Wednesday, July 17, 2019

Death of Mortimer Caplin

I'm sorry to hear of Mort Caplin's death, although it's great that he made it to age 103 (and was mentally sharp even when extremely old).

I worked at Caplin & Drysdale in the early 1980s, and I agree with Scott Michel (who started the same year I did but stayed a lot longer, and is quoted in the above article) that Mort set a crucial positive tone regarding the office atmosphere, as well as one about serving clients assertively if needed but ethically. He was also affable and charming, including to junior associates.

Only on one occasion did I work with Mort directly on a project, but it left a good taste. He was interested in a live issue at the time, concerning the IRS's ability in audits to access tax accrual workpapers that a given taxpayer's accountants had used to evaluate tax risks for financial accounting purposes.

Mort was thinking about pursuing in litigation a legal position to the effect that the IRS should generally be denied access to such workpapers, on the view that allowing it would undermine financial accounting by inducing accountants (or taxpayers in discussions with them) to pull punches regarding soft spots, the taxpayer's possible settlement strategy, etc.

This concern is clearly a meaningful one, even if on balance one nonetheless favors granting access. But my task (obviously) wasn't to figure out what I thought about the merits, but rather to look at precedents, etc., for a sense of how strong the case would be. I concluded from my research that, based on the case authorities etc. to date, the IRS was extremely likely to win on this issue. (As indeed was soon confirmed - see U.S. v. Arthur Young, decided by a 9-0 Supreme Court in 1984.)

After working all day on a Saturday or Sunday to finish the memo, I per instructions took a taxi up to Mort's rather nice home (in NW Washington, I think? - but I could be mistaken) to hand him the memo and briefly discuss it. Given the circumstances, I was grungily dressed and unshaven, and I recall having a harder time getting a cab to stop for me than would usually have been the case when I was wearing my regular weekday suit and tie.

When I got there, Mort, though gracious, was clearly not pleased with my conclusion, as it was not what he wanted to hear. But I got the sense that he accepted both its legitimacy (although obviously he didn't read it in detail until I had left), and that I had properly done my job.

Friday, July 12, 2019

Fall 2019 NYU Tax Policy Colloquium schedule

We have now completed our schedule for the fall 2019 NYU Tax Policy Colloquium. (By "we" I mean myself and my co-convenor, Lily Batchelder, with the gracious cooperation of our invitees.) This will be the first, but hopefully not the last, time that we offer the colloquium in the fall.  All sessions will meet on Tuesdays, from 4 to 5:50 pm, in a room on the second floor of Vanderbilt Hall. Anyway, here goes:

1.      Tuesday, September 3 – Lily Batchelder, NYU Law School.
2.      Tuesday, September 10 – Eric Zwick, University of Chicago Booth School of Business.
3.      Tuesday, September 17 – Zachary Liscow, Yale Law School.
4.      Tuesday, September 24 – Li Liu, International Monetary Fund.

5.      Tuesday, October 1 – Daniel Shaviro, NYU Law School.
6.      Tuesday, October 8 – Katherine Pratt, Loyola Law School Los Angeles
7.      Tuesday, October 15 – Gabriel Zucman, University of California at Berkeley, Economics Department.
8.      Tuesday, October 22 – Diane Ring, Boston College Law School.
9.      Tuesday, October 29 – John Friedman, Brown University Economics Department

10.  Tuesday, November 5 – Marc Fleurbaey, Princeton University, Woodrow Wilson School.
11.  Tuesday, November 12 – Stacie LaPlante, University of Wisconsin School of Business.
12.  Tuesday, November 19 – Joseph Bankman, Stanford Law School.
13.  Tuesday, November 26 – Deborah Paul, Wachtell, Lipton, Rosen, and Katz.
14.  Tuesday, December 3 – Joshua Blank, University of California at Irvine Law School.

Thursday, July 11, 2019

The French digital services tax

As I am currently writing an article that will extensively discuss digital services taxes (DSTs) - albeit, in a broader context of thinking about multinational entities' (MNEs') economic rents and stateless income - I am certainly interested by France's enactment of a DST, and by the prospect of a punitive U.S. response.

I'm still trying to learn more about the tax (my French might not be good enough for reading an untranslated text to do me much good). But it is summarized, for example, here,

The NYT discusses the possible U.S. response - tariffs, of course, as no matter the question they are often the current Administration's preferred answer - here.

Perhaps unusually among tax experts (and Americans!), I am inclined to be sympathetic to properly designed DSTs, for reasons that I discussed here and here in response to Wei Cui's very interesting paper on the topic (presented this past April 30 at the winter-spring 2019 NYU Tax Policy Colloquium). And I also think that an aggressive American response would be unwise, among other reasons because our friends - as I hope they still are - across the pond are addressing reasonable concerns about tax avoidance and locally generated rents.

The French DST appears to be aimed primarily at the likes of Facebook and Google  Per the EY summary (and translation of some provisions) that I linked above, it would apply to:

1. “The supply, by electronic means, of a digital interface that allows users to contact and interact with other users, including for the delivery of goods or services directly between those users.”

2. “Services provided to advertisers or their agents enabling them to purchase advertising space located on a digital interface accessible by electronic means in order to display targeted advertisements to users located in France, based on data provided by such users. These services include, among others, the buying, stocking and diffusion of advertising messages and the management and communication of users’ data.”

But it would exclude, inter alia, digital interfaces that provide users with digital content, communications services, and payment services (e.g., Youtube, Netflix, and the financial intermediation industry). As I'll discuss in my article, if one otherwise views the tax favorably, such exclusions may not be well rationalized - leaving aside the financial sector, which might call for separate and more comprehensive treatment.

Obviously this is what they call a developing story, and I'll try to comment here when appropriate although at the moment I'm more focused on getting my arms around the issues from a broader and more conceptual standpoint.

Saturday, June 08, 2019

Rationality wins, for a change

The Ninth Circuit opinion in Altera v. Commissioner has now come out, reversing a Tax Court decision in a transfer pricing / cost-sharing case that I previously discussed here. It's a win for the government, and a win for good sense both in regulatory review generally and with respect to the particular issues posed here.

The majority opinion appears to have wholly adopted the viewpoints expressed in amicus briefs that multiple law professors signed, one lead-penned by Clint Wallace (I was among the signatories) and the other by Susan Morse. Whether or not the court thought about it this way, the fact that so many law profs were on one side, without any financial stake, remuneration, etc. (and I believe none were on the other side, at least on this basis) may conceivably have served as a useful signal. There have been quite a few recent international or state tax cases in which law profs were on both sides, and there the proper takeaway was indeed that, in those cases, the merits were far more substantially in dispute among experts than here.

In Altera, the Tax Court unfortunately lost its way, and adopted the views both that stock options cost the issuer zero (in which case I'd like some, please) and that particular details of exchanges between unrelated parties in wholly different contexts should be used mechanically as evidence of "arm's length," without an adequate analysis of actual comparability or of how incentives and circumstances might differ as between the settings. The Ninth Circuit's Altera opinion does a nice job in explaining why the so-called comparable transactions, in which costs of incentive compensation were apparently ignored in particular deals between unrelated parties, weren't actually comparable in any serious or realistic sense.

The majority opinion also offers a useful and instructive primer on both the history of, and the legislative rationales for, the U.S. transfer pricing rules, in particular as they apply to intangibles. And it sensibly explains why the trap that taxpayers tried to set for the government in the regulatory "notice and comment" stage, by submitting an avalanche of not very relevant material that they correctly guessed the Treasury preamble wouldn't spend countless pages rebutting point by point, shouldn't be treated as showing a process failure on the Treasury's part.

The just-released decision is in effect a do-over. It came out the same way a couple of years ago, but Judge Stephen Reinhardt's death, after he had signed the majority opinion but before it was reissued, persuaded the Ninth Circuit that the case should be reheard. Given the merits. I'm not at all surprised that Judge Graber, who replaced Reinhardt on the panel, ended up voting the same way.

Monday, June 03, 2019

2019 Law and Society Association Annual Meeting

This past Thursday through Saturday (May 30-June 1), I was attending, as I do most years, the Law and Society Association’s Annual Meeting, which was held this year in Washington D.C. (Next year, Denver.)

I went to a couple of LSA annual meetings about twenty years ago, then stopped going because there was almost no one there who had any interest whatsoever in tax or budget topics. But then Neil Buchanan created an institution in which lots of tax people would attend the LSA and have their own panels – kind of a separate conference within the LSA conference. And when Neil eventually got tired of doing all the grunt work year after year after year, Jennifer Bird-Pollan and Mirit Eyal Cohen volunteered to help out so that he / they / we could keep the thing going.

This was a typical year, with a tax panel in every single conference time slot (including a lunchtime slot), and I think about 60 tax people attending – mainly from the U.S. and Canada, but also from farther afield, such as the EU and New Zealand. It’s a nice group, with diverse interests and a supportive / collegial vibe that makes attending the LSA a pleasure. The seniority range is from very junior to very senior plus everything in between.

In this type of setting, one won’t have read the papers that are being presented, absent significant extra effort. But you do get to hear the twenty minute talks, and if one paper doesn’t happen to interest you enormously (as is inevitable when there are so many), there’s always the next one. Its being a “law and society” conference tends to reduce – but not eliminate – hardcore public economics content in favor of diverse methodologies and interests, but you get a range of standard tax policy papers, tax history, sociology, focus on retirement or inequality issues, etc.

