I have been assuming for some time now that some version of the horrible tax bill is bound to go through, probably within a week or two. After all, it is not as if any significant number of Congressional Republicans (and it would only take three of them in the Senate) appears to care in the slightest about how it would affect people other than their donors. Even the so-called "moderates" in the Senate, like Collins and Murkowski, readily accept "assurances" from Trump that they cannot be stupid enough to believe. They just want deniability or a fig leaf. I suspect the same holds for the supposed "budget hawks" such as Flake, whom I would guess - despite his not facing reelection - will ask no more of the "trigger" than that it qualify as a visible if irrelevant gesture. Likewise, while others have noted the significant remaining differences between the House and Senate bills, it's not as if anyone on either side actually cares enough about the substance, or real world effects, to let the bill die over mere trivialities such as whether 13 million people will lose their health insurance.
There may of course be political ramifications, such as electoral danger for House Republicans in blue states from repealing state and local income tax deductions (although the most electorally vulnerable may be freed to cast ineffectual votes against it). But the underlying theory is either pluto-populism - you buy enough support from the donors to unleash a blizzard of ads on racial and "cultural" issues - or else that, even if political payback is coming, you might as well do it while you can.
A broader lesson, beyond the mystery of why the Republican Party - it's not just Trump - seems to have completely rejected notions of responsible or informed governance, which did matter to its leaders in the 1980s - is that, at least when money has unchecked reign in politics, it causes the government's redistributive policy over time to have an anti-insurance feature.
Rising high-end inequality that has adverse social consequences for everyone else ought to trigger policies aimed at scaling it back. But instead, because it increases the relative political and economic power of those at the top, it is self-reinforcing. Greater high-end inequality triggers the adoption of policies that further increase high-end inequality, triggering the adoption of policies that still further increase high-end inequality. It's a positive feedback loop.
One further broader lesson is as follows. Political scientists for decades followed the so-called "rational voter" model, in which people voted in favor of their economic interests. But the model is basically false. One of its main problems (although there are many others) lies in the voting paradox. Given how unlikely it is that my vote would change the outcome, it would be decidedly irrational for me to spend any time figuring it out and voting that way. So even if I do vote, it must be for other reasons and reflect other impulses. To use a favorite illustration, how much time would you spend figuring out what is the best car for you to buy (if you're not inherently interested in cars) in the scenario where you had only one vote, among millions, with regard to which car you would actually get?
An important recent political science book, decisively rebutting the misnamed (because irrational) "rational choice" model of voting, is Christopher Achen's and Larry Bartels' Democracy for Realists: Why Elections Do Not Produce Responsive Government.
In such a world (i.e., our actual world), responsible governance depends less on voting, or on politicians' electoral self-interest as ostensible agents on behalf of their constituents, than on the ideology and value structure that the elites happen to have. Donors are obviously a big part of this, but not all - a lot, I think, lies in the mysterious black box realm that I will just call culture or values or sources of prestige because I don't have a more definite handle on it at present.
Thus, the fact, which I really don't understand and can't fully explain, that at least since 1994 Republican elites - though, obviously, not all conservative intellectuals - have increasingly and acceleratingly gone mad is at the core both of what ails us more broadly as a society, and of the apparent (I think) near certainty that a horrible, harmful, and recklessly irresponsible and sloppy and thoughtless tax bill is about to be enacted.
Of course, I could (I hope) be wrong about the tax bill, although not (I fear) about the rest.
Unfair but balanced commentary on tax and budget policy, contemporary U.S. politics and culture, and whatever else happens to come up
Thursday, November 30, 2017
Tuesday, November 28, 2017
Perhaps it figures
The Senate is currently working on its version of the most plutocratic and fiscally irresponsible federal tax legislation in U.S. history. Also probably the sloppiest and most poorly designed ever. (I can vouch for this going back to 1981, and before that the nature of the process probably prevented this sort of malfeasance.)
Nonetheless, as McConnell hunts for 50 votes, the impetus, as the New York Times reports, is to make it more plutocratic still. Senators Johnson and Daines are demanding larger tax benefits for passthroughs, which supposedly - but not actually - are treated worse than C corporations in the bill. More on that in a moment.
Buying Johnson's and Daines' votes would definitely cause the legislation to be both more plutocratic and even more poorly designed. The passthrough provisions don't, and as a matter of basic design really can't (especially in the abbreviated timeframe) have even remotely adequate guardrails. They are a tax lawyer's Full Employment Act for all sorts of tricks that I have discussed in prior posts, and I suspect that I am just scratching the surface.
Whether giving more goodies to passthroughs would also make the legislation still more fiscally irresponsible depends on how they do it. Johnson and Daines propose taking at least some of the lost revenue out of the hides of C corporations, via repeal of the state and local (income?) tax deduction for such companies. This actually is not entirely lacking in rationality, if one takes it as given that state and local income taxes shouldn't otherwise be deductible, but it's a hard sell optically, plus it would further undermine state and local governments along the same lines as repealing the deduction for individuals. (But that's a separate debate.)
C corporations are probably right to be a bit nervous here. Apart from the insistence on giving them a 20 percent rate and territoriality, they are, as Willy Loman would have put it, liked but not well-liked by Congressional Republicans. It's the super-rich pass-through owners who are well-liked. And while there is clearly an immense willingness to do harm to middle-class and poor taxpayers, for the former at least there are concerns about the political optics.
In any event, as I noted above, it's also false that the passthroughs (or more precisely, their owners) are being treated worse than if they operated C corporations. We know this for a very simple reason: they would simply restructure to be C corporations if they thought that would benefit them.
Some of them are already incorporated under state law, and have simply elected to be taxed as S corporations (which are treated as passthroughs). And even for the rest, there is really no significant business reason not to do this. They don't even have to use states' corporate law statutes, since other flexible entities, such as limited liability companies (LLCs) can readily serve as C corporations for federal income tax purposes, with just minimal planning.
Why wouldn't they want to do this? Well, the reason TO do it, obviously, is to get the 20 percent corporate rate, in lieu of the higher passthrough rate that even the House bill offers. But then they would face the second level of tax, upon receiving corporate distributions. The tax cost (or tax-induced inconvenience) of doing that offers the only credible reason why they wouldn't choose to incorporate.
The argument is therefore being made in bad faith, whether or not Senators Johnson and Daines (who are not generally considered the Senate's two leading tax minds) are aware of this.
Here's a further amusing snippet, from Richard Rubin and Siobhan Hughes in the Wall Street Journal, concerning Johnson's arguments for additional passthrough rate cuts:
"Mr. Johnson said the rate disparity ... would cause pass-throughs to change their legal status and become traditional corporations. He said that would cause revenue losses that congressional estimators haven't accounted for; it wasn't clear Monday what those estimates assumed."
It's unclear how (or if) Johnson thinks this can be reconciled with his claiming that the passthroughs are disfavored. But it's actually plausible that if passthrough owners did convert, this would cause revenue losses within the period being measured by the official score, even if the present value of their tax liabilities increased (except, in that case they presumably wouldn't convert to begin with). The second level of tax might often be incurred after the close of the estimating period, and the forecasts aren't infinite-horizon.
Another way of putting this is that conversion to C corporation status might be less bad fiscally over the long run than within the ten-year estimating window. But, from the standpoint of what Johnson is trying to argue, he's still trapped in nonsense. They're not disfavored if they can readily convert, and if they don't want to convert then they're evidently not disfavored even under their current organizational form as passthroughs.
Nonetheless, as McConnell hunts for 50 votes, the impetus, as the New York Times reports, is to make it more plutocratic still. Senators Johnson and Daines are demanding larger tax benefits for passthroughs, which supposedly - but not actually - are treated worse than C corporations in the bill. More on that in a moment.
Buying Johnson's and Daines' votes would definitely cause the legislation to be both more plutocratic and even more poorly designed. The passthrough provisions don't, and as a matter of basic design really can't (especially in the abbreviated timeframe) have even remotely adequate guardrails. They are a tax lawyer's Full Employment Act for all sorts of tricks that I have discussed in prior posts, and I suspect that I am just scratching the surface.
Whether giving more goodies to passthroughs would also make the legislation still more fiscally irresponsible depends on how they do it. Johnson and Daines propose taking at least some of the lost revenue out of the hides of C corporations, via repeal of the state and local (income?) tax deduction for such companies. This actually is not entirely lacking in rationality, if one takes it as given that state and local income taxes shouldn't otherwise be deductible, but it's a hard sell optically, plus it would further undermine state and local governments along the same lines as repealing the deduction for individuals. (But that's a separate debate.)
C corporations are probably right to be a bit nervous here. Apart from the insistence on giving them a 20 percent rate and territoriality, they are, as Willy Loman would have put it, liked but not well-liked by Congressional Republicans. It's the super-rich pass-through owners who are well-liked. And while there is clearly an immense willingness to do harm to middle-class and poor taxpayers, for the former at least there are concerns about the political optics.
In any event, as I noted above, it's also false that the passthroughs (or more precisely, their owners) are being treated worse than if they operated C corporations. We know this for a very simple reason: they would simply restructure to be C corporations if they thought that would benefit them.
Some of them are already incorporated under state law, and have simply elected to be taxed as S corporations (which are treated as passthroughs). And even for the rest, there is really no significant business reason not to do this. They don't even have to use states' corporate law statutes, since other flexible entities, such as limited liability companies (LLCs) can readily serve as C corporations for federal income tax purposes, with just minimal planning.
Why wouldn't they want to do this? Well, the reason TO do it, obviously, is to get the 20 percent corporate rate, in lieu of the higher passthrough rate that even the House bill offers. But then they would face the second level of tax, upon receiving corporate distributions. The tax cost (or tax-induced inconvenience) of doing that offers the only credible reason why they wouldn't choose to incorporate.
The argument is therefore being made in bad faith, whether or not Senators Johnson and Daines (who are not generally considered the Senate's two leading tax minds) are aware of this.
Here's a further amusing snippet, from Richard Rubin and Siobhan Hughes in the Wall Street Journal, concerning Johnson's arguments for additional passthrough rate cuts:
"Mr. Johnson said the rate disparity ... would cause pass-throughs to change their legal status and become traditional corporations. He said that would cause revenue losses that congressional estimators haven't accounted for; it wasn't clear Monday what those estimates assumed."
It's unclear how (or if) Johnson thinks this can be reconciled with his claiming that the passthroughs are disfavored. But it's actually plausible that if passthrough owners did convert, this would cause revenue losses within the period being measured by the official score, even if the present value of their tax liabilities increased (except, in that case they presumably wouldn't convert to begin with). The second level of tax might often be incurred after the close of the estimating period, and the forecasts aren't infinite-horizon.
Another way of putting this is that conversion to C corporation status might be less bad fiscally over the long run than within the ten-year estimating window. But, from the standpoint of what Johnson is trying to argue, he's still trapped in nonsense. They're not disfavored if they can readily convert, and if they don't want to convert then they're evidently not disfavored even under their current organizational form as passthroughs.
Monday, November 27, 2017
Unfortunate news for NYU Law School
My colleague Joshua Blank is leaving NYU for UC Irvine Law School, as detailed here. This is very unfortunate, both from my personal standpoint and for NYU Law School institutionally (as well as personally, both for my colleagues and for scores of our students who have come to know him). But it's great news for UC Irvine, and I know that Josh will thrive there.
Wednesday, November 22, 2017
54th anniversary of the JFK assassination
A friend noted on Facebook that November 22 is still "the most memorable of all dates for some of us." He quotes Mary McGrory as saying, at the time, "We'll never laugh again," to which Patrick Moynihan replied, "No, we'll laugh again. But we'll never be young again."
I was in my first grade classroom when the assassination happened. The teacher was called out of the room to hear something on the radio, which seemed very odd and unprecedented. Then we got the news, which verged on unfathomable for a group of middle class New York City 6-year olds. The Oswald shooting, which came a couple of days later then added a touch of yet further previously unimagined grotesque madness.
I nonetheless certainly still felt young for a long time afterwards, and I have laughed plenty since, albeit not about what happened on 11/22/63. Yet for me, and I know for many others in my age cohort, it was the first major crack for us in what one might now call the era's Leave It to Beaver edifice. But this now seems as if it ought to have been particular to people who were as young at the time as we were.
I was too young, as of 11/22/63, to know anything much about World War II or McCarthyism, or to have much understanding of what was going on with, say, the civil rights movement or the early stages in the lurch towards U.S. involvement in the Vietnam War. So it really was a first hint that the world was more scary, dangerous, and chaotic than those in my age cohort, living in similarly benign and sheltered circumstances, had been led to assume. But, without belittling the immense immediate emotional impact of the tragedy, weren't the likes of McGrory and Moynihan old enough to have seen plenty of dark and horrible things before?
I was in my first grade classroom when the assassination happened. The teacher was called out of the room to hear something on the radio, which seemed very odd and unprecedented. Then we got the news, which verged on unfathomable for a group of middle class New York City 6-year olds. The Oswald shooting, which came a couple of days later then added a touch of yet further previously unimagined grotesque madness.
I nonetheless certainly still felt young for a long time afterwards, and I have laughed plenty since, albeit not about what happened on 11/22/63. Yet for me, and I know for many others in my age cohort, it was the first major crack for us in what one might now call the era's Leave It to Beaver edifice. But this now seems as if it ought to have been particular to people who were as young at the time as we were.
I was too young, as of 11/22/63, to know anything much about World War II or McCarthyism, or to have much understanding of what was going on with, say, the civil rights movement or the early stages in the lurch towards U.S. involvement in the Vietnam War. So it really was a first hint that the world was more scary, dangerous, and chaotic than those in my age cohort, living in similarly benign and sheltered circumstances, had been led to assume. But, without belittling the immense immediate emotional impact of the tragedy, weren't the likes of McGrory and Moynihan old enough to have seen plenty of dark and horrible things before?
Third time's a charm?
I've done multiple versions of talks, using slides, that discuss the destination-based cash flow tax - a proposal that (despite my respect for and friendship with its leading academic proponents) I consider greatly overrated conceptually. The fullest version of the slides is here, but a more recent (though shorter) version is here.
When I say the DBCFT is overrated conceptually, I mean that it's really just a VAT (with a couple of extra features) in lieu of the existing entity-level corporate income tax - based on the sometimes undefended, and clearly erroneous, assumption that one can only have one or the other, not both. Discussing it tends to obscure or crowd out properly focusing on the issues it actually raises - such as whether the origin-based corporate income tax rate should actually be lowered all the way to 0%, what with the individual income tax generally remaining in place (and serving some desirable purposes, even if imperfectly). So my critique is distinct from, albeit hardly incompatible with, arguing that the DBCFT oughtn't to be enacted - a question that cannot really be answered properly until one has done more to specify the rest of the surrounding fiscal system.
Because the DBCFT, unlike its forebear David Bradford's X-tax, isn't embedded in a system that also specifies how individuals are generally taxed, it reflects a failure to address one of the most biggest questions, which is how to integrate it with the rest. And sometimes less is less, not somehow more.
My skepticism has certainly influenced my titles. The first version was called: "The Rise and Fall of the Destination-Based Cash Flow Tax: What Was That All About?" The second was called "A Requiem for the Destination-Based Cash Flow Tax."
They say (never matter who "they" are) that the third time's a charm. And, as I've been asked to discuss the DBCFT in a conference at Munich next month, I've been working on a new version, to be posted after that conference, currently called "Goodbye to All That? A Requiem for the Destination-Based Cash Flow Tax." Yes, the degree of originality in the titles appears to be declining precipitously.
But also, I've decided (I think) to write up a textual version of those slides that will appear in a conference volume sometime next year, presumably after showing up on SSRN with a link that I'll post here.
When I say the DBCFT is overrated conceptually, I mean that it's really just a VAT (with a couple of extra features) in lieu of the existing entity-level corporate income tax - based on the sometimes undefended, and clearly erroneous, assumption that one can only have one or the other, not both. Discussing it tends to obscure or crowd out properly focusing on the issues it actually raises - such as whether the origin-based corporate income tax rate should actually be lowered all the way to 0%, what with the individual income tax generally remaining in place (and serving some desirable purposes, even if imperfectly). So my critique is distinct from, albeit hardly incompatible with, arguing that the DBCFT oughtn't to be enacted - a question that cannot really be answered properly until one has done more to specify the rest of the surrounding fiscal system.
Because the DBCFT, unlike its forebear David Bradford's X-tax, isn't embedded in a system that also specifies how individuals are generally taxed, it reflects a failure to address one of the most biggest questions, which is how to integrate it with the rest. And sometimes less is less, not somehow more.
My skepticism has certainly influenced my titles. The first version was called: "The Rise and Fall of the Destination-Based Cash Flow Tax: What Was That All About?" The second was called "A Requiem for the Destination-Based Cash Flow Tax."
