Wednesday, October 31, 2012

Post-storm update

Life is a bit grim right now, in the aftermath of Hurricane Sandy.  Those of us below 30th Street in New York City are without electrical power in our homes, and will probably remain so for at least several days.  There are worse fates, but it is not very enjoyable.

Due to pockets of better conditions around here, I've actually been able to work a bit, although getting oneself to focus mentally is another matter.  Classes have been canceled for the entire week, and I suppose next week remains uncertain, along with the question of makeup classes.

I have, however, been able to look at and think about materials that I will be using for the next paper on my agenda, which I have committed to write for "100 Years of the Income Tax" conferences that will be held in early 2013 at Florida State Law School and USC Law School.

I had been thinking of doing some sort of "Important Early Income Tax Thinkers, Then & Now" paper, possibly looking at the likes of E.R.A. Seligman, Haig, Fisher, T.S. Adams, etcetera.  But as soon as I stuck a foot in the water, it became obvious to me that the one I am interested in writing about is Henry Simons.  This partly reflects personal connections (e.g., I feel as if I have a cross-generational mentorship link to Simons, through Walter Blum at the University of Chicago Law School), but it also reflects Simons' extraordinary combination of intellectual modernity and otherness.

So I now have both a tentative title and, more importantly, a plan of action.  "Henry Simons, Then and Now," with four main topics, each to be discussed with a presentist (more than a historical) eye to what we may learn from it all today:

(1) Simons: a different kind of libertarian

(2) Why progressive redistribution?

(3) Why an income tax?

(4) How should we design the income tax?

Each part should have a number of (at least to me) interesting and surprising features, not discovered by me, although I have my own perspective to add, but not generally well-known.

Thursday, October 25, 2012

Great big sigh of relief

I have completed a first draft (except for a brief conclusion) of an article, entitled "Should Social Security and Medicare Be More Market-Based?," that I will be using as the basis for the Ann F. Baum Memorial Elder Law Lecture, which I will be delivering at the University of Illinois College of Law on March 4, 2013.

Once I've received comments from a couple of readers (and written an abstract plus the conclusion), I anticipate posting it on SSRN.

I will have to update it for the results of the presidential election, as references in the article to the Obama Administration and the Social Security and Medicare plans that were issued by Congressman Paul Ryan might need modification.  (Likewise, a Bowles-Simpson-style grand bargain after Obama won, or the repeal of existing Medicare for people under age 55 if Romney won, would need to be acknowledged and incorporated.)  But the issues will still be there in any event.

Wednesday, October 24, 2012

Paul Krugman on the worst case scenario if Romney wins

In a live interview at the Huffington Post, Krugman says the following:

"I think there's a real chance that he'll manage to pursue a policy in the first couple of years that simultaneously blows up the deficit and depresses the economy. Tax cuts for the rich, who won't spend them, and slash spending for the poor and the middle class, who will be forced to cut back. And so we end up managing to have a simultaneous deficit explosion and double-dip recession....

"I'm not seeing a lot of evidence that he [Romney] really does understand it [economics]. People say he's a smart guy, but it's not visible in his statements, and it's not visible in his off-the-cuff reactions either."

As we've all learned over the last 12-plus years, Krugman has a startlingly good track record when he makes predictions.  But, while I certainly share his sense of the lack of verbal evidence that Romney is intelligent or understands economics, I note that there are indications, from time to time, that Romney does indeed know about the basic Keynesian stimulative story.  And several of his economic advisors have made statements in the past suggesting that they favor fiscal stimulus (as well as more aggressive Fed policies) when there is a Republican president.

So the question is how Romney could meet his commitments to cut taxes on the rich and spending on the middle class and the poor - which I think the Republicans in Congress and the commentariat would be demanding, even if we agree that he is devoid of actual policy views beyond general plutocratic sentiment - and yet avoid a double-dip recession, which he knows would not be good for him politically.  Pushing the Fed to be more aggressive is probably not enough, given its lack of strong tools, although I am certain he would try it far more aggressively than Obama has.

One possibility is that a Democratic Senate would give him running room to simply do nothing and let the economy continue recovering slowly by itself.  But a Republican House plus Fox News would still be all over him, and he might be able to peel off a couple of conservative Democratic Senators to vote for his budget policies even if Republicans don't have the majority.  Hard to think that he wouldn't do this, despite the political virtues of having an excuse, if it is indeed possible.  He does, after all, seem to want to look effective and strong.

