Thursday, April 28, 2016

Deferred cat exchange with a famous neighbor

I won't give the name, because that would be creepy, but there's a famous person living on our block - famous enough to have drawn, not just tourists,but also paparazzi.  Let's just call this famous person FP.

I see FP occasionally on the street, but have never said anything because it would be invasive and probably unwanted.  One thing about New Yorkers - we generally let famous people be.  But once, close to 10 years ago, our cat Buddy, who was an extraordinarily gifted escape artist in his youth, got out our backdoor, went over the fence, and disappeared for almost a week.

I finally saw him, from several backyards over, sitting on FP's balcony.  He started to meow at me, perhaps ready for his excellent adventure to end.

One of the mysteries was how he had gotten to this balcony.  It was on the second floor, and there was no obvious access, even for a cat (e.g., no steps or overhanging tree).

FP was away (it was NYC summer, after all).  But with help from a neighbor we were able to reach FP's "people" and get Buddy back.  He looked just fine, by the way - neither scrawny nor ragged nor bloody, despite all the hazards that a cat may face in the urban outdoors.  But Buddy is calm and resourceful - I would even say rational - as well as willing to enlist human help (especially that of humans with food).

OK, let's go forward a few years.  This morning, I found this individual, pressed right up against our front door.  (Brown tabby like Buddy, but long-haired and female.)  The picture may not do her full justice.  She was cowering a bit, but she didn't act especially afraid of me (and liked being petted).  When we opened the door, she went right in.  We gave her food, water, and a litter box, while isolating her from our already numerous cats.

She had a collar with name tag and phone number. The address that came up on a Google search of the number is 0.7 miles away.  So we were wondering how she got to our place.  But no less than Buddy after his adventure, she was sleek, clean, and seemed fine.

When we got through to the phone number that was listed on her collar, it eventually turned out to be one of FP's people,   That solved one mystery: she had apparently just gone down the street from FP's house, rather than covering 7/10 of a mile across lower Manhattan.  Said person promptly came and reclaimed the cat on FP's behalf, so the story has a happy ending for everyone.  (Not that we mightn't have considered keeping her if unable to find where she came from.)

If I were teaching Tax I (Individual Income Taxation) this semester, I suppose I would ask the students: Might this (at least, with a few harmless tweaks to the actual facts) count as a deferred like-kind exchange under Internal Revenue Code section 1031?  Let's see:

Exchange? Obviously no - we each just got our own cats back.  But here's where we can change the facts, so as to make the rest of the analysis potentially relevant. Suppose that it had been an actual and intended trade, in which FP gave us Buddy some years ago, in exchange for our furnishing this individual to FP earlier today.  After all, they say possession is 9/10 of the law, and each of us had physical custody of the other's cat, however briefly.  So let's just overlook this point, even though it's negatively dispositive, and do the rest of the analysis.

Like kind?  Yes.  They're even both tabbies, albeit long-hair versus short-hair.  But I think this requirement would still be met, as between two house pets, even if one of them were an octopus (which apparently make interesting companions, at least if you can care for them properly). See Code section 1033, which provides that "involuntary conversions" of property are tax-free if the "before" and "after" properties are "similar or related in service or use."  This is generally viewed as a narrower standard than like-kind under section 1031, so the fact that both are pets should do it under section 1031 as well.  (And let's suppose that we actually held the girl as a pet, as we would have been willing to do.)

While section 1031(e) states that "livestock of different sexes are not property of a like kind,"  I'd give a "will" opinion to the effect that cats are not livestock.  Dictionary.com defines livestock as, among other things, "useful animals," and cats - despite their mousing abilities, which they generally will deploy free of charge - appear to glory in not being "useful."

Property? Well, it's said that you can never really own a cat (it's more like the reverse).  But sometimes they let us pretend otherwise.

Held for productive use in a trade or business?  If you ever try to make "productive use" of a cat, good luck with that, and you have my sympathies.  As an aside, Key and Peele just completed a movie in which they co-star with a kitten, and apparently - even with multiple actors to play the one role - they found it almost as challenging as the Coen brothers did, when they made Inside Llewyn Davis.  (There's a story about this somewhere on the Internet - one of the Coens says they swore, never again.)

Held for investment?  As it happens, no, although at least here (for a fertile member of a show-worthy breed) we'd be in the realm of feasibility.

Within the 45-day identification period and the 180-day transfer period for deferred exchanges?  No, not even close.

Not looking good for the like-kind exchange, so it's certainly a relief that there was no taxable event here to begin with.  This spares us the valuation problem (cats are cheap, leading to low basis, but their owners may highly value them).

Wednesday, April 27, 2016

NYU Tax Policy Colloquium, week 13: Jane Gravelle's "Policy Options to Address Corporate Profit-Shifting: Carrots or Sticks?"

Yesterday Jane Gravelle presented the above paper, which she actually wrote for our session.  It addresses possible responses to profit-shifting by U.S. multinationals, either via carrots or sticks.  The carrots, or incentives to reduce profit-shifting, that it discusses are (1) lowering statutory tax rates, (2) patent or innovation box proposals, and (3) a lower tax rate on royalties earned abroad.  The sticks, or compulsory measures to reduce profit-shifting, that it discusses include (1) ending deferral and possibly cross-crediting, (2) restricting deferral and cross-crediting through interest allocation and foreign tax credit pooling, (3) expanding the scope of subpart F, (4) anti-inversion rules, and (5) formulary apportionment.

A starting point for the paper's analysis is a brief review of the empirical literature of the magnitude and U.S. tax rate elasticity of profit-shifting.  It concludes that the elasticity is fairly low.  Thus, for each dollar of tax revenues lost by lowering the U.S. corporate tax rate, only between one and nine cents would be recouped via reduced profit-shifting.

In principle, one might expect profit-shifting to be highly elastic.  After all, it's defined as finding ways to change the jurisdiction in which income is reported without actually changing anything significantly on the ground.  Nonetheless, a low elasticity measure makes intuitive sense given that profit-shifting typically permits the underlying income to be placed in a tax haven and taxed at zero percent.  Also, while  we don't have really have great models regarding how to think about profit-shifting, it's plausible that it requires incurring certain fixed costs, but then has low marginal costs for a while until somehow it reaches its limit.  (Not all of multinationals' profits end up in tax havens, after all.)  Is there a "cliff" at the end?  Or a range of rising marginal costs that suddenly grow steep?  (These could involve, e.g., audit risk and/or inconvenience from tying up internal funds.)  It's not entirely clear. However, low elasticity makes intuitive sense if, to some extent, companies are asking themselves - once the fixed costs have been incurred, and if there's a "cliff" that they've already reached - whether they'd rather pay tax at zero or at the U.S. rate.  From that standpoint, 25% might not be that much different than 35%, implying low elasticity.

This empirical point governs the paper's analysis of using carrots to reduce profit-shifting.  It suggests that one should not enact tax cuts for multinationals just so they'll do less profit-shifting, because there's still likely to be a large revenue loss.

The paper takes the view that the main problem associated with profit-shifting is revenue.  Once that's the framework, then of course one shouldn't lower tax rates in response to profit-shifting, unless we're above the peak of the Laffer curve, which the low elasticity estimates contradict.

I agree that there's a fallacy or non sequitur in arguments for lowering the corporate rate, etc., in response to profit-shifting.  But, if one is thinking about what international tax policy ought to look like, rather than about bad arguments that are  currently being made in Washington, the issue raised by profit-shifting isn't revenue - it's revenue in relation to deadweight loss (plus of course distribution issues, although these require thinking about corporate tax incidence).