They say (never matter who "they" are) that the third time's a charm. And, as I've been asked to discuss the DBCFT in a conference at Munich next month, I've been working on a new version, to be posted after that conference, currently called "Goodbye to All That? A Requiem for the Destination-Based Cash Flow Tax." Yes, the degree of originality in the titles appears to be declining precipitously.
But also, I've decided (I think) to write up a textual version of those slides that will appear in a conference volume sometime next year, presumably after showing up on SSRN with a link that I'll post here.
Monday, November 13, 2017
110th Annual NTA Conference on Taxation
From Thursday through Saturday, I spent an enjoyable if hectic stretch of time at the National Tax Association's 110th Annual Conference on Taxation, which this year took place in Philadelphia. I stayed overnight even though NYC is close by, hence I guess cue the W.C. Fields jokes ("Last night I spent a weekend in Philadelphia").
I always enjoy going to the conference, both intellectually and socially. One gets to hear about a smattering of current research (I focused on international tax and tax "reform" panels), and to meet old friends or (less commonly at this point) make new ones who are in the "biz" whether as economists, lawyers, government folk, or practitioners.
My own direct involvement, apart from moderating a panel, consisted of presenting a shortened (by more than 50%) but also modestly updated version of my slides discussing the destination-based cash flow tax. In deference to events since I gave the earlier version of this talk, I call the new version "A Requiem for the Destination-Based Cash Flow Tax."
The earlier version remains available here.
I wasn't exactly a winner in the scheduling for this talk. It ended up in a far-off room that one pretty much needed a compass plus trail mix to find. Plus, the other two papers on the same panel were quite different from mine. One discussed the incidence effects of sales tax holidays, while the other discussed tax-favored tobacco sales by Indian tribes. Both were quite interesting and good, but the common ground with my talk wasn't enormous.
This is not, in the slightest, meant as a complaint! I know how hard it is to schedule all the panels and talks, as Tracy Gordon and I shared this same job a few years ago. I am certain that we inadvertently did the same or worse to lots of people,* because this is simply inevitable when you are scheduling dozens of panels. Not all of the papers will fit together into unified panels, and not all of the panels can get the best locations. In consequence, as a presenter, you win some and you lose some.
________________________________________________________________________________
*Indeed, I also remember - and here the fault was definitely mine, not Tracy's - inadvertently rejecting all three papers by a given author, even though they were interesting and good, due to a screw-up in the course of deciding which one of the three to accept. I was able to correct this error when I discovered it in the course of looking for commentators on other papers.
I always enjoy going to the conference, both intellectually and socially. One gets to hear about a smattering of current research (I focused on international tax and tax "reform" panels), and to meet old friends or (less commonly at this point) make new ones who are in the "biz" whether as economists, lawyers, government folk, or practitioners.
My own direct involvement, apart from moderating a panel, consisted of presenting a shortened (by more than 50%) but also modestly updated version of my slides discussing the destination-based cash flow tax. In deference to events since I gave the earlier version of this talk, I call the new version "A Requiem for the Destination-Based Cash Flow Tax."
The earlier version remains available here.
I wasn't exactly a winner in the scheduling for this talk. It ended up in a far-off room that one pretty much needed a compass plus trail mix to find. Plus, the other two papers on the same panel were quite different from mine. One discussed the incidence effects of sales tax holidays, while the other discussed tax-favored tobacco sales by Indian tribes. Both were quite interesting and good, but the common ground with my talk wasn't enormous.
This is not, in the slightest, meant as a complaint! I know how hard it is to schedule all the panels and talks, as Tracy Gordon and I shared this same job a few years ago. I am certain that we inadvertently did the same or worse to lots of people,* because this is simply inevitable when you are scheduling dozens of panels. Not all of the papers will fit together into unified panels, and not all of the panels can get the best locations. In consequence, as a presenter, you win some and you lose some.
________________________________________________________________________________
*Indeed, I also remember - and here the fault was definitely mine, not Tracy's - inadvertently rejecting all three papers by a given author, even though they were interesting and good, due to a screw-up in the course of deciding which one of the three to accept. I was able to correct this error when I discovered it in the course of looking for commentators on other papers.
The Tax Arbitrage Act of 2018?
Tax arbitrage, as the term is used in the literature, involves having offsetting long and short positions that are taxed asymmetrically.
In a "pure tax arbitrage," as Eugene Steuerle first (to my knowledge) dubbed it in 1985, the taxpayer has perfectly offsetting economic positions that may pair, say, deductibility of the payout with excludability (or at least deferral) for the receipt. A classic example is the Knetsch case, decided by the Supreme Court in 1960. Here the taxpayer purported to borrow and lend the same $4 million from the same insurance company counter-party. But he "borrowed" at 3.5% and "invested" at 2.5%, leading to $140,000 of accrued interest expense and only $100,000 of accrued annuity appreciation per year. So he'd write the company a $40,000 check for the difference and deduct $140,000 of interest. (Black letter law at the time unambiguously supported both the deduction and the exclusion, leaving aside economic substance doctrine).
In a regular tax arbitrage, the positions aren't perfect offsets. Hence, they may not be arbitrages in the way that finance people use the term, but they are still tax arbitrages. For example, if you borrow to hold non-dividend-paying stock, deducting the interest while deferring the offsetting appreciation, this would give you a tax arbitrage, even though you have a net position (e.g., bad news for you if the stock market plunges). However, the tax juice from this little game is addressed by the investment interest limitation, which generally limits deductions for investment interest to net investment income.
There would be no tax arbitrages under a pure Haig-Simons income tax that was consistently applied. But when there is a hodge-podge of different rules for different types of items, some of it becomes inevitable. A whole host of special rules in the Internal Revenue Code try to limit it in one setting or another. These rules add complexity if one defines it simply as the number of pages of tax law, but they may actually reduce complexity in practice if they sufficiently discourage taxpayers from going to great (or any) lengths to arrange tax arbitrages that would siphon money out of the Treasury to no socially or economically valuable end.
Asymmetric substantive rules are one way get to the creation of tax arbitrages that serve no good purpose. Having at least some of this is inevitable once you have a realization-based income tax. But the creation of pointless tax arbitrages becomes even easier for taxpayers, if one allows them to pick and choose between alternative marginal rates for the income and/or loss from the same activities.
It's amazing to me to what extent the House and Senate versions of tax "reform" pointlessly create huge tax arbitrages of this kind. The proposed special rate for pass-throughs, a key feature of both bills, has the potential to become the single greatest inducement to tax arbitrage ever enacted by a single Congress.
And of course I have been noting here how the Senate Finance Committee's idea of expanding expensing immediately while delaying the corporate rate increase by a year, creates a massive tax arbitrage loophole. As per my prior post, it is economically equivalent to providing 175% expensing - i.e., allowing deductions of $1.75 for every $1 the taxpayer spends - for 2018 only. Spending a dollar to earn a dollar, but getting to deduct $1.75 while only including $1, is a classic tax arbitrage example.
If I were willing to lengthen this post still more, I could explain in detail a further tax arbitrage that is possibly more important than the ones I have been emphasizing. The bills combine allowing expensing for new investment with partially retaining interest deductibility, and the literature has shown that this allows the creation of tax arbitrages that can drive the effective tax rate for new investment below 0 percent (i.e., to amount to a net payout from the government even if the investment offers a pretax return of zero).
Given these egregious problems in the bills, I am thinking that the Republicans should relabel what they are doing the Tax Arbitrage Act of 2018.
They may not have fully realized this, but it's an inevitable byproduct of trying to craft multiple rates that can apply to the same taxpayer and (with requisite planning) to the same offsetting outlays and receipts.
In a "pure tax arbitrage," as Eugene Steuerle first (to my knowledge) dubbed it in 1985, the taxpayer has perfectly offsetting economic positions that may pair, say, deductibility of the payout with excludability (or at least deferral) for the receipt. A classic example is the Knetsch case, decided by the Supreme Court in 1960. Here the taxpayer purported to borrow and lend the same $4 million from the same insurance company counter-party. But he "borrowed" at 3.5% and "invested" at 2.5%, leading to $140,000 of accrued interest expense and only $100,000 of accrued annuity appreciation per year. So he'd write the company a $40,000 check for the difference and deduct $140,000 of interest. (Black letter law at the time unambiguously supported both the deduction and the exclusion, leaving aside economic substance doctrine).
In a regular tax arbitrage, the positions aren't perfect offsets. Hence, they may not be arbitrages in the way that finance people use the term, but they are still tax arbitrages. For example, if you borrow to hold non-dividend-paying stock, deducting the interest while deferring the offsetting appreciation, this would give you a tax arbitrage, even though you have a net position (e.g., bad news for you if the stock market plunges). However, the tax juice from this little game is addressed by the investment interest limitation, which generally limits deductions for investment interest to net investment income.
There would be no tax arbitrages under a pure Haig-Simons income tax that was consistently applied. But when there is a hodge-podge of different rules for different types of items, some of it becomes inevitable. A whole host of special rules in the Internal Revenue Code try to limit it in one setting or another. These rules add complexity if one defines it simply as the number of pages of tax law, but they may actually reduce complexity in practice if they sufficiently discourage taxpayers from going to great (or any) lengths to arrange tax arbitrages that would siphon money out of the Treasury to no socially or economically valuable end.
Asymmetric substantive rules are one way get to the creation of tax arbitrages that serve no good purpose. Having at least some of this is inevitable once you have a realization-based income tax. But the creation of pointless tax arbitrages becomes even easier for taxpayers, if one allows them to pick and choose between alternative marginal rates for the income and/or loss from the same activities.
It's amazing to me to what extent the House and Senate versions of tax "reform" pointlessly create huge tax arbitrages of this kind. The proposed special rate for pass-throughs, a key feature of both bills, has the potential to become the single greatest inducement to tax arbitrage ever enacted by a single Congress.
And of course I have been noting here how the Senate Finance Committee's idea of expanding expensing immediately while delaying the corporate rate increase by a year, creates a massive tax arbitrage loophole. As per my prior post, it is economically equivalent to providing 175% expensing - i.e., allowing deductions of $1.75 for every $1 the taxpayer spends - for 2018 only. Spending a dollar to earn a dollar, but getting to deduct $1.75 while only including $1, is a classic tax arbitrage example.
If I were willing to lengthen this post still more, I could explain in detail a further tax arbitrage that is possibly more important than the ones I have been emphasizing. The bills combine allowing expensing for new investment with partially retaining interest deductibility, and the literature has shown that this allows the creation of tax arbitrages that can drive the effective tax rate for new investment below 0 percent (i.e., to amount to a net payout from the government even if the investment offers a pretax return of zero).
Given these egregious problems in the bills, I am thinking that the Republicans should relabel what they are doing the Tax Arbitrage Act of 2018.
They may not have fully realized this, but it's an inevitable byproduct of trying to craft multiple rates that can apply to the same taxpayer and (with requisite planning) to the same offsetting outlays and receipts.
Sunday, November 12, 2017
Trying to rationalize the Senate Finance Committee's mistake
There's a story about a man who goes hunting and accidentally shoots his own thumb off. "Why''d you do that?," he's asked.
"Oh, I don't know, but it seemed like a good idea at the time."
Give him an extra day, however, and perhaps he'd do better at rationalizing what happened. If sufficiently averse to admitting the blunder, he might be able to fake out an explanation of why it not only seemed like, but actually was, a good idea, and not only at the time but even now.
Maybe: "I never liked that thumb. It always got dry in the winter and the skin would crack." Or, "I figured it was easier to do that than buy mittens."
I am reminded of this story by desperate, recently emerging efforts by supporters of the Senate Finance Committee chairman's mark to explain why it was actually the height of wisdom, rather than a blunder, to delay the low corporate rate for a year while expanding expensing immediately.
As I've explained in earlier posts, here and here, this combination of timing approaches strongly encourages taxpayers to make negative-value (on a pretax basis) investments, such as expensing $100 in 2018 when the rate is 35%, in order to earn $90 in 2019 when the tax rate is 20%, thereby converting a $10 pretax loss into a $7 after-tax gain.
But now the pushback has started. Given that they've already, with high publicity, included this blunder in the chairman's mark, and are still counting on tax savings from delaying the low rate by a year (even if over-estimated by the Joint Committee on Taxation, if it didn't think sufficiently about the revenue hole that I have been discussing), the new line that I gather someone has been trying out on reporters is that it was actually a brilliant plan to promote growth. Companies will invest more in 2018 because it pays off specially!
Let's explain a bit more straightforwardly the claim that they are trying to make here. It is effectively a call for one year of 175% expensing in 2018 - an approach under which each dollar spent triggers a $1.75 deduction - since that would yield the same after-tax economics, in my example, as if the tax rate were indeed 20% both years.
Does anyone on the Senate Finance Committee, or among their supporters and apologists, wish to call for a year of 175% expensing? If so, I'd like to hear it.
Why wouldn't we want to have a year of 175% expensing? Well, for one thing, we're not currently in recession. For another, it encourages negative-value investments, including (as I've discussed in the prior posts) those that verge on being shams, featuring the use of circular cash flows (or transactions as close to that as the economic substance doctrine will permit).
But it's also true that what the Senate Finance Committee is actually proposing is less stimulative than that silly plan would be. After all, by postponing the 20% rate for a year, while they are encouraging 2018 investment outlays under the high rate, they are discouraging 2018 gain realizations - from consumer sales, for example. Postponing the rate cut incentivizes companies to postpone 2018 income into 2019, whenever and wherever they can. So what they are actually doing is significantly worse, from a stimulative standpoint, than offering a year of 175% expensing.
If you've made a mistake, as the Senate Finance Committee has, why not just admit it? Attempting silly rationalizations isn't likely to help.
"Oh, I don't know, but it seemed like a good idea at the time."
Give him an extra day, however, and perhaps he'd do better at rationalizing what happened. If sufficiently averse to admitting the blunder, he might be able to fake out an explanation of why it not only seemed like, but actually was, a good idea, and not only at the time but even now.
Maybe: "I never liked that thumb. It always got dry in the winter and the skin would crack." Or, "I figured it was easier to do that than buy mittens."
I am reminded of this story by desperate, recently emerging efforts by supporters of the Senate Finance Committee chairman's mark to explain why it was actually the height of wisdom, rather than a blunder, to delay the low corporate rate for a year while expanding expensing immediately.
As I've explained in earlier posts, here and here, this combination of timing approaches strongly encourages taxpayers to make negative-value (on a pretax basis) investments, such as expensing $100 in 2018 when the rate is 35%, in order to earn $90 in 2019 when the tax rate is 20%, thereby converting a $10 pretax loss into a $7 after-tax gain.
But now the pushback has started. Given that they've already, with high publicity, included this blunder in the chairman's mark, and are still counting on tax savings from delaying the low rate by a year (even if over-estimated by the Joint Committee on Taxation, if it didn't think sufficiently about the revenue hole that I have been discussing), the new line that I gather someone has been trying out on reporters is that it was actually a brilliant plan to promote growth. Companies will invest more in 2018 because it pays off specially!
Let's explain a bit more straightforwardly the claim that they are trying to make here. It is effectively a call for one year of 175% expensing in 2018 - an approach under which each dollar spent triggers a $1.75 deduction - since that would yield the same after-tax economics, in my example, as if the tax rate were indeed 20% both years.
Does anyone on the Senate Finance Committee, or among their supporters and apologists, wish to call for a year of 175% expensing? If so, I'd like to hear it.
Why wouldn't we want to have a year of 175% expensing? Well, for one thing, we're not currently in recession. For another, it encourages negative-value investments, including (as I've discussed in the prior posts) those that verge on being shams, featuring the use of circular cash flows (or transactions as close to that as the economic substance doctrine will permit).
But it's also true that what the Senate Finance Committee is actually proposing is less stimulative than that silly plan would be. After all, by postponing the 20% rate for a year, while they are encouraging 2018 investment outlays under the high rate, they are discouraging 2018 gain realizations - from consumer sales, for example. Postponing the rate cut incentivizes companies to postpone 2018 income into 2019, whenever and wherever they can. So what they are actually doing is significantly worse, from a stimulative standpoint, than offering a year of 175% expensing.
If you've made a mistake, as the Senate Finance Committee has, why not just admit it? Attempting silly rationalizations isn't likely to help.
Saturday, November 11, 2017
Yet another problem with the House's (and Senate's?) special tax rate for passthroughs
Things are happening too fast in Washington tax "reform" for one to keep full track of all the snafus and scandals that are likely to be hidden in all the weeds. But here's one more that a friend brought to my attention.
There's nothing better than getting to make "heads I win, tails you lose" bets. So here's one, when you get a special 25% tax rate for certain income from pass-throughs, as under the House bill. What about losses?
The ideal, from the taxpayer's standpoint but not anyone else's, would be to include profits from the favored activities at 25%, while still getting to deduct losses at 39.6%, if one is rich enough to reach the top bracket. So what does the House bill do to prevent that?
