Tax policy colloquium, week 9: Miranda Stewart's "Transnational Tax Law: Fiction or Reality, Future or Now?"

While I’m not Catholic, I like to be catholic.  Hence, I was glad that this week’s paper by Miranda Stewart, while in some respects covering familiar ground for us this semester – international tax policy, with particular reference to OECD-BEPS and FATCA – was methodologically distinct from our usual fare.  It’s more in the fiscal sociology literature, with particular reference, for example, to the well-known (though not previously to me) work on globalization by Saskia Sassen, and on the “transnational legal order of international taxation” as discussed by European political scientists Philipp Genschel and Thomas Rixen.

Two discussion topics of particular interest that I saw in the paper pertain to (1) the notion of “sovereignty” in international taxation, raised at the start of the paper (and by Genschel and Rixen), and (2) the question of whether, as a descriptive matter, we are witnessing developments that could rightly be described as involving the growth of a “transnational legal order” in international taxation.  Hence, I will here address these two topics in turn.

1.         SOVEREIGNTY

Tax law has traditionally been considered Ground Zero (or at least a major part of Ground Zero) for countries’ exercise, at least in the purely domestic case, of unfettered “sovereignty.”  This has been interpreted as meaning, not just that they can do whatever they like internally, but also that they don’t extensively cooperate with each other.  For example, the U.S. and France generally would not collect each other’s income tax liabilities, even as to nationals of the other country who can be found within their borders.  Obviously, however, the bounds of cooperation have been expanding recently.

Genschel and Rixen argue that countries’ “tax sovereignty” is being reduced or undermined because it conflicts with other goals that countries have.  For example, they discern a “trilemma” as between countries’ aims of (1) preserving their tax sovereignty, (2) avoiding double taxation, and (3) restraining tax competition.

For reasons not entirely germane here, I don’t entirely agree with this analysis.  When you have a trilemma, that means that you can attain any two of three goals, but not all three.  It’s certainly true that, in principle, all countries in the world, by adopting a single uniform global tax base and set of rates that eliminated all tax sovereignty for particular countries, could also completely eliminate double taxation and tax competition.  But the other two parts of the purported trilemma don’t work for me – again, for reasons not worth running through here, as it is only a side-theme in Stewart’s paper.

But anyway, Genschel and Rixen see tax sovereignty as being undermined – not that they necessarily consider this bad on balance – because countries are finding it increasingly important to harmonize and cooperate in what they do, so as to better achieve mutual aims.  Stewart, by contrast, sees countries’ sovereignty as potentially being strengthened by the fact that, through greater cooperation, they may become more able to achieve their goals (e.g., limiting tax evasion by high-income individuals and tax avoidance by large multinationals).

For me, this disagreement reflects that “sovereignty” is a murky concept, and often not helpful in these debates.  What it does mean and/or should mean, and why or when we should value it, is not always clear.  The underlying problem can be illustrated via a famous bit of dialogue in Shakespeare’s Henry IV, Part I:

Owen Glendower: “I can call spirits from the vasty deep.”

 

Hotspur: “Why, so can I, and so can any man. But will they come when you do call for them?”

Glendower, if interpreted literally in the manner that Hotspur proposes, is describing autonomy.  I can do whatever I want – and if I want to issue a verbal command regarding spirits from the vasty deep, I bloody well will.  As applied to a state rather than an individual, this is sovereignty in the sense of autonomy.

Hotspur, by contrast, speaks in terms of power or empowerment.  Can you actually get those spirits to come?  As applied to a state, this is the other sense of sovereignty: the capacity to achieve one’s aims.

Semantically speaking, “sovereignty” can be and has been used either way.  Genschel and Rixen are with Glendower, asking whether a state can choose whatever tax rules it likes, no outside approval or coordination needed.  Stewart is asking whether states can succeed in achieving their aims, and in this sense sees sovereignty as potentially strengthened by cooperation, deference to common norms, etcetera, that may reduce their purely individualized discretion over tax law design.

While I’m agnostic about the semantic debate (which is why I tend to find “sovereignty” not a very useful concept), I am more on Stewart’s side regarding what I value.  One could analogize the debate about whether it’s more important for states to do whatever they like, or to achieve their goals, to the question of autonomy and free choice for individuals.  Does it matter for its own sake, or just instrumentally to some other aim, such as maximizing welfare?  I’m in the latter camp in terms of what I value.  The big difference between the two contexts is that valuing states’ sovereignty, in the sense of full autonomy and discretion rather than empowerment, requires jumping into the muddy waters of collective choice.  We know too much about the dilemmas and difficulties associated with collective choice for the argument that it should be valued for its own sake, not just instrumentally, to be as straightforward as that in the context of individuals.

The upshot for me is that, while my small-c catholicism induces me to take an interest in discussing sovereignty as a key issue in international taxation, I don’t regard it as the best peg on which to hang the debate.  Under any given international tax regime, we should certainly be interested in such questions as which countries have power, which countries’  interests are being served, and what a given country might benefit from doing or be likely to do.  But I would tend to think the discussion can be clearer if the ambiguities around what we might mean by “sovereignty” as a concept can be kept from clouding the debate.

2.         IS A “TRANSNATIONAL” INTERNATIONAL TAX REGIME INCREASINGLY EMERGING?

Sometimes the question of whether there is such a thing as truly “international” tax law – rather than just the laws of particular countries – or equivalently, for my purposes, of whether there is at least to some extent a “transnational” regime emerging in the field of international taxation – is debated for ideological purposes.  The assertion that such a regime already exists, or does not exist, may be deployed in support of particular policy moves.

                                                                                                            

Stewart’s interest, however, is descriptive or analytical: to what extent does such a thing actually exist?  I prefer this focus to the other one, which puts the international tax policy debate in terms different from those I consider clearest.  I would  certainly consider it relevant whether a given country should expect cooperative or other (such as straight-out competitive, or else tit-for-tat) strategic responses by other countries to what it does, but a 1-versus-0 “is there currently an international tax regime” framing strikes me as more distracting than illuminating.

What might “transnational” usefully mean in this context, from a descriptive standpoint?  For me, it would mean that countries, at least in particular cases, follow a given rule or approach at least in part because it is followed by others, not just as a unilateral choice. 

One way this can happen is through the top-down assertion of vertical power.  In particular tax settings, the U.S. federal government (through Congress or the courts) can tell the states what to do or what not to do, the ECJ can do so with EU countries, and a (fictional) universal global tax authority could do so with all countries.

But vertical command is only one mechanism for creating aspects of a transnational regime. Lateral treaty arrangements, such as the WTO for trade, can also do so.  And so could, say, pronouncements on international tax policy by the OECD if countries treat these pronouncements as mattering for their own sake.

Here’s a counterfactual example.  The EU has been debating for some time creating a “common consolidated corporate tax base” (CCCTB).  It could be adopted as binding on all EU countries if unanimous consent were obtained for a particular design.  Then all EU countries would have the same corporate tax base and the same (formulary) approach to apportioning taxable income between member states.  Only tax rates could still differ in the corporate income tax as between member states, in this scenario.  As it happens, no agreement has been reached, and I wouldn’t be shocked if none ever is.

Suppose the EU adopted a CCCTB.  Then clearly there’d be a “transnational” regime, in this regard, within the set of EU countries, applying through vertical hierarchy.  But suppose alternatively that there were a “soft” and non-binding agreement, leading to some compliance but not 100%.  Insofar as countries came closer to following the CCCTB than they would have absent the agreement, one could say there is some transnational element at work.

Circling back to the sovereignty debate for just a moment, clearly for each EU country it could be optimal if everyone else in the EU had to follow the CCCTB, but “we” alone didn’t have to.  This is not something the others are likely to agree to, however – “we’re bound, but you’re not.”  So the question, which again I think isn’t usefully illuminated by the sovereignty concept, is whether “we” should in practice comply – at least, more than we would have otherwise – based on the view that it will increase the extent to which others comply, or at least, less calculatingly, that we are in a situation where it makes sense to lean towards cooperating rather than defecting.  (This, again, is anti-sovereignty in the Glendower sense but potentially pro-sovereignty in the Hotspur sense.) 

But how do you determine in practice whether or not there is a true transnational regime in place?  The problem is that countries having similar rules doesn't directly tell you anything.  After all, there's no need to invoke the transnational regime if they all happen unilaterally to favor doing the same thing.

