Tuesday, February 28, 2017

A brand-new bad idea?

According to both Treasury Secretary Mnuchin and a White House spokesperson, the Administration is considering a "reciprocal tax on countries that tax American imports." This appears to mean retaliation against the use of a VAT that taxes domestic consumption, insofar as such consumption is of imported goods from the US.

So, the use of a tax system (the VAT) that is trade-neutral would trigger "retaliation"? How exactly? Via tariffs on countries with VATs, with the tariff level pegged to their US imports and/or their VAT rates and/or their US trade balance?  After all, we can't "retaliate" just by having our own VAT if the tax level on domestic consumption depends on (a) whether it's an import and (b) the country of origin.

I would like to hear anyone with even a rudimentary understanding of economics try to defend such a proposal. (Might this be in Kevin Hassett's future?! Suppose he is unable to talk them out of it.)

NYU Tax Policy Colloquium, week 6: Steve Shay (et al), "'A Better Way' Business Tax Reform: Theory and Practical Complications"

Yesterday at the colloquium, Steve Shay presented an early draft of an article (being coauthored with Cliff Fleming and Bob Peroni) that critically reviews the House GOP proposal to replace the existing income tax on corporate and individual business income with what many call the "DBCFT" (destination-based cash flow tax). The draft is still preliminary, so I'm not posting a link or even the abstract. But here are some thoughts on how one might parse the main issues that the paper discusses: I won't try to offer a full assessment of the DBCFT here - that would require a very long article.

As it happens, many others are writing such articles (including Shay et al). Given how well it's already being covered, the only way in which I plan to enter this fray via conventional publication is from somewhat of an angle. On June 1, I am giving a talk in Haikko Borga, Finland at the annual meeting of the Nordic Tax Research Counsel, in which I'll discuss how the U.S. ended up considering going this way, how the plan relates to what other countries have done, in particular with VATs, what light it sheds on where we and they might want to get in the long run,etcetera. This piece I believe will end up being published in a Nordic tax journal, but also perhaps in the US if it develops in a direction that I deem compatible with this. It differs from what people have been writing these days in that it might involve looking at the thing from a distance and with an effort at historical perspective, rather than focusing on how it might work or whether, taking all the parts together as given, it's on the whole good or bad.

Okay, enough of that detour; back to some of the main issues that Shay, Fleming, and Peroni are evaluating:

(1) Distributional effects – The House GOP tax plan as a whole is extremely regressive, and meant to be so, especially when one adds in the financing for the tax cuts that, while not currently being provided for, the Speaker no doubt intends. He wants to massively slash tax rates on rich people and pay for it by massively slashing benefits for poor people. But let's hold all that to one side - the DBCFT itself raises more interesting, complex, and potentially ambiguous distributional issues than this clear underlying intent might have led one to expect.

Since it's a compound proposal, I think one has to analyze it distributionally in multiple pieces. And for each piece, one must analyze both the transition effects of repeal and the long-term effects. These can be quite different. E.g., even if one were to conclude that the corporate income tax is mainly borne by labor rather than capital, a surprise overnight repeal would offer a huge transition gain to shareholders.

Anyway: here is one way of organizing the pieces one needs to think about, in terms of both the transition and the long-term incidence. BTW, I'm just looking here at the tax side. Obviously, if net revenues change, one must also look at what changes end up resulting on the spending side.

(a) repeal the corporate income tax (and other business income taxes insofar as they are replaced by this).

(b) enact an origin-basis VAT. I put this here as a separate stage to distinguish between (a) the shift to expensing, and an R-based system in which financial flows are ignored, and (b) the destination basis piece, which could end up being called off.

(c) convert the VAT from origin basis to destination basis,

(d) add a wage deduction to the VAT. People have been calling this a wage subsidy, which is fair enough, but since wages are being taxed under the individual income tax one really needs to think about them as a whole. Note that in, say, David Bradford's X-tax, there was a much tighter connection than there seems to be here between the wage subsidy and the wage tax. There the idea was to match the business rate to the top individual rate, which only applied to wages; hence a straightforward net wage subsidy applied until one reached the top bracket (at which point it became a wash).

(e) replace the exclusion of financial flows under a true VAT with a rule apparently including them, subject to disallowing net interest deductions.

(2) Expensing doesn’t automatically yield neutrality – Expensing is commonly lauded as permitting the tax system to be neutral between assets, and also between businesses. But the proponents don't plan to make losses refundable, as they are in a VAT. Instead, they'll offer interest, which is fine (any cash flow problems aside) if one is going to have enough net "income" eventually, but otherwise may disadvantage small and medium sized businesses. Net losses should be especially common here, in contrast to under a VAT, due to the wage deduction plus, in early years, expensing for new assets plus (one presumes, as a transition rule) continued depreciation deductions for pre-enactment assets. There may be a lot of distortionary transactions that end up being used to provide effective refundability.

(3) WTO illegality – It seems to be little disputed these days that the system would be immediately and successfully challenged as illegal under the WTO, even though an equivalent instrument (in which the wage subsidy was handled separately) would presumably be legal. Passing a law that one knows is going to have to be changed or repealed in a few years is pretty crazy. But if one wanted to look at it in a positive light, the idea might be: as soon as it's held to be illegal (which will presumably take a couple of years at least), and before any sanctions start taking effect, change the system then. Only, we'd have to feel good about the feasibility of doing this. I don't feel so good about this given the low health level of our political system, but it could conceivably become a path to having a conventional VAT.

(4) Hard to tax inbound – We in the US are late to the game, and hence are inclined to think that VATs are much better administratively than our various tax instruments. But while this is probably still true, VATs' workability has been undermined by the rise of e-commerce and global service industries. So finding and taxing inbound consumer items, by notionally policing the "border," is much more problematic today than it was when most major VATs came into force. While the OECD and various countries are trying to address this, it's unclear how successful they'll be. Would the DBCFT eventually need to include a use tax that was collected directly from households? Our income tax treaties may impede requiring exporters to the US, if they lack a U.S. permanent establishment, 

(5) Hard to trace "true" outbound – This is the flip side of the inbound problem.

