at the option's strike price.

Why aren't executive stock options taxable when granted? After all, they may have significant option value even if they are not yet "in the money." The reason that they usually are not taxable when granted is that they usually remain subject to a "substantial risk of forfeiture" (rather than having irrevocably vested), rationalized on the ground that they represent contingent compensation for future services that might affect the stock price and thus the option value.

Under the relevant Code provision, however, employees can elect to have the options valued and included (as well as deducted by the company) in the year when they are granted. If they make this election, the option is valued as if the risk of forfeiture did not exist.

This in turn led for years to the following tax planning trick. I elect to have my option valued and included / deducted in the year when it's granted. But I claim that the option value is zero, reflecting that it is not yet in the money (i.e., the stock price doesn't yet exceed the exercise price). In fact, the claimed value is ludicrous, since the person claiming the zero value would very likely refuse to sell the option, if this were permissible, even if offered many thousands (or perhaps millions) of dollars for it.

The IRS was so upset about this trick that it issued a regulation providing that, if the option's value isn't sufficiently "ascertainable" (which basically requires that it have an observable market price), taxpayers can't go the election route here. So the IRS effectively forces many taxpayers, contrary to their preferences and an arguably fairer reading of the statute itself before the regulation was issued, to wait for taxable income at a later point.

The funny thing about this, in turn, is that, once the employee has recognized taxable income (and the employer a matching deduction), further appreciation is taxable to the employee (though generally at just the capital gain rate) without a matching employer deduction off any kind. So the low valuation "scam" that taxpayers prefer and the IRS prevents may actually be a route to higher, rather than lower, overall taxation.

What could possibly be going on here? Well, probably several things. For one, if the company has net losses (as may be common in the start-up period even without tax haven games and the like) then the employer deduction doesn't actually make up in full for the employee inclusion. For another, if you hold the stock until death then the deferred tax on post-taxability appreciation permanently disappears. Perhaps a few people are myopic and just want to defer the employee-side day of reckoning. Executives who are trying to hide the ball regarding how much they are actually getting paid don't want to pay tax sooner since it's inconvenient to have to rely on gross-up to make themselves whole.

Bottom line, without condemning today's article in the Times there are still some interesting angles to pursue, though it's possible that the editors would consider them too esoteric for a page 1 placement. But perhaps still worthy of page 1 in the business section?

Wonky teaser for my FAT versus FTT article

Bruce Bartlett's newly posted Tax Notes column criticizing financial transactions taxes (FTTs) reminded me that, while James Tobin is often considered the FTT's grandfather due to his 1970s advocacy of a tax on currency exchange transactions, John Maynard Keynes offered a seemingly very similar rationale for a tax on securities trades. However, I may argue in my paper that, insofar as the rationales can be teased apart, Keynes' actually stands up better today than Tobin's.

As the year winds down ..

I'll be spending a significant portion of the winter break writing a short article (based on my talk at the Amsterdam conference earlier this month) called "The Financial Transactions Tax Versus the Financial Activities Tax." I conclude, however, that the article's title states a false opposition, since a financial activities tax (FAT) should be passed in any event, whereas a financial transactions tax (FTT) might or might not be desirable on balance - whether or not there is an FAT - based on issues entirely distinct from the overall treatment of financial sector firms and the risk of another 2008.

The one time I baffled my Amsterdam audience with American slang

In general, I thought my Amsterdam talk went smoothly and was well-received. But at one point, with reference to bankers who make bets that have positive expected returns for them because they don't bear the downside tail risk, I unthinkingly said something about how sometimes it comes up snake eyes. Alas, pretty much no one in the predominantly Dutch audience knew what this meant, and several asked me afterwards. But they agreed that the Americanism for rolling a pair of ones in craps is striking and apt.

Amsterdam conference on bank taxation

Yesterday was the conference day in Amsterdam at which I delivered my talk on the FTT versus the FAT (see previous entry). The FTT, aka (in an absurd misnomer, whether one Iikes the tax or not) the "Robin Hood tax," did not, for the most part, receive a lot of love. Not surprisingly, representatives of banks and hedge fund-type asset managers were, shall we say, restrained in their enthusiasm for the measure. But academics were mostly skeptical as well, for good reason, notwithstanding the contrarian instincts that a couple of us had.

By the way, although for convenience I'll continue calling the European Commission's proposal an FTT, it is really an STT, or securities transaction tax, as stock trading (other than primary issuance) is the core item covered, and things such as currency exchange (the original Tobin tax target) and debt transactions are excluded.

An FTT is potentially extremely avoidable. For example, as is well known, geographically. A telling example arose when Sweden enacted an FTT a few years back, even though all the financial actors that would have been charged with collecting the tax said they would avoid it by going to London. This of course is a standard taxpayer threat, not always fulfilled in practice, but lo and behold, when the tax was enacted 60 percent to 80 percent (depending which estimate you take) did indeed go to London virtually overnight.

Then of course there is the issue of using derivatives. Why sell stock, for example, if you can use a swap instead. So a modern day FTT is a joke unless it can reach derivative transactions, by interpreting them as versions of some underlying "primary" transaction.

The Commission's response to this problem has been to try to pitch the proposal broadly. While it can't reach transactions that wholly leave the European tax net (e.g., say an American pension fund would have used German bankers to purchase developing world equities, but decides instead to use a U.S. broker), but the design tries to push having some sort of European connection as hard as it can.

Likewise, derivative transactions ostensibly are reached by basing the tax (though at a lower rate than for other transactions) on the highest (in effect) notional principal amount one can come up with in defining the direct transactional equivalent. (Unclear, of course, whether this is coherent or feasible.)

Exceptions for debt and insurance, which are excluded from the reach of the tax, would likely offer fertile tax planning grounds for avoidance efforts, especially if some EU countries decided to compete with each other for the hosting privilege by, say, broadening their state law definitions of insurance.

The Commission's STT would reach a lot of inter-bank transactions (often taxing both sides), and ostensibly would thus apply even to deemed transactions between branches of the same company or corporate group. Indeed, the Commission may regard this as a strength of the proposal, as it ostensibly counters the critique that customers rather than the banks themselves are being taxed. Some pointed out that this sort of cascading tax within the productive process is exactly what the VAT was supposed to end. (And it is of course contrary to any well-informed economic view about how to make business taxation less rather than more inefficient.)

As the next to last speaker on a long day, I was able to modify and fill out my commentary (from the previous blog entry) a bit, such as by noting that what I see as the best case for some sort of an STT (to discourage socially excessive pursuit of zero sum trading gains) would face many of the same problems but require a very different design. I might want to emphasize taxing trades with customers rather than internal cascading, but then again, what is a "customer" for this purpose? Surely it should include people who are seeking trading gains through a business entity (whether via share ownership or compensation arrangements), which potentially brings back the cascading issue. (And, just because integrated businesses, as distinct from those dealing with each other at army's length, are engaged in zero sum battles over division of the surplus, does that mean we want to comparatively tax-favor them? That wholly contradicts the Coase principle of hoping they will pick the arrangements that are best on a pretax basis.) So perhaps I have to settle for an STT just on sales to customers, though including some legal entities such as shells and pension funds, and without here affirming that it would actually be worth doing in the end.

A financial activities tax or FAT on banks, using a VAT-like design but perhaps with rising marginal rates to address bigness, rents, or suspected hidden tail risk (with the choice importantly affecting key design features) seems considerably easier both to design and to rationalize persuasively.

Amsterdam slides: The Financial Transactions Tax Versus the Financial Activities Tax

My slides on the FTT versus the FAT, to be presented this Friday at the Amsterdam Centre for Tax Law's conference on taxing the financial sector, are available here.

One topic I don't address in the slides, because I didn't think it was within my topic assignment, concerns the question of FTT feasibility. An FAT is pretty much feasible. The only really troubling question (and I admit it's a significant problem) is defining the set of financial sector firms to which it would apply. In particular, what does one do about the issue of financial firms that are in effect embedded in non-financial firms?

With respect to the FTT, one problem is international considerations, which are likely to be a lot more troubling than those presented by the FAT. Domestic banking activity, which the latter tries to reach, is a more stable and less elusive category than the former's reach of domestic financial transactions (or even those conducted by domestic taxpayers).

But in addition, the wonderful world of derivatives presents a huge challenge for the FTT. I know people are aware of this, and contemplate taxing derivative transactions under the FTT equivalently to the "primary" (or whatever one calls it) transactions that they replicate. But it may often be impossible to determine this equivalence, since there may be multiple renderings of what is equivalent to a given derivative transaction. This is likely to be a big problem even if regulators are able to observe everything that is happening, which is a big question in itself. I believe that other panels at the Amsterdam conference may be directly addressing this issue, but it did not appear to be the focus of the more bigthink-oriented panel on which I was asked to participate. It is certainly important, however.