Just for a cultural reference more low-brow than Henry IV, Part 1, consider the Internet comedy series, "Chad Vader, Day Shift Manager."  Chad, who looks, sounds, and dresses like Darth Vader, whom he claims as an older brother, lives in Madison, Wisconsin, and is the day shift manager at the Empire Market.  He does stuff like take a woman to a restaurant on a date, and say to the waiter, in his most resonant James Earl Jones tones, "I command you to bring us the menus."  But since the waiter was planning to do this anyway, he is not actually demonstrating the power of a Sith Lord over weak-willed individuals.  But I digress.

Here is a more direct pass on the same issue.  If we observe countries having the same or similar international tax rules, does that mean there is a transnational regime?  Not necessarily.  It may be parallelism rather than even soft verticality.  Consider the evolutionary concept of convergence, well-demonstrated by these two creatures:

The first is a dolphin.  The second is an ichthyosaur (marine reptile from the Mesozoic Era).  They are quite similar because it turned out that the evolutionary pressures guiding their similar lifestyles (swimming around the ocean, scooping up fish or, for the ichthyosaurs, ammonites) pushed both of them in similar design directions.  Indeed, I gather that the ichthyosaurs even gave life birth at sea, perhaps unlike the plesiosaurs, which I recall reading may have had to swim up on the beach to lay eggs, like today's marine turtles.  But I digress again.

When we're talking about human institutions, convergence can be assisted by direct imitation.  (A snarky example would be the rise of tax policy colloquia in law schools around the country after we introduced ours at NYU in 1996.)  This is how I interpret the rise of controlled foreign corporation (CFC) rules after the U.S. adopted its CFC rules, known colloquially as the subpart F rules, in 1962.  My own view is that this wasn't a "transnational" phenomenon - countries weren't choosing to cooperate rather than defect by some global welfare metric.  Rather, policymakers who observed the U.S. rules and others that were adopted apparently said to themselves "That's a good idea - we could benefit from doing that, too."

This immediately brings to mind a failed transnational effort.  During the OECD-BEPS process, there was support in some circles for inclusion in the final report of tough minimum-standard CFC rules.  This ended up getting greatly watered down because certain key countries were opposed.  And even if OECD-BEPS had ended up specifying tough CFC rules, the next question would have been how much influence this ended up having.  This, in turn, reflects that, as I've discussed elsewhere, countries have good reason to be a bit ambivalent about using CFC rules, under which certain low-taxed foreign source income of resident companies' foreign subsidiaries may face current domestic taxation.  This may be good for unilateral national welfare if it helps protect the domestic tax base, may be bad for such welfare if it results in higher rather than lower foreign taxes being paid, and may also be bad insofar as it raises too high the tax "price" of investing through resident companies.

In sum, I tend to view the near-universality of CFC rules as convergence plus imitation in the pursuit of unilateral objectives, rather than as evidence of a transnational regime.  The widespread adoption of stronger CFC rules would have evidenced a transnational regime at work, but it doesn't appear to be happening.  I also don't view the widespread adoption of economic substance / business purpose / generalized anti-avoidance rules (GAARs) as transnationality.  Once again, this strikes me as a unilaterally motivated convergence plus imitation story.  Note, for example, that, according to an interesting student paper that I saw last semester, China has adopted a GAAR approach recently (leading to problems that reflect its particular institutions), apparently based on its own perceived fiscal self-interest, not as a way of buttering up the international tax community.

So where are the true examples of transnational movement?  With regard to OECD-BEPS, we may need to wait a few years to answer that question, and a favorable outcome is not guaranteed.  But perhaps the global FATCA process can already be viewed in these terms.

Working hard, or hardly working?

The kittens seem to get most of the screen time here, but Seymour and Buddy also can get it done (whatever "it" might be, and probably it should be something that's not too rigorous or vigorous).

Tax policy colloquium, week 8: James Kwak's "Reducing Inequality With a Retrospective Tax on Capital," part 2

In my prior post I offered background concerning retrospective income taxation, as set forth in prior work by Alan Auerbach and David Bradford.  This brings us to the twist that Kwak's paper offers.  Again, under the retrospective income tax one uses two pieces of information, the amount realized upon selling an asset and the holding period, in order to impute its value throughout the entire holding period, based solely on working back from the normal rate of return, and without regard to the actual cost basis.  So one ignores the actual gain or loss, for reasons detailed in my prior post (and pertaining to the avoidance of lock-in, the assumption that actual risky outcomes can be disregarded, and restriction of the method to "arm's length" asset acquisitions).

In the wealth tax context, however, one is using the assumed value in prior periods NOT to determine how much income was fictively realized in each period, but rather to devise an annual measure of the taxpayer's wealth.  This causes the same method to have, in some respects, opposite consequences.

Now what happens to actual winners and losers, relative to the scenario where value actually had equaled the assumed amount each year?  The answer is, it reverses relative to the retrospective income tax case.

In the new scenario, the winner is over-taxed for the period in which value has not yet jumped from the actual line to the assumed line.  That is, she pays a larger retrospective wealth tax than she would have paid, if it had been possible to measure value accurately each year.

By contrast, the loser is under-taxed for the period, relative to "accurate" wealth taxation, for the period before value dipped to that shown by the Assumed Value line.  She would have paid more wealth tax in those years than she actually does, had we been able to measure asset value accurately.  Wealth taxes generally don't give you a refund for past years just because you experience a subsequent loss.

A few points about this.  First, it means that applying the method to non-arm's length assets is feasible.  It doesn't result in wiping out the bulk of tax liability for successful entrepreneurs such as Mark Zuckerberg.

Second, it does mean that the tax hits the upwardly mobile relatively hard.  They would have paid less under a "true" wealth tax.  This arguably targets upward mobility a bit more than proponents of wealth taxation, based on concern about high-end inequality, might actually have wanted to do.  It depends on how you think about the issue.  The likes of a Thomas Piketty, who particularly despises rentiers (as distinct from my preferred opposite term, "arrivistes") for reasons that link normative / meritocratic beliefs re. distributive desert with empirical beliefs regarding the effects of upward mobility, might consider this misdirected.  So might someone who felt entirely neutral as between rentiers and arrivistes, and who wanted a wealth tax to bear on them equally (as measured based on actual annual wealth).

Third, the "over-taxation" of entrepreneurs / arrivistes may be diminished under one particular set of views.  Suppose one thinks that these individuals likely or generally had valuable human capital, implying high expected future earnings, even before they got around to using this human capital to create commensurately valuable financial or other capital.  And suppose one believes that human capital should, insofar as it is feasible, be treated like other capital (including for purposes of the wealth tax).  Then one may espy less over-taxation of the big winner than there otherwise had seemed to be.

Note, however, that there may be a risk story here beyond that which we would assume in the case of arm's length asset purchases.  How likely was Mark Zuckerberg to succeed as vastly as he did?  Suppose he was one of 10 people with equal chances of making it that big, and that he just happened to beat out the other 9 by luck.  Due to its involving human capital, this was a non-diversifiable risk.  So the "true" picture, defined in terms of including human capital (at actual contemporaneous values in the wealth tax base, might still have involved his paying less tax than he ends up paying.  But at least we're "over-taxing" the winner, rather than the relative losers, and thus providing insurance rather than anti-insurance.  Presumably the main issue raised by this "over-taxation" goes to incentives, rather than distributive desert, but one might question how much this is likely to matter.

Fourth, the optical problem that the retrospective income tax raised - taxing the fictive gain of someone who actually suffered a loss - no longer arises, at least in the same way.  It's true that someone who sells property at a loss is immediately hit up with a wealth tax liability, but this reflects the value that she actually received from the sale.  Wealth taxation is based on value, rather than changes in value

Fifth, while one still may want to ask what follows from viewing risk more realistically than the manner in which it's treated by the underlying model, at least one is "over-taxing" winners and "under-taxing" losers, rather than the other way around, causing the system to provide insurance, rather than anti-insurance, relative to the true annual wealth tax.

Despite all this, I am skeptical that the proposal is going to end up on The List.  Plus, I might be skeptical about it, compared to some of the possible alternatives, even if was on The List.  Nonetheless, it offered an interesting and illuminating thought experiment.