(Similar question, what does the Senate bill do to prevent this in their version of the passthrough tax break? Answer, at this stage nothing so far as we know, but we haven't seen the statutory language yet.)
I'm currently on an Amtrak with relatively limited access to the things one could look up in one's office. But, as I recall, what it does is require a limited species of recapture, that fails to reach all cases.
Suppose you are in an activity that would generate profits at 25%. In Year One, it instead generates losses, and indeed you get to deduct them at 39.6 percent. What the bill appears to try to do is require "recapture" of this income at the full rate. So in Year 2, you wouldn't get the special rate until you had reversed out the prior loss deduction.
(What if the activity changes status under the rules from year to year? Let's not even go there yet. It may turn on what the passive loss rules have to say about "former passive activities" - at least, leaving aside the case where one only gets the special rate for 30% of the income.)
Suppose that provision works properly within its four corners, although I haven't as yet had the chance to look it over carefully. (I am posting now, rather than waiting, because speed is of the essence given their timetable.)
It still isn't good enough to do the job. Case 1, risky activity that now ex ante faces a 25% rate on the income if it comes out heads, and a 39.6% reimbursement rate via deductions if it's tails. So heads I win, tails you (the Treasury and other taxpayers) lose.
Case 2, income first and deductions/losses later. Normally, due to the time value of money, taxpayers want to accelerate deductions and defer income. But here, if doing it the other way around creates a huge tax rate disparity, there are strong incentives, and no doubt when well-advised means, of flipping it around. So you pay tax at 25%, and then the next time you deduct the losses at 39.6%. I don't believe there's a carryback for losses into prior tax years - which would of course complicate things still more.
True, it might be somewhat of a one-time gain given that the recapture might get you again further down the line, but still potentially well worth doing if the payoff is large enough.
Same question as in my last post about the problems with the deferred corporate rate cut in the Senate bill: Is this issue properly reflected in the Joint Committee of Taxation revenue estimate? I bet not, as their process has been so rushed and you need time to think in order to start locating all these things
And I'm only focusing on a couple of the areas that I happen to know something about. There are plenty of other portions of the House and Senate bills that might raise similar or analogous issues
There's nothing better than getting to make "heads I win, tails you lose" bets. So here's one, when you get a special 25% tax rate for certain income from pass-throughs, as under the House bill. What about losses?
The ideal, from the taxpayer's standpoint but not anyone else's, would be to include profits from the favored activities at 25%, while still getting to deduct losses at 39.6%, if one is rich enough to reach the top bracket. So what does the House bill do to prevent that?
(Similar question, what does the Senate bill do to prevent this in their version of the passthrough tax break? Answer, at this stage nothing so far as we know, but we haven't seen the statutory language yet.)
I'm currently on an Amtrak with relatively limited access to the things one could look up in one's office. But, as I recall, what it does is require a limited species of recapture, that fails to reach all cases.
Suppose you are in an activity that would generate profits at 25%. In Year One, it instead generates losses, and indeed you get to deduct them at 39.6 percent. What the bill appears to try to do is require "recapture" of this income at the full rate. So in Year 2, you wouldn't get the special rate until you had reversed out the prior loss deduction.
(What if the activity changes status under the rules from year to year? Let's not even go there yet. It may turn on what the passive loss rules have to say about "former passive activities" - at least, leaving aside the case where one only gets the special rate for 30% of the income.)
Suppose that provision works properly within its four corners, although I haven't as yet had the chance to look it over carefully. (I am posting now, rather than waiting, because speed is of the essence given their timetable.)
It still isn't good enough to do the job. Case 1, risky activity that now ex ante faces a 25% rate on the income if it comes out heads, and a 39.6% reimbursement rate via deductions if it's tails. So heads I win, tails you (the Treasury and other taxpayers) lose.
Case 2, income first and deductions/losses later. Normally, due to the time value of money, taxpayers want to accelerate deductions and defer income. But here, if doing it the other way around creates a huge tax rate disparity, there are strong incentives, and no doubt when well-advised means, of flipping it around. So you pay tax at 25%, and then the next time you deduct the losses at 39.6%. I don't believe there's a carryback for losses into prior tax years - which would of course complicate things still more.
True, it might be somewhat of a one-time gain given that the recapture might get you again further down the line, but still potentially well worth doing if the payoff is large enough.
Same question as in my last post about the problems with the deferred corporate rate cut in the Senate bill: Is this issue properly reflected in the Joint Committee of Taxation revenue estimate? I bet not, as their process has been so rushed and you need time to think in order to start locating all these things
And I'm only focusing on a couple of the areas that I happen to know something about. There are plenty of other portions of the House and Senate bills that might raise similar or analogous issues
Huge problems with the Senate Finance Committee's delayed effective date for the corporate rate cut?
In my last blog post I offered a simple illustration of the problems that may result from the Senate Finance Committee's planning to enact expanded expensing immediately, while delaying the corporate rate cut for a year. Again, it said: expense $100 in December 2018, collect $35 in tax savings from the expensing, earn $90 in January 2019, pay $18 of tax at the new 20% rate. Result: a $10 pre-tax loss is converted into a $7 after-tax gain, by reason of one's extracting $17 net from the U.S. Treasury.
This is just a toy example, but the more I think about it, the more it becomes clear to me that this is potentially a huge problem - in terms both of revenue and ridiculous tax planning games.
Whenever the tax rate on a given actor is declining with a delay, it has an incentive to accelerate deductions and defer realizing positive income. We already knew that. But here the spread is really large - 15 percent - and the period of pre-announcement is really long - more than a year. Has there ever before, in U.S. tax history, been so large a rate cut that (if the Senate approach becomes law) was pre-announced so far in advance? Willing to stand corrected, but I think not.
Plus, the problem is hugely worsened by the presence of expensing. In the 1986 tax reform process, when the corporate rate did indeed decline by 12 points, not only was there offsetting base-broadening, but there was movement towards economic depreciation, rather than towards expensing. Now, as a matter of steady-state tax policy, you may prefer one, or you may prefer the other. But one thing that's indisputable is that expensing creates a much greater gulf between the time when the deduction arises, and that when the income arises. So it is much more problematic and gameable when the specific issue is one of tax rate changes between years.
So again, we can take it just for starters that there will be huge incentives to accelerate deductions and defer income realization. But beyond that, there will be huge incentives to arrange economically senseless (or meaningless) transactions in order to extract huge boatloads of money from the Treasury.
Example: in December 2018, a U.S. corporation pays $100 million to a tax-indifferent counter-party that generates an immediate expensing deduction. In January 2019, the corporation sells it for $90 million, in the simplest case to the very same counter-party. Bingo, everybody wins except for the American people via the effect on the U.S. Treasury.
Who are tax-indifferent counter-parties? We can start with tax-exempts, foreigners under appropriate circumstances, etcetera. But the counter-party doesn't have to be literally tax-indifferent. It just has to be tax-indifferent as between 2018 and 2019. So everyone outside the corporate sector who has the same tax rate in 2018 and 2019 is a potential counter-party.
Okay, as described here that's a sham transaction that would lose under the economic substance rules. But not to worry, build in some economic reality - there's plenty of juice to make sure it will still be worth everybody's while. Companies are starting at huge tax savings from circular cash flows, and there's plenty of room to accommodate tax-indifferent counter-parties, when this is even necessary, and also to tolerate real economic effects (sufficient to defeat the economic substance doctrine) that they'd just as soon do without.
Did the Joint Committee on Taxation include this, and at a proper level, in their revenue estimates? Sorry to be skeptical regarding my old employer, and I know they're doing their best under trying circumstances and at hyper-speed, but I would bet not.
This is just a toy example, but the more I think about it, the more it becomes clear to me that this is potentially a huge problem - in terms both of revenue and ridiculous tax planning games.
Whenever the tax rate on a given actor is declining with a delay, it has an incentive to accelerate deductions and defer realizing positive income. We already knew that. But here the spread is really large - 15 percent - and the period of pre-announcement is really long - more than a year. Has there ever before, in U.S. tax history, been so large a rate cut that (if the Senate approach becomes law) was pre-announced so far in advance? Willing to stand corrected, but I think not.
Plus, the problem is hugely worsened by the presence of expensing. In the 1986 tax reform process, when the corporate rate did indeed decline by 12 points, not only was there offsetting base-broadening, but there was movement towards economic depreciation, rather than towards expensing. Now, as a matter of steady-state tax policy, you may prefer one, or you may prefer the other. But one thing that's indisputable is that expensing creates a much greater gulf between the time when the deduction arises, and that when the income arises. So it is much more problematic and gameable when the specific issue is one of tax rate changes between years.
So again, we can take it just for starters that there will be huge incentives to accelerate deductions and defer income realization. But beyond that, there will be huge incentives to arrange economically senseless (or meaningless) transactions in order to extract huge boatloads of money from the Treasury.
Example: in December 2018, a U.S. corporation pays $100 million to a tax-indifferent counter-party that generates an immediate expensing deduction. In January 2019, the corporation sells it for $90 million, in the simplest case to the very same counter-party. Bingo, everybody wins except for the American people via the effect on the U.S. Treasury.
Who are tax-indifferent counter-parties? We can start with tax-exempts, foreigners under appropriate circumstances, etcetera. But the counter-party doesn't have to be literally tax-indifferent. It just has to be tax-indifferent as between 2018 and 2019. So everyone outside the corporate sector who has the same tax rate in 2018 and 2019 is a potential counter-party.
Okay, as described here that's a sham transaction that would lose under the economic substance rules. But not to worry, build in some economic reality - there's plenty of juice to make sure it will still be worth everybody's while. Companies are starting at huge tax savings from circular cash flows, and there's plenty of room to accommodate tax-indifferent counter-parties, when this is even necessary, and also to tolerate real economic effects (sufficient to defeat the economic substance doctrine) that they'd just as soon do without.
Did the Joint Committee on Taxation include this, and at a proper level, in their revenue estimates? Sorry to be skeptical regarding my old employer, and I know they're doing their best under trying circumstances and at hyper-speed, but I would bet not.
Friday, November 10, 2017
Perverse transitional incentive under the Senate tax bill
The Senate tax bill provides increased expensing immediately (i.e., for 2018), but delays the corporate rate cut for a year (until 2019). This has interesting transition effects, and I don't mean "interesting" as a compliment.
Suppose a company has the opportunity to spend $100 in 2018, in order to earn $90 in 2019. So it faces a $10 loss before tax. But if it can expense the outlay at a 35 percent rate, and include the receipt at a 20 percent rate, then after-tax it's out only $65 in 2018, and retains $72 in 2019. Voila, profitable after-tax investment.
This is a standard problem about tax rate changes with expensing, accelerated depreciation, etc. (And it's why David Bradford came to favor a consumption tax with income tax accounting and interest on basis.) But it's accentuated here by enacting a corporate rate cut more than a year in advance, while providing increased expensing immediately. Not a great idea, I would say.
This time around, I'm sure the villain is inadvertence, not malevolence, but it is an example of how ill-advised it can be to rush out massive tax reform bills with inadequate feedback and vetting, and with ad hoc decisions being made on the fly to finesse revenue targets.
Suppose a company has the opportunity to spend $100 in 2018, in order to earn $90 in 2019. So it faces a $10 loss before tax. But if it can expense the outlay at a 35 percent rate, and include the receipt at a 20 percent rate, then after-tax it's out only $65 in 2018, and retains $72 in 2019. Voila, profitable after-tax investment.
This is a standard problem about tax rate changes with expensing, accelerated depreciation, etc. (And it's why David Bradford came to favor a consumption tax with income tax accounting and interest on basis.) But it's accentuated here by enacting a corporate rate cut more than a year in advance, while providing increased expensing immediately. Not a great idea, I would say.
This time around, I'm sure the villain is inadvertence, not malevolence, but it is an example of how ill-advised it can be to rush out massive tax reform bills with inadequate feedback and vetting, and with ad hoc decisions being made on the fly to finesse revenue targets.
Thursday, November 09, 2017
Pass-throughs remain a train wreck in the Senate Finance Committee chairman's mark
For reasons I have discussed in earlier posts, I continue to be baffled (other than on cynical grounds) by the Congressional Republicans' interest in creating lower tax rates for pass-through income. So it's a disappointment, though not a surprise, to find this bad idea being perpetuated in the Senate Finance Committee chairman's mark.
Basically, the chairman's mark provides a 17.4 percent (just over one-sixth) deduction for business income from partnerships, S corporations, and sole proprietorships, although generally not for service businesses (defined similarly to in the House bill).
While the tax rate cut is smaller at the top than in the House bill, in some ways the guardrails are even weaker. Nothing about material participation as in the House bill. On the other hand, other than for sole proprietors the deduction is limited to 50% of the amount of related W-2 wages. So an S corp sole owner whose business earned, say $800,000, and who paid herself $200,000 of salary would only be able to deduct $100,000 (which is just under 17.4%) of the remaining $600,000 of business income,. She thus might end up reducing her marginal tax rate by only 1/8, under these facts, rather than 1/6. And if, say, a law firm wanted to take advantage by having a separate capital partnership that owned the building and the goodwill and then used transfer pricing to siphon off a share of the profits, it would also have to contrive an excuse for salary payments from the capital partnership (not just the service partnership) to the partners, in order for them to get the deduction.
The provision remains unmotivated industrial policy that sacrifices efficiency, simplicity, revenue, and progressivity in exchange for I can't see what (apart from pleasing donors and employing tax planners). Admittedly, in several respects it is not quite so laser-focused on people at the very top as the House bill. But still there's no tradeoff here - it's just bad tax policy.
Too soon for a victory lap
Today Ways and Means Chair Brady sent a letter to Congressman Blumenauer that seemingly - but not actually - puts the question of state and local tax deductibility by pass-through owners to bed.
Distastefully and inaccurately, but unsurprisingly, he blames the entire thing on the Joint Committee of Taxation. First he notes, in accordance with what we already pretty much knew, that the revenue estimate was prepared under the assumption that state and local income taxes incurred by the owners of pass-through businesses would not be allowable as itemized deductions.
As an aside, I suspect that some combination of that and the adverse political effects of public exposure may possibly have played a role in the decision to "clarify" that no itemized deductions would be allowed to pass-through business owners for state and local income taxes. Ways and Means majority staff has done too much communicating of the contrary answer for one to be confident that what he says now was really the intent, before today.
Anyway, back to the letter. He quotes a JCT publication as saying - the added italics are his - "State and local income ... taxes paid or accrued, other than those paid or accrued in carrying on a trade or business or an [investment] activity ... are no longer allowed as an itemized deduction."
Then he says: "We have discussed the italicized language with the JCT staff, and they have confirmed that this language was an error. We intend to correct this mistake in the Committee Report."
Comment 1: While it's inaccurate and unfair for him to blame the JCT, taking unfair blame is part of their job and they know it. You have to be a grown-up to work for that staff, and preferably not too thin-skinned.
Comment 2: I don't think saying something in the Committee Report is sufficient. They need to address the text of the statute, so that it's clear that pass-through owners can't deduct state and local income taxes despite arguably favorable statutory language that a court could decide to interpret differently than the Committee Report.
Comment 3: What about income taxes that a state or local government formally places on the business itself, not the business owner? A case in point is New York City's unincorporated business tax, which I gather many people believe is deductible as a business expense under present law. There may well be wholesale changes in the formal structure of state and local income taxes, to maximize deductibility for resident business owners, if that works. So this too needs to be "clarified," preferably in the statute as well as the Committee Report.
Distastefully and inaccurately, but unsurprisingly, he blames the entire thing on the Joint Committee of Taxation. First he notes, in accordance with what we already pretty much knew, that the revenue estimate was prepared under the assumption that state and local income taxes incurred by the owners of pass-through businesses would not be allowable as itemized deductions.
As an aside, I suspect that some combination of that and the adverse political effects of public exposure may possibly have played a role in the decision to "clarify" that no itemized deductions would be allowed to pass-through business owners for state and local income taxes. Ways and Means majority staff has done too much communicating of the contrary answer for one to be confident that what he says now was really the intent, before today.
Anyway, back to the letter. He quotes a JCT publication as saying - the added italics are his - "State and local income ... taxes paid or accrued, other than those paid or accrued in carrying on a trade or business or an [investment] activity ... are no longer allowed as an itemized deduction."
Then he says: "We have discussed the italicized language with the JCT staff, and they have confirmed that this language was an error. We intend to correct this mistake in the Committee Report."
Comment 1: While it's inaccurate and unfair for him to blame the JCT, taking unfair blame is part of their job and they know it. You have to be a grown-up to work for that staff, and preferably not too thin-skinned.
Comment 2: I don't think saying something in the Committee Report is sufficient. They need to address the text of the statute, so that it's clear that pass-through owners can't deduct state and local income taxes despite arguably favorable statutory language that a court could decide to interpret differently than the Committee Report.