Part of my responsibility in connection with the proceedings is to write (by the middle of January) a short article that will be published in a conference volume that the Amsterdam Centre for Tax Law is planning. I will of course post it on SSRN, and I also have permission to do something with it in the U.S., such as submitting it to Tax Notes. But I don't know yet if I will consider this suitable. (I'd have to see what I write in order to evaluate this - the issues being both how happy I am with it and whether it seems sufficiently in-context for U.S. publication.)

That photo surfaces again

A number of friends and acquaintances have mentioned to me, over the last couple of days that this 1992 photo of me with (now)-Justice Elena Kagan has surfaced again, this time in the latest issue of New York Magazine.

Someone was kind enough to say that I don't look much different today despite the nearly twenty year interval. But I suppose that, if only the photo were doing all of the aging for both of us, Dorian Gray-style, perhaps I would feel better still. As it is, I can certainly tell the difference between then and now, even if it doesn't all show.

If it's Friday, this must be the Netherlands

Okay, I admit to having overextended myself a bit these past couple of months. But I am hoping my body will accept the last few insults (such as time zone changes and overnight flights) without getting too angry at me.

Although I returned from Brazil only yesterday (Monday, December 5), an evening flight on Wednesday, December 7, will take me to Amsterdam early on Thursday, thus giving me a day to time zone-adjust before I present a talk on Friday at the Amsterdam Centre for Tax Law's Conference on Taxing the Financial Sector. This time, I am just one voice in the crowd, rather than the headliner.

Why did I accept, notwithstanding the events' close proximity? Well, for a few reasons, even apart from my being generally more temperamentally inclined towards yes than no. One is that the conference looks interesting and has a good group of people that is different from those I have been seeing lately at other conferences. Another is that the topic is quite interesting, and different from international tax, which has been my main focus in recent months. Plus, I haven't been in Amsterdam since 1983, and wouldn't mind seeing the Van Gogh Museum and Rijskmuseum again, as well as the Anne Frank House for the first time, not to mention having some rijstaffel and strolling around the canals and all that, even in what is likely to be fairly dismal weather.

The background for the conference is that people in Europe are debating various tax instruments for the financial sector. Unlike in the U.S., such taxes can actually be enacted, at least here and there. The International Monetary Fund Staff advocated a financial activities tax (FAT), which is essentially an excess profits tax on banks (reaching high-end employee compensation as well as profits that remain after paying all that swag). But the European Commission has endorsed a financial transactions tax (FTT) in lieu of the FAT. An FTT is a tax on securities transactions (other than initial stock issuance).

It's unclear to me, even after reading the European Commission's work on the subject, exactly why they prefer the FTT to the FAT. There is probably a political backstory, at which I can guess, but as an American (and thus an outsider to the European debates) I certainly don't know anything about this firsthand.

My own prior work, as well as blog posts, explain why I consider the FAT a better choice than the FTT. But, as my slides will show when I post them here in the next couple of days, I actually do see a decent rationale for enacting a modest FTT in addition to (not instead of) an FAT - or more precisely, independently of whether or not an FAT is enacted. Only, this rationale for an FTT has nothing to do with those offered by the European Commission, or with addressing past or expected future financial sector defalcations, or indeed with responding in any way to the threat of future bank failures reflecting undue risk-taking incentives that are likely to lead in the future either to costly bailouts or to further macroeconomic catastrophes (or perhaps, like last time, to both).

More on this shortly.

Reprieve

Today I flew back from Sao Paulo to engage, among other things, in the grim task of going to the veterinarian in order to assess how my favorite little gal, Ursula, is doing.

The state of the play when I left for Sao Paulo was: Not so good. A couple of years ago, she just barely survived a kidney infection that left her with damaged but still for the most part functioning kidneys. But she had worsened again from a new infection, needing to be hospitalized and placed on IV, which in turn had transitioned to no-heroic-measures. Here is how she looked in the vet's office a few days ago.











So when I went to see her today (with spouse), having pretty much just gotten off the plane from a redeye flight, my understanding was that it was not impossible that we would need to be saying goodbye to her very soon. To my relief, however, she looked pretty good - there is plenty of energy and fight left in the little gal yet, at least for now. So she has returned back home, where she is eating and rubbing her head against people while purring loudly in the accustomed manner. No telling how long this will last, however, and she will be needing daily water shots.

I hope Ursula wouldn't mind if she knew that I was cozying up with some other animals while I was in Sao Paulo. Kind of burying my sorrows, I suppose.

Deborah Paul comments on Avi-Yonah dividend deductibility proposal for corporate integration

Some time back (on October 4 of this year), I was a commentator, along with Deborah Paul of Wachtell, Lipton, Rosen, and Katz, on a paper by Reuven Avi-Yonah of U. Michigan Law School concerning dividend deductibility as a corporate integration method. A link for Reuven's paper is available at my blog entry here, and my comments at the session are available here.

Debbie Paul, whose comments I thought were quite good, has now published a written version on SSRN. It is available here.

Conference in Sao Paulo, Brazil

I'm in the Sao Paulo airport, awaiting my overnight flight back to the U.S. after a very enjoyable few days here.

My talk, from the PPT slides posted in my previous entry, appeared to go well apart from the obvious distress that I caused the live-simultaneous translators. It took three of them to handle my talk (of perhaps about an hour?). They were dropping like horses on the Pony Express overnight delivery run, and seemed to think I was talking a bit fast. Not the first time I've heard this critique, but the live audience, which was 99 percent listening in English, appeared to be getting it fine. I later observed that quite a few of the Portuguese speakers at the conference, who were likewise being translated live (I believe, just for me), spoke every bit as fast as I do. But the translators told me afterwards (between shudders at the memory of the exhausting experience) that, for every 10 words or so of English speech, you on average need 13 or 14 words to say the same thing in Portuguese.

Anyway, people seemed interested in the talk. Brazil is an interesting case. At one time in the past a territorial country in re. outbound multinational investment, they have gone opposite to much of the rest of the world by shifting to a fairly tough worldwide system, with no deferral, tough formulaic transfer pricing rules, and anti-tax haven rules for foreign tax credit use (cross-crediting). They also have a 34 percent corporate rate, and are asking some of the same questions as people in the U.S. re. what to make of trends elsewhere.

Apparently, their shift in the other direction reflected that the government was looking for tax revenue and acted, whether for better or worse, without a lot of political debate about the usual set of international tax policy issues. But now Brazilian academics and civil society are getting interested, not in a particular change that they've already picked out, but in thinking about the issues more.

I offered the sort of analysis I've been arguing for in international tax policy lately, but without purporting to say "you should definitely do X." Rather, in addition to the structure of the analysis I noted some empirical issues that might help in evaluating what was best.

I also ended up commenting on a couple of other panels, first more on international taxation and then concerning transparency. I also participated in an informal seminar at a very nice separate location (on Ihla Bella, an accurately named island 3-plus hours from Sao Paulo), on issues of how the Internet et al has affected legal issues such as those pertaining to intellectual property. I suppose you could say I took somewhat of a modified Frank Easterbrook "law of the horse" type position.

I can't really say enough about what a warm and hospitable reception I received from the Brazilian and other (such as Argentinian) participants in these various events. I got a cultural impression of greater personal warmth and also taste for having a good time (such as with live music and very late evenings) than one would expect in a get-together of, say, North Americans or Europeans.

Slides for my talk in Sao Paulo on international tax policy

A pdf of the slides for my keynote lecture at the NEF's Third Annual Colloquium in Sao Paulo, entitled "Rethinking International Tax Policy," is available here.

Upcoming talk this week

This Wednesday morning, at the horrifying time of 4:45 AM, I will be heading to the airport en route to Sao Paulo, Brazil, where I will be the keynote speaker on Thursday, December 1, at the Third International Colloquium, to be held at the Center for Fiscal Studies (called the NEF due to its name in Portuguese), which is affiliated with the University of Sao Paulo Law School. The NEF is a think tank that aims to bring together academics, government representatives, the private sector, and civil society organizations to advance public thinking about tax reform.

A Portuguese-language schedule for this colloquium is available here. Prior keynote speakers were Richard Bird in 2009 and Vito Tanzi in 2010.

My talk will be called "Rethinking International Tax Policy," which I consider adequately descriptive, albeit not, as titles go, especially original or inspired. (How many "Rethinking ..." papers have there been on various legal subjects in the last 20 years?) But I am hoping that the content will be more original than the title.