This year, because it’s a hot topic, there were several papers touching on the digital service taxes that are currently emerging in the EU and elsewhere (does the UK still count as “EU” for this purpose?). This was good news for me, as DSTs are a current interest that I’m writing about. Indeed, during spare moments I was able to think about the structure of my paper-to-be. Current working title, which is perhaps too long and wordy: “Digital Service Taxes and the Broader Shift From Determining the Source of Income to Devising (Sub?-) Optimal Tariffs.”

My own talk concerned a paper on P.G. Wodehouse that I may or may not write, either as a freestanding piece or as an early chapter in Volume 2 of a possible book sequence on literature and high-end inequality. I have already written Volume 1, which is currently on offer to publishers and has the working title Dangerous Grandiosity: Literary Perspectives on High-End Inequality Through the First Gilded Age

My talk discussed the completed book, along with what I might (or might not) write about P.G. Wodehouse. Its title is “Reading Wodehouse Seriously (?!),” with the ?! serving to acknowledge the point, why on Earth would one want to be such a spoilsport as to do that? The slides are available here.

At least one audience member had thought in advance – quite reasonably and logically, I’d say – that I meant to discuss P.G. Wodehouse v. Commissioner, a well-known U.S. international tax case. But that was not the case, and the main Wodehouse text that I discuss discussing is his immortal Right Ho, Jeeves.

This is the novel that begins something like this:

Jeeves, I said, may I speak frankly?

Certainly, sir.

What I have to say may wound you.

Not at all, sir.

Well then, Jeeves –

But then our narrator, who is of course the immortal Bertie Wooster (rentier supreme in an era when rentiers have long since ceased to view themselves or be viewed like a Darcy), realizes that he has failed to give the reader the necessary background information preceding this exchange. So we don’t get the next words in this dialogue for maybe 30 pages or so.

The joke, immediately clear to any reader who knows about the Jeeves-Wooster relationship, is that Jeeves the servant cannot possibly be “wounded” emotionally by anything that the "mentally negligible" (his own phrase) Bertie might have to say about him.

There are actually rich possibilities in a close reading of Right Ho, Jeeves and associated works (such as its successor, Code of the Woosters), even though one doesn't wish to be stodgy or to kill all the fun. My slides briefly allude to some of the possibilities.

Conference aside, it was nice to be back in Washington (my home base for six years in the 1980s), and I also briefly got to meet these individuals.

Wednesday, May 22, 2019

The IRS memo on Trump's taxes

I haven't had much to say here about the "dispute" concerning the House Democrats' request and subpoena for Trump's taxes, because I try to focus on things that are interesting, and here there is no bona fide legal dispute (hence the scare quotes). But the recent revelation that the IRS wrote a draft memo reaching this obvious conclusion merits a brief comment here.

The case that the IRS has to hand over the tax returns is 100% ironclad, since the statute says "shall" and the request is clearly within legitimate Congressional oversight functions.

Mnuchin is being lawless in refusing to comply. It's true that one generally has the right to contest claims with which one disagrees legally, and then let the courts decide. But here the grounds for objection are frivolous. I thought it was settled back in Magna Carta days, or certainly before the American Revolution, that the Parliament had oversight powers with regard to the executive branch, and the U.S. Constitution clearly reflects a stronger balance of powers commitment than they had in those days across the Pond.

Mnuchin's position is apparently that Congress has no oversight powers. This is not within the range of debate about what the U.S. Constitution might mean, whatever one's interpretive theory. And no one at even the very highest levels of the Administration actually believes it, at least in the sense of agreeing that a Democratic president would be similarly exempt from Congressional oversight.

It's true that Mnuchin is being ordered from above not to comply. But when you receive a lawless order, your choices are to decline to follow it, or else to resign.

The IRS memo has no authoritative legal force as such, but it shows two things. The first is that the IRS lawyers realized how clearcut and indisputable the legal issue is. (The mention of executive privilege presumably reflects a view that such issues would be outside IRS legal expertise, but of course it's completely absurd to argue that a president could have executive privilege regarding the tax returns he filed as a private citizen, and also no such claim has been made.)

Second, the fact that the IRS memo apparently played no role in the Administration's, or Mnuchin's, consideration of what to do unsurprisingly confirms their lawlessness. In an Administration that viewed legality as at least relevant, the memo would have been considered, and if its analysis was rejected that would have been based on non-risible legal arguments to the contrary. That does not appear to be what happened here.

Monday, May 20, 2019

Sticking the ending is tough

Last night I watched the Game of Thrones finale, what with others in the household watching it & its having become such a huge cultural event, etc.

I had seen most or all of Season 1, but then quit although I recognized the quality as I simply wasn't in the market for another long-haul medieval dragons & kings fantasy. But I've seen bits here and there, and was familiar with the general story arc et al because it had become so culturally prominent.

My gawd but the ending was awful. Slow, portentious, pretentious, mawkish. They could have done the whole thing in 10 minutes, or alternatively they should have taken 6 weeks. And all the convenient happy ending bits, but also the oh-I'm-so-noble sorrow bits, were bad cliche.

Also the burning city was a bit too picturesque. Nicely curated little fires burning at regular intervals near arranged rubble. The set designer needed to go a bit more chaotic and rando.

But I recognize, from all I've heard about G of T online and in person from its fans, while this is the fault of the show runners it doesn't say anything against the high quality of the first 6 seasons.

All that said, sticking the ending is tough. The Seinfeld finale was awful - strained, unfunny, completely misconceived - although it didn't really matter since story arcs weren't key to the show, so it was really just a by then rare bad episode. (Early Seinfeld episodes are interesting in that one can see they hadn't quite figured it out yet.)

The famous, controversial Sopranos ending I thought was great, along with the entire series.

Breaking Bad I thought blew it a bit in the ending. Like Game of Thrones, they made things too nice and even rah-rah at the end, at the expense of everything that had come before. But at least it was a dramatic and fast-paced episode.

Luckily a bad ending to a miniseries doesn't do as much harm to what came before as, say, failing to land a plane.

Wednesday, May 15, 2019

Considering exercise of the House's inherent arrest power

My USC tax colleague and friend Ed Kleinbard, along with USC con law professor Sam Erman, argue here - I think entirely persuasively as a matter of law - that the House of Representatives has well-settled inherent power to arrest the likes of Steven Mnuchin and Robert Barr for their lawless defiance of subpoenas, and to forcibly detain them (say, in Capital Hill hotel rooms under guard) until they comply. (The arrestees would be free to try going to court themselves, but they would lose if precedent still means anything.)

I have to admit, I consider it a tough question how this would end up playing out in the public arena, given that these individuals do not seem terribly committed to the rule of law, have armed bodyguards, and would not necessarily agree to go peaceably.

Friday, May 10, 2019

Back in the day

As I approach another birthday (let's not say what #, although the info is publicly available), I enjoyed seeing this photo from a vacation many years ago. I wonder where (if?) she is today.

Sunday, May 05, 2019

2019 Tribeca Film Festival

Sometimes I wonder if New York is worth it - expensive, crowded, crumbling infrastructure (although our whole country is like that), and I've grown to hate the winters.

But it does have some things going for it, like endless restaurant variety, along with cultural events that are scarcer in most other places. An example was getting to see Hannah Gadsby (and soon I'll be seeing her again) before she had broken through on Netflix. One of my faves, however, is the Tribeca Film Festival, held each year around lower Manhattan in late April and the beginning of May (just at the right time for one to wish the weather was better, although that's almost always true here).

You can get an 8-ticket package and go with partner to 4 movies that you choose before they're otherwise on sale, but this year we doubled down and got a 16-ticket package, with the end result of seeing 8 films in 9 days.

Best news: none of them were superhero movies or anything like it. Indeed, it was a common joke on the lines where you wait for admission to your event: "Are you here for The Avengers?"

If you play your cards right you can try for a varied slate by genre, site, time of day, etc., reducing the monotony of having to get somewhere (half an hour early) each day, and turning it into more of a staycation. You also generally get to see and hear a short Q&A with the director, stars, etc., after each show, which adds human context.

This year's slate for us was as follows:

1) Lost Bayou - small film about a troubled young woman who has to go see her faith-healer dad on a houseboat in the Louisiana swamp. Beautifully photographed, a bit slow, unlikely to go far commercially, but it felt worth seeing.

2) Good Posture - excellent indie growing-up film with Angelika-style potential, young woman in a beautifully shot Brooklyn meets (fictional) famous writer, great cameos by Zadie Smith, Martin Amis, and Jonathan Ames.

3) Plus One - rom com that also has breakout potential, very enjoyable to watch, and with a charming performance by the female lead, but a bit cliched despite efforts to address the genre's familiarity, and seemingly aimed more at commercial success than, say, artistic exploration.

4) Inna de Yard - documentary about founding musicians from the Jamaican reggae scene who are still performing today.  Great music and a nice cultural document.

5) Woodstock - new documentary about the famous 1969 concert, based on previously unused archival footage and interviews. Rather than being a concert movie like the original 1970 release about this epochal event, it focuses on how the organizers put the concert together, why people went there and what they felt they got out of it, and how everyone got through the challenging circumstances of a prolonged mass concert experience with inadequate facilities, drenching rain, etcetera.

6) The Quiet One - documentary about former Rolling Stones bassist Bill Wyman, featuring a dip into his massive archives that go back to before the group's beginning. Interesting and had some nice footage, but mainly stayed on the opaque surface and also steered clear of controversy.

7) Buffaloed - Zoey Deutch stars in a somewhat Wolf of Wall Street-ish comedy-drama about a young woman in Buffalo who is desperate to rise from poverty. Enjoyable and lively, although at times straining dramatic credibility.

