Sunday, January 31, 2016

Mitchell Kane's "A Defense of Source Rules in International Taxation"

My colleague Mitchell Kane has recently published a quite interesting article on source rules in international taxation, taking a view that differs more from mine on the surface than I think it does in underlying substance.

A commonly quoted line about determining the source of income, from Hugh Ault's and David Bradford's piece on the subject more than 25 years ago, says that the notion of "source" lacks coherent economic content. I recall Bradford frequently noting that, while there is an intellectually coherent Haig-Simons income concept, there is no such benchmark for source. I've frequently quoted this line, as it's seemed both (a) clearly right and (b) related to the difficulties that source-based taxation presents in practice.  But I've also been aware that (a) it's easy to determine source in some cases, and (b) in other cases it depends on how you define it - e.g., origin basis vs. destination basis (more on this shortly).

Kane agrees at least arguendo that there may be no coherent economic definition of source, but then says: Why would the definition have to be an economic one?  "Household" or "family," for example, can't be satisfyingly defined for tax or other transfer system purposes unless one informs it with ideas taken from somewhere else that express one's underlying purposes.  For source, he sees the purposes as relating to how countries try to divvy up income tax bases between themselves.  He approaches this as a multilateral cooperative process, whereas - just as a matter of taste or interest; either approach can be fine - I tend to think about it more in terms of unilateral processes that may be conducted in the shadow of particular strategic interactions.

Then comes an important point that I've been thinking of writing about, although at the moment I'm engaged in my literature book - origin-based vs. destination-based income concepts. Say I sit at my desk in New York and write a book in Bengali that I will sell for large profits to people on the Indian subcontinent. Under the origin concept, the income is U.S.-source because that's where I did the work.  Under the destination concept, the income is sourced in India and Bangladesh because that's where the sales occurred.

In the context of, say, a retail sales tax or value-added tax, we often hear about the point that they can use either the destination basis (which is the universal norm) or the origin basis (as under some progressive consumption tax models that would use a VAT as part of their structure).  It's a familiar point that, in the consumption tax environment, one can use either, and in the long run it doesn't matter which one uses, leaving aside some extremely important issues pertaining to transition and administrability.

Income is commonly called an origin concept, and I've written about the difficulty of trying to run an income tax off the destination basis.  Absent some very fancy footwork, the equivalence from the consumption tax context is undermined by the fact that how long one saves before consuming (e.g., the time between exports to earn $$ and imports to spend it) affects income tax liability, whereas it hypothetically doesn't affect the present value of consumption tax liability using constant rates across time.

But in fact there are plenty of destination-based source concepts in existing income taxes.  For example, the U.S. income tax sources labor income based on where the work occurs, but it sources royalties based on where the property is used. So what if you use labor to create royalties? Then formalism determines the source of income.

The mix between origin and destination concepts in the income tax creates various tax planning opportunities, but that's not to say, at least right off, that a given country isn't better off using both in different places rather than just one.

Now let's consider source in the taxation of multinational enterprises.  Using transfer pricing between affiliated entities is apparently an origin based concept, but doesn't work too well.  Shifting to one-factor formulary apportionment that was based solely on sales would make it a destination concept.  But as Jerry Seinfeld and George Constanza would say, not that there's (necessarily) anything wrong with that.  When Reuven Avi-Yonah, Kim Clausing, and Michael Durst propose replacing transfer pricing with formulary apportionment, they are surely not "wrong' by reason of urging the use of a destination concept in a mainly origin-based system. After all, suppose the switch has predominantly good effects, whether adopted just by the U.S. or more generally. And the assessment of that depends on all sorts of wholly separate things (e.g., how manipulable would the sales factor be) that are quite distinct from the theoretical choice between income and consumption taxation.

Anyway, back to Kane's article.  The fact that one can use either origin or destination concepts to define the source of income has figured in my thinking as evidence for the prosecution in calling the source concept incoherent. Kane instead views it as evidence for the defense, showing that there are two ways one can actually do the thing, and it is simply a question of deciding which is better.  He mainly comes out pro-origin, because of the points that make it a better fit with the income concept.

Is the choice "really" evidence for the prosecution, as I have thought, or for the defense, as he argues? Once again this is really a matter of perspective - it's not a case where reasoning logically from required premises leads to one conclusion or the other.