Profit-shifting surely does waste some resources (both directly in terms of its enabling mechanisms, and indirectly via the operation of deferral), but the core point about it is that it enables multinationals to reduce their effective tax rates.  So the big question is what  their effective tax rates should be, and and also how one gets there (e.g., what role, if any, should deferral and foreign tax credits play).

There are tax neutrality reasons for wanting multinationals (both U.S. and foreign) to pay the same effective tax rate on their U.S. economic activity as purely domestic businesses.  On the other hand, there are tax elasticity arguments for allowing multinationals to pay a lower effective tax rate, since they have more of an option to leave.  I regard these issues as fundamentally intertwined with the question of how best to respond to profit-shifting (which might be seen as having, in recent years, overly lowered multinationals' effective tax rates, even if one would be fine with their doing so up to a lesser point).

Plus, as I've written about elsewhere, there are major problems with how the U.S. rules get to the effective tax rates that they end up imposing.  Not to expatiate at length on all that here, but I regard both deferral and foreign tax credits as terrible rules (compared to simply having a lower statutory tax rate for foreign source income) that happen to have the odd effect of somewhat offsetting each other.  Less "lockout" if you can claim foreign tax credits; less dampening of the incentive to avoid foreign tax liabilities if you will be claiming deferral indefinitely.

So there's clearly a broader conversation needed, beyond just revenue.  But the low elasticity estimates do indeed suggest that "carrots" shouldn't be adopted on revenue grounds in response to profit-shifting.

Measurement error?

I felt reasonably strong on the elliptical machine today (trying to work off yesterday's colloquium meals), but I hadn't thought my heartbeat was quite that low.

Friday, April 22, 2016

More on the implications for Social Security policy of workforce heterogeneity

In a recent blog post, I mentioned that Anne Alstott's new book had got me thinking about how the Social Security system ought to make greater use than it currently does of information that it collects regarding people's career earnings.  Specifically, low-earners are more likely than high-earners to suffer a significant "ability drop" as they enter their sixties - strengthening the case for empowering the former, relative to the latter, to choose an affordable earlier retirement without penalty.  Also, when prospective retirees are choosing between early and late retirement options, with annual benefits being adjusted accordingly, the fact that low-earners generally have lower remaining life expectancies than high-earners, at any given age, means that their "neutrality points" with regard to this choice may systematically differ.

Neil Irwin, in his Upshot column in today's New York Times, makes another point that is related to this theme.  As recent research by Raj Chetty et al has shown, the fact that high-earners have longer life expectancies than low-earners means that the former may often get higher internal rates of return from the system than the latter, even though the benefits formula has a progressive declining-match-rate feature.

This suggests that, in principle, if an insurer in a robust private market was offering life annuities to people who were near retirement age, and if it had ready access to information about career earnings, it would have reason to use this information in setting the relationship between premiums and annual benefits.  Otherwise, it would face adverse selection (i.e., high-earners would be able to masquerade as having average, rather than above-average, life expectancies).

The more I think about it (although I am not currently planning to write about it - too much else on my plate), the more it seems like career earnings-based heterogeneity in the workforce is an interesting frontier to think about in Social Security design, and not just on the standard redistributive ground that lifetime income may be relevant to need.

New Jotwell "jot"

I'm not sure when it will be out - June or earlier - but I have penned (or rather keyboarded) my latest annual mini-essay for Jotwell, or the "Journal of Things We Like (Lots)."

My prior three "jots" concerned a Benn Steil book on Bretton Woods, Piketty's Capital in the 21st Century, and work by Michael Knoll, Ruth Mason, Ryan Lirette, and Alan Viard concerning the legal concept of discrimination against interstate commerce.

This time around, I'll be discussing Branko Milanovic's new book, Global Inequality: A New Approach for the Age of Globalization.

Thursday, April 21, 2016

For those in the NYC area

My wife, Patricia Ludwig, will be showing some of her quilts at an artists' / artisans' spring sale in lower Manhattan, two weeks from today.

I was reminded of her quilts by my current process in working on a chapter, regarding Charles Dickens's A Christmas Carol, for my projected literature book.  At the moment, the chapter's components are, in effect, lying around in scraps, much like the pieces of her quilts before she assembles them.  I can only hope it comes together in the end even half as well.

Wednesday, April 20, 2016

New book by Anne Alstott on Social Security

Anne Alstott spoke at NYU Law School today regarding her new book, Social Security, A New Deal for Old Age: Toward a Progressive Retirement.

I haven't read it yet, but plan to.  It contains a detailed plan for modifying Social Security that, for many people, will be its chief takeaway - including, for example, a proposed floor on benefits and gradual removal of the "free" secondary earner benefit, grounded in discussion of economic and demographic changes over the last few decades.  These are certainly changes that I would view sympathetically.

But I'm a bit of a quirky reader - I tend to be more interested in useful conceptual tools that help me to advance my understanding than I am in reform specifics.  From that standpoint, here was my favorite takeaway from the talk.  The book proposes using information that the Social Security system has regarding one's career earnings (or at least covered earnings) through age 62 to affect the relationship between annual benefits under early, normal, and late retirement.  Or more specifically, rather than just having the three options of early, normal, and late like current Social Security, it proposes a gradient of annual benefits, for any given career earnings level, depending on which retirement year one chooses as between ages 62 and 76.  But onto the conceptual part.

Here are two things that are generally known among people who discuss Social Security policy.  First, while high-earners often have the types of jobs in which they can easily keep going long past age 65 or 70, this is not so true for low-earners, who often really are physically constrained in a new way, relative to their jobs' requirements, by the time they reach the early 60s.  Second, life expectancy is now significantly greater for high-earners than low-earners.

Both points show (as has been previously discussed by various analysts) that it is not so obvious that we should generally raise the Social Security retirement age, even if average life expectancy is increasing.  But why stop the analysis there.

The first point also shows that low-earners with inadequate retirement savings may need to choose early Social Security retirement even if it is actuarially bad for them.  The second point shows that, if one wants the tradeoff between early, normal, and late retirement to be actuarially neutral as to a given individual, one needs to distinguish between low-earners and high-earners.  They will have different neutrality points, so far as the tradeoff between annual benefit levels and the expected lifetime value of the retirement benefits is concerned.

Alstott proposes to have the decline in annual benefits, as one chooses between retirement at age 62 or 76 or somewhere in between, depend on career earnings.  Low-earners get a more favorable tradeoff, so that it's easier for them to retire early in both an absolute and relative sense.

Conceptually, I think of this as using Social Security's information about career earnings in a new way.  The fact that a given individual had low, rather than high, career earnings is evidence, statistically speaking, of both (a) a drop in current-period earnings "ability" when one reaches the early 60s, and (b) a low individual life expectancy, which is relevant to the actuarial neutrality point from retiring early versus late.  This is information that the system can use creatively in benefit design.

With rising income inequality producing (and/or being produced by) rising heterogeneity as between members of the workforce at the high end as compared to the low end, it's increasingly important to use such differentiating information.

"The Mapmaker's Dilemma in Evaluating High-End Inequality"

I have just submitted the above-titled paper to SSRN, and I believe it can be accessed here.

The abstract is as follows:

"The last thirty years have witnessed rising income and wealth concentration among the top 0.1 percent of the population, leading to intense political debate regarding how, if at all, policymakers should respond.  Often, this debate emphasizes the tools of public economics, and in particular optimal income taxation.  However, while these tools can help us in evaluating the issues raised by high-end inequality, their extreme reductionism – which, in other settings, often offers significant analytic payoffs – here proves to have serious drawbacks.  This paper addresses what we do and don’t learn from the optimal income tax literature regarding high-end inequality, and what other inputs might be needed to help one evaluate the relevant issues."