How else could he get out of the box?  Well, it strikes me that war with Iran (or anyone else who proves conveniently available) would certainly be one way to go about it.  This would create a scapegoat, allow stimulative spending in pursuit of the war, and perhaps inoculate him politically for a while via the rally-round-the-flag phenomenon that we commonly observe in times of foreign policy crisis.

Has Krugman therefore missed out on what is actually the worst case scenario here?

Tuesday, October 23, 2012

A dangerous trend?

 Here is a picture of our new kittens, Gary (the striped gray one) and Sylvester (the black-&-white).  We've had them for just over 6 weeks (they were not quite two months old when we got them), and during this time their combined body weight has increased from 2.9 pounds to 8 pounds.

Hmmm ... Say their weight triples every 7 weeks.  If this trend continues for the next 6 months, we will at some point be in deadly danger.  You wouldn't think it to look at them, though.

Inquisitive and playful little fellas, as you might imagine.

Sunday, October 21, 2012

How strange

I was at a website (for the Washington Monthly), and, to my great surprise, came across an ad for this.  The next step, I suppose, is auctioning off the movie rights.

Chuck Schumer makes a good point

From an interview with Ezra Klein:

"When Republicans say the first thing you do when you do deficit reduction is reduce rates, it would be like Democrats saying the first thing you do when you do deficit reduction is provide free Medicare at age 55. We’d like to do that! But it won’t bring the deficit down. That’s for sure.

"It just makes no sense and I’m surprised so many have swallowed it for so long. If your number one goal is deficit reduction, you don’t start out by lowering the rates. You don’t need a PhD in economics to understand that."

UPDATE: Okay, it's true that lowering the rates may lessen the magnitude both of the existing distortions in the tax system, and of political incentives to create more loopholes via exclusion or deferral.  But as an economic matter (contrary to the mantra of "broaden the base, lower the rates") a broader base and a higher rate are complements, not substitutes.

Saturday, October 20, 2012

The moral and political philosophy of Mitt Romney

Building on a couple of throwaway items in my last post, I am happy to report that the Mitt Romney Philosophy Project is off to a great start.

We have so far the following:

(1) Maximax: welfarist social welfare function that accords absolute priority to increasing the single best-off individual's welfare.

This term can actually be found here in the decision literature: "In decision theory,  the optimistic (aggressive) decision making rule under conditions of uncertainty.  It states that the decision maker should select the course of action whose best (maximum) gain is better than the best gain of all other courses of action possible in given circumstances."

 Sounds as plausible to me as the infinite risk aversion behind the Rawlsian maximin.

(2) Minimin: inverted welfarist social welfare function that accords absolute priority to lowering the single worst-off individual's welfare.

Alas, when I did an online search for this principle all I could find was that it is someone's nickname. 

(3) Veil of arrogance: the starting assumption that you are the richest, smartest, and worthiest person in the society being described; helps to motivate the adoption of maximax.  Also (since you are disgusted by others' inferiority to you) contributes to the appeal of minimin.

(4) Primary goods: the things that every rational individual is assumed to want.  Obvious examples would include Caymans investments, tax shelters, the carried interest rule, Swiss bank accounts, and car elevators.

(5) The original position: Where you stand after you have received government subsidies (so long as they aren't from entitlements or poverty programs), but before you have paid any federal income taxes.

(6) Veil of ignorance: voters' rightful state concerning your plans if you win the election.

(7) Deceptive equilibrium: a state of balance or coherence as between your listeners' beliefs and what they think are your beliefs; arrived at by a process of unilateral rhetorical adjustment.

Am I missing anything here?

Friday, October 19, 2012

A few things I learned at today's NYU-UCLA Tax Policy Conference

Here are a few interesting things I heard  at today's NYU-UCLA Tax Policy Conference (organized around the theme of "100 years of the income tax," but covering a broad array of topics).

1) As David Kamin discussed, suppose we agree that federal income tax revenues will be relatively constant.  Then distributional issues within the income tax will be more important on the bottom end of the income scale than on the top end, for reasons that I can illustrate with the following hypothetical.