(6) Multiple tax rates – Most prior proposal in the DBCFT's ballpark had a single business rate. Here you have instead a bit of a mess, with different rates for passthroughs and C corporations, continued income taxation at the individual level, etc.  The multiple rates can raise a host of problems - relating, for example, to related party transactions and, for that matter, to exactly how the currency adjustment would play out.  The proponents would also need to figure out and execute rules pertaining to tax-exempts.

(7) Treatment of interest expense – A true R-based system is so much simpler and cleaner than taxing financial income but disallowing net interest deductions. For example, the DBCFT would presumably cause taxpayers to prefer interest income to other income, since it can be used to soak up interest deductions. We have various such problems under present law, but they're hardly a good thing. Note also the need to figure out how to tax financial institutions - more urgent here than under VATs, because the countries with VATs also have corporate income taxes that apply to financial institutions, whereas we would be jettisoning that backup.

(8) How would other countries respond? – Apart from filing WTO claims, via tax competition? Emulation? Taxing US companies more on a source basis, given that treaty reciprocity had ceased to matter and the US had abandoned the outbound-taxation field? If the thing is enacted, which I consider unlikely, we will certainly find out.

(9) No tax on domestic but "outbound' rents - Countries with significant natural resources often like to tax domestic extraction for export. Also, U.S. companies that develop valuable IP may create rents that they realize through foreign sales. One should always want to tax outbound rents domestically, for two reasons. If they're earned by foreigners, it's efficient and the foreigners will actually bear the incidence of the tax. If they're earned by domestic individuals, it's still efficient and inclusion may be desirable from a distributional standpoint. This point tends to be conceded by DBCFT advocates, whom I have heard say (a) we could have a special rule for natural resources, and (b) we're not currently doing a great job with the likes of Apple and Google anyway. But why give up altogether? That's a clear defect, even if outweighed by other features that one considered clear advantages of the DBCFT.

One irony here, by the way, is that after all the huffing and puffing in the Treasury White Paper about how only the U.S. can tax the profits that Apple purported to stash in Ireland, because it's U.S. source income and the Europeans should keep their hands off, the DBCFT would actually define that income (which pertained to EU sales) as foreign source. So much for self-righteous vehemence.

(10) A very tough transition in multiple dimensions – The rush to enact this thing - if it gets enacted - is bound, I think, to end badly. The IRS isn't ready for it, state and local governments aren't ready for it, taxpayers are desperately scrambling to get ready for it, there's unlikely to be any stress-testing or a multi-stage process like that which gave rise to the Tax Reform Act of 1986, last-minute dark deals on obscure aspects are likely to occur, there may not be enough staff with enough time (and treated with enough respect) to get enough of it right, technical corrections may be politically impossible, etcetera. So even if this thing can in principle be done well enough to be worth doing, don't count on its actually happening that way, if it happens.

Monday, February 27, 2017

Martin Feldstein on border adjustment

Today in the Wall Street Journal,  a Martin Feldstein op-ed on border adjustment argued that its flaws are purely "illusory," since "[f]oreign exporters would pay for the Republicans' proposed trillion-dollar tax cut."

Whatever one thinks about the merits of border adjustment, this op-ed does not appear to be an entirely above-board intellectual exercise. Two problems in particular:

First, he treats the estimated $100 billion revenue gain, by reason of switching to the destination basis in an era when current-year imports (which would be newly taxed) exceed current-year exports (which would be newly exempted) as borne by foreign exporters.  He notes that, once the dollar appreciated relative to foreign currencies such as the Euro, foreign exporters to the U.S. would suffer a reduction in the U.S. goods and services that they could purchase in exchange for their exports to us.

But what about the fact that, as he admits "a rising dollar would reduce the real value of foreign investments owned by Americans"? He dismisses this by looking at it as a percentage of Americans' household net worth. That's a rather different metric than he uses for the foreign exporters.

He also fails to mention that a rising dollar would increase the real value of U.S. investments held by foreigners. That could be a much bigger item than the one that he emphasizes with regard to foreign exporters.

Feldstein is therefore being unexplainedly selective and inconsistent in his treatment of the effects of dollar appreciation, relative to other currencies, on U.S. individuals and foreign individuals.

Second, Feldstein lauds the ten-year revenue gain on the ground that it would "produce enough revenue to make cutting the corporate tax politically feasible .... That revenue is enough to finance almost all of the proposed reduction in the corporate tax."

Here's the problem with this argument. It treats revenue over the next ten years as merely a political constraint that we need to overcome in order to pass what he considers desirable legislation. Fair enough, up to a point. But - less than a year ago Feldstein wrote a piece entitled "America's Exploding Deficit."  It denounced U.S. policymakers for potentially turning our country, via rising deficits, into the next Italy, Portugal, or Greece. (But that, of course, was during Obama's presidency.)

Against that background, he now considers 10-year revenue balance just a political problem to be finessed? He realizes, I presume, that the estimated $1 trillion revenue gain might be considered a temporary, rather than a permanent, revenue gain if we think in terms of infinite horizon trade balance.

I wonder - or rather, I really don't much wonder - what Feldstein would have said had a Democratic Administration proposed to use $1 trillion (over 10 years) in temporary border adjustment revenue to pay for something he didn't like - e.g., expanding the social safety net. Thirty years ago, unlike today, he was above this sort of contemptuously and tendentiously partisan sleight of hand trickery.

Friday, February 24, 2017

Trump on the border adjustment tax

Courtesy of a Reuters interview, here's Trump on the border adjustment tax, with my annotations after each sentence:

“It could lead to a lot more jobs in the United States." Good work by his standards, as this is less false than any of the claims that follow. Replacing the corporate tax with the destination-based cash flow tax (DBCFT) could increase U.S. investment, which could conceivably increase U.S. jobs, or at least U.S. wages, over some time period by some amount. How fast and how much is unclear.

"I certainly support a form of tax on the border because everybody else does." Powerfully reasoned grounds for supporting it. Not true, of course, that "everybody else does."

"We’re the only country, we’re one of the very few countries, possibly the only country, that has no border tax." True as to the VAT. He evidently doesn't know the difference between the DBCFT and a VAT. Most of the quotes below likewise appear to be based on his classifying the DBCFT as a VAT. Needless to say, he is unaware that no country has ever had a DBCFT.

