Part 2 re. yesterday's NYU Tax Policy Colloquium discussing Daniel Hemel's Law and the New Dynamic Public Finance

 The immediately preceding blogpost offers part 1 of my reflections concerning the paper by Daniel Hemel that we discussed at the NYU Tax Policy Colloquium yesterday. Herewith part 2, discussing just three of the particular issues that the paper raises. (There are actually lots more, if you wish to take a look.)

Relevance of age differences; age-dependent tax rates - Whether you are looking at the same person at different life stages, or the average individuals at given age levels at a particular point in time, immense age-dependent differences become apparent. People at different ages generally differ in their average income and wealth levels (and degrees of dispersion), labor supply elasticity, and it is plausible to say utility functions. This has recently prompted a large economics literature on age-dependent taxation, including age-varying tax rates. This literature may be identified with NDPF, although much of it self-labels as OIT. Moreover, while it deals with how people change over time, to some extent the changes are predictable in advance, whereas NDPF often is focused on stochastic change.

As the Hemel paper notes, people might be expected to want more insurance via the tax system against "ability risk" in their 50s and 60s than in their 20s. Also, current labor supply elasticity is probably higher in the earlier period, given not just "gap years" and such but also schooling that aims to increase future earnings at the expense of current earnings. Then of course people tend to become more interested in retirement, and perhaps less able to earn current income or to have hopes of doing so in their future, as they enter their 60s and beyond.

There is nonetheless a widespread intuition or feeling that age-dependent tax rates are inappropriate. Their use therefore tends to congregate in particular side-realms. Examples include the earned income tax credit's being limited to people between the ages of 25 to 64, and the Social Security rule (for many years) under which benefit payouts would be reduced if one had current wages.

This topic is rich for further exploration. One area that comes to mind is income averaging, which existed in the federal income tax from 1964 to 1986 but then was generally eliminated. While the use of income averaging is not inherently age-related, those rules were designed to cover up-and-down swings in how much people earned in a given year (although, to benefit, you needed to have the low-income years first). They were intended and designed (albeit imperfectly) not to cover the case where, say, you were a currently impoverished law or medical student whose income then shot up, not due to volatility but because you had newly entered your high-wage years. But it's actually not obvious that they should be so limited.

For example, consider two individuals who enjoy the same lifetime earnings in present value. But A has expensive schooling until age 28, whereas B enters the workforce at age 22 and earns less per year but the same in PV due to the 6 extra years. Insofar as we think that lifetime income is the proper gauge, they ought to pay the same lifetime taxes in PV, but A might end up paying more due to graduated rates. Indeed, A might even be worse off in a lifetime sense if she has to backload her consumption due to the difficulty of borrowing against "great expectations." (We also have to think about the total and marginal welfare implications of A's six extra years slaving away in law or medical school rather than entering the paid workforce immediately.)

Now suppose we change the facts so that A simply postponed working, in order to have fun traveling the world, knowing that she could earn more once she started. Here it seems that she is actually better-off than B in a lifetime sense, given that in her voluntary non-working years she got to enjoy herself rather than slave away in school. But it's not clear that the possible impact of graduated rates to the concentration of the same PV earnings into future years gets us quite to the right place. 

Anyway, age-dependent taxation is bound to be part of the analysis here, however it might come out.

History-dependence in unemployment insurance (UI) and Social Security disability insurance (SSDI) - The paper also discusses certain history-dependent rules that apply in UI, SSDI, and also in such areas such as tort compensation for injury. If you lose your job or become disabled, the amount that you are entitled to collect depends on lost wages, which are discerned by looking at past wages. Therefore, if you and I both become entitled to collect UI or SSDI, or to receive tort compensation for lost wages, the one who used to earn more is presumably going to get a large payout. The paper notes that this might be viewed as peculiar since it provides what one might deem regressive payouts. For example, if A is a high-low (i.e., one with low current earnings but high past earnings), whereas B is a low-low, we might think A better-off overall, as she presumably is in a lifetime earnings sense, yet we give A more $$ than B. The paper discusses NDPF-derived reasons why this might increase the tax system's incentive compatibility (by offering a positive expected payoff, otherwise reduced by the tax system, to being high-wage in Period 1).

