Observations concerning the broader institutional background to the section 385 regulations

As noted in a previous blog entry, I had planned to attend an NYC Bar Association event this Wednesday evening discussing the newly issued section 385 regulations.  It turns out now that I unfortunately won't be there.  However, since I had already prepared remarks for the session, I've decided to flesh them out slightly and post them here.

In short (or long), what I had planned to say was something like this:

I’ll address 3 topics.  The first is the use of regulations, instead of legislation, to address the second big wave of corporate inversions.

The second is the currently highly contested issue of the breadth of the Treasury’s regulatory authority generally.

And the third is the use of interest deductions to strip out US source taxable income, in relation not just to the new section 385 regulations but corporate tax reform.

1.         REGULATIONS VS. LEGISLATION

The Treasury’s recently issued section 385 regulations emerge from the 2^nd wave of corporate inversions.  Twelve years ago, the first wave of pure paper-shuffling self-inversions promptly gave rise to the enactment of section 7874.  This was not just a bipartisan process, but a Republican-led one, as George W. Bush was president and the Republicans controlled both houses of Congress.

The second wave of inversions raised harder policy issues, because it involved, not just paper-shuffling, but real business transactions, even if significantly tax-motivated.  But I think it should easily have been a bipartisan no-brainer to slow down the inversions wave, at least as a stopgap while deciding what to do about their underlying causes.

By the way, whether or not the U.S. statutory corporate tax rate is too high, that is not what second-wave inversions are about.  Instead, they’re about two main things.  The first is the gigantic buildup of foreign earnings that, as an accounting matter, have been labeled as permanently reinvested abroad.  Companies want to be able to access the funds more conveniently without taking an actual tax hit or a reported earnings hit.  The second is the aim of using interest deductions to reduce U.S. source income, which is easier for foreign corporations than U.S. corporations.

Both of these issues need to be addressed, but it’s foolish to encourage an inversion wave before we get around to dealing with them.  So it should have been uncontroversial to slow down inversions in the interim.  But because the legislative process in Washington has completely broken down, due to partisan disputes since 2009, this was not possible.

As many will recall, the Treasury initially thought that it couldn’t do anything if Congress wouldn’t act.  But then Stephen Shay and others weighed in to say that the Treasury actually does have some reg authority, so we got the first set of anti-inversion regulations, followed by the section 385 regulations that we’re discussing today.

Some people have been shocked by this, because they think it violates informal comity norms between the executive branch and Congress that have been well-accepted for many decades.  They’re right that the Treasury is indeed departing from those norms.  But guess what.  Those norms are dead, and they’re not coming back.  They were killed by the breakdown of the bipartisan tax legislative process that we used to have.  Once that happened, there was no reason to expect the Treasury, with either party in control of the executive branch, to figure that it would just defer until Congress got around to legislating.  So long as our politics is so dysfunctional, the action is inevitably not just going to disappear – it’s going to move up Pennsylvania Avenue from Capital Hill to the Treasury Building (or else the White House).

Just to put this in the context of the upcoming election, even if we assume that Clinton wins, Republicans in Congress have already announced their plan to confirm no judges, devote the next four years to investigations, and gear up for impeachment proceedings.  So I don’t think there will be a whole lot of actual legislating.

Whether all this is good or bad, taxpayers and their advisors are going to have to get used to it – and, of course, adjust their lobbying and other government outreach accordingly.  But it brings us to the second question: how broad is the Treasury’s regulatory authority, both in specific cases and in general.

2.         THE TREASURY’S REGULATORY AUTHORITY

I’m not going to address today the particulars of challenges to the Treasury’s claim of regulatory authority under section 385.  But I will say this: Congress deliberately gave the Treasury very broad discretion.  It wasn’t limited to things that Congress particularly had in mind when it enacted the grant.  And of course the Treasury hasn’t limited the new regulations to inversion transactions.  It has addressed broader issues that relate to interest deductions, via the distinction between debt and equity.  So any court challenges that are based on Treasury’s discretion under section 385 face a steep uphill climb.

One unfortunate byproduct of the breakdown of the legislative process is that, while Congress can use any tool it likes, the Treasury can only use the tools that it has.  Thus, suppose it would make more sense to disallow interest deductions than to reclassify what’s nominally debt as equity.  The Treasury may not have that choice when it’s exploring what to do.  But that doesn’t necessarily mean that it shouldn’t do anything. If the best response is unavailable, it shouldn’t be the enemy of the good.

Now, the shift in ability and willingness to act from Capital Hill to 1500 or 1600 Pennsylvania Avenue has happened at the same time as other tectonic shifts in the legal environment.  Treasury regulations are now, in the aftermath of the Mayo Foundation Supreme Court decision, fully subject to the standard administrative law regime.  This raises transition issues, given all the regs that were finalized before Mayo, and it has also required both the Treasury and the Tax Court to face a bit of a learning curve.

One recent chapter in this process was the Tax Court’s ludicrously misguided decision in the Altera case, concerning transfer pricing under the cost-sharing regs, which is currently on appeal to the 9^th Circuit.  One of the things that the Tax Court did particularly poorly in that case was look at the regulatory preamble that accompanied the regulations at issue in light of the requirement of reasoned deliberation to qualify for deference. 

While reasoned deliberation by administrative agencies is a good thing, the Tax Court’s ham-handed version of testing for it meant that the role of regulatory preambles was bound to change.  Instead of preambles’ being useful and informative documents that explain the Treasury’s reasoning and beliefs to taxpayers, as they had previously been, the Tax Court ensured that, henceforth, they will simply be litigating documents, composed with an eye to heading off future regulatory challenges.  That’s unfortunate but necessary from the Treasury’s standpoint, and we can certainly see it at work in the lamentably interminable Treasury preamble to the section 385 regulations.

Once again, the new world we live in now may be worse than the old one, but we’d better get used to it, because it’s not going away any time soon.

3.         INTEREST DEDUCTIONS AND CORPORATE TAX REFORM

Again, the section 385 regulations are not just about inversions, but more broadly about the use of debt that yields interest deductions to strip profits out of the U.S. tax base.  This reflects the fact that our current rules for addressing excess leverage are very weak, especially for non-U.S. companies that don’t need to worry about subpart F.  It also reflects how weak our earnings-stripping rules are, under section 163(j).

