Yesterday at the colloquium, Andrew Hayashi presented an early draft of an interesting project that brings together two recently burgeoning (but still on balance underpopulated) sub-genres in tax policy scholarship. The first is looking at macroeconomic, or more specifically, Keynesian, policy considerations - in particular, the design of fiscal policy instruments to be automatically countercyclical (or at least not procyclical). The second is state and local taxation, which gets less attention in the literature (despite some excellent scholars) than its overall importance deserves, in part because it's harder to look at all 50 states than simply at the federal level.
Hayashi is interested in examining, from both a theoretical and an empirical perspective, the question of how the choice of tax base by local governments could affect the depth of recessions and speed of recovery within their borders.
In recent years, we have of course learned that serious recessions actually can and do still happen. Plus, they may be inadequately addressed at the federal level, despite the multiple tools of monetary policy, automatic fiscal policy adjustments, and discretionary fiscal policy responses. Plus, recessions may vary significantly in severity as between localities, even if geographical mobility within the United States is not quite so low as, say, that between distinctive parts of the EU.
So, even if one is skeptical of the potential of discretionary fiscal policy at the state and local level - if only due to balanced budget constraints on state and local governments - one might like to ask what automatic fiscal policy can do. Only, when one thinks about this, balanced budget constraints remain relevant.
State and local governments may face balanced budget legal requirements with varying degrees of rigor. But even if the legal constraints aren't binding, the governments may face market constraints since, their credit ratings can plummet if they don't take care (reflecting a long history of sub-federal defaults).
If a locality's balanced budget constraint is sufficiently binding, then a countercyclical reduction in tax revenues may be promptly (or even verging on simultaneously) offset by a procyclical reduction in government outlays. So then the question becomes, from the standpoint of countercyclical fiscal policy, which of these two sets of opposite changes is likely to have a greater business cycle effect.
Joseph Stiglitz and Peter Orszag have apparently argued that marginal changes in state and local government spending, amid a recession, tend to affect consumption levels more than marginal changes in state and local tax levels - reflecting that taxes may tend to be paid by higher-income households that respond to the tax changes via their savings levels. If and insofar as this is true, one gets a seemingly paradoxical reversal of the standard wisdom regarding automatic fiscal policy.
If the tax side changed by itself, then the Keynesian macro standpoint would counsel the use by state and local governments of tax instruments that are relatively volatile and correlated with the business cycle. State and local income taxes are the classic example. By contrast, real property tax revenues tend to be extremely stable, even if home values are fluctuating. For example, property tax reassessments may be sporadic, may lean in practice against reducing the assessed value, and have enough discretion in the joints to permit keeping revenues steady. (Recent research by John Mikesell confirms that real property tax revenues were extremely stable during the Great Recession.)
So one has the paradigmatic choice between state and local taxes - income taxes, which fluctuate countercyclically but thereby draw procyclical spending changes, and real property taxes, which may fail to boost consumption in a recession, since they remain about the same, but have the virtue of not similarly drawing procyclical spending cuts.
A question of central interest in Hayashi's paper is whether one can find an empirical correlation between (a) the use of income taxation versus property taxation at the county level and (b) the severity of and speed of recovery from recessions. Then a second question is whether one can draw a causal arrow from (a) to (b), based on the above scenario in which volatile income taxes, but not stable property taxes, draw matching spending cuts. Early work, reflected in the draft discussed yesterday, suggests that there may indeed be some positive correlation between using property taxes and doing better in recessions, but much work remains to be done before any causal interpretation of the data can be confidently advanced.
Wednesday, January 31, 2018
Thursday, January 25, 2018
Now, that's what I call a bargain
According to the International Business Times, the 2017 tax bill may cause the Koch brothers to clear an extra $1 billion after-tax each year that it remains in force.
Given that point, what a bargain for them to have paid Paul Ryan's fundraising committee a mere $500,000 shortly after the tax act passed. That's only about 0.05% of a single year's yield - although it's obviously true that they've paid off plenty of other people as well.
Ryan of course also benefited, and got paid by, plenty of other very rich people by helping to ram through the tax bill. But still, without needing to compute who paid him how much in exchange for how much (and express, criminally punishable quid pro quos are wholly unnecessary to this), it is an interesting question, which the public choice literature has studied over a period of decades, why he and others like him can't clear even more from their largesse than they already do.
Gordon Tullock wrote a number of interesting works, including this one, on why the Washington rent-seeking industry, although we think of it as large, is actually so small (and poorly paying for the government actors who provide the payoffs) relative to the benefits they provide. He noted that this suggests the industry is highly "inefficient" - a fact of which we should be glad, since if it were more "efficient" at rent extraction this would probably cause the collapse of the U.S. economy and immiserate (or further immiserate) the hundreds of millions of Americans who are not in a position to reap the fruits of perverting government processes.
One of the key factors Tullock identifies is that both legal constraints and informal norms, by making it harder to pay really large amounts and have explicit quid pro quo deals without courting jail time, help to make the industry so "inefficient." But the rise of partisan norms, decline of democratic accountability, and decline of prosecutorial independence from the presidency (if sustained) could certainly move towards making the rent-seeking / corruption market increasingly "efficient."
Forget draining the swamp; the question now is to what extent the swamp will start draining us.
Given that point, what a bargain for them to have paid Paul Ryan's fundraising committee a mere $500,000 shortly after the tax act passed. That's only about 0.05% of a single year's yield - although it's obviously true that they've paid off plenty of other people as well.
Ryan of course also benefited, and got paid by, plenty of other very rich people by helping to ram through the tax bill. But still, without needing to compute who paid him how much in exchange for how much (and express, criminally punishable quid pro quos are wholly unnecessary to this), it is an interesting question, which the public choice literature has studied over a period of decades, why he and others like him can't clear even more from their largesse than they already do.
Gordon Tullock wrote a number of interesting works, including this one, on why the Washington rent-seeking industry, although we think of it as large, is actually so small (and poorly paying for the government actors who provide the payoffs) relative to the benefits they provide. He noted that this suggests the industry is highly "inefficient" - a fact of which we should be glad, since if it were more "efficient" at rent extraction this would probably cause the collapse of the U.S. economy and immiserate (or further immiserate) the hundreds of millions of Americans who are not in a position to reap the fruits of perverting government processes.
One of the key factors Tullock identifies is that both legal constraints and informal norms, by making it harder to pay really large amounts and have explicit quid pro quo deals without courting jail time, help to make the industry so "inefficient." But the rise of partisan norms, decline of democratic accountability, and decline of prosecutorial independence from the presidency (if sustained) could certainly move towards making the rent-seeking / corruption market increasingly "efficient."
Forget draining the swamp; the question now is to what extent the swamp will start draining us.
Wednesday, January 24, 2018
Tax policy colloquium, week 2: Peter Dietsch's "Tax Competition and Global Background Justice"
Yesterday at
the Tax Policy Colloquium, Peter Dietsch of the University of Montreal’s
Philosophy Department presented “Tax Competition and Global Background Justice,”
coauthored by Thomas Rixen.
Given our
interdisciplinary interests at the Colloquium, it was great to have a paper by
a philosopher, especially one who understands both economics and legal
institutions at a sufficient level to be able to make a serious and grounded
inquiry.
The paper's underlying concern is that global tax competition may undermine countries' fiscal systems in two ways: by reducing (1) their tax capacity (how much revenue they can raise, and thus what sorts of spending policies they can afford, and (2) their ability to achieve distributional aims, in particular at the high end of the wealth or income distribution. (Obviously, some readers may view these limitations as good rather than bad - noted in the interest of completeness, although I am not in that camp myself.) One might reasonably posit that problem #1 is more likely to be binding for small and developing countries, while problem #2 is more likely to affect larger, wealthier, and more developed countries.
The normative framework that the paper applies to these issues is consequentialist, but not welfarist. The aim is to maximize aggregate fiscal self-determination, a country-level analogue to thinking about individuals' autonomy. This is founded on accepting pluralism and countries' having distinctive sets of policy preferences, and the concern is about effective de facto, not just formal de jure, powers of fiscal self-determination.
A simple example that's drawn from the paper may help to illustrate this. Suppose Sweden has a preference for high taxes and a big welfare state; the UK for low taxes and only a small welfare state. Fiscal self-determination is advanced if both countries can do what they prefer.
With global capital mobility, capital will tend to flow out of Sweden and into the UK if each country simply implements its preferences (which one might think of them as having wholly without regard to global capital mobility - although, in fact, one might ask if there's a kind of not-behind-the-veil issue going on here. So what the UK does potentially undermines Sweden's ability to do what it likes. But suppose a global tax authority therefore told the UK: You need to have higher taxes, so that you don't undermine Sweden's ability to fund a large welfare state. This would aid Swedish fiscal self-determination, but at the cost of denying fiscal self-determination to the UK. So there is an inherent tension that makes it harder to decide how fiscal self-determination is best maximized.