8) See You Yesterday - This was one of my three favorites (along with Good Posture and Woodstock). Like Get Out, it takes a familiar genre, here sci-fi, and imbues it with observation and commentary on where the United States is today racially. A young black woman and man who are completing their junior years at Bronx Science have a science project that they hope will get them scholarships to the likes of MIT and Stanford. To wit, they've invented a time machine, although they can only go back a day (raised gradually to a week) due to its energy and system demands. The sci fi premise would not by itself make the film worthwhile, but it enables the sociological exploration that is the film's real topic. While, at first, the two of them just want to time-travel to show themselves that they can, police violence leads to a tragedy that makes them want to go back and fix things. But that proves not so easy. Great performances, great ending, very moving, and it does not make one happy(nor should it) about the society we live in.

Thursday, May 02, 2019

NYU Tax Policy Colloquium soon to be back for its 25th season

As noted in passing in my last two blog posts (concerning digital service taxation and Wei Cui's paper discussing it), this week marked the end of the "spring" 2019 NYU Tax Policy Colloquium, number 24 in our annual series.

We will be back quite soon, however. My co-convener Lily Batchelder and I have decided to switch the colloquium to the fall semester, at least on a trial basis and probably (as we hope) permanently.

Season #25 of the NYU Tax Policy Colloquium will therefore be running on Tuesdays from September 3 through December 3 of this year. As usual, the public sessions (after we meet privately with our students in the morning) will go from 4 to 5:50 pm, in Vanderbilt Hall, room 208, and to be followed by a small group dinner nearby.

We're in the process of developing our speaker schedule, and I will post it here once it's reasonably set.

Digital services taxes, part 2: inter-nation equity and global coordination / political economy issues

Wei Cui's The Digital Services Tax: A Conceptual Defense, which we discussed earlier this week in the final session of this semester's NYU Tax Policy Colloquium, deserves props for lucidly and significantly advancing the debate on digital services taxes (along with an associated debate on corporate income taxes). My prior blog post emphasized the efficiency issues discussed in the paper, but Cui also more briefly discusses equity issues, and this post will address them.

"Equity" here means inter-nation equity, a concept which is distressingly difficult either to use or, when global coordination / who-should-get-the-revenue issues arise, to avoid. The core challenges in using it relate to (1) the fact that nations are collective entities, composed of individuals but not themselves sensate, and (2) the difficulty of determining consistently how people in one country should weight the interests of people in other countries.

As to (1): Any approach to tax or other policy that is based on the welfare of individuals can readily be deployed to evaluate distributional issues as between the members of all those whom one classifies as members of the relevant group - for example, the rich and the poor within a given society. But a nation is a legal or sociological entity, which can't itself experience welfare, any more than a corporation can. So it is hard to get one's hands around the concept of, say, America's versus France's welfare. To be sure, one has American and French individuals - although the membership list for each group may be both contested and fluid. But we can be sure, for example, that some American individuals are better-off than some French individuals, and vice versa.

One needn't employ a fully welfare-based standard in order to face problems of this kind. In standard distributional analysis of a group of people, I can understand the claim that, if X has gotten very rich due to her effort in applying her talents, she deserves to keep everything based on entitlement, not just incentive effects. I disagree with this line of argument, but I understand it.

Now suppose we say that investment from Americans into France will be taxed in a certain way, leaving only the question of which country will get the revenues. To say that France "deserves" the revenues, perhaps on some sort of benefit theory, and notwithstanding the possibility that France would choose not to tax the activity at all if the alternative were that no one (rather than the U.S.) would get the revenues, is hard to make coherent enough even to be refuted in a specific way. I sometimes feel that one might as well be discussing with the Walrus and the Carpenter "why the sea is boiling hot, and whether pigs have wings."

But then again, suppose we hear that Finland or Taiwan wants to claim the revenue from Americans investing in France. Or suppose I want to claim the revenues personally. (As Al Franken used to say, decades before his disgrace, "Why not me?") From an efficiency standpoint that focuses just on taxpayers' incentives, it makes no difference who gets the revenue. So where do we go to conclude that, perhaps, if anyone is to claim revenue from these cross-border investments, it should probably go (absent further complicating facts) either to the U.S. or France.

Obviously, there might be rationales here of political economy, making global coordination more feasible, requiring national and other actors to treat each other "reasonably," having rules of the road like driving on either the left or the right, etcetera. But the language of inter-nation equity naturally creeps in here, whether or not one ultimately thinks it is about equity.

This brings us to (2) the difficulty of determining consistently how people in one country should weight the interests of people in other countries. I've written about this before, but, in a nutshell, global beneficence - valuing everyone's interests equally - is hard to beat as a moral standard. But we accept that countries may greatly prioritize the interests of their own community members (a concept which of course is in itself highly fraught). This is at least analogous to the fact that individuals who might consider themselves utilitarians may nonetheless not beat them themselves up to much over using their own material resources chiefly on behalf of themselves and other members of their households or families, rather than asking themselves who in the entire world is most in need.

From this standpoint, at a first approximation tax revenues that go to another country, rather than to one's own country, have zero value to oneself. So why not be Finland or Taiwan with respect to U.S. to France cross-border investment? But again one may reach for the idea that all may gain if all behave reasonably and cooperatively. And this in turn takes us to the case for generally behaving cooperatively in prisoner's dilemmas (at least, if one thinks others are sufficiently doing so) even insofar as one doesn't expect this to pay off directly for oneself via multi-stage strategic play.

I'm known in some circles for arguing that the U.S. (and other countries) should make international tax policy choices as if foreign taxes were just a cost like any other. My argument was partly just about logical consistency - those who claimed otherwise could not, or at least had not been able to, explain coherently why a global welfare standard should apply here in particular but not elsewhere. But it was more fundamentally about disagreeing that, in recent and present circumstances, any one country's offering foreign tax credits (while other countries were shifting their international tax systems in a more territorial direction) made sense either unilaterally, or strategically, or as conditional-Kantian cooperation (in John Roemer's sense). I probably would not have regarded this line of argument as indicating, say in 1976 if I were flown back there with my present state of beliefs, that the U.S. should go first in reducing foreign tax creditability.

With all that as background, let's turn now to the inter-nation equity issues in Wei Cui's paper, Suppose we posit the following. There are a bunch of people out there who have become billionaires by launching successful start-up companies that exploded via the creation of digital platforms that are being used globally. As it happens, many or perhaps even most of these people are Americans - e.g., the Facebook, Google, Amazon, Apple, et al founders. Suppose further that they are generating rents, which in turn can be divided, if one likes, into the location-specific rents (involving zero marginal cost and non-rival use) that are available to be earned in each particular country.

Now suppose that one is thinking about entity-level corporate income taxation, and that one starts out by regarding it as purely a proxy for income taxation of individuals - which could be wholly avoided or at least deferred, by one's operating through corporations, unless the income was contemporaneously taxed at the entity level (or otherwise adjusted for at the individual level). This clearly is AN important reason for corporate income taxation, treating the rest of the fiscal system as fixed, although not necessarily the only purpose that it could be designed to serve.

From this perspective, the mega-profits earned by those mega-companies - or to be earned in an accounting sense, but already reflected in stock price valuations - belong to the individuals who own the companies. Insofar as these people are U.S. residents (Zuckerberg, Page, Bezos, et al), the U.S. has reason to, and should want to, tax them on the location-specific rents that they are earning around the world. Or more precisely, it has reason to count those rents' effect on these individuals' annual economic income and net worth. In addition, to the extent not already following automatically from the above, it has reason to tax U.S. individuals' foreign source income on the same terms as their domestic source income, so that such individuals can't avoid source-based U.S. income taxation by investing abroad. (The reason this doesn't follow so automatically for entity-level corporate income taxation of resident companies relates to the differences between corporate and individual residence as operating concepts.)

From a U.S. standpoint, therefore, if one were to assume that only one country should be able to tax the location-specific rents that U.S. individuals earn abroad (whether through corporations or not), it would be us. This is even leaving aside the "Finland or Taiwan" reasonableness point from above that we'd also want to be the one taxing all the other rents that arise anywhere in the world.

On the other hand, suppose people from other countries are earning location-specific rents from investing in the United States. Even under the reasonableness constraint, we'd want to tax those, too. And by the same token, all the other countries out there in which U.S. individuals, often through U.S. corporations, are earning location-specific rents may quite reasonably want to be the ones to tax at least the rents earned in their own jurisdictions. Not to mention that they have also observed our not especially taxing those rents, given the porousness of U.S. (and other countries') corporate income taxation as applied to multinationals.

Cui's paper on digital services taxes argues that it is at least prima facie reasonable and fair, subject to further development of the relevant inter-nation equity issues, for a given country to want to tax a piece of the location-specific rents that multinationals deploying highly profitable digital platforms are earning with regard to activity that takes place inside such country and/or involves individuals who are among its residents.

I agree with this proposition. At a minimum, we're not in the realm of Finland, Taiwan, or me trying to grab the rents from, say, U.S.-into-UK activity, and we've all generally agreed that self-interested behavior is permissible within those broad bounds. How to handle the coordination issues that may arise, and how well they are likely to be handled, is of course another, and far more difficult, question.