Our defenses against the use of interest deductions against earnings-stripping are weak in two senses: absolutely, and relatively for foreign as opposed to U.S. companies. That of course has been a key reason for the second inversions wave.  Peer countries, such as Germany and the UK, appear to have absolutely tougher rules against earnings-stripping than we do, if I’ve been accurately informed by people who know those countries’ rules better than I do, but they also don’t place the same relative weight on corporate residence as our overall regime does, given the role played by subpart F. And importantly, I gather that they look at the global debt of a worldwide affiliated group, without being confined to looking at the resident company and its foreign subsidiaries (as distinct from corporate parents and siblings).

I think that the U.S., if we are able to overcome the breakdown of our tax legislative process, needs to consider addressing earnings-stripping through rules that look at the debt of the entire multinational group, whether it is U.S.-headed or not.  And while I have been, and remain, pessimistic about the legislative prospects for corporate tax reform, there are several pieces of a package that one could imagine making sense for everyone who is rational, including the companies themselves.

While the companies are unlikely to welcome tougher rules against earnings-stripping, they could support an accompanying reduction in the corporate rate.  And while in isolation they might not like a deemed repatriation of their trapped foreign earnings, this could be at less than the full rate, and they’d benefit from loosening the use-of-funds shackles that they now face.

So there are important things that the Treasury can’t do on its own, but that Congress could do if our politics got less poisonous and dysfunctional.  That’s a lot to hope for, but we do have an election next week, so perhaps this is as good a time to be hopeful as any.

Webpage for the High-End Inequality Colloquium

We now have an NYU webpage up for the Colloquium on High-End Inequality that Robert Frank and I will be co-running at the law school for the next 6 weeks (Mondays through December 5).  It shows the full schedule and links for the first couple of papers, and links for more papers are to follow soon.

Available here.

Today's OECD-BEPS conference at NYU Law School

Interesting OECD-BEPS conference today at NYU Law School.  The whole thing should be streamable on the NYU Law School website by sometime next week.  But herein a quick summary regarding the day's 4 panels:

PANEL ONE, on which I participated, discussed the EU state aid cases. From Hein Vermeulen and Dennis Weber I learned that it's very wide open at this point whether the European Court of Justice will sustain the European Commission.  I wonder if the US outcry, including via the Treasury White Paper, is strengthening the EC's hand, by making a reversal look like bowing to American pressure rather than reflecting the conflicting currents in EU jurisprudence.

Itai Grinberg, who has been very critical of the EC (whereas I say the US should not be so overwrought about it) was the other panelist.  After our colloquy, I get the sense that we disagree far LESS than I had thought, even though our bottom lines differ.  Perhaps the video will help show this.

Here are the slides for my talk.  While linked to my EU state aid paper, they also talk quite a bit about the source concept, as in "How should we think about the source of Apple's income?"

I use the words "origin basis and destination basis" here, reflecting how they've been used, for example, in VAT / X-tax type discussions.  People in international income tax policy debate often use somewhat different words to mean similar things.  One could reconcile the lingo a bit by saying that origin basis means taxing it in the production jurisdiction, while destination basis means taxing it in the market jurisdiction.  It's also sometimes put in terms of residence country taxation vs. source country taxation, but I didn't use that terminology because, when you're asking where the source of income is, it causes confusion to use the term "source jurisdiction" for one of the two possibilities.  Plus, the residence jurisdiction can differ from that of economic production, given cross-border choices in corporate residence.

PANEL TWO discussed country-by-country reporting of profits, employees, etcetera.  There appeared to be wide agreement, extending to speakers on other panels, that this is potentially a "game-changer."  It may tend to move the location of reported profits to being far closer to that which would be suggested by formulary apportionment (FA), even if FA isn't formally adopted.  After all, if you report lots of sales in a given high-tax jurisdiction, it may be hard to resist agreeing that profits arose there.  And if you want to support a higher profit allocation to a given low-tax jurisdiction, it may help to put more employees there.

The move in an FA direction tends to require more distortion in association with profit-shifting (since it requires than transfer pricing's paper-shuffling), but it presumably greatly reduces taxpayer discretion.  I wonder if it will create a new motive of tax competition to lower one's corporate tax rate  - so that companies will want to locate enough employees in one's country to justify allocating profits there.  This of course is not unrelated to how Ireland reached agreement to help Apple.

PANEL THREE discussed treaties and less-developed / least-developed countries. It covered some of the challenges and difficulties involved with trying to broaden the participatory sphere from OECD countries to the rest, and explored the relative roles that the UN and OECD can play.

PANEL FOUR discussed how the US has been implementing (or not) OECD-BEPS, and suggested that we are already substantially compliant.  The US may have lost politically in OECD-BEPS, since we wanted stronger CFC rules but didn't get them, and were far less enthused about strengthening "source country" (meaning destination-based or market country) taxation and perhaps to a degree did get that.  At least one panelist believed that we win from CBCR.  I would assume the reasoning here would be that US companies will have to report more profits in the US post-CBCR, arguably to our benefit, although they might also have to report more profits in market countries rather than tax havens, arguably (or at least directly) to our detriment.

What would Trump really care about as president?

The obvious answer is, the same things he cares about as a candidate for president.  These are (1) attacking, and if possible silencing, people who criticize him or report things that he would rather not have reported, and (2) enriching himself.

The easiest way to get #1 is to secure a compliant Justice Department, packed with his people, while letting Republicans have whatever they like in tax policy and judicial appointments.

The third thing he may care about - it's hard to fully understand why, but the statements he keeps making about Putin, to his apparent political disadvantage, make one wonder - is aiding Russian foreign policy to achieve all of its aims, even perhaps maximalist ones.

It was 30 years ago today

Today is the thirtieth anniversary of the 1986 World Series, Game 7, when the Mets defeated the Red Sox to complete their miraculous comeback.

I had suffered, then rejoiced, during the end of game 6, via a TV at the foot of the bed where I was staying with friends during a visit to NYC.  (I still lived in Washington, where I was working for the Joint Committee on Taxation. The Tax Reform Act of 1986 had been enacted just days previously, and I was out on the road explaining the parts I had worked on to various tax lawyer groups.)

During the climactic moments of Game 6, I had kept turning the TV off then on again and muttering to myself.  I meant to turn it off for good at the very moment the Mets lost (as they were down two runs, with two outs and no one on base, in the bottom of the tenth inning). As the rally proceeded, I moved slowly backwards towards the pillow end of the bed, and the tenor of my muttering started to change.