"And that’s not a tax to the consumer, because that’s going to be a tax to companies and it’s going to be a tax to other countries much more so than it is to the consumer. That’s a tax to other countries.Three falsehoods in a row.  (For them to be lies, however, there would need to be an underlying mental state of knowledge.) Try finding an economist who doesn't think a VAT is a tax on the consumer. It's remitted by the companies, but few if any economists would call it a tax on the companies. It's certainly not a tax on other countries. That would require the US to be successfully exercising monopsony power when it applies the tax to imports.

"And what will happen is, don’t forget there is no tax if we make our product in the United States. So I don’t consider it a tax." Does he realize that VATs apply to domestic consumption? Apparently not. It's true that, under the DBCFT, the business gets to deduct wages. But they're also generally included in income by the employee. Or perhaps he's referring to the fact that there's no tax if the item is exported. But I would say that a tax on domestic consumption, like a tax on domestic production, is still in fact a tax. He may almost grasp that there are arguments for replacing taxes on domestic production with taxes on domestic consumption, but, it would seem, not very clearly.

"That’s a tax if companies are buying their product outside of the United States. But ... if they make their product in the United States, there is no tax. So what is going to happen is companies are going to come back here, they’re going to build their factories and they’re going to create a lot of jobs and there’s no tax.” This largely repeats claims that I addressed above. Note how it's both "a tax to the companies" and yet when they operate here "there's no tax." And also, of course, taxing domestic consumption apparently equals taxing other countries.

Thursday, February 23, 2017

EU State Aid panel at IFA US branch annual meeting

Today I was the lone American on the IFA panel I mentioned in my prior post, discussing the raft of ongoing, or perhaps soon to be ongoing, EU state aid cases before the European Commission (and ultimately the European Court of Justice).  Three quick takeaways:

1) EU tax lawyers with whom I spoke believe that the EC's Apple ruling, whatever one thinks of it on the merits, is extremely well-crafted from a legal standpoint.

2) I noted, although I doubt this was a surprise to many people, that it's currently difficult to imagine U.S. tax policymakers over the next few years paying close attention to the state aid cases. They have a lot of higher agenda items at present, and it's not clear that the Treasury will ever, in the next few years, get up to having a normal-sized bandwidth.

3) Once the EU state aid precedents are out there by reason of EC decisions (assuming they are upheld by the ECJ), EU law permits a whole lot of causes of action attacking claimed state aid to be brought by a wide range of actors: NGOs, rival firms, trade unions, and so forth. These actions would not involve the EC, and they would initially be brought in national courts, with ultimate appealability to the ECJ.  So the French and German governments, say, if they have made arrangements with multinational or other companies that are open to challenge under state aid doctrine, might find themselves litigating in defense. I was told that this could definitely happen as to France, and that Germany's recent move supporting Spain in the Santander litigation indicates that it is feeling sensitive too, whether on this ground or based on concern that the EC is over-reaching as an EU political matter.

Wednesday, February 22, 2017

Upcoming talks

I seem to be accumulating a hefty set of appearances for 2017. They include the following:

1) Thursday, February 23 - The USA Branch of the International Fiscal Association is currently holding its annual meeting, in the Waldorf Astoria Hotel in New York City. Tomorrow, from 9 to 10 am, I will be speaking on a panel entitled "State Aid: Where Are We?"

2) Friday, March 10 - I'll be speaking on a panel at the annual NYU-KPMG Tax Lecture, held at NYU Law School. As usual, I'll be with the debate group, which this year may look at such issues as current corporate tax reform proposals.

3) Wednesday, April 12 - At Northwestern Law School's Tax Policy Colloquium I'll be discussing my recent paper, "Interrogating the Relationship Between 'Legally Defensible' Tax Planning and Social Justice."

4) Tuesday, May 30 - At Luxembourg University, at a seminar entitled "BEPS, State Aid, and Tax Competition: A Bird's-Eye View Across the Atlantic," I'll be discussing U.S. international tax policy with respect to OECD-BEPS and the EU state aid cases.

5) Thursday, June 1 - At the Nordic Tax Research Council's annual meeting in Haikko Borga, Finland (near Helsinki), I'll be discussing the Ryan Blueprint tax reform plan.

6) Friday, June 2 -  At the European Association of Tax Law Professors' Annual Meeting, in Lodz, Poland, the theme of which is "Corporate Tax Residence and Mobility," I'll be on a panel discussing the future of tax residence. Luckily from a travel standpoint, this one is in the afternoon, whereas the prior one is in the morning.

7) Tuesday, June 20-Friday, June 23 - At the Law and Society Association's Annual Meeting in Mexico City, I'll be discussing a chapter from my book on literature and high-end inequality - probably "Why Aren't Things Better Than This? Class Relations Within the Top One Percent in Jane Austen's Pride and Prejudice."

8 Monday, June 26 - Wednesday, June 28 - This is tentative, but I may attend the 2017 Academic Symposium at Said Business School, Oxford University. Probably as a discussant, rather than as a presenter, if I do indeed go.

That's it for the moment. But in September and October, I'll be spending 3 weeks at NYU Berlin, and teaching an intensive mini-course at Vienna University's Doctoral Program in International Business Taxation on international tax policy. Possible side trips to suitable nearby EU academic institutions.

NYU Tax Policy Colloquium, week 5: Jason Oh's "Are the Rich Responsible for Progressive Tax Rates?"

Yesterday Jason Oh presented "Are the Rich Responsible for Progressive Tax Rates?" The current draft is written in the format for a law review paper. I personally am hoping that he rewrites it as, say, an NTJ paper. While I think a good law review should be quite happy to publish the paper in its present form, the real uniqueness and strengths would come out more if it were done NTJ-style. So high-end cognoscenti would be best served by the NTJ format, although this is not to pre-judge what would be the best career move, get the largest readership, etc.