Comment 3: What about income taxes that a state or local government formally places on the business itself, not the business owner? A case in point is New York City's unincorporated business tax, which I gather many people believe is deductible as a business expense under present law. There may well be wholesale changes in the formal structure of state and local income taxes, to maximize deductibility for resident business owners, if that works. So this too needs to be "clarified," preferably in the statute as well as the Committee Report.
House bill international tax provisions update
Since I posted on the House bill's international tax provisions, they have amended the rather aggressive excise tax provision that I discussed, limiting its reach to high-return foreign subsidiaries, apparently reducing its revenue estimate by 95 percent.
A fuller analysis of the state and local income tax deductibility issue
Here is joint analysis, penned by David Kamin, regarding the state of the play re. state and local income tax deductions for Trump and law firm partners, but not for you.
Because I'm a gentle and charitable soul, I am open to the theory that the mistakenly low revenue estimate - albeit, apparently reflecting a deliberate choice to retain likely state and local income tax deductibility for business owners and passive investors but no one else - arose innocently. But a lot of foot-dragging seems to have been going on towards the end of preventing its being addressed or corrected. And at this point, even if they do correct it, I for one will be inclined to attribute it to their having decided the game was up. A mere misunderstanding could easily have been fixed as early as Tuesday, three days ago, and it wasn't.
Some people not familiar in detail with the substantive analysis have been skeptical of our conclusion - likely continued state and local income tax deductibility for the favored ones - for a couple of reasons. One has been that, under current law, they are rightly skeptical that the favored ones can deduct state and local income taxes other than as itemized deductions on grounds that are independent of the business/ investment aspect (and that are being repealed). But: this view overlooks (a) the subtle backdoor change to flush language at the end of section 164(a) that supports the result, and (b) the distinguishability of existing case law that arises under a different provision altogether (as discussed in the Kamin post. So their assumption that the only deductions at issue are those from a narrow category of existing state and local taxes, such as NYC's "unincorporated business tax" (UBT) is probably incorrect even as things stand. Plus, as Kamin points out, even under that interpretation states could do a whole lot of self-help to make much of their income taxes effectively deductible at the federal level without significant substantive change to their laws. (And it would be a freebie to their own high-flyers that would come purely at the expense of the federal government, not at the expense of less privileged fellow citizens within their own states.)
Second, they may be relying on language in existing section 164(a) that admittedly is not 100% slam dunk certain to provide the result that we have been arguing is probable. The relevant language refers to taxes "paid or accrued within the taxable year in carrying on a trade or business or an activity described in section 212." One could argue, against our view, that this means the tax has to be imposed directly on the trade or business, etc., in its capacity as such - whence NYC's UBT but not regular income taxes.
Not impossible, but it puts an awful lot of weight on a very particular reading of "in." Note how incredibly easy it would have been to signal, either in the statute or the legislative history, that this meant distinguishing between the individual on the one hand and the business on the other hand (even in the case of a sole proprietorship), such that the tax had to be imposed on the business qua business in order to be deductible. But rather than signaling any such view, either in the statute or the legislative history, we have repeated statements that there will be deductions for state and local taxes, including income taxes, incurred in the trade or business and investment settings.
Because I'm a gentle and charitable soul, I am open to the theory that the mistakenly low revenue estimate - albeit, apparently reflecting a deliberate choice to retain likely state and local income tax deductibility for business owners and passive investors but no one else - arose innocently. But a lot of foot-dragging seems to have been going on towards the end of preventing its being addressed or corrected. And at this point, even if they do correct it, I for one will be inclined to attribute it to their having decided the game was up. A mere misunderstanding could easily have been fixed as early as Tuesday, three days ago, and it wasn't.
Some people not familiar in detail with the substantive analysis have been skeptical of our conclusion - likely continued state and local income tax deductibility for the favored ones - for a couple of reasons. One has been that, under current law, they are rightly skeptical that the favored ones can deduct state and local income taxes other than as itemized deductions on grounds that are independent of the business/ investment aspect (and that are being repealed). But: this view overlooks (a) the subtle backdoor change to flush language at the end of section 164(a) that supports the result, and (b) the distinguishability of existing case law that arises under a different provision altogether (as discussed in the Kamin post. So their assumption that the only deductions at issue are those from a narrow category of existing state and local taxes, such as NYC's "unincorporated business tax" (UBT) is probably incorrect even as things stand. Plus, as Kamin points out, even under that interpretation states could do a whole lot of self-help to make much of their income taxes effectively deductible at the federal level without significant substantive change to their laws. (And it would be a freebie to their own high-flyers that would come purely at the expense of the federal government, not at the expense of less privileged fellow citizens within their own states.)
Second, they may be relying on language in existing section 164(a) that admittedly is not 100% slam dunk certain to provide the result that we have been arguing is probable. The relevant language refers to taxes "paid or accrued within the taxable year in carrying on a trade or business or an activity described in section 212." One could argue, against our view, that this means the tax has to be imposed directly on the trade or business, etc., in its capacity as such - whence NYC's UBT but not regular income taxes.
Not impossible, but it puts an awful lot of weight on a very particular reading of "in." Note how incredibly easy it would have been to signal, either in the statute or the legislative history, that this meant distinguishing between the individual on the one hand and the business on the other hand (even in the case of a sole proprietorship), such that the tax had to be imposed on the business qua business in order to be deductible. But rather than signaling any such view, either in the statute or the legislative history, we have repeated statements that there will be deductions for state and local taxes, including income taxes, incurred in the trade or business and investment settings.
Wednesday, November 08, 2017
Dirty business afoot in the Ways and Means Committee?
There was an interesting snippet in today's Ways and Means hearing on the tax legislation. The Youtube footage is here, and the action that I have in mind starts at exactly 3:38:28. It's a colloquy between Democratic Congressman Blumenauer and Republican Committee Chair Brady.
Blumenauer reveals that he has been trying to get an answer for 3 days to the question of whether pass-through business owners - Donald Trump, law firm partners, etcetera - get to deduct state and local income taxes as trade or business (or investment) expenses that are allowable as itemized deductions, even though employees cannot do so, and whether the Joint Committee on Taxation revenue estimate was based on the correct and intended view of this.
He notes that JCT chief of staff Tom Barthold told him one thing - which, as I've pointed out in earlier blog posts, was in at least one respect (and probably more than that) unambiguously mistaken - while the Ways and Means majority staff was simultaneously suggesting something very different (namely that yes, Trump and the law firm partner CAN deduct all of their state and local income taxes under the bill, whereas their employees can't).
Despite the old-style Congressional politesse that both Blumenauer and Brady resolutely stick to, there appears to be some anger under the surface about this. Brady won't let Blumenauer ask Barthold a simple question, and promises only to provide some sort of answer to something or other in writing at some unspecified time or other (and while the clock is running out on committee consideration).
Here is what I strongly suspect is happening:
(1) While the Committee leadership knows that the answer is yes - the likes of Trump and the law firm partner can deduct their state and local income taxes under the bill, whereas employees can't - it does not want this to be generally understood at present. So they are trying to stonewall.
And very possibly also:
(2) The Committee leadership knows that the JCT revenue estimate is wrong because it didn't account properly for the widespread "business owner" deductibility of state and local taxes. This could either have been an honest blunder amid the high-speed train wreck of the rapid-fire drafting, or it could have reflected diffidence about fully explaining things to the JCT - it doesn't matter now. But if they know that the revenue estimate is wrong, and that it would be higher if done right, and that this is at risk of coming out, then they may feel they are trapped and have to push aggressively forward, in the hope of completing this stage of the process before their actions are exposed.
Again, I don't know that #2 is so, but stonewalling has a way of broadening one's suspicions. It would also help to explain why they appear to be so set on stonewalling, when the bill's substantive effect is bound to come out well before enactment anyway.
I'm also quite confident that the bill as it stands, is best interpreted as allowing state and local income tax deductions to business owners, including those who don't qualify for the 25% plutocrat rate. This is the clearly expressed intent of the committee report. It is also the best (and, as things stand, only convincing) reading of the bill's statutory language. But it could very easily be changed if they wanted to change it - except, I gather that they don't want to change it.
Something should be out on this tomorrow morning, possibly with my name among the co-authors but not on this blog (although I'll link to it when I get the chance - busy day as I'll be traveling to Philadelphia for the National Tax Association's Annual Meeting). But now, for the tax geeks in the audience (all others can skip the next three paragraphs), I'll just say:
Take a look at section 164(a) of present law, including the first sentence of the flush language at the end of it. See what is removed from the scope of that flush language ("not described in the preceding sentence") by section 164(a)(3). Then look at section 1303 of the bill, which would amend section 164(b)(5) of present law. The new section 164(b)(5) would make changes to how section 164(a)(3) would now read with respect to individuals. Finally, ask yourself how that change to section 164(a)(3) for individuals affects the scope of the first sentence of the flush language at the end of section 164(a).
I think the answer you will come up with, if you are practiced at reading tax statutes, is that the flush language now newly authorizes the likes of Donald Trump and the law firm partner to take state and local income taxes as an itemized deduction because they were "paid or accrued ... in carrying on a trade or business" and are no longer removed from the scope of the flush language by reason of section 164(a)(3).
This would retain the deduction for employees too (since they are in a trade or business as such), except that elsewhere the bill denies employees all itemized deductions with respect to this trade or business. So it's just for the business owners and passive investors, not for the employees.
It's been elegantly done, and all the more so if they managed to keep it out of the revenue estimate (or did so accidentally but now don't want to fess up). But are we only judging style here, or morality too?
Blumenauer reveals that he has been trying to get an answer for 3 days to the question of whether pass-through business owners - Donald Trump, law firm partners, etcetera - get to deduct state and local income taxes as trade or business (or investment) expenses that are allowable as itemized deductions, even though employees cannot do so, and whether the Joint Committee on Taxation revenue estimate was based on the correct and intended view of this.
He notes that JCT chief of staff Tom Barthold told him one thing - which, as I've pointed out in earlier blog posts, was in at least one respect (and probably more than that) unambiguously mistaken - while the Ways and Means majority staff was simultaneously suggesting something very different (namely that yes, Trump and the law firm partner CAN deduct all of their state and local income taxes under the bill, whereas their employees can't).
Despite the old-style Congressional politesse that both Blumenauer and Brady resolutely stick to, there appears to be some anger under the surface about this. Brady won't let Blumenauer ask Barthold a simple question, and promises only to provide some sort of answer to something or other in writing at some unspecified time or other (and while the clock is running out on committee consideration).
Here is what I strongly suspect is happening:
(1) While the Committee leadership knows that the answer is yes - the likes of Trump and the law firm partner can deduct their state and local income taxes under the bill, whereas employees can't - it does not want this to be generally understood at present. So they are trying to stonewall.
And very possibly also:
(2) The Committee leadership knows that the JCT revenue estimate is wrong because it didn't account properly for the widespread "business owner" deductibility of state and local taxes. This could either have been an honest blunder amid the high-speed train wreck of the rapid-fire drafting, or it could have reflected diffidence about fully explaining things to the JCT - it doesn't matter now. But if they know that the revenue estimate is wrong, and that it would be higher if done right, and that this is at risk of coming out, then they may feel they are trapped and have to push aggressively forward, in the hope of completing this stage of the process before their actions are exposed.
Again, I don't know that #2 is so, but stonewalling has a way of broadening one's suspicions. It would also help to explain why they appear to be so set on stonewalling, when the bill's substantive effect is bound to come out well before enactment anyway.
I'm also quite confident that the bill as it stands, is best interpreted as allowing state and local income tax deductions to business owners, including those who don't qualify for the 25% plutocrat rate. This is the clearly expressed intent of the committee report. It is also the best (and, as things stand, only convincing) reading of the bill's statutory language. But it could very easily be changed if they wanted to change it - except, I gather that they don't want to change it.
Something should be out on this tomorrow morning, possibly with my name among the co-authors but not on this blog (although I'll link to it when I get the chance - busy day as I'll be traveling to Philadelphia for the National Tax Association's Annual Meeting). But now, for the tax geeks in the audience (all others can skip the next three paragraphs), I'll just say:
Take a look at section 164(a) of present law, including the first sentence of the flush language at the end of it. See what is removed from the scope of that flush language ("not described in the preceding sentence") by section 164(a)(3). Then look at section 1303 of the bill, which would amend section 164(b)(5) of present law. The new section 164(b)(5) would make changes to how section 164(a)(3) would now read with respect to individuals. Finally, ask yourself how that change to section 164(a)(3) for individuals affects the scope of the first sentence of the flush language at the end of section 164(a).
I think the answer you will come up with, if you are practiced at reading tax statutes, is that the flush language now newly authorizes the likes of Donald Trump and the law firm partner to take state and local income taxes as an itemized deduction because they were "paid or accrued ... in carrying on a trade or business" and are no longer removed from the scope of the flush language by reason of section 164(a)(3).
This would retain the deduction for employees too (since they are in a trade or business as such), except that elsewhere the bill denies employees all itemized deductions with respect to this trade or business. So it's just for the business owners and passive investors, not for the employees.
It's been elegantly done, and all the more so if they managed to keep it out of the revenue estimate (or did so accidentally but now don't want to fess up). But are we only judging style here, or morality too?
Talk on the EU State Aid Cases at Fordham Law School
Yesterday afternoon at Fordham Law School, I participated in a session discussing the EU state aid cases. After Amedeo Arena of the University of Naples "Federico II" School of Law offered a European perspective, I offered a U.S. perspective, the slides for which are available here.
Tuesday, November 07, 2017
Has the House bill received an accurate revenue estimate?
I've posted recently on the question of how the House bill treats state and local income taxes paid by "business owners" - a term that includes Trump, hedge fund managers, and, for that matter, law firm partners who generally wouldn't get the special 25% plutocrat rate because they are in a service business. [Side note: calling it the "plutocrat rate," while perhaps a bit aggressive, is more accurate than calling it the "small business rate." I'll stop if they do.]
As David Kamin lucidly explains here, it appears that the state and local income tax deduction has NOT been repealed for these individuals. The longstanding itemized deduction for these taxes is gone under the bill, but the business owners would get to deduct the taxes as a business expense, whereas employees would be denied the same deduction (even though it would technically qualify as a business expense for them, too) because they're in the trade or business of being an employee, and employee business expenses are disallowed under the bill.
Kamin's eye-opening follow-up, available here, is strongly recommended reading. Without putting words in his mouth that he didn't say, it raises questions about the accuracy, and perhaps even the integrity, of the revenue estimating process for this bill.
As Kamin explains:
(1) the House Ways and Means Republicans, whose bill this is, "intend to write a loophole into the limitation on the state and local income tax deduction - or have us believe they are. They've said so. Repeatedly. Over time. And the statutory language, though ambiguous, could get them there."
(2) Thomas Barthold, Chief of Staff for the Joint Committee on Taxation, believes otherwise. When asked in a Way and Means mark-up hearing on the legislation, "he said the loophole doesn't exist and that owners and investors wouldn't be able to take the deduction for state and local income taxes, though he conveyed this in a confusing fashion."
Barthold also made a clearly erroneous suggestion to the effect that, among business owners, those engaged in service businesses certainly wouldn't get the deduction. But while service businesses don't get the special 25% plutocrat rate, there is no ambiguity in the legislation about the lack of any tie between this issue and that of state and local income tax deductibility by business owners.
You can check it out for yourself here (footage of the relevant moment in the mark-up hearing).
Now, I don't mean in any way to criticize Tom Barthold for this. Even leaving aside the ridiculously abbreviated process that has got to be over-taxing (so to speak) the entire JCT staff, he is a person of great integrity, in keeping with a proud tradition of JCT integrity that goes back to long before my own days there (I was on the JCT staff from 1984 to 1987). It would be amazing if the JCT chief got everything right in a markup under these circumstances.
But if I understand how a JCT chief prepares for hearings like this, he works closely with his staff. What he says about a particular issue is highly likely to reflect what those among his staffers who are working on the issue believe to be the case. There are JCT staffers on point of two relevant kinds: (1) the lawyers, who are working on structuring, drafting, and explaining the legislation (possibly with an economist or two), and (2) the revenue estimators, who determine the revenue "score." And of course these groups (1) and (2) are talking to each other as well.
So I consider what Barthold said to be plausible prima facie evidence of what JCT believes about the legislation, and assumed for purposes of its revenue estimate.
This brings us back to the House Republicans whose bill this is believing something else about state and local income tax deductibility - or at least, as Kamin says, wanting to "have us believe" they are creating the loophole. (For "us," perhaps one might substitute "the lobbyists who are also pushing for the 25% plutocrat rate.")
Have the House Republicans tried to communicate their true understanding (assuming it's true) to the JCT? Have they tried to avoid communicating it? Has it simply been a huge oversight? If so, has anyone been eager to correct it, and thus fix the revenue estimate if necessary, before the House votes on the bill? Are the lobbyists, not the JCT, the ones who are being fooled? (But in that case, why wouldn't the loophole prevail, given the evidence supporting its being intended?)