My now-wife was with me, trying to sleep (so I was trying to keep the muttering as low as possible).  I told her afterwards that she had now seen the very worst of me; there were no more secrets to worry about.

But on to game 7, the one that is 30 years ago today.  She must have gone to see her family, as I was in an NYC hotel room, hosting several friends from college and/or law school who had dropped by to see the game.  We went through anxious moments early on, as Ron Darling faltered and Bruce Hurst was mowing the Mets down for the third time in just over a week.  But when Keith Hernandex doubled to narrow the score to 3-2, we knew what was going to happen.  (I think the Red Sox knew at that point, too.)

Colloquium on high-end inequality

Yesterday was the first day of the seven-week Colloquium on High-End Inequality that I am co-leading with Robert Frank.  Afternoon sessions, from 4;10 to 6 pm in Vanderbilt 202, are open to the public.

Our first session was devoted to several of Bob's short pieces, including one on the importance of luck, another on expenditure cascades, and a third on winner-take-all markets.  The following is a fleshed-out version of my main comments:

2 discussion topics today: the relevance of luck, what if anything is wrong with high-end inequality.

1. Luck

Obviously, luck matters in life. Everyone knows that.  So why, in relation to thinking about high-end inequality, is it particularly worth mentioning?

Because of the alternative view – which, here, is not that everything was predetermined or inevitable, but that all success is just flat-out deserved, period.

3 examples from the papers: Bob survived a dangerous heart attack, Mike Edwards of ELO was buried by a hay bale, Michael Lewis happened to sit next to a Salomon Brothers spouse, who gave him the idea to write Liars Poker, and launch his amazingly successful career.

The first two counterfactuals, but for the luck, are indisputable.  Bob wouldn’t have lived, Mike Edwards wouldn’t have died.  And there’s no particular policy payoff to them, apart perhaps from promoting emergency treatment and road safety.

But for Michael Lewis, some might say: C’mon, he was Michael Lewis. He had extraordinary talents. Surely he was bound to succeed anyway.

Now, that may or may not be true.  We don’t get to run a thousand simulations in which we see how many times he becomes “Michael Lewis.”  But suppose that he wouldn’t have comparably succeeded in many or most of those simulations, even if he never got a heart attack or was buried by a hay bale. What would we learn?

Maybe it’s just attitudinal. Even if you’re highly successful, you should retain proper humility and compassion.

My own answer is that the role of luck, which Bob highlights in his papers, doesn’t matter all that much substantively to how we should think about high-end inequality.  But it might matter not just attitudinally in people’s private thoughts, but also rhetorically in public policy debate.

I think it matters rhetorically due to what I’d call the ideology around meritocracy.  We live in a society where everyone who’s successful claims to have earned it. It’s not just Donald Trump pretending that he didn’t get $14 million from his dad. It’s all kinds of people who were born on third base and believe they hit a triple.

Meritocracy becomes toxic when it divides the world into deserving “winners” and stupid, pathetic “losers,” and that’s where I think our culture often is these days.

Correcting attitudes become all the more important when we have winner-take-all markets.  One person makes a billion & the second makes nothing. Even if the winner was a hair “better,” not just a hair luckier or five seconds earlier, the discontinuity between relative merit and relative reward is well worth keeping in mind.

But suppose all market outcomes were fixed given people’s genetic endowments.  It would still be brute luck what genetic endowment you had.  And it would still be brute luck how your particular talents happened to fit your particular environment.  For example, how much would Michael Lewis’ particular endowments help him in modern Somalia, or 12^th century England?

If you think of Shaquille O’Neal as having been lucky, not just to be over 7 feet tall but to live in a society with millions of basketball fans, you’ll have a point in mind that applies far more generally.

So for me, realizing that successful people were often lucky, in the sense of Michael Lewis and the dinner conversation with the Salomon spouse, doesn’t do that much work, for three reasons.

First, I already knew it was true.

Second, I define luck broadly enough that it had to be true.

Third, I don’t subscribe to a theory of distributive desert that’s based on inherently deserving what you’ve earned.

Instead, for me the rationale for property rights and keeping tax rates at reasonable levels is just about incentives & their effects on behavior.  But admittedly we (including I) have intuitions about desert that are not entirely reducible to this.

2. What (if anything) is wrong with high-end inequality?

In the public economics literature, often the only reason for mitigating high-end inequality is the declining marginal utility.  You’d never reduce a rich person’s wealth by a dollar unless at least a penny, or some fraction of it, was successfully transferred to someone else.  This follows from the standard assumption that people only derive utility from own consumption.

Bob challenges this approach by emphasizing the importance of status and relative position, which are affected by relative consumption.  Plus, he posits socially costly expenditure cascades from the top on down.

I myself tend to agree with these points, but I want to note a few possible objections.

First, it’s often argued that all this is just “envy” and should be discounted.  This combines a descriptive claim about people who care about relative position, with a normative claim about envy’s unworthiness to be counted.

Second, recall the old phrase “keeping up with the Joneses.” Suppose that relative position matters more laterally, between peers, than it does vertically, or from the super-rich on down.  Then we might want to tax positional goods relative to non-positional goods, but with no particular reference to rich versus poor.

One definition of positional goods might be market consumption generally, as distinct from leisure. So we might want a high rate of consumption tax, as a kind of pollution tax on negative externalities, but it wouldn’t necessarily be progressive.

Third, what if high-end inequality has positive externalities as well as negative ones? An example might be, the market for luxury goods, including high-end healthcare, leads to technological advances that then become cheap to provide for everyone.  So why limit the analysis to negative externalities from high-end inequality?

Two upcoming panel appearances

In each of the next two weeks, I will be speaking (probably for about 15 minutes each time) on an international tax panel that is meeting in the NYC area.  In each case, I plan to post a version of my remarks here afterwards.

First, next Friday, October 28, NYU Law School will be hosting an event (as I've mentioned here previously) called Divergent Country Views of Base Erosion and Profit-Shifting.  Details available here.  I'll be moderating and commenting on a panel that meets from 8:15(!) to 9:45 am, discussing the European Commission's state aid cases.

At this session, I will not be just reprising my recent Tax Notes paper on the topic, which is available here.  For example, I will focus much more than I did in that paper on the relevance of "source" issues to the analysis.