To explain, Part I of the paper, "The Political Economy of Progressive Rates," does an excellent job of explaining basic optimal tax models that underlie thinking about progressive and other tax rates, along with rational choice-based political economy models that can be used to predict legislative outcomes in a majoritarian framework. But that's just the set-up or background. The real work of the paper is done in Part II, "The Instability of Rate Schedules."  Here, given the fact that, in the set-up, for any current set of rate schedules there is a majority that would prefer something else - leading to cycling, and making agenda control important - the paper "uses a set of Markov chain Monte Carlo simulations [to] explore what rate schedules are most likely under majoritarian voting."  This takes the form of "heat maps" showing what rate structures emerge most frequently, among the assumed possibilities, under different sets of assumptions, e.g., regarding agenda control and the influence of the rich. "The simulations suggest that (1) rate progressivity becomes more likely as political power is concentrated in the hands of the rich, and (2) progressive rate structures are predominant even if there are relatively more rich than poor."

Under the rational choice model, the voters perfectly understand all the possible tax systems and everyone else's preferences. They are rational utility-maximizers, whose utility depends solely on own consumption and leisure. Disregarding changes to leisure (from adjustments to labor supply) to simplify the exposition, all they care about is having more money rather than less, from how a given tax change affects (a) their own tax liabilities, plus (b) the demogrant that they get given the overall revenue raised. (The demogrant functions as a proxy for positing uniform benefit from government spending.)

I myself tend to be somewhat of a skeptic regarding rational choice models of this kind.  First there are the issues about rational choice generally, secondly about assuming that utility depends solely on own consumption and leisure, but also thirdly about applying it to voting in particular.

Last November 8 - before it had become clear to me what political outcomes would become known several hours later on that dark day - I posted the following, in the course of discussing a paper presented by Ilyana Kuziemko the day before at the Colloquium on High-End Inequality:

"The paper notes that, under the “workhorse political economy model” in which voters simply follow their own narrow economic self-interest, it would be paradoxical to find that rising inequality didn’t trigger increased support for redistribution.  The model – which, happily, the authors, no less than I, regard as a useful strawman rather than something that is actually credible – posits that each voter’s support or opposition for addressing income inequality is simply a function of mean income minus own income, as this would determine whether symmetrically compressing income inequality would yield one a gain or a loss.

"This is not a convincing model for numerous reasons.  Let’s even posit that people didn’t care about anything other than the effect on own income under the above setup.  The model would still founder on the paradox of voting – i.e., the fact that, since I cannot have any statistically significant effect on the outcome, my voting (and even informing myself about the economic stakes to me) are a total waste of time when modeled in such a framework.  People “shouldn’t” vote, and if rational “wouldn’t” vote, unless something else was going on....

"What’s a better basic account of how voters generally make choices?  I rather like this quote from the newly published Christopher Achen and Larry Bartels, Democracy for Realists:  

“'[M]ost residents of democratic countries have little interest in politics and do not follow news of public affairs beyond browsing the headlines. They do not know the details of even salient policy debates, they do not have a firm understanding of what the political parties stand for, and they often vote for parties whose longstanding issue positions are at odds with their own.  Mostly, they identify with ethnic, racial, occupational, or other sorts of groups and often – whether through group ties or hereditary loyalties – with a political party. Even the more attentive citizens mostly adopt the political positions of the parties as their own: they are mirrors of the parties, not masters. For most citizens most of the time, party and group loyalty are the primary drivers of vote choices.'”

Oh's paper does not, however, make unsupported claims about the model's degree of descriptive accuracy. Instead, in its Part III, "Moving to the Real World," it discusses the issue of what we actually learn from the model. I agree that these models can provide an interesting perspective to add to other perspectives, and hence are worth doing.

BTW, the paper's current title doesn't do a perfect job of conveying what we learn from Part II. In essence, what the simulations show is that, in the model, the rich are more successful in gaining allies when they agree to a plan in which rates below the top income level are lowered. E.g., suppose that there initially were a flat 40% rate throughout.  Lowering the tax rate to, say, 20% for the first $100,000 of income would reduce taxes by $20,000 for each individual with more than $100,000 of income. This would exceed the reduction in the demogrant, so they'd be better off. While they would also benefit for lowering the tax rate that applied to income above $100,000, they wouldn't have as many allies if they proposed that. Everyone who was earning $100,000 or less would be opposed, whereas people in the upper ranges of that group would also benefit (despite the reduced demogrant) from lowering tax rates for the first $100,000.

Another way of thinking about the paper is that it illustrates the benefit to people in the upper rate brackets from lowering what are, for them, inframarginal rates. This indeed is a point that may have helped, say, the designers of the 2001 Bush tax cuts - not to mention the current Republican Congressional leadership - in creating false impressions among voters regarding the overall distributional slant of their tax proposals.

Tuesday, February 21, 2017

Interesting argument; good luck with that

A recent article by Irish tax lawyer Aisling Donohue notes that Apple, according to the summary of its appeal of the European Commission’s EU state aid verdict against Ireland, makes the following two arguments, among others:

“3. Third plea in law, alleging that the Commission made fundamental errors relating to the applicants’ activities outside of Ireland. — The Commission made fundamental errors by failing to recognise that the applicants’ profit-driving activities, in particular the development and commercialisation of intellectual property (‘Apple IP’), were controlled and managed in the United States. The profits from those activities were attributable to the United States, not Ireland. The Commission wrongly considered only the minutes of the applicants’ board meetings and ignored all other evidence of activities.

“ 4. Fourth plea in law, alleging that the Commission made fundamental errors relating to the applicants’ activities in Ireland.

“— The Commission failed to recognise that the Irish branches carried out only routine functions and were not involved in the development and commercialisation of Apple IP which drove profits.”

This is a flat-out statement that all of the "Irish" (or nowhere) income that Apple succeeded in treating as non-U.S. source under the then-operative version of our cost-sharing rules was in fact, as an economic matter, U.S. source.

Well, duh.  But I am not aware that Apple has publicly conceded this before in so express and unvarnished a matter. One would think they would be reluctant to speak so candidly about where the income actually arose, given other elements of their global tax position.

Might the admission matter under U.S. income tax law, looking backwards? Presumably not. How about as a matter of U.S. income tax law and politics, looking forward? Not impossible.

The legal position that Apple appears to be expressing at least implicitly (although I haven't seen the full brief) is not, I think, tenable. It seems to posit two layers of source rules. First, there is "true source." A country can only tax income that truly arose there as an economic matter.  Second, there is "claimed source." A country, like the U.S. with Apple, is free to treat less than all of the income that economically arose there as domestic source for tax purposes. But it cannot treat more as domestic source. So some principle (perhaps of general international tax law?) that constrains EU tax law, at least as interpreted by the European Commission, requires applying a one-way ratchet in favor of multinational companies.