Wednesday, May 01, 2019

NYU Tax Policy Colloquium, week 14: Part 1 regarding Wei Cui's The Digital Service Tax: A Conceptual Defense

Yesterday we completed the NYU Tax Policy Colloquium's (and my) 24th year of operations with a paper on a hot topic, Wei Cui's The Digital Services Tax: A Conceptual Defense. The paper makes creative and important contributions regarding how best to think about a new fiscal instrument that has been attracting a lot of attention, most of it hostile. Digital services taxes (DSTs) are a rich topic that I will probably be thinking about some more in the near future. E.g., I'm scheduled to give an international tax policy talk in Singapore next January, and my lecture topic will likely have something to do with DSTs, whether as themselves the prime topic or as an important subordinate / illustrative piece thereof.

There are some actual DSTs out there, in varying stages of being adopted or proposed. There are also related instruments that appear not to be quite the same - for example, Singapore recently enacted what appears at an initial glance to be an extension of their VAT/GST to digital services, requiring certain foreign suppliers to register and participate. That's not quite the same thing, and indeed might be relatively uncontroversial as a tax policy matter.

In this post, I'll lay out some preliminary structure that might aid one in understanding Cui's arguments and the DST debate more generally. For reasons of overall length, I'll continue the discussion in a follow-up, Part 2 post.

1) What is a DST for the paper's purposes?

a) Conceptual overview - In principle, whether or not perfectly in practice, a DST within the paper's conceptual defense is a gross receipts tax on the use of a digital platform to earn location-specific rents in a given country, via an (at least) two-sided business model, and featuring both non-rival deployment within the country and zero marginal cost. The paper recognizes that some of these features will never be completely true, but, as noted below, if they are sufficiently true they might be highly policy-relevant.

b) Whom might one have in mind as companies potentially subject to such a tax? - Before unpacking this a bit more, let's give a sense of the territory, by noting some well-known companies that might be subject to a DST - although, in fact, many of them are deliberately exempted by existing versions.

Consider Facebook, Google, Amazon Marketplace, AirBnB, Uber and Lyft, Microsoft and Android, Apple, Netflix, PayPal, Spotify, LinkedIn, EBay, Expedia, YouTube, and Seamless and GrubHub if they went international. All are potentially within scope at least as to some of their operations, if one conceptualizes the DST as Cui does.

To be clear, here, many of the above companies have been deliberately left outside the scope of existing DST proposals. In some cases, the DST proponents have had express rationales for the exclusions that reflect their viewing the instrument's purposes differently than the paper does. For example, they may focus on whether content or valuable data is being provided by local customers, or instead is being supplied from outside the jurisdiction (a la Netflix and YouTube). This reflects rationalizing the DST differently than the paper does.

It will be illuminating below to compare a couple of these companies with one that presumably would NOT be subject to any DST, yet that shares some (though not all) of the key economic features noted above. The company I have in mind for this purpose is Starbucks, although I'll also briefly mention American Express and Visa.

2) Illustrating and rationalizing each of the above DST's main features

a) Gross receipts tax - Suppose the taxing jurisdiction is the UK, and that the taxpayer is either Facebook or AirBnB. The tax as envisioned by Cui would fall on the company's gross revenues from exploiting the UK market. For Facebook, this would be advertising revenues that Facebook earns from third party advertisers (wherever located) that are targeted to UK consumers. For AirBnb, the tax would fall on fees paid to it by guests (wherever located) who used it to book UK accommodations. (In other words, this would be the excess of what they paid AirBnB over what it then remitted to the host.)

b) Digital platform - According to a standard online definition of digital platforms, they are "online businesses that facilitate commercial interactions between at least two different groups, with one typically being suppliers and the other consumers." This obviously fits most of the companies that I listed above as potentially subject to the DST, although for some it either applies only to some of the company's operations, or is debatable. For example, Netflix presumably isn't intermediating between two groups as to its own content, but (along with Spotify) could be seen as doing so for commercially released stuff that it allows one to stream. Apple isn't intermediating when it sells iPhones, but is doing so as between app developers and iPhone owners. PayPal and Venmo are playing a similar market role to American Express and Visa, but the latter aren't using a digital platform in the same way as the former. Starbucks has physical stores and really isn't using a digital platform at all (unless I am missing something), although it's true that the stores may attract some customers via free wireless.

Who cares, for tax design purposes, whether or not one uses a digital platform? It doesn't or at least shouldn't, directly matter at all. It's just one way of doing business, and there are others. But the use of a digital platform may be highly correlated with various features that do matter.

Just to name one for now, although more will emerge below, digital platforms can make it easy for a company to reach a given country's consumers (or suppliers, as in the AirBnB case) without having the sort of physical presence that can give rise to a "permanent establishment" (PE) for tax purposes. Both tax treaties, and numerous countries' domestic income tax laws, treat the existence of a PE (or of something similar, such as a "U.S. trade or business" under U.S. income tax law) as a precondition to taxing non-resident companies on the profits that they earn from interacting with one's resident consumers and/or suppliers.

Suppose one thinks that a PE really oughtn't to be necessary in order for a given country reasonably to tax non-resident companies on the profits that they earn from interacting with one's residents. It's rather an obsolete concept, from the days when interaction without physical presence was costly and cumbersome, and when nonresident businesses might find it difficult to understand, or costly to comply with, a given country's tax regime unless their people were there. Then companies with digital platforms would be at least among those that one wanted to tax and that found it easy to avoid a PE. But seemingly the most direct response would be to eliminate the PE requirement, not focus directly on the presence or absence of a digital platform.

To illustrate, suppose that Starbucks used franchising to place stores in a given country such as the UK, rather than operating its own store. Now, I presume that the main reason they don't do this is that it simply isn't the business model they prefer to maximize profits from their brand. As explained by Ronald Coase's theory of the firm, they have apparently concluded that direct control over employees is the best way to get the behavior and incentives that they want. But if they DID use franchising and independent agents, and if this worked as well from a business standpoint as what they actually do, then they might be able to avoid having PEs outside the United States. Yet they would not be a penny less globally profitable than they actually are (again, under the assumption that doing business this way worked just fine).

In that scenario, the UK would of course be taxing Starbucks' UK franchisees on the profits that they earned from the UK stores. But let me offer a guess: these profits wouldn't be very impressive. Indeed, at a first approximation they'd resemble those currently earned by Starbucks' UK employees (adjusting for the allowance of normal returns to any capital that they supplied or entrepreneurial risk that they bore). Or perhaps a better comparison is to the folks running rival coffee establishments that couldn't take advantage of the Starbucks brand. After all. why would Starbucks give away to them any more than it had to, given their wage rates and opportunity costs that had nothing to do with the value of the Starbucks brand?

Among other things, this point arguably puts a rather low ceiling on the amount of profit that would end up in Starbucks UK operations for corporate income tax purposes, under its existing commercial structure, if arm's length transfer pricing principles were neutrally and "accurately" deployed with respect to its UK PEs. Starbucks may be earning huge global profits, but not by reason of what's happening in the UK in particular. But this doesn't tell us whether either "we" from the standpoint of global welfare, or the UK from the standpoint of its residents' self-interest, ought to support the UK's getting its hands on what one reasonably deemed to be the UK piece of Starbucks' global hyper-success.

c) Location-specific rents - Suppose one takes here for granted the point, admittedly requiring further analysis, that a host of highly successful global companies, such as all those that I named above with digital platforms, but also the likes of Starbucks, are earning extra-normal returns that we can properly call rents, within standard economic parlance. And let's ignore for now the issue of whether, while looking like rents ex post, they are better thought of as quasi-rents that, from an ex ante perspective, merely reflected an ordinary, competitive, risk-adjusted return to intermingled labor effort and capital investment.

From at least the ex post perspective, taxing rents is efficient and in theory will not lead to efficiency costs. For example, if I can costlessly pocket $1 billion (e.g., by reason of getting extra-normal returns on investments for which I only required the normal return), then taxing even 99% of it away won't deter me from still pocketing it all so that I can keep the residue.

If either Facebook or Starbucks is properly viewed asd earning rents around the world, then those it is earning in any particular place might be called rents specific to that location. For example, we might say that Facebook has UK rents from selling advertising that is targeted at UK users (as identified by their IP addresses or whatever). And Starbucks has UK rents from the profits it derives, given the value of its trademark etc., from operating stores in the UK. (Or, one might instead or also say, from selling to UK individuals anywhere in the world, if this fact automatically emerged in the course of a normal customer transaction.)

d) Non-rival deployment - Crucial to the idea of calling Facebook's or Starbucks' UK rents location-specific is the view that its IP can be simultaneously deployed everywhere. A given car, or for that matter a given espresso shot using particular Starbucks beans, can only be sold in one place. But Facebook's platform can be offered and used around the world in non-rival fashion. The same holds for Starbucks' brand value and basic organizational scheme. Thus, taking as given that the two companies are earning rents, they needn't ask themselves where they should try to earn these rents. The answer is everywhere. There is no opportunity cost to entering the UK market - in the pure case, their doing so has no impact on their also doing so everyplace else. So if the global rents that they can earn include some that we have defined as location-specific to the UK, then of course they will choose to do so, (at least within the model's contours) even if these rents are highly taxed.

e) Zero marginal cost - A further and related key assumption, in terms of making an appealing theoretical case for something like a DST, is that the firm has zero marginal costs of operating in a given jurisdiction. If Facebook already has a digital platform at the ready, then one could imagine its costing the company zero to allow UK users to access the platform, and outside advertisers to pay for targeted access to these users. In practice, this of course is not likely to be literally true. For example, Facebook may need to be able to handle more traffic by reason of its being in the UK, and may need to address U.K. regulatory issues, along with users who speak in English dialect (rather than, say, American or Australian).