Before turning to the paper's proposed response to the dilemma or tradeoff, it's useful to mention 3 well-chosen scenarios that it emphasizes:
CASE 1: An individual hides income from the national tax authorities by earning it through (and stashing it in) a bank in a tax haven jurisdiction that (still) offers banks secrecy. This is fraud by the taxpayer under domestic law. The haven jurisdiction, or people in it, might conceivably be thought of as enablers or even accessories to this fraud, but rather than use all those issues the paper refers to this as "poaching" by that jurisdiction at the expense of the residence jurisdiction.
CASE 2: A company uses transfer pricing and other tricks of the trade to divert taxable income from the places where it actually arose (perhaps an ambiguous concept, of course) to a tax haven jurisdiction. This is profit-shifting by the taxpayer, and the paper likewise calls it poaching by the tax haven jurisdiction. The key difference between Cases 1 and 2, other than individual vs. corporation, is that 1 involves straight-up fraud, while here the profit-shifting may be at least arguably, or even unambiguously, legally permissible under the tax rules of the "true" source jurisdiction (and perhaps also the residence jurisdiction).
CASE 3: A multinational firm places a factory wherever the effective tax rate on the production will be lowest. We can call this production-shifting, rather than profit-shifting, because here the "true" source changes - this is "real" rather than formal tax competition. The paper's term for jurisdictions that seek to attract factories and other real investment via lower effective tax rates is "luring."
An example of the paper's shrewdness is its recognizing that cutting back on poaching may increase luring. Real tax competition may become fiercer if higher-tax countries can't mitigate their headline rates via the availability of profit-shifting. But let's go back to the central line of argument.
If we think of tax competition as a race to the bottom, poaching inevitably leads there, to the extent that it is feasible, since profits can in principle be placed wherever one likes. Luring also pushes in that direction, although it is more constrained since one has to place the factory somewhere where real production activity is not just feasible but cost-competitive with the alternatives on an all-in, after-tax basis.
The paper offers two main principles in addressing the challenges to fiscal self-determination that these three scenarios raise. The first is a "membership principle," holding that one should be liable to pay tax wherever one is a "member" of the given society. This works in familiar fashion for individuals, who in the simplest cases are unambiguously residents of one country but not others. But the paper also argues that corporations - perhaps a better concept would be "businesses" - are members wherever they make significant use of local resources. Thus, if I (at least through a corporation) sat around in NYC writing books in Hindi that I then had printed in Singapore and sold in India, I'd have some membership in the US, in Singapore, and in India. As I'll address shortly, it might seem a bit odd to say my corporation is a "member" of these three societies, but it would be unexceptional to say that all three have legal nexus permitting them to tax my activity of writing, printing, and selling books.
Second, the paper offers what it calls a "fiscal policy constraint" on how countries should decide on their tax rules. To simplify slightly, the idea is no poaching and no luring. In other words - but, to be fair, putting it in my words, not exactly those of the paper - they should set their tax rules (such as the corporate rate) under the counterfactual assumption that capital is geographically inelastic.
Back to the UK, with its lower tax rate than Sweden. It's fine, and a basic exercise of their fiscal sovereignty, if they set a low corporate tax rate in part because they believe UK residents will save and invest more if this rate is low, rather than high. But if the elasticity on which they rely is cross-border, rather than internal - if they are setting their tax rate at least in part to "lure" capital away from other places such as high-tax Sweden - then they are acting improperly.
As an aspirational aim for the distant future, the paper envisions the creation someday of an "International Tax Organization" or ITO, by analogy to the World Trade Organization (WTO), or more distantly, say, the International Court of Justice. In a world where all this was in place, if the UK cut its tax rate (to keep things simpler, let's leave aside preexisting low rates), Sweden could contest this in the ITO, which would rule against the UK if the Swedes sufficiently demonstrated that luring was afoot and that it had an adverse impact on Sweden.
I don't consider the fact that (as the authors recognize) this is not very short-term practical or likely to happen as an insuperable objection to evaluating it normatively. Our underlying principles (and what they should be) are of interest even with relevant political, etc., constraints. But several main comments occur to me, even leaving aside the broader issue of whether one might view at least some aspects of tax competition as good rather than bad.
1) To what extent is multilateral cooperation necessary to preserve countries' tax capacity and ability to achieve their distributional aims? A big part of the problem is that so much business income is taxed at the entity level, via corporate income taxes, thus causing corporate residence electivity plus source manipulability (through both real tax competition and profit-shifting) to have large effects. But, so long as Problem 1 (fraud) is being addressed - and I note that FATCA et al suggest that it is increasingly being addressed - countries might have other ways of getting to where they might want. A key aspect may be shifting effective taxation to be more at the owner level and less at the entity level. Some recent US academic tax reform plans that would have done this are (a) Toder-Viard (mark to market taxation at the SH level, tax rate is reduced to 15%), (b) Grubert-Altshuler (deferral charge for the receipt of dividends, plus realization at death for shareholders, with the corporate rate likewise being reduced to 15%), and (c) Kleinbard's BEIT proposal, shifting taxation of normal returns to the owner level (among other changes). Adopting progressive consumption taxation (which I would want to supplement with something such as inheritance taxation) might also decouple achievement of the fiscal sovereignty aims from the issues around tax competition.
2) To say not just no poaching but also no luring is a rather demanding standard. In effect, nations are being urged to make tax policy around a counterfactual, and to overlook key empirical consequences of their choices that may be quite difficult to disregard. Note of course that, in well-governed countries, the legislators recognize fiduciary duties towards the wellbeing of their constituents, and that one may especially uneasy about disregarding important empirical issues if one is not convinced that legislators in other countries are doing this as well.
3) This may be as much a semantic as a substantive objection, but it seems inapt to me to say that my hypothetical Hindi book publishing and writing business makes me a "member" of Singapore's and India's polities under the above hypothetical facts. The paper invokes the notion of benefit. But the normative force of the concept is unclear to me, especially where the benefits that I'm getting impose no net cost (and perhaps even convey a net benefit) to the jurisdictions that provide them. Singapore is presumably better-off (rather than, say, predominantly more "congested") by reason of my doing some basic manufacturing there, likewise India by reason of my hypothetical eloquence in Hindi. So the idea is really nexus with an associated notion of proportionality. (The paper anticipates, say, 3-factor formulary apportionment's being used, so that Singapore & India merely get a share - they can't over-grab merely because my company has nexus &/or is deemed a "member" of their polities.)
Nexus is a familiar legal concept, but hard to ground directly in clear normative terms. I think of it in this context in terms of what I like to call the "Monty Python tax principle."
A silly Pythoneer in a bowler hat comments, in one of the old episodes, "To aid the British economy, we should tax foreigners living abroad." Hence, under the Monty Python tax principle, every country in the world might like to tax my activity of writing books in the US that are printed in Singapore and sold in India. But this would lead in a rather chaotic direction, to say the least (even apart from the question of how all those countries could actually collect these taxes).
Nexus is clearly an important practical idea, but I myself wouldn't ground it semantically in terms of "membership." I also might not ground it normatively in terms of "benefit," although admittedly I haven't focused on nexus issues, more or less taking it for granted that, in the above scenario, the only 3 relecant players are likely to be the US, Singapore, and India. But it's a topic that certainly merits attention.
Despite quibbling with some aspects of the paper's analysis, I found it very helpful and interesting, and thought that it prompted a great discussion at both our AM and PM sessions.
Dietsch's recently published book, Catching Capital: The Ethics of Tax Competition, discusses his views more broadly. Recommended & worth a look by all with related interests. Its multidisciplinary strengths are not often found in the biz.
The paper's underlying concern is that global tax competition may undermine countries' fiscal systems in two ways: by reducing (1) their tax capacity (how much revenue they can raise, and thus what sorts of spending policies they can afford, and (2) their ability to achieve distributional aims, in particular at the high end of the wealth or income distribution. (Obviously, some readers may view these limitations as good rather than bad - noted in the interest of completeness, although I am not in that camp myself.) One might reasonably posit that problem #1 is more likely to be binding for small and developing countries, while problem #2 is more likely to affect larger, wealthier, and more developed countries.
The normative framework that the paper applies to these issues is consequentialist, but not welfarist. The aim is to maximize aggregate fiscal self-determination, a country-level analogue to thinking about individuals' autonomy. This is founded on accepting pluralism and countries' having distinctive sets of policy preferences, and the concern is about effective de facto, not just formal de jure, powers of fiscal self-determination.
A simple example that's drawn from the paper may help to illustrate this. Suppose Sweden has a preference for high taxes and a big welfare state; the UK for low taxes and only a small welfare state. Fiscal self-determination is advanced if both countries can do what they prefer.
With global capital mobility, capital will tend to flow out of Sweden and into the UK if each country simply implements its preferences (which one might think of them as having wholly without regard to global capital mobility - although, in fact, one might ask if there's a kind of not-behind-the-veil issue going on here. So what the UK does potentially undermines Sweden's ability to do what it likes. But suppose a global tax authority therefore told the UK: You need to have higher taxes, so that you don't undermine Sweden's ability to fund a large welfare state. This would aid Swedish fiscal self-determination, but at the cost of denying fiscal self-determination to the UK. So there is an inherent tension that makes it harder to decide how fiscal self-determination is best maximized.