It will be appearing in volume 71 of the University of Miami Law Review.  Although a distinct and freestanding piece, it relates to my book in progress on high-end inequality and literature.  No discussion of literature within it, however - rather, it gives my view of why such approaches as mine in the literature book might be needed to supplement what we can learn from standard practice in the public economics and the optimal income tax literatures, with respect to evaluating the social consequences of rising high-end inequality.

NYU Tax Policy Colloquium, week 12: James Alm's and Jay Soled's "Whither the Tax Gap?"

Yesterday at the colloquium, James Alm and Jay Soled presented their paper, “Whither the Tax Gap?”

The paper argues that, contrary to widespread anxiety about the tax gap, there are actually several reasons for thinking it may shrink.  In particular:

1) The use of cash, which is much harder to trace than banking, card, and phone app payment transactions, is in decline.  Even if the use of cash doesn’t disappear, the convenience advantages of using other payment methods may reduce the net expected benefit from using it to facilitate evasion.

2) Computerization generally makes it easier for tax authorities to access data and process it readily.

3) The relative shift of employment from small to large businesses means that there will be more reporting and less opportunity for under-the-radar screen evasion.

To each of these observations, there are possibly counter-arguments.  For example, as to (1) and (2), perhaps it’s hard to predict which way technology will go, as between the “cops” and the “robbers.”  Bitcoin is an example of a non-cash technology that might end up having the same advantages as cash for would-be evaders.  As to (3), perhaps in some ways different types of problems may pertain to large businesses.

For example, suppose we define the tax gap as the difference between what was paid in taxes and what should have been paid.  Say that a large business does ten things on its tax return, each purporting to save $1 million of tax, and classified as tax avoidance rather than tax evasion, except that the legal permissibility of each is open to question.  Suppose, for example, that each of these items has an independent 40 percent chance of being upheld if the IRS understands and fully reviews.  (Suppose further for simplicity, albeit perhaps na├»vely, that this 40 percent probability is truly a frequentist one, rather than just expressing someone’s subjective probability.)

Then, on average, the “true” tax gap as to this company is an expected $6 million.  To be sure, under standard measuring techniques, none of this would be included in the tax gap (nor, perhaps, could it be).  But it would fit within the broad conceptual definition that I gave above.  And it might be viewed as indicating that the nature of enforcement problems had merely changed, rather than necessarily easing.

Still, there's something to be said both for a thought-provoking against-the-grain prediction, and (if the prediction proves correct) for lessening outright fraud as an enforcement problem.

Tax policy "debate" at yesterday"s NYU-KPMG Tax Policy Lecture

Yesterday at NYU Law School, I participated in a “debate” with audience voting on alternative propositions at the annual NYU-KPMG Tax Lecture.  Other panelists were Bob Stack from Treasury, Michael Plowgian, David Rosenbloom, and Paul Oosterhuis, plus Willard Taylor was the moderator.  The debate propositions were preceded by a talk by Oosterhuis and Rosenbloom on the Treasury’s newly issued proposed regulations under section 385, which provide that, in certain cases when one member of an affiliated group distributes what’s ostensibly a debt instrument to another member of the group, the instrument is classified as equity, rather than as debt.  The point is to disallow interest deductions by U.S. companies (owned by foreign companies) that might otherwise serve to strip profits out of the U.S. tax base – not limited to companies that have recently inverted.

One point that emerged from the talk was that, in principle, it might have been better for the Treasury simply to deny interest deductions in these cases, rather than reclassifying the instruments as equity (which potentially has broader implications, not necessarily within the purpose being served).  But the fact that the Treasury was acting under section 385, which deals with debt versus equity classification rather than with the allowance of interest deductions, presumably made this necessary.

Anywhere, here are the debate propositions, followed by approximations of what I tried to say.

1) Regulations proposed 2 weeks ago under section 385 would treat the distribution of a note to a related foreign person (and similar transactions) as equity, disallowing any deduction for interest.  Is this a good idea?

Since the moment the new regulations came out, I have been expecting the net balance of public commentary to be heavily slanted against them.  And while I found the Oosterhuis and Rosenbloom comments at the session to be thoughtful and fair, I am still expecting this.

Both Steve Shay of Harvard Law School and Steve Rosenthal of the Urban-Brookings Tax Policy Center have been speaking publicly in favor of the regulations.  (Shay helped point the Treasury in this direction.)  But most of the other people who will be commenting have client interests, and/or are comfortable with the way things were before the regs were issued.

One possibly countervailing factor, however, is that those who are speaking for or on behalf of U.S. firms that aren’t inverting may be glad to see foreign firms’ relative advantage in profit-shifting out of the U.S. narrowed by the new rule – although only “new” earnings-stripping by such firms, as distinct from that which they already had in place, is potentially impeded.

Academic types, such as myself, even when willing or strongly inclined to take a pro-government position, don’t generally go as deep in the weeds as one would need to go in order to address the rules in detail.  (And while we can certainly do legal analysis of them, we may not be as well-equipped as people in practice to figure out how the practicalities will develop.)  Maybe this aversion to going deep in the weeds is our bad – but certainly it can affect the overall tenor of the debate.

That said, here are four particular observations regarding the new section 385 regulations:

First, section 385 gives the Treasury VERY broad discretion.  So anyone who wants to argue that the regs are invalid is swimming steeply uphill.  It’s true that the regs address particular practices that were not specifically in Congress’s collective mind when it enacted the provision in 1969.  But the grant of broad discretion seems clearly to have been meant to let the Treasury respond to new developments.  Note also that this is not just an anti-inversion provision.

Second, one could see the regulation as a small and admittedly discrete move away from separate entity tax accounting for multinational groups.  Given the general economic significance (and potentially large tax significance) of the lines between legally distinct but economically integrated affiliated entities, this is a good direction to be going in.

Third, it’s important, and probably a good thing, that the regulation addresses “inbound” investment – i.e., U.S. economic activity by multinationals with a foreign parent – rather than just inversions.  A key reason for the inversion wave is that, in addressing profit-shifting out of the domestic tax base, the U.S. rules appear to over-rely on residence-based rules that apply only to U.S. multinationals, relative to rules that affect foreign multinationals.  This is a topic I’ll be addressing further in other settings.

Fourth, by acting unilaterally (here as previously) in response to the recent inversion wave, the Treasury has rejected old, 1980s-vintage notions of comity between the branches, by acting on a live and prominent policy topic rather than working with Congress via the design and enactment of new legislation.  But guess what – it isn’t the 1980s anymore!  We now live in a world where the tax legislative process has generally broken down, unless one party holds all the levers.  This is going to keep happening in the future, under both Democratic and Republican administrations.  Whether one regrets the lost 1980s of bipartisan legislation or not, that world is gone, and comity norms are going to change in consequence.  So one might as well get used to it.

2) Should the EC retroactively revoke rulings issued by the tax authorities of EU member states?  Are there better ways to address the concerns?  Is revocation consistent with US tax treaties?

It’s useful to look at this from an EU standpoint, just so one can understand what they’re about  Then there’s plenty of time to think about it from a US standpoint.

From an EU standpoint, it’s totally understandable that they would issue the “state aid” rulings requiring countries to take back favorable tax rulings that mainly had been issued to U.S. companies.  If the EC wants to restrain certain types of race-to-the-bottom internal competition between member states, it can’t let labels (such as the use of the tax system to deliver what are effectively subsidies) to lead to frustration of their policy!