Zero marginal cost matters because, where found, it takes away the sting from DSTs' being a gross receipts tax. Gross revenue equals net revenue if there are no marginal costs. So one avoids the problems with gross turnover taxes that made their decades-ago replacement by VATs a huge step forward for various European and other countries. And even if there are some marginal costs, so that the gross revenue facing DST exceeds true net revenue, corporate income tax accounting efforts to measure the latter, especially for a given location within a company's global operations, may conceivably lead to answers that are actually further from the mark. So there may be a case for gross revenue taxes on digital platforms if we believe that net revenues from its deployment in a given country are both small enough in truth, and tax-manipulable enough in practice.

What about Starbucks? Well, a tax on gross revenues from its UK operations would be normatively unappealing, given that it clearly does have substantial marginal operating costs, such as from paying rent, wages, and for supplies. So its not using a digital platform has a lot to do with why placing it under a pure DST-style regime would not make sense. Yet there is an element of its operations that overlaps with the DST rationale. After all, analogously to Facebook, it might be viewed as earning location-specific rents in the UK from non-rival deployment there of its global brand value.

Suppose that the UK corporate income tax was inevitably going to under-tax both Facebook and Starbucks, relative to a UK-only firm that had no rents. I am here using "under-tax" to refer both to the unique profit-shifting opportunities that multinational firms often have - although the concept of "profit-shifting" implies a judgment as to "true" UK-source income - and to the rationale for imposing higher taxes on rents than on normal returns. Also, I am ignoring here the considerable flexibility that an instrument which we chose to label as the "corporate income tax" might in practice actually have - at least, if not overly constrained by income tax treaties.

Then applying a DST to Facebook, but nothing new to Starbucks, might combine the virtue of raising revenue efficiently from the former, and better aligning its taxation to that of the UK-only firm, with the vice of newly tax-disfavoring it relative to the latter. This is a tradeoff that DSTs will almost inevitably offer, even where the theoretical conditions for favoring them are pretty well met, if the underlying concept couldn't somehow be suitably generalized and adapted to settings outside that of digital platforms.

f) Two-sided business model - There is an extensive literature (not currently all that familiar to me) concerning two-sided business models, and referenced by Cui's paper. A key issue here is that the intermediary, such as a digital platform, doesn't have to charge an independent arm's length price to each side of the arrangement. It can subsidize one side and recover by charging the other side, because (a) it only cares about its net from the two together, and (b) things are suitably adjusted as between the other two parties in their indirect dealings with each other.

The Facebook example is: We get to use the platform for free because Facebook is delivering us to advertisers (or others through whom it monetizes the data it has acquired about us).

This of course isn't a newfangled product of modern digital platform technology. TV and radio stations that broadcast for free to non-subscribers but that are funded by commercials are doing a version of the same thing.

The AirBnB example is: the company offers value to hosts who sign up, but doesn't directly charge them anything, because it can collect fees on the consumer side (i.e., the gross amounts guests remit to it, minus what it then pays forward to the host).

While I'm planning to read up more on the literature concerning two-sided business models, my impression is this feature doesn't play a first-order role in the DST debate. Rather, it matters here mainly via its effect on the application of conventional corporate income taxes to platform companies.

In the Facebook example, the UK can't glom onto the fees paid by users to Facebook, as a ground either for taxing those fees or using them to establish a broader PE from which it can stake its claim to other revenues or profits that are attributable to Facebook's having UK users.

In the AirBnb example, the fact that the company gets nothing directly from UK hosts, as distinct from the hypothetical case (with identical net cash flows) in which guests paid hosts directly and the hosts then remitted a piece to the company - or, for that matter, from that where hosts paid it sign-up and subscription fees - similarly at least complicates things for the UK tax authorities, if they would have liked to get revenues from the company, say through the corporate income tax.

Two-sided business platforms therefore strike me as potentially important to the motivation for imposing DSTs, but less so as to how one might think about DSTs in fundamental economic terms.

Okay, that's plenty long enough, if not too long, for a single blog post. It offers grist for both sides with respect to DSTs' good and bad efficiency properties. I'll shortly (or when I can) post a follow-up that looks to the equity issues - meaning here inter-nation equity, not say vertical distribution - aka, who gets the money and how should we think about that issue.

Wednesday, April 24, 2019

NYU Tax Policy Colloquium, week 13: Sara Greene's A Theory of Poverty: Legal Immobility

Yesterday at the Tax Policy Colloquium, Sara Greene of Duke Law School presented her paper “A Theory of Poverty: Legal Immobility.”

Given the old gag (as P.G. Wodehouse would call it) about first impressions, it’s worth noting that the title risks creating inaccurate expectations regarding the paper’s actual content and contribution. It’s not primarily about what causes poverty, but about how state and local law can burden people who are trying to escape poverty, or even create downward spirals for the poor or near-poor.

Here are two alternative titles that one might have in one’s mind instead when reading the paper: (1) A Theory of State and Local Law: Needless Harm to Upward Mobility by the Poor, and (2) The Hidden Regressivity of State and Local Law. Although only the first of these was my particular suggestion, I think there is a case for each, or for trying to combine them somehow.

The first of these two alternative titles relates to an important point about why poverty can be hard to escape. One bad thing about being poor is that you have much less margin to handle adverse shocks. Say you have a low-wage job and a child, and live in an area where public transit is inadequate or nonexistent. (This is, after all, the United States, not Western Europe.) Getting the flu, or having your car break down and require major repairs, may trigger a broader crisis that a middle class person wouldn't face despite the extreme unpleasantness of such developments to anyone. For example, it may trigger income or job loss that one is not in a good position to bear without more serious disruption. Downward spirals are possible. People who live more comfortable lives, and who may self-congratutorily wonder why others aren't doing as well as themselves, may feel to appreciate how significant these risks and shocks can be. Walk a mile in other people's shoes before you judge them. And, such issues are relevant to how we as a society might go about addressing poverty.

But what does this have to do with state and local law? The paper's answer is that its defects, reflecting power imbalances that can lead to deliberate exploitation, to not so benign neglect of their needs and interests, and to an undue focus on social control, can have the effect of imposing needless adverse shocks - for example, via the over-use of eviction, driver's license suspension, and what is effectively debtors' prison as a consequence of unpaid fines.

The relevance of the second proposed title from above comes from the paper's also looking at the imposition of burdens, such as through former slave states' reliance on sales taxes, that don't impose shocks but may have adverse distributional effects at the bottom of the income distribution.

Why focus on state and local law in particular here? There are lots of other reasons why America is so unequal at the bottom and poverty is so hard to escape. The paper's main answers are (1) because this aspect is underappreciated and merits further study, and (2) because in many cases it is changeable for the better (leaving aside the political question of how one fixes defects that reflect underlying power imbalance).

Perhaps for some readers there will also be (3): because there is often an at least implicit assumption in legal discourse that "law" is neutral and objective and so forth. But of course "law" is a social product like anything else.

While I generally accept the paper's critique, one point I'd note, with which I know the author agrees, is that often there are hard choices and conflicting interests, even just regarding the welfare of the poor. For example, consider nuisance law and 911 calls (which the paper discusses), or "broken windows" issues, or the adverse impact on poor communities that both drug-dealing and the War on Drugs can have. Or for that matter, over-used though the suspension of driving licenses for speeding may perhaps be, consider that speed limits save lives. Some in poor communities may be helped and others hurt by disciplinary and other interventions, and getting it right is no easy matter for policymakers.

Tuesday, April 16, 2019

Tax policy colloquium, week 12: Day Manoli's "The Effects of EITC Correspondence Audits on Low-Income Earners"

Today at the colloquium, Day Manoli presented the above-named paper, which can't be posted yet for IRS clearance reasons. But it promises to be of considerable interest when it comes out. It looks at the data around IRS documentation requests to randomly selected taxpayers, within a group that is deemed to present low or intermediate risk scores re. the need for an auditing adjustment, who have claimed the earned income tax credit (EITC).

It would probably be premature at this point to discuss the study's particular findings, but the administrative intervention that Manoli et al are studying involves "correspondence audits" in which the IRS sends a letter requiring documentation - say, of claimed earnings or dependents - and failure to respond with the requested items results in the EITC's being denied.

EITC denial by reason of the correspondence audits appears to have decreased Type II errors (giving the EITC to those who didn't legally qualify). But it also appears to have increased, perhaps quite significantly as a percentage matter, Type I errors (denying the EITC to those who did legally qualify but couldn't handle the extra hurdles - in some cases because the IRS letter wasn't successfully delivered to them).

Some general observations that I would offer here include the following:

1) By Congressional diktat, audit rates are generally higher for EITC claimants than for any other individual taxpayers other than the very rich. This cannot be justified as a matter of generating the maximum bang for the buck from the allocation of IRS audit resources. I don't think there is good justification for it otherwise either. Among its possible motivations are classism, racism, and fiscal language illusion or bias (viewing over-payment of "transfers" as worse than under-payment of "taxes" even though (a) a dollar is a dollar, and (b) we are all net taxpayers on a lifetime basis, hence it's absurd to code some of the sub-transfers differently than others).

2) Relatedly, the relative priority that public debate gives to focusing on Type II errors in EITC provision, relative to Type 1 errors, appears to me to lack adequate justification.