Second, on Wednesday, November 2, from 6 to 8:30 pm, I'll be participating in a session sponsored by the New York City Bar Association (and held at the NYC Bar building, 42 West 44th Street), entitled Beyond Labels: Exploring the Revised Scope of the Final and Temporary Section 385 Debt-Equity Recharacterization Regulations.  Details are available here.

I'll be speaking towards the back end, maybe at 7:45 or so.  As we will already, by then, have extensively discussed the nuts-and-bolts aspects of the topic, I'll offer a more big-picture perspective on three issues: the use of regulations instead of legislation to address corporate inversions, issues around Treasury regulatory discretion and court challenges to regs generally, and the prospects for international tax reform that includes addressing earnings-stripping via the use of interest deductions.

Musical tidbit

I've started listening to Big Star's Complete Third on Spotify.  The first third of it is demos from the start of this famous and ill-fated project - stunningly beautiful solo acoustic performances by Alex Chilton of great songs that generally ended up on the album.

Paper on the Treasury White Paper and EU state aid posted on SSRN

With permission, I have now posted on SSRN my paper on the Treasury White Paper and the EU state aid cases, which appeared in Tax Notes and Tax Notes International on September 19 of this year. It's available here.

UPDATE: The piece was temporarily taken down by SSRN, because it requires permission from Tax Notes, which I have.  I've communicated this (with relevant proof) to SSRN, and I am hoping it will be back up soon.

FURTHER UPDATE: Ah, we're back in business.  I thnk it's the same link as previously, but just to be sure, use this.

A partly supply-side theory of Trumpism

A recent Vox column by Dylan Matthews exposes the fatuity, or at least inaccuracy, of widespread assumptions that Trump voters, however unworthy their ranting idol, have economic grievances that reflect their "living on the edges of the economy" and having been "left behind."  To the contrary, their "median household income [is] $72,000, a fair bit higher than the $62,000 median household income for non-Hispanic whites in America .... Trump support [is] correlated with higher, not lower, income, both among the population as a whole and among white people. Trump supporters were less likely to be unemployed or to have dropped out of the labor force. Areas with more manufacturing, or higher exposure to imports from China, were less likely to think favorably of Trump."

Instead, support for Trump correlates with racial resentment, which, in turn, I believe, often correlates with living in all-white communities where one doesn't actually meet or get to know African-Americans or non-white immigrants..

It's widely recognized that Trumpism also reflects people's living in a bubble where the only media or other information sources that they get to see are those confirming their ideological biases.  Needless to say, this phenomenon is not limited to Trump supporters, and it's always unhealthy even if not always this toxic.

In this regard, however, I thought of two things that might usefully be put together.  First, a shout-out to Cass Sunstein, who wrote about the self-selected media bubble phenomenon as early as 2002 in his book Republic.com (the revised or "2.0" edition of which is available here).

Second, I thought of something I heard about many years ago, when the post-Yugoslavian civil war between Serbs and Croats was at its height.  I heard it said (via someone who grew up in Yugoslavia during the Tito era) that, for many years, intense Serb versus Croat ethnic identification was very much on the wane, at least in areas where members of both groups lived. It really seemed to be something from the past. There was intermarriage, people didn't strongly identify with their groups or stay away from the other one, etcetera.  But then, of course, when the larger state broke up, ambitious Serb and Croat politicians deliberately took the opportunity to stir up ethnic hatred and violence as a way of strengthening their own political positions.

The fact that this proved so successful showed that people still remembered enough of those old hatreds to be capable of sinking back into them. The haters on both sides are fully morally responsible for what they became. But it was also an act of insidious political entrepreneurship by the leaders who chose to stir up the hatred, because they saw that it would be to their advantage.

I think there is something similar going on with Trumpism.  Media entrepreneurs, from Fox News to the further-out fringes, have seen that they could build their audiences by exciting racial and ethnic hatred. Their consumers evidently decided to embrace this, but also were probably changed by exposure to it.  So one can see this in part as a John Kenneth Galbraith-type manipulative advertising story, in which the entrepreneurs take an active role in shaping people's preferences, albeit requiring those people willingly to take the first, second, and third steps themselves.

This is a point that one could add to Sunstein's Republic.com analysis.  Not only do people retreat into like-minded media bubbles, thus entirely separating their realities from each others' realities, but there's an entrepreneurial environment in which extremism and hatred "sell."  Thus, powerful market incentives invite creating the sort of monstrous dysfunctionality that we see rampant in the 2016 presidential campaign.

I have no particular proposal to make about all this, but it might help one better to understand Trumpism, and in particular the nihilistic rage and hatred that seems to have consumed people who often aren't doing all that terribly.

Sleep of the innocent

Some of us are lucky enough not to know anything about our toxic presidential election.

NYU Colloquium on High-End Inequality - starting next Monday (October 24)!

Long-planned but finally approaching, our half-semester NYU Law School Colloquium on High-End Inequality is finally starting next Monday.  Robert Frank of Cornell University and I will be the co-convenors.  Sessions will meet at the main NYU Law School building, Vanderbilt Hall (40 Washington Square South) from 4:10 to 6 pm.  A small group will go to dinner after each session; those who wish to go to a particular dinner (subject to space availability) should get in touch with us.

The sessions are open to the public.  Papers should shortly become available online, but in any event we'll be sending them out in weekly emails to all who ask to be put on the email distribution list.

The schedule is as follows:

October 24 – Robert Frank, Cornell University. 5 short pieces: (1) Why Has Inequality Been Growing?, (2)Why Luck Matters More Than You Might Think, (3) Does Inequality Matter?, (4) Why have weddings and houses gotten so ridiculously expensive? Blame inequality, and (5) The Progressive Consumption Tax.  Guest commentator: K. Anthony Appiah, NYU Philosophy Department.

October 31 – Kate Pickett, Department of Health Sciences, University of York.  (1) Income Inequality and Health: A Causal Review; (2) The Enemy Between Us: The Psychological and Social Costs of Inequality (both co-authored by Richard Wilkinson).

November 7 – Ilyana Kuziemko, Princeton University Economics Department.  Support for Redistribution in an Age of Rising Inequality: New Stylized Facts and Some Tentative Explanations (coauthored by Vivekinan Ashok and Ebonya Washington).