Also, when one is adjudicating the merits of what has been done – in effect judicially, although the EC is a commission, not a court – of course it will apply “retroactively.”  Saying “Next time we’ll be really mad!,” and acting only nominally prospectively, would have been widely scoffed at, and would likely have failed to deliver a credible message to EU governments.

That said, from a US standpoint I am concerned about the degree of focus on US firms.  And I also understand that the EU structure makes it trickier for us to figure out how to negotiate individually with EU countries.  But that’s relevant to how we should respond – not to whether what they’re doing makes sense from their standpoint.

One last point, however – while the US doesn’t benefit directly – indeed, it loses – when a given US company (with mainly US shareholders) ends up paying more tax to EU countries, we may benefit indirectly in the long run, if it lowers the expected after-tax return to US companies from profit-shifting out of the US.

To put it differently, the EU may have affected its prospective tax-attractiveness, and this potentially benefits the US insofar as there is zero-sum tax competition at work between us.

3) Given the EC’s almost exclusive focus on US companies, should the US invoke section 891?

This provision permits us to double the tax rates on residents of foreign companies that subject US taxpayers to discriminatory taxes.  The apparent EU focus on US companies in the state aid cases has led some to urge that we consider invoking this provision.  (BTW, the chance that this will actually happen is probably about zero.)

I think of it this way.  In principle, bluffing is great, if one specifies in advance that it will actually work.  So if we threatened to invoke §891 and won valuable concessions of some kind from the Europeans, great.

But it’s hard to bluff effectively if you aren’t actually willing to pull the trigger.  And here I don’t think we should, plus the Europeans surely know that we won’t, plus there is also a downside to attempted Trumpist bullying.

So no, on balance we shouldn’t invoke section 891 or even waste too much breath pretending to think about it.

How should we respond, insofar as we’re seriously concerned about the focus on US companies?  I’d say, by doing something we might actually want to do anyway – doing more to address profit-shifting out of the US by EU (and other non-US) companies.

4) Is the US discussion of international tax reform disproportionately focused on “outward” investment by US corporations? What about foreign investment in the US?  Can the two be separated?
Is this in part what the §385 regulations are about? Should the US consider a US version of the UK “diverted profits” Tax? Should the US challenge supply chain structures and/or significantly broaden and tighten the earnings-stripping rules?

The inbound and outbound rules are closely conceptually linked.  These days, our main reason for taxing outbound is to address profit-shifting out of the US by US companies.  Likewise, our inbound rules address profit-shifting out of the US by non-US companies.
So it’s the same problem, just involving different groups of companies.  And of the two sets of rules get too out of whack, you get incentives for inversions, among other things.

The US rules may be too lax overall on profit-shifting out of the US – although that is legitimately debatable.

But what’s clear is that we’re more lax in this regard on inbound than outbound.  So even if we can do a better job addressing outbound by US companies, we need to bring those rules into balance with those for inbound investment.

Transfer pricing and earnings- stripping are the 2 obvious places to focus.

Finally, without endorsing the particulars of the UK diverted profits tax, it’s definitely an example of seeking to address domestic tax avoidance by non-resident companies.

5) Without any way to force members to sign on, is BEPS going anywhere? Will it become irrelevant? Will it make a meaningful contribution to the international tax rules or just cause disruption?

I’d restate the question as: Is the glass ¼ full or ¾ empty?

I expect BEPS’s true results to fall far short of the rhetoric and expectations.  I wish had a dollar for every speaker at every conference on OECD-BEPS over the last 3 years.  I’d be a rich man.  

From all that attention, you might think it would end up being a bigger deal than it actually is going to be.

But you can’t force members to sign on – views and interests differ – and the BEPS methodology, such as continuing to rely on separate-company accounting within affiliated groups, is a bit unpromising for BEPS.

That said, some real changes may indeed not just emerge but persist.  But the main thing is that, if the global tax policy climate has indeed changed, BEPS may be remembered as a harbinger or leading edge of this change, even if what really matters is that change, rather than its particular content.

6) If the US corporate tax rate on US multinational income is reduced, should pass-through entities help pay for the reduction?

Lowering the corporate rate ought to be fully financed.  Otherwise, we worsen the long-term budget picture and hand windfall gains to current investors, who are generally from the top of the income and wealth distribution.

Base-broadening (from an income tax standpoint) that applies to the pass-through sector as well as the corporate sector is the logical way to do it.  This obviously implies raising taxes for pass-throughs.

Is that so bad?  Well, I think it verges on making corporate tax reform a political non-starter. But it might not be so bad in substance for one very simple reason.  Recent research suggests that the partnership sector (although not sub S corps or proprietorships) is currently comparatively lightly taxed.  So the shift in taxes from the corporate to the pass-through sector might tend towards equalizing their overall tax burdens.

Two final points about broadening the base to pay for corporate rate cuts.  First, even if it’s revenue-neutral, it tends to hand a windfall to existing investment, at the expense of new investment.  That generally isn’t a great idea.

Second, Congress should look outside the budget window when it asks whether a change is fully financed.  Breaking even for 5 or 10 years based on one-time pay-fors is not good enough, if the change actually loses revenue in the long run.

Saturday, April 16, 2016

Another view of U.S. international taxation

I recently got to hear a non-U.S. individual who is a prominent tax lawyer abroad addressing international tax issues in the context of OECD-BEPS.  What he said was interesting, whether or not one fully agrees with it.

In his account, the U.S. decided long ago to treat its own multinational firms far more favorably than any peer country treats its multinationals.  The mechanism for this was permitting the U.S. firms to treat royalties that are foreign source income as active rather than passive (even though they generally are deductible in the jurisdiction from which one group members pay them out to other group members).  Thus, the royalties don't face either foreign tax or our subpart F rules, but accumulate tax-free in tax haven affiliates.  Peer countries, by contrast, would have taxed the royalties under their CFC rules.

The U.S. decision effectively to sacrifice any taxing claims with respect to its multinationals' foreign source income has led the EU countries to say: Maybe we should grab something here, since the U.S. has decided against taxing it.  Hence, OECD-BEPS, to which the U.S. has been invited - but not as a guest, rather as the meal.

This coming Tuesday, when I speak at the annual NYU-KPMG Tax Lecture on Current Issues in (International) Taxation, I strongly suspect that U.S. tax lawyers, with U.S. corporate clients, who are on my panel (a mid-afternoon "debate" session) will sing quite a different tune regarding how rigorously the U.S. treats its multinationals compared to peer countries, although not regarding OECD-BEPS.

Friday, April 15, 2016

Democratic debate last night, and the $15 minimum wage

I watched some of the Democratic debate last night, which seemed to have imbibed just a bit of the Republican debates' spirit (with shouting and interrupting), albeit conducted on a more substantive and less fantastical (in the sense of fantasies and falsehoods) plane.

One topic of interest to me was the minimum wage, which I've written about.  In my 1997 U of Chicago Law Review piece, The Minimum Wage, the Earned Income Tax Credit, and Optimal Subsidy Policy, I addressed the two alternatives noted in the title from a public economics tax/transfer standpoint, and also in light of the then-still-recent research by David Card and Alan Krueger that found little or no disemployment effects from modest increases to the minimum wage.