Kane has one other main point in defending the coherence (whether it's economic or not) of the source concept.  He notes the problem of, say, deciding where interest should be deducted, when a multinational has both interest expense and gross income that presumably was produced by using the borrowed funds.  (But of course we don't really know what income this "really" is, given that the fungibility of money makes it quite meaningless where the particular loan proceeds were directly sent.)  But he notes that this is simply a broader difficulty of applying the income concept which applies even in the context of one-country taxation where there is no source issue.

Let me broaden that a bit.  Consider the "synergy" problem in transfer pricing. Standard example: U.S. and French company, if separately owned, would have earned $1M each. But they're co-owned by a multinational enterprise, leading to synergies that increase their combined net income to $2.5M. Where did the extra $500,000 of synergy income actually arise? I see it as in principle a bilateral monopoly bargaining problem - one could imagine the U.S. and French entities negotiating over it, if we posit that neither could realize it separately.  But since we can't really say anything about bilateral monopoly bargaining outcomes in the abstract, there's seemingly no good answer here.

So source might be viewed as an economically (and otherwise?) incoherent concept with respect to the $500,000 - though not as to the underlying $1 million that "should" be the minimum reported in each jurisdiction.

Once again, however, Kane's argument, to the effect that this is not a "source" problem as such, can be made here.  Suppose you have related entities in the U.S. that are taxed at different rates - e.g., because we have a special tax rate for the finance industry as compared to the electrical generating industry, and a given conglomerate entity or set of entities does both.  Now it matters which entity has how much income, but there is comparably no coherent answer to the bilateral monopoly bargaining issue that's raised by the synergy income.  So the transfer pricing problem isn't so much a source problem as a related-parties problem.

How much does all this matter in the end?  The issues of ultimate importance really turn on the consequences of alternative rule designs, as judged based on some underlying set of metrics.  So I'm not substantially more (or for that matter less) sanguine on the question of how well or poorly one can use source concepts in practice than I was before reading the Kane article.  But it provides very useful clarification regarding a set of conceptual issues that interest me, and on which I may still write a bit (in light of this article) at some point down the road.

Wednesday, January 27, 2016

Tax policy colloquium, week 2: Michael Simkovic's The Knowledge Tax

Yesterday, we discussed the above paper, which builds on Mike's co-authored empirical work on the economic value of a law degree, along with other empirical work that Mike and others have done suggesting that higher education degrees (college and up) offer highly favorable pre-tax (and to a lesser degree, after-tax) rates of return, even taking into account of opportunity costs (foregone earnings while one is in school).

The underlying research reaches two main conclusions.  The first is that lifetime earnings are sufficiently higher for those who get higher education degrees (despite the time away from being more than part-time in the workforce) to offer an above-market rate of return on tuition, etcetera.  The  comparison here is to investment returns on different forms of capital other than human capital.  The second is that a causal arrow runs from higher education to higher earnings - in other words, that it's not just selection bias, as in the case where those motivation and abilities will tend to produce higher earnings in any event also happen to pursue higher education.

Both of these conclusions, perhaps the second in particular, are controversial in the literature. Based admittedly on just superficial inquiry, Simkovic's work on these issues strikes me as plausible and well-reasoned, but I admittedly don't know enough to form a definite opinion.

In reading The Knowledge Tax for our session, I thought it reasonable to accept the empirical conclusions for argument's sake (which again, is not to suggest skepticism about them), because the main issue presented by the paper concerns their further implications. The paper argues that part, though not all, of the higher pre-tax return associated with higher education reflects that human capital investment is treated less favorably by the U.S. fiscal system (and in particular, though not exclusively, the U.S. federal income tax) than other investment. It thus argues that more favorable treatment of higher education would increase tax neutrality, economic efficiency, and long-term growth, due not only to the standard efficiency arguments for tax neutrality between particular alternatives, but also positive externalities.

There is of course a difference between devising "neutral" rules, at some particular margin, and those that are aimed at inducing particular behavioral responses, but if the rules are currently biased against something with positive externalities, then up to a point the two modes of analysis may have some tendency to travel together.