Brazil is an interesting country, and also has fairly distinctive international tax rules, which I will mention in passing, although I certainly would not claim any more than a very general and superficial familiarity with them.

I have PowerPoint slides for the talk, and will post a pdf of them here on Thursday, if my iPad and wireless access cooperate. I've completed them and thus, I suppose, could post them now, but in general I don't like scooping my own talks at conferences in this way.

Cruel practical jokes

I would never actually do this, but when I see one of my cats sniffing the seat of a soft chair while turning slowly around, preparatory to curling up for a nap, it occurs to me: What if some cruel practical joker had sprayed coyote scent (at a level undetectable by humans) on the spot?

NTA Annual Meeting in New Orleans, part 4

The final panel in which I participated in New Orleans was one at which I presented my article on rising U.S. corporate residence electivity.

Since this article is verging on old and cold (i.e., it's based on a talk that I gave in September 2010, and appeared in the Tax Law Review earlier this year), I decided to use the talk as a vehicle for pushing forward a bit, and including thoughts that I have been developing in the last few months while working on my international tax book in progress. Hence, I called my talk "The Rising Tax-Electivity of U.S. Corporate Residence (... and Beyond)," and used the last couple of slides to push farther than I have thus far in print (other perhaps than earlier powerpoint slides that I have posted at this blog) on how I am thinking these days about how we should tax U.S. multinationals' foreign source income.

The slides are available here. I should note one difference between the version that I am posting and the one that I actually used in New Orleans. The latter included a slide asserting that Desai and Hines are "in error" insofar as they assert that the asserted national welfare norm of national ownership neutrality (NON) supports exempting U.S. companies' foreign source income. But, as Jim Hines noted at the session, there is no error either in identifying NON as a relevant margin at which distortion is undesirable (all else equal), or in asserting that NON supports exemption.

What I would regard as in error is saying that U.S. national efficiency would be maximized by basing our international tax policy on NON. I would argue that this, by over-focusing on one margin when in fact there are many to consider, would affirmatively diverge from minimizing the overall economic distortion caused by the U.S. federal income tax system. Even given this point, however, Desai and Hines are only in error if they do in fact assert that NON establishes that exemption is the most efficient international tax policy for the U.S. to follow.

Now, some may feel that they do effectively assert this, but the articles in which they introduced NON to the literature acknowledge that there are broader efficiency issues to consider. Thus, I decided to remove the "error" claim before posting the slides.

NTA Annual Meeting in New Orleans, part 3

As noted in earlier blog entries, I wanted to offer a brief account of the other two panels in which I participated at the NTA Annual Meeting in New Orleans. Herewith the first additional entry, concerning a panel at which I commented on two empirical papers on international taxation.

The first paper on which I commented was Eric Allen & Susan Morse, "Firm Incorporation Outside the U.S.: No Exodus Yet," which is available here. Allen and Morse use hand-collected data (a phrase in general usage that I nonetheless find charmingly antiquarian, since I would assume people mostly do it with computers) to make a very useful rifleshot finding that contributes to our understanding of U.S. incorporation practices.

As I noted in my residence electivity article, if the U.S. pushes worldwide taxation of U.S. companies especially hard, one might expect rising foreign incorporation by U.S. start-ups. The article notes anecdotal evidence, offered to me by leading practitioners, explaining why in their experience home incorporation remains the norm in most business sectors, even for the potential multinationals of the future. Home incorporation turns out to have significant advantages in the start-up phase. Plus, so long as one places one's valuable international property abroad for tax purposes, the U.S. regime generally is not all that onerous anyway. But I noted suggestive evidence from an article by Mihir Desai and Dhammika Dharmapala that tax haven incorporations have risen in recent years. Might this be the start of a trend? Both I and the authors of that article stroked our chins (metaphorically speaking) and said yes, it's just possible that it might be.

Allen and Morse lay this to rest, however, by finding that the recent tax haven incorporation boomlet appears to reflect almost exclusively action involving start-ups from China and Hong Kong. U.S.-headquartered companies are not contributing to it at any significant level.

Good to know this. Now, I noted that this finding doesn't rebut the possibility that rising tax-elasticity of overseas investment by U.S. companies might still be a current trend and a problem, operating along other margins (e.g., new equity issuances, and clientele effects regarding who ends up investing where). Nonetheless, Allen and Morse have made a very nice contribution by making this new finding about tax haven start-ups, and I imagine that they will be cited regularly for this (certainly by me).

The second paper on which I commented was "Taxes and the Clustering of Foreign Subsidiaries," by Scott Dyreng, Brad Lindsey, Kevin Markle, and Douglas Shackelford, which is not yet available on-line. This paper notes that the empirical literature to date on how U.S. (and other) multinationals (MNEs) shift income between affiliates has generally operated under the assumption that all company choices regarding where to place an overseas affiliate are made independently.

For example, if Acme Products U.S. decides to place a controlled subsidiary in the Netherlands, this is assumed to have absolutely no effect on whether it will also put one, say, in Belgium, France, Germany, Ireland, or the Bahamas (to name just a few where we know that in fact there might be interacting causation). The literature adopts this view, not because anyone actually believes that affiliate choices are independent, but because we don't know how they interact with each other.

The Dyreng-Lindsey-Markle-Shackelford paper attempts to figure out relationships by coming up with "expected" correlations between where one has an overseas affiliate in the absence of a tax motivation, and then comparing this to the actual correlations that are found. E.g., if one found lots and lots of MNEs with affiliates in Germany plus the Caymans, this might suggest that the pairing is tax-motivated unless there are other grounds for expecting it.

The difficulties in deriving findings on this very interesting topic (which potentially would help inform policymakers), include the following:

--It's hard to say what correlations would be expected absent tax considerations. For example, should companies be expected commonly to have affiliates in neighboring countries? Leaving tax aside, one could imagine that a Netherlands sub is either a substitute or a complement for one in Belgium. On the one hand, the MNE is active in the area and thus might want to go to more countries that are nearby. On the other hand, perhaps the Netherlands is close enough to Belgium to reduce the need for a specifically Belgian sub if one starts being active there.

--Likewise, tax-induced relationships between affiliates may turn on either substitution or complementarity. E.g., being in one tax haven may either make a second tax haven less needed than otherwise, or else make the second one all the more valuable, as in "Double-Dutch-Sandwich" type schemes that require laundering profits through several successive locations. In addition, by going to one tax haven, a company may provide evidence that it is the type of company that likes to use tax havens. So, if it was also in other tax havens at "unexpected" levels, this might reflect endogeneity rather than complementarity.

--The real action may involve multi-jurisdictional clustering, not just two-country pairings. But that makes testing for empirical relationships even harder.

--Suppose that having a sub in Bermuda is a substitute for having one in the Caymans for companies following Strategy A, but a complement for those that are following Strategy B. Then one might fail to find net correlations that reflect tax planning, but it would still be going on in case after case.

The authors are quite aware of all these problems, and are struggling ingeniously to refine their empirical strategy. I look forward to the end result, as it could be both interesting and useful. But in the interim, virtue (choosing an interesting project even though it is hard) may serve as its own unfair punishment.

Great news for NYU Law School

We at NYU Law School will be adding a new member to our tax faculty next year, David Kamin, a recent grad who is currently working on tax and budget policy at the White House. Details here. David is going to be an outstanding academic as well a great colleague, and I'm very excited that he will be joining us.

Nudge nudge, wink wink

No, that can't be. Is demure little Ursula actually winking at the camera?

NTA Annual Meeting in New Orleans, part 2

Herewith some quick notes on one of the three panels in which I participated at NTA New Orleans. I guess you could call me a triple threat, as I moderated once, presented once, and was a commentator once.

The moderating gig was for a panel on corporate tax reform, with Rosanne Altshuler, Peter Merrill, and Martin Sullivan. As background, at a session the day before, it became clear to me that Rick Perry jokes have not yet reached their sell-by date, although I would imagine it won't be much longer. There are only so many changes you can ring on the theme of having three things to say and forgetting the third.

But it occurred to me at that prior day's session that I had a fairly good Rick Perry joke in mind that I could use at the corporate tax reform panel. I won't try to re-create it word for word here, but suffice it to sketch out the basic idea, which was that, if Rick Perry, rather than Herman Cain, had been the candidate who was pushing the 9-9-9 plan, he would have forgotten the third 9.