These questions ought to be answered, and the sooner the better.
As David Kamin lucidly explains here, it appears that the state and local income tax deduction has NOT been repealed for these individuals. The longstanding itemized deduction for these taxes is gone under the bill, but the business owners would get to deduct the taxes as a business expense, whereas employees would be denied the same deduction (even though it would technically qualify as a business expense for them, too) because they're in the trade or business of being an employee, and employee business expenses are disallowed under the bill.
Kamin's eye-opening follow-up, available here, is strongly recommended reading. Without putting words in his mouth that he didn't say, it raises questions about the accuracy, and perhaps even the integrity, of the revenue estimating process for this bill.
As Kamin explains:
(1) the House Ways and Means Republicans, whose bill this is, "intend to write a loophole into the limitation on the state and local income tax deduction - or have us believe they are. They've said so. Repeatedly. Over time. And the statutory language, though ambiguous, could get them there."
(2) Thomas Barthold, Chief of Staff for the Joint Committee on Taxation, believes otherwise. When asked in a Way and Means mark-up hearing on the legislation, "he said the loophole doesn't exist and that owners and investors wouldn't be able to take the deduction for state and local income taxes, though he conveyed this in a confusing fashion."
Barthold also made a clearly erroneous suggestion to the effect that, among business owners, those engaged in service businesses certainly wouldn't get the deduction. But while service businesses don't get the special 25% plutocrat rate, there is no ambiguity in the legislation about the lack of any tie between this issue and that of state and local income tax deductibility by business owners.
You can check it out for yourself here (footage of the relevant moment in the mark-up hearing).
Now, I don't mean in any way to criticize Tom Barthold for this. Even leaving aside the ridiculously abbreviated process that has got to be over-taxing (so to speak) the entire JCT staff, he is a person of great integrity, in keeping with a proud tradition of JCT integrity that goes back to long before my own days there (I was on the JCT staff from 1984 to 1987). It would be amazing if the JCT chief got everything right in a markup under these circumstances.
But if I understand how a JCT chief prepares for hearings like this, he works closely with his staff. What he says about a particular issue is highly likely to reflect what those among his staffers who are working on the issue believe to be the case. There are JCT staffers on point of two relevant kinds: (1) the lawyers, who are working on structuring, drafting, and explaining the legislation (possibly with an economist or two), and (2) the revenue estimators, who determine the revenue "score." And of course these groups (1) and (2) are talking to each other as well.
So I consider what Barthold said to be plausible prima facie evidence of what JCT believes about the legislation, and assumed for purposes of its revenue estimate.
This brings us back to the House Republicans whose bill this is believing something else about state and local income tax deductibility - or at least, as Kamin says, wanting to "have us believe" they are creating the loophole. (For "us," perhaps one might substitute "the lobbyists who are also pushing for the 25% plutocrat rate.")
Have the House Republicans tried to communicate their true understanding (assuming it's true) to the JCT? Have they tried to avoid communicating it? Has it simply been a huge oversight? If so, has anyone been eager to correct it, and thus fix the revenue estimate if necessary, before the House votes on the bill? Are the lobbyists, not the JCT, the ones who are being fooled? (But in that case, why wouldn't the loophole prevail, given the evidence supporting its being intended?)
These questions ought to be answered, and the sooner the better.
Monday, November 06, 2017
Broader thoughts on the House Republican bill's international provisions
I realize that my posts on the proposed pass-through legislation have been quite harsh. I really don't like sounding that way - it literally makes me heartsick, but I find those provisions to be so bad, indefensible, and redolent of bad faith that I'm pretty much driven to it. I feel it's necessary to sound the alarm.
The international provisions in the House Republican bill are different. So it's with considerable relief that I can address them, albeit still just preliminarily here, in an entirely different tone.
I've already briefly addressed, in that less heated vein, section 4301 of the House bill, which requires current incluson by U.S.-headed multinationals of foreign high returns. Herewith a bit of expansion in scope.
I would group the international tax provisions in the House bill into three categories.
First, tax cuts that are mainly from exemption, plus making permanent a rule in the current Code that facilitates foreign-to-foreign tax planning by U.S. companies, would lose $212B during the period. (Note, however, that exemption here just means dividend exemption - subpart F, which denies deferral to certain foreign earnings, would remain in place with specified changes, and would now have the effect of denying exemption, rather than denying deferral.)
Second, anti-base erosion provisions would raise $265B during the period. So we are already, at this point, plus $53B in projected revenue.
Third, the deemed repatriation provision for pre-enactment unrepatriated foreign earnings would raise $212B.
Should #3 be added together with ##1 and 2? If so, then the net revenue increase rises to $265B. The answer to this is Yes or No, depending on your purpose. It is additional tax liability from US multinationals. On the other hand, it's from past stuff that doesn't have the same relevance for incentives and tax burdens going forward. The US companies would certainly have voluntarily paid something to wipe clean the deferred liability. But I doubt that the amount they'd be happy to pay is anywhere as high as $212B. I imagine that they anticipated getting off cheaper (and probably still do).
To return to the cynical tone for a moment, what seems to have happened here is that the House Republicans pulled a Willy Loman on the US multinationals. In short, those companies are liked, but not well-liked, by the House Republicans, and hence have been sacrificed to the cause of directing more of the kitty to the pass-throughs, for whom even "well-liked" is probably too milquetoast a term (try "loved").
I don't know as yet how U.S. multinationals are reacting to this. They can't be ecstatic, although it's true they get the general U.S. rate reduction. They may even, for all I know at this early point, be strongly opposed. One thing that's got to displease them in particular is that, even if none of this passes, the anti-base erosion provisions are now on The List. The fact that a generally business-friendly House Republican leadership proposed them may offer a kind of free pass for others to re-propose them in the future, and to have a strong talking point to the effect of: This can't be crazy harsh - look at who proposed it!
I mentioned in my earlier blog post that the provision (sec. 4301) requiring current year inclusion by US shareholders of certain foreign high returns (projected to raise $77B in ten years) has the virtues of (a) taxing the income that is subject to it at a rate between 0 and the full domestic rate, and (b) making foreign taxes only partly creditable, hence having a marginal reimbursement rate (MRR) that is between the marginal tax rate and 100%. Both of these very general ranges are the ones that I have argued for, which obviously leaves a whole lot of room for debate about too high vs. too low. This provision appears to be aimed above all at rents, such as from intellectual property, that typically ends up in a tax haven at the expense of US as well as foreign tax bases.
The next of the three anti-base erosion rules addresses interest-stripping - in other words, the use of intra-group interest deductions and strategic placement in the US of third-party bank borrowing - that companies would use to reduce US source taxable income. Notably, it applies to foreign-headed as well as US-headed multinational groups. The key term of art, making one potentially subject to the rule, is membership in an "international financial reporting group." I don't as yet know how problematic (or not) that will be to apply, but I do like the aim of moving towards residence-neutrality in anti-base erosion rules (i.e., not just applying such rules to US companies). Here the 10-year revenue estimate is $34B.
The third anti-base erosion rule is the biggest, with a 10-year revenue estimate of $154.5B. It definitely raises some issues, but certainly has the advantage of being interesting.
It slaps a 20% excise tax on payments from domestic companies to related foreign companies if the payment is either deductible in the US or added to the basis of something. One exception to the application of this rule is for certain commodities transactions. But the big exception is for payments at cost (i.e., with no markup). Once again, it's residence-neutral, with respect to US vs. foreign multinational, via application to international financial reporting groups.
Here is a possible illustration (if I am understanding this correctly). US company buys good or services from a foreign affiliate for $1M. If the foreign company has sold it to the US company at cost (i.e., its cost was $1M), no effect. But if there is any markup (its cost was <$1M) then bingo, 20% excise tax, or $200K.
Let's elide for now the issue of determining the foreign company's cost, which the statute does indeed address (it appears, under pro rata type principles for expenses of doing lots of different things). The result would be over-harsh, and subject to a severe cliff effect since the whole thing becomes taxable as soon as there's any markup, if one imagined it actually applying. But the excise tax appears to be intended as a hammer that taxpayers will opt out of, rather than as something that's actually meant to apply frequently.
One way to avoid it is by electing, as the provision permits, to have the payments to the foreign affiliate treated as effectively connected US business income. In other words, one avoids the 20% excise tax on the gross amount by electing to pay a 20% income tax on the net profit. This eliminates the transfer pricing benefit to having the US affiliate pay a high price to the foreign affiliate. Plus, it applies this 20% tax to the profit that the foreign affiliate would have treated as foreign source even with reasonable and defensible transfer pricing.
The other way to avoid it is by doing a true arm's length sale with a third party. That presumably is meant to assure that the arm's length price will truly be a market price. I would think that one has to look at what happens next, on the other side of the transaction, to address strategic use of third party companies as well-compensated intermediaries, and the statute contains an authorization for the Treasury to issue regulations addressing conduit transactions. This could end up being drafted either narrowly, for pure conduits that just get a fee for spending 5 minutes in the middle, to more broadly, if both sides of the transaction (US company to third party, third party to foreign affiliate of US company) are sufficiently closely scrutinized.
This may be quite significant. After all, it seems eminently worthwhile to pay an accommodation party something just to get out of all the rest. But if the high revenue estimate is correct then it must not be (in the estimators' judgment) quite as trivial as all that.
Hard to tell at this point how this provision would work out in practice - e.g., too harsh? too avoidable? too complicated and uncertain? It also may raise treaty issues. I would expect US companies to aim a lot of fire at this provision if it goes far enough for this to be worth their while, and if they agree as a ballpark matter with the revenue estimate,. What they have to say may be illuminating, even if (to mix the metaphors) one has to discount it with a grain of salt. But it does look like the House Republicans have taken a urprisingly big swing at transfer pricing games by both US and foreign multinationals.
One further political aspect here is that a lot of the pain (such as it is) is being imposed on foreign multinationals, rather than US multinationals. The latter may be fine with this!
While I think a whole lot more work and information will be needed to evaluate the anti-base erosion rules, it does look like they should be taken seriously, and at a minimum added to the list of proposals in this genre to consider no matter what happens (or doesn't) to the rest of the U.S. international tax regime.
Again, it feels much better, on my part, to be able to take such a tone rather than the sharply hostile one that I felt was unavoidable with respect to the pass-through proposals.
Message to US multinationals: the House Republicans don't like you as much as you thought they did. True, they'd undoubtedly be happy to give you everything you want if the political cost to them was low enough. But they evidently like you a whole lot less than they like their friends in the pass-through sector. This is something you should keep in mind even if, with changing circumstances, they choose to re-align with you.
The international provisions in the House Republican bill are different. So it's with considerable relief that I can address them, albeit still just preliminarily here, in an entirely different tone.
I've already briefly addressed, in that less heated vein, section 4301 of the House bill, which requires current incluson by U.S.-headed multinationals of foreign high returns. Herewith a bit of expansion in scope.
I would group the international tax provisions in the House bill into three categories.
First, tax cuts that are mainly from exemption, plus making permanent a rule in the current Code that facilitates foreign-to-foreign tax planning by U.S. companies, would lose $212B during the period. (Note, however, that exemption here just means dividend exemption - subpart F, which denies deferral to certain foreign earnings, would remain in place with specified changes, and would now have the effect of denying exemption, rather than denying deferral.)
Second, anti-base erosion provisions would raise $265B during the period. So we are already, at this point, plus $53B in projected revenue.
Third, the deemed repatriation provision for pre-enactment unrepatriated foreign earnings would raise $212B.
Should #3 be added together with ##1 and 2? If so, then the net revenue increase rises to $265B. The answer to this is Yes or No, depending on your purpose. It is additional tax liability from US multinationals. On the other hand, it's from past stuff that doesn't have the same relevance for incentives and tax burdens going forward. The US companies would certainly have voluntarily paid something to wipe clean the deferred liability. But I doubt that the amount they'd be happy to pay is anywhere as high as $212B. I imagine that they anticipated getting off cheaper (and probably still do).
To return to the cynical tone for a moment, what seems to have happened here is that the House Republicans pulled a Willy Loman on the US multinationals. In short, those companies are liked, but not well-liked, by the House Republicans, and hence have been sacrificed to the cause of directing more of the kitty to the pass-throughs, for whom even "well-liked" is probably too milquetoast a term (try "loved").
I don't know as yet how U.S. multinationals are reacting to this. They can't be ecstatic, although it's true they get the general U.S. rate reduction. They may even, for all I know at this early point, be strongly opposed. One thing that's got to displease them in particular is that, even if none of this passes, the anti-base erosion provisions are now on The List. The fact that a generally business-friendly House Republican leadership proposed them may offer a kind of free pass for others to re-propose them in the future, and to have a strong talking point to the effect of: This can't be crazy harsh - look at who proposed it!
I mentioned in my earlier blog post that the provision (sec. 4301) requiring current year inclusion by US shareholders of certain foreign high returns (projected to raise $77B in ten years) has the virtues of (a) taxing the income that is subject to it at a rate between 0 and the full domestic rate, and (b) making foreign taxes only partly creditable, hence having a marginal reimbursement rate (MRR) that is between the marginal tax rate and 100%. Both of these very general ranges are the ones that I have argued for, which obviously leaves a whole lot of room for debate about too high vs. too low. This provision appears to be aimed above all at rents, such as from intellectual property, that typically ends up in a tax haven at the expense of US as well as foreign tax bases.
The next of the three anti-base erosion rules addresses interest-stripping - in other words, the use of intra-group interest deductions and strategic placement in the US of third-party bank borrowing - that companies would use to reduce US source taxable income. Notably, it applies to foreign-headed as well as US-headed multinational groups. The key term of art, making one potentially subject to the rule, is membership in an "international financial reporting group." I don't as yet know how problematic (or not) that will be to apply, but I do like the aim of moving towards residence-neutrality in anti-base erosion rules (i.e., not just applying such rules to US companies). Here the 10-year revenue estimate is $34B.
The third anti-base erosion rule is the biggest, with a 10-year revenue estimate of $154.5B. It definitely raises some issues, but certainly has the advantage of being interesting.
It slaps a 20% excise tax on payments from domestic companies to related foreign companies if the payment is either deductible in the US or added to the basis of something. One exception to the application of this rule is for certain commodities transactions. But the big exception is for payments at cost (i.e., with no markup). Once again, it's residence-neutral, with respect to US vs. foreign multinational, via application to international financial reporting groups.
Here is a possible illustration (if I am understanding this correctly). US company buys good or services from a foreign affiliate for $1M. If the foreign company has sold it to the US company at cost (i.e., its cost was $1M), no effect. But if there is any markup (its cost was <$1M) then bingo, 20% excise tax, or $200K.
Let's elide for now the issue of determining the foreign company's cost, which the statute does indeed address (it appears, under pro rata type principles for expenses of doing lots of different things). The result would be over-harsh, and subject to a severe cliff effect since the whole thing becomes taxable as soon as there's any markup, if one imagined it actually applying. But the excise tax appears to be intended as a hammer that taxpayers will opt out of, rather than as something that's actually meant to apply frequently.
One way to avoid it is by electing, as the provision permits, to have the payments to the foreign affiliate treated as effectively connected US business income. In other words, one avoids the 20% excise tax on the gross amount by electing to pay a 20% income tax on the net profit. This eliminates the transfer pricing benefit to having the US affiliate pay a high price to the foreign affiliate. Plus, it applies this 20% tax to the profit that the foreign affiliate would have treated as foreign source even with reasonable and defensible transfer pricing.
The other way to avoid it is by doing a true arm's length sale with a third party. That presumably is meant to assure that the arm's length price will truly be a market price. I would think that one has to look at what happens next, on the other side of the transaction, to address strategic use of third party companies as well-compensated intermediaries, and the statute contains an authorization for the Treasury to issue regulations addressing conduit transactions. This could end up being drafted either narrowly, for pure conduits that just get a fee for spending 5 minutes in the middle, to more broadly, if both sides of the transaction (US company to third party, third party to foreign affiliate of US company) are sufficiently closely scrutinized.
This may be quite significant. After all, it seems eminently worthwhile to pay an accommodation party something just to get out of all the rest. But if the high revenue estimate is correct then it must not be (in the estimators' judgment) quite as trivial as all that.
Hard to tell at this point how this provision would work out in practice - e.g., too harsh? too avoidable? too complicated and uncertain? It also may raise treaty issues. I would expect US companies to aim a lot of fire at this provision if it goes far enough for this to be worth their while, and if they agree as a ballpark matter with the revenue estimate,. What they have to say may be illuminating, even if (to mix the metaphors) one has to discount it with a grain of salt. But it does look like the House Republicans have taken a urprisingly big swing at transfer pricing games by both US and foreign multinationals.