Suppose a certain candidate for president wins the election, and enacts the following tax plan:  Everyone in the "47 percent" group that paid no federal income taxes this year gets hit with a $1,000 federal income tax bill.  We then bundle the amounts received into a number of $10 million checks, and hand these to the individuals who we have determined are the very wealthiest people in our society.  (We start with the very richest and keep heading on down the income scale, until we run out of checks.)

[Quick, snarky aside: When you look at Romney's entire set of budget proposals (insofar as they can be discerned), including on the spending side such as Medicaid, this thought experiment is probably far less redistributive towards the top than what he is actually planning, even if one believed him about income tax revenue neutrality for the broader top bracket as a whole.  No worries, however.  Rawlsians sometimes talk about "maximin," but you get to a very different policy place if you believe, as it appears Romney does, in "maximax,"* accompanied by a dollop of "minimin."**  But I digress.]

Seemingly, the headline item here is bundling big checks (in the form of income tax refunds) to give to very rich people.  But the distributional impact is actually greater on the low end than on the high end, because losing $1,000 has a much greater impact on the life circumstances of a poor person than gaining $10 million has on those of a very rich person.

The takeaway here is that the tax system's effect on income distribution in society is likely to be more significant at the bottom of the income distribution than at the top, if you don't raise the issue of the level of tax revenue and how it is being used. Or to put it differently, if you are concerned about wealth concentration at the top, issues of tax rates and tax base design within a constant-revenue framework are probably not where you should place most of your chips.  By contrast, it is fairly easy to have significant effects on the bottom, such as through items like the earned income tax credit and child tax credit that played significant roles - at one time, with Republican support - in creating the policies underlying the 47% pseudo-factoid.

2) Would an increase in the top rate tax hurt "job-creating entrepeneurs"?  As Leonard Burman noted, to the limited extent it actually mattered, it might actually help those guys attract relative to others in the top bracket  The entrepeneurs, as owner-employees, can effectively get expensing for their own capital-creating labor services if they underpay themselves.  The relative tax preference for such activity is increased if you raise the top individual rate.

3) Why is the income tax marriage penalty so politically prominent today?  In part, because, as Anne Alstott discussed, stable, long-term marriage (often with two earners) is statistically correlated with being high-income.  So you have behavior that is arguably a tag for "ability" in the sense that we use it in the tax policy literature, and that is relatively inelastic, creating tax policy arguments in its favor - but also guaranteeing political controversiality, because (a) these are the people who have political clout, and (b) as Albert Hirschman might have put it, you're most likely to use voice when you aren't using exit.

*Maximax would presumably be a version of welfarism in which the only thing that matters is increasing the single best-off individual's welfare.

**Minimin would presumably be an inverted version of welfarism in which the only thing that matters is lowering the single worst-off individual's welfare.

UPDATE: A reader (my brother) suggests expanding on the notion of Romney as a philosopher.  "Instead of Rawls' 'veil of ignorance,' we would have Romney's 'veil of arrogance,' the starting assumption with which you approach any discussion of possible social arrangements is that you are the richest [and I would add worthiest] person in the society being described."

Thursday, October 18, 2012

Conference at NYU Law School on Friday, October 19

Tomorrow, the Second Annual NYU-UCLA Tax Symposium will be taking place at NYU Law School.  I will miss the opening session, as I teach a class at that time, but may report here afterwards on anything of particular blogging interest.  It should be an excellent conference.

The Internal Revenue Code at 100, October 19th, 9:00 AM to 5:00 PM

Breakfast and Registration 8:30-9:00 a.m. Greenberg Lounge

Introduction/Opening Remarks 9:00-9:20 a.m.

Deborah Schenk, Marilynn and Ronald Grossman Professor of Taxation, NYU Law School and Editor-in-Chief, Tax Law Review

Business Tax Panel 9:20-10:50 a.m.

Moderator: Josh Blank, Professor of Tax Practice; Faculty Director, Graduate Tax Program, NYU Law School

1. Kimberly Clausing, Thormund A. Miller and Walter Mintz Professor of Economics, Reed College

2. Steven Bank, Professor of Law, UCLA Law School

3. Noƫl Cunningham, Professor of Law, NYU Law School and Mitchell Engler, Professor of Law, Cardozo Law School

Break 10:50-11:05 a.m.

Inequality Panel 11:05 a.m. -12:35 p.m.