From a straight public economics standpoint, the minimum wage has an odd design.  One can think of it as follows.  Suppose we are looking at a $10/hour minimum wage.  That's equivalent to the case where there was no minimum wage, but when the market wage was less than this, imposing a tax and a transfer.  Suppose that, in the absence of the minimum wage, I would have worked an hour at McDonald's for $8.  Leaving aside administrative issues, the actual order of cash flows, etc., the min wage is equivalent to allowing that transaction to occur, but also having the government pay me a $2 transfer, financed by a $2 tax on the McDonald's franchise owner.

Two notable things about the transfer.  First, it only goes to low-hourly-wage who actually are employed, not those who would like a job but can't get one (or don't like this one enough to take it).  In that respect, it is just like the earned income tax credit (EITC).

Second, unlike the EITC, it identifies recipients based purely on the difference between the hypothetical market wage they would otherwise have gotten, and the mandated minimum hourly wage.  The EITC, by contrast, looks at annual earnings and income, as well as at household information (e.g., whether one has 0, 1, or at least 2 dependent children).  So the EITC is better targeted in terms of people who are actually poor - as distinct from, say, teenagers from affluent households.

Let's now look at the financing.  The EITC is financed out of general revenues, whereas the minimum wage is "collected" from low-wage employers.  Now, the EITC's funding design certainly sounds better, although of course there are optical advantages (really, from the structure of the spending side) to the minimum wage setup.

The "tax" on low-wage employers, from the minimum wage's funding design, presumably is not borne by those parties at equilibrium - one would expect to be passed on somehow, e.g., through effects on consumer prices and low-wage employment levels, as well as through allocative shifts in the business sector.

Standard price theory would, of course, suggest that the employment level must drop.  Low-wage workers might still collectively gain - in effect, they have been cartelized to demand at least the minimum wage - but their increased net wages as a group (if the price was not set too high) wouldn't be evenly shared, if some lost their jobs.

But here's where the Card-Krueger research kicks in.  It showed that modest minimum wage increases might not reduce employment levels.  The core reason, to put it very broadly, is that labor markets are different from, say, boring commodity markets with fungible items.  For example, labor supply may respond to perceived wage fairness.  And on the demand side, low-wage employers are making various choices, e.g., should we pay less and get worse workers who also quit a lot, or should we pay a bit more and get slightly better workers (not otherwise distinguishable to the employer) who also quit less.  Even aside from the quality trade-off, there is that between (a) paying lower wages but having to scramble more to replace and at least minimally train new workers, and (b) paying higher wages but reducing those problems.

So, from that last factor alone, one could luck into increased, rather than reduced, employment (measured by total hours) by finding the sweet spot in which there is enough employer switching from the high-turnover to the low-turnover strategy.

That makes the min wage's "funding instrument" potentially appealing in a way that standard price theory as applied to tax would miss.  But there can be no doubt that, at some point, the neoclassical view that minimum wages will reduce employment, will kick in.  After all, suppose we made the min wage $50 per hour, indexed to inflation.  That is unlikely to turn out well.

OK, back to Bernie and Hillary.  I realize one needs to score dramatic political points, when one is trailing in the late stages of a contested primary campaign, but I was nonetheless made uneasy by Bernie's flag-waving about the national $15 minimum wage.  I am not an expert on this, but I strongly suspect that, for much of the country, a minimum wage at that level is just too high.

Indeed, I don't know enough to deny that it might be too high everywhere - but at least high-price-level urban centers, such as New York City, Los Angeles, and Seattle, have a better chance of finding the sweet spot rather than proving too high.  Nonetheless, we get Bernie bludgeoning away over the $15 minimum wage, treating it as a matter of principle that Hillary is simply too craven and right-wing to accept unless she's forced to.

I'd like to think that Bernie is just grandstanding for the TV audience and in truth knows that $15 might be too high.  Better a bit of cant to help in the election process than genuine closed-mindedness to possible contrary evidence.  But I have no grounds for believing that he knows better.  He seems, rather, to think that a $15 national minimum wage is just a matter of principle, with no further analysis being needed.

If that's the right way to look at it, I was saying to myself during this part of the debate, why stop at $15?  Why not $50 or $100 per hour?

This gives me a bit of sympathy with the following Paul Krugman comment in his blog today:

"What you see ... on multiple issues, is the casual adoption, with no visible effort to check the premises, of a story line that sounds good .... In each case the story runs into big trouble if you do a bit of homework; if not completely wrong, it needs a lot of qualification.... It's about an attitude, the sense that righteousness excuses you from the need for hard thinking."

Krugman could be kinder to one of the reasons why Sanders and his supporters are inclined to think this way - money talks big in politics, certainly including to members of the Democratic establishment (and not just Hillary).  So genuine good faith commitment to a set of objectives is truly an issue here, and people have reason to be looking for evidence of it.  But one has to be able to think dispassionately about the actual effects that high-minded, well-intentioned policies might have.  Otherwise, one is selfishly treating the opportunity to feel virtuous as if it were more important than the welfare of the individuals whom one ostensibly wants to help.

Thursday, April 14, 2016

OECD-BEPS: Slides from panel appearance

Today I was among the panelists at an international tax panel that was held at the 2016 Spring Meeting of the ABA Section of International Law.  The slides for my portion of the panel discussion, in which I discussed OECD-BEPS, are available here.

Wednesday, April 13, 2016

A different upcoming colloquium at NYU

This fall, in the second half of the semester - Mondays from October 24 through December 5 - I will be co-leading a new colloquium at NYU.  This one is about high-end inequality, without distinctively focusing on tax issues as such.  (However, I'll still be doing the regular tax colloquium in the spring semester, from January through May 2017.)

My co-convenor will be the economist Robert Frank, whom I very much look forward to working with for the first time.  Bob once presented a paper at our tax colloquium, back in the days when I was co-convening it with David Bradford, on the topic of income vs. consumption taxation under the lens of his work regarding positional goods.  (See for example herehere, and here.)

As per the course description that will be available to NYU law students shortly, the colloquium will aim to "study the issues associated with high-end inequality (i.e., pertaining to income and wealth concentration at the top) from a multi-disciplinary perspective.  Its primary focus is papers and works in progress, or recently published works, by legal scholars, economists, political scientists, other social scientists, and philosophers."

PM sessions will be held at NYU Law School, from 4 to 6 pm on the Mondays from October 24 through December 5, and will be open to the public.

NYU Tax Policy Colloquium, week 11: Lily Kahng's "Who Owns Human Capital?"

Yesterday at the colloquium, Lily Kahng presented the above paper.

The paper makes two main arguments.  First, recent legal developments that augment business owners’ ability to “propertize” intellectual capital created by their workers have been increasing high-end inequality.  Second, these distributional effects are further increased by the U.S. tax law’s unduly (a) favorable treatment of intellectual property to business owners, and (b) unfavorable treatment of human capital investment (and expenses of earning labor income) to workers.

Each of these arguments raises issues that are worth addressing separately.

1.         PROPERTIZATION

1) The Piketty issue: Is rising high-end inequality a function of capital vs. labor, or high-earners vs. low earners, or both?

Central to the paper’s analysis is the so-called Piketty issue.  Piketty gives “r>g” a dominant role in explaining recent and predicted future increases in high-end inequality.

An alternative emphasis would focus on the role played by rising wage inequality, especially in the U.S.  Here the story is less about “capital,” and more about corporate governance, the financial sector, winner-take-all tournaments between entrepreneurial start-ups, etcetera.