Anyway, at the discussion panelists noted that international is really the key issue even if we are thinking about domestic corporate tax reform. At least for now, Congressional Republicans, no less than the Administration, are committed to revenue neutrality if they lower the domestic corporate rate (say, to 25 percent) and also so if they enact some version of a territorial system that exempts at least a substantial swathe of foreign source active business income. But international looms at center stage even just with respect to the first of these ideas.

In this connection, I mentioned a central conundrum that I gather has been baffling policymakers from both parties. On the one hand, we keep hearing about corporate tax avoidance, such as in newspaper articles about the likes of Google and GE. On the other hand, the revenue estimators and those conversant with them keep telling the policymakers that it is extremely difficult to finance a lower corporate rate through base-broadening. How can both of these propositions be true? Shouldn't we be able to make the "headline babies" pay more through base-broadening?

The answer, of course, is that base-broadening, as conventionally conceived in terms of explicit tax preferences, has only a very limited overlap with multinationals' (MNEs') modern tax avoidance techniques. They mainly exploit structural weaknesses in the income tax, and above all the ease of transferring economic value that arises from people's activity in the US (such as when Google-bots create valuable IP in California, or wherever it is they work their magic) so that the resulting taxable income will appear in someplace low-tax and far away, such as Bermuda.

Thus, aggressively addressing problems with the source rules - or enacting worldwide taxation without deferral for suspect classes of foreign source income - is crucial to revenue neutrality here, as well as to ensuring that the domestic US corporate tax base - which vitally backstops the income tax on individuals for high-flying owner employees - is not entirely gutted with respect to MNEs, leaving it to fall just on domestic businesses (which might then become takeover targets by reason of the tax synergies).

One last point worth noting here, before I adjourn to the next post to discuss the other other panels I was on, is that it's extremely misleading to hear the constant refrain about how the US is "out of step" because everyone else has shifted to exemption. This statement is only true if one is extremely simplistic in using a one-zero scale to classify each international tax system as either US-style or territorial.

What such a classification misses is that most "territorial" countries make some effort to address the Google-style problems that many U.S. advocates of territoriality appear eager to embrace or at least ignore. In other words, the putatively territorial countries impose tax on a lot of "foreign source income" as to which there are grounds for suspecting that it is actually domestic source.

For example, a number of territorial countries limit exemption to foreign source income that is earned in other high-tax countries. The rationale arguably is not what it seems - that one wants domestic companies to pay more rather than less tax abroad - but rather that income which shows up in a tax haven probably wasn't actually earned there, and thus may well have been earned at home.

In my view, limiting exemption to investment in other high-tax countries is the wrong response to the problem, for the same reason that I question the foreign tax credit. From a national welfare standpoint, there is nothing wrong, and indeed it is affirmatively desirable, for one's companies (if owned by domestic individuals) to pay less tax abroad rather than more. Thus, I would counsel alternative means of in effect "tagging" the ostensibly foreign source income that is relatively likely to represent game-playing that erodes the domestic tax base. For example, rules concerning intangibles and intellectual property, as well as interest expense, may be able to serve the tagging function without incentivizing resident companies to pay "just enough" tax abroad to avoid the rule and consequent full domestic taxation.

More on this in due course as I try to advance my still not-entirely-formed thinking about source issues.

NTA Annual Meeting in N'Awlins, part 1

I spent the last two days, and indeed all day both days, at the National Tax Association's annual meeting, which was held this year in New Orleans. All told, I participated in three sessions and attended (depending on how you count) as many as nine others, including an award session for lifetime accomplishment honoring Alan Auerbach, as well as a lunch on Friday in which Peter Diamond gave a keynote address on how policymakers ought to assess the current macroeconomic situation.

Diamond made, to my mind, a compelling and verging on unanswerable case for the proposition that policy makers ought to be VERY concerned about persistent cyclical unemployment, and not, under current circumstances, at all concerned about the immediate prospects for inflation. OK, this is a very familiar point to anyone who reads the New York Times. But in addition to making it well he explained his view, which I largely share, that the long-term fiscal gap, while a significant long-term problem, is not an immediate crisis.

In the course of doing this, he focused on the projected path of the U.S. publicly-held debt to GDP ratio, which is not projected to get really hairy for at least 15 years.

This led to a question after his speech by a well-known (at least within the field) and somewhat idiosyncratic economist who has done important work relating to how we should think about long-term budgetary issues, but who has not previously been named in this blog post (hint hint). This individual strongly holds the view that public debt is an entirely, and I mean 100 percent, meaningless measure and that only the infinite horizon fiscal gap has any economic meaning whatsoever. Hence, in his view, if the infinite horizon fiscal gap, under our best forecasts of current Medicare, Social Security, & Medicaid policy et al, indicates fiscal unsustainability, then it is utterly irrelevant how fast the public debt rises. In his view, if there is a present value of, say, $20 trillion for expected 22nd century unfunded Medicare outlays, the fiscal problem this represents is literally indistinguishable from the case where the U.S. issues (for zero cash) $20 trillion of additional public debt today. If you say: Ah, but we could change Medicare policy before the 22nd century actually gets here, he will answer: So what, it is equally true that we could renounce $20 trillion of explicit debt. Only naive formalists, he is certain, could see any difference whatsoever between the two. (What is more, to him this is a matter of logic or science, not empirics. He alternates between saying that the empirics MUST match up with the economic logic, and that if they don't, then so much the worse for them.)

Diamond, who is familiar with these arguments by this individual, gave them somewhat short shrift. This brought to my mind e-mail debates that I have had with this individual on exactly this topic. In these debates, he repeatedly, and one could almost say a bit indelicately or even tactlessly, told me that the only reason I don't realize that he is correct is because my training as a lawyer has left me cognitively unable to see past mere semantics and form. This struck me as not just ad hominem but affirmatively incorrect, given that (I am pretty sure) at least 99 out of 100 economists would agree with me and not with him. (Indeed, perhaps all 100 unless he was included in the group.)

Anyway, I saw this individual afterwards, and could not resist noting that Diamond shares my view rather than his. I said, while this doesn't prove that we are correct, surely it does suggest that my view doesn't just rest on my being a lawyer.

"Oh, Diamond isn't very serious about the economics of this," he replied - perhaps not quite breezily, which in any case would be clichéd writing on my part, but certainly dismissively.

Speak of non-falsifiable propositions ...

Today's Occupy Wall Street developments

I was distressed to learn today of Mayor Bloomberg's ugly and under-handed quasi-military police action in Zuccotti Park last night. It is exactly the sort of arrogant, sneaky, bad-faith, and self-pleasing venture, complete with police violence and concerted efforts to muzzle live press coverage, that one would expect of such colleagues of his in the media and government businesses as fellow oligarch Silvio Berlusconi. I am hoping that mayoral recall petitions (if there is such a procedure in NYC) will start to circulate.

That said, while I was disappointed by the ruling just issued by the New York State Supreme Court to the effect that, while OWS people must be allowed back into the park, they cannot reestablish a permanent encampment with tents and such, I did feel upon reading the ruling that it appears legally reasonable.

The OWS people need to be very smart now about how best to keep public attention focused on the issues of wealth distribution, rigged crony capitalism, and government policymakers' indifference to the interests of the "99 percent" that I gather motivate them - and how to retain broader public sympathy for themselves and their issues when the other side is just looking for excuses to demonize them - in a tough situation and when they no doubt are upset. Played correctly, it could end up having given them the perfect exit strategy from having to stay in Zuccotti Park (perhaps with ever-dwindling forces) all through the winter. But the next step is crucial, and it's unclear how well their collective decision structure can handle it.

Slides from prior post

In case you saw my last post (on the University of Chicago Tax Conference, where I discussed foreign tax credits) while the link to (a pdf version of) my slides was still broken, I've fixed it, but you can also find them here.

Foreign tax credit discussion in Chicago

I flew to Chicago last night in order to appear on a foreign tax credit panel this morning at the 64th Annual University of Chicago Tax Conference. As I said at the start of my remarks this morning, I was glad to appear there, not just because it's an excellent conference (though it is - surely the best practitioner-led tax conference that I know of anywhere), and not just because I saw many old friends and acquaintances all around the room (although I did, some going back more than 25 years and whom I don't see regularly), but also because the conference was originally inspired and led by the great Walter Blum, whom I had the privilege to know when I started teaching at the University of Chicago Law School in 1987, and who was kind enough as to serve as a mentor (as well as being a friend) back in those days.