One further political aspect here is that a lot of the pain (such as it is) is being imposed on foreign multinationals, rather than US multinationals. The latter may be fine with this!
While I think a whole lot more work and information will be needed to evaluate the anti-base erosion rules, it does look like they should be taken seriously, and at a minimum added to the list of proposals in this genre to consider no matter what happens (or doesn't) to the rest of the U.S. international tax regime.
Again, it feels much better, on my part, to be able to take such a tone rather than the sharply hostile one that I felt was unavoidable with respect to the pass-through proposals.
Message to US multinationals: the House Republicans don't like you as much as you thought they did. True, they'd undoubtedly be happy to give you everything you want if the political cost to them was low enough. But they evidently like you a whole lot less than they like their friends in the pass-through sector. This is something you should keep in mind even if, with changing circumstances, they choose to re-align with you.
Sunday, November 05, 2017
Amazing audacity
As David Kamin explains here, the House Republicans appear to have attempted a very sneaky move that they may have been hoping people wouldn't catch until it was too late. The committee report makes it clear that they are trying to make state and local income taxes still deductible for "business owners" and passive investors - but not for anyone else.
As a technical matter, they arguably screwed this up and failed to get the result they have stated they want. But the legislative language may well be, at a minimum, ambiguous enough to permit its being interpreted the way that they evidently want it to be.
For a full technical dive, read Kamin's just-posted column, including the full walk through at the end. But the basics are as follows:
The bill repeals the itemized deduction for state and local income taxes. Thus, no more state and local income tax deduction of any sort, UNLESS - and this is a big "unless" - it's a business expense or an expense of earning income.
So let's take 3 people: (1) Donald Trump (pass-through owner who gets the special 25% plutocrat's discount rate for business owners),
(2) Law Firm Partner, who doesn't get the 25% plutocrat's rate because he or she is in a service business (leaving aside the inevitable real estate partnership that owns the building and will be used to drain off profits from the service partnership, as Victor Fleischer has explained), and
(3) Regular Employee - in the law firm context, including associates, paralegals, and secretaries, but also generally all employees everywhere.
All three are in a trade or business. And the proposed legislation expressly says that state and local income taxes, though no longer allowable as an itemized deduction, can be treated as a business expense or expense of earning income. (See Kamin, in particular the appendix at the end, in re. why and how this may have changed from present law, under which state and local income taxes generally are forced into the itemized deduction rubric for individual returns, and otherwise can't be deducted by the individuals who incur them.)
But the bill also disallows ALL itemized deductions by employees in relation to their trade or business of being an employee. (This is probably intended in part as a sneak attack on deducting union dues, but it also reaches plenty of other meritorious items, along perhaps with some dubious ones, that under present law would generally be deductible below-the-line at least to the extent in excess of 2 percent of adjusted gross income.)
So here's where we end up, assuming that the above analysis is correct:
First, Trump still gets to deduct all of his state and local income taxes, other than those that relate to being an employee (which presumably will just be for his salary as president). Note that he also no longer has to worry about state and local income taxes being disallowed as an itemized deduction under the alternative minimum tax (AMT), since that is being repealed. So, his president's salary aside, he is actually getting an expanded state and local income tax deduction compared to present law, albeit that its value is reduced by the bill's slashing his marginal rate for most of his income to 25%.
Second, the law firm partner, although denied the 25% plutocrat's rate because he is in a service business, gets to deduct his state and local income tax because he incurs them as a business owner.
Third, all of the employees, at the law firm and elsewhere, are denied state and local income tax deductions because they are under the wholly disallowed employee business expense rubric.
Kamin asks in his blog whether the revenue estimators at JCT understood this when they prepared their estimates. I would presume that the answer is Yes, because (a) they're smart folks, would have spotted the issue, and would have needed to know how to estimate it, plus (b) the intent by the drafters appears to be quite clear. But in truth who knows at this point. If it fell between the cracks - or was successfully concealed from them - and they thus didn't know, then the revenue estimate for repealing the state and local income deduction is going to decline significantly. This is probably big enough to have nontrivial implications for the overall bottom line revenue estimate relative to the budget ceiling with which they were working.
If the proponents didn't mean to allow state and local income tax deductions for plutocrats and other business owners, while denying the deductions for everyone else, then they'd best say so ASAP.
I'm not easily shocked, but, unless an innocent explanation unexpectedly emerges, I consider this a truly disgusting episode. Trying to sneak in continued state and local income tax deductions for what are generally high-income people and no one else, and doing it in a way that meant significant legwork was needed to figure it out, is both substantively indefensible and a slap in the face of honest and open lawmaking.
As a technical matter, they arguably screwed this up and failed to get the result they have stated they want. But the legislative language may well be, at a minimum, ambiguous enough to permit its being interpreted the way that they evidently want it to be.
For a full technical dive, read Kamin's just-posted column, including the full walk through at the end. But the basics are as follows:
The bill repeals the itemized deduction for state and local income taxes. Thus, no more state and local income tax deduction of any sort, UNLESS - and this is a big "unless" - it's a business expense or an expense of earning income.
So let's take 3 people: (1) Donald Trump (pass-through owner who gets the special 25% plutocrat's discount rate for business owners),
(2) Law Firm Partner, who doesn't get the 25% plutocrat's rate because he or she is in a service business (leaving aside the inevitable real estate partnership that owns the building and will be used to drain off profits from the service partnership, as Victor Fleischer has explained), and
(3) Regular Employee - in the law firm context, including associates, paralegals, and secretaries, but also generally all employees everywhere.
All three are in a trade or business. And the proposed legislation expressly says that state and local income taxes, though no longer allowable as an itemized deduction, can be treated as a business expense or expense of earning income. (See Kamin, in particular the appendix at the end, in re. why and how this may have changed from present law, under which state and local income taxes generally are forced into the itemized deduction rubric for individual returns, and otherwise can't be deducted by the individuals who incur them.)
But the bill also disallows ALL itemized deductions by employees in relation to their trade or business of being an employee. (This is probably intended in part as a sneak attack on deducting union dues, but it also reaches plenty of other meritorious items, along perhaps with some dubious ones, that under present law would generally be deductible below-the-line at least to the extent in excess of 2 percent of adjusted gross income.)
So here's where we end up, assuming that the above analysis is correct:
First, Trump still gets to deduct all of his state and local income taxes, other than those that relate to being an employee (which presumably will just be for his salary as president). Note that he also no longer has to worry about state and local income taxes being disallowed as an itemized deduction under the alternative minimum tax (AMT), since that is being repealed. So, his president's salary aside, he is actually getting an expanded state and local income tax deduction compared to present law, albeit that its value is reduced by the bill's slashing his marginal rate for most of his income to 25%.
Second, the law firm partner, although denied the 25% plutocrat's rate because he is in a service business, gets to deduct his state and local income tax because he incurs them as a business owner.
Third, all of the employees, at the law firm and elsewhere, are denied state and local income tax deductions because they are under the wholly disallowed employee business expense rubric.
Kamin asks in his blog whether the revenue estimators at JCT understood this when they prepared their estimates. I would presume that the answer is Yes, because (a) they're smart folks, would have spotted the issue, and would have needed to know how to estimate it, plus (b) the intent by the drafters appears to be quite clear. But in truth who knows at this point. If it fell between the cracks - or was successfully concealed from them - and they thus didn't know, then the revenue estimate for repealing the state and local income deduction is going to decline significantly. This is probably big enough to have nontrivial implications for the overall bottom line revenue estimate relative to the budget ceiling with which they were working.
If the proponents didn't mean to allow state and local income tax deductions for plutocrats and other business owners, while denying the deductions for everyone else, then they'd best say so ASAP.
I'm not easily shocked, but, unless an innocent explanation unexpectedly emerges, I consider this a truly disgusting episode. Trying to sneak in continued state and local income tax deductions for what are generally high-income people and no one else, and doing it in a way that meant significant legwork was needed to figure it out, is both substantively indefensible and a slap in the face of honest and open lawmaking.
Friday, November 03, 2017
Two gigs next week
I'll be participating in panels twice next week. For each, I've prepared slides that I'll post in due course.
First, on Tuesday at 5 pm at Fordham Law School, I'll be commenting on the EU State Aid cases, in the aftermath of comments by Professor Amedeo Arena of the University of Naples School of Law. Details about the event are available here.
Then on Thursday, I'll be in Philadelphia at the National Tax Association's Annual Meeting. In addition to chairing a panel, I'll be giving a shortened and altered version of my talk from early June 2017, entitled The Rise and Fall of the Destination-Based Cash Flow Tax: What Was That All About? This time, my slides are entitled "A Requiem for the Destination-Based Cash Flow Tax."
First, on Tuesday at 5 pm at Fordham Law School, I'll be commenting on the EU State Aid cases, in the aftermath of comments by Professor Amedeo Arena of the University of Naples School of Law. Details about the event are available here.
Then on Thursday, I'll be in Philadelphia at the National Tax Association's Annual Meeting. In addition to chairing a panel, I'll be giving a shortened and altered version of my talk from early June 2017, entitled The Rise and Fall of the Destination-Based Cash Flow Tax: What Was That All About? This time, my slides are entitled "A Requiem for the Destination-Based Cash Flow Tax."
Meanwhile, back at the ranch ...
While I've felt impelled to think a bit about the House Republican tax bill, and to write a few blog posts about it, my main scholarly efforts and interests at present are actually in a very different area.
As some regular readers may know, I've been working for some time on a book about high-end inequality as it has figured in various (mostly great) works of literature over the last 200+ years. The description of the project here is by now quite out of date, but it shows where I was at an earlier stage. Where I am now is having two separate books, for reasons of length plus natural divisibility. Book 1, of which I'm in the later stages now, takes the story from the Age of Revolution to the Gilded Age & run-up to World War I.
As of a couple of months ago, I thought the only books I'd discuss at length in Book 1 (although I have a shorter section on Horatio Alger) would be the following:
Part 1, Age of Revolution
Chapter 2 (after introduction) - Austen, Pride and Prejudice.
Chapter 3 - Stendhal, Le Rouge et Le Noir
Chapter 4 - Balzac, Le Pere Goriot and La Maison Nucingen
Part 2, England Mid-Nineteenth Century Through the Onset of World War I
Chapter 5 - Dickens, A Christmas Carol
Chapter 6 - Trollope, The Way We Live Now
Chapter 7 - Forster, Howards End.
Part 3, American in the Gilded Age
Chapter 8 - Twain and Warner, The Gilded Age
Chapter 9 - Dreiser, The Financier and The Titan
I have completed drafts of all these chapters and am reasonably happy (despite self-critical tendencies) with most or perhaps even all of them.
Okay, quiz question. How does Part 3 look different from Parts 1 and 2? Snap answer, it only covers two books, not three. I had persuaded myself, partly for reasons of length, that this made sense, but I've now come to realize that it doesn't. I need a third book not just for symmetry, but to broaden the inquiry and get to where I see it all going.
I've now picked my book, which will be new Chapter 9 (ahead of Dreiser). It's an obvious choice, I guess - Edith Wharton's The House of Mirth. I'm in the later stages of researching the chapter and have begun to lay out, albeit still tentatively, the chapter's structure and trajectory.
Quick shout-out: I absolutely love this book. Although I'm biased at the point when I am actually writing about a particular book (which causes me to engage with it emotionally), I would probably rate it in the top 3 out of the 9 that I am discussing (along with Austen and Stendhal).
It's an amazingly angry and bitter book. None of the others on my list comes close (well, Stendhal perhaps closest). It's also exceptionally timely and prescient, in the age of Trump and Weinstein, on gender issues as well as status battles at the top. Indeed, a lot of its anger is about gender issues, as distinct from class, although the two are intertwined and my project is directed at the latter.
Reflecting sexism, Wharton has always tended to be dismissed as a junior varsity Henry James. (Indeed, James was among those taking this view.) But here's a snippet for you. The House of Mirth has a scene in which the heroine, Lily Bart, is sexually assaulted by a rich and powerful man who she thought was helping her. (Using the standard powerful man's playbook, he tricks her into going to his house when he's alone there, in this case by making her think his wife invited her.)
Lily escapes the assault. But it leaves her feeling shamed, embarrassed, disgraced, and as if it were HER fault. She doesn't need others to blame the victim - she's doing it herself.
But not to worry, others are happy to blame her, too. These include the man who she thinks is her friend and defender, Lawrence Selden, but who, seeing her leave the assaulter's house in dishevelment, immediately assumes it's her fault, and that she's unworthy, and so, without any further inquiry, abandons her.
There isn't too much of that sort of thing in Henry James novels. Or indeed in anything by male novelists writing > 100 years ago.
As some regular readers may know, I've been working for some time on a book about high-end inequality as it has figured in various (mostly great) works of literature over the last 200+ years. The description of the project here is by now quite out of date, but it shows where I was at an earlier stage. Where I am now is having two separate books, for reasons of length plus natural divisibility. Book 1, of which I'm in the later stages now, takes the story from the Age of Revolution to the Gilded Age & run-up to World War I.
As of a couple of months ago, I thought the only books I'd discuss at length in Book 1 (although I have a shorter section on Horatio Alger) would be the following:
Part 1, Age of Revolution
Chapter 2 (after introduction) - Austen, Pride and Prejudice.
Chapter 3 - Stendhal, Le Rouge et Le Noir
Chapter 4 - Balzac, Le Pere Goriot and La Maison Nucingen
Part 2, England Mid-Nineteenth Century Through the Onset of World War I
Chapter 5 - Dickens, A Christmas Carol
Chapter 6 - Trollope, The Way We Live Now
Chapter 7 - Forster, Howards End.
Part 3, American in the Gilded Age
Chapter 8 - Twain and Warner, The Gilded Age
Chapter 9 - Dreiser, The Financier and The Titan
I have completed drafts of all these chapters and am reasonably happy (despite self-critical tendencies) with most or perhaps even all of them.
Okay, quiz question. How does Part 3 look different from Parts 1 and 2? Snap answer, it only covers two books, not three. I had persuaded myself, partly for reasons of length, that this made sense, but I've now come to realize that it doesn't. I need a third book not just for symmetry, but to broaden the inquiry and get to where I see it all going.
I've now picked my book, which will be new Chapter 9 (ahead of Dreiser). It's an obvious choice, I guess - Edith Wharton's The House of Mirth. I'm in the later stages of researching the chapter and have begun to lay out, albeit still tentatively, the chapter's structure and trajectory.
Quick shout-out: I absolutely love this book. Although I'm biased at the point when I am actually writing about a particular book (which causes me to engage with it emotionally), I would probably rate it in the top 3 out of the 9 that I am discussing (along with Austen and Stendhal).
It's an amazingly angry and bitter book. None of the others on my list comes close (well, Stendhal perhaps closest). It's also exceptionally timely and prescient, in the age of Trump and Weinstein, on gender issues as well as status battles at the top. Indeed, a lot of its anger is about gender issues, as distinct from class, although the two are intertwined and my project is directed at the latter.
Reflecting sexism, Wharton has always tended to be dismissed as a junior varsity Henry James. (Indeed, James was among those taking this view.) But here's a snippet for you. The House of Mirth has a scene in which the heroine, Lily Bart, is sexually assaulted by a rich and powerful man who she thought was helping her. (Using the standard powerful man's playbook, he tricks her into going to his house when he's alone there, in this case by making her think his wife invited her.)
Lily escapes the assault. But it leaves her feeling shamed, embarrassed, disgraced, and as if it were HER fault. She doesn't need others to blame the victim - she's doing it herself.
But not to worry, others are happy to blame her, too. These include the man who she thinks is her friend and defender, Lawrence Selden, but who, seeing her leave the assaulter's house in dishevelment, immediately assumes it's her fault, and that she's unworthy, and so, without any further inquiry, abandons her.
There isn't too much of that sort of thing in Henry James novels. Or indeed in anything by male novelists writing > 100 years ago.
Time to dust off the shingle?
An old friend who's a tax lawyer called to ask me if I am celebrating the Republican House bill. He had a particular (if partly tongue-in-cheek) reason why he thought I should be. A bit of background will supply the reason.
As I've noted, the special 25 percent percent rate for business owners in industries that the House Republicans like relies heavily on the passive loss rules in order to determine who gets the 25 percent rate as to all of their income from a given business, not just 30% of it.
I was in drafting sessions during my days as a legislative staffer, and I can totally understand why the drafters, if it was their call, decided to do this. It solves a drafting problem for them, related to higher vs. lower labor income component from a given business, without requiring them to draft anything new. The passive loss rules have been there for 30+ years, and apparently have worked okay for the most part. So why not borrow them for this purpose? Drafters do this sort of thing all the time, and indeed, given the constraints they face, they must.