Before turning to the paper's proposed response to the dilemma or tradeoff, it's useful to mention 3 well-chosen scenarios that it emphasizes:
CASE 1: An individual hides income from the national tax authorities by earning it through (and stashing it in) a bank in a tax haven jurisdiction that (still) offers banks secrecy. This is fraud by the taxpayer under domestic law. The haven jurisdiction, or people in it, might conceivably be thought of as enablers or even accessories to this fraud, but rather than use all those issues the paper refers to this as "poaching" by that jurisdiction at the expense of the residence jurisdiction.
CASE 2: A company uses transfer pricing and other tricks of the trade to divert taxable income from the places where it actually arose (perhaps an ambiguous concept, of course) to a tax haven jurisdiction. This is profit-shifting by the taxpayer, and the paper likewise calls it poaching by the tax haven jurisdiction. The key difference between Cases 1 and 2, other than individual vs. corporation, is that 1 involves straight-up fraud, while here the profit-shifting may be at least arguably, or even unambiguously, legally permissible under the tax rules of the "true" source jurisdiction (and perhaps also the residence jurisdiction).
CASE 3: A multinational firm places a factory wherever the effective tax rate on the production will be lowest. We can call this production-shifting, rather than profit-shifting, because here the "true" source changes - this is "real" rather than formal tax competition. The paper's term for jurisdictions that seek to attract factories and other real investment via lower effective tax rates is "luring."
An example of the paper's shrewdness is its recognizing that cutting back on poaching may increase luring. Real tax competition may become fiercer if higher-tax countries can't mitigate their headline rates via the availability of profit-shifting. But let's go back to the central line of argument.
If we think of tax competition as a race to the bottom, poaching inevitably leads there, to the extent that it is feasible, since profits can in principle be placed wherever one likes. Luring also pushes in that direction, although it is more constrained since one has to place the factory somewhere where real production activity is not just feasible but cost-competitive with the alternatives on an all-in, after-tax basis.
The paper offers two main principles in addressing the challenges to fiscal self-determination that these three scenarios raise. The first is a "membership principle," holding that one should be liable to pay tax wherever one is a "member" of the given society. This works in familiar fashion for individuals, who in the simplest cases are unambiguously residents of one country but not others. But the paper also argues that corporations - perhaps a better concept would be "businesses" - are members wherever they make significant use of local resources. Thus, if I (at least through a corporation) sat around in NYC writing books in Hindi that I then had printed in Singapore and sold in India, I'd have some membership in the US, in Singapore, and in India. As I'll address shortly, it might seem a bit odd to say my corporation is a "member" of these three societies, but it would be unexceptional to say that all three have legal nexus permitting them to tax my activity of writing, printing, and selling books.
Second, the paper offers what it calls a "fiscal policy constraint" on how countries should decide on their tax rules. To simplify slightly, the idea is no poaching and no luring. In other words - but, to be fair, putting it in my words, not exactly those of the paper - they should set their tax rules (such as the corporate rate) under the counterfactual assumption that capital is geographically inelastic.
Back to the UK, with its lower tax rate than Sweden. It's fine, and a basic exercise of their fiscal sovereignty, if they set a low corporate tax rate in part because they believe UK residents will save and invest more if this rate is low, rather than high. But if the elasticity on which they rely is cross-border, rather than internal - if they are setting their tax rate at least in part to "lure" capital away from other places such as high-tax Sweden - then they are acting improperly.
As an aspirational aim for the distant future, the paper envisions the creation someday of an "International Tax Organization" or ITO, by analogy to the World Trade Organization (WTO), or more distantly, say, the International Court of Justice. In a world where all this was in place, if the UK cut its tax rate (to keep things simpler, let's leave aside preexisting low rates), Sweden could contest this in the ITO, which would rule against the UK if the Swedes sufficiently demonstrated that luring was afoot and that it had an adverse impact on Sweden.
I don't consider the fact that (as the authors recognize) this is not very short-term practical or likely to happen as an insuperable objection to evaluating it normatively. Our underlying principles (and what they should be) are of interest even with relevant political, etc., constraints. But several main comments occur to me, even leaving aside the broader issue of whether one might view at least some aspects of tax competition as good rather than bad.
1) To what extent is multilateral cooperation necessary to preserve countries' tax capacity and ability to achieve their distributional aims? A big part of the problem is that so much business income is taxed at the entity level, via corporate income taxes, thus causing corporate residence electivity plus source manipulability (through both real tax competition and profit-shifting) to have large effects. But, so long as Problem 1 (fraud) is being addressed - and I note that FATCA et al suggest that it is increasingly being addressed - countries might have other ways of getting to where they might want. A key aspect may be shifting effective taxation to be more at the owner level and less at the entity level. Some recent US academic tax reform plans that would have done this are (a) Toder-Viard (mark to market taxation at the SH level, tax rate is reduced to 15%), (b) Grubert-Altshuler (deferral charge for the receipt of dividends, plus realization at death for shareholders, with the corporate rate likewise being reduced to 15%), and (c) Kleinbard's BEIT proposal, shifting taxation of normal returns to the owner level (among other changes). Adopting progressive consumption taxation (which I would want to supplement with something such as inheritance taxation) might also decouple achievement of the fiscal sovereignty aims from the issues around tax competition.
2) To say not just no poaching but also no luring is a rather demanding standard. In effect, nations are being urged to make tax policy around a counterfactual, and to overlook key empirical consequences of their choices that may be quite difficult to disregard. Note of course that, in well-governed countries, the legislators recognize fiduciary duties towards the wellbeing of their constituents, and that one may especially uneasy about disregarding important empirical issues if one is not convinced that legislators in other countries are doing this as well.
3) This may be as much a semantic as a substantive objection, but it seems inapt to me to say that my hypothetical Hindi book publishing and writing business makes me a "member" of Singapore's and India's polities under the above hypothetical facts. The paper invokes the notion of benefit. But the normative force of the concept is unclear to me, especially where the benefits that I'm getting impose no net cost (and perhaps even convey a net benefit) to the jurisdictions that provide them. Singapore is presumably better-off (rather than, say, predominantly more "congested") by reason of my doing some basic manufacturing there, likewise India by reason of my hypothetical eloquence in Hindi. So the idea is really nexus with an associated notion of proportionality. (The paper anticipates, say, 3-factor formulary apportionment's being used, so that Singapore & India merely get a share - they can't over-grab merely because my company has nexus &/or is deemed a "member" of their polities.)
Nexus is a familiar legal concept, but hard to ground directly in clear normative terms. I think of it in this context in terms of what I like to call the "Monty Python tax principle."
A silly Pythoneer in a bowler hat comments, in one of the old episodes, "To aid the British economy, we should tax foreigners living abroad." Hence, under the Monty Python tax principle, every country in the world might like to tax my activity of writing books in the US that are printed in Singapore and sold in India. But this would lead in a rather chaotic direction, to say the least (even apart from the question of how all those countries could actually collect these taxes).
Nexus is clearly an important practical idea, but I myself wouldn't ground it semantically in terms of "membership." I also might not ground it normatively in terms of "benefit," although admittedly I haven't focused on nexus issues, more or less taking it for granted that, in the above scenario, the only 3 relecant players are likely to be the US, Singapore, and India. But it's a topic that certainly merits attention.
Despite quibbling with some aspects of the paper's analysis, I found it very helpful and interesting, and thought that it prompted a great discussion at both our AM and PM sessions.
Dietsch's recently published book, Catching Capital: The Ethics of Tax Competition, discusses his views more broadly. Recommended & worth a look by all with related interests. Its multidisciplinary strengths are not often found in the biz.
Monday, January 22, 2018
Lost in translation
I spoke briefly by phone in December to a reporter from Japan who was asking me how the 2017 Republican tax bill compared to 1986 tax reform. Today he kindly sent me the text of his article, with highlighting for the portion where my comments are mentioned.
Unfortunately for my comprehension, the article is in Japanese, but he suggested that I use Google Translate for the highlighted portion. I did so, and here is what I got:
"Mr. Trump often cites tax reductions of the Reagan administration about 30 years ago. However, Daniel Shaviro, who worked as a lawyer in planning a tax cut on Reagan, said, 'At that time, the principle that equitable taxation should be imposed on whatever income it was in was at the bottom of the line: the current tax system to distinguish by how earned, It is not similar even though they are similar.'"
Hmm, not sure Google Translate absolutely nailed it here.
But perhaps I was noting that the passthrough rules cause the same earnings to be taxed differentially based on whether or not one is formally classified as an employee.
Unfortunately for my comprehension, the article is in Japanese, but he suggested that I use Google Translate for the highlighted portion. I did so, and here is what I got:
"Mr. Trump often cites tax reductions of the Reagan administration about 30 years ago. However, Daniel Shaviro, who worked as a lawyer in planning a tax cut on Reagan, said, 'At that time, the principle that equitable taxation should be imposed on whatever income it was in was at the bottom of the line: the current tax system to distinguish by how earned, It is not similar even though they are similar.'"
Hmm, not sure Google Translate absolutely nailed it here.