The paper also raised various other interesting issues.  For example, how feasible is it to apply graduated marginal wealth tax rates?  This requires looking back to all the past years whenever an asset is sold?  Is the tax likely to be constitutional, even if a standard wealth tax would be treated as unconstitutional under authorities pertaining to "direct taxation" and apportionment between the states?  What tax instruments should it be paired with?  (E.g., a progressive consumption tax?)  If one agrees with the paper - as I do - that, under the proposed system, one should also treat gifts and bequests as realization events, how well will the two methodologies - backwards imputation and valuation without the benefit of a sale - coexist with each other?  But given the length of this post along with the prior one, perhaps that is best left for another day that might itself be indefinitely deferred.

Tax policy colloquium, week 8: James Kwak's "Reducing Inequality With a Retrospective Tax on Capital," part 1

Yesterday's paper, by James Kwak, discusses an old favorite around here (at least as a fun topic to discuss) - retrospective taxation as devised by David Bradford and Alan Auerbach.  David co-hosted the Tax Policy Colloquium 8 times before his tragic death, Alan has done so 5 times, and in long-ago sessions we discussed retrospective taxation papers by both of them.

The new twist that Kwak offers is retrospective wealth taxation, in lieu of retrospective income (or capital gains) taxation.  While I don't think the proposal is likely to end up having political traction, it's a great topic that can be very illuminating in thinking about income and wealth taxation design issues.  Kwak, who does not have an extensive tax practice or teaching / scholarly background, has nonetheless done an impressive job of mastering relevant aspects of the very complicated tax policy literature concerning income and consumption taxation.

To give a sense of what retrospective income and wealth taxation are all about, a picture is worth n words (where n ≥ 1,000).  Let's start in this post with retrospective income taxation, as developed by Auerbach and Bradford in their work.  I will then turn to the retrospective wealth tax in my next post.

Sorry if this chart seems hard to read - this problem should fix itself if you click on it. To put the issue in perspective, suppose we know three things about an asset that the taxpayer just sold: the amount realized on the sale, how long she held the asset, and what she initially paid for it.  A realization-based income tax discourages selling appreciated assets (and encourages selling those that have lost value) due to deferral of the unrealized value change.  And the problem gets exponentially worse if, as under the current U.S. income tax, the tax will be permanently eliminated if one holds the asset until death.

A logical response to this problem might be deeming the gain (or loss) to have accrued ratably (with compounding) over the asset's holding period.  Then interest might be charged on the deferral, based on the extra tax that would have been due in prior years by reason of current inclusion. But here's the problem.  Under constant information, assets might be expected to appreciate at just the risk-adjusted normal rate of return.  An asset that did better than this must have jumped up or down in value when information about it changed (e.g., a risk was resolved favorably).

Let's simplify the story to allow for just one relevant information change, and put it in terms of the above chart, where we know that the asset was sold for the price and at the time shown at the upper right.  The assumed value path shows how much it "must" have been purchased for if there was never an information change.  But suppose it was purchased for less (as in the case of "Actual (Winner)" or for more (as per "Actual (Loser)."  Then it must have appreciated from that starting point until the information shock occurred, whereupon it jumped to the Assumed Value line and stayed there the rest of the way.

Suppose we add the following assumptions.  First, the taxpayer always knows the value, but the government can only observe the purchase and sale transactions (time and price).  Second, the taxpayer cannot predict the time or direction of the information change that leads to the up-or-down value jump. Or more precisely, information is symmetric - she can't outguess the market, which has incorporated the already-known information into the asset price.

Having the tax system assume ratable accrual, as determined at the time of sale, would amount to drawing a straight line from the actual purchase price to the eventual sales price, rather than having the correct slope (at a higher or lower level) followed by adherence to the assumed path.  Thus, suppose that, in the "Winner" case, the taxpayer knows that there has been a favorable value jump.  Even if we were allowing for further, as yet unpredictable, value jumps, the taxpayer would now expect the asset, on average, to stay on this path.  But note that, once the (positive) value jump has occurred, the assumed value path under ratable accrual always treats value as lower than it actually was.  Only when the sale occurs does the assumed value path converge with actual value.  So, the longer you delay the sale, the longer you get to "average forward in time" the amount of the value jump.

This creates lock-in for an appreciated asset that has had a positive value jump. So it fails to eliminate lock-in, although it does reduce the magnitude of the problem.

Suppose one wants to eliminate that lock-in problem altogether.  As Auerbach and Bradford realized and explained, the easiest way to do it is by simply ignoring the actual basis of the asset in the taxpayer's hands.  Instead, the tax system would  simply use the amount realized upon sale, and the holding period, to impute gain based purely on the Assumed Value Path.  In effect, one would use a fictional basis in lieu of the actual one.  Then one would determine the gain that "should" have been taxed in earlier periods, compute the effect on past years' tax liabilities, and make the tax adjustments payable at sale with requisite interest.

This seems odd - what might motivate it? Now again, it truly does eliminate any tax-induced incentive to hold or sell the asset at any time, under the assumption that the taxpayer can never outguess the assumed value path suggested by the value that is known to her at any particular time.  But don't we also actually want to get the amount of the tax right?

Under certain assumptions, NO.  Suppose we think of the gain or loss, relative to the assumed value path, as purely reflecting risk.  And suppose further that we believe taxpayers will adjust their investment portfolios, in light of the tax, to get to the exact point along the risk-return frontier that they like.  For example, if gains are taxable and losses are refundable, that amounts to making the taxpayer's portfolio less risky (and with a lower expected return) than she preferred.  So in theory she can respond by selecting a riskier pre-tax portfolio and getting right back to the same place.

Not so fast?  Well, this is a common assumption in models, albeit not necessarily to be found in the real world.  It requires complete markets, consistent rational choice, a flat tax rate including loss refundability at that rate, and the ability to borrow at the risk-free rate.

To the extent that it is true, however - i.e., assuming a can-opener - ignoring actual basis just doesn't matter.  It merely reflects a risky outcome that the taxpayer can get to with or without the tax.  (Also, with complete markets, rational choice and no externalities, there is no reason to offer the tax system's insurance feature by taxing gains and reimbursing losses - that is for cases where private insurance is  crippled by adverse selection, e.g., with respect to the "ability lottery" and under-diversified human capital).

Accordingly, under sufficiently rarefied assumptions, retrospective income taxation makes sense as a way of eliminating distortions regarding when to sell assets, without any relevant downside given the assumptions that relate to issues of risk.

Even within this rarefied (and indeed, concededly unrealistic) scenario, there is an important limiting factor to keep in mind with regard to allowing the use of this method.  It is appropriate SOLELY with regard to what David Bradford, in designing his "Blueprints" cash-flow consumption tax system in the 1970s, called "arm's length" transactions.  Within Bradford's meaning, if I purchase Facebook stock at its current market price, that is an arm's length transaction.  But if Mark Zuckerberg does so, be it at the pre-IPO stage or even today, if he can affect its value (e.g., by supplying labor that he uses to increase the stock's value, because he is not paid a wage equal to the value he has contributed), that is non-arm's length.

In Bradford's Blueprints cash flow consumption tax system, yield-exempt treatment of investments was allowed only for those that qualified as arm's length.  Expensing had to be used for those that were non-arm's length, so that the tax system would reach inframarginal or labor-related returns.

In the context of retrospective income taxation, allowing use of the Assumed Value Path for non-arm's length transactions, such as Zuckerberg's getting Facebook stock when he was creating the company, would be unacceptable.  It would not even avoid tax-discouraging sale if he anticipated being able to create further value jumps through further contributions of under-priced labor in the future (assuming that, post-sale, he could no longer avoid being taxed on such contributions, e.g., because he would now have reason to demand a full-value wage).  But even if it did permit the timing of sale to be tax-neutral, it would be unacceptable because we want to tax people on the economic value that they derive through their "ability" plus labor supply.

Summing up the merits, if (and insofar as) we buy into the full risk, etcetera, analysis, Auerbach-Bradford retrospective income taxation may be an appealing method for the taxation of asset sales that are not taken into account, for tax purposes, until the gain or loss is realized.  But it would have to be limited to arm's length transactions in order to be acceptable.  And it may require taking a couple of stiff drinks, so that one is ready to accept the risk analysis and thus to ignore actual cost basis with no tears.