Less than 24 hours in Chicago, and I dodged a couple of bullets - first yesterday, when my flight to Chicago was canceled shortly before I was going to leave for the airport. I was re-booked to get there today, long after my session had ended, but I was able to scramble and find another flight. Then today I came extremely close (in distance terms, perhaps a couple of millimeters) to losing a contact lens down the sink in my hotel room. This could have left me a bit like Piggy in Lord of the Flies, albeit in a much friendlier setting.

But then I was able to catch an earlier flight home and was even upgraded to first class (the fruits of just how much travel I have been doing on United and Continental over the last year). I feel so much less like a head of cattle when I get an upgrade.

But perhaps of more interest was the session itself. Phil West of Steptoe & Johnson (a leading international tax practitioner, and former International Tax Counsel at the Treasury) was the main presenter on the subject "The Future of the Foreign Tax Credit." Lowell Yoder of McDermott Will & Emery chaired and organized the panel, as well as whipping it into shape over Giardano's pizza, and the other commentator was Michael J. Caballero, who is currently the International Tax Counsel.

Phil gave a very useful overview of where the foreign tax credit has been, and where it might be conceivably be heading, with a particular eye on a number of recent and ongoing controversies, enactments, and proposals, on many of which Michael commented. But my assigned task, which Phil very kindly gave the audience highly favorable word about, was to shed a different light on discussion of the foreign tax credit (and international tax issues generally) than perhaps one generally hears.

I welcomed this (as who wouldn't, in my shoes) in part because, as I have tediously yammered here from time to time, I really do believe that I have rethought the international tax field in an important way, previewed to some extent in recent articles that I have published but not to be fully laid out until my international tax book comes out (and I would be lucky to finish writing it by, say, mid to late 2012, what with the welter of conflicting obligations that I've either been handed or deliberately accepted).

One doesn't always feel that way about one's work (except perhaps if one is only loosely tethered to reality), even if one likes it, because it is hard to pull off that sort of thing very often, or indeed perhaps at all. But given that I do believe that I've done it this time around, it felt very good to get a strong confirmatory feeling from a lot of the audience - not that anyone there is necessarily chargeable with agreeing with me, but that people seemed to see the significance and, at least, plausibility of viewing the whole field rather differently than in the traditional international tax policy literature.

The first time I previewed these ideas, at a conference in North Carolina back in January 2010, I was distressed not to feel that what I had to say had gone over. But I've thought it through better, learned to say it better, and perhaps people have had more of a chance to think about it.

I also felt like I was in pretty decent form today. Just as NBA players (these are people who used to play something like "professional basketball" back in the distant past when there was such a thing) have good days and bad, so I felt like my jump shot was connecting a bit today. But not to worry, one can always count on worse days as well as better ones.

Anyway, here are the slides from my talk, which in many cases (I hope readers, like the conference attendees, can tell which ones) are borrowed from Phil West's talk, with my comments just added at the bottom to express my response to the standard approach that Phil was very ably laying out.

I should be able to post a fuller PPT version of what I have to say in early December, after giving a 45-minute talk on international taxation as a headliner at a conference in Sao Paulo, Brazil.

English-Al Jazeera story on corporate tax loopholes

I appear more prominently in this one; wish they could have edited out the inadvertent grimace, but I guess that's on me.

CNN Situation Room corporate tax story in which I briefly appear

The CNN story from last night discussing corporate tax avoidance, in which I briefly appear, is available on-line here. I appear near the end, and am quoted in relation to the political prospects for corporate tax reform.

My tax reform talk at yesterday's AAA-CPA Fall Meeting

As kindly linked by the Tax Prof Blog, my talk at the AAA-CPA Fall Meeting yesterday had the following description:

"Dissatisfaction with the U.S. federal income tax has led to widespread discussion of fundamental tax reform including the possibility of replacing it with a consumption tax. What different forms could such a reform take? What are the best arguments for it and against it? And what are its political prospects for enactment? Among the alternatives that Professor Shaviro will discuss are a national retail sales tax, X-tax or flat tax, and a consumed income tax, and he will consider how these proposals’ chances might be affected both by Congressional politics and by the long-term budgetary problems facing the U.S."

This was not a new paper, as I've written extensively on this subject before, such as here. But a pdf version of my slides for the talk, offering a handy if somewhat condensed outline, is available here.

TV update

In addition to taping a short interview with CNN's Situation Room show regarding the Citizens for Tax Justice report on corporate tax dodgers, I also ended up going to the Al Jazeera English studio in midtown to do a short TV interview with them on the same subject. (Each will apparently be used, probably a short snippet only, in a feature story on the CTJ report.)

Extra bonus, while leaving the Al Jazeera studio I met the German film director Werner Herzog, who introduced himself to me while we were both waiting for the elevator. I told him that I am very eager to see his 3-D film on the Lascaux cave paintings, and he noted that it is still playing in Greenwich Village.

The CNN and Al-Jazeera interviews followed somewhat different paths. For CNN, the main question was, is the bottom line of the CTJ report (showing massive though varying levels of U.S. tax avoidance by U.S, companies) accurate and credible? I said yes, and that the CTJ findings are no surprise to knowledgeable people, although no doubt there would be plenty to quibble regarding how they did the measure and in particular cases. On Al Jazeera, same bottom line reason for interviewing me (seeking independent expert assessment of the main CTJ findings), but more interest in questions such as, how does this pattern relate to the concerns of the "Occupy Wall Street" movement.

UPDATE TO THE UPDATE: I haven't been able to determine what ran on English Al-Jazeera. But I've seen the CNN story by Mary Snow (which ran tonight at 5:36 pm EST). I only made it on-screen for a very short soundbite saying that the politics of the 1986 Act can't be replicated today because compromises between the parties are dead. But the producers may also have viewed me as validating that the CTJ study is intellectually respectable (although they ran a he-said she-said on CTJ vs. GE, the latter of which used counter-argument rather than denial).

Perhaps the most interesting aspect of the CNN coverage was how Occupy Wall Street has changed the narrative frame that a major network uses in approaching a story like this. I view this as evidence that OWS is having a significant (whether or not lasting) impact on the framing of public debate, of a sort that companies such as GE are unlikely to welcome.

TV appearance today?

I'll shortly be leaving my office to give a talk this afternoon at a meeting of the American Association of Attorney-Certified Public Accountants, entitled "Can, Should, and Will the Federal Income Tax Be Replaced by a National Consumption Tax?" While my slides are fairly skeletal in proportion to the length and coverage of the talk, I will post them here tomorrow, time permitting.

On the way there, I am stopping by at CNN headquarters for a short interview, a snippet from which may appear this evening on CNN's The Situation Room. The topic will be the newly issued Citizens for Tax Justice report, "Corporate Taxpayers and Corporate Tax Dodgers, 2008-2010."

Just as a preview, I believe that, while one could (and in the right setting should) nitpick and question various aspects of the report's analysis, the bottom line claims are important and have a significant degree of truth.

NYU-UCLA Tax Policy Conference on Tax Law and Healthcare Reform

This afternoon, weather permitting (the East Coast will be rainswept all day), I am flying to Los Angeles, in order to participate in tomorrow's NYU-UCLA conference concerning tax policy and healthcare reform.

I'll be chairing the fourth and final panel, entitled "Health Care Reform and the Long-Term Fiscal Outlook." The papers, which will eventually appear in the Tax Law Review, are (1) Howard Gleckman, Healthcare and the Long-Term Fiscal Outlook, (2) Daniel Kessler, "Reforming Medicare," and (3) Mark Pauly, "The Real Burden of Tax-Financed Medical Care in the United States."

I won't have slides or a formal presentation, so there will likely be nothing to post here on Monday. During the session, however, I will be offering quick comments and reactions after the three presentations, mainly to focus and jump-start the broader discussion.

Everyone knows that the projected path of healthcare growth is at the heart of the grim long-term U.S. fiscal situation, and the question is what to do about it. I suspect that a central issue throughout the panel will relate to the basic fundamentals of why there is such a large government role (around the world) with respect to healthcare provision and financing, and how one should think about the relative defects of government provision on the one hand and market provision on the other. Plus, what happens when you mix them in different ways.

Healthcare's unique characteristics (especially when, but not only because, we decide that everyone should get basic care) inevitably will play a central role in this conversation. It hasn't been seriously disputed in economic circles for decades that, in a whole lot of consumer areas (say, cars or shoes or breakfast cereral), markets generally do better than government provision from the standpoint of efficiency and responsiveness to consumer demand. But is healthcare different, and if so then to what extent and in what ways? And if a critique of how markets work in the healthcare sector does not necessarily rebut pessimism about the informational and incentive issues raised by government involvement, then how do we navigate between various competing problems?