But perhaps I was noting that the passthrough rules cause the same earnings to be taxed differentially based on whether or not one is formally classified as an employee.
Thursday, January 18, 2018
New tax policy articles
Although largely not reflected until now in my public profile, I've been busy writing tax articles over the last month, and it looks like I'll be continuing to do so for a bit. I have more or less completed two short articles (each about 10,000 words long) and just started a new piece today.
The two that I've largely completed are as follows:
1) "The Disgraceful U.S. Passthrough Rules," drawing on analysis that will be familiar to people who have been reading this blog over the last few months. Yes, this piece has a definite point of view. I plan to post it on SSRN fairly soon.
2) "Goodbye to All That? A Requiem for the Destination-Based Cash Flow Tax." Here the content will likewise be familiar to people who have looked at slides that I've posted in various incarnations here (and in one of them on SSRN). This one will also probably be on SSRN soon.
Then there's the new one. I've just started it, but am hoping it will go fast as I can use portions of an early draft of an article that I wrote (but never posted) in the last quarter of 2017, before U.S. legislative developments made portions of it obsolete.
Its current working title is "Does the United States Now Have a Territorial Tax System?" The answer, in a word, is No.
I don't make readers wait for this conclusion - it actually comes on the bottom of page 1. And I note, of course, that this isn't my novel conclusion - sophisticated observers were saying it publicly before the bill had even been signed. What makes it seem useful to me as the article's title is that it helps to show the thorough unhelpfulness of the terms "worldwide" and "territorial" - not just as descriptions of actual real world tax systems, but even as basic analytical tools.
I'm planning to go on from there to point at what I think are better tools for analyzing international tax systems. Design issues of interest include (1) whether or not there is deferral, (2) what is the domestic tax rate for different kinds of foreign source income, (3) what is the effective marginal reimbursement rate for foreign taxes paid, and (4) how does one address profit-shifting, both in general and when it's done by resident as opposed to nonresident multinational firms (as classified by domestic law).
One point I will make is that the new U.S. international tax rules (along with various international tax rules in other countries) show the influence of considerations that I have argued are important with respect to the above questions.
It will also be clear to readers of the article that I by no means lump the 2017 act's international tax rules with its abysmal (or, per my article title, 'disgraceful") passthrough rules. There are clearly some serious problems with the new international tax rules. But even if they're not better than prior law right now - on which I don't have a definite conclusion at this point - they certainly could be tweaked to be significantly better.
This is partly a "compared to what"" point. The U.S. international tax rules were bad beforehand, and getting rid of deferral is an immediate plus, although the next question has always been what replaces it. (Both pure worldwide and pure territorial advocates, who have long existed in academia despite what I'd call the underlying weakness and analytical sloppiness of both positions, alike hated deferral.)
But it also reflects that the legislative effort with respect to international tax law changes appears to have been fundamentally different in character than that with respect to the passthrough rules and the corporate rate cut.
I argue in "Disgraceful" that the passthrough rules, along with the lack of any serious effort to cabin heightened incentives to use corporations as tax shelters for labor income, raise serious concerns about the competency and even the good faith character of the legislative effort. But the new international rules, despite having some sloppy and rushed elements, are in a different category, as some serious thought by serious people does seem to have gone into designing them.
It's a relief to be able to take a far less negative tone in my second piece addressing aspects of the 2017 act than in my first.
It's a relief to be able to take a far less negative tone in my second piece addressing aspects of the 2017 act than in my first.
Wednesday, January 17, 2018
2018 NYU Tax Policy Colloquium: Greg Leiserson on dynamic scoring, part 3
The central conclusion I reached in my prior two posts (here and here) was not that dynamic scoring - i.e., attempting to measure macroeconomic responses to proposed tax law changes and to incorporate them in revenue estimates - is inherently wrong (it's not), but rather that its prominence within the information package that Congress considers can lead to worsened short-termism and biased decision-making.
In the particular context of the 2017 act, suppose all that one changed was to base the centrally reported dynamic score numbers on gross national product (GNP), rather than gross domestic product (GDP). That would focus attention on the change in Americans' wealth, rather than on growth in the U.S. economy without regard to how much of the value being produced was owned by foreigners. That would be no less "dynamic" a score. What is more, neither GNP or GDP is inherently a better measure. - it depends entirely on what one wants to know. But in context this would likely have been less misleading, as consumers of the dynamic score, and the growth effects it suggested, probably implicitly assumed that it was all to the benefit of U.S. individuals.
This brings me back to the point that dynamic scoring was pushed by people on the right as a weaponized tool to favor their side in the tax cut debate. This point is not contradicted by dynamic scoring's having arguments in its favor, and indeed potentially improving information with regard to the particular narrow questions that it addresses.
This in turn calls less for rejecting it than recalibrating its use and seeking other tools to give greater prominence instead. These should both aim to supply useful information and to counter pervasive short-termism in the political budget process (possibly through different and complementary measures).
But a further question of interest is the following. Great, the right has had a shot at weaponizing the instruments used in budget debate in order to tilt the budgetary battlefield in its favor. Suppose people on the left wanted to do the same thing, only in their favor. Then what sorts of measures might they urge Congress, along with other information providers, to emphasize?
Here are three ideas that emerged from discussions that I had in relation to the colloquium. (I am putting it this way to minimize taking undue personal credit for ideas I got from other people, while also not directly reporting on the colloquium discussion, which was off the record.) None is anywhere close to fully formed or ready for primetime. They are rather possible directions for further thinking.
Idea #1 - dynamic scoring for growth-promoting public spending - For example, educational and infrastructure investment could have budget estimates that reduce the net cost by taking account of expected productivity gains and (perhaps separately) the tax revenue consequences of productivity gains.
Idea #2 - a measure that focuses on how tax changes affect inequality. This might be focused on high-end inequality (and separately on low-end inequality), and could take a number of different forms.
I don't think that a Gini-style composite measure is at all useful here. It both conflates two quite distinct issues - high-end and low-end inequality - and is too bloodless and technocratic-looking.
Instead, some sort of measure that looks at gains to the top 1% and the top 0.1%. This could be put in a number of different ways, but the point is to have something that combines good optics with being intellectually defensible to focus attention on plutocrats' gains from 2017-style tax changes.
Idea #3 - middle-class tax impact: Suppose one were to assume that unfunded tax cuts (or, say, income tax cuts) will be offset at some point by income tax increases, and that the latter will be proportionate to the different income percentiles' shares of overall federal tax (or income tax) liability after adoption of the tax cuts. Hence, anything that cut taxes disproportionately for people at the top, a la the 2017 tax act, would be shown as increasing middle class taxes once the tax cut was funded in the specified manner.
In each of these cases, accurate information would actually have been provided. (In case 3, this pertains to the particular set of questions being asked, whether or not it's true that the funding for the tax cut would definitely take that form.) So, no less than dynamic scoring, both may expand the information that policymakers have, only with a rather different focus on what questions are being asked.
Given that these ideas are still so preliminary and unformed, let me close here by making a more general point. This is not a matter of right or wrong - political players have every reason to try to tilt the process in their own favor - but I believe Republicans have, for decades, been much more active than Democrats in trying to shift the rules of various ongoing poltical games in their favor - whether we're talking about districting, campaign finance, voting restrictions, budget rules, or budgetary information. This has led to asymmetric warfare that one could blame, if one is so inclined, more on the Democrats than on the Republicans.
Democrats ought as a matter of self-interest to address this. In the budgetary realm in particular, one thing they ought to do, if they take control of Congress in 2018 or later, is change the budgetary and information reporting rules, and much else as well, in their favor. It's how the game is played these days. Dynamic scoring, other ways of doing dynamic scoring, and budgetary and information-providing rules more generally (in tax and elsewhere) are areas that they would be poring over carefully, if they were smart, in search of places to take advantage.
If the so-called wave emerges later this year, we will see if any of this actually happens.
In the particular context of the 2017 act, suppose all that one changed was to base the centrally reported dynamic score numbers on gross national product (GNP), rather than gross domestic product (GDP). That would focus attention on the change in Americans' wealth, rather than on growth in the U.S. economy without regard to how much of the value being produced was owned by foreigners. That would be no less "dynamic" a score. What is more, neither GNP or GDP is inherently a better measure. - it depends entirely on what one wants to know. But in context this would likely have been less misleading, as consumers of the dynamic score, and the growth effects it suggested, probably implicitly assumed that it was all to the benefit of U.S. individuals.
This brings me back to the point that dynamic scoring was pushed by people on the right as a weaponized tool to favor their side in the tax cut debate. This point is not contradicted by dynamic scoring's having arguments in its favor, and indeed potentially improving information with regard to the particular narrow questions that it addresses.
This in turn calls less for rejecting it than recalibrating its use and seeking other tools to give greater prominence instead. These should both aim to supply useful information and to counter pervasive short-termism in the political budget process (possibly through different and complementary measures).
But a further question of interest is the following. Great, the right has had a shot at weaponizing the instruments used in budget debate in order to tilt the budgetary battlefield in its favor. Suppose people on the left wanted to do the same thing, only in their favor. Then what sorts of measures might they urge Congress, along with other information providers, to emphasize?