Even so, it seems likely to be politically unacceptable.  Returning to Figure 1, it taxes a gain to someone who actually suffered a loss.  (Please indulgently note that I meant to show the actual cost basis for the loser as lying above the eventual sales price.)  That is likely to be optically unacceptable, even if you yourself have had enough of the spiked kool-aid to accept it with equanimity.

Plus, relative to an income tax based on correct actual values that were taken into account annually, it under-taxes the big winner who earned more than the normal rate of return.

So it looks like anti-insurance: under-taxing winners, and not just over-taxing losers but imputing fictional gain to them.  This is not something that one is likely to be able to "sell" to policymakers, even under a far less politically fraught environment than one could imagine us ever actually facing.

The retrospective income tax has therefore never really gotten anywhere, even in the tax policy community.  My sense, which I believe others share, is that it's a clever idea from which we learn something - it helps us to think more deeply about real world effects and their causes, and about the universe of proposals that might actually be politically feasible at some imaginable point.  But there has been relatively little work done towards showing how it might actually be implemented, because the effort seems too unlikely to bear fruit.

But here's the thing about retrospective wealth taxation, as proposed by Kwak (and as I will discuss in my next blog entry).  Despite the strong analytical overlap, it's surprisingly different, and in some respects has opposite effects on who wins and loses from its being used in place of an annual wealth tax based on actual (albeit, to the tax system unknowable) values.  This adds to the interest of analyzing and writing about it, even if one does not end up concluding that it might actually be added to the universe (or shelf) of potentially feasible proposals.

The Paul Ryan / Harwood interview

What does Paul Ryan actually think about tax policy?  Whether or not the question is intellectually interesting for its own sake, it may matter politically, given Ryan’s position and extraordinary eminence within the Republican Party.

A recent Paul Ryan interview by CNBC journalist John Harwood has been getting attention lately.  Of particular note, Ryan flatly rejects the notion that comprehensive tax reform needs to be “distributionally neutral.”  Thus, whereas Dave Camp, when he was Ways & Means chair, attempted to devise a tax reform plan that would avoid cutting taxes for the very richest individuals, at least within the estimating window, despite the fact that high-end rates were going to be cut significantly, Ryan is evidently willing, and one surmises eager, to make the richest individuals better-off than under current law.

Harwood noted that this might cause blue-collar Republican primary voters (a.k.a. Trump supporters) to believe that Ryan is more interested in helping people at the top than in helping them.  Ryan breezily demurred that this was any problem.  But it is hard to say whether or not (a) he really believes that there is no problem getting the Republican voter base to continue accepting tax cuts for the rich as the party’s #1 fiscal policy goal, and (b) he would be right in so believing, as a matter of political prognostication.  All we can say for sure is that he wants to keep the Republican dogma status quo in place.

There’s been a lot of discussion regarding what lies behind Ryan’s view – and indeed, his doubling-down relative to Dave Camp (whose plans were DOA among Republicans by reason of his effort to preserve distributional neutrality).  What is the underlying rationale, and where would it leave Ryan if he had a free hand in setting U.S. tax policy?

Paul Krugman today argued that Ryan is saying that distribution doesn’t matter “because economic positions change all the time.  People who are rich this year might not be rich next year, so the gap between the rich and the rest of us doesn’t matter, right?”  He notes that data regarding actual economic mobility would not even remotely support taking this view, as a strict empirical matter.  He then notes what he, along with many others, considers Republicans’ frequent imperviousness to evidence – for example, with regard to claims about tax cuts and growth, not to mention various other subjects (e.g., climate change).  He hopes that the Trump shock and/or a “period in the political wilderness … will finally force the Republican establishment to rethink its premises.”

In general, I am sympathetic to this critique, including the underlying premise that, if the Republicans returned to the sanity of the Reagan and Bush I administrations, things would be a lot better for everyone.  But I didn’t actually read Ryan, in the interview, as relying on economic mobility to the extent that Krugman thinks he was.  This reflects the fact that, in a quick verbal exchange such as the Harwood interview, exactly what a given individual is saying or means to say can be ambiguous.

Here is the text of the Harwood-Ryan exchange (as condensed and edited by Harwood) insofar as it pertains to tax policy:

  

HARWOOD: On taxes, when your predecessor as Ways and Means chair, Dave Camp, came out with a comprehensive tax reform a few years ago, he adopted as a principle that it was going to be distributionally neutral. It wasn't going to give an advantage to any group over the current system. Is that still a principle that you think is appropriate for the Republican tax agenda?

RYAN: So I do not like the idea of buying into these distributional tables. What you're talking about is what we call static distribution. It's a ridiculous notion. What it presumes is life in the economy is some fixed pie, and it's not going to change. And it's really up to government to redistribute the slices more equitably. That is not how the world works. That's now how life works. You can shrink or expand the economy, and what we want to maximize is economic growth and upward mobility so that everybody can get a bigger slice of the pie.

HARWOOD: And you're not worried that those blue-collar Republican voters, who are voting in the primaries right now, are going to say, "Hey, wait a minute. You're really taking care of people at the top more than you're taking care of me."

RYAN: I think most people don't think, "John's success comes at my expense." Or, "my success comes at your expense." People don't think like that. People want to know the deck is fair. Bernie Sanders talks about that stuff. That's not who we are.

OK.  First point, I think Ryan is referring not to mobility within the income distribution, but rather to the growth effects that he chooses to attribute to tax cuts.  “[W]hat we want to maximize is economic growth and upward mobility so that everybody can get a bigger slice of the pie.”  So the claim here is not, who cares about rich versus poor because lots of us are going up and down the escalator all the time, but rather that everyone will be better-off due to the growth effects.

In short, it’s trickle-down, which still leaves in place the Krugman argument that Ryan is acting impervious to evidence about the actual growth effects of high-end tax cuts (especially when they are likely to explode the growth rate of national debt and thus create severe fiscal drag).

Ryan’s second comment however, raises a different point.  Ryan rejects the argument that the rich have succeeded at the expense of others.  Unless you’re Bernie Sanders, he asserts, all that matters is that “the deck is fair.”

Okay, fair enough, that’s his view.  But the thing is, in a budgetarily neutral scenario where the growth effects are only second-order (if that), there necessarily is a zero-sum game.  Rich people cannot pay less without others paying more or getting less, and this has nothing to do with whether the economic success of the rich came at the expense of others’ economic success.

So while Ryan chooses to gloss over it, clearly (and unsurprisingly) he does think that, relative to the current state of the play, there should be redistribution from the poor to the rich.

Obviously, he wouldn’t call it redistribution, because he’d reject the current policy baseline for assessing distributional policy.  Ayn Randian that he is, the baseline that he likes, and from which perspective he rejects redistribution, is evidently some sort of “pre-tax and transfers” baseline that he views as reflecting people’s economic contributions and consequent moral desert.

This is not a view of distributional policy that I share.  It falls within the ambit of what Liam Murphy and Thomas Nagel critiqued, under the label of “everyday libertarianism,” in their book The Myth of Ownership.

Rather than argue with that here, what does it imply Ryan actually wants our tax and transfer policy to look like distributionally?  How does one define the zero-redistribution baseline, given the impossibility of measuring the value of public goods or of defining a historically fictive pre-tax state of affairs?

One common answer is to say that tax rates should be flat.  But that not only is hard to defend intellectually (as Barbara Fried has argued), and is bizarrely unmoored if one doesn’t also specify the tax base, but also is not necessarily what people like Ryan actually want.  Would he oppose special concessions or low taxes at the top, if they were politically available?  Fried argues that libertarians (for example, Richard Epstein) should logically favor regressive rates, and perhaps even a uniform head tax, but are constrained by the political difficulty of getting there.

I myself think it’s quite plausible that Ryan would truly favor a uniform head tax, accompanied by minimal or no transfers to the poor, if he thought he could get there.  But he knows he can’t get there.  What’s more, his day job is that of a practical politician, not someone writing papers at a think tank.  So he doesn’t need to figure out just how far he’d be willing to go if he had complete control over tax and transfer policy outcomes.  What he does presumably know is that no politically available set of tax cuts for the rich and benefit cuts for the poor would go as far as he wants to go, so “the larger, the better” is a reasonable operating principle for him on both fronts.