I thought the paper made a good case that we should mainly think of higher education expenses as investment, rather than as consumption (an old debate, of course).  But it's harder to draw firm conclusions about the current degrees of relative bias.  Obviously, the question of how favorably the U.S. federal income tax system actually treats non-human capital investment of varying kinds is quite complicated.  And one tax benefit of pursuing higher education, in lieu of working currently, is that the opportunity cost isn't taxable.

E.g., say I could have earned $50,000 this year, but instead I earn zero and rely on loans, savings, or family resources to spend an additional $50,000 going to law school.  I get implicit expensing of the $50,000 foregone earnings, even though the law degree may have future value that goes forward for decades.  This is highly favorable treatment from an economic standpoint.  On the other hand, I never get cost recovery for the $50,000 of tuition, even though it may reasonably be viewed as a cost of generating earnings.  There is of course no general answer to the question of how alternative investment choices would have been treated by the tax system, given the crazy quilt of possibilities.  So figuring out what's treated better or worse than what is quite tricky.

It's also fair game to ask how we think people who are considering higher education actually decide, and to what extent they are focusing on the long run, and sophisticated aspects of it such as the tax treatment of alternative types of future income.  As I discuss in my recent paper on behavioral economics and retirement saving, people often act as if they are myopic, even if that is not exactly the internal mental process. Now, when one decides to pursue higher education, evidently there is some sort of departure from the blinkered, short-term focus of the classic myope.  But still, even if people are taking account (or act as if they are taking account) of long-term earnings potential, it is possible that some aspects of the myopic or as-if-myopic frameworks will continue to influence them.  And this is potentially relevant to how they respond to reasonably expected after-tax earnings under alternative choices, and to tax rules that would change the overall treatment (especially down the road).

There are also important institutional issues to think about, e.g., does the education sector respond to demand (e.g., given that much of it is nonprofit), and how do relevant labor markets function - e.g., those for lawyers and doctors.

So it's a rich topic, to which the paper makes an interesting (if inevitably inconclusive) contribution.

Behavioral economics and retirement saving

My recently published Connecticut Law Review article, "Multiple Myopias, Multiple Selves, and the Under-Saving Problem," is now available on-line here.  It joins the fray regarding the reasons for apparent under-saving for retirement, with particular reference to the "nudges" debate, the well-known Chetty et al Denmark study, and the sometimes under-appreciated links between income tax "incentives" for retirement saving, fundamental tax reform, and Social Security reform.

Wednesday, January 20, 2016

Tax Policy Colloquium, week 1: Eric Talley's "Corporate Inversions and the Unbundling of Regulatory Competition"

Yesterday we began Year 21 of the NYU Tax Policy Colloquium. It occurred to me that I have been doing the Colloquium for more than half of the adult portion of my life, whether we date if from my first being eligible to drive (other than on a learner's permit), to vote, or to drink. At least we haven't yet reached the point where the age of the colloquium exceeds that of any student in the class (given that we don't have undergraduates). But that is not so many years off.

My co-convenor this year is Chris Sanchirico, and the speaker for Week 1 yesterday was Eric Talley, We discussed his recently published U Va Law Review piece on corporate inversions.

Because the sessions are off the record (although it is not as if a lot of Page Six-worthy stuff happens at them), my procedure here is to focus just on the paper and my reactions to it, as opposed to discussing what happened at the session.

Talley's paper takes advantage of his expertise in corporate governance and securities law to offer an insight that was not, so far as I know, familiar to tax people who have been thinking, talking, and writing about corporate inversions. Certainly it was new to me. He notes that recent moves towards the effective federalization of U.S. corporate governance law have potential implications for taxpayers' interest in engaging in corporate inversions that cause a given multinational to have a non-U.S., rather than a U.S., parent.

Federalization in this context refers particularly to the enactment of Dodd-Frank and Sarbanes-Oxley. Whether these laws are good, bad, mixed, or indifferent, one effect they have is to move legal provisions that are relevant to corporate governance, managerial discretion, etcetera, from the state level (such as Delaware corporate law) to the federal level.