A few quick points about Perry's tax plan

Perry's tax plan is in many ways the usual nonsense, not really worth addressing seriously. For example, it's clearly a huge revenue-loser, is a huge tax break for the wealthy, etcetera.

This is all par for the course. But here are a few particular points about his plan's distinctive quirks that are worth emphasizing.

First, the idea of an election between the simple system and current law is simply nonsense. Goodbye simplicity. People with tax planning capacity are going to be running the numbers to see which is better. Does anything with the slightest bit of common sense really think a well-advised taxpayer going to opt for the postcard return even if, due to base-broadening, it turns out this would increase his or her tax liability by several thousand dollars a year? Adding elections adds complexity, it generally doesn't reduce it.

Second, why even bother having a flat tax if you are going to retain big itemized deductions, such as for home mortgage interest, charitable contributions, and (if I am reading the under-specific language correctly) state and local tax deductions?

Third, how can he purport to combine a flat tax (and simplification) with phasing out the itemized deductions for people who earn more than $500,000? True, this increases the progressivity of the plan, at least relative to providing the deductions and not phasing them out. But this effectively adds higher tax rates to people in the phase-out range, albeit eventually declining back to 20% once all the deductions are gone. And with this feature, that is going to be some postcard.

Fourth, can anyone seriously doubt that the exemption for dividends and capital gains will be exploited by tax planners, on behalf of owner-employees, to avoid paying even 20% on what is effectively wage income?

Fifth, how exactly is he going to broaden the base of the corporate tax to pay for lowering the corporate rate to 20%? Note that some of the key items often called corporate tax preferences disappear under a consumption tax - and at the individual level the so-called flat tax is in fact a consumption tax. Is he going to get rid of accelerated depreciation and LIFO accounting for inventory? Under a consumption tax, the purchase price of items such as equipment and inventory would be expensed. So, unless he wants to confine the shift from an income to a consumption tax to the individual level, and still inexplicably apply income tax-style accounting just to the corporate tax, I certainly don't see what sort of base-broadening he has in mind at the corporate level. To the contrary, it seems likely that he would want to make changes that would reduce corporate taxable income at the same time that he wants to lower the corporate rate.

So the Perry plan in many ways makes less sense than Cain's 9-9-9 plan.

Talk at University of Louisville Law Review Symposium on Deficit Reduction

This past Saturday (Oct. 22), during a lightning appearance in Louisville to participate in a conference on federal deficit reduction that was sponsored by the University of Louisville Law Review, I presented my paper, previously linked and available here, entitled "Tax Reform Implications of the Risk of a U.S. Budget Catastrophe." This is a kind of short interplanetary grand tour through previous work I've written that has a bearing on how concern about the long-term fiscal gap might affect our thinking about tax reform. It also briefly addresses why we face a long-term default risk. I use the analogy (also in several previous talks that I have linked here, but not previously in any of my published work) to the nesting Russian "Matryoshka" dolls, one inside another. I posit that, while the outermost doll is the fiscal impact of rising life expectancy plus the baby bust plus the current path of healthcare technology, the fact that this could in principle easily be addressed means one has to look to the next doll inside (U.S. political economy problems), and then to the doll inside that (potentially malfunctioning and discontinuously responding financial markets).

For a pithy overview of the already somewhat pithy paper, a pdf version of the PowerPoint slides that I used for my talk is available here.

Among the things I'm sorry to have missed at the conference, which I had to leave early, were the afternoon talks by Daniel L. Thornton, who is Vice President and Economic Advisor at the Federal Reserve Bank of St. Louis, and UNC law prof Greg Polsky. Although I suspect I would have disagreed with a lot in Thornton's talk (addressing how we have arrived at the current fiscal situation), I am sure it was interesting and provocative. And Polsky's talk on cutting tax expenditures is certainly a topic of interest to me (and I suspect I would have agreed with a lot of his analysis).

Another interesting talk that I missed was by GW law prof Neil Buchanan, arguing against ever fully paying off the U.S. national debt. Once again I suspect I would have agreed a lot, although I'm not convinced we'll be dealing with this problem any time soon. Buchanan and I appear to agree more than we used to about budgetary issues. He might argue that I've moved a bit towards him, and maybe he'd have a point. But I might respond that current events have pushed me towards a terrain where we always agreed to a considerable extent. I probably remain more favorably inclined than he is to adopting (under appropriate circumstances) policy changes that curtail the rate of growth of existing entitlement programs, with these changes to be announced ASAP and to begin being implemented as soon as the macroeconomic climate permits. I believe in "smoothing" expected long-term changes to the entitlement programs, based on the best available fiscal estimates of what will be necessary, and I am quite willing to reduce expected benefits to the better-off members of current retirees - again, subject to the macroeconomic climate and to this being part of a good overall package that includes, e.g., needed tax increases.

I did get to hear Penn State law prof Sam Thompson's interesting paper, arguing that Social Security and Medicare benefits should be phased out fairly rapidly for high income retirees, whose capital income might suggest that they have substantial wealth. Thompson had a powerful rhetorical point to the effect that, if you give retirement benefits to an individual who will be leaving a bequest, and if this means that the bequest ends up being larger than it would have been otherwise, one could view this as something not far from a federal match or supplement to the bequest. I could imagine this point being politically significant, and it is also reasonably intellectually defensible.

One concern I had with Thompson's proposal was that, by rapidly phasing out retirees' Social Security and Medicare benefits as their income increases, it operates as a powerful work disincentive. Even people who have retired from their prior full-time jobs and begun claiming retirement benefits often do some work on the side, and the empirical evidence suggests that they are quite tax-responsive. Such individuals do not necessarily have the wealth and expected bequest profile that Thompson assumes when arguing for his proposal, and I see no good reason, even with high unemployment, to discourage work by seniors. But in the limited time we had, we didn't get to discuss this issue more fully.

In response to my paper and talk, Berkeley law prof David Gamage argued that what he called my "let's preserve revenues" model for evaluating how concern about the fiscal gap should affect tax reform thinking - a fair enough label, I'll concede - doesn't take the next step that one ought to take in thinking about these issues. He proposes analyzing much more fully than I as yet have the question of how a given change (even a small one) that is adopted today might influence the likely long-term political equilibrium, assuming that the political chicken games do indeed eventually give away to a negotiated solution. Two examples he noted: (a) 1986-style tax reform, with base-broadening plus rate reduction, might grease the skids for raising the rates again in the future, (b) once a VAT is enacted, Congress's ability to raise revenue easily by boosting the rate becomes much enhanced, compared to when one doesn't have a VAT in place. I suppose there might be analogues for entitlements changes as well.

This may be a good next-stage framework for thinking about tax reform in relation to the long-term fiscal situation, albeit going beyond the relatively modest tasks I set for myself in recent writing about the issue, but certainly worth consideration. (Whether or not by me depends on where my interests take me over the next few years.)

Unauthorized activity

I would assume that Seymour is eyeing the chicken, not the lettuce.

From 9-9-9 to 9-0-9?

In response to criticism of 9-9-9's low-end regressivity, Herman Cain has apparently partially dropped one of the 9's. He is quoted by CNN as saying the following:

"If you are at or below the poverty level, your plan isn't 9-9-9 it is 9-0-9. Say amen y'all. 9-0-9."

This appears to refer to putting a zero bracket into the personal income tax (or wage tax?) portion of the 9-9-9 plan. However, three thoughts about this are the following:

(1) Poor people who are unemployed will get no benefit, since they already are earning zero. An 18 percent federal tax rate is a huge hike for them, compared to present law.

(2) Once you agree to a zero bracket, haven't you surrendered the entire supposed logic (whatever it is) of having a flat tax? This, of course, is also an issue for the so-called flat tax that Rick Perry is expected to endorse shortly. That proposal has historically had two brackets, one of them at zero percent, and I gather that the Perry proposal is expected to share this feature. So it isn't actually a flat tax.

Once you agree to a zero bracket, in a certain sense the flat tax game is over. As the old saying goes, from there on in we're just haggling over the price. Is there some natural law holding that having exactly two brackets is best? That strikes me as even more peculiar than insisting that there must only be one.

(3) Once Cain has agreed to put a zero rate in one of his three taxes, why not in the other two? Obviously, as an administrative matter one can't have a retail sales tax, or a quasi-VAT that has been mislabeled as a "business income tax," apply multiple brackets based on the income level of the individuals who purchase consumer goods. But doesn't the zero-rate feature that has now been added to Cain's personal tax imply that this is a defect one might want to address?