3) Lots of EITC non-compliance is not deliberate. This reflects the EITC rules' excessive complexity. A prominent NYC tax lawyer of my acquaintance once wrote an article urging his colleagues to offer tax advice pro bono to needy clients, rather than working for more billable hours and giving the extra $$ to charity. One can agree or disagree with his view, given billing rates vs. the value of one's services to someone who can't pay for them, but one of the arguments he made was that in fact the EITC can be daunting enough in practice that skilled tax lawyers actually CAN offer their pro bono clients something that is scarce and of value. The EITC oughtn't to have been designed in such a way that high-end legal skills might come in handy towards claiming it properly.

4) Papers on Food Stamps or SNAP, such as that by Tatiana Homonoff which we discussed several week ago at the colloquium, often discuss "targeting efficiency" - e.g., the relative social welfare costs of SNAP benefit loss to worse-off versus better-off individuals among those whose incomes are low enough to qualify for it. The welfare costs under the EITC not only of Type I errors but even of correcting at least innocent Type II errors (which often reflect the rules' needless complexity) likewise ought to be treated as relevant to the analysis. These are generally people in the lower income ranges, often with dependent children, who may have significant unmet material needs but who are punished for lacking political clout.

"Debate" re. the 2017 tax act's international tax provisions

Today at the annual NYU-KPMG tax symposium at NYU Law School, Kim Blanchard and I "debated" Itai Grinberg and Michael Plowgian, with Diana Wollman moderating, regarding whether the 2017 tax act made the U.S. international tax system better or worse. I use scare quotes around "debating" because we had assigned roles (not guaranteed to reflect our actual views) and aimed to be lively and give the audience a good show, rather than to engage in an academic seminar-style serious mutual exploration of the issue. Kim and I were assigned the role of saying that, yes, the 2017 act improved U.S. international tax law.

I happened to go first. Keeping in mind the nature of the assignment, I started by mentioning the wonderful scene in Alice Through the Looking Glass when Alice (unwillingly) hears "The Walrus and the Carpenter," whose two protagonists cruelly trick a group of oysters into being eaten by them (under the false pretense of taking a walk to discuss "why the sea is boiling hot, and whether pigs have wings"), and then the following ensues:

‘I like the Walrus best,’ said Alice: ‘because you see he was a little sorry for the poor oysters.’
‘He ate more than the Carpenter, though,’ said Tweedledee. ‘You see he held his handkerchief in front, so that the Carpenter couldn’t count how many he took: contrariwise.’
‘That was mean!’ Alice said indignantly. ‘Then I like the Carpenter best—if he didn’t eat so many as the Walrus.’
‘But he ate as many as he could get,’ said Tweedledum.
This was a puzzler. After a pause, Alice began, ‘Well! They were both very unpleasant characters."

I have always admired Alice's solution here - practical and clear-headed, as she so often is. Rather than deciding whether one's judgment should reflect actions taken or state of mind, or whether moral judgments should be harsher or milder when one knows that what one is doing is wrong, she crisply dismisses the entire question that she has raised.

But the four of us were evidently less wise than Alice, since we took on the assignment of debating whether or not the 2017 act improved the U.S. international regime. We didn't just leave it at agreeing that they are both very unpleasant

The case Kim and I made for "yes, it made things better" had the following main points:

1) No more deferral! - This particular way of lowering the effective tax rate on foreign source income (FSI) never made any sense (as compared to, say, contemporaneously applying intermediate rates), and led U.S. multinationals to jump through hoops to avoid taxable repatriations, while they lobbied for tax holidays, trapped themselves by accepting the accounting benefits of claiming that profits were permanently reinvested abroad, and based decisions on current versus expected future repatriation tax rates.

Our debating opponents not unreasonably pointed out in response that it's not clear how huge the inefficiencies resulting from this admittedly quite poorly conceived regime actually were.

2) Enactment of GILTI - For all its flaws, GILTI makes it harder for highly profitable U.S. multinationals to pay a global 0% rate on large swathes of their income. And as minimum tax proposals go, it has the virtue of preserving some incentive for U.S. companies to minimize foreign taxes, rather than just pay them in lieu of higher U.S. taxes, because GILTI makes foreign taxes only 80% creditable.

3) Enactment of the BEAT - This provision, for all its perhaps even greater flaws, at least responds to the ineluctable problems with transfer pricing. In effect, it imposes an excise tax on "base erosion tax benefits" (deductible payments to foreign affiliates) that has a 0% rate until one is on the BEAT, then effectively a 21% rate. Admittedly, the rationale for this rate structure is not overwhelmingly obvious. But could one argue that it results in a kind of rough justice that might improve things overall?

4) Changes to business interest disallowance - Code section 163(j) now applies to inbound as well as outbound interest expense. Not all of its ramifications lie in the international realm, but it might be significant in relation to inbound earnings-stripping, which might (depending on the effective tax rates one favors for inbound) be a good thing.

5) Room for improvement? - We pointed out that many of the most egregious flaws in GILTI and the BEAT rules could in principle be addressed legislatively. Plus, FDII might not last long and who really cares about it anyway.

Here we were trying a rotten debating trick: Rather than debate the rules as they are, which the proposition to be debated arguably placed on the table, we tried to shift our defense to the rules as they might hypothetically become.

But then again our opponents had their own rotten debating trick, which we tried to call them on, while hoping they wouldn't call us on ours. (Needless to say, this was all done on both sides entirely in good humor, and I am using the word "rotten" with tongue firmly in cheek.) They spent part of their time comparing the actual effects of the 2017 tax act's international provisions to the proponents' stated intent, which made their case (even) stronger than if they had been comparing present law to prior law, with all of its defects.

But perhaps it was more rotten still that they also powerfully addressed the comparison that the debate proposition actually called for! I have to say, listening to them I was glad I didn't have a vote, as they might conceivably have gotten it.

Friday, April 12, 2019

Issues posed by Senator Warren's Real Corporate Profits Tax

Here is a list of some of the main issues that I see as being posed by Senator Warren's Real Corporate Profits Tax (RCPT) proposal:

1) How high should the overall effective corporate tax rate be? - Adopting the proposal, against the steady state background of current US. corporate income tax law, would affect the overall effective U.S. tax rate faced by companies subject to the tax. Included in this are the effective tax rate on U.S. companies' foreign source income (outbound), and on foreign corporations investing in the U.S. (inbound, insofar as the provision applies to them). These aspects are of course distinguishable from each other, at least in principle.

Broadly speaking, any overall effective tax rate on any of these aspects could be accomplished with or without the RCPT.  (Of course, exactly who and what will pay how much inevitably depends on the mix that is employed between the existing corporate tax and the new proposed instrument.) But while the pure structural question is simply what use to make of each instrument, given one's overall target effective rates, in practice, and at least in the short run, adopting the RCPT would result in particular levels for everything given the background set of institutions.

2) Big companies versus small companies - With its zero bracket up to a given amount ($100 million of profits in the current proposal), this introduces a kind of rate graduation to the corporate tax. It's often agreed that the corporate tax rate ought to have a flat rate, since marginal utility isn't really an issue at the entity level (it pertains to individuals, who can own stock in either large or small companies). But there are a couple of rationales for having a higher tax rate for very large companies. One is that they are likely to be better at tax avoidance than small companies, so this might tend to level the playing field, albeit via the imposition of a somewhat arbitrary line. A second is that these companies might tend to have more rents and monopoly power than the smaller companies, justifying a higher tax rate (although, again, the sieve being used is imperfect) on efficiency grounds.

3) Public companies versus private companies - The RCPT's application to non-publicly traded companies is limited by the zero bracket. But for private companies that are big enough to be subject to it - and might one need consolidation rules to ensure that commonly controlled siblings are treated as the same company? - reported profits can still be given a coherent meaning, but may be significantly less of a constraint than it is for public companies with managerial agency costs.

4) Managerial incentives issue - Clearly one of the proposal's main virtues is what I called its metaphorically "Madisonian" character in my Georgetown Law Review piece on taxable income and financial accounting income. Madison wanted to set one distortionary interest against another in order to prevent the polity's being captured by any of them. Here, it's different incentives of the same people: the corporate managers who want to lower taxable income while raising financial accounting income. They face an internal contradiction in accomplishing all their aims, rather than being set against someone else, but in an optimistic view the benignity of the result might be the same.

But it's certainly not the ideal to have financial accounting decisions affect tax liability. It's a second-best kind of argument that one is making here, and  there are certainly settings in which managerial incentives might be worse given the proposal than without it.

5) Political incentives issue - One of the RCPT's virtues is its taking part of the effective corporate tax base out of Congress's direct control - if Congress is willing to let things stay like that! But obviously the concern is that it will either start monkeying with financial accounting itself, or that it will start enacting RCPT exceptions from treating financial accounting income as taxable. The former risks harm to the information that public capital markets use, and the latter risks unwinding the RCPT, much as the corporate alternative minimum tax enacted in 1986 (partly based on the hope that it would lack the tax preferences in the regular corporate tax base) unwound as exceptions to it were enacted. It's fundamentally hard to overcome our having a flawed political system in which public understanding and accountability are so low, and in which interest group politics frequently drives the bus.

6) Integration between the systems - I'm glad that the RCPT is simply an add-on tax rather than a minimum tax (like the corporate AMT, or the BEAT in international tax). Minimum taxes tend to create unneeded complications that aren't worth the candle. But one could argue against my view that a minimum tax structure would tend to level the playing field so far as big companies paying different regular tax effective rates was concerned.

7) Other structural issues within the RCPT - As I noted in my prior post on the topic, there is the question of how to treat companies with fluctuating reported profits. Even apart from the issue of reported losses in one year and profits in another, what about "wasting" space in the zero bracket because one falls short of it some years while going above in others? There are doubtless more structural issues lurking here as well.