November 14 – Alan Viard, American Enterprise Institute.  Progressive Consumption Taxation: The X Tax Revisited (chapters 1-3) (coauthored by Robert Carroll)

November 21 – Daniel Shaviro, NYU Law School.  The Mapmaker’s Dilemma in Evaluating High-End Inequality.  Guest commentator: Liam Murphy, NYU Law School.

November 28 – Adair Morse, Haas School of Business, University of California at Berkeley.  Trickle-Down Consumption (coauthored by Marianne Bertrand).

December 5 – Daniel Markovits, Yale Law School.  Meritocracy and Its Discontents.

Where we are as a country

People at Trump rallies are openly calling for the sexual assault accusers to be jailed - as well as for Election Day violence and voter intimidation, the murder of Hillary Clinton if she wins (they might settle for jailing her if she loses), and violent revolution if she wins. Trump has also been very clear that "unfair" reporting alone is enough to render the outcome "rigged." So absent pro-Trump advance censorship he will reject the voters' verdict.

Global Tax Conference at NYU

On Friday, October 28, from 8 am to 4:30, we'll be hosting a conference at NYU Law School (in Vanderbilt Hall, room 210) entitled Divergent Country Views of Base Erosion and Profit-Shifting. This is a follow-up to the June 1 conference on OECD-BEPS that we co-sponsored in Amsterdam with that event's hosts (and co-sponsors this time as well), the Amsterdam Centre for Tax Law.  More information, including re. how to register, is available here.

The conference will feature divergent views - the title is definitely right about that - from academics, practitioners, and business people from the U.S., the EU, and Brazil, regarding OECD-BEPS, the EU state aid cases, country-by-country reporting, and less-developed-countries' issues with treaties.  Indeed, here is the schedule:

8:15 AM – 9:45 AM:  Panel 1:  European Commission State Aid Cases

• Dan Shaviro (NYU Law) (moderator)

• Itai Grinberg (Georgetown Law Center)

• Hein Vermeulen (University of Amsterdam)

• Dennis Webber (University of Amsterdam)

9:45 AM – 10:00 AM:  Coffee Break

10:00 – 11:30 AM:  Panel 2: Predictive Value of BEPS Country-by-Country Reports

• Joshua Blank (NYU Law) (moderator)

• Steve Wrappe (KPMG)

• David Ernick (PwC)

• Reena Bhatt (Geller & Company)

11:30 AM – 1:00 PM:  Lunch Break

 Afternoon Session (Vanderbilt Hall Room 204)

1:00 PM – 2:30 PM:  Panel 3: Less Developed Countries and Tax Treaties

• Rick Reinhold (Willkie Farr & Gallagher) (moderator)

• Steve Dean (Brooklyn Law School)

• Lily Faulhaber (Georgetown Law Center)

• Michael Lennard (UN – by video)

2:30 PM – 3:00 PM: Coffee Break

3:00 PM – 4:30 PM Panel 4: US Compliance with the OECD BEPS Project

• Mitchell Kane (NYU Law) (moderator)

• Stephen Shay (Harvard Law School)

• Dennis Webber (University of Amsterdam)

• Gustavo Vettori (Fundação Getúlio Vargas)

4:30 PM:  Concluding Remarks

Nobel Laureate message for dark times

Everybody's in despair / Every girl and boy / But when Quinn the Eskimo gets here / Everybody's gonna jump for joy.

Strange days indeed

It's hard to stay focused or relaxed, what with all the insane political news exploding almost hourly.  Such a giant attention and emotion sink.

But the most satisfying things I did today, when I was able to ignore the Internet for periods here and there, were (1) figuring out how to explain a couple of international tax rules more clearly (I hope) to my class, (2) improving the opening to my E.M. Forster chapter, although I may be unable to do very much more on it for the next 2 months, and (3) quasi-following a Thai recipe for sautéed fish (flounder came out okay although the recipe rightly called for something meatier).

I will also be putting myself on Twitter at some point soon, although  more to link to this blog (and possibly news items in my field) than for anything else.  I don't plan to tweet away about the likes of presidential debates or even tax reform panels.

Video from Tax and Human Rights Conference

Video has now been posted of the sessions at the Tax and Human Rights Conference that took place at NYU on Friday, September 23.  The video from my panel is here, so you can see my talk, once I've been introduced, right at the start, and ending at about 15 minutes into the video.  Unfortunately, the powerpoint slides that I was using can't really be seen in the video, but they're separately available here.

State-level earned income tax credits

I was the discussant at the very last panel of the NYU-UCLA Tax Policy Conference.  This had the disadvantage of putting me in front of a half-empty room, as many of the participants had already fled for the airport or the LA freeways in advance of maximum rush-hour gridlock.  For this reason, I never like going last at a conference, although by definition it's bound to happen to somebody.

The upside was that at least I got to comment on an interesting paper: "Upward Mobility and State-Level EITCs," by Kim Rueben, Frank Sammartino, and Kirk Stark.  They discuss the different by which various states supplement or otherwise add to the federal income tax system's earned income tax credit for low-earners.

There are a number of different ways in which a given state can supplement the EITC. For example, a number of states simply have a straight "piggyback," adding a specified percentage to the amount provided by the federal EITC. Other states choose to target the state-level EITCs in particular fashions, e.g., by focusing on particular populations.  Thus, the District of Columbia expands the EITC for childless individuals.  California enhances it for the lowest-wage workers who are eligible for the federal EITC, and phases it out even while the federal EITC is still expanding for people in the upper regions of the federal phase-in.

Among the most interesting issues raised by the Rueben-Sammartino-Stark paper, and by the provisions that they discuss, are those pertaining to (1) why have an EITC and how it might optimally be designed in the single-government case, (2) fiscal federalism and the state versus federal question, and (3) interactions between the federal and state EITCs, and how they might be viewed from the federal perspective.  E.g., to what extent are the states expanding versus modifying versus contradicting / offsetting the policy aims of the federal EITC.

The slides for my comments, which offer some preliminary reflections on these questions, can be found here.

Putting the comment in my last post a bit less flippantly

From Josh Marshall:

"I don't think we can discuss this debate as citizens, take stock of it as a country, without noting that this is certainly the first time one candidate has openly threatened to jail the other candidate. Trump said openly that he would instruct the Justice Department to open a new investigation of Clinton and that he'd make sure it ended with her imprisonment. That's something we expect in kleptocracies and thin democracies where electoral defeat can mean exile, imprisonment, or death.