The paper’s analysis of propertization fits within the Piketty story, as it is about “capital” winning relative to “labor.”  Indeed, propertization could conceivably fit within the narrative arguing that keeps r so high is not just conventional market forces but the legal and political choices that countries make.  But this requires, among other things, determining the incidence of benefit from propertization.  If businesses can increasingly claim property rights in intellectual capital created by their employees, then even if this increases the businesses’ gross revenues, the incidence as between capital and labor depends on how it affects wages.

However one ends up resolving these questions – both the relative significance of the “capital vs. labor” story and the incidence question re. benefits from propertization – I think it’s important to keep in mind the high-wage aspect.  “Workers” are heterogeneous and include some people at the very high end, and the people who hold capital are often highly compensated “workers” – whether this be owner-employees at the helm, a la Mark Zuckerberg, or hot-shot techies who really are employees rather than having controlling interests, but who get compensated with stock options.  Wage inequality and “worker” heterogeneity (plus overlap with capital owners) at a minimum complicate the story.

2)  Should propertization be expected to increase wages? 

Business owners have long been able to create patents or copyrights that give them legal ownership of intellectual capital created through someone’s labor.  But the paper notes that the effective equivalent of such ownership may arise through other mechanisms as well – for example, via covenants not to compete, nondisclosure agreements, and trade secrets laws.

Let’s focus for simplicity on a non-compete that is indeed effectively enforceable.  Say the equilibrium wage for a given job would be $X for year without the non-compete, but then the non-compete becomes standard.  Employers are getting more than previously, so their demand for labor at a salary of $X should increase.  Employees are giving more than previously (e.g., suppose they are in effect giving away expected future wages), so their supply of labor at $X should increase.  In a very simple supply-demand model, the implication is that the wage increases to something above $X.  (One could also view the “real” wage as not changing – it’s just that there’s a rearrangement of terms so that more of the value is expressed by the current year wage.)

Here the non-compete merely affects the exact terms of the bargain, so there’s no reason to think it affects one side relative to the other side.  If the non-compete also increases expected gross revenues for the business, then we’d need to know more about the supply and demand curves in order to predict how this gain is split.

Why wouldn’t this hold, and contradict the paper’s suggestion that propertization is benefiting capital relative to labor?  Well, there certainly are possible explanations.  Labor markets are distinctive in many ways.  One could have, for example, a model in which the parties differ in far-sightedness or time preference, and “capital” ends up winning.  Or one could see it as a bilateral monopoly bargaining game in which relative market power controls the outcome, and in which “capital” not only has more market power to begin with, but further increases the power imbalance via propertization.  So the paper’s story could be true, but one would need to explain why the simple standard model doesn’t hold.

Heterogeneity may also figure here.  Highly paid, highly skilled workers with market power (and stock options) may fare differently than lower-paid workers who lack distinctive skills and equity-based compensation.  So the story is most plausible for workers who are subject to propertization yet who are not the stereotypical Silicon Valley hotshots.

3)  Under propertization, is “capital” capturing returns to “labor”?  Alternatively, should we adopt a “joint venture” view of income that is jointly produced by capital owners (with or without their labor) and non-owners’ labor?

Much of the paper argues that, if the gains from propertization are being captured by capital rather than labor, this is unfair in a particular sense.  Given the top end-skewed concentration of capital ownership, one would certainly expect propertization, in this scenario, to be increasing high-end inequality.  But the paper further argues that it involves capital owners claiming labor income that was produced by workers other than the capital owners themselves.

This could be viewed as applying something like the labor theory of value (and exploitation as the term is used in Marxian economics), as distinct from a market theory of value.  I myself tend to be skeptical of viewing the fruits of production by capital plus labor as inherently belonging to one or the other of the players.  I agree that market power can influence who gets what, and my policy preferences may cause me to prefer more equal distributional outcomes to less equal ones, but the view that some portion of the value in some sense “really” was created by one party rather than the other doesn’t do much work for me normatively.

The paper argues the diversion of workers’ labor income to the owners, where it gets labeled as capital income, weighs against taxing capital income at the lower rate of the two.  From page 37: “On an intuitive level, it seems irrational and unfair that the tax disparate treatment should turn on the identity of the person who is deriving income from the labor.”  But I would note that we’re fine with applying different marginal tax rates to income, depending on to whom it accrues.

The paper also explores an alternative view under which owners (whether they work or not) and worker non-owners would be viewed as joint venturers in economic production.  It suggests that, if we can’t disaggregate their true contributions (as distinct from how much each side ends up getting to take home), this similarly supports taxing labor income and capital income at the same rate.  Leaving aside the disaggregation problem as between the two parts of income (which fits into part 2 below), I tend to take the same view of this as of the diversion issue.  That is, I care about distribution but this wouldn’t as such affect my view as to the tax rates I wanted to apply to particular individuals or types of income.  But one might reach a different conclusion than I do if one’s distributional views partake more of notions of entitlement and distributive desert (associated with the act of economic production) than mine do.

2.         TAXING LABOR INCOME AND CAPITAL INCOME

1) What’s the difference between these two types of income in theory?

One doesn’t need to have a tax system in order to want to distinguish conceptually between labor income and capital income.  For example, when Piketty discusses r > g, he needs to (and tries to) relabel capital gains that are actually better viewed as labor income.  For example, suppose Mark Zuckerberg pays $1,000 into the newly created Facebook in exchange for all of its stock, and subsequently sells the stock for $1 billion, having paid himself zero salary in the interim because that would merely be transferring funds from one pocket to another.  The salary he would have gotten at arm’s length is labor income.

Suppose he has gains above that, e.g., because he enjoyed a gigantic windfall gain (from good luck) that exceeded reasonable ex ante expectations.  Maybe we should call this capital income, but the label is only going to do so much work once we turn to the tax policy analysis.

Let’s start by taking risk out of the story.  So all we have is normal returns at the regular interest rate (without regard to risk premia ex ante, and actual risky outcomes ex post), plus extraordinary or inframarginal returns that may well represent labor income, as in the case of Zuckerberg’s unpaid salary.  But now I don’t particularly care what he would have paid himself at arm’s length – just about the distinction between the normal return and  the extra return.  (Call it rent or whatever you like – in practice, of course, it’s easiest to make sense of this part of the story if we also have risk in the picture, but I’ll bring it back in a moment.)

Suppose one favors a consumption tax, under which “capital income” is taxed at a zero rate.  Under any reasonable normative view, that support for exemption extends only to the normal rate of return – not to the extra return.  So it may be semantically convenient to say: Ah, capital income is just the normal rate – the rest is actually labor income.  But semantics aside, that exempting of the normal rate, with taxation of the extra return, is all that the reasonable arguments for consumption taxation support doing.  So if we view the semantics differently, and say that some of the extra return is “really” capital income after all, it makes no difference to the normative analysis.

Suppose we stupidly adopt yield exemption, without an arm’s length rule, for investments such as Zuckerberg’s hypothetical $1,000 stake in Facebook.  Then we get a bad result – newly minted billionaires are tax-exempt on their earnings, for reasons that make no sense distributionally even under the sort of lifetime model that leads most naturally to support for consumption taxation.

Suppose instead that we use expensing to achieve consumption taxation.  For simplicity, suppose that Zuckerberg holds the FB stock for just one year, and that the normal rate of return is 10%., while the tax rate is 40%.  Had he just earned the normal rate of return, and sold the stock in a year for $110, he would have gotten a $40 refund in Year 1 and paid $44 of tax in Year 2.  This exempts the normal return, in the sense that the present value of $40 immediately equals that of $44 in a year at a 10% discount rate.