Focusing for convenience just on UI, I have tended to think that it makes sense as a government program despite its regressivity compared to offering all people who lose their jobs the same payoff. Suppose that people are averse to the risk of losing their jobs - and not just to being involuntarily unemployed in the current period - because it is costly to suffer a sudden and unexpected negative shock to their earnings. This might result, not just from psychological habituation to a given wage level, but also from having pre-committed to a spending path that presumed wage stability. (E.g., consider buying a home with a high mortgage or else paying a high monthly rental, and sending your kids to an expensive school.) Aversion to a downward shock would suggest buying insurance against it, but suppose that moral hazard and adverse selection prevent this insurance from being available at reasonable terms. But suppose the government can better address the adverse selection problem than private insurers would be able to. This  can create a straightforward case for the government's offering and indeed mandating the insurance on actuarially fair terms, on efficiency grounds and even without regard to distribution.

Traditional versus Roth IRAs - In a traditional IRA, you deduct the contribution and then are taxed on the distribution. By contrast, under a Roth IRA, there is neither deduction nor inclusion.

It's well-known that these two methods are present-value equivalent, assuming a fixed rate of return and constant tax rates. For example, say the money held in the IRA will exactly double during the multi-year savings period no matter how great or small it might be, and that the relevant tax rate at all times is 33.3%.

Under a traditional IRA, you contribute $150 as this costs you only $100 after-tax, and then withdraw $300 that the distributions tax reduces to $200.

Under a Roth IRA, you contribute $100, this costs you $100 after-tax, and you withdraw and keep $200.

Nonetheless, in real world scenarios the two can play out quite differently. Tax rates may change between the contribution year and the distribution year. Also, the scaled-up traditional IRA would earn a lower overall rate of return if, say, you had a special opportunity to earn more than the normal rate of return but it ran out once you had invested $100 in it. (To show why this is plausible in real world scenarios, suppose that the scaling-up issue, outside the IRA context but resulting from tax rules that operate to similar effect, would require Jeff Bezos to in effect create 1-1/2 Amazons, rather than just 1, in order to maintain his extraordinary rate of return on a nominally larger pre-tax investment.)

The Hemel paper notes that, under traditional IRAs, the tax rate when one contributes is often higher than that when one receives distributions, reflecting retirement's downward influence on one's marginal tax rate. Certain NDPF-style considerations suggest that this is effectively backwards. This therefore might suggest policymakers' favoring Roth over traditional IRAs, all else equal.

Hemel has also offered interesting arguments elsewhere that there are distinct grounds for policymakers to prefer Roth to traditional IRAs. Here, for example, he notes that management firms such as Black Rock may prefer the traditional structure, because they get to earn a fee on the scaled-up assets under management. In effect, they are charging the government their standard fee for earning the $$ that it will claim when the funds are distributed, but we might be highly skeptical that paying this fee is worth it economically to the government in terms of ultimately enhanced returns to it.

I read this portion of the article against the background of a prior view that Roth IRAs are often worse from a policy standpoint for two reasons. The first is that, in Bezos-type cases, taxpayers earn scarce extra-normal returns through Roth IRAs that result in their avoiding any tax on the rents (whereas they would have to pay tax on the rents under a traditional IRA structure). The second is that fixed-period (such as 10-year) Congressional budget rules cause Roths unduly to look cheaper for the government than traditional IRAs, because the revenue loss (from excluding distributions) is largely pushed outside the estimating period.

Without purporting to resolve the traditional versus Roth issue based on any one issue alone, I would note that, at least in principle (and subject to policy change risk for rules that have a deferred application), one need not base the traditional IRA deduction and inclusion rules on the taxpayer's contemporaneous marginal tax rate. Suppose, for example, that one wanted a net positive tax but was concerned that taxpayers' marginal tax rates would decline between the two periods due to retirement. Then one could mandate, say, a 20% credit for the contribution and a 30% tax on the distribution - or, for that matter, equal percentage credits if one wanted the PV of the net tax to be zero. In short, the question of when one provides partial reimbursement (such as via deductions), and when one imposes positive tax liability (such as via the inclusion of distributions) is not indissolubly tied to the taxpayer's income tax MTR in the relevant year. Subject again to the question of political risk, this actually might leave one with more scope than otherwise to apply NDPF-style analysis to the question of how the overall set of transactions ought to be taxed.