The reason this matters to inversions is as follows. Suppose the relevant choosers (be they the managers who direct corporate planning, or the shareholders and other investors, if their preferences constrain or influence management) like Delaware corporate law. An inversion that makes, say, Dutch, Swiss, U.K., or Irish corporate law the relevant body will have the disadvantage, to the choosers, of supplanting Delaware law.

But so long as the company's stock is still traded on U.S. markets post-inversion, the federal regimes, such as Dodd-Frank and Sarbanes-Oxley, continue to apply.  So one doesn't opt out of them by inverting, even though one does effectively opt out of Delaware.

To get Delaware corporate law, you have to be incorporated in Delaware, with the inevitable consequence that the company is a U.S. tax resident. But if you want Dodd-Frank and Sarbanes-Oxley (which is not to say whether companies DO generally want them), you don't have to be U.S.-incorporated.  In short, in the paper's lingo, we have unbundled them from the requirement that one be treated as a resident U.S. company.

It is possible that this change, by allowing U.S. companies to invert without as fully exiting U.S. corporate governance law, has made inversions more attractive to some companies than they would otherwise have been. Of course, the magnitude of this effect is unclear. But I'm less sold on the paper's analysis of bundling corporate governance services with makng one accept resident taxpayer status. Under the paper's basic model, this functions as the means of (a) funding the costly provision of corporate governance services and (b) permitting corporate tax revenues to be collected, up to the value that choosers place on those services.

Some particular points I might make, in questioning the bundling model, include the following:

1) How costly is it to provide governance services? Of course they don't cost zero, but are they significant enough to make a model that emphasizes them especially useful?

2) Even if governance services are costly and funded by choosers, why fund it this way? The residence-based aspect of corporate income taxation presents a rather odd funding model for corporate governance services.  Note that companies that act in the U.S. are taxable here on a source basis anyway. So what I mean by the "residence-based aspect of corporate income taxation" is (a) the issues around deferral for profits stashed abroad and (b) the greater difficulty in some respects of profit-shifting out of the U.S., if one is a resident U.S. company.

3) Note that corporate governance services are not currently funded by choosers in the manner that the model envisions. Extra corporate income tax revenues to the federal government don't pay for Delaware's corporate law regime, and (as the paper notes) U.S.-listed companies don't distinctively pay for Sarbanes-Oxley and Dodd-Frank.

4) Suppose you have a public goods argument for the federalized corporate governance rules, e.g., based on systemic risk to the economy or the general benefits of having well-functioning and transparent corporate securities markets. These aspects can't be funded via value provided to the choosers, given the public goods aspect. So they can only be funded through general revenues or some other dedicated source that relies in some different way on the governance jurisdiction's market power.

BTW, what would I do about inversions, at a more general level than simply tightening the inversion rules? I think the key elements are (1) addressing the $2.3 trillion buildup in public companies' "permanently reinvested earnings" abroad, such as via mandatory deemed repatriations of some kind, (2) changing the U.S. rules' current relative over-reliance, in combating profit-shifting by multinationals, on (a) CFC rules that only apply to resident companies relative to (b) rules that apply comparably to all multinationals (e.g., thin capitalization rules), and (3) perhaps broadening the grounds on which a given company will be deemed a U.S. company (e.g., headquarters location in addition to place of incorporation).

But the paper makes a nice contribution by raising the issue of governance-federalization's effects. It also argues that the inversion wave is likely to exhaust itself faster than many have been assuming, due to the relative scarcity of suitable foreign "dance partners" for U.S. companies.  This, in turn, reflects both (1) the substantive requirements for tax-effective inversions that have been put in place since the last corporate inversions wave, and (2) companies' apparent preference, at least so far, in confining inversions to those that are at least arguably strategic (i.e., involving companies in the same industry - such as Burger King and Tim Horton's, or Pfizer and Allergan.

Wednesday, January 13, 2016

Dean Baker on "A Progressive Way to End Corporate Taxes"

In today's New York Times, Dean Baker floats a corporate tax reform proposal that, as he notes, is well-known in the biz and yet has gotten little attention in recent years:

"Suppose that, instead of taxing corporate profits, we required companies to turn over an amount of stock, in the form of nonvoting shares, to the government.  We can fight over the percentage later ....