And if one thinks in terms of inter-nation comity, Apple seems to be asserting that the U.S. can combine (a) asserting that, for purposes of its source rules, income arose outside the U.S. - and evidently in Ireland, with (b) demanding that no other country, including the Irish, tax the same income. Not that this is a wholly new assertion - the U.S. Treasury appeared to be saying the same thing in its infamous White Paper concerning the EU state aid cases, which I critiqued (in Tax Notes) here.

I would agree that, just because the U.S. has decided not to tax particular "true" U.S. source income (at least, if one makes this judgment under an origin-based, rather than a destination-based, approach to source questions) does not mean that absolutely anyone at all, no matter who, must have a reasonable claim to tax it. E.g., I don't think Japan would be on strong ground if it were to claim that there was Japanese source income when U.S. employees of U.S. companies created intellectual property that they then used to sell goods in the EU. But, whatever ultimately happens in the ECJ appeal of the EC's state aid decision regarding Apple and Ireland, I would be surprised if this set of arguments ended up cutting much ice. It looks too self-servingly inconsistent, given all the formal tax planning steps that Apple took within Ireland, to be the sort of thing judges often go for. Indeed, it reminds me of the old line about the "kid who kills his parents and then asks the judge for mercy because he's an orphan."

Tuesday, February 14, 2017

NYU Tax Policy Colloquium, week 4: Allison Christians' "Human Rights at the Borders of Tax Sovereignty"

Yesterday at the colloquium, Allison Christians, having braved our no doubt fraught international border to the north, presented her work in progress, Human Rights at the Borders of Tax Sovereignty. Despite the title, it's less a "human rights" piece as such than an inquiry into how countries' rights to tax may properly be defined and limited.

In making this inquiry, she operates from the view, as I do, that we must ultimately be thinking in terms of people. States are often the actors, not only in the reality of international relations but also in terms of how writers in the field conceptualize law and justice. E.g, from a Hobbesian starting point one might think of a state's rightful powers being limited only by other states. She doesn't accept this (nor do I), since (a) when thinking in terms of one state we are not fans of totalitarian absolutism, (b) states' only good purpose is to act on behalf of some set of individuals, and (c) it is individuals' interests, wellbeing, and/or rights that ought to concern us.

In an article (Taxing Potential Community Members' Foreign Source Income) that I gather will be coming out shortly in the Tax Law Review, I noted what I called the "Monty Python tax principle." It's derived from the bit in an old Monty Python skit in which a silly man in a bowler hat says: "To boost the British economy, I'd tax all foreigners living abroad." This is exactly what a given country seemingly should want to do, as a matter of self-interest, if we posit both that it's feasible (think greatly expanded drone capabilities) and there will be no blowback from other countries. If benign policymakers in a given country as prioritizing their own people's (citizens? residents? domiciliaries? community members') wellbeing over that of people outside the charmed circle - a move that seems unavoidable, yet is hard to support ethically in a wholly satisfying way - then this both (a) enriches the favored group relative to outsiders who are assumed to matter less, and (b) avoids tax-discouraging domestic activity. Think of it as the idea that the U.S. ought to want to tax, say, dealings by people in Germany with each other and/or people in China, if only it could and if only the Germans and Chinese wouldn't respond by doing something we disliked.

In the article, I took it as given that of course we don't try to do this, presumably at least in part because we ARE concerned about how the Germans and Chinese would respond. It helped to set up what I considered the paradoxical character of how we tax, say, people living in Germany or China who might or might not potentially be viewed as Americans for purposes of applying the U.S. income tax (e.g., in the case where they are U.S. citizens but long-time expatriates with only very limited if any continuing U.S. ties). The paradox, or irony, or whatever you want to call it that I discerned goes as follows: To say you are a U.S. person, e.g., by reason of your citizenship, is to say: You are still one of us. We still care about you. But the direct practical consequence is that, if you're still one of us and thus we still care about you, we respond by imposing continuing U.S. tax burdens on you - whereas if we don't care about you we DON'T impose those burdens. Talk about tough love! This approach would be exactly backwards if we were actually thinking in terms of the Monty Python tax principle (i.e., if we preferred imposing disutility on those we don't care about), at least if no other strategic or other considerations were relevant here.

Anyway, a further line of thought that our article for yesterday's colloquium interested me in pursuing was that we in the U.S. would not only be displeased and disadvantaged if, say, the Germans and Chinese imposed taxes on Americans transacting with themselves or with Mexicans or Canadians; we would indeed likely think that it was outrageous and unfair. So despite the limited scope by reason of national boundaries (e.g., the U.S. government can properly be mainly concerned with Americans' welfare), there are also reciprocity types of norms that we bring to our thinking about how we and other countries alike should exercise our tax jurisdiction. Hence, not generally following the Monty Python tax principle (which is not to say it never influences one's behavior) is not just a matter of limited power or concern about retaliation, but also about subscribing (at least to a degree) to cooperative behavioral norms that one may view as properly limiting one's claims of taxing power.

That in turn brings us back to the paper by Allison Christians. At this early stage, it posits three alternative ways of thinking about how a given country's right to tax might be conceptualized and limited. One's view might be based on (a) sovereignty, (b) nexus, comprising residence and source principles, or (c) a notion of "membership" such as that recently explored in work on tax competition by Peter Dietsch, who is at McGill and writes about distributional justice, including in the international setting. I am generally sympathetic to the normative views the paper expresses, but I would tend to cast differently the relationship between these alternative approaches.

1) Sovereignty - The article describes this as the idea that a state's power to tax is absolute, unless perhaps it butts up against the claims of another state. I agree with the paper that this is not a normatively satisfying position, even in a one-state world. My own take is that rejecting this view commits one to believing that a given country's tax claims must be reasonable, in terms of some underlying, but as yet unspecified, set of metrics. In the one-state case, these might mainly relate to ideas about due process, limiting uncompensated takings, etcetera. In the case where a given state has limited membership and limited territory, they may relate to why we don't generally accept the Monty Python tax principle, and agree, for example, that the U.S. should not be taxing the people of Germany or China when they transact with themselves or each other.