Here are three ideas that emerged from discussions that I had in relation to the colloquium. (I am putting it this way to minimize taking undue personal credit for ideas I got from other people, while also not directly reporting on the colloquium discussion, which was off the record.) None is anywhere close to fully formed or ready for primetime. They are rather possible directions for further thinking.
Idea #1 - dynamic scoring for growth-promoting public spending - For example, educational and infrastructure investment could have budget estimates that reduce the net cost by taking account of expected productivity gains and (perhaps separately) the tax revenue consequences of productivity gains.
Idea #2 - a measure that focuses on how tax changes affect inequality. This might be focused on high-end inequality (and separately on low-end inequality), and could take a number of different forms.
I don't think that a Gini-style composite measure is at all useful here. It both conflates two quite distinct issues - high-end and low-end inequality - and is too bloodless and technocratic-looking.
Instead, some sort of measure that looks at gains to the top 1% and the top 0.1%. This could be put in a number of different ways, but the point is to have something that combines good optics with being intellectually defensible to focus attention on plutocrats' gains from 2017-style tax changes.
Idea #3 - middle-class tax impact: Suppose one were to assume that unfunded tax cuts (or, say, income tax cuts) will be offset at some point by income tax increases, and that the latter will be proportionate to the different income percentiles' shares of overall federal tax (or income tax) liability after adoption of the tax cuts. Hence, anything that cut taxes disproportionately for people at the top, a la the 2017 tax act, would be shown as increasing middle class taxes once the tax cut was funded in the specified manner.
In each of these cases, accurate information would actually have been provided. (In case 3, this pertains to the particular set of questions being asked, whether or not it's true that the funding for the tax cut would definitely take that form.) So, no less than dynamic scoring, both may expand the information that policymakers have, only with a rather different focus on what questions are being asked.
Given that these ideas are still so preliminary and unformed, let me close here by making a more general point. This is not a matter of right or wrong - political players have every reason to try to tilt the process in their own favor - but I believe Republicans have, for decades, been much more active than Democrats in trying to shift the rules of various ongoing poltical games in their favor - whether we're talking about districting, campaign finance, voting restrictions, budget rules, or budgetary information. This has led to asymmetric warfare that one could blame, if one is so inclined, more on the Democrats than on the Republicans.
Democrats ought as a matter of self-interest to address this. In the budgetary realm in particular, one thing they ought to do, if they take control of Congress in 2018 or later, is change the budgetary and information reporting rules, and much else as well, in their favor. It's how the game is played these days. Dynamic scoring, other ways of doing dynamic scoring, and budgetary and information-providing rules more generally (in tax and elsewhere) are areas that they would be poring over carefully, if they were smart, in search of places to take advantage.
If the so-called wave emerges later this year, we will see if any of this actually happens.
2018 NYU Tax Policy Colloquium: Greg Leiserson on dynamic scoring, part 2
Greg Leiserson's colloquium paper on dynamic scoring powerfully argues that dynamic scoring, as currently practiced, is a flawed and asymmetric approach that leans unduly in favoring tax cuts - almost, but not quite 100%, the bigger the better - without properly addressing the relevant tradeoffs, such as the fact that there will be losers in the future from reductions in net revenue.
But let's start here with why one might want to do dynamic scoring. By saying that "one" might want to do it, I am abstracting for a moment from the political process, in which dynamic scoring is a weaponized tool pushed by those on the political right to advance their own subjective policy preferences, to ask only why it might be of interest to good faith players who wanted more and better information, even absent that entire side of things.
To set things straight from the start, conventional revenue estimates, no less than "dynamic" ones, are completely dynamic in a microeconomic sense. They build in, for example, the point that, if one doubled tax preferences for solar panels on people's roofs, there would likely be a supply side response (more $$ spent by more people on such panels). What conventional revenue estimates treat as fixed is the macroeconomic side of things - aggregate labor supply, savings, available capital, etc.
Now, those things are not in fact fixed. They can change in response to a tax change, at least if it's big enough and has some direct impact on them. So in principle one ought to take those things into account.
Suppose, for example, that the 2017 tax act actually would have paid in full for itself. That would have been worth knowing. And even if it, say, one-third pays for itself, that, too, is worth knowing.
Suppose further that members of Congress ask the staff: At what level do you project 2020 GDP, (a) without vs. (b) with a particular tax bill's being enacted? It's a reasonable question to ask, and one that merits a fully informed answer. But this brings us to the various "buts" regarding dynamic scoring, especially as practiced.
An iniital point is sharp dissensus among macroeconomic models. But that of course doesn't mean we should have no such estimates, it just means they should be handled with care and that there should probably be multiple forecasts presented. (But JCT was instead told to provide a single operative estimate this time around.)
A second, more telling point, is that estimators are being asked to forecast incompletely specified policies. A budget forecast should be forward-looking for two reasons. One is that we should care about the future. The second is that actual economic actors may be forward-looking, so what they do may reflect their expectations about the future.
When there's a preexisting fiscal gap, and a giant tax cut would make it even worse (even building in today's actors' expectations), the actual full set of policies, including the consequences of the set of pay-fors, remains unspecified. Now, this does not entirely defeat one's making estimates about what will happen over the next ten years if the announced policies remain in force. But it creates a set of discontinuities - inside vs. outside the budget window, and announced vs. as yet unannounced policies - that can be misleading to policymakers and the public even if the 10-year forecast is accurate.
If there's one fundamental political economy problem in budget policymaking, other than power imbalances and disregard for the interests of the less powerful, it's short-termism. Politicians and voters want good stuff now without due regard for the nation's future. (This is the subject, for example, of James Buchanan and Robert Wagner's famous book, Democracy in Deficit.)
Dynamic scoring, when added to a budget window, accentuates short-termism. (One could reasonably argue, however, that the underlying problem is more about the budget window than dynamic scoring as such.) It gets back to the question that, as I noted in my prior post, policymakers might reasonably want to ask their staff: What would a given tax bill do, say, to GDP in 2 or 3 years? Revenue-losing tax bills such as the 2017 act have a tendency to increase short-term GDP growth in exchange for lowering it in the long run, due to fiscal crowdout. So while one ought to supply the information, one makes the political process worse if the result is to increase focus on the short term at the expense of the long term.
To put it another way, budget rules aren't just about the quantum of information, they're also about relative emphasis (as well as imposing specific constraints in particular cases, although the dynamic score was not used that way in 2017). Dynamic scoring as used - not necessarily, as an inherent conceptual thing - accentuates short-termism, when arguably the single most important thing that budget rules and scoring methodologies should do, apart from just supplying information, is to counter short-termism.
What happens if one puts dynamic scoring at the center of the process, and cares only about net revenue cost and GDP growth within the 10-year window? It's possible that this would lead to one's deriving the result that GDP would be the highest if federal revenue went all the way to zero - i.e., no taxes whatsoever.
To put it more precisely, the only way that wouldn't be true is if crowd-out within the ten year period from having no tax revenues whatsoever, hence skyrocketing public debt and annual interest charges, sufficiently suppressed growth within the 10-year period by reason of crowd-out. Now this might happen in the forecast, even if estimators didn't decide that they needed to consider modeling a full-blown fiscal crisis inside the budget window.
But there's still a sense in which the wrong question (at least as a matter of emphasis) is being asked. If one centrally relies on dynamic scoring PLUS exclusive focus on the 10-year budget window, the optimal level of taxation appears to be that which would be optimal if (a) one had to pay interest charges and deal with crowd-out within the 10-year period, but also (b) at the end of 10 years, one got to cancel the public debt run-up - settle it for zero -without this having been anticipated or having adverse effects afterwards.
That is obviously not a sensible way to approach actual budget policy. As the Leiserson paper convincingly shows, dynamic scoring - again, conditioned on how it is being used, not necessarily in the abstract as one tool among dozens - creates bias in favor of ever larger tax cuts without offering any clue as to the fact that diminishing government revenues adversely affects people who therefore either get less from the federal government, now or in the future, or else end up paying more taxes later due to new enactments.
One last perspective that I want to offer with regard to dynamic scoring is its having been used as a "weaponized" tool in the federal budget and tax policy wars, and its not being the only possible weaponized tool, in support of the only existing interests, that one could imagine. But I will leave that point for a separate post that is to follow shortly.
But let's start here with why one might want to do dynamic scoring. By saying that "one" might want to do it, I am abstracting for a moment from the political process, in which dynamic scoring is a weaponized tool pushed by those on the political right to advance their own subjective policy preferences, to ask only why it might be of interest to good faith players who wanted more and better information, even absent that entire side of things.
To set things straight from the start, conventional revenue estimates, no less than "dynamic" ones, are completely dynamic in a microeconomic sense. They build in, for example, the point that, if one doubled tax preferences for solar panels on people's roofs, there would likely be a supply side response (more $$ spent by more people on such panels). What conventional revenue estimates treat as fixed is the macroeconomic side of things - aggregate labor supply, savings, available capital, etc.