"The shares would be nontransferable, except in the case of mergers and buyouts, but they otherwise would be treated just like any other shares.  If the company paid a dividend to its other shareholders, then it would pay the same per share dividend to the government. If it bought back 10 percent of its shares, then it would buy back 10 percent of the government's shares at the same price. In the event of a takeover, the buyer would have to pay the same per-share price to the government as it did to the holders."

Suppose the government's non-voting share percentage is 25%.  If $75 million in dividends are paid to the regular shareholders, the government gets $25 million.  Obviously, this has a lot in common with the case where the government taxes dividends to the shareholders at a 25% rate, in lieu of owning nonvoting shares. In that scenario, the company pays out the same total of $100 million, all to the shareholders, but they pay $25 million over to the government.  Or, you can think in terms of the case where, with an entity-level corporate income tax of 25%, the company earns $100 million, pays $25 million in taxes to the government, and then can pay out the remaining $75 million to the shareholders.

Obviously, this is an integrated corporate tax if we don't otherwise tax dividends.  But if we still do, then it's analogous to the existing two-level corporate income tax. To make life simpler, one could imagine eliminating the shareholder-level tax when the proposal is hypothetically adopted, and simply taking that elimination into account when one decides what share ownership percentage to give the federal government.

The rationale for the proposal is that the corporation can no longer use tax planning to avoid its liability. The government stands in the same boat as shareholders.  Now, this clearly does leave some other games on the table.  As Herwig Schlunk notes, in his article "The Cashless Corporate Tax" that I believe we discussed at the NYU Tax Policy Colloquium around 15 years ago, the games companies might be expected to play include "the use of [financial] instruments that can avoid the designation of equity. This is not a new problem. Under the current corporate tax, the tax base (taxable income) is avoided through the use of debt." These problems might get worse under the new regime, albeit subject to influence by the question of how dividends versus interest are treated at the holder level, but presumably there'd still be less overall scope for tax planning than under present law.

To my mind, one of the biggest problems with the approach, which I haven't seen addressed at length although there might be something out there that I simply don't recall offhand or haven't seen, lies in the international realm. If we apply the proposal to domestically incorporated companies without regard to their mix between domestic source and foreign source income, then we have in effect adopted the equivalent of a worldwide residence-based corporate income tax (with no deferral, and foreign taxes merely being deductible).  If we try to avoid that result for U.S.-incorporated companies, then we are at a minimum bringing back some of the problems that the proposal presumably is meant to avoid.

What about foreign-incorporated companies that have U.S. source income?  Baker says in the op-ed that "we would presumably ... require that foreign companies making a substantial portion of their profit in the United States grant shares."

Without meaning to be too dismissive up-front, I am inclined to say "Ah, there's the rub."  Presumably, we'd have to look at the U.S. source versus foreign source income of foreign companies. That's bad enough to start with, but it's not even clear how income shares for a given year would translate to ownership percentages over a longer period.

The proposal is a non-starter unless something that's good enough can be devised to handle international issues.  I'm pessimistic about this, but admittedly have not studied the question, or read about it recently.

Tuesday, January 12, 2016

More on David Bowie

When not working on my Tax Policy Colloquium (which starts next week) or my book on literature and high-end inequality (I'm currently having fun with Stendhal's The Red and the Black), I've found myself mulling over David Bowie's career and death, and what he meant and means to me - at this point, more than any surviving Rock God from days of yore, apart from Dylan, who is obviously very different.

Herewith a few random reflections:

1) "A whole new school of pretension" - Bowie in 1973 or so famously said that he had already authored a whole new school of pretension. I didn't hear about this quote until some time later, but it was part of his image from the start.

I didn't naturally have a huge interest in the theatricality and the characters, but what I did find striking from early on was the commentary on / contrast with the rock 'n' roll ideal from the 1960s of being totally "authentic." This was a credo I thought I believed in. But someone like Springsteen, who carried it forward in the 1970s so resolutely and reverently, I found less interesting and provocative than someone like Bowie, who audaciously challenged it.

One could think of the Beatles as having pioneered the idea of pop music staying fresh, and changing from album to album, by reason of the writers' organic evolution.  Bowie, in a sense, made a mockery of this, by instead making disjunctive stylistic jumps from one album to another.  But again, despite my liking the prior model, I also liked its being transformed or subverted in this way.  Of course, it helped that Bowie did so many of his new styles so well.