In sum, therefore, the sovereignty view that she describes is not a proposed standard for deciding which claims of taxing authority that a government might make are reasonable - it's an alternative to requiring reasonableness of any kind.

2) Nexus - Here we have the traditional standards, which have been around in varying forms for close to a hundred years, since the work of League of Nations economists in the 1920s (but probably in fact for even longer). As they have crystallized today, let's call them the ideas of "residence" and "source." Under the nexis view, a country can reasonably tax its residents on any of their worldwide income (yes, for the moment let's assume an income tax, although at some point the analysis may need to be more general).  Or it can reasonably tax non-residents on income the source of which is domestic.

Let's abstract from the, in many ways arbitrary and unsatisfying, aspects of actual residence and source rules, as they have evolved in given countries' laws, in tax treaties, in the work of multilateral institutions (such as the OECD and the UN). Corporate residence, for example, is inherently a formalistic and unsatisfying idea, albeit hard to avoid once one has an entity-level corporate income tax. Likewise, source rules for particular types of income are inevitably formalistic and unsatisfying, e.g.., when (lacking better alternatives) we "source" passive income based on the place of residence of the issuer. And the source idea inherently can employ either origin-based or destination-based approaches. E.g., if I write a book and it's sold and read in India, this is U.S. source income if we focus on the act of production but Indian source income if we focus on the act of production. (An income tax is seemingly a production-based concept, but the existing U.S. income tax uses both types of approaches here and there - even leaving aside the currently prominent idea of replacing it with a "destination-based" tax.) But of course to say that we might think of the income from this as U.S. source or Indian source does not mean that we might also (without more facts) reasonably think of it as German source or Chinese source.

Okay, enough throat-clearing and back to the point I meant to make. Without in any way tieing oneself to existing residence and source doctrine, these are versions of two fundamental ideas on which an anti-Monty Pythonesque claim of "reasonable" tax jurisdiction might rest. First, you are one of our people or a member of our community. Second, while you aren't one of our people or a member of our community, you are doing something that relates to us sufficiently to make it reasonable that we might impose tax consequences on it (potentially meaning that you might have to participate in payment of the tax, and/or be expected to bear its economic incidence).

Thus, standards somewhat like "residence" and "source" appear to be fundamental once we have multiple states with distinct members and territories, even if current legal doctrine lacks any sort of fundamental or universal character. So I'd say, "nexus" as defined to mean generalized ideas akin to (a) residence and (b) source seems fundamental here - of course, also without any further implication that we are necessarily thinking in terms of the current legal meanings of the term nexus.

So we now have, I would say, at least some very guidance re. thinking about reasonableness here - reasonableness in terms of what? But of course this still leaves the vast majority of the hard work still to be done.

3) Membership - As I understand this set of concepts from the discussion in the paper, it comprises (a) an approach to thinking about what "residence" might reasonably mean, plus (b) a benefits-based approach to thinking about what "source" might reasonably mean.

On (a) or residence, I'm sympathetic. In defining "Americans" who might be treated as U.S. taxpayers for purposes of being taxable on non-U.S. source income, notions that the paper discusses of voluntariness, intentionality, ability to opt out, the importance of factors suggesting true affiliation (not limited to geographic presence within a given period), may be very helpful as we try to flesh out the contours of reasonableness. Christians, of course, has written eloquently about what she views as the grotesque over-reach of the U.S. tax system with respect to foreign non-resident U.S. citizens who may not even know that they are citizens or ever have valued or chosen a U.S. affiliation, e.g., by reason of having been born here without ever subsequently living here. (Indeed, her eloquence on this point is such that I am sometimes reminded of Hamlet speaking to his mother: "You go not till I set you up a glass / Where you may see the inmost part of you" - she is good at holding up the glass so that we can see what our system is doing to people whom we apparently don't care about.)

On (b) or source, I'm unsympathetic at least to treating benefit as an exclusive ground for viewing tax jurisdiction as reasonable. Take the case of an optimal tariff, applied to inbound sales that would otherwise be generating rents to the sellers, e.g., by reason of the monopoly power conveyed by intellectual property rights. This might include the case where, say, Apple is selling iPhones in India.

Do we really care about whether India has a "benefit" theory on hand for the existence of a consumer market that Apple can now exploit? I don't find a benefit analysis here particularly necessary or interesting. The optimal tariff that India might levy, even if we called it a source-based income tax, can be thought of as organizing the Indian consumers to exercise monopsony power that offsets Apple's monopoly power as a seller and thus creates a bilateral monopoly, under which India can extract some of the surplus, in lieu of Apple's owners getting it all. I see nothing wrong with this, especially once we think of the Indian government as rightly acting on behalf of its people's interests. And even if one has monopsony power being exercised in otherwise competitive market settings, one might think of negotiations between countries as being the best way to create Pareto improvements - as distinct from positing that a given country lacks "rights" with respect to influencing the terms of transactions that involve its own people.

It's probably fair to say that I find the topic of this paper interesting enough to add it to the list of topics for future papers that I probably won't ever write, but that, who knows, perhaps someday I would (especially if asked).

Tuesday, February 07, 2017

Auerbach et al on intra-generational accounting, part 2

I like the intra-generational accounting methodology that Auerbach et al introduce in their paper. By "like," I mean that I believe it makes a positive contribution to our understanding and should be part of one's toolkit in evaluating U.S. distribution and progressivity issues. But herewith a few comments re. both its limits and particular ways in which it might be used.

Technical measurement issues - Obviously, there are a lot of these, which got considerable attention at both our AM and PM sessions. For example, is capital income actually less tax-burdened than the model assumes? (E.g., due to flow-throughs' ability in many cases to avoid even one level of tax). Should low-earners be assumed to earn a normal rate of return on their saving than high-earners, or to pay higher borrowing rates when they're not entirely liquidity-constrained? The model can of course be adjusted to accommodate alternative assumptions on these and other issues.

What is inequality, and why does it matter? - The paper states that "ultimate inequality" is nothing more or less than "inequality in remaining lifetime spending." Similarly, it says that "economically relevant inequality" is limited to inequality in spending power.  I would tend to view inequality as a more flexible and multi-faceted issue than this language suggests, and I suspect Auerbach agrees.