But as I pointed out in an earlier post, the passive loss rules are highly unlikely to be able to function adequately in this new area. They most commonly induce taxpayers to try to claim they HAVE materially participated, not that they haven't. This question has strong factual inputs that the taxpayer can take care to document - e.g., hours spent on a given activity. And in any case the passive loss rules, by helping to shut down the late-1980s tax shelter industry, meant that a lot of the intended targets simply gave up, rather than trying to establish material participation.
Now, if the passthrough provision passes, we will have enormous tax stakes for people at extremely high income levels who have multiple "activities" for purposes of the passive loss rules, and who will want to DENY, not establish, that they have materially participated. This leaves the IRS in the uncomfortable position of having to prove that they have actually spent more time than they say on each item, or that others haven't spent more time, etc.
This strikes me as a huge problem. The passive loss rules were mainly able to handle the material participation issue that they created, but I don't think they can handle this problem adequately. It is going to be a mess.
But back to my friend's telling me I should celebrate. Here's the thing. I'm actually an expert on the passive loss rules. (A bit out of date at the moment as I haven't been involved with them for a while, but it would be easy to catch up.) I was present at the creation, as I was part of the team that designed and drafted them. Subsequently, I wrote a leading practitioner guide on the rules that I for a while was updating regularly. I've done consulting on the rules' proper application, and I've even been co-counsel, with a taxpayer's own representative, for purposes of discussing particular passive loss issues with IRS appellate conferees.
If this thing passes, I suppose I could hang out my shingle and do quite well, even keeping in mind that I'd want to keep the hours low due to (a) my greater enjoyment of doing academic work and (b) my internal normative compass.
So there's that, I guess.
As I've noted, the special 25 percent percent rate for business owners in industries that the House Republicans like relies heavily on the passive loss rules in order to determine who gets the 25 percent rate as to all of their income from a given business, not just 30% of it.
I was in drafting sessions during my days as a legislative staffer, and I can totally understand why the drafters, if it was their call, decided to do this. It solves a drafting problem for them, related to higher vs. lower labor income component from a given business, without requiring them to draft anything new. The passive loss rules have been there for 30+ years, and apparently have worked okay for the most part. So why not borrow them for this purpose? Drafters do this sort of thing all the time, and indeed, given the constraints they face, they must.
But as I pointed out in an earlier post, the passive loss rules are highly unlikely to be able to function adequately in this new area. They most commonly induce taxpayers to try to claim they HAVE materially participated, not that they haven't. This question has strong factual inputs that the taxpayer can take care to document - e.g., hours spent on a given activity. And in any case the passive loss rules, by helping to shut down the late-1980s tax shelter industry, meant that a lot of the intended targets simply gave up, rather than trying to establish material participation.
Now, if the passthrough provision passes, we will have enormous tax stakes for people at extremely high income levels who have multiple "activities" for purposes of the passive loss rules, and who will want to DENY, not establish, that they have materially participated. This leaves the IRS in the uncomfortable position of having to prove that they have actually spent more time than they say on each item, or that others haven't spent more time, etc.
This strikes me as a huge problem. The passive loss rules were mainly able to handle the material participation issue that they created, but I don't think they can handle this problem adequately. It is going to be a mess.
But back to my friend's telling me I should celebrate. Here's the thing. I'm actually an expert on the passive loss rules. (A bit out of date at the moment as I haven't been involved with them for a while, but it would be easy to catch up.) I was present at the creation, as I was part of the team that designed and drafted them. Subsequently, I wrote a leading practitioner guide on the rules that I for a while was updating regularly. I've done consulting on the rules' proper application, and I've even been co-counsel, with a taxpayer's own representative, for purposes of discussing particular passive loss issues with IRS appellate conferees.
If this thing passes, I suppose I could hang out my shingle and do quite well, even keeping in mind that I'd want to keep the hours low due to (a) my greater enjoyment of doing academic work and (b) my internal normative compass.
So there's that, I guess.
Regressive, distortionary pseudo-consumption taxation
A lot of tax policy folks across the political spectrum see great potential advantages in consumption taxation. By excluding the normal risk-free return to saving (which is all that gets distinctively excluded, compared to an income tax, in theoretical textbook models), it can achieve greater efficiency and economic growth. Plus, it is more readily made neutral between assets, because expensing for everything is easier to figure out than correct economic cost recovery for everything. Plus, it needn't have a realization problem (although one does have the problem of rate changes that can destroy inter-temporal neutrality if anticipated).
But many people think that a flat rate consumption tax would be too regressive. This is not just people like me. Hall and Rabushka weren't exactly raging leftists, and they devised a progressive flat tax, made progressive despite the name due to its zero bracket.
Lots of work since then on progressive consumption taxation has established that it has intriguing possibilities. E.g., this could be a consumed income tax in which traditional IRA treatment extends to all saving and dissaving. Or it could be the X-tax, which (depending on the exact model) can be thought of as Hall and Rabushka plus a more progressive rate structure.
I myself feel that rising wealth inequality at the top means that something else has to be done too. This might involve sufficiently effective inheritance taxation. But all that is a topic for another day.
This brings me to the House Republican bill. This would move the tax system closer to a consumption model. It also still has progressive rates. Yet in some ways it is best thought of as regressive, distortionary, fake consumption taxation with huge gouged-out holes in the base that mainly accrue to the super-rich, in effect permitting them to exempt a lot of their consumption from ever being taxed, at least at the top rate.
For example, there's a move towards expensing, but also enough retention of interest deductibility to mix-and-match consumption and income tax models in a wholly inappropriate way that can result in net subsidies for debt-financed investment.
And then there's the ludicrous 25% rate for business owners who happen to be in industries that the House Republicans like, which will cost an estimated $448 billion over ten years - nearly one-third of the entire net revenue loss. That is clearly a very highly motivated provision, but not by any plausible tax policy rationale.
Even less defensible is the movement towards eliminating the estate and gift tax without addressing the tax-free step-up in basis at death. Despite what remains of entity-level corporate taxation, this means that a huge proportion of the consumption enjoyed by the self-made super-rich (such as by borrowing against appreciated assets) will be permanently exempted from taxation of any kind. This would NOT happen under any well-designed and genuine consumption tax.
So we get enhanced inter-asset distortions and inefficiency (such as from inducing massive tax planning) in various respects, plus potentially a steeply falling lifetime net tax rate as one moves from the bottom to the top of the top 1 percent.
But many people think that a flat rate consumption tax would be too regressive. This is not just people like me. Hall and Rabushka weren't exactly raging leftists, and they devised a progressive flat tax, made progressive despite the name due to its zero bracket.
Lots of work since then on progressive consumption taxation has established that it has intriguing possibilities. E.g., this could be a consumed income tax in which traditional IRA treatment extends to all saving and dissaving. Or it could be the X-tax, which (depending on the exact model) can be thought of as Hall and Rabushka plus a more progressive rate structure.
I myself feel that rising wealth inequality at the top means that something else has to be done too. This might involve sufficiently effective inheritance taxation. But all that is a topic for another day.
This brings me to the House Republican bill. This would move the tax system closer to a consumption model. It also still has progressive rates. Yet in some ways it is best thought of as regressive, distortionary, fake consumption taxation with huge gouged-out holes in the base that mainly accrue to the super-rich, in effect permitting them to exempt a lot of their consumption from ever being taxed, at least at the top rate.
For example, there's a move towards expensing, but also enough retention of interest deductibility to mix-and-match consumption and income tax models in a wholly inappropriate way that can result in net subsidies for debt-financed investment.
And then there's the ludicrous 25% rate for business owners who happen to be in industries that the House Republicans like, which will cost an estimated $448 billion over ten years - nearly one-third of the entire net revenue loss. That is clearly a very highly motivated provision, but not by any plausible tax policy rationale.
Even less defensible is the movement towards eliminating the estate and gift tax without addressing the tax-free step-up in basis at death. Despite what remains of entity-level corporate taxation, this means that a huge proportion of the consumption enjoyed by the self-made super-rich (such as by borrowing against appreciated assets) will be permanently exempted from taxation of any kind. This would NOT happen under any well-designed and genuine consumption tax.
So we get enhanced inter-asset distortions and inefficiency (such as from inducing massive tax planning) in various respects, plus potentially a steeply falling lifetime net tax rate as one moves from the bottom to the top of the top 1 percent.
Thursday, November 02, 2017
Unexpectedly interesting international idea in the House bill?
I just don't have the time today to come fully to grips with what the House bill does to U.S. companies' foreign source income (FSI), as it's complicated and requires studying 100 pages of statutory language that's full of newly defined terms and cross-references.
But, if I am reading it correctly, while generally creating an exemption system, it appears to address base erosion by taxing 50% of certain "foreign high returns." This involves (1) computing a rate of return, based on relevant capital invested, following complicated rules for the treatment of interest flows, etc., (2) comparing that rate of return to the 3-month Treasury rate, and (3) taxing 50% of the excess over a Treasury return plus 7%. It appears that commensurately scaled down foreign tax credits will apply to the taxable piece.
This looks like a version of the approach that I have proposed with regard to taxing FSI. In short, "foreign high returns" face a U.S. marginal tax rate (MTR) that is in between zero and the full U.S. rate, and get a marginal reimbursement rate (MRR) for foreign taxes that is less than 100%, given the foreign tax credit scaledown for the excluded portion. So one gets intermediate rates, as I have been advocating, for both the MTR and the MRR. (By intermediate, I mean an MTR between zero and the full domestic rate, and an MRR between the MTR and 100%.)
Suppose, where this rule applies, that a US company earns 15% (reflecting rents) and the US Treasury bond rate is 2%. Then the excess return is 6% [i.e., 15 - (2+7)], and half of this is taxed at 20% (the bill's corporate rate), which is equivalent to saying that the entire 6% extra return is taxed at a 10% rate. Given that 3/5 is exempted (under my numbers) and the rest is taxed at half the domestic rate, the overall tax rate for the FSI here is 1/5 of the domestic rate (4%). And if the foreign tax credit aspect works as I would presume it is meant to work, there would be, in effect, a 1/5 foreign tax credit and 4/5 at least implicit (whether or not literal) foreign tax deduction under these facts.
Exempting something that is based on the normal rate of return, defined in terms of bond rates, raises concerns about workability, but otherwise has good arguments in its favor.
It's dangerous to comment on this without understanding it more fully than I do at this point. But insofar as the "foreign high return" rule is a key operating feature at the end of the day, and is not overly gamable, they certainly could have done a whole lot worse.
Note also that, while they exempt the Treasury return plus 7%, there are U.S. companies with giant rents that might actually face non-trivial liability under this, again depending on how well the rate of return computation can be done in practice.
I'll also admit that I'm pleased to see ideas that I've advocated, and that I think make some sense, appearing to have some actual policy traction on Capital Hill.
NOTE: I've edited this entry to reflect my initially getting the provision a bit wrong on a quick read. Thanks to a Twitter reader (whom I thanked on Twitter) for setting me straight.
But, if I am reading it correctly, while generally creating an exemption system, it appears to address base erosion by taxing 50% of certain "foreign high returns." This involves (1) computing a rate of return, based on relevant capital invested, following complicated rules for the treatment of interest flows, etc., (2) comparing that rate of return to the 3-month Treasury rate, and (3) taxing 50% of the excess over a Treasury return plus 7%. It appears that commensurately scaled down foreign tax credits will apply to the taxable piece.
This looks like a version of the approach that I have proposed with regard to taxing FSI. In short, "foreign high returns" face a U.S. marginal tax rate (MTR) that is in between zero and the full U.S. rate, and get a marginal reimbursement rate (MRR) for foreign taxes that is less than 100%, given the foreign tax credit scaledown for the excluded portion. So one gets intermediate rates, as I have been advocating, for both the MTR and the MRR. (By intermediate, I mean an MTR between zero and the full domestic rate, and an MRR between the MTR and 100%.)
Suppose, where this rule applies, that a US company earns 15% (reflecting rents) and the US Treasury bond rate is 2%. Then the excess return is 6% [i.e., 15 - (2+7)], and half of this is taxed at 20% (the bill's corporate rate), which is equivalent to saying that the entire 6% extra return is taxed at a 10% rate. Given that 3/5 is exempted (under my numbers) and the rest is taxed at half the domestic rate, the overall tax rate for the FSI here is 1/5 of the domestic rate (4%). And if the foreign tax credit aspect works as I would presume it is meant to work, there would be, in effect, a 1/5 foreign tax credit and 4/5 at least implicit (whether or not literal) foreign tax deduction under these facts.
Exempting something that is based on the normal rate of return, defined in terms of bond rates, raises concerns about workability, but otherwise has good arguments in its favor.
It's dangerous to comment on this without understanding it more fully than I do at this point. But insofar as the "foreign high return" rule is a key operating feature at the end of the day, and is not overly gamable, they certainly could have done a whole lot worse.
Note also that, while they exempt the Treasury return plus 7%, there are U.S. companies with giant rents that might actually face non-trivial liability under this, again depending on how well the rate of return computation can be done in practice.
I'll also admit that I'm pleased to see ideas that I've advocated, and that I think make some sense, appearing to have some actual policy traction on Capital Hill.
NOTE: I've edited this entry to reflect my initially getting the provision a bit wrong on a quick read. Thanks to a Twitter reader (whom I thanked on Twitter) for setting me straight.
All hail the NPIP!
NPIP stands for "New Plutocratic Industrial Policy." It's the label that occurs to me with regard to the 25% maximum tax rate for business income that the House Republican drafters have decided they like.
While they have been claiming it's for "small business," there is absolutely nothing that so limits it. Indeed, it's been very carefully drafted to make sure that people in the 39.6 percent get the full rate reduction. Under the bill, these are people with taxable income of at least $1 million. So we can be reasonably confident that its $4448 billion 10-year revenue estimate is mainly about big non-corporate businesses and their very rich owners. (Since I first posted this, it's been pointed out to me that reportedly 86% of small business pays at a rate of 25% or less anyway, meaning they'd get nothing from giving them a 25% maximum rate.)
So what must you do, or whom must you be, to get the 25% rate? First, you get it for 100% of your net business income from passive activities, which generally are business activities in which you personally do not materially participate. (They take this definition directly from the passive loss rules, which I helped to draft back in 1986.) This typically applies to people who invest money in all kinds of partnerships, S corporation activities, etcetera that engage in pretty much any type of business - subject to the carve-out that I'll mention below. But they are passive investors, giving $$ but not sufficiently working in the business to meet the passive loss rules' material participation standards.
Second, you get the low business rate for 30% (in the simplest case) of net business income from all such activities in which you DO materially participate. This percentage can change under complicated, and at least partly elective (by the taxpayer) tests that seem aimed at raising it for more capital-intensive activities.
Suppose, then, that I have a business activity on which I work full time, earning $1 million and having no expenses. So far as I can tell at an initial read - subject to the limitation that I discuss next - 30% of the $1 million gets the 25% rate. But this income does count to pushing me into higher tax brackets for the rest of my taxable income.
Okay, so what exactly limits this? Under the passive activity rules cross-reference, a business activity is any activity which involves the conduct of a trade or business. I note that being an employee is a trade or business activity. So the one big thing limiting it is an exclusion from the special rate for "specified service activities," defined in a preexisting Internal Revenue Code section that the provision cross-reference as follows:
"ANY TRADE OR BUSINESS INVOLVING THE PERFORMANCE OF SERVICES IN THE FIELDS OF HEALTH, LAW, ENGINEERING, ARCHITECTURE, ACCOUNTING, ACTUARIAL SCIENCE, PERFORMING ARTS, CONSULTING, ATHLETICS, FINANCIAL SERVICES, BROKERAGE SERVICES, OR ANY TRADE OR BUSINESS WHERE THE PRINCIPAL ASSET OF SUCH TRADE OR BUSINESS IS THE REPUTATION OR SKILL OF 1 OR MORE OF ITS EMPLOYEES."
There are also a couple of items added for particular functions in the financial services industry.
What does this mean? If you're in the professional service industries, the arts, sports, financial services, consulting, etc., you lose. If you're in the trade or business of being an employee, you lose. But if you're a business owner (including via passive investment) in, say, the real estate, oil and gas, manufacturing, or retail sectors, it sure looks like you win. Although you win more (from 100% vs. 30%) if you aren't actually doing the work.
This is industrial policy - picking favored industries that should win while the rest lose. Businesses using capital and not just selling services are good, services businesses are bad. Perhaps the regulations will pick winners and losers in an even more fine-grained manner, especially if you can lobby the White House, not just the Treasury and IRS.
And it's a weapon to enhance plutocracy - offering the biggest rate cut to millionaires, allowing plutocrats who work to get the low rate for 30% of their income, and those who are in effect rentiers to get the low rate for 100%.
And here's a tax planning trick that occurs to me right off. I'm a plutocrat and so are you. If we just got the $$ from our own businesses, in which we're working actively, we'd only get the low rate for 30% of our net business income. But if we invest in each other's business, 100% since we're passive as to the other person's business.