"Such a ferocious claim, one that puts our whole constitutional order on its head, is not something that can be easily undone. That's the ranting threat of a would-be strongman and dictator. The threat itself is like a bell that can't be un-rung. Through the course of what was often an ugly debate, I was thinking a lot of the destructiveness of this entire campaign, virtually all of which stems from Trump's transgressive, norm-demolishing behavior. It's a topic ... the country is going to need to wrestle with. None of this is going to disappear after November 8th. These are slashing wounds to the country's political fabric that will at best leave tremendous scar tissue we'll still see for decades."

UPDATE: Will Wilkinson of the libertarian Niskanen Center agrees.

It's just my opinion, but ...

... it's probably not a great answer to: "It's just awfully good that someone with the temperament of Donald Trump is not in charge of the law in our country," to say: "Because you'd be in jail."

NYU-UCLA Tax Policy Symposium

This Friday, I will be appearing at the Sixth Annual NYU/UCLA Tax Policy Symposium, the schedule for which you can find here.

This year's topic is "Tax Policy and Upward Mobility."  I'll be the moderator and discussant for a paper by Kim Rueben, Frank Sammartino, and Kirk Stark, entitled "Upward Mobility and State-Level EITCs: Evaluating California's Earned Income Tax Credit."

I've spent most of today preparing my slides, at the risk of putting myself a bit behind the 8-ball with regard to other upcoming responsibilities (all that TV stuff took time that I didn't entirely have, but at least I didn't accept everything that was on offer).

I'll post the slides here early next week.  I think I've found a couple of interesting things to discuss, albeit cursorily for the purposes of 10-15 minute verbal comments, and I may flesh them out a  bit later on if, as I seem to recall, I'm expected, or at least encouraged (or, short of that, at least permitted), to write them up for purposes of the Tax Law Review symposium issue that will eventually appear, containing most or all of the conference papers.

Jack Mitnick for president?

Trump campaign surrogates have been claiming that their snarling hero is a tax "genius" who has used the tax laws "brilliantly."  Trump himself claims to understand the tax laws "better than almost anyone," which ostensibly shows what a great president he would be.

But Jack Mitnick, the semi-retired 80-year-old accountant who actually prepared the 1995 tax return with the $900 million loss, reports that Trump' played no role whatsoever in preparing his own tax returns.  Indeed, as paraphrased by the Times, Mitnick reports that Trump, unlike his own father, "lacked a sophisticated understanding of the tax code, and ... rarely showed any interest in the details behind various tax strategies."  All he knew was that the people working for him "could use the tax code to protect him."

The one thing Trump apparently did do was show up annually, with his then-wife Ivana, to sign the tax forms, but even then "it was almost always Ivana who asked more questions."

The Times also quotes Mitnick as saying that Trump's "use of net operating losses was no different from that of his other wealthy clients. 'This may have had a couple extra digits compared to someone else's operation, but they all benefited in the same way.'"

Genius in the form of generating losses with "a couple extra digits" is something, perhaps, but not quite the same as what we have been hearing about from the Trump campaign.

Donald Trump and the passive loss rules

Back in 1986, when I was a Legislation Attorney at the Joint Committee on Taxation, I was a member of the staff team that worked on drafting and designing the passive loss rules, which famously dinged tax shelters in general, including those that used real estate investments.  (Shelters were more general than this, however - e.g., cattle feeding shelters were another big favorite, and I remember one which involved marketing master cassette videotapes of Vincent Price narrating passages from the Bible.)

So it's been interesting - a trip down memory lane and all that - to see the passive loss rules resurfacing in re. Trump's taxes.  But this has actually followed two distinct channels.  First, however, a bit of background.

The passive loss rules' basic aim, in very broad overview, is as follows.  At the time of enactment, people with sources of high taxable income that could not directly be tax-massaged very much (e.g., salaried professionals such as doctors, dentists, and lawyers) were buying investments that were designed to generate large tax losses, without commensurate economic losses.  These losses were used to offset the positive taxable income, hence "sheltering" it.  So the rules said: If you invest in a passive activity, i.e., one in which you do not "materially participate" or that is a rental activity (since those often require little work), you generally can't deduct any resulting passive losses against your nonpassive income.  This appears to have been quite effective in shutting down the 1980s-era tax shelter industry, although as usual there are empirical questions about what caused what.

In 1993, or six years after I had left the JCT and started my academic career,Congress enacted a special exception to the passive loss rules, permitting people who qualified as real estate professionals to avoid having their rental real estate activities treated as passive. This meant that their tax losses from these activities could indeed be deducted against other positive income.

Anyway, onto the dual Trump connection.  First, yesterday's NYT had an editorial decrying Trump's tax avoidance, and singling out the exception to the passive loss rules for real estate professionals cas case in point. The Times rightly notes that this would have permitted Trump to deduct tax losses from rental real estate against "earnings from The Apprentice and money made from selling steaks and neckties."

Fair enough. But I'll admit that I never considered the passive loss rules' impact on that type of circumstance as being really at its core, which (as noted above) had more to do with the mass-marketed tax shelter industry of that era.

Second, someone sent me the tape and transcipt of a 1991 Donald Trump CSPAN appearance, as a witness at a House hearing about real estate policy, available here.  (You have to scroll down a bit for Trump's testimony.) Interesting stuff.

An initial point is that reading this transcript increases my estimate of the probability that the Trump of today is suffering from age-related dementia.  (This is actually something that I have been wondering about.)  He is more coherent and focused - able to speak in complete sentences and pursue a single line of thought - in the 1991 tape & transcript than he appears to be today.  But what he has to say about tax policy is rather amusing.

In particular, he denounces the 1986 Tax Reform Act, and the passive activity rules in particular, as a horrible disaster for real estate. Given his line of business, he is understandably upset that the passive loss rules took passive investors out of the market, thereby (he asserts) depressing real estate prices and activity.

It does, however, feature a comical misunderstanding by Trump of how market economies operate.  He says we are now in a Soviet-style world where there are no "incentives" to invest.

But what he means by no "incentives" to invest is that the only reason to invest would be expecting an actual (and pre-tax) profit.  So, for Trump in 1991, "Soviet-style" means market-based, whereas the approach that's actually closer to being Soviet-style - having the government, through tax policy, decide where investment capital should go - is supposedly its opposite.