I do think that Ryan is going to have to worry about whether the Republican base is going to continue to accept this.  But he may know that as well – he would presumably say the same thing in the Harwood interview whether he is actually worried or not about the evidence of a revolt by the base.

Optionality and the Merrick Garland nomination

I don't have any unique insights into why he was nominated, what's the likely short-term and long-term playout, how one should think about it from various normative perspectives, etcetera.

But just thinking about it strategically, it's an interesting and multifaceted play.  For example:

Suppose we think of the entire nomination process here as a zero-sum game.  Under this framework, a new Supreme Court justice who is younger and further to the left (within the relevant ideological range) is always good for the Democrats and bad for the Republicans, in pure mirror-image fashion, and vice versa for older/further to the right.

Likewise, insofar as both sides are interested in effects on the November election, since only one side can win the presidential election or any particular senatorial election, once again it's zero sum unless we tell a more complicated story (e.g., involving Trump, factions within a given party, or longer-term relationships between particular politicians and their constituencies).

By naming Garland, Obama has given the Republicans an option that they might actually benefit from exercising.  We've already heard about the possibility that the Republicans might want to confirm in the lame-duck session, if Hillary wins the election and especially if the Senate turns.  It's not clear that they would actually have this option, but there are scenarios in which the Republican side - whether or not the actual Republican senators making the choice - would benefit from exercising it pre-election.  For example, they confirm him because they can see the electoral writing on the wall, or because they're at war with Trump as well as the Democrats, or to save endangered Senate seats.

Insofar as it's a zero-sum game, good for one side means, by definition, bad for the other side.  And one can only benefit from having an option, if one would exercise it properly given one's true interests. So, under this framework, Obama's giving the Senate Republicans an option that their side might actually benefit from exercising in some scenarios can only be bad for the Democrats, as a necessary implication of its being good for the Republicans.

Conclusion: there are two possible explanations for Obama's decision to give the Republicans an option they might actually benefit from exercising.  The first is that he doesn't think of it as purely zero-sum.  This could reflect, for example, his stake in being the person who got to make a transformative nomination.  Or it could reflect his long-held preference for moving Washington politics in a less confrontational direction (although the last seven years have obviously been disillusioning for him), or a personal taste for being and looking reasonable even if it doesn't bring positive results.

Second, he could think that the Senate Republicans are unlikely to use the option rationally from their side's perspective.  Such a failure on their part, in turn, could reflect either their own irrationality, or else agency costs in relation to their base (reflecting the point that, even if the outcome is worse from their side's perspective if obduracy hurts them in November and/or leads to a younger and more progressive choice, at least they wouldn't be blamed for it by the proponents of always fighting and never compromising).

Though logically in tension, these two explanations are not mutually exclusive - one could easily have both of them in mind.

Occam's razor

Today at my annual eye doctor appointment, an intake person asked for my middle name.  She said she needed it because the office has two patients, both named Daniel Shaviro and both born on the same day in the same year, but only one of them has a middle name.

I suggested that perhaps they had entered me into the system twice, but she seemed skeptical about this.  If I am wrong, I wish my mystery doppelganger would get in touch with me already.

Spring reading

With spring break at hand I actually read three books this weekend, albeit all short and more or less compulsively digestible.  (I may now try to get back to Paul Scott's Jewel in the Crown, which is slower going.)  All three are highly recommended, depending on one's taste.

The first was Elisabeth Sanxay Holding's The Blank Wall, a 40s noir that's included in an excellent compilation of period noirs written by women.  It reads a bit as if one had taken Mrs. Dalloway and plunged her into the world of Patricia Highsmith.  Best of the four stories in its volume, perhaps in a tie with Dorothy Hughes' In a Lonely Place (which was softened considerably for the Bogart film).

Next up, Patrick Modiano's In the Cafe of Lost Youth.  I knew little in advance about Modiano, a French writer who won the 2014 Nobel Literature Prize, but I've come across so many startlingly good New York Review of Books reissues that I joined their book club, which sends you a new re-publication of their choice every month.  Very sad and quiet but compelling, and I'll certainly be reading more by Modiano.

Finally, being out of town for the weekend and out of books other than on my Kindle, but not wanting to start anything on it that wasn't  a quick read, I downloaded a dark and very hard-boiled noir from around the same period as The Blank Wall - David Goodis's Cassidy's Girl.  Obsession, violence, alcoholism, despair, fate, desperation, and recurring tragedy would have been among the keywords for this one, had the author (improbably and anachronistically) posted it on SSRN.

Tax Policy Colloquium, week 7: Theodore Seto's "Preference-Shifting and the Non-Falsifiability of Optimal Tax Theory"

Yesterday's paper, by Ted Seto, could be read more narrowly as concerning how advertising affects revealed preferences relative to utility, or more broadly as concerning the general relationship that price theory and optimal tax models often assume as between revealed preferences and utility.  Here is a brief overview of the main ideas that I had upon reading the paper:

The paper starts by giving us a couple of typical supply and demand curves. In the first, we get the standard equilibrium, given where they intersect.  In the second, a tax is being imposed on the demand side, so the equilibrium quantity declines, and the incidence is split between producers and consumers.

As the paper rightly notes, in a narrow reading this set-up merely how we should think about the equilibrium, with and without the tax.  There would not necessarily be any normative consequences. But a more ambitious reading, which captures how economic reasoning is commonly used these days, would assert that the shift in the equilibrium by reason of the tax creates deadweight loss (as shown by the triangle), resulting in lost utility to some set of individuals.

Economists for many decades - especially if they went to graduate school before, say, 1970 - were quite leery about making normative statements founded on claims about utility.  Hence, for example, Samuelson's famous revealed preference theory, expressly founded on the idea that we could bloody well do without "utility," thank you.  But today's less circumspect economists have, I think, a point.  First, there is absolutely no reason to care about the lost surplus (from transactions that don't take place even though willingness to pay exceeded the reservation price), unless there are people who are made worse off by their inability to share this surplus between themselves.  Second, the underlying psychological theory on which it is based (where I get utility from own consumption plus leisure, based on rational choice under a utility function that features non-satiation and declining marginal utility), while perhaps a bit simplistic and incomplete, has in my view enough merit to be worth using as one of one's tools.

But there are certainly a bunch of problems that one ought to keep in mind when using it, especially if it is being used in relation to large normative claims (not just micro-claims about particular markets).  For example, there are issues of rational choice, the implications of which include the internalities issues that I discussed with regard to our week 4 paper, by Donald Marron, entitled "Should We Tax Unhealthy Food and Drinks?"

Among the other issues that may be important, depending on the context, are the following two:

(1) Suppose you have two states of the world in which people's utility functions are different.  The method that Seto's paper critiques can be used to define equilibrium and tax-induced deadweight loss in each state of the world, but it can't be used to compare welfare as between the two states of the world.  So if something changes the preferences (and utility) that underlie the supply and demand curves, we'll need some other sort of tool to choose between them.

(2) Social context: the standard model looks at revealed preferences, based implicitly on utility from own consumption, but it's not addressed to the question of how utility functions might arise and change.  Since we are such social beings, it's clear that social context can affect such utility a lot, in ways that might matter but that, again, we'd need different sorts of tools to evaluate.  Here are two simple examples.

First, suppose positional goods (such as material consumption) in effect create negative externalities.  E.g., as in Robert Frank's work, suppose my having a bigger house means that you now have to work harder and sacrifice leisure just to get back to the same place (i.e., having as big a house as I do).  This might support taxing positional goods, relative to non-positional goods, and again we'd need different tools to evaluate this.

Second, and conceivably going in the opposite direction, suppose there are positive externalities to shared consumption experiences - reflecting, for example, imitation or influence or mutual reinforcement. I mention this here because advertising brings it to mind.  Think of the explosion of Beatlemania in the U.S. starting in 1964.  Or for an example that I find considerably less heartwarming, think of the collective meme that Coca Cola seems to be aiming for with ad slogans such as "Coke is it!," "It's the real thing," or "I'd like to buy the world a Coke."  Now, mind you, this definitely does NOT induce me to think that we should be subsidizing Coke (or for that matter, the 1960s "British Invasion"), but if we're asking, as this paper does, what exactly commercials are doing, in cases where they clearly are not making "rational" appeals to price and quality, then we should have this sort of thing in mind.