Moderator: Jason Oh, Acting Professor of Law, UCLA Law School

1. David Kamin, Assistant Professor of Law, NYU Law School

2. Eric Zolt, Michael H. Schill Distinguished Professor of Law, UCLA Law School

3. Len Burman, Daniel Patrick Moynihan Professor of Public Affairs, Maxwell School, Syracuse University

Lunch break 12:45-1:45 p.m.

International Tax Panel 1:45 - 3:15 p.m.

Moderator: Daniel Shaviro, Wayne Perry Professor of Taxation, NYU Law School

1. Mitchell Kane, Professor of Law, NYU Law School

2. David Lenter, Legislation Counsel, Joint Committee on Taxation

3. John Steines, Professor of Law, NYU Law School

Break 3:15 – 3:30 p.m.

Politics Panel 3:30 – 5 p.m.

Moderator: Kirk Stark, Professor of Law, UCLA Law School

1. George Yin, Edwin S. Cohen Distinguished Professor of Law and Taxation, Thomas F. Bergin Teaching Professor, University of Virginia School of Law

2. Anne Alstott, Jacquin D. Bierman Professor of Taxation, Yale Law School

3. Joseph Thorndike, Director, Tax History Project, Tax Analysts

What to expect when you're not expecting

Today I gave a lunch talk in midtown Manhattan, at the Covington Retreat for International Tax Executives, entitled "The Prospects for Corporate and International Tax Reform: What to Expect When You're Not Expecting."  Slides (which I used as lecture notes rather than as slides) that give a detailed overview of my talk are available here.

The basic topic is why I don't expect major corporate and international tax reform to happen - or, if it happens, to be very stable - not just for obvious political reasons but also due to the fundamental dilemmas we face once we are forced, by the existence of the individual income tax, to sign on to entity-level corporate income taxation.

Among other things, it offers first-ever full details of the fictional "Shaviro tax reform plan," which I confidently assert could and would happen shortly, apart from the unfortunate fact that it actually can't and won't happen.  (This is a device to help explain why changes that depart from it, by reason of being administratively feasible as it is not, are inevitably so unsatisfying.)

Wednesday, October 17, 2012

Has Romney gotten away with not releasing any pre-2010 tax returns?

It certainly appears that way, although the 2009 return, unlike the one he recently released for 2011, had a decent chance of being very interesting (for example, no net capital gain, hence adjusted gross income was probably below $1 million - not to mention, the chance of a Swiss bank account-related amnesty).

I guess it goes to show that sometimes, if you keep on stonewalling long enough, the press just gets bored and it works.

Not close enough for government work

Romney apparently proposes to pay for $4.8 trillion worth of rate cuts with a $25,000 deduction cap that would raise about $730 billion.  Sorry, but offering one-seventh of the needed funding is not quite close enough for me.

Tuesday, October 16, 2012

Cynicism and dishonesty in tax reform debate (although, perhaps, what else is new?)

With all the questions that I keep getting about the Romney tax plan and the Tax Policy Center study, I think it's worth reviewing briefly what the Romney people (a group that includes some talented and well-informed economists) undoubtedly know.

They know, as well as any of their critics, that it is impossible for Romney to cut the tax rate by 20 percent, achieve revenue neutrality, avoid a "middle-class" (including upper middle class) tax increase, and keep high earners' taxes from declining overall - especially when they are also committed to preserving current law rules that treat saving and investment relatively favorably.  If they don't know this, they should have their PhDs taken away, and be sent to the corner wearing dunce caps.  But trust me, they know this, and surely they have told Romney.

But the Romney campaign's first calculation evidently was that it made sense politically for him to promise all these incompatible things anyway.  Olkay, that's kind of par for the course, but the follow-up steps were more innovative.

The second calculation was that, if you keep it vague enough and supply virtually no details, you can rebut any attempt to show that it's impossible by saying "That's not how we'd do it."  How can anyone estimate something that has been specifically set up with an eye to making it impossible to estimate?

There is also, of course, a two-birds-with-one-stone aspect to all this.  No tax reform proponent wants to admit in advance that he or she is targeting popular items - say, the home mortgage interest deduction, the exclusion for employer-provided health insurance, and the charitable contributions deduction.  So we understand that they will be a bit shy about admitting all this up front.  But that was only part of the dodge - making the claims impossible to evaluate was the other part.