At least Trump in 1991 sufficiently had the courage of his convictions to say that tax rates should be much higher than they were after 1986 - not, mind you, to raise revenue or in pursuit of tax fairness, but simply to make the tax incentives (if delivered in the form of deductions) more powerful than they would otherwise be.

I know of no other case in which someone called for higher tax rates just to make tax incentives more powerful.  I recall from 1986 that the charitable community was very aware that lower tax rates would be expected to reduce charitable giving, all else equal, but the use they made of this was more to argue that something else should be done for them than to say that rates should stay high just for their convenience.

Needless to say, lower tax rates don't have to imply weaker tax incentives for particular activities.  E.g., Congress could provide percentage credits in lieu of deductions.  An example would be combining (a) reduction of the top tax rate from 50% to 28% with (b) conversion of charitable deductions into 50% credits, so that if you gave $1 to charity you got a 50-cent credit against your overall tax liability.

TV appearances, the day after

A Reuters story on which I briefly speak about Trump's $900 million loss is available here.

From an NBC Nightly News bit, I'm quoted in the article here. A clip that appeared on-air at about 6:35, on which I'm briefly on-screen, can be found here.

My MSNBC segment with Lawrence O'Donnell and David Cay Johnston can be viewed here . It's 12:52 long, and I speak briefly at about 9:35 and 12:20. One small clean-up bit: on the first soundbite, I note that Trump's extremely low "salary" on the leaked tax return might be related to avoiding the Social Security and Medicare payroll tax.  I was thinking of this in terms of a general practice of paying himself as little "salary" as possible. O'Donnell then makes a comment which might be read as implying that Trump wouldn't have been subject to the payroll tax on anything else from the NYT leak (e.g., Schedule C income), which I did not mean to suggest but couldn't address in the hurly-burly of things.

And, not a moment too soon, it's back to regular day life (teaching an International Tax class, working on the E.M. Forster chapter in my literature book, etc.).

TV night

I might be in a brief clip tonight on the NBC Nightly News, on a story that might start at 6:35 or so, and am also apparently going to be live on MSNBC's 10 pm show tonight with Lawrence O'Donnell (the other guest on this segment will be David Cay Johnston).

Mark Cuban weighs in

Another perspective on Trump's $900 million loss, from Mark Cuban:

"Cuban said voters shouldn’t rush to the conclusion that Trump’s loss is simply the result of failed casinos.

“'If Donald is taking tax shortcuts, maybe he bought an insurance company instead of doing something in real estate,' Cuban speculated, 'and he took a huge tax write-off to offset income.'

“'We’ve all heard about tax scams and tax shelters, right? What we don’t know is whether or not this is a tax shelter,' he added. 'This could be something where he got involved in currencies or insurance tax shelters, there a thousand and one tax shelters that were very aggressive and were being offered at the time.'

"Cuban recalled that in the '90s, 'there were accounting companies, accounting agencies, and tax shelter companies coming to me, offering me ways to offset my income so I didn’t have to pay taxes.'

“'We don’t know. And that’s the inherent problem,' he continued. 'There’s no transparency, and he is so ashamed of what he’s done, he’s not willing to speak up and explain to us what happened.'”

Cuban is right that these sorts of things were around in the 1990s, and were generally on offer to people such as himself and Trump. He also is right that the NYT reveal doesn't in any way rule out this being the cause.  And he's right that a shelter of those kinds certainly could have been used to create a $900 million loss.  For that matter, they could have been used to create a $900 billion loss. One of their core features was to use circular cash flows to create fake losses.  E.g., suppose I purport to pay you $X, and you purport to pay me $X, and I claim that my payment to you is currently deductible, while yours to me is not currently includable.  Then, since it's just a sham swap of offsetting notional amounts, we can make X as big as we like.

The reason I'd continue to assume that this is less likely than the real estate scenario is that the IRS did eventually get around to being fairly assertive in countering these scams, so it might not have worked. Plus, they were generally used to offset positive taxable income, not to set up huge NOLs that would be used in the future, probably for reasons centered on the hope that one wouldn't be audited (which becomes a bit tricky when one is claiming a $900 million loss).

Still, it's a possibility worth keeping in mind.

Three main takeaways from the Trump tax story: business, tax, and policymaking

An extra day's reflection helps me to see more clearly what are the three main takeaways from the NYT's Trump tax story.  Nothing new here, just a matter of suggesting the right emphasis.

1) Business - Not many people could lose $900 million like Trump did.  But we've already seen his management skills at work in the presidential campaign.  Feckless, erratic, and undisciplined are not the qualities one would want in either a business person or a president, and the fruits here are plain for all to see.

2) Tax - Here I think the big story is that, while it's likely that someone lost $900 million, it probably wasn't Trump.  The question of what happened to debts that he presumably escaped in bankruptcy looms over the loss claim here.  Now it's possible that debt cancellation later on, while not creating taxable income because the discharge occurred in bankruptcy or when he was insolvent, reduced the NOLs.  This is consistent with the known facts, which solely relate to 1995, but we can pretty much rule it out because then the Trump campaign could have pointed out that he didn't spend all the years since using NOLs for someone else's losses against his own income.

So it's plausible that he avoided reduction of the NOLs, by either a more straightforward method or a more esoteric one.  The straightforward method would involve electing, under Internal Revenue Code section 108(b)(5), to reduce the basis of depreciable property before taking a hit to his NOLs.  But the problem with this is that it would in effect reduce the NOLs, albeit slowly, via the loss of depreciation deductions over time.  Even for real property, which gets depreciated slowly, this could add up after a while.  So the more advanced method, involving dubious tax planning, would be to try to park the debt somewhere where it wasn't formally forgiven but in actual economic effect was, thereby getting to continue deducting other people's losses.

Let's try to put this more saliently. It's all very well (to tax experts if not the general public) to pay no tax for years because one's loss years plus one's gain years didn't actually add up to a net gain.  But it's not so innocuous if, in effect, he was deducting other people's losses against his income.

3) Policymaking - If that's what he did, does that, as the Trump campaign would have it. show that he's a "genius" and knows the Code better than anyone, hence can fix it?