To repeat where I stand, I consider the RCPT a very interesting proposal that is potentially worth adopting, except we don't really know for sure just yet (and of course we'll never know with high confidence, other than perhaps if it is adopted and we get to observe its trajectory). Hopefully it will be debated by thoughtful people over the next year-plus, with the effect of improving our understanding of whether to do it, and if so how.

Thursday, April 11, 2019

Note to all the Howard Schultz types out there

Sometimes bipartisan legislative ideas can be despicable. A case in point is the provision in the Taxpayer First Act that, as ProPublica explains here, would "make it illegal for the IRS to create its own online system of tax filing. Companies like Intuit, the maker of TurboTax, and H&R Block have lobbied for years to block the IRS from creating such a system. If the tax agency created its own program, which would be similar to programs other developed countries have, it would threaten the industry's profits."

It's true that the IRS is still, to say the least, not very computer-savvy. (But this is largely Congress's fault for underfunding it, whatever internal institutional issues may have contributed negatively as well.)  But it's not true that a well-designed program would, e.g., undermine taxpayer confidentiality. The idea would be to create pre-populated tax returns based on information that the IRS already has, and that taxpayers could modify as needed.

And if the companies believe that taxpayers have good reason to pay for an independent service, rather than using a free pre-populated return from the IRS, let them do what businesses that have a worthwhile product usually do: that is, offer to sell it. Suppressing a free alternative that the nation's taxpayers have already effectively paid for amounts to making them pay for the same thing twice: first as taxpayers, and then again as Intuit customers.

Senator Warren's "Real Corporate Profits Tax" proposal

Senator Elizabeth Warren has unveiled a proposal for what she calls the Real Corporate Profits Tax, the initial details of which can be found here. Basically, it's a second tax system - but not an alternative minimum tax - that applies to companies (currently about 1,200 in number) that report more than $100 million in profits for a given year. The Real Corporate Profits Tax would impose tax, at a 7 percent rate, on financial accounting profits - such as those reported under GAAP by public companies - to the extent in excess of $100 million.

As Senator Warren notes, recently "Amazon reported more than $10 billion in profits and paid zero federal corporate income taxes. Occidental Petroleum reported $4.1 billion in profits and paid zero federal corporate income taxes." Under her plan, "Amazon would pay $698 million in taxes instead of paying zero. And Occidental Petroleum would pay $280 million in taxes instead of paying zero."

Such disparities between the income and accounting measures are multicausal. Sometimes there are just timing swings between years. Also, the income tax allows net operating losses (whereby loss years can offset the tax due in gain years), as in the case where a company loses $10 billion in Year 1 and makes $10 billion in Year 2. The financial accounting measure is for worldwide income, including that earned abroad through foreign subsidiaries. But also, the managers of publicly traded companies notoriously, at least in some cases, engage in complicated maneuvers to raise financial accounting income while lowering taxable income. The latter is likely to be in the shareholders' interest but not necessarily the country's. The former serves managerial goals but is potentially harmful to the aims of financial accounting, which is supposed to provide the capital markets with reliable information.

I gather that the proposal may also attempt to discern and tax inbound, U.S. source profits by foreign corporations, as measured for financial accounting purposes, and subject them to the tax as well.

I have long thought that the interplay between corporate managers' sub-optimal incentives - i.e., to inflate financial accounting income and unduly reduce taxable income (such as through aggressive tax avoidance transactions) - creates a potentially fruitful opportunity for the U.S. federal income tax system to graze two birds with one stone. If managers have difficulty doing both at the same time - e.g., if raising financial accounting income has adverse tax consequences for them - it's possible that the overall incentives that they face will be improved. It's true that this creates pressures on financial accounting choices that, all else equal, would be undesirable. But financial accounting experts who make this point - and they tend, in my experience, to hate proposals of this kind! - need to consider as well the fact that this bias may potentially offset an opposite bias that they know quite well is there.

In sum, while financial accounting is not inherently well-designed as an income tax base, its use in a very secondary fashion, a la the Warren proposal with its 7% rate (I might prefer 5%) and its $100 million exemption amount (which I'd consider increasing), has the virtue of offsetting existing imperfections in both systems. One danger, however, is that having tax consequences depend on financial accounting would cause interest groups, through Congress, to bring their dark arts more to bear than they have already on distorting how financial accounting income is measured.

I discuss these sorts of issues in this article, the final version of which appeared (here, but possibly behind a paywall for some readers?) in the Georgetown Law Journal.

One issue to think about in relation to the Real Corporate Profits Tax is the equivalent of income averaging. E.g., what should be the result if a company has, say, $80 million of reported profits in Year 1, $200 million in Year 2, and $80 million in Year 3. Should the company just pay $7 million (i.e., 7% of the excess over $100 million) in Year 2? Should there be an adjustment in Year 2 for Year 1? In Year 3 for Year 2?

People in the Warren campaign asked me what I thought about the proposal, and I replied as follows:

"This is a serious proposal that has a lot of merit, and that deserves further debate. It addresses several problems at once – in particular: (1) the excessive size of the unfunded corporate tax cut that Congress enacted in 2017, (2) possible under-taxation of both outbound investment by U.S. firms and inbound investment by foreign firms, and (3) the socially undesirable incentive that public companies’ managers have to overstate their companies’ book earnings.

"It also has the potential to raise revenue from the upper tier of the corporate sector without putting Congress even further into the business of picking winners and losers as between industries, and without magnifying the importance of existing distortions in the corporate tax base."

Trump tax returns discussion on Ari Melber's The Beat this past Monday

Earlier this week, I was briefly on Ari Melber's The Beat, on MSNBC, to discuss the Trump tax return kerfuffle. The only clip from it that appears to have been posted online is here.

Wednesday, April 10, 2019

Tax policy colloquium, week 11: Steve Bank's "Manufacturing Tax Populism: Revisiting the 1962 Campaign Against Dividend and Interest Withholding"

Yesterday at the colloquium, Steve Bank of UCLA Law School (a former Chicago student of mine, way back in the day) presented a tax history paper concerning an interesting episode in modern U.S. tax law: the failed effort by the Kennedy Administration, as part of what became the 1962 tax act, to enact withholding for people’s dividend and interest income, in response to substantial under-reporting. The effort failed due to unexpectedly intense opposition from members of the general public whom the banks successfully riled up and organized into what was apparently a genuine, not merely Astroturf, grass roots opposition movement. Faced with this level of unusual public upset, Congress settled for expanding information reporting, although it would be some time before the IRS would have the ability to make much use of this resource (which nonetheless over time led to increased compliance).

The article isn’t posted because it’s an early draft. It will be a chapter in a larger book concerning a U.S. change in social norms towards greater respectability and acceptance for aggressive tax avoidance behavior. One might view this as a likely consequence of the income tax’s becoming a “mass tax” rather than just a “class tax” on the rich, during World War II. But the change in norms was lagged and perhaps related to broader cultural trends, such as the Vietnam / Watergate / inflation decade-plus of gloom that looks sunny now by our standards, along with the Republican-led shift in political norms starting with Reagan.

Case studies like this don’t need policy payoffs to be interesting – I find them so for their own sake. But three topics in particular struck me as of particular interest here, from the standpoint of conducting a tax policy seminar.

1.         TAX POLITICS
The 1962 “rebellion” against dividend and interest withholding mainly took the form of a flood of letters, postcards, phone calls, et al to Congress, complaining about the dividend and interest withholding proposal. The banks (along with dividend-paying public companies) hated the proposal, at least in part because they would need to incur the costs of administering it, and perhaps also because it helped them attract customers if non-reporting meant that they were in effect offering people tax-free income. Their efforts to get customers, depositors, shareholders, etc. to protest bore fruit to an extent that possibly startled them, and that showed the proposal was touching a nerve (albeit augmented by deliberate misinformation that the banks were happy to spread).

The 1962 act was mainly tax cut legislation, with the investment tax credit as a centerpiece. Its main “populist” feature – a term the paper uses, and that I’ll further discuss below – was a proposed sharp cutback on deductibility for business meals and entertainment. That effort, by the way, in my view largely failed. Congress enacted a new Code provision, section 274, shot through with provisions limiting business meal and entertainment deductibility, but JFK had proposed outright repeal for a lot of the stuff, and instead Congress just put in a bunch of toothless rules about its not being “lavish and extravagant,” and being “directly related” or some such thing to the pursuit of a particular business deal. (Probably the most efficacious new provision was one requiring greater substantiation of these sorts of expenses, rather than allowing them to be estimated.)

Well yes, it's true that JFK said “the three martini lunch must pass from the scene,” or some such thing, and that indeed it has, but I think we can agree that the causation was otherwise.

Anyway, back to dividend and interest withholding. It was a partial pay-for, meant to reduce the overall cost of the act by increasing compliance (rather than enacting a new tax of any sort). It would have had a flat 20% withholding rate, meaning that rich people would still owe more and some at the low end would need to file income tax returns so they could claim refunds. But the resistance to it was “populist,” in the sense that it took the form of: Why is the Administration going after us, mere pikers when it comes to tax avoidance or evasion, when so many rich people and big corporations are getting away with murder? Go after them first, if you’re going after anyone!

Since Congress backed off – albeit, expanding information reporting rather than doing nothing – this is a rare case in which members of the general public affected political outcomes. But it involved the main such vein in which the public does at times influence legislative outcomes. (Let’s note, of course, the point, that the people who protested here weren’t “the public” in the sense of everyone – they were a particular group, albeit one outside the usual corridors of influence.)