The Romney camp may have been surprised when the Tax Policy Center actually took on the conundrum they had set, by releasing a study based on reasonable (and generally favorable) assumptions.  So at this point the Romney people made a third calculation.  Let's get people in our camp to issue something that takes issue with the TPC and at least seems to support our stance, they decided.  Then, before long, we will be able to say that we have "six studies" in our favor.  (Why six?  I think because the phrase just sounds better than five studies or even seven.  It's crisp and alliterative.)

Never mind that most of these are not really "studies," and never mind that the honest ones among them - the majority - don't actually support the Romney claims that all of the promises could simultaneously be met, in defiance of simple arithmetic.  They just show how one could arguably come closer than the TPC assumed was possible, in one dimension or another, often by making another dimension worse.  But never mind all that.  You just keep saying "six studies," and what remains in fact a conscious lie by the Romney campaign shifts firmly (they are hoping) into murky "he said / she said" territory, so far as the public debate is concerned.

What's distinctive about all this?  Maybe not so much.  In JFK's 1960 campaign for president, he talked a lot about the "missile gap" between the U.S. and the Soviet Union, which did not in fact exist (or rather, it favored us, not them), and which some reports say he was told during the campaign did not exist.  It's even been claimed that the Eisenhower Administration could have definitely rebutted the claim, but had policy reasons for not disclosing what they knew, and that the Kennedy campaign deliberately took advantage of this expected reticence.  If so, then that was pretty raw as well.

But I do find the Romney camp's tactics here insulting, contemptuous, smarmy, and too clever by half.  It shows a basic political style that we will get to know all too well if Romney wins the election.

Tuesday, October 09, 2012

Great minds think alike, part 2

Matthew Yglesias criticizes David Brooks for loading the rhetorical dice in favor of the Romney-Ryan approach to slowing long-term Medicare growth, as distinct from the Obama Administration approach, via use of the term "market-based."  In particular:

"Brooks says Obama's plan to do this with price controls is doomed for political economy reasons. A politically powerful coalition of elderly people and health care providers will block it. That's certainly plausible. But what's the alternative?

"Brooks says the alternative is to insert an additional layer of rent-seekers into the dynamic by contracting Medicare services out to private health insurance companies ....

"If you read the column, I think that what you'll find is that basically all the analytical work is being done by a project of ideological labeling. Brooks describes this as a plan that works 'through a market system' featuring 'normal market incentives.' He twice calls it a 'market-based approach' and once refers to critics as scoffing at 'market-based strategies.' The idea of a market has positive emotional resonance with many people, so if you convince them that you have a 'market-based' alternative to price controls that will sound good. But a system of government-funded subcontractors is only market-based if you squint at it really funny. Or, rather, it's very much a market but it's a market for political influence."

Fair enough.  But one reason this particularly interested me is that I am currently writing an article about Social Security and Medicare financing and reform, called "Should Social Security and Medicare Be More Market-Based?"  I use the term neutrally rather than (like Brooks) to load the rhetorical dice, and indeed I am mainly skeptical about the family of reform proposals that are thus described.

Yglesias makes a valid point, albeit that (as he recognizes) the issue devolves into one of comparative political economy, with none of the alternatives being likely to inspire much optimism.  But another point about Social Security and Medicare design is the following: If "more market-based" is always better, based on the view that rational consumers are optimizing under conditions of robust competition and in the absence of serious market failure, you will see no need for Social Security and Medicare to begin with.  For example, why would we require people to save for retirement, and to have health insurance at that point, as Social Security and Medicare effectively do even under the more market-based plans?  Why, for that matter, does the most recent Ryan Social Security plan (from 2010) limit the investment options that people are granted to relatively safe and well-diversified ones?  For that matter, why does it forbid retirees to keep right on betting on stock and bond prices, as it does by saying that they cannot choose retirement annuities with payoffs that depend on asset performance?  These, too, are "non-market-based" approaches relative to the alternatives.  Indeed, if you wanted to be as "market-based" as it was possible to be, you would simply abolish the programs, perhaps with a cash payout for the value of whatever existing interests one chose to recognize.