The paper offers a model for how to think about advertising that is basically the internalities story.  (If you download the paper, which again is available here, it's Figure 11 on p. 16.)  But I think that this is often the wrong way to think about what advertising is trying to do.  It gives a nice example where that might be a plausible explanation - describing, at pp. 7-8, a case in which including a small picture of an attractive woman in a commercial loan solicitation increased loan demand by about as much as a 25% interest rate reduction.  But "Coke is it!" doesn't strike me as being about internalities.  It's doing something else, whatever that is.

Another well-known ad campaign that the paper mentions is "The Ultimate Driving Machine," for BMW.  While we might think of this as making a very soft factual claim about BMW quality, or at least as referencing prior beliefs that BMWs are high-quality cars, it also seems to be about social context.  Only, whereas for Coke the message seems to be "I drink Coke and so do you," for BMW perhaps it is more along the lines of "I have a BMW and you don't."

Here's why this might matter, in relation to Figure 11 on p. 16.  The reason I think of that as telling an internalities story, is that it contrasts two demand curves.  The first is "true" demand, reflecting underlying utility.  The second, higher demand curve, is revealed preference after one has been manipulated by the advertising campaign.  In effect, one's utility from buying the product is the same as it was before, but one is buying more of it than previously by reason of the advertising manipulation.  So it is like an internalities story, where (by hypothesis) we know how the "true" preferences related to revealed preferences, and therefore in theory can correct the behavior via a corrective tax.  (As Marron noted, if one wants to be certain that the consumers who pay the tax will generally or collectively be better off overall, one may need to find a lump sum way to rebate the tax revenues to them.)

If the Coke and BMW ad campaigns end up increasing demand for those products, I don't think we can just say that people's utility functions are the same as they were before.  These campaigns are getting right in there and affecting our utility functions, by affecting the social meaning of these products.  Plus, there's no such thing as the "unpolluted prior," comprising the "true," pre-social meaning, utility value of a given commodity.

Now, I don't comprehensively subscribe to the Gary Becker of advertising as just (or even primarily) offering useful information - although that clearly is one part of what may be happening.  And I am skeptical that the Coke and BMW campaigns are increasing net social welfare to the same degree as they (if successful) increase the producers' profitability.  In short, I am open to further evidence and debate regarding how we should think about advertising, and what the policy implications might be.  But I would view the internalities story as just one of many stories that might be going on.

Nonetheless, it's a nice paper that raises interesting issues, and I am certainly in sympathy with its broader aim, which is to say that we need to think about looking behind supply and demand curves with regard to underlying utility (or welfare or wellbeing) claims, and should not just take them as canonically or always expressing the social optimum - even leaving aside distributional issues and standard-issue externalities.

A huge 2017 tax cut?

In today's Tax Notes, Martin Sullivan discusses what might happen on the tax legislative front if Republicans, despite all the  current Sturm und Drang, end up winning the White House and holding both houses in Congress.  The background for this is that, despite what Alan Auerbach and Bill Gale have recently called our "deteriorating fiscal outlook" over the medium to long term, all Republican candidates are calling for enormous tax cuts, for which they offer no realistic funding suggestions.

Thus, according to the Tax Policy Center, the 10-year revenue loss from the Trump tax plan is $9.5 trillion.  For the Cruz tax plan it's $8.6 trillion (Sullivan says $19.5 trillion, but I'm not sure where he gets that number).  For the Rubio tax plan - worth noting even though the candidate is not exactly amassing huge vote or delegate numbers, given that it may be the best evidence of what Republican orthodoxy favors - hence, perhaps predictive if the convention nominates None of the Above - the 10-year total is $6.8 trillion.

These are revenue loss figures.  If they're correct, the actual budgetary impact on national debt and the annual budget deficit would be greater, because one would have to add in added annual interest costs on the debt.  Plus, while the proposals might have some pro-growth impact, to a modest degree, from their lowering marginal tax rates, they would also have negative growth effects - which I suspect would outweigh the positive dynamic effects - from their increasing so enormously the fiscal drag from the rising public debt.

Sullivan argues that, in the scenario where the Republicans take the White House while holding both houses in Congress, they would likely end up proposing tax cuts "more modest than [what] they are proposing now."  Leaving aside Trump's evident unpredictability, I see no reason to believe this.  They would have campaigned for the big tax cuts, and would have strong internal constituencies demanding them, and it is not as if grounded empirical reasoning appears to cut a lot of mustard with this crowd.  Even the Jeb Bush tax cut was projected to be in about the same ballpark as that proposed by Rubio, and I gather that he had the greatest buy-in by leading Republican economist types.

Sullivan concludes, I think correctly, as follows: "If they push aggressively for tax cuts in 2017, there is a good chance Republicans in Congress will be creating a situation similar to that of Republicans in Kansas after their 2012 tax cuts.  The revenue losses are real, but the hoped-for supply side economic benefits don't materialize.  This may be a risk they are willing to take, although the financial markets may not be so complacent.

"The uncertainty surrounding the CBO's projections about the future of the economy and federal finances cannot be emphasized enough .... But if they [and we] are unlucky ... the federal debt could reach stratospheric levels and Dick Cheney's dictum that 'Reagan proved deficits don't matter' will be severely tested."

UPDATE: There are two extra points that I want to add to this discussion.  First, according to the Tax Policy Center study on which both Sullivan and I are relying, $8.6 trillion (or more precisely, about $8.75 trillion) is the 10-year revenue loss from the Cruz tax plan, whereas $19.5 trillion is the 20-year increase in federal debt from the Cruz plan.  So the latter number reflects 10 additional years of negative revenue results, plus interest payments on the added federal debt throughout the twenty-year period.

Second, the recent Wall Street Journal editorial attacking the TPC estimates as if they were a partisan hit job is beneath noticing, although obviously TPC had to respond and did so.  Among the main points they made in their response is that, in all of these cases, as I informally noted above, the positive growth effects from lowering marginal rates would likely be relatively modest (a huge weight of empirical evidence suggests), and might even be outweighed by the negative growth effects of the increased fiscal drag from substantially higher federal debt.  They also note that they have gotten feedback on their estimates from reputable economists across the political spectrum, including, e.g., Gregory Mankiw from the more conservative side.

It's shocking to me that any reputable person would endorse unfunded tax cuts as large as those in the leading Republican plans, given our broader fiscal circumstances, even if one's preferred end-state would include those tax cuts plus other changes on the outlays side that in fact are unlikely to be adopted.  But that is the partisan political world we live in.

The centrality and heterogeneity of sentiments around hierarchy and subordination in U.S. politics

Chronic campaigner Mitt Romney, who evidently hopes that a deadlocked Republican convention would turn to him, has inadvertently shot a flare across the psychic landscape of American politics.  (Needless to say, he's unlikely to have the self-awareness to grasp any of this, but it's still a kind of intellectual public service, wholly leaving aside the question of how it ends up affecting the election.)

Political debate is often conducted in terms of ideas, and conceptualized in terms of economic interests, and both clearly matter a lot.  But also vitally important are feelings about hierarchy and subordination, which can involve both (a) tensions between rival claimants to elite status, and (b) popular resentment of elites' claims that they are entitled to lead and guide the rest.  How all this is conceptualized, however, can be startlingly heterogeneous.

Let's start with Romney's broadside against Trump, which I (like many others) found wildly hypocritical.  Consider Romney's own willingness in 2012 to dip his well-pedicured toe into the waters of racism, anti-immigrant sentiment, hypocritical flip-flopping out of political opportunism (e.g., Romneycare / Obamacare), and dishonest under-specification of his fiscal plans (e.g., while Trump of course doesn't explain how he'd pay for his tax cuts - he can't - Romney similarly couldn't explain how he'd cut rates so steeply without either losing revenue or raising middle and lower-echelon taxes).  And it's not just Romney in 2012; Cruz and Rubio are also both guilty on all these counts; at most there's a modest manner of degree as between them and Trump, and even that is debatable in some of the relevant dimensions.

But I'll give Romney credit for one thing - despite the underlying calculation and evident hypocrisy, it seems clear that Trump has genuinely enraged him.  For this I see two main causes.