The paper's implicit model reflects viewing people as deriving utility solely from their own market consumption. The underlying public economics behavioral models would broaden this slightly, treating people as deriving utility solely from their own market consumption plus leisure, but leisure isn't in the measure. If it were, one possible implication would be opening up the question: Are A and B actually the same, if A has $10 million in the bank and lives at the beach, while B has nothing in the bank but has remaining career earnings with an expected value of $10 million? In short, is human capital relevantly the same as wealth? Even staying mainly within the confines of a standard public economics model, I would say this depends on whether B disvalues having to work,

Then there are all the issues around inequality arising from the fact that (as I have discussed elsewhere) the simple public economics model is simply too simple for some purposes. For example, people evidently care about status, prestige, relative position, etc. This not only might increase the social costs of inequality, but also might affect how one needs to measure it. Suppose, for example, that - in keeping, say, with the research by Wilkinson and Pickett - inequality tends to increase stress-related social gradient ills from the top to the bottom, albeit especially at the bottom. Does the inequality that people observe or feel, and that leads to these effects, necessarily track inequality in remaining lifetime spending? Not necessarily. The logic behind the paper's definition is rooted in rational choice assumptions about a particular individual, which (even apart from its incomplete accuracy, especially with the constrained utility function) may be significantly different.

Likewise, suppose that the harms resulting from extreme high-end inequality include its political economy effects.  These might range from outright plutocratic capture of the political system to reduced democratic responsiveness, loss of social solidarity, etc. It's not necessarily clear that this, either, would have to track inequality in remaining lifetime spending power better than some other metric.

But again, this just counsels having multiple ideas in mind and using multiple tools - it does not discredit intra-generational accounting as a useful method.

One final point concerns how intra-generational accounting might reasonably be used. Suppose we are evaluating how Paul Ryan's fiscal roadmap would affect the distribution of remaining lifetime spending power. My guess is that - starting with a statiic analysis; I'll note the dynamic issues shortly - it would have a very large effect, especially if the true plan were set forth a bit more forthrightly (e.g., with respect to long-term fiscal sustainability). The plan's elements, so considered, would include enormous tax cuts at the top, and significant cuts (over time, likely far greater than are being acknowledged) to at least the growth rates of privatized Social Security and Medicare, block-granted Medicaid, etcetera.

This might have very large effects indeed on inequality in remaining lifetime spending power. A Saez-Zucman-style wealth measure (assuming it was projected forward, rather than just being computed looking backwards) would fail to show the impact as meaningfully. So would typical tax distribution tables. So the ability to use intra-generational accounting towards measuring the distributional effects of major long-term government fiscal policy changes strikes me as potentially a huge contribution.

But it would require addressing two very large measurement problems. The first is what to do about the fiscal gap - i.e., the fact that current fiscal policy appears not to be sustainable over the long term, and any plans that Ryan has ever announced (disregarding magic asterisks) would make the sustainability problem far worse. Generational accounting tried to deal with this issue by assigning the entire cost of meeting the fiscal gap to "future generations" - a solution that proved confusing (since it was a measurement convention, rather than an actual prediction) and that undermined its acceptance. Not sure what best to do re. intra-generational accounting: use alternative scenarios involving multiple age cohorts?

Second, one has to consider the dynamic issues when designing such a measure. E.g., Ryan et al claim huge positive growth effects, which others believe would be lower even without the "fiscal overhang" issue of failing to fund all of the tax cuts. Again, I suppose one could use alternative scenarios here, including with and without rising interim fiscal overhang.

These difficulties may be too great to support much optimism that intra-generational accounting can play a large part (or perhaps any part) in the political process regarding major policy change proposals. But it may have analytical value for those who are interested in better understanding the distributional issues that are posed by a given policy scenario.

NYU Tax Policy Colloquium, week 3: Alan Auerbach (et al)'s "U.S. Inequality, Fiscal Progressivity, and Work Disincentives: An Intragenerational Accounting" - Part 1

Yesterday my frequent past colloquium co-convenor Alan Auerbach came to the NYU Tax Policy Colloquium to discuss the DBCFT how we should measure the fiscal system's progressivity. His paper (coauthored with Laurence Kotlikoff and Darryl Koehler) draws on earlier work (with Kotlikoff) that I've always liked and considered important, despite criticisms that it has received elsewhere, concerning generational accounting (GA).  GA aims to look at how the fiscal system - taxes, transfers, and whatever spending one can reasonably classify as funding consumption by particular individuals - affects generational distribution. More shortly on a couple of the issues that raised. The current paper, as per its title, engages in "intragenerational accounting" - measuring the fiscal system's distributional effects within an age cohort, in particular as between richer and poorer individuals (although a key part of the issue is how to classify people in this vertical sense.

I'll discuss the paper in two separate blog posts, so as to keep this one from getting too long.

To place the paper's analysis in context, consider the following chart from Table 1 of a 2014 NBER working paper by Auerbach's Berkeley colleagues Emmanuel Saez and Gabriel Zucman (containing findings that are also mentioned in their forthcoming Quarterly Journal of Economics Paper):

Wealth group
# of families
$$ threshold
Average wealth
Wealth share
Full population

Top 10%
Top 1%
Top 0.1%
Top 0.01%
Bottom 90%


One point from this table that has received a lot of attention is that the top 0.1% in the U.S. population, in terms of families ranked by wealth, holds almost as high a share as the bottom 90%. A second widely noted point, also mentioned in Saez-Zucman 2016, is that the wealth share of the top 0.1% has more than tripled since 1978.

But how should we think of wealth as a measure, in assessing U.S. progressivity and distribution? Auerbach et al note in their paper that its defects include the following:

1) It doesn't include the value of human capital, i.e. the present value of one's future earning power. To show why this might be important, suppose there are 2 people, one with $10 million in the bank and no job (or plans to get one), and the other with a job and/or career, as secure as the first one's wealth, that is expected to generate earnings with a present value of $10 million. These two individuals seemingly can afford the same value of remaining lifetime consumption (including bequests, which Auerbach et al note can often be thought of as a personal consumption choice, preferred to other uses by the individual who leaves the bequest). A big difference, of course, is that the first one doesn't have to work, while the second one does. But - suppose the second individual actually likes working, and indeed prefers it to "leisure."