As I note in the current (as yet unposted) draft, "In effect, proponents have conceded the principle that [pure market approaches] should be limited or even denied in some respects, and all that remains is 'haggling over the price.'  So the merits of [a more market-based approach] cannot simply be assumed here, even if we favor it in many other settings.  Rather, they need to be specifically demonstrated in relation to Social Security’s [and Medicare's] accepted purposes."

1986-style tax reform: a good idea whose time has passed

In May 2011, I published an article with the above title, available here

My main argument: while it made plenty of sense in the mid-1980s to implement a tax reform plan that financed significant rate cuts (making the overall plan revenue-neutral) by broadening the base, that approach simply does not make sense today.  Given both the long-term U.S. fiscal gap and the worrying increase in high-end inequality since 1986, cutting the rates is simply not a sensible way to use the budgetary gain that could be generated through base-broadening - at least in the individual income tax, although for the corporate tax it's a closer call.

Whether or not the article had any direct influence, the view it takes appears to be gaining ground, at least on the Democratic side of the aisle.  Senator Charles Schumer is quoted here as criticizing the 1986-style approach, which the Bowles-Simpson proposal employs in significant degree, for reasons that are similar to my own.

Along the same lines, you know the old line that everything happens twice, first as tragedy and then as farce.  The 1986 reform certainly wasn't a tragedy, but you can see it being replayed as farce by the Romney campaign, which claims that the budgetary cost of high-end rate reduction would be completely offset by base-broadening measures that they almost entirely refuse to identify (although Romney's riff about the $17,000 ceiling was admittedly a step forward), notwithstanding the fact that it's been shown, as a matter of arithmetic, that the plan would fall at least $1 trillion short of paying for the high-end rate cuts over the next ten years.

The Reagan Administration in 1984 and 1985, rather than playing this cynical game, actually released two comprehensive proposals (the Treasury I and Treasury II plans) showing exactly how proposed rate cuts would be fully financed over a five-year period, on what was estimated to be a distributionally neutral basis.  But this time around, it's apparently going to be done with faith, and trust, and a generous helping of pixie dust (a.k.a. implausible economic growth projections).

Friday, October 05, 2012

Follow-up on the financial transactions tax

Yesterday, as mentioned in the previous post, I participated in a panel discussion at the International Fiscal Association’s annual meeting (held this year in Boston), entitled: “Towards an EU Financial Transactions Tax?” The discussion was chaired by Malcolm Gammie of the UK, and the panelists, besides me, were (1) Manfred Bergmann of the European Commission, who is the principal author of the Commission’s financial transactions tax (FTT) proposal, (2) Francesco Guelfi, an Italian tax lawyer, (3) Axel Haelterman, a Belgian tax professor and tax lawyer, and (4) Urs Kapalle, a Swiss tax lawyer. Thanks are also due to Eric Roeder of the Max Planck Institute, who made sure the whole thing worked out.

A word on the state of the play for the European FTT: as an EU-wide proposal, it is dead as a doornail, having been conclusively rejected this past summer due to some member states’ unyielding opposition (the UK being a key player here). But a number of EU countries are adopting FTTs anyway. For example, Germany and France have already acted, and Spain may joint them soon. FTT proponents are hoping for coordinated adoption by a significant subset of EU countries. So the European FTT is alive, kicking, and potentially still relevant, even if the European Community as a whole is not going to act.

Wholly without regard to the merits, this is a tricky scenario to sustain. Everyone agrees that, given the mobility of financial transactions, a pretty wide scope is needed for them to work. On the other hand, insofar as countries follow the EC proposal’s structure of imposing the taxes on a residence basis, not just where the deal is executed, single-country FTTs (at least for relatively large countries) may actually succeed in generating non-trivial tax revenues, on an ongoing basis, at a relatively low administrative cost.

This, of course, doesn’t tell us that the proposals are a good idea – and not just because there will still be plenty of exit (the English may well be delighted to see FTTs on the books in Germany and France) but due to the broader efficiency costs of a cascading tax that is levied on a gross, per-transaction basis. Case in point: the European Commission estimated that its tax on derivatives would lower trading volume by 75%. They believe that this would mostly have reflected fewer deals, as opposed to tax avoidance via exit. This is not a result that one should like, to the extent that the parties to the eliminated derivative trades are consenting adults who are optimizing for themselves without hurting anyone else. So liking this result has to rest on believing that many of the eliminated transactions are bad ones, e.g., due to externalities (such as their increasing market volatility – except, it is hard to generalize, either theoretically or empirically, about how they affect volatility overall).