To put this outcome in perspective, it’s useful to consider recent political science research about the question of whose preferences affect U.S. political outcomes. A 2014 paper by Martin Gilens and Benjamin Page has a neat chart showing the effects on the probability of a policy’s being adopted changes as support for it rises among (a) average citizens, (b) economic elites, and (c) organized interest groups.

For (a), the general public, the line is flat – rising public support for a proposal from 0 towards 100% has almost no effect whatsoever on the likelihood of adoption. Well-known recent examples would include, e.g., the preference even among Republican voters for increasing taxation of the rich, and the public’s support for addressing climate change.

By contrast, rising support for a proposal by either economic elites or interest groups has a very sharp upward-sloping effect on the likelihood of policy adoption.

Of course, we knew this already. So why was something like interest and dividend withholding in the 1962 act different?

This is by no means a unique episode. Consider, for example, public opposition to Treasury proposals some decades later to (a) require contemporaneous “auto logs,” documenting people’s claims to have used their cars for business, and (b) crack down on people’s making personal use of frequent flyer miles that had been earned through deductible or reimbursed travel. There are plenty of other examples as well from recent decades.

In each of the above three cases, the outrage was generated by policymakers’ efforts to change the status quo on the ground by collecting taxes that were legally due but not being paid. And in each case the proposal would have imposed compliance burdens, in addition to requiring people to pay more than they had become used to paying. Each time this stimulated defensive pushback, focusing both on the compliance burden and on the “unfairness” of targeting decent and hardworking regular folks, etc.

The lesson that I’d derive from this for policymakers, if I were advising them on how to get what they want without arousing general public opposition, could be called “Don’t wake the sleeping baby.” You can do whatever you like in the next room while the baby is sleeping, as long as you don’t start banging gongs (or whatever) in a manner that will rouse it from its slumbers. Changing settled practice and imposing confusing and anxiety-creating compliance burdens is a good example of unduly banging gongs.

But most of the time the baby sleeps quite soundly. Consider the DC legislative process since Trump took office. The public has had very little influence on any of it, with one exception – the attempted repeal of the ACA. That indeed roused public pushback that, by the barest of margins, led to the effort’s failure. (Several Republican Senators were uneasy about voting to take away health insurance from millions of their own voters, but even so the thing nearly happened.)

The public had next to no discernible impact on the passage or content of the 2017 tax act. That was an inside-the-Beltway process on both sides. Probably the most widely noted provision was reducing state and local tax deductions, which may have helped lose a few blue state Republicans their seats the next year. But that was a narrow yet salient adverse change (its effect perhaps overestimated by voters who were previously subject to the alternative minimum tax), and of course recently we’ve seen news about how people can’t tell apart the 2017 act’s actual impact on their liabilities from its apparent impact, the latter being based on what refunds they get, net of changes to withholding.

2.         TAX POPULISM
The paper views the 1962 outcome as to dividend and interest withholding an example of “tax populism,” because discontent so focused on the issue: Why go after us, when the rich and big corporations are getting away with so much more than we are?

BTW, the rich certainly were “getting away” with a lot in those days, in the sense that there was a 91% statutory rate that almost no one was actually paying. There has been a shift since then towards lowering the statutory rate but also requiring that rate to be closer than it was in 1962 to the actual effective rate. In effect, the regime then was: We’ll have very high rates as a kind of public statement, but we’ll tolerate all sorts of devices, a great many of them unambiguously legal, to avoid actually imposing those rates.

But is this “tax populism”? Two particular thoughts on this topic:

(a) If this is populism, it’s very limited and pretextual – People aren’t saying: “Go after tax avoidance by the rich!” They’re saying: “Don’t go after us UNTIL you’ve done that first!” But this is unaccompanied by any strong appetite for actually doing the latter.

Strange as it may seem today, that era’s closest Democratic Party equivalent to, say, Elizabeth Warren or Bernie Sanders today was the Minnesota senator Hubert Humphrey. Among the era’s most progressive mainstream politicians on racial justice issues, Humphrey had long been waiving the era’s more truly “populist” banner for what was then called tax reform. He wanted to attack the era’s income tax preferences that, say, favored the oil industry, or kept effective rate for high-income individuals so far below the top statutory rates.

(As an aside, “tax reform” then meant base-broadening so that the rich and corporations would pay more. In the 1980s, it came to mean instead revenue-neutral and distribution-neutral base-broadening plus rate cuts. In the 2010s, it came to mean absolutely nothing at all.)

Anyway, my sense is that Humphrey never got much mileage out of this tax and other left-populism, either personally or politically. Tax reform in its first manifestation never got too far, in part because the sleeping baby really didn’t care much after all. The scaling back of the 1962 effort to address three martini lunches et al then taught the same lesson.

As for Humphrey himself, JFK famously crushed him in the 1960 West Virginia Democratic primary, being handsomer and far better funded. After that Humphrey, in what sadly became his slavering desperation for the presidency, first became Lyndon Johnson’s abused and widely mocked pro-Vietnam War toady, and then tried a nails-scratching-the-blackboard lurch to the right in 1972 that still got him nowhere. It was a sad ending to a career that had featured earlier moral high points.

Anyway, the point so far as 1962 dividend and interest withholding is concerned is that the public, or such of it as could be roused to harry Congress, might have in principle favored taxing the rich more, but was more than willing to settle for just being left alone itself. Or at least, left alone so far as ways that it would notice were concerned. The expansion of interest and dividend withholding arguably means that, at least over time, riled opponents of the withholding proposal fell well short of getting to preserve the status quo (for many) of significantly under-reporting interest and dividend income.

(b) What is “populism”? – This is a larger and richer subject than I can hope to address here. And there is no single answer, across times and places or even perhaps in a single given time and place. Trump and Elizabeth Warren, for example, have both been called populists, and they do not have a whole lot in common.

But at a very general level, I’d call populism a tool used by one elite against another elite in the effort to call in outside support as they struggle against each other for desired outcomes. Note that elites need not be economic – they can also be social, political, administrative, technological, etc. If you aren’t a member of some elite or other, then you aren’t in the political game to begin with.

Recall the 2012 presidential election. Romney was attacked by the Democrats as epitomizing the out-of-touch business elite (car elevators, firing acquired businesses’ employees when at Bain, etc). Obama was attacked by the Republicans as epitomizing some sort of global / intellectual / professional elite (didn't bowl, liked Grey Poupon mustard, etc.). The business elite on the one hand, and the professional / intellectual / academic elite on the other, have frequently been at odds for more than a century, at a minimum in both the US and the UK, as I show in my forthcoming book DANGEROUS GRANDIOSITY: LITERARY PERSPECTIVES ON HIGH-END INEQUALITY THROUGH THE FIRST GILDED AGE. [Still awaiting a contract to publish, though I’ve had nibbles.] Now, I would say that the super-rich / business elite is the true elite, the one with real power that might reasonably lead to resentment, but then again I’m biased by my own affiliations on the other side of this divide.

Okay, but what about the 1962 political fight that Bank’s chapter documents and discusses? It was reprised, by the way, in 1982, when Congress actually enacted dividend and interest withholding (as part of that year’s revenue-raising TEFRA legislation), only to repeal it, in the face of similar public outcry, six months later and before it took effect.

Here I’d say, despite any seeming disparagement above of the outcry, that the public may have had a very good point. Dividend and interest withholding truly did impose burdens, and not just on the banks but on people who would have had to file for refunds. And, for behavioral economics reasons, it would likely have reduced saving by people who target-save specified amounts in distinct vehicles, and simply spend the rest of their after-tax income, for the same reason that people apparently save more through Roth IRAs than traditional IRAs, without realizing that they’re doing so, when they fail to equate taxes within the savings vehicle to those imposed outside it.

Yes, compliance was a problem, and it was perfectly reasonable for the technocrats to aim at increasing it, but they may have under-appreciated the burdens being imposed relative to working harder to make information reporting work.

Do we need interest and dividend withholding today? Probably not – compliance with respect to interest and dividends is pretty high due to information reporting.

But what about wage withholding? Well, the thing is that everyone wants that – apart from Grover Norquist types today, and Milton Friedman when he lamented having worked on its WW II era implementation.

The objections of a Friedman or a Norquist rest on the fact that people perceive their income tax burdens as smaller when they pay in small bits, and perhaps even get a refund on April 15, than if the whole thing came due then. But the taxpayers themselves want it to feel smaller. And they don’t want to have to plan for and then implement a large-scale cash withdrawal from their savings on Tax Day.

Against this background – scarcely at all applicable to dividend and interest withholding, especially given the rules for filing estimated taxes – someone who took to the campaign trail pushing the Friedman-Norquist viewpoint would likely see it fall quite flat.

Thus, consider Barry Goldwater’s 1964 presidential campaign. Should he have taken the hint from what happened in 1962 that withholding was generally unpopular, and therefore concluded that he should campaign for the repeal of wage withholding? I doubt this would have worked well for him, and his advisors surely knew that rather than overlooking an opportunity.

Bottom line (or one among others): perhaps the story told in Bank’s Manufacturing Tax Populism should be viewed as having a happy ending, in the sense that it yielded a very reasonable outcome: more information reporting, but no dividend and interest withholding. And the fact that its "success" of populism was accompanied by a more significant failure with regard to the treatment of high-end business meal and entertainment expenses, is instructive as well. (When that stuff was more efficaciously scaled back later, that was a revenue-driven, inside-the-Beltway story.)