Now, those things are not in fact fixed. They can change in response to a tax change, at least if it's big enough and has some direct impact on them. So in principle one ought to take those things into account.
Suppose, for example, that the 2017 tax act actually would have paid in full for itself. That would have been worth knowing. And even if it, say, one-third pays for itself, that, too, is worth knowing.
Suppose further that members of Congress ask the staff: At what level do you project 2020 GDP, (a) without vs. (b) with a particular tax bill's being enacted? It's a reasonable question to ask, and one that merits a fully informed answer. But this brings us to the various "buts" regarding dynamic scoring, especially as practiced.
An iniital point is sharp dissensus among macroeconomic models. But that of course doesn't mean we should have no such estimates, it just means they should be handled with care and that there should probably be multiple forecasts presented. (But JCT was instead told to provide a single operative estimate this time around.)
A second, more telling point, is that estimators are being asked to forecast incompletely specified policies. A budget forecast should be forward-looking for two reasons. One is that we should care about the future. The second is that actual economic actors may be forward-looking, so what they do may reflect their expectations about the future.
When there's a preexisting fiscal gap, and a giant tax cut would make it even worse (even building in today's actors' expectations), the actual full set of policies, including the consequences of the set of pay-fors, remains unspecified. Now, this does not entirely defeat one's making estimates about what will happen over the next ten years if the announced policies remain in force. But it creates a set of discontinuities - inside vs. outside the budget window, and announced vs. as yet unannounced policies - that can be misleading to policymakers and the public even if the 10-year forecast is accurate.
If there's one fundamental political economy problem in budget policymaking, other than power imbalances and disregard for the interests of the less powerful, it's short-termism. Politicians and voters want good stuff now without due regard for the nation's future. (This is the subject, for example, of James Buchanan and Robert Wagner's famous book, Democracy in Deficit.)
Dynamic scoring, when added to a budget window, accentuates short-termism. (One could reasonably argue, however, that the underlying problem is more about the budget window than dynamic scoring as such.) It gets back to the question that, as I noted in my prior post, policymakers might reasonably want to ask their staff: What would a given tax bill do, say, to GDP in 2 or 3 years? Revenue-losing tax bills such as the 2017 act have a tendency to increase short-term GDP growth in exchange for lowering it in the long run, due to fiscal crowdout. So while one ought to supply the information, one makes the political process worse if the result is to increase focus on the short term at the expense of the long term.
To put it another way, budget rules aren't just about the quantum of information, they're also about relative emphasis (as well as imposing specific constraints in particular cases, although the dynamic score was not used that way in 2017). Dynamic scoring as used - not necessarily, as an inherent conceptual thing - accentuates short-termism, when arguably the single most important thing that budget rules and scoring methodologies should do, apart from just supplying information, is to counter short-termism.
What happens if one puts dynamic scoring at the center of the process, and cares only about net revenue cost and GDP growth within the 10-year window? It's possible that this would lead to one's deriving the result that GDP would be the highest if federal revenue went all the way to zero - i.e., no taxes whatsoever.
To put it more precisely, the only way that wouldn't be true is if crowd-out within the ten year period from having no tax revenues whatsoever, hence skyrocketing public debt and annual interest charges, sufficiently suppressed growth within the 10-year period by reason of crowd-out. Now this might happen in the forecast, even if estimators didn't decide that they needed to consider modeling a full-blown fiscal crisis inside the budget window.
But there's still a sense in which the wrong question (at least as a matter of emphasis) is being asked. If one centrally relies on dynamic scoring PLUS exclusive focus on the 10-year budget window, the optimal level of taxation appears to be that which would be optimal if (a) one had to pay interest charges and deal with crowd-out within the 10-year period, but also (b) at the end of 10 years, one got to cancel the public debt run-up - settle it for zero -without this having been anticipated or having adverse effects afterwards.
That is obviously not a sensible way to approach actual budget policy. As the Leiserson paper convincingly shows, dynamic scoring - again, conditioned on how it is being used, not necessarily in the abstract as one tool among dozens - creates bias in favor of ever larger tax cuts without offering any clue as to the fact that diminishing government revenues adversely affects people who therefore either get less from the federal government, now or in the future, or else end up paying more taxes later due to new enactments.
One last perspective that I want to offer with regard to dynamic scoring is its having been used as a "weaponized" tool in the federal budget and tax policy wars, and its not being the only possible weaponized tool, in support of the only existing interests, that one could imagine. But I will leave that point for a separate post that is to follow shortly.
2018 NYU Tax Policy Colloquium: Greg Leiserson on dynamic scoring, part 1
Yesterday was the first day of the 23rd annual NYU Tax Policy Colloquium. It was great to meet this year's class, and to see old friends at the PM session, and to start co-teaching it with Lily Batchelder.
At the session, Greg Leiserson of the Washington Center for Equitable Growth presented his very timely paper, "Removing the free lunch from dynamic scores: Reconciling the scoring perspective with the optimal tax perspective."
Obviously, this paper comes in the immediate aftermath of the enactment of the 2017 tax act, in which "dynamic scoring" played what I would call a quasi-prominent role. I modify "prominent" with "quasi" because:
1) the regular score, not the dynamic score, was the one that ended up being used to measure compliance with the budget rule capping the revenue loss at $1.5 trillion,
2) due to the rushed process, the Joint Committee on Taxation wasn't able to issue its dynamic score until late in the process, when the end result was verging on fixed and certain. So it doesn't seem to have had any direct influence on what happened. Plus, once the score came out, showing an estimated dynamic revenue loss of about $1 trillion, Senate Republicans promptly rejected it for no good reason, based purely on their supposed intuitions.
Nonetheless, the score did matter atmospherically in a couple of ways that may linger. For one, it actually rebutted claims that the act would pay for itself, and even come close for doing so. For another, it did indeed predict a significant, albeit inadequate, growth response to the tax cuts, which it showed as reducing the revenue cost by about one-third.
As it happens, there are many reasons why I and others think that the $1 trillion dynamic revenue score was way too optimistic. Just as a starting point to motivate viewing it as very contingent, it's based on weighted combinations of three radically different forecasting models, without disclosure as to what each of those models separately showed. JCT really hasn't disclosed very much regarding the inputs to the dynamic aspect. But that says nothing as such about too low versus too high, except insofar as one might draw inferences from the extreme pressure JCT was under from its bosses to lean towards optimism, at least to the degree consistent with its incentive to limit harm to its own institutional reputation.
My reasons for thinking the score was probably too low, not too high, are as follows:
1) I think their regular score was too low, reflecting insufficient adjustment for the massive tax planning opportunities that the act has encouraged and that we will be reading about in the newspapers within a year or two, if not sooner.
2) There are several reasons for thinking the dynamic adjustments were too high. Perhaps the most important is that the model is based on assuming that other countries won't respond by lowering corporate tax rates in response to what we've done. That's an extremely unrealistic assumption, adopted solely because it's outside their models to build in how other countries are likely to respond. But just because that's hard to model (or outside their models) doesn't mean it isn't both likely and important.
3) My prior would have been to lean towards the Penn-Wharton budget model, which came out a bit higher.
All this is just background for Greg Leiserson's paper. He is interested in dynamic scoring as an approach, not (for purposes of this paper) in whether the estimators got it right. He raises important challenges to what he calls the emerging consensus on how dynamic scoring is (and ostensibly should be) done. But I will save this set of issues for my next post.
At the session, Greg Leiserson of the Washington Center for Equitable Growth presented his very timely paper, "Removing the free lunch from dynamic scores: Reconciling the scoring perspective with the optimal tax perspective."
Obviously, this paper comes in the immediate aftermath of the enactment of the 2017 tax act, in which "dynamic scoring" played what I would call a quasi-prominent role. I modify "prominent" with "quasi" because:
1) the regular score, not the dynamic score, was the one that ended up being used to measure compliance with the budget rule capping the revenue loss at $1.5 trillion,
2) due to the rushed process, the Joint Committee on Taxation wasn't able to issue its dynamic score until late in the process, when the end result was verging on fixed and certain. So it doesn't seem to have had any direct influence on what happened. Plus, once the score came out, showing an estimated dynamic revenue loss of about $1 trillion, Senate Republicans promptly rejected it for no good reason, based purely on their supposed intuitions.
Nonetheless, the score did matter atmospherically in a couple of ways that may linger. For one, it actually rebutted claims that the act would pay for itself, and even come close for doing so. For another, it did indeed predict a significant, albeit inadequate, growth response to the tax cuts, which it showed as reducing the revenue cost by about one-third.
As it happens, there are many reasons why I and others think that the $1 trillion dynamic revenue score was way too optimistic. Just as a starting point to motivate viewing it as very contingent, it's based on weighted combinations of three radically different forecasting models, without disclosure as to what each of those models separately showed. JCT really hasn't disclosed very much regarding the inputs to the dynamic aspect. But that says nothing as such about too low versus too high, except insofar as one might draw inferences from the extreme pressure JCT was under from its bosses to lean towards optimism, at least to the degree consistent with its incentive to limit harm to its own institutional reputation.