The so-called FAIR tax does so through what is effectively a demogrant, rather than a rate bracket. I've seen indications that Cain would like to have something of that nature in his 9-9-9 plan as well, but he hasn't made this entirely clear, and it would have significant budgetary / revenue implications unless its scope was trivial.

Cain also claims to add progressivity to his plan through an "opportunity zone" proposal. The idea, as described by CNN, is that "in cities facing high unemployment ... businesses could also deduct a certain amount of payroll expenses from their corporate taxes."

Enterprise zone features of income taxes generally have not received a hugely favorable write-up in the literature. In addition, if we can imagine Cain's proposals being adopted by Congress - and I certainly can't imagine this, even if he were to become president - it's hard to see why this special feature would be adopted and no others. Mightn't it open the floodgates? It's also fun to think about how the set of qualifying cities at any given time would be compiled, and whether businesses would be able to use this as a ground for deducting, say, high-end Wall Street salaries if New York qualified as an opportunity zone. Sure, one could start writing rules to address these problems, but by then (if not sooner) the 9-9-9 tax would be starting to look like a very different and more complicated animal.

They're calling the wrong tax the "Robin Hood tax"

A report on the web suggests that Occupy Wall Street protestors may coalesce on a specific policy demand: the enactment of the so-called "Robin Hood tax" on financial transactions.

Although I have considerable sympathy for what I deem to be the OWS political economy critique of U.S. policy and institutions, I fear that they are being misled by labels into supporting the wrong tax. It's understandable. After all, how could they resist something that proponents call the "Robin Hood tax" and that would be collected from banks and other such financial institutions, given what the OWS protestors (and we) know about the U.S. financial sector and its grip on the U.S. economy and government, as well as that sector's responsibility for the last few years' disasters and the evident possibility that they will soon be doing it to us again?

The problem is, the wrong instrument has been labeled the "Robin Hood tax," apparently because some enterprising policy entrepeneurs, undoubtedly acting in good faith, took the initiative thus to label what those of us in the biz call the "financial transactions tax" or FTT.

The so-called Robin Hood tax - which I will now switch to calling the FTT - would be levied at a very low rate (say. 0.05%) on a wide range of financial asset transactions - for example, the sale of stocks, bonds, commodities, unit trusts, mutual funds, and derivatives such as futures and options. Thus, if you buy Microsoft stock for $10,000, the tax at 0.05% would be $5. Despite the low rate, enough financial assets in face value are sold that it could add up to a lot of money. For the thing to work, it obviously would have to address the problem of people, say, using swap transactions to replicate the economics of a debt-financed purchase of stock without actually doing the literal sale. That's a big problem, but let's put it to one side for present purposes.

Presumably your broker will actually remit the $5 sale proceeds to the tax authorities. I would guess that he'd list it as a separate charge that you had to pay, and would simply add it on to the other fees he was charging you. In principle, this could exert a mite of downward pressure on broker fees, raising the economic incidence question of who bears the tax, along with the possibility that, with sales being costlier, there'll be a small bit of exit from the broker industry. But it might be a good first approximation to say that you are likely to bear the tax, whether the broker separately states it or simply charges you $5 more than he would have otherwise.

Now let's consider Goldman Sachs, which presumably would be remitting a whole lot of fees to the government from the deals it does. (Leaving aside the fact that they would no doubt be at the forefront of figuring out, at least for their large customers, how to structure deals so as to avoid the tax.) Is this a tax "on" Goldman Sachs - or more specifically, on the firm's owners and highly compensated employees? I am a bit skeptical, as a matter of economic incidence. Come to think of it, if they do figure out how big players can avoid the tax they will be well-compensated for that, but even in other cases I suspect the incidence issue might play out a bit like the retail sales tax that the guy in the candy store collects from you and then remits to the local authorities.

The broader academic debate about the FTT - on which I will be presenting a short piece at a conference in Amsterdam in early December - emphasizes the efficiency question. Will the FTT have desirable economic effects? With perfectly functioning financial markets, the answer would obviously be no. Why burden trades that conventional economic reasoning suggests make the transactors better off while hurting no one else. But I would agree that we have reason to be very unhappy about a lot of what goes on in financial markets, so the FTT has a fighting chance.

What among the things that might be wrong with financial markets might the FTT address? The main argument is about volatility, which some types of trading may make worse. This is basically an externalities argument. By running computer programs that, say, go SELL-SELL-SELL as soon as the price of Zircon stock falls below $X, one can prompt runaway market panics. But the problem is that the FTT is not well-designed to address a specific externality. Trading can also reduce volatility. And if I want to buy or sell a given stock then it's good for me that someone else is actually willing to do so at a given price. FTT studies suggest that the tax might well make volatility worse rather than better. More generally, a well-designed instrument would have to target the types of trading that were worth discouraging.

A second point is sometimes called "internalities." Suppose people trade too much from the standpoint of their own welfare because they over-rate their ability to out-smart or correctly time the market. Once again, we're only in a subcategory of the overall trading that would be subject to the FTT. I have doubts about how strongly this line of reasoning can support the so-called Robin Hood tax, and it is certainly light years from the rationale and assumed incidence.

Now here's what I not only prefer to the FTT but think is far more entitled to the label of "Robin Hood tax" - a financial activities tax or FAT, such as that recently proposed by the staff of the International Monetary Fund.

The FAT would be a tax on extra-normal returns earned by financial institutions, with the potentially taxable returns including high-end compensation paid out to the big hitters. The FAT has two main rationales, other than the fact that the financial industry may generally be both over-large from a normative standpoint and widely under-taxed under VATs and income taxes.

The first rationale is that extra-normal returns may be rents, or opportunities that they have, in effect, to get free money not available to others. Taxing rents is efficient because it won't discourage activity that still has an extra-normal after-tax return. Plus, a tax on rents is borne by the party that is earning the rents.

The second rationale is that observed extra-normal returns in the financial sector are in a sense fake. They represent risky bets, the expected return from which is merely normal, but where the bettors earn an above-market rate in most states of the world, subject to downside "tail risk" if things go badly wrong. We don't want the financial sector making these bets due to their "heads I win, tails you lose" character, in which first they get extra-normal returns, then we have to bail them out so as to mitigate the degree of global macroeconomic collapse.

Once again, we would expect the financial sector to bear the incidence of this tax, because they'd be pushed back in the direction of a merely normal return by the mechanism of in effect taxing them for the suspected transfer of tail risk to the rest of us.

The FAT truly is a Robin Hood tax that would address the problems with the financial sector and likely be borne by the bankers themselves. Why tax Goldman Sachs' customers under the FTT, with no clear efficiency gain, instead of taxing Goldman Sachs itself under the FAT (leaving aside the most recent quarter, in which they reported losses) and addressing the costs that it may be imposing on the rest of us?

Virtually there

Zocalo Public Square, a website devoted to "connecting people to ideas and each other" that also has actual, in-the-flesh public events, usually in Los Angeles, is having a session today on economist Robert Frank's new book, The Darwin Economy: Liberty, Competition, and the Common Good.

On to the personal plug for a moment, then back to the more substantial topic of Frank and his new book. In connection with this session, Zocalo has posted 4 short sets of comments on the topic "Taxes Hurt So Good: Levies Can Be Painful, But the Right Ones Bring Big Gains." The question for discussion was whether taxes can promote good behavior. Available here. As you may have guessed by now, I am one of the commentators; the others are Daniel Markovits, Timothy Hackenberg, and Annette Nellen.

Bob Frank, in his book, "argues that the man who best understood how economics works was not an economist at all [such as Adam Smith with his theory of the invisible hand], but renowned naturalist Charles Darwin. Darwin's understanding of competition held that favored traits were the ones that best served the individual, whether they benefited the group or not -- a theory Frank says explains the modern system much better than Smith's [invisible hand theory]."

To my mind, it risks being a bit cute to deploy Darwin as actually an economist. But Frank's basic point is quite sound. Smith's invisible hand theory derives a lot of powerful results from the fact that, under certain conditions, the possibility of mutual gain through trade can cause people to have interests in common and to behave cooperatively. But - as Smith certainly recognized but perhaps downplayed a bit - when these conditions don't hold, there is no general reason to expect cooperative rather than socially damaging beggar-your-neighbor behavior.

In this regard, evolution at least provides an analogy, and perhaps can even be described as directly operative in economic behavior (although people's battles over wealth, success, and power play out in arenas not limited to gene transmission). Cooperative group behavior has to pay off at the individual level (which depends on the specific environment and the odds it presents for various things) in order to be sustainable. And there is certainly no reason to assume that compatible incentives and cooperative behavior are the dominant features in a modern economy, any more than it makes sense to assume that "nature red in tooth and claw" is the dominant model in biological evolution. "Cooperation or competition - which prevails?" is a silly question, to which the only good answers are "both," "it depends," and "they're likely to be complexly intertwined."