Anyone who actually thinks that Trump knows anything about the federal income tax, please raise your hand.  This is not a man who can read more than two sentences in a row, or who appears to know much of anything about anything substantive.  The last time I checked, the best tax experts get paid a lot of money because they actually can read, think, and analyze things.  Whatever his skill set, it doesn't appear to include any of that.  But also, as many have pointed out, his latest tax plan, possibly the most detailed policy proposal that he has issued in any area (although he is trying to have it both ways on whether all business would get a 15% rate), does nothing whatsoever to eliminate any of the games that he (presumably through his advisors) played.  Instead, all it does is throw further giant tax cuts at people like himself.

Coupla Trump tax follow-ups

The Trump campaign said he "has a fiduciary responsibility to his business, his family and his employees to pay no more tax than legally required."  While that's ludicrous - one might as well say he has a fiduciary responsibility to all of them not to over-spend on personal helicopter rides - I would agree that he didn't have a responsibility of any kind to pay more than was legally required.  But as I discuss in this article, the legal defensibility of one's positions doesn't put an end to all ethical issues, especially if one is planning aggressively in "unintended" ways, relying on legal uncertainty and the audit lottery, etc.  (Yes, you can be audited every year and yet be playing the "audit lottery" - the relevant question is whether the auditors detect a questionable tax position with sufficient acuity to subject it to proper challenge based on a decent understanding of the underlying facts.)

Still, I think the bigger takeaway from this is that he's a bad businessman (other than when selling his name as a brand), and that he wanted to try to hide all this from public view, rather than getting it out early and moving on.

The revelation of likely use of NOLs to zero out tax liability helps one to refine the questions associated with the Trump Foundation diversion-of-income scam.  To the extent he still had NOLs, they would have sheltered the diverted payments, but this might have had the effect of using up the NOLs faster (depending on what was left, how fast they were expiring, his ability to "freshen them up," as it's called, etc.).

Insofar as he would have had offsetting income inclusions and charitable deductions - seemingly true for some but not all of the Trump Foundation stuff - if he was getting his income to zero anyway then he wouldn't have been able to claim the charitable deductions due to the AGI limit (30% for gifts to private foundations, 50% for most other cash gifts).  But there is also a charitable deductions carryover - generally 5 years.  Use of the carryover is itself, of course, subject to the annual percentage-of-AGI limits.

Might there be a scenario in which Trump's possibly illegal use of the Trump Foundation as a diversion of income piggybank might actually have been bad tax planning?  Not impossible, but one would need particular numbers to make this scenario work out.  Still, let's give it a try, if only for the fun (?) of it.  Say that in Year X Trump has $1 million of expiring NOLs.  He ends up with zero taxable income due to diversion of $1 million to the Foundation, so the NOLs expire unused.  Say also that the Trump Foundation uses the $1 million in a way that would have given him a charitable deduction if done directly.

Now in the non-diversion counterfactual, he has $1 million of income pre-NOLs, zero post-NOLs, and a $1 million charitable deduction that he can't use.  But he also has a $1 million charitable contributions carryforward that he can use to that value over the next 5 years (albeit, subject to the 30 percent limit annually if it would have gone to the Foundation, 50% if it would have gone directly to the relevant charity).

This is similar to "freshening up" NOLs, although the charitable contributions carryforward is less valuable than an NOL (shorter duration, AGI limit).  We know far too little about Trump's tax returns to know if this scenario would ever have applied, but he certainly seems dumb enough (and poorly advised enough, since he doesn't seem to want good but independent people working for him, plus you can't count on him to pay you) that one shouldn't rule it out.

A broader point, though, is that just because he uses an illegal scam doesn't mean it's actually helping him.  It's just the way he operates.

Trump's $900 million tax loss

People who are quoted in a Politico article say pretty much what I would have:

"Tax experts said there is nothing surprising about the writeoffs Trump may have used to avoid paying federal income taxes for nearly two decades, and that the bigger question is what generated the large losses he reported.

"Losses like the $916 million that Times said Trump claimed in 1995 could at that time be used to offset taxes in the three prior tax years and 15 years going forward. But it’s unknown at this point exactly how Trump accrued those losses, which he claimed during a ruinous financial time for his businesses, and how legitimate they were.

"Nobody thinks that’s wrong,” Howard Abrams, director of tax programs at the University of San Diego School of Law, said of the tax provisions Trump appears to have used. “The question is what generated the $900 million loss.”

“The billion-dollar NOL [net operating loss] isn't evidence of shady tax behavior per se; in fact, I'm sure the IRS audited it,” Alan Cole, an economist at the conservative-leaning Tax Foundation tweeted. “It's evidence of bad business.”

Joe Thorndike, director of the Tax History Project at Tax Analysts, said: “Obviously the optics are less than ideal from a political standpoint. But on its face, using losses to offset gains is routine and uncontroversial. In fact, it's part of what makes the income tax work as well as it does.” 

The tax advantages that the real estate industry can exploit are well known to tax experts. For instance, Abrams said, while commercial real estate historically increases in value, owners can take deductions as if it were depreciating.

“It seems that Trump may have been part of Mitt Romney's infamous ‘47 percent,’” Thorndike said. “But like many other nonpayers, his status could have been a function of deliberate tax policy decisions, not creative tax avoidance or sneaky ‘loopholes.’”

"Abrams agreed. “If the deductions are overly favorable, they need to change the law,” he said."

In sum, a few main points. Horrid business decisions (since those were good times economically) generated large economic losses.  Favorable tax rules, such as depreciation deductions for property that is actually appreciating economically (and that one can then borrow against, generating interest deductions) could have made the tax losses larger than the economic losses. One thing I do wonder about is why Trump's bankruptcies didn't require reduction of "tax attributes" such as net operating losses. E.g., if you wipe out a $100 million debt due to bankruptcy, you escape having $100 million in "cancellation of indebtedness income" in exchange for having tax attributes such as NOLs reduced by that amount. (But there are tricks that taxpayers can play to minimize that.)

The reason why using NOLs is not inherently objectionable can be explained as follows. Say Trump, being an incompetent businessman but good at "branding," loses $900 million when he actually tries to run businesses, but then makes $900 million by licensing his name. Over time his net income is actually zero.  So taxing him the same (i.e., zero) as his net equal in business savvy, the guy who makes exactly zero each year, is not inherently inappropriate.

That said, losing so much money that you don't have to pay tax for a long while upon gradually recovering it doesn't exactly show that you're "smart."  And it's clearer than ever that, without daddy's original stake, this guy would likely be washing dishes somewhere, and wishing he had saved something for his retirement.