My reasons for thinking the score was probably too low, not too high, are as follows:
1) I think their regular score was too low, reflecting insufficient adjustment for the massive tax planning opportunities that the act has encouraged and that we will be reading about in the newspapers within a year or two, if not sooner.
2) There are several reasons for thinking the dynamic adjustments were too high. Perhaps the most important is that the model is based on assuming that other countries won't respond by lowering corporate tax rates in response to what we've done. That's an extremely unrealistic assumption, adopted solely because it's outside their models to build in how other countries are likely to respond. But just because that's hard to model (or outside their models) doesn't mean it isn't both likely and important.
3) My prior would have been to lean towards the Penn-Wharton budget model, which came out a bit higher.
All this is just background for Greg Leiserson's paper. He is interested in dynamic scoring as an approach, not (for purposes of this paper) in whether the estimators got it right. He raises important challenges to what he calls the emerging consensus on how dynamic scoring is (and ostensibly should be) done. But I will save this set of issues for my next post.
Wednesday, January 10, 2018
A better way to explain the introduction of credits against states' income taxes to serve charitable objectives
There has been a whole lot of talk recently (from me as well as others) concerning how state and local governments should respond to the drastic curtailment of federal income tax deductibility for state and local income and property taxes.
One theme that has emerged is that states can encourage charitable giving by taxpayers, to causes that the states will help fund, in lieu of direct state and local tax deductibility. E.g., taxpayers can give donations to state entities, perhaps serving particular purposes, that are creditable (in whole or large part) against, say, one's state income tax liability.
It occurs to me that proponents of examining this response (including me) have at times not been charitable enough to themselves regarding how this effort should be described.
Suppose a state offers 95% credits against state income tax liability, for contributions to state-run charitable entities that serve broad "silos" that are dedicated to different purposes - healthcare, housing, education, infrastructure, public safety, etc. And suppose the amounts are indeed dedicated, such as via a "trust fund" methodology, to the indicated purposes, although annual spending levels may be constrained to, say, 100% or 105% of the amount the legislature had separately designated for spending in the areas that these silos represent.
As I and others have been discussing, there is a risk of the IRS making "substance over form" challenges to these efforts, under the view that the state-creditable charitable contributions are "really" just re-labeled state and local tax payments.
But consider Point #1: If you build enough economic substance into it, it works. The analogy to economic substance in business deals is important, because there one typically has to have a pretax profit motive and business purpose. Here, we are talking about what people want to do about issues that they care about from a charitable standpoint. So just as in the famous Learned Hand quote about no one having an obligation to pay more federal income tax than is due, here it's okay that one was mindful of the federal income tax benefits of doing it this way, so long as there was indeed charitable purpose and charitable substance to what the taxpayer did. (Meaning here the donor, but he or she will be responding to the institutional setup that the state government has decided to offer.)
Then there is Point #2: There is absolutely no reason to think of this as trying to end-run the limit on state and local tax deductibility. Rather, it is about serving the objectives that were previously served by tax-funded state and local government spending. It's about advancing healthcare, public safety, education, etcetera, via the best mechanisms available, which is partly a function of how Congress has decided to structure federal income tax deductibility.
If (1) Congress decides to continue granting deductions for charitable contributions that advance public goals, but to limit state and local income tax deductions (above the $10K level) that could fund spending advancing the same goals, and (2) states and individuals restructure so that they are now doing things the way that Congress apparently likes, rather than the way that it apparently (at least relatively) dislikes, they aren't avoiding Congressional intent - they are fulfilling it.
To say that one was just looking for end runs would be both inaccurate and unfair to the actual motivations that are at work. What's really at issue here is the underlying objectives (healthcare, public safety, infrastructure, income support, etcetera). It is not the use of one means versus another as an end in itself. What Congress has addressed is the use of one means versus another, and proponents of restructuring state charitable credits are taking it at its word, and seeking to do what it has encouraged them to do, in the way that it has encouraged them to do it.
One theme that has emerged is that states can encourage charitable giving by taxpayers, to causes that the states will help fund, in lieu of direct state and local tax deductibility. E.g., taxpayers can give donations to state entities, perhaps serving particular purposes, that are creditable (in whole or large part) against, say, one's state income tax liability.
It occurs to me that proponents of examining this response (including me) have at times not been charitable enough to themselves regarding how this effort should be described.
Suppose a state offers 95% credits against state income tax liability, for contributions to state-run charitable entities that serve broad "silos" that are dedicated to different purposes - healthcare, housing, education, infrastructure, public safety, etc. And suppose the amounts are indeed dedicated, such as via a "trust fund" methodology, to the indicated purposes, although annual spending levels may be constrained to, say, 100% or 105% of the amount the legislature had separately designated for spending in the areas that these silos represent.
As I and others have been discussing, there is a risk of the IRS making "substance over form" challenges to these efforts, under the view that the state-creditable charitable contributions are "really" just re-labeled state and local tax payments.
But consider Point #1: If you build enough economic substance into it, it works. The analogy to economic substance in business deals is important, because there one typically has to have a pretax profit motive and business purpose. Here, we are talking about what people want to do about issues that they care about from a charitable standpoint. So just as in the famous Learned Hand quote about no one having an obligation to pay more federal income tax than is due, here it's okay that one was mindful of the federal income tax benefits of doing it this way, so long as there was indeed charitable purpose and charitable substance to what the taxpayer did. (Meaning here the donor, but he or she will be responding to the institutional setup that the state government has decided to offer.)
Then there is Point #2: There is absolutely no reason to think of this as trying to end-run the limit on state and local tax deductibility. Rather, it is about serving the objectives that were previously served by tax-funded state and local government spending. It's about advancing healthcare, public safety, education, etcetera, via the best mechanisms available, which is partly a function of how Congress has decided to structure federal income tax deductibility.
If (1) Congress decides to continue granting deductions for charitable contributions that advance public goals, but to limit state and local income tax deductions (above the $10K level) that could fund spending advancing the same goals, and (2) states and individuals restructure so that they are now doing things the way that Congress apparently likes, rather than the way that it apparently (at least relatively) dislikes, they aren't avoiding Congressional intent - they are fulfilling it.
To say that one was just looking for end runs would be both inaccurate and unfair to the actual motivations that are at work. What's really at issue here is the underlying objectives (healthcare, public safety, infrastructure, income support, etcetera). It is not the use of one means versus another as an end in itself. What Congress has addressed is the use of one means versus another, and proponents of restructuring state charitable credits are taking it at its word, and seeking to do what it has encouraged them to do, in the way that it has encouraged them to do it.
Tuesday, January 09, 2018
Restoring state and local tax deductibility through self-help
Eight eminent tax law professors have coauthored an important new SSRN piece entitled "Federal Income Tax Treatment of Charitable Contributions Entitling Donor to a State Tax Credit." It's available here.
Just for the record, as all are good friends and outstanding members of the field, they are: Joe Bankman, David Gamage, Jacob Goldin, Daniel Hemel, Darien Shanske, Kirk Stark, Dennis Ventry, and Manoj Viswanathan.
The piece addresses the issue of what state governments can do to address the repeal of state and local income and property tax deductibility by individuals above the first $10,000. Plus, it addresses whether the federal government should respond, either administratively or legislatively, to such state government responses.
In particular, the question presented is whether states can tax-effectively rely on charitable contribution credits against state tax liability, and thereby permit their own taxpayers who take advantage to claim federal charitable deductions.
To illustrate the basic idea, suppose I would pay New York State (and New York City) $100,000 of income taxes if I did nothing differently in the future than I have in the past. But now suppose that I can reduce my New York State and City income tax liability, dollar-for-dollar, by making charitable contributions to designated state and local government entities. E.g., I give $90,000 in such contributions, and thereby reduce my remaining liability to $10,000 that falls within the deduction limit.
For this to offer maximum benefit, the income taxes would need to be provide 100% credits against such liability for particular donations. There are already some such provisions in existing state and local income tax law, however, as the article documents in its appendix. And these have generally been held, by case law and/or administrative rulings (with and without express precedential effect), to work for federal income tax purposes. That is, one gets the full charitable deductions contribution for the amount one paid that was 100% creditable against state and/or local income tax liability.
There are two main legal obstacles to success of this gambit under federal income tax law.* The first is allowance of the full federal charitable deduction despite any issue regarding the state tax law benefit that one garnered by reason of making the charitable contribution. By analogy, suppose I gave $100 to NPR and got a bookbag that is worth $20. Then my federal charitable deduction would be limited to $80, i.e., to the gift minus the offsetting benefit. So legal question #1 in the above scenario is whether my federal charitable deduction would be offset by the value of the state income tax saving.
The second main federal legal obstacle to success is substance over form doctrine. Am I actually, in substance as this question is analyzed for federal income tax purposes, making a charitable contribution, rather than simply relabeling my state income tax liability?