I am definitely a fan of Bob Frank, who, through his work on positional goods and status competition, has made a very important contribution to modern thinking about GDP, technological progress, tradeoffs between equity and efficiency, and yes, tax policy. As it happens, he was a speaker at the NYU Tax Policy Colloquium many years ago. Our main criticism (I was still doing the colloquium with David Bradford at the time) was that his important insights didn't necessarily translate into thinking about income versus consumption taxation as he thought they did, since the two are arguably the same insofar as the points of interest to him are concerned. (Income and consumption taxation differ in how they treat present versus future consumption, either of which one might want to tax-discourage on the ground that people are competing over positional goods, and thus imposing disutility on others, to a greater extent when they choose work and thus present or future market consumption, than when they choose leisure.)

Frank was also a very pleasant guest and speaker at the colloquium. In person, he turned out (I had worried about this) to have no objection whatsoever to such things as having a nice dinner and accompanying it with a nice bottle of wine.

Does it matter how many separate taxes are in 9-9-9?

Short answer: No, it does not matter at all in substance, although it evidently matters quite a lot optically.

By the way, Grover Norquist, who is no fool when it comes to assessing optics, understands this, and has apparently criticized 9-9-9 for permitting taxes to look lower because they appear to come in separate bundles. There is an ironic jujitsu to all this: so much of Cain's momentum on this issue reflects the fact that, to the conservative base, 9-9-9 looks lower than 27. But holding constant what the taxes actually are, Norquist is right that, if they look lower, this may grease the wheels for letting them go higher than otherwise.

But enough about the optics - why, as a matter of substance, doesn't it matter if there are three 9% taxes, or an 18% tax and a 9% tax, or one 27% tax?

Let's start with the point that Ed Kleinbard and I have been making, and that others such as Ezra Klein have picked up on, which is that 9-9-9's "business tax" and its sales tax are basically the same tax (a few odd details aside), since they are both flat-rate consumption taxes where the tax base is consumer purchases. So we have at a minimum just two taxes, 18% on consumption plus the possibly separate (or not?) 9% personal income (?) tax.

When I made this point in a previous blog post, a commenter made the point that what I called the business-level VAT is in some ways not that far from an income tax. Basically, all you have to do in order to make it an income tax is the following:

(a) allow wages to be deducted by the business. In the standard VAT setting, deducting wages or not is a wash - it doesn't matter in the end - if (i) they are made includable by the worker only if they are made deductible by the business and (ii) the worker and business tax rate are the same. After all, if my business pays me $100 and both its tax rate and mine are 35%, then deduction and inclusion, instead of neither, saves the business $35 of tax and costs me $35 of tax. By the way, even if I don't own the business, then if the net tax on wage payments is zero one would expect wages to adjust, reflecting real market conditions and people's responding to their actual incentives from after-tax returns, so it wouldn't matter (once everything had time to adjust) whether the wages were includable and deductible or neither - apart from in the situation where the worker's marginal tax rate differs from that of the business.

The Cain plan screws this up, of course, by making wages includable by the worker but not deductible by the business. Is this an evil example of that odious crime, "double taxation"? As an optical matter, I suppose you could argue that it is. But in reality, all it does is cause workers who are paid wages to be taxed, in effect once, at 27%. The problem here, as I have noted in prior posts, is that paying observable wages is tax-discouraged, so owner-employees with sufficient liquidity to fund their personal consumption expenses will tend to avoid it and lower their overall tax rates to 18%.

Okay, that more than covers the first important difference between a business VAT and an income tax. On to the next two:

(b) In a business income tax, financial flows such as interest would tend to be deducted by the business that pays them and included by the recipient. (In the present income tax, of course, dividend payments, unlike interest, are not deductible.) In a VAT, all of these financial flows are typically ignored on both sides of the transaction, leading to problems in figuring out how to tax financial institutions (which embed service fees in the spread between the low interest rates they pay and the high interest rates they charge). Once again, however, leaving aside the double taxation of dividends problem in the existing income tax, both including and deducting or doing neither is a wash if the tax rates on both sides of the transaction are the same.

(c) And now for the big difference, applying even when all cash flows are taken into account (or not) reciprocally and when all tax rates are the same. In an income tax, business outlays that create durable assets or lasting value or income expectations beyond the current year are not deducted. Instead, they are capitalized, creating an asset that has a tax "basis," and are only recovered against gross proceeds, such as through depreciation deductions or by only taxing net gain on an asset sale (amount realized minus basis). An income tax, therefore, unlike a consumption tax style VAT, burdens saving and investment.

Suppose Cain altered the business tax in the 9-9-9 plan to be some sort of an income tax version of the VAT, with business outlays potentially being capitalized rather than immediately deducted. This would make the "business tax" component meaningfully different from the sales tax component. At the cost of economic distortion (i.e., discouraging saving and investment), it would burden the business owners and thus presumably increase progressivity.

But to say that there were now two separate 9s, while in a sense optically true, would in a sense be pure semantics. By making the two taxes a bit more different, we would be burdening some people a bit more and others a bit less. But if rates were adjusted to raise the same revenue either way, there would just as much taxation going on from the two taxes that now were somewhat distinct than there would have been if they were the same.

This brings us to the next element of major confusion in the 9-9-9 plan. The campaign website proudly trumpets that dividends will be deductible, so as to avoid present law's double taxation. But what about interest? Is that deductible as well? It is under the current income tax, but again, a VAT generally ignores it. But of course, to understand what would make sense here, we need to consider the last (or first?) of the three 9's, the tax on individuals.

Surely that must include dividends if deducting them at the company level is necessary to avoid double taxation. But surely interest has to be treated symmetrically as well, and the plan says nothing about it.

What is the base for the individual tax? The website says it's "gross income." But what is that? In the existing Internal Revenue Code, "gross income" includes all receipts (except that basis is deducted from the amount realized, so that only the net gain from an asset sale is included) but has no business deductions whatsoever. But everyone seems to agree that the "personal" tax here will not apply to the gross proceeds of, say, a neighborhood candy store, but is only for salary plus apparently some other gross income items - dividends and (despite the hiccup in the business tax) presumably interest, and perhaps all the other stuff that under present law leads you to get a W-2 or 1099. (Though not capital gain, as the plan purports to exempt this.) By the way, if we are including all this gross income, then I don't entirely understand how Cain is repealing the entire existing Internal Revenue Code, since parts of it are surely needed to figure out what income is.

For example, if interest is included by individuals, and is meant to be deducted by the business even though the plan does not say so, then might we need the original issue discount (OID) rules for interest that has accrued economically but not yet been paid? To be sure, if the treatment is symmetric and all the rates are the same, then perhaps this doesn't matter as much.

What the Cain campaign presumably does mean by "gross income" is that there will be none of the deductions that the Internal Revenue Code allows against "adjusted gross income" or AGI. By AGI, it means net rather than gross income, but without itemized deductions such as home mortgage interest, and without personal exemptions or the standard deduction.

Incidentally, I assume that fringe benefits that aren't currently included would be taxed in the Cain plan. Most would agree that the exclusion for employer-provided health insurance is no less a special tax expenditure than the home mortgage interest deduction. So does he mean to make it nondeductible at the business level as part of the wage (although it's currently deductible), AND includable at the individual level on the same rationale? Inquiring minds would like to know.

Okay, suppose we were to conclude that the personal income tax really is an income tax while the other two parts are consumption taxes. This probably isn't right, as it appears to be more of a wage tax plus perhaps a tax on interest and dividends (which of course are includable in "gross income" under present law). But suppose that one of the 9's is an income tax while the other two 9's are consumption taxes. Does this mean we have two taxes of 18 and 9 rather than one at 27?

This question really has no correct answer, or at least none that is meaningful, as it's a matter of optics and semantics. Let's consider instead substance. Suppose we had a single 27% tax but it was one-third income tax and two-thirds consumption tax. (E.g., suppose returns to capital that were income but not current consumption were two-thirds deductible, or alternatively were taxable, in the manner of capital gains today, at a special rate that happened to be 9% instead of 27%.) This would in a sense be the same as 9-9-9 if one of the bits is an income tax and the other two are consumption taxes, yet it would clearly be one instrument.

Bottom line: counting separate tax instruments is a fool's game. What matters is the overall tax being levied. And here, 9 + 9 + 9 = 27. Since this is an equation, the left side equals the right side, and no one should think it matters which side you are looking at.