As noted in prior posts and in my article on the subject, I am not a huge FTT fan. The two points I see in its favor are as follows:

(1) I believe that there is too much trading, from a social standpoint, in that people invest too much effort in seeking trading gains at the expense of other traders.

(2) That issue aside, I view the FTT as an inefficiently designed tax on capital, borne mainly by investors in general. This hardly sounds like an endorsement so far, but suppose it is more politically feasible than better choices, that a given country has desperate revenue needs that would otherwise be politically hard to meet, and that at least the thing is fairly progressive (albeit more poorly designed than other progressive levies). Then I would hate to be a purist and say no, based on superior alternatives that are unavailable, unless the efficiency costs (relative to the revenue) are on the high end, rather than the low end, of the range that I think possible.

All this makes me in the end a bit agnostic about whether or not to adopt the FTT if the available alternatives are very highly constrained. Sorry to dodge a more definite answer here, but I am not running for office, and spouting a bottom line when one is unsure can turn into mere spitballing.

OK, what I probably would do if less constrained is (a) address income tax (and, outside the U.S., VAT) under-taxation of financial services, (b) adopt the “FAT-2” version of the financial activities tax, in response to apparently durable rents in the financial sector that make me very suspicious of what is going on there (see here for further details), and (c) maybe do something – through the income tax?? somewhere else?? – about the excessive trading issue.

One of the core problems with the FTT not only affects the merits of adopting it, but impedes figuring out how it should be designed. I thought I made this point more articulately at the IFA panel yesterday than I have managed previously, so here’s an effort to repeat what I said (at characteristically high words-per-minute volume) during the session.

Consider having an income tax, a consumption tax, or a carbon tax. In each case we know what we are trying to do and why, and this really helps to inform design choices. The income tax and the consumption tax are attempted (albeit imperfect) measures of material wellbeing, or ability, or ability to pay, or whatever you want to call it. It’s not that we want to discourage income or consumption, but we believe they have informational content about, or correlation with, something else. To a large extent though not 100%, we know what we mean by “income” or “consumption,” and this helps a lot – although not all the time – in making design choices for the system, albeit that we still need to consider a host of other issues (e.g., tax planning, compliance, and administrative costs, not to mention other types of information that are relevant to distribution).

Now take the carbon tax. We know what we don’t like: carbon’s effect on global warming. Happily (or not), all carbon atoms are relevantly the same. So we know what we are trying to tax and why, and this really helps in designing a carbon tax – leaving aside the issue of global cooperation, since the scope of the public good (moderating climate change) is global.

Now let’s turn to the FTT. What are we trying to tax and why? Even if on balance adopting the tax would have good consequences relative to not adopting it, it’s not clear what the “thing” we’re after is. And this makes it really hard, for example, to say how derivatives should be treated under the FTT.

Suppose that what we are after is excessive effort to seek trading gains. Even with just old-fashioned stock trading, it’s not entirely clear how good a proxy gross trading volume is for the thing we have in mind. For example, do we want to tax repos that involve financial instruments? These are transactions in which I “sell” you a financial asset for $X, but we agree that I will buy it back at a given time for $X + $Y, where Y is essentially an interest return. This is really just a way of doing a secured loan, which principally wouldn’t be taxed if it weren’t structured as a repo. (The repo, by contrast, is potentially taxed twice: when I “sell” to you, and when you “sell” back to me.)

Sure, we could put an economic substance rule regarding sales into our FTT, just as the U.S. income tax has (requiring that at least sufficiently clearcut repos be treated as loans, not sales), but no one wants to run the FTT that way – it is supposed to be administratively much simpler and more automatic.

OK, I assumed that we don’t want to tax the repo or the secured lending under the FTT, but suppose it is partly speculation by the lender regarding the asset value. Thus, suppose the lender really is to some extent betting on the value of the secured asset in making the secured loan. Thus, the return of $Y might actually be a speculative bet on the financial asset’s upside – say, with cash settlement rather than physical settlement at the back end, so that there isn’t an asset transfer (in the secured loan version) even then.

Admittedly, this example is a bit picayune. It probably wouldn’t stop us from adopting the FTT, if otherwise we liked it enough, all by itself. But when you start considering the taxation of derivatives, the fact that the underlying goal is a bit murky becomes a real impediment to figuring out how the FTT should operate.