2) It doesn't include the net positive value (if any) of expected future net transfers (minus taxes) from the government. Now, while Social Security obviously is not generous enough to offer anyone expected future benefits with a present value of $10 million, if it did (and if these benefits were politically secure) that person - also leaving aside liquidity issues - would be able to afford just as much remaining lifetime consumption as the two whom I mentioned above. Now obviously, Social Security and Medicare "wealth" (which raises further issues, since it has to be consumed in the form of healthcare) isn't going to do much about the wealth numbers we observe at the top. But it would discernibly raise numbers at the lower wealth echelons.

3) It's a snapshot that doesn't count for lifecycle effects. In a standard pattern, people have little wealth (unless they have inherited it) when they are young, then gradually build up some wealth as they save during their working careers, then spend it down during their retirement years except insofar as they are leaving bequests (either deliberately or as a byproduct of precautionary saving).

Suppose - although we of course know that this isn't the case - that the Saez-Zucman wealth charts were solely a function of lifecycle effects. That is, suppose everyone did identically on a lifetime basis, but started at the bottom when they were young, gradually marched up to the top 0.01 percent as they reached their late peak working years, and then went down again (say, to zero wealth at death) during retirement. Then the Saez-Zucman chart would say nothing whatsoever about wealth distribution in our society, at least as conceived of on a lifetime basis. Each of us would be taking the same full ride. It would still be interesting to know why things have changed so much since 1978, and there might be issues of failed lifetime consumption smoothing - meaning that we might need policies to make it easier for people to borrow or save as needed to consume as much they wanted (given the lifetime budget constraint) in low-wealth periods. But everyone would be doing the same on a lifetime basis.

Now, I am convinced that the Saez-Zucman info is extremely important despite all these issues (and I would guess that Auerbach, whether or not all of his coauthors, agrees). But they offer a system of measurement that aims to adjust for these issues. It aims to group people in a given age cohort by the present value of their remaining lifetime spending power, and also to look at the fiscal system's impact on where they end up.

One finding is that U.S. inequality is far less extreme by this measure than by the Saez-Zucman wealth measure. Now, surely we already knew that. Saez-Zucman would be portraying a horrific dystopia, featuring mass privation in the U.S. population, if people could only consume - including necessities such as food and shelter - by using saved wealth. Insert Trump Administration joke here if you like, but we know that things aren't actually currently like that here. And it's by reason of the excluded factors, such as earning capacity and U.S. transfer programs (especially during retirement) that things aren't so dire. But looking ahead for a moment, that doesn't mean the Saez-Zucman finding is "wrong' or irrelevant - just that one needs to think further about what its significance might be. The Auerbach et al measure of expected remaining lifetime consumption is also highly relevant, and for some purposes clearly the more informative of the two.

A second finding in the Auerbach et al paper is that the U.S. fiscal system is significantly redistributive. People at the high end, by its metric, appear to pay far higher marginal and tax rates than those lower down. One reason for this is the U.S. transfer system, especially for retirement. A second reason is that we do indeed tax capital income, and thus saving to fund future consumption (or bequests). Indeed, between the entity-level corporate tax and owner-level capital income taxes on saving, the effective rate as measured may exceed current year marginal tax rates.

A third finding is that there's lots of dispersion in marginal tax rates, as among people whom the study groups at the same level vertically. Loss of Medicaid benefits when one places out of it on earning or asset grounds is one reason for this at the lower end. The paper looks at marginal tax rates by examining what one happens to one's taxes and transfers if one earns an extra $1,000, and might come out differently if one were asking, say, the effect of permanently earning an extra, say, $1,000 per year (which in some cases might be a better rendering of the actual marginal choice that a given individual faced).

Auerbach et al haven't done similar studies for other countries, which would require a whole lot of data and also local detail regarding the relevant fiscal systems. But it's likely that our peer countries show significantly greater after-tax-and-transfer equality in remaining lifetime spending power. To make good cross-country comparisons, however, one might need to tweak the treatment of government spending to adjust for the fact that other countries often offer a lot more by way of benefits that are methodologically tricky to assign to particular individuals, and yet that are enjoyed sufficiently pro rata (while being funded through VATs and income taxes under which the rich pay absolutely more) to have a potentially significant bottom line impact.

Further comments on intra-generational accounting to come in Part 2, which I hope to post shortly.

Wednesday, February 01, 2017

Next section of my literature book

I'm finally getting a chance to turn to part 3 of my literature book (U.S. from post-Civil War through World War I). In the general Part 3 intro, I may talk a bit about Horatio Alger, whom I've been both reading and reading about. Then, going into today, I had figured my 3 chapters would be on ??, Theodore Dreiser's The Financier and The Titan, and Edith Wharton's House of Mirth. But I've now moved a bit further forward.

For ?? I had been leaning towards William Dean Howell's The Rise of Silas Lapham, but also considering mentioning Mark Twain's and Charles Dudley Warner's The Gilded Age. But today I decided to do Twain-Warner, not Howells (whom I'll at most mention in passing). It's not just darker, but also I think significantly richer, and also more attuned to what I'd enjoy discussing about that era. There's something a bit simplistic and not terribly interestingly moralistic about the Howells novel, although I do on balance like it.

For Dreiser, I had initially thought I might just cover The Financier, but (as I may have mentioned in an earlier post) when I re-read both over the winter break I realized that The Titan is, if anything, even richer. David Frum's great comment is that these are Ayn Rand novels written by a socialist.

It took me most of the way through Wharton (also a re-reading, from many decades ago) to see a through-line for writing about it, but now I think I have a good one, although it will be many months before I get there. It's about values that are really aesthetic, not moral, that money is destroying. I'd also considered Booth Tarkington's The Magnificent Ambersons, but that, too, is less rich, although it has an interesting and slightly complementary perspective. (And I'll have to re-see the movie; that's also been several decades.)

Of course, I can only do so much of these things while I am teaching and otherwise busy during the semester.  They require a lot of concentration and focus - I think, more than when I am engaged in more familiar (to me) types of projects. But I do have sabbatical the next two falls, although I plan to travel a lot during those periods as well.