But if he sells the stock for $1 billion in a year, he gets a $40 refund followed by $400 million of tax liability.  These rather obviously are not equal in present value at a 10% discount rate, which is why we say that expensing exempts only the normal rate of return.

There’s a long literature and debate about whether we should exempt the normal rate of return.  Most of this is about income taxation vs. consumption taxation, although there is also an extensive literature about taxing the normal rate of return at a rate between zero and the full tax rate or rates for the stuff that both systems reach. 

Wherever one comes out in the end, there clearly are significant arguments for taxing the normal rate of return – “capital income” if one likes, but without regard to the semantics of how one ends up defining the term for other purposes – at a lower rate than labor returns and extra-normal returns.  My own views on this issue are influenced by rising high-end inequality, but are not influenced by issues of joint venture or diversion of labor income to the holders of capital.

What about risk?  This blogpost is already long enough (or too long), so I’ll just say that both income taxes and consumption taxes nominally reach risky returns (other than in special cases such as the use of yield exemption), but the extent to which one actually ends up taxing risk depends on how portfolios end up being affected by the existence of this formally (whether or not substantively) mandatory insurance.  I like the insurance feature except insofar as people don’t need it because they already can and do optimize via their portfolio choices, in which case they should be able to get rid of some or all of the tax on risk and there is thus less of an issue.
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2) Is it easy or hard to distinguish between capital income and labor income?  How/why might one try to do this?

It’s obviously extremely difficult, at best, under the approach of current U.S. income tax law – with partnership taxation and carried interest, sweat equity, the formal definition of capital gains, etcetera.

But in principle it’s not that hard.  Again, a well-designed consumption tax is just one example of an instrument that distinguishes between the normal return via expensing and everything else.  Another example is the dual income tax that Scandinavian countries have deployed from time to time, and that Ed Kleinbard has written extensively about.  Here the idea is that the corporate income tax base consists of normal returns plus rents, underpaid owner-employee compensation, etc.  So, if you want to tax the normal return at a lower rate than everything else, you adopt a low corporate rate, but apply that rate solely to returns that are “normal” in relation to basis.

In sum, as things go I consider it relatively easy, rather than hard, to distinguish between capital income and labor income, so long as one defines capital income as the normal return to capital.  (Perhaps the risk-free return, but that raises further issues for another day.)  That is generally the right way to define capital income, where the issue is how broadly to apply a rule treating it more favorably than labor income – whether or not it is semantically the most appealing view of “capital income” in any other context.

3) How important to high-end inequality are the “anti-INDOPCO” regulations?

The paper also discusses particular rules in the U.S. income tax that might exacerbate high-end inequality in relation to propertization and the tax treatment of human capital investment.  It notes that the INDOPCO case, decided by the U.S. Supreme Court in 1992, suggested that capitalization, in lieu of immediate deduction, might apply for a very wide range of outlays that create or enhance future value, including a whole lot of intellectual capital that has become firm-owned via propertization.  But then, for a variety of reasons that include the effects of politics, interest group lobbying, and a set of lower court defeats, the Treasury issued INDOPCO regulations (which, as has been noted, should properly be called the anti-INDOPCO regulations, that reversed much of what INDOPCO appeared to imply beyond its particular facts.  Lots of long-term value creation now gets expensing.  This is “incorrect” from an income tax standpoint, and it creates inter-asset biases if other items that are associated with long-term value get capitalized rather than being expensed.  It also might, if sufficiently widespread, but also depending on the various factors that affect economic incidence, result in r’s being higher after-tax than it would have been had the INDOPCO approach prevailed and been extended.

Did this materially increase high-end inequality?  This is an empirical question about significance and incidence.  But when only the normal return is at issue, and that is presumably fairly low in an era of relatively low nominal and real interest rates, it seems unlikely to be of first-order importance.

4)  Would more favorable treatment of workers’ human capital investments (and costs of producing labor income) increase progressivity?

The paper notes that various costs of developing human capital (e.g., education expenses) and of producing labor income often are treated more favorably when the business makes them on workers’ behalf than when the workers make them directly.  The doctrinal reason for this is that there’s no issue of personal consumption by the owner of a business that pays money for these purposes with respect to a non-owner employee.  (There is, however, a question of whether this yields taxable income to the employee, just like paying cash salary.)

In addressing how this may affect high-end inequality, it’s important to remember the high-wage workers again.  If greater deductibility were allowed at the worker level, the benefits would depend on the particular worker’s marginal tax rate and amount spent.  These may both often be higher for higher-income than for lower-income employees.

Tax Filing Simplification Act of 2016

Senator Elizabeth Warren has introduced the Tax Filing Simplification Act of 2016, which aims to build on Joe Bankman's Ready Return work in California at the federal level.  Unfortunately, the idea of making federal income tax filing easier and less painful for (potentially) millions of Americans is opposed both by the private sector software industry and by Grover Norquist types who want to encourage dislike of the tax system and the federal government, for substantive policy reasons of their own.

I am among the 41 law professors and economists who recently signed a letter expressing support for the measure.

Saturday, April 09, 2016

Unpleasant (and seasonally inappropriate) weather encourages reading ...

... as does the knowledge that a stretch of relatively frenetic activity lies ahead (Tribeca Film Festival, a local play, Tax Policy Colloquium, local conferences, writing efforts, other social plans).

The books I've been reading this weekend are Branko Milanovic's Global Inequality (an important and multi-dimensional work), Ron Darling's Game 7, 1986: Failure and Triumph in the Biggest Game of My Life (interesting introspection plus a trip for me down Memory Lane), and Frank Norris's McTeague (called an American Zola, dumb hulk of a lead character adds interest in some ways).

Thursday, April 07, 2016

Pfizer-Allergan

I'm glad to see that the Pfizer-Allergan deal has apparently fallen apart.  It probably wasn't a great deal from a business standpoint, especially for the Pfizer shareholders who may have been over-paying.  (Pfizer stock apparently rose when the deal collapsed - Allergan stock first fell a lot, then rebounded a little.)

What were the tax advantages that Pfizer hoped to garner from the deal?  Presumably some of it related to greater ease of earnings-stripping out of the U.S., which U.S. taxpayers would have no reason to welcome.  But as discussed here, Robert Willens suggests that enhancement of Pfizer's ability to access some $140 billion in foreign earnings, tax-free, for loans among its affiliated companies was "100 percent the reason behind this deal."

That complicates the normative story a bit since, insofar as Pfizer would merely be incurring deadweight loss from more complicated financing arrangements and internal fund flows, rather than paying an extra $35 billion in U.S. tax (as suggested by the Americans for Tax Fairness, a progressive advocacy group, based on assuming massive repatriations in any event).  The U.S. doesn't benefit directly from the deadweight loss, although the prospect of incurring it can potentially reduce profit-shifting incentives ex ante.  But large-scale, fully taxable repatriations do happen sometimes (GE is a recent example).  We may get to see, in the next few years, just how much U.S. tax (if any) Pfizer decides to incur via taxable repatriations, if it can't conjure up an alternative inversion deal.

Treasury's success in blocking this particular inversion plan is just one micro-episode in a very long battle.  Whatever regulatory or statutory rules impeding inversions one might like (or not like) to see adopted, including those just-issued that torpedoed the deal, it's important to address more directly the underlying incentives that induce U.S. companies to seek to invert.  Here I think two main things should be done:

1) Imposing a deemed repatriation of U.S. companies' foreign earnings or "permanently reinvested earnings," to lower the outstanding "loan balances" on deferred U.S. taxes.  This just buys time before addressing deferral more permanently, but the balances have gotten so high that it strikes me as an important interim step.  There's certainly room for legislative negotiation over the terms of the deemed repatriation.