So why don't I invest in your business and you invest in mine? And I get some of the returns from your business, while you get some of the returns from mine? But since we don't really want to invest in each other's businesses, rather than our own, what can we do to ensure indirectly that, at the end, of the day, our takes from each other will be somehow adjusted so that we are really getting ultimate net payouts based on our own stuff, not each other's?
Let the drafting, of contracts followed by tax opinions, begin.
But that's not the worst of it, purely as a matter of tax administration. Consider also this. Under the passive activity rules, people most commonly want to AVOID being classified as passive, and to show that they are materially participating. This often depends on things such as how many hours they spent working on the activity. They are as a practical matter encouraged, although not required, to keep records establishing their hours spent. There has actually been Tax Court litigation about what sorts of hours count.
But now it's reversed. To get the 25% rate for ALL of your business income, not just 30% of it, you have to AVOID materially participating. So it's up to the IRS to prove how you actually spent your time (!!). How exactly are they supposed to do that, for business people with ownership interests who go around doing this & that?
So you have a horrendously bad statute administratively, devoted solely, it seems, to enforcing an incoherent industrial policy and enhancing plutocracy. If there's ever been a worse federal income tax enactment, I'd like to know what it could possibly be.
While they have been claiming it's for "small business," there is absolutely nothing that so limits it. Indeed, it's been very carefully drafted to make sure that people in the 39.6 percent get the full rate reduction. Under the bill, these are people with taxable income of at least $1 million. So we can be reasonably confident that its $4448 billion 10-year revenue estimate is mainly about big non-corporate businesses and their very rich owners. (Since I first posted this, it's been pointed out to me that reportedly 86% of small business pays at a rate of 25% or less anyway, meaning they'd get nothing from giving them a 25% maximum rate.)
So what must you do, or whom must you be, to get the 25% rate? First, you get it for 100% of your net business income from passive activities, which generally are business activities in which you personally do not materially participate. (They take this definition directly from the passive loss rules, which I helped to draft back in 1986.) This typically applies to people who invest money in all kinds of partnerships, S corporation activities, etcetera that engage in pretty much any type of business - subject to the carve-out that I'll mention below. But they are passive investors, giving $$ but not sufficiently working in the business to meet the passive loss rules' material participation standards.
Second, you get the low business rate for 30% (in the simplest case) of net business income from all such activities in which you DO materially participate. This percentage can change under complicated, and at least partly elective (by the taxpayer) tests that seem aimed at raising it for more capital-intensive activities.
Suppose, then, that I have a business activity on which I work full time, earning $1 million and having no expenses. So far as I can tell at an initial read - subject to the limitation that I discuss next - 30% of the $1 million gets the 25% rate. But this income does count to pushing me into higher tax brackets for the rest of my taxable income.
Okay, so what exactly limits this? Under the passive activity rules cross-reference, a business activity is any activity which involves the conduct of a trade or business. I note that being an employee is a trade or business activity. So the one big thing limiting it is an exclusion from the special rate for "specified service activities," defined in a preexisting Internal Revenue Code section that the provision cross-reference as follows:
"ANY TRADE OR BUSINESS INVOLVING THE PERFORMANCE OF SERVICES IN THE FIELDS OF HEALTH, LAW, ENGINEERING, ARCHITECTURE, ACCOUNTING, ACTUARIAL SCIENCE, PERFORMING ARTS, CONSULTING, ATHLETICS, FINANCIAL SERVICES, BROKERAGE SERVICES, OR ANY TRADE OR BUSINESS WHERE THE PRINCIPAL ASSET OF SUCH TRADE OR BUSINESS IS THE REPUTATION OR SKILL OF 1 OR MORE OF ITS EMPLOYEES."
There are also a couple of items added for particular functions in the financial services industry.
What does this mean? If you're in the professional service industries, the arts, sports, financial services, consulting, etc., you lose. If you're in the trade or business of being an employee, you lose. But if you're a business owner (including via passive investment) in, say, the real estate, oil and gas, manufacturing, or retail sectors, it sure looks like you win. Although you win more (from 100% vs. 30%) if you aren't actually doing the work.
This is industrial policy - picking favored industries that should win while the rest lose. Businesses using capital and not just selling services are good, services businesses are bad. Perhaps the regulations will pick winners and losers in an even more fine-grained manner, especially if you can lobby the White House, not just the Treasury and IRS.
And it's a weapon to enhance plutocracy - offering the biggest rate cut to millionaires, allowing plutocrats who work to get the low rate for 30% of their income, and those who are in effect rentiers to get the low rate for 100%.
And here's a tax planning trick that occurs to me right off. I'm a plutocrat and so are you. If we just got the $$ from our own businesses, in which we're working actively, we'd only get the low rate for 30% of our net business income. But if we invest in each other's business, 100% since we're passive as to the other person's business.
So why don't I invest in your business and you invest in mine? And I get some of the returns from your business, while you get some of the returns from mine? But since we don't really want to invest in each other's businesses, rather than our own, what can we do to ensure indirectly that, at the end, of the day, our takes from each other will be somehow adjusted so that we are really getting ultimate net payouts based on our own stuff, not each other's?
Let the drafting, of contracts followed by tax opinions, begin.
But that's not the worst of it, purely as a matter of tax administration. Consider also this. Under the passive activity rules, people most commonly want to AVOID being classified as passive, and to show that they are materially participating. This often depends on things such as how many hours they spent working on the activity. They are as a practical matter encouraged, although not required, to keep records establishing their hours spent. There has actually been Tax Court litigation about what sorts of hours count.
But now it's reversed. To get the 25% rate for ALL of your business income, not just 30% of it, you have to AVOID materially participating. So it's up to the IRS to prove how you actually spent your time (!!). How exactly are they supposed to do that, for business people with ownership interests who go around doing this & that?
So you have a horrendously bad statute administratively, devoted solely, it seems, to enforcing an incoherent industrial policy and enhancing plutocracy. If there's ever been a worse federal income tax enactment, I'd like to know what it could possibly be.
Wednesday, November 01, 2017
Renaissance Technologies and "basket options"
Earlier this week, I was on MSNBC discussing (with Stephanie Ruhle) Robert Mercer / Renaissance Technologies in re. the "basket options" tax avoidance scheme that they are reported to have used to the tune of $6.8 billion or so. I'm told that the feature may air again later this week, but you needn't wait if you click here. It's about a 4-minute clip, and I first appear at about 2:30. It also features Steve Rosenthal.
The interview was taped a couple of weeks back. So I hadn't known exactly when it would air. But then I heard about it from excited fans (so to speak).
I think there's a possible journalistic backstory to this that doesn't appear in the piece, but that may have helped to motivate general press interest. Mercer's political activism has increased since the IRS started questioning his reported $6.8 billion of claimed tax benefits from the basket options, and I gather that his involvement has extended to the conservative campaign against the IRS Commissioner. One might deem this a bit tactless and tasteless, although Mercer certainly appears to have far bigger (and, I would say, more rancid) fish to fry than "just" a possible $6.8B tax liability.
Another question that I suspect has prompted journalistic interest in the story pertains to whether the Trump Administration would interfere with the IRS to Mercer's benefit. When I've been asked about this, I've said that for decades we have had clear norms that generally prevent any such thing from happening. These norms and institutional barriers date back to Nixon, who tried to weaponize the IRS against his political foes, and thereby provoked a whole lot of pushback.
But we do of course live in an era when norms of fair and honest governance seem to be increasingly under threat. So, while this would not have been a major concern at any time in the last 40+ years, who knows what one should expect today.
The interview was taped a couple of weeks back. So I hadn't known exactly when it would air. But then I heard about it from excited fans (so to speak).
I think there's a possible journalistic backstory to this that doesn't appear in the piece, but that may have helped to motivate general press interest. Mercer's political activism has increased since the IRS started questioning his reported $6.8 billion of claimed tax benefits from the basket options, and I gather that his involvement has extended to the conservative campaign against the IRS Commissioner. One might deem this a bit tactless and tasteless, although Mercer certainly appears to have far bigger (and, I would say, more rancid) fish to fry than "just" a possible $6.8B tax liability.
Another question that I suspect has prompted journalistic interest in the story pertains to whether the Trump Administration would interfere with the IRS to Mercer's benefit. When I've been asked about this, I've said that for decades we have had clear norms that generally prevent any such thing from happening. These norms and institutional barriers date back to Nixon, who tried to weaponize the IRS against his political foes, and thereby provoked a whole lot of pushback.
But we do of course live in an era when norms of fair and honest governance seem to be increasingly under threat. So, while this would not have been a major concern at any time in the last 40+ years, who knows what one should expect today.
Taking a (more) charitable ad hominem view of CEA wage claims about corporate tax reform
Kevin Hassett, in his new perch at CEA, has dismayed me by claiming - I would say (and I'm not alone in this) absurdly - that cutting the corporate rate from 35% to 20% would in short order raise wages by at least $4,000 per household. Indeed, I have considered this claim dubious enough to cause me to speculate that he has consciously decided that academic and think tank economists, among whom he has certainly hurt his credibility by making this claim, are not the audience that he believes will matter to him personally or professionally when his CEA stint is done.
But to put it more charitably, perhaps he is subject to sincere (if ill-founded) over-exuberance - akin to Dr. Malcolm's "deplorable excess of personality" in the Jurassic Park I movie - that can lead him astray without evidencing bad faith. As evidence for continued sincerity and good faith, he today reiterated, in a Politico interview, a previously expressed view that is anathema to right-wing Trumpite opinion leaders, and hence that presumably reflects sincere conviction while not otherwise serving his or the Administration's interests.
He says, in particular: "We've not done a good job as a society at thinking about how do we take people who have become discouraged [from participating in the workforce] and reconnect them. And it's such an urgent problem that government programs that directly hire people might be part of the solution."
As the Politico column describing the interview notes, "[t]hat's a New Deal-style idea more closely associated with highly progressive Democrats." It has already begun to attract the inevitable brickbats, and I see no reason to think that there's anything more behind it than his believing that it's actually true. It doesn't look, from here at least, like a deliberate sop or pitch to the Bannon wing.
The interview does, however, rewrite history a bit concerning a prior instance of ill-founded over-exuberance:
"Hassett, an affable economist with friends on both sides of the partisan aisle, also spoke about his often-lampooned 1999 book with James Glassman, Dow 36,000, that predicted stocks would hit that mark by 2004. Instead, the dot-com bubble burst and stocks tanked.
"Hassett described the title of the book as a bit of a 'youthful indiscretion' that was also somewhat unfairly maligned. 'The point was that people who buy and hold stocks tend to do well, but that stocks go up and down a lot and it's scary.'"
With all due respect, while that may reflect how he thinks about the stock market now, it's not quite the same as what the book said. Again, Dow 36,000 offered a specific prediction with an equally specific analysis behind it. This framework went well beyond "buy and hold," to assert that historical evidence supported viewing stocks as grossly undervalued based on their expected future payouts, even allowing for a reasonable degree of risk aversion.
I actually recall speaking to Kevin, at an AEI event, before Dow 36,000 came out or had been widely publicized. He explained the book's basic undervaluation claim to me, and added that, because he was so convinced it was true, he had placed all his savings in the stock market, none in bonds.
I asked him (obviously paraphrasing here): "If you're so bullish about stocks, why stop at 100% of your net equity, instead of also borrowing a lot of money and putting that in the stock market, too?" But someone else came up to chat just then, so I never got an answer to this question. From today's perspective, I'd note that even going 100% of net equity, without also borrowing so that one can push past that line, seems a bit aggressive (even allowing for the fact that Kevin, like me, was younger at the time) if "stocks go up and down a lot and it's scary."
In fairness, he was not alone in 1999 in thinking that the stock market was undervalued, even duly adjusting for risk (e.g., based on evidence of comparative asset riskiness and how people adjusted for it elsewhere). Finance folk were writing a lot more in those days than they seem to be doing today about the "equity premium puzzle," i.e., the view that, all things considered, stock prices seemed to be over-discounting for risk.
At a general conceptual level, the main things that Dow 36,000 added to merely relying on the equity premium puzzle were (1) a particular set of claims about what stock values "should" be if the premium, assumed to be mysterious and irrational, were to disappear, and (2) as assertion of confidence that it would indeed disappear in fairly short order. (This too I recall, perhaps from the same conversation, as resting on the idea, not exactly uncommon among economists, that surely rationality will soon prevail.)
Even back then, however, a mutual friend with unimpeachable academic credentials, who was highly skeptical of the book's thesis even at the time, told me that he had advised Kevin to have stickers ready for all the book's copies to cover the last zero if necessary. This would have allowed rapidly changing the title to Dow 3600.
In sum, one could think of Dow 36,000 as supporting a relatively charitable explanation for what we are hearing from Kevin these days about how a corporate rate cut would rapidly boost wages. Both in a personal sense and given his possible influence while at CEA, that's good to know. But I believe that at least the general basics of his Dow 36,000 claim were closer to the mainstream, and to apparent contemporary plausibility, than what he is saying about corporate tax rates and wages now.
But to put it more charitably, perhaps he is subject to sincere (if ill-founded) over-exuberance - akin to Dr. Malcolm's "deplorable excess of personality" in the Jurassic Park I movie - that can lead him astray without evidencing bad faith. As evidence for continued sincerity and good faith, he today reiterated, in a Politico interview, a previously expressed view that is anathema to right-wing Trumpite opinion leaders, and hence that presumably reflects sincere conviction while not otherwise serving his or the Administration's interests.
He says, in particular: "We've not done a good job as a society at thinking about how do we take people who have become discouraged [from participating in the workforce] and reconnect them. And it's such an urgent problem that government programs that directly hire people might be part of the solution."
As the Politico column describing the interview notes, "[t]hat's a New Deal-style idea more closely associated with highly progressive Democrats." It has already begun to attract the inevitable brickbats, and I see no reason to think that there's anything more behind it than his believing that it's actually true. It doesn't look, from here at least, like a deliberate sop or pitch to the Bannon wing.
The interview does, however, rewrite history a bit concerning a prior instance of ill-founded over-exuberance:
"Hassett, an affable economist with friends on both sides of the partisan aisle, also spoke about his often-lampooned 1999 book with James Glassman, Dow 36,000, that predicted stocks would hit that mark by 2004. Instead, the dot-com bubble burst and stocks tanked.
"Hassett described the title of the book as a bit of a 'youthful indiscretion' that was also somewhat unfairly maligned. 'The point was that people who buy and hold stocks tend to do well, but that stocks go up and down a lot and it's scary.'"
With all due respect, while that may reflect how he thinks about the stock market now, it's not quite the same as what the book said. Again, Dow 36,000 offered a specific prediction with an equally specific analysis behind it. This framework went well beyond "buy and hold," to assert that historical evidence supported viewing stocks as grossly undervalued based on their expected future payouts, even allowing for a reasonable degree of risk aversion.
I actually recall speaking to Kevin, at an AEI event, before Dow 36,000 came out or had been widely publicized. He explained the book's basic undervaluation claim to me, and added that, because he was so convinced it was true, he had placed all his savings in the stock market, none in bonds.
I asked him (obviously paraphrasing here): "If you're so bullish about stocks, why stop at 100% of your net equity, instead of also borrowing a lot of money and putting that in the stock market, too?" But someone else came up to chat just then, so I never got an answer to this question. From today's perspective, I'd note that even going 100% of net equity, without also borrowing so that one can push past that line, seems a bit aggressive (even allowing for the fact that Kevin, like me, was younger at the time) if "stocks go up and down a lot and it's scary."
In fairness, he was not alone in 1999 in thinking that the stock market was undervalued, even duly adjusting for risk (e.g., based on evidence of comparative asset riskiness and how people adjusted for it elsewhere). Finance folk were writing a lot more in those days than they seem to be doing today about the "equity premium puzzle," i.e., the view that, all things considered, stock prices seemed to be over-discounting for risk.
At a general conceptual level, the main things that Dow 36,000 added to merely relying on the equity premium puzzle were (1) a particular set of claims about what stock values "should" be if the premium, assumed to be mysterious and irrational, were to disappear, and (2) as assertion of confidence that it would indeed disappear in fairly short order. (This too I recall, perhaps from the same conversation, as resting on the idea, not exactly uncommon among economists, that surely rationality will soon prevail.)
Even back then, however, a mutual friend with unimpeachable academic credentials, who was highly skeptical of the book's thesis even at the time, told me that he had advised Kevin to have stickers ready for all the book's copies to cover the last zero if necessary. This would have allowed rapidly changing the title to Dow 3600.
In sum, one could think of Dow 36,000 as supporting a relatively charitable explanation for what we are hearing from Kevin these days about how a corporate rate cut would rapidly boost wages. Both in a personal sense and given his possible influence while at CEA, that's good to know. But I believe that at least the general basics of his Dow 36,000 claim were closer to the mainstream, and to apparent contemporary plausibility, than what he is saying about corporate tax rates and wages now.