Case 1 is a total return equity swap. Rather than my buying 150 shares of Apple stock for $100,000, and financing it with a loan, the bank and I agree that in one year’s time we will net the following two obligations: (a) I owe them the interest that a $100K loan would have earned them, plus the amount, if any, by which 150 shares of Apple stock declined in value during the year; (b) they owe me an amount equal to the dividends paid plus the share appreciation, if any, for 150 shares of Apple stock during the same one-year period.

Counter-party risk aside, this is economically equivalent to my buying the 150 shares for the $100K loan. So, if we don’t tax it under our FTT – or even, like the European Commission’s proposal, if we tax it at a much lower rate (relative to the $100K “notional principal amount”) than a stock sale – we are simply telling people to replace stock sales with total return equity swaps.

But what about all sorts of other derivative instruments (which can of course be mixed and matched with the above swap if you like)? E.g., an interest rate swap: in one year, I’ll pay you the amount that I would have owed you on a $100K loan at a fixed interest rate, and you’ll pay me the amount that you would have owed me on a $100K loan at a floating rate.

Had we done the actual transaction (the offsetting loans) rather than the swap, the FTT wouldn’t have hit us. So here the derivative is being taxed worse than the underlying, for no obvious reason. What’s more, it isn’t entirely clear that we have a good reason for wanting to tax this swap. Is this socially excessive speculation on the likely direction of interest rate movement? What if I am simply trying to hedge my other economic positions from my business, and the bank is hedging or swapping out everything as well?

Anyway, this discussion has gone on long enough for a blog post (or perhaps too long), but the main point I want to make here is that it’s hard to bridge the gap between the underlying reasons we might have for imposing an FTT and the questions of how to tax various derivative transactions, which (if they were taxed differently) would be run through the blender and the Obscurathon anyway.

Wednesday, October 03, 2012

IFA travels

I am currently at the International Fiscal Association's annual meeting, which is being held this year in Boston.  These days I tend not to go to conferences unless I am one of the speakers, but as it happens I am one at the IFA.  I am appearing on a panel tomorrow to discuss financial transactions taxes, as well as alternatives such as the financial activities tax.  Our seven-person panel had a 5 (!) hour meeting today to plan our 2-hour panel tomorrow - the IFA norm for panels emphasizes rigorous advance preparation, verging on scripting.  But it was actually reasonably enjoyable and interesting, especially considering how long we all were there.

Turning to the panel's subject, I am not a huge fan of the financial transactions tax compared to the alternative tax instruments of my choice, but if it is the FTT or nothing, I would certainly consider saying yes to it, either for the EU (the issue in tomorrow's panel discussion) or the U.S.  Given our political system's severe dysfunctionality and our revenue needs, along with the fact that (as Keynes argued back in 1935) there seems to be too much effort invested in seeking stock profits at the expense of rival investors, and finally given that the FTT is fairly progressive (albeit as an oddly designed tax on saving and investment), there is something to be said for it if we rule out all the alternatives (progressive consumption tax, VAT, carbon tax, financial activities tax, etc.).  And I do respect the very serious effort that the European Commission folks put in trying to design it appropriately.  That said, there certainly are lots of problems, such as in how to treat derivative transactions, as well as the prospect of cascading inter-business taxes that could prompt financial market disintermediation.  But tomorrow I will be more analytical than bottom line.

The IFA's annual meeting is an interesting sociological event that I have never attended before.  A few thousand people attend, mostly European and Third World, mostly practitioners but with a few academics and NGO or government types.  I know a lot of people here in numerical terms, not that many in percentage terms, and it is obviously a huge networking event for tax professionals who want to meet their peers in other countries.  I gather that it used to be mostly OECD, but now countries such as South Korea and India are huge players as well.  Probably lots of interesting dynamics that I cannot myself directly observe.

Tuesday, October 02, 2012

Doubling down on my personal economic plan

"Want to increase your productivity? Study says: Look at this adorable kitten," says the link on Ezra Klein's Wonkblog.

In that case, I am expecting double enhancement of my productivity (which I could really use, given all the speaking and writing commitments that I've accepted recently).  The gray one is Gary, and the black-and-white one is Sylvester.