2) "To be played at maximum volume" - Those words appeared prominently on the back of Ziggy Stardust, and were no small part of this album's eventual appeal to me.

Again, as a Beatles-Stones mid-1960s classicist (although I was  young for this role), I had thought things got less interesting with the rise, say, of groups such as Creedence Clearwater Revival (although I liked them OK) and CSNY.  I also was left cold by the prog rockers such as Jethro Tull and Yes.  (I remember a debate with a prog rock-loving friend of mine regarding whether the best new song on the Beatles' Yellow Submarine album was "It's All Too Much," his choice, or "Hey Bulldog," which I liked much better.)

Bowie may have toyed with intellectual pretension (albeit to his artistic benefit, overall), but he was much less prone to windy musical pretension.  His early-70s music often matched the urgency and directness of great 1960s forebears, and thus (like the punk and new wave music that started coming out later in the decade) was very easy for one with my musical foundations to embrace.

Obviously, another huge part of Bowie's image in those days was the exploration of different sexual roles and gender identities.  I was too straight-laced, as was my milieu insofar as I knew, for this to matter to me as directly as it did to all those people, and I know now that there were many of them, who felt personally validated and empowered by it.  But again, it meant to me that he was interesting and creative and different.

It also importantly saved Bowie from a particular niche that I probably would have disliked even then. A big part of the appeal of an album such as Ziggy Stardust was that it spoke to teenage, and to a considerable extent teenage boy, angst. I thought of it from early on as the type of thing kids who feel alienated from school or the parents or the culture play "at maximum volume" in their rooms, with the door closed.  But loud music for teenage boys can be too bro / jock / frat boy to hit the dissident gene unless there is something there that feels outrageous or transgressive, which Bowie of course had.  Again, I think of Springsteen, decent joe though he always was, as the contrast that I found less interesting despite his classicism, authenticity, compassion, etcetera.

3) Catch-22 and beyond - In those days, unless radio stations or roommates' / neighbors' / friends' record collections came to the rescue, I had a Catch-22 issue with buying new records by artists I wasn't familiar with.  I didn't want to buy new records unless I'd like them, but I couldn't know if I'd like them unless I bought them.  (I think this was a combination of limited budget, not wanting to make a "mistake," and figuring there was just too much out there to know which things to try first.)  So I'd heard about Bowie, but I didn't take the plunge until 1976 when his first greatest hits collection, Changesonebowie, came out.

This I did partly because Tom Carson, a writer on pop culture who was always in the college newspaper, a couple of years older than me and clearly a hipster in waiting, kept writing these raves about Bowie.  (I knew who Carson was, as he was a prominent campus figure, but I didn't know him personally.) It got to be funny.  Not only did he rave about Bowie when he was writing about Bowie, but it seemed like he would write, in effect, "What a beautiful sunny day. It reminds me of how great all of Bowie's albums are."  (Only so much snark is intended here, however - I did regard Carson as someone to take notes from.)

I finally figured: OK, fine, I'll give up and actually buy a Bowie album, especially now that I can cream-skim via the greatest hits.

I liked Changesonebowie right away (although soon, of course, I transitioned to buying the actual albums), and for a while was continually playing it in rotation with another record that I got at the same time, Eno's Taking Tiger Mountain By Strategy.  These, you might say, are the two records that really got me ready for the punk / new wave movement when it hit the next year (via Television, the Talking Heads, Blondie (first album), the Ramones, the Sex Pistols, the Clash, Elvis Costello - to name the ones I liked best at that time).  So thanks in part to Bowie for all that.

BTW, I couldn't resist checking online what Tom Carson might have to say now about Bowie's death.  (I figured he'd have some expressive vehicle at hand, and it turns out he's on Twitter.)  Sure enough, he had tweeted the following: "I only have one request for the gods today: let David Johansen outlive me. Bowie I can (barely) handle, but never David Jo."

Watch it there, Tom - this wish could be fulfilled in multiple ways, some of them better for you than others.

Monday, January 11, 2016

Death of David Bowie

I haven't really followed his work since the Berlin trilogy plus the one after it (Scary Monsters), but still very sad to hear of David Bowie's death.