The first is that he finds Trump simply too vulgar to be an acceptable member of the leadership class.  As others have noted, we're seeing a replay of Caddyshack, with Romney having taken Jeb's place in the Ted Knight role, and Trump still playing Rodney Dangerfield.  You can accept an endorsement from such a person, as Romney did in 2012, and perhaps you can even give him gracious verbal props as part of the arrangement, but to Romney this does not contradict taking the stance he does now when one of Those People gets so out of line and above himself.

Second, Romney is furious because Trump has been unacceptably rude towards other members of the Republican leadership class.  It's okay to defame your political enemies, as well as, say, members of the "47%," but it's not okay to be so rude as Trump has been to the likes of McCain, Jeb, and Rubio.  These people are supposed to be treated respectfully as a personal matter, even if you take a shiv to them politically.  (Or at least, you need to subcontract the thuggery, a la the George W. Bush campaign's slanders against McCain in the 2000 South Carolina primary.)

So we have Romney sincerely and passionately defending one of the few things (beyond himself) he actually cares about - the right of the Republican leadership class to keep out vulgar parvenus and to be treated respectfully.

This brings us to the other side of the coin - the anger that Romney's stance has triggered among Trump voters who espy a "patronizing directive from an elite figure who thoroughly misunderstands their feelings of alienation from the political system."

So we have social battles among rival elites, plus popular anger over what is viewed as an elitist asserting his prerogatives.

Two more general comments.  First, it's noteworthy how pervasive this type of thing is in American politics.  For example, a sentiment underlying the Sanders campaign is that the economic elite - the top 0.1 percent - has gotten out of control and needs to be reined in.  But one reason for Sanders' apparently limited political appeal is that not everyone who is angry about perceived or actual subordination is coding the problem this way.  Obviously, within the Democratic race, there's been the question over relative focus on plutocracy versus, say, issues of racial hierarchy and subordination.  And, equally obviously, those on the right who are angry about elites telling them what to do often direct their anger at targets other than plutocracy.  For decades - think of George H.W. Bush insisting that he liked to gnaw on pork rinds - we've had Republicans tapping mass resentment of elites defined quite differently - intellectuals or Ivy Leaguers or civil servants, for example.  And this evidently has authentic roots of a kind.  Richard Nixon, the dark genius of American politics during his long (1946-1974) career, was able to put his finger on it in part because he himself had felt it when dealing with those he thought of as members of the Ivy League "Eastern Establishment."

Second point, already illustrated by the above paragraph: there's remarkable heterogeneity around how elites are defined, whether they're (a) battling with each other or (b) being targeted for popular resentment.  Consider the rage of many business and financial industry types over the Obama Administration's rather mild (I thought) criticism of them after the 2008 financial meltdown.  And, to be fair, consider as well how people like me think about the problem of plutocracy in current U.S. politics and society.  An important subtext here, and source of the anger and passion on both sides, is the rivalry between economic/business and intellectual/academic self-styled elites, who invoke different ranking systems for determining who deserves authority and deference.  Now, I would say that the other group's resentment is a bit farcical, given how much more power (and everything else) they clearly have than anyone else, most definitely including my own group.  But then again, I'm saying this from the inside of the dispute, not from a lofty perspective above it.

Jealousy among cats ... can't have that

Cats are too individualistic to think in terms of jealousy or envy.  Only social species (people, dogs, etc.) that live in groups have the psychic structures, whether or not the cognitive structures, for that. But just in case there is the theoretical possibility of feline jealousy, having posted a Sylvester photo the other day, here's an old photo of his twin half(?)-brother Gary.  It was taken a couple of years ago, so nowadays he's larger and a tad less kittenish - albeit not fundamentally changed.

Gary is viewed by some who know him as being in all ways perfect.  From this perspective, he is Gallant, as compared to the (in the end equally lovable) Goofus that is Sylvester.  However, one of his three feline colleagues (not to mention all potential prey animals - he is absolutely mad about hunting, even in the absence of actual opportunities) would strongly reject viewing him so positively.

Tax policy colloquium, week 6: Kevin Markle's (with Scott Dyreng) "The Effect of Financial Constraints on Income-Shifting by U.S. Multinationals

The above paper, which we discussed at our session yesterday, is empirical but raises normative issues.  I'll start with the latter, as it gives context and relevance to the paper's empirical contribution.

The paper's core idea (as it notes at page 3) is to examine the apparently conflicting views recently stated by two experts.  Both views relate to the question of how deferral for the foreign source income (FSI) of U.S. multinationals' ("US MNEs") foreign subsidiaries ("CFCs," for "controlled foreign corporations") affects the extent to which the companies engage in profit-shifting - that is, engaging in tax planning manipulations to create FSI of the CFCs in lieu of U.S. source income of the parent companies.

Suppose we are thinking of repealing deferral.  Now, the standard view is that this could be done in either of two ways: either by making the CFCs' FSI immediately taxable in full (say, as a deemed dividend) to the U.S. parents, or by adopting a territorial system, under which the CFCs' FSI generally would not be taxed - albeit, in practice likely subject to "CFC rules," making some such income immediately taxable to the parent, in keeping with actual practice in all major countries that have adopted "territorial" systems.

A third option, which I favor and have discussed at length in various places, would be to repeal deferral, generally tax FSI at a lower rate than U.S. source income but not at 0% as under a pure territorial system, and repeal foreign tax credits.  However, foreign taxes might still get effectively better-than-deductible treatment in some settings, and this might indeed be achieved at least partly through the use of CFC rules that, like those in many territorial countries, treated actually or presumptively low-tax FSI less favorably than other FSI.  But one could write a whole book on this, as indeed I have, so let's leave that to one side for now.

Anyway, suppose that what we mean by "repeal deferral" is "adopt a territorial system," albeit possibly with CFC rules that actually make certain FSI domestically taxable.  Then one question that would arise is whether, at least as a standalone matter, this would increase outbound profit-shifting by U.S. companies to the detriment of the U.S. tax base.  If it would, then we might either have an argument against repealing deferral, or else a concern that we might need to address by other means as a part of the deferral repeal package.

Now to the two apparently conflicting claims by leading experts.  John Samuels of GE asserted in 2010 (at a symposium discussion that was published in Tax Notes) that deferral does NOT reduce profit-shifting by U.S. companies.  In effect, he said, profit-shifting to take advantage of deferral is a free option.  Suppose you profit-shift in Year 1 and then have to repatriate the shifted earnings in Year 2.  Unless the repatriation tax rate has increased in the interim, you haven't actually lost anything.  So far as the deferred principal is concerned, you just pay the same tax in Year 2 that you would have otherwise paid in Year 1.  (Also, while you got to defer it for a year, the amount that's out there also grows at your foreign rate of return - still leaving you, however, with a net time value benefit if the after-tax rate of return available to funds that are classified under tax rules as sitting "abroad" exceeds that which you could have garnered if they were classified as sitting "back home.")

Samuels has a nice point here, whether or not one entirely agrees with it.  If profit-shifting imposes zero costs on the taxpayer, it's a free option and there's usually no reason NOT to do as much of it as possible.  The worst-case scenario - so long as the repatriation tax rate doesn't increase, and the after-tax rate of return that you get "abroad" at least equals that which is available "domestically" - is that there's nothing lost, albeit not much gained if it was just for a year.

If this point is wholly true, how should it affect our thinking about the repeal of deferral in the context of shifting to a "territorial" system?  I would say, possibly not so much (although it would be a relevant input to one's thinking).

Here's why.  Suppose one were to say: Ah, Samuels has shown us that deferral doesn't actually reduce profit-shifting.  So we don't need to think about the repeal of deferral, in the context of going more territorial (but possibly subject to revised source and CFC rules!), as a step that makes the profit-shifting problem worse.

But here's the thing.  In this thought experiment, we haven't just repealed deferral - we have also repealed the tax on FSI that previously arose upon repatriation.  In Samuels' scenario, companies are sometimes paying the repatriation tax.  If we're eliminating that, it matters.  Even just looking at the direct revenue effects, the U.S. loses tax revenue, if it either was collecting positive repatriation taxes, or there was a positive present value for future expected repatriation taxes.  There may also be indirect positive effects on U.S. tax revenues.

Now, from a U.S. budgetary standpoint, after all, the primary problem isn't profit-shifting as such - it's the reduction in U.S. tax collections.