The first main point that the article makes is that current legal authority, both from cases and IRS administrative pronouncements, strongly supports what it calls the "Full Deduction Rule." This rule holds that "the amount of the donor's charitable contribution is not reduced by the value of state tax benefits." In short, legal obstacle #1 as described above should not prevent the relabeling from working. As a matter of formal legal analysis, the main point here is that the state and local income tax liability doesn't actually exist until one fully applies the pertinent law. So the fact that the income tax liability never arose, due to the credit, means that there was no legally cognizable benefit. Again, the article shows that this line of reasoning has repeatedly been upheld.
The second main point that the article makes is that there are good policy rationales in favor of continuing to allow the Full Deduction Rule to apply. E.g., does one draw the line at 100% credits? Should charitable deductions generally be reduced for the value of state and local charitable deductions? Must taxpayers always compute alternative state liabilities with and without the credits? Etc. Plus, the article argues that the Full Deduction Rule serves important federalism values and is consistent with decades of federal tax policymaking. Hence, "Congress should tread carefully if it seeks to alter the Full Deduction Rule by statute."
I find these arguments convincing. But there is still the issue, not addressed by the article as it would require a much longer and largely distinct analysis, of the circumstances in which 100% (or lesser) credits against state and local income tax liability, for charitable contributions to particular state entities, would have economic substance.
Here is a preliminary thought of mine regarding one way of establishing the requisite economic substance. Key word here is preliminary: A lot of people need to weigh in on this, regarding both federal income tax law and state and local government practicalities.
Suppose a state government offers large buckets to which one can charitably designate one's charitable contributions that generate a 100% credit against the tax liability. E.g., Medicaid and Public Health; Schools; Infrastructure, etc. Suppose there were 4 or 5 buckets and that one could get a 100% credit for up to X% of one's state income tax liability by making such designated contributions, but that no more than Y% could go to any one bucket.
The state government would still determine overall annual spending in each category, which wouldn't be directly affected by taxpayers' charitable contribution designations. (NOTE - these contributions probably should be required to be paid separately and prior to the state tax itself - not by designation on the state income tax return.)
So where's the economic substance? Point #1, I get to decide where "my" dollars, as opposed to someone else's, go. Many people actually care about this, as a matter of subjective psychological fact.
But what if the designations to a given category exceed what the state wants to spend on that category? Simple. The state designates those extra $$ as notionally in a "trust fund" that it currently pledges WILL be spent on that budgetary purpose in the future. Consider the analogy to the Social Security Trust Fund. My FICA payroll taxes ostensibly "will" be spent at some point on paying Social Security benefits. Now, budget aficionados may think this doesn't really mean much. But actual voters and taxpayers, and perhaps even the U.S. Congress, actually do think it matters. So who are we to second-guess them? (Especially as they may be correct in the sense of the Trust Fund's affecting likely future political outcomes.)
Hence we get Point #2 for economic substance. My, say, Medicaid-designated contributions WILL, the state now pledges, be spent on Medicaid or other public health either this year in the future. A trust fund pre-commits them to be spent in this way. Sure, the state could change the law next year and take back the promise without recourse on the donor's part. But, just as in the case of the Social Security Trust Fund, the donor gets the benefit of the political force, if any, that the designation might have in the future. Plus, the state legislators are getting what they might deem valuable information about taxpayer sentiment.
Do others agree with the economic substance analysis that I offer here? Are there other features that they'd deem important? Can states make this workable for themselves and their taxpayers, without undue inconvenience on either side? I am hoping that others will address these issues as well.
______________________________________________________
* Extra challenges may arise making this practically workable in the case of (a) local as well as state income tax liability, and (b) property taxes that often are paid to a smallish local government unit.
Just for the record, as all are good friends and outstanding members of the field, they are: Joe Bankman, David Gamage, Jacob Goldin, Daniel Hemel, Darien Shanske, Kirk Stark, Dennis Ventry, and Manoj Viswanathan.
The piece addresses the issue of what state governments can do to address the repeal of state and local income and property tax deductibility by individuals above the first $10,000. Plus, it addresses whether the federal government should respond, either administratively or legislatively, to such state government responses.
In particular, the question presented is whether states can tax-effectively rely on charitable contribution credits against state tax liability, and thereby permit their own taxpayers who take advantage to claim federal charitable deductions.
To illustrate the basic idea, suppose I would pay New York State (and New York City) $100,000 of income taxes if I did nothing differently in the future than I have in the past. But now suppose that I can reduce my New York State and City income tax liability, dollar-for-dollar, by making charitable contributions to designated state and local government entities. E.g., I give $90,000 in such contributions, and thereby reduce my remaining liability to $10,000 that falls within the deduction limit.
For this to offer maximum benefit, the income taxes would need to be provide 100% credits against such liability for particular donations. There are already some such provisions in existing state and local income tax law, however, as the article documents in its appendix. And these have generally been held, by case law and/or administrative rulings (with and without express precedential effect), to work for federal income tax purposes. That is, one gets the full charitable deductions contribution for the amount one paid that was 100% creditable against state and/or local income tax liability.
There are two main legal obstacles to success of this gambit under federal income tax law.* The first is allowance of the full federal charitable deduction despite any issue regarding the state tax law benefit that one garnered by reason of making the charitable contribution. By analogy, suppose I gave $100 to NPR and got a bookbag that is worth $20. Then my federal charitable deduction would be limited to $80, i.e., to the gift minus the offsetting benefit. So legal question #1 in the above scenario is whether my federal charitable deduction would be offset by the value of the state income tax saving.
The second main federal legal obstacle to success is substance over form doctrine. Am I actually, in substance as this question is analyzed for federal income tax purposes, making a charitable contribution, rather than simply relabeling my state income tax liability?
The first main point that the article makes is that current legal authority, both from cases and IRS administrative pronouncements, strongly supports what it calls the "Full Deduction Rule." This rule holds that "the amount of the donor's charitable contribution is not reduced by the value of state tax benefits." In short, legal obstacle #1 as described above should not prevent the relabeling from working. As a matter of formal legal analysis, the main point here is that the state and local income tax liability doesn't actually exist until one fully applies the pertinent law. So the fact that the income tax liability never arose, due to the credit, means that there was no legally cognizable benefit. Again, the article shows that this line of reasoning has repeatedly been upheld.
The second main point that the article makes is that there are good policy rationales in favor of continuing to allow the Full Deduction Rule to apply. E.g., does one draw the line at 100% credits? Should charitable deductions generally be reduced for the value of state and local charitable deductions? Must taxpayers always compute alternative state liabilities with and without the credits? Etc. Plus, the article argues that the Full Deduction Rule serves important federalism values and is consistent with decades of federal tax policymaking. Hence, "Congress should tread carefully if it seeks to alter the Full Deduction Rule by statute."
I find these arguments convincing. But there is still the issue, not addressed by the article as it would require a much longer and largely distinct analysis, of the circumstances in which 100% (or lesser) credits against state and local income tax liability, for charitable contributions to particular state entities, would have economic substance.
Here is a preliminary thought of mine regarding one way of establishing the requisite economic substance. Key word here is preliminary: A lot of people need to weigh in on this, regarding both federal income tax law and state and local government practicalities.
Suppose a state government offers large buckets to which one can charitably designate one's charitable contributions that generate a 100% credit against the tax liability. E.g., Medicaid and Public Health; Schools; Infrastructure, etc. Suppose there were 4 or 5 buckets and that one could get a 100% credit for up to X% of one's state income tax liability by making such designated contributions, but that no more than Y% could go to any one bucket.
The state government would still determine overall annual spending in each category, which wouldn't be directly affected by taxpayers' charitable contribution designations. (NOTE - these contributions probably should be required to be paid separately and prior to the state tax itself - not by designation on the state income tax return.)
So where's the economic substance? Point #1, I get to decide where "my" dollars, as opposed to someone else's, go. Many people actually care about this, as a matter of subjective psychological fact.
But what if the designations to a given category exceed what the state wants to spend on that category? Simple. The state designates those extra $$ as notionally in a "trust fund" that it currently pledges WILL be spent on that budgetary purpose in the future. Consider the analogy to the Social Security Trust Fund. My FICA payroll taxes ostensibly "will" be spent at some point on paying Social Security benefits. Now, budget aficionados may think this doesn't really mean much. But actual voters and taxpayers, and perhaps even the U.S. Congress, actually do think it matters. So who are we to second-guess them? (Especially as they may be correct in the sense of the Trust Fund's affecting likely future political outcomes.)
Hence we get Point #2 for economic substance. My, say, Medicaid-designated contributions WILL, the state now pledges, be spent on Medicaid or other public health either this year in the future. A trust fund pre-commits them to be spent in this way. Sure, the state could change the law next year and take back the promise without recourse on the donor's part. But, just as in the case of the Social Security Trust Fund, the donor gets the benefit of the political force, if any, that the designation might have in the future. Plus, the state legislators are getting what they might deem valuable information about taxpayer sentiment.
Do others agree with the economic substance analysis that I offer here? Are there other features that they'd deem important? Can states make this workable for themselves and their taxpayers, without undue inconvenience on either side? I am hoping that others will address these issues as well.
______________________________________________________
* Extra challenges may arise making this practically workable in the case of (a) local as well as state income tax liability, and (b) property taxes that often are paid to a smallish local government unit.
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