2) Re-balance U.S. rules that address profit-shifting out of the U.S. domestic tax base, so that they rely relatively more on approaches that affect foreign as well as domestic multinationals, and relatively less on approaches that only hit U.S. companies (i.e., via our CFC rules).  The rules should probably also be tougher overall, but that's distinct from the re-balancing point.

Wednesday, April 06, 2016

2017 NYU Tax Policy Colloquium

Just for those who might have any relevant planning considerations to think about (such as in re. teaching schedules), next year we will be offering the NYU Tax Policy Colloquium on Mondays, from 4-6 pm.  This is a change from our Tuesday schedule over the last few years.  The dates will be Monday, January 23, through Monday, May 1.  We'll meet on Tuesday, rather than Monday, on the week of President's Day (Feb. 20 vs. 21), and on Monday, March 13, we won't meet due to spring break.

More important than these tedious details, I'm happy to report that I will be co-teaching the Colloquium with Rosanne Altshuler. We've co-taught the Colloquium once before, though just for half of a semester.  I'm looking forward to another great collaboration.

Spring concert tour

Unlike the Rolling Stones, I have not as yet been invited to perform (or, as we say in my biz, to present) in Cuba.  Now, they admittedly have better stagecraft than I do (even if their act has become a bit stale, predictable, and inadvertently self-parodying).  But, then again, I feel I've done better work than they have since Some Girls came out in 1978.  (OK, there's still a bit of resonant aftershock on Emotional Rescue and Tattoo You, but that's still going back 35+ years.)

My own spring concert tour schedule is taking form, however.  Current entries are as follows:

1) On Thursday, April 14, from 2:30 to 4 pm, I'll be on a panel on international taxation at the 2016 Spring Meeting of the ABA Section of International Law.  This meeting is being held at the Grand Hyatt New York from April 12-16.

2) On Tuesday, April 19, sometime during the early afternoon (in between the AM and PM sessions of my Tax Policy Colloquium on that day), I'll be participating in a debate on corporate and international tax policy at the 16th Annual NYU/KPMG Tax Lecture, taking place at NYU Law School.  This year's theme for the day's proceedings is "Navigating the Global Tax Climate Change."

3) On Thursday, May 12, I'll be the luncheon speaker at the National Tax Association's 46th Annual Spring Symposium, meeting in Washington, D.C., at the Holiday Inn Capitol.  I'll be discussing U.S. international tax policy, and I will try to offer fresh thoughts that are suitably pitched for the sophistication of my audience.

4) On Wednesday, June 1, in Amsterdam, I'll be speaking on a panel at a one-day conference entitled "Anti-BEPS implementation in the EU - the Anti-Tax Avoidance Directive: the Major Implications for the Tax (Planning) Landscape in the EU."  The conference is co-sponsored by the Amsterdam Centre for Tax Law and NYU Law School.  It's one of 4 conferences to be held over a period of a year or so.  The other three will be at NYU, in Beijing, and in Sao Paulo.  I may also speak at one or both of the latter two conferences.  My topic will be the U.S. response to OECD-BEPS and to the EU state aid cases.

Tax policy colloquium,week 10: Treasury-NBER paper on pass-through taxation of business entities

Yesterday at the colloquium, Richard Prisinzano of the Treasury Department and Danny Yagan of the Berkeley Economics Department presented their joint work (along with six co-authors from Treasury and the University of Chicago), which will soon be appearing in the next annual volume of the NBER's Tax Policy and the Economy, entitled "Business in the United States: Who Owns It and How Much Tax Do They Pay?"

This is an important contribution, or rather the first of what are likely to be a series of important contributions, that attempt to increase our knowledge by making use of U.S. federal tax return information about businesses in the U.S. that are taxed as pass-throughs (i.e., partnerships or S corporations).  In particular, it seeks to link information from partnership-level Form 1065 returns to that from partner-level Schedule K-1 returns, thereby presenting a comprehensive picture of who reports partnership income and how much U.S. federal income tax is paid on such income.  In a more rational world, this would have been done years ago, and doing it would be easier than it actually is.  I'll focus here just on partnerships, although there is also some information in the paper in re. S corporations.

The paper's main conclusions are threefold:

(1) Taxable income from partnerships  is more concentrated among high-earners than that from C corporations.

(2) Partnership ownership is opaque - 20% of it goes to unclassifiable partners, and 15% is in circularly owned partnerships (as in the case where ABC owns most of DEF, which owns most of GHI, which owns most of ABC).  The income that they can trace through to the K-1s ends up being less than the 100% that should be there, given the 1065s.

(3) The average federal income tax rate on business income from U.S. pass-throughs appears to be significantly lower than that for C corporations.  This reflects both the types of income involved (much of it dividends and capital gains) and the tax rates of the partners (including tax-exempt entities and foreigners) that get allocated partnership income.

There are many remaining questions, e.g., pertaining to whether the authors have correctly identified "business income," as opposed to investment income, as this might be relevant to how one thinks about the findings.  Data limitations, along with open questions regarding what we mean, for policy-relevant purposes, by "business versus investment income," make this an area for further research.  Also, the paper's data is for 2011, and it will be interesting to see what happens to the various bottom lines starting in 2013, when the long-term capital gain and dividends tax rates increased from 15% to 20% (or 23.8% if one can't avoid the 3.8% Medicare tax on net investment income).

If one accepts the above findings and they continue to hold post-2013, possible implications include the following:

1) The finding that partnership income is lower-taxed might be relevant to the debate about corporate tax reform, including in the scenario where a corporate tax rate reduction is financed through base-broadening that raises net revenue from the partnership sector,

2) That same finding also calls attention to partnership tax issues of recent note - pertaining, for example, to the carried interest rule and what for a long time was the astonishingly low (although now apparently increasing) audit rate for large partnerships.

3) It also might be relevant to how one thinks about high-end inequality and current U.S. federal income taxation of the top 1 percent or 0.1 percent.

4) The fact that tax-exempt entities and foreigners can invest tax-free through partnerships, whereas they are effectively (albeit indirectly) taxed if they own shares in C corporations that can't wholly avoid paying U.S. tax, ought to get further attention.  Now, we've known along that these persons are treated differently, depending on which way they invest.  And there are further issues pertinent to how we should want to tax them.  For example, do we think that various types of tax-exempt entities, whether they be pension funds or universities, should be getting larger subsidies or smaller ones than under present law?  And to what extent do we think that foreigners would bear the incidence of the taxes that they pay through corporate investment and don't pay through partnership investment?

Monday, April 04, 2016

What's in a name

In one of the less surprising events of the year so far (given alumni relations and fundraising considerations), Princeton is keeping Woodrow Wilson's name on things despite the recent discussion of his vicious (even in the context of his times) racism.

Personally, I'm fine with the last name but would change the first names: Delroy Wilson College, Brian Wilson School.  These are two people whose achievements I actually admire.

Less flippantly, I don't know the proper metric for deciding questions such as this.  If you're Princeton's president, there are multiple constituencies that you have to think about, and in the long run where you steer the school matters more than these symbolic issues, fraught though they are.

I personally find Woodrow Wilson detestable on balance, and would not want to honor him in any way.  But it's a complicated story (history is complicated), as the history of our country is morally complicated (featuring both some very good and some very bad things).  I have sympathy for both the Progressive Era legislation of Wilson's first term and the aspirations behind his League of Nations push.  But for me personally they're outweighed by the bad.