There also is the flip side to think about.  Samuels has long argued that the U.S. should shift to a territorial system, by reason of the effects that he attributes to our imposing expected tax liabilities on U.S. MNEs with respect to their FSI.  Obviously (and as I am sure he agrees), the problems that concern him are still there, even if deferral is a free option, if forced repatriation might (and sometimes does) occur at some point.  So his main arguments for going territorial are still there - the free option to profit-shift for now doesn't make his arguments about disadvantaging U.S. companies, etc., go away.

Now suppose instead that profit-shifting, within a deferral regime, is costly rather than a free option.  There might be fixed up-front costs of setting it up - for example, putting enough real stuff abroad to be able to profit-shift, paying lawyers and accountants to set up all the shell entity mechanisms and such, etc.  Then companies would have to ask themselves whether profit-shifting's benefits would be worth these costs.  All else equal, they'd be more likely to say no if they were anticipating only very short deferral periods.

Suppose also that there are ongoing marginal costs of profit-shifting.  An example would be having to  make sub-optimal interim investments (defined in terms of risk-adjusted after-tax returns) with the "trapped earnings."  This would likewise undermine the "free option" argument, although it's not necessarily related in the same way to short-term versus long-term deferral periods.

Based mainly on the fixed costs, Patrick Driessen has argued (as cited at page 3 of the Dyreng-Markle paper, right after the Samuels quote) that some U.S. companies might have profit-shifted a lot more, but for the fixed costs that made them think it wouldn't be worth if taxable repatriation might be likely fairly soon.  For such companies, adopting a territorial system under which repatriating the supposedly foreign-source profits had no adverse U.S. tax consequences would indeed, Driessen argues, induce additional profit-shifting out of the U.S.

Now, once again, what matters the most here is the prospect of paying a U.S. tax at some point - not the deferral period as such.  Again, let them profit-shift all they like, but if we always got to tax the full profits in the very next year (at the same rate) it wouldn't matter so much.

Despite all this, one's choice between the Samuels and Driessen views, as descriptions of some underlying reality, does, to a degree, matter substantively all on its own.  For example, the incentive to defer both has greater efficiency costs, and greater efficacy in discouraging profit-shifting - so it is both bad and good - under the Driessen view.  Also, the amounts and periods at stake might be large enough to matter on their own.  And, if US MNEs differ in their capacity to benefit from incurring the fixed costs of setting up profit-shifting mechanisms, we might be taxing them unequally - to the relative benefit of those that CAN benefit from incurring the fixed costs - in a way that is independently undesirable.

So the question is  certainly interesting and important - one just wants to avoid misstating (and possibly overstating) why, how, and how much it matters.

Anyway, Dyreng and Markle explore a particular hypothesis that is pursuant to the Driessen view, and in tension with the Samuels view.  Suppose, they say, that financially constrained firms expect shorter deferral periods than financially unconstrained firms.  E.g., they anticipate bringing the funds home sooner rather than later, because they are less well-positioned to meet anticipated short-term cash needs, such as by borrowing. Then, by reason of the fixed cost problem, one might expect less profit shifting from the constrained firms than from the unconstrained ones.

Dyreng and Markle therefore attempt the following.  First, devise (a) a measure of financially constrained firms.  Second, devise (b) a measure of profit-shifting.  Third, determine (a) is negatively correlated with (b), and in such a way that we can reasonably conclude that (a) indeed caused (b).

The problem here is that both (a) and (b) are hard measures to devise.  As to (a), note that "financially constrained" need not mean distressed, losing money, etc.  It just refers to difficulty in cheaply raising funds commensurate with one's appetite for same.  They look at three preexisting measures of financially constrained firms in the literature - all of which have serious problems - but figure that, if they get a positive finding and alternative explanations aren't good enough, then they must be onto something.

As to (b), their task is made easier by the fact that they don't need an underlying measure of "correct" linkages and particular countries - just differences between the two types of firms identified by (a).  Thus, suppose a U.S. company develops valuable IP in California, leading to $2X of worldwide sales, exactly half of which ($X) are in the U.S.  Under an origin-basis approach to defining the source of income, arguably all of the income ought to be classified as U.S. source.  Under a destination-basis approach, such as that which would arise under sales-based formulary apportionment, arguably half of the income ought to be classified as FSI.

Dyreng and Markle need not resolve this conundrum, in order to apply their test.  Suppose for convenience that the company had basis and expenses of zero, such that its worldwide income was $2X.  And suppose this meant that a financially constrained firm that couldn't profit-shift had a U.S. to foreign income breakdown of $2X / 0 under the origin method, or $X / $X under the destination method.  Either way, an identical, except financially unconstrained, firm that could profit-shift in the amount of $Y would be visibly different.  Its breakdown would ($2X - $Y) / $Y if everyone used the origin basis, and ($X - $Y) / ($X + $Y) under the destination basis,  So the difference - not the "correct" answer absent profit-shifting - is the point of interest here.

The paper finds that being financially constrained does appear to reduce profit-shifting, in tension with the "free option" argument.  This suggests that deferral does tend to reduce profit-shifting, albeit just for a subset of firms, although it also might support inferring that deferral has greater year-by-year efficiency costs than one might have inferred under the "free option" view.

The reverse Dorian Gray and the X-tax

These days I aim to minimize posts that directly concern current events, such as the presidential election, for a couple of reasons.  One is that the emotions that come over all of us about these things, in real time, can conflict with achieving the degree of reflective equilibrium in my posts that I prefer to aim for.  The second is that politics these days is so tribal - like we were all a bunch of 14 year olds, among whom the Mets fans just hate the Yankee fans, and vice versa, no matter what else they might have in common - that I think I would lose the ear of people on the "other side" who might otherwise have some interest in things that I say.  (This is not about page views, which one can probably increase through partisan screeching, but about engaging with people in, I hope, a more thoughtful way.)

All this is a throat-clearing wind-up to my saying something - or rather, preparing to say something later - about the tax plan issued by the candidate against whom, for broader reasons not worth fully reviewing here, I am currently rooting the most vehemently: Rubio.

OK, I'll indulge myself for just a moment.  This reverse Dorian Gray - you can see in his face how little thought, care, and character he has - it's too empty and unlived in, hence the opposite of the Oscar Wilde character (as revealed in the painting) who has erred in the other direction - has put out proposals that I believe are not on balance worth taking seriously on any ground other than that he might win (which does not currently appear to be likely).  For example, when you propose cutting federal tax revenues by almost $7 trillion over ten years while also proposing massive increases in military spending and probably several wars, and when you propose to make income inequality much worse, to gut regulation of the financial services industry, and to do nothing about climate change, then I think your program is really unworthy of being considered anything better than crank lunacy on the extremist fringe, notwithstanding the smiling face that he tries to shove in front of all this.

But the interesting thing is that he is actually proposing to replace the income tax with a variant of David Bradford's X-tax, which I have certainly said nice things about in the past that I still mostly believe.  (My thinking has changed in some ways, but I'd still endorse a great deal of what I previously wrote, and certainly the basic analytics would start from the same place.)

Leaving aside that Rubio takes the X-tax and plunks it into an overall platform that makes no sense, what with the calamitous budgetary crisis he'd create and his refusal to address any of the actual rising problems of the 21st century, might this be worth more reflection than it has gotten from most people so far, and certainly from me?  For example, how might we either reconcile or choose between arguments that I and others have made, to the effect that the X-tax can in principle match the progressivity of present law, and the distributional picture that serious arbiters (i.e., the Tax Policy Center) offer regarding this plan?  Obviously, no one ever said (or could reasonably say) that the Rubio X-tax must, as a logical matter, match the progressivity of 2016 present law, but consumption tax proponents argue for using a different time frame in thinking about distributional effects than is standard in prevailing models.  (E.g., if you are deferring current tax liability indefinitely, but without reducing its present value, so no tax is paid in the 5-year window, how should we think about that?)

I want to address these topics a bit further at some point, whether here or in actual academic writing, but (a) I just don't have the time right now, given other things that are higher on my current action list, and (b) I'd rather wait for Rubio to disappear from the race (which may conceivably happen after March 15, depending on the Florida results), since it's not his X-tax, within his overall program, that actually deserves to be taken seriously.

Anyway, more (perhaps) on this later.