NYU Tax Policy Colloquium, week 4: Daniel Hemel's Law and the New Dynamic Public Finance, Part 1

 Yesterday at the colloquium, Daniel Hemel presented the above-named article. We have now settled into our every-other-week, hybrid format, and numerous friends from outside NYC dropped by via Zoom, although most of them didn't stay all the way through. I hope the audio is good enough that they can hear speakers from around the room during the discussion, although they can't see them on the video feed. I probably wouldn't stay all the way through under those conditions either, but it would certainly be great to hear from them if they have comments.

Anyway, on to the paper. My thoughts about the issues it raises can be grouped into two main headings: how tax lawyers should or do use economic theory, and particular issues discussed in the paper. While Part 1 appears directly below, I will reserve Part 2 for a separate blog entry.

1) Lawyers and Economic Theory

The paper focuses on the existence of a new(ish) economic literature out there, commonly called the New Dynamic Public Finance (NDPF), that has been flourishing for a couple of decades in the economics journals, while almost never being cited in the law reviews. (Okay, the one prominent exception to this, as it notes up front, is Daniel Shaviro, "Beyond the Pro-Consumption Tax Consensus," 60 Stanford Law Review 745 (2007).)

The paper's central message is that tax (and other) lawyers with academic or policy interests should read and use the NDPF literature, although it is not super user-friendly in form (e.g., highly technical models with lots of math), due to the important insights they can derive from it.

But here is an alternative framing of the same central message: In evaluating tax and other legal policy issues, it's important to think about such things as:

1) the fact that people's opportunities to earn $$ in the market can change unpredictability,

2) the effects that people's expectations regarding future government policy can have on their  behavior, and

3) the information that policymakers can derive from the year-to-year details of people's earnings flows, consumption, and saving or dissaving.

The NDPF framing is catchier and more salient. However, its effect on a legal audience's reception of the message may be complicated by a widely-known (if little-discussed) sociological fact about the tax policy world: that is, the fact, that economists as a group have more prestige within it than lawyers as a group.

By reason of this fact, lawyers who are eager to emulate economists at all costs will be excited to hear about this literature. But from others, such as lawyers who are uneasy or insecure about the economists' reign, it might provoke hostility or resistance. These folks might therefore miss the intellectual payoff that the article actually offers them.

With either framing, a key takeaway is that a prominent branch of the public economics literature that has deeply influenced academic tax lawyers (and perhaps policymakers) for decades - the optimal income tax (OIT) literature that was founded by James Mirrlees' classic 1971 article - has been revised or even (in its earliest forms) refuted in certain key respects, with the consequence that certain familiar conclusions that commonly are derived from it turn to be mistaken.

As a result, here is a misapprehension that prospective readers could derive from the article's chosen framing: Rather than saying: "Lawyers must follow abstruse economic models in order to better grasp important policy issues," it is actually saying: "Lawyers should free themselves from too narrowly and literalistically following economic models that inevitably are stripped-down and simplified relative to the reality that they seek to represent. Instead, they should embrace more complex and multifaceted, albeit inevitably open-ended and ambiguous, ways of thinking about various important issues."

Going back to the three points that I listed above in the alternative framing, one should not think of them as being only in the NDPF literature and nowhere else. For examples from the pre- or non-NDPF OIT literature, and/or relevant legal literature, of considering their importance, consider the following:

--In the OIT literature, there is a thread (which I associate with an article by Hal Varian) that looks at the income tax (i.e., wage tax) as offering risk insurance for under-diversified human capital, which is subject to stochastic shocks. This is the point about earnings opportunities changing unpredictably, although this branch of the OIT literature does not (to my knowledge) look at the information to be gleaned from year-to-year earnings changes, a factor that is emphasized in some NDPF literature.

--The classic time consistency problem in tax and other policy was well-known in prior literature E.g., in principle there are huge efficiency gains to be derived from encouraging people to invest, then expropriating their holdings and promising never to do it again. But this can utterly break down not, just because ex post the promise may prove less than credible, but also because ex ante people may anticipate its being done. NDPF merely adds to this a richer and more varied inquiry into how expectations regarding possible future policies might play out.

--There is a huge legal and economic tax policy literature, to which I along with many others have contributed, concerning the effects of tax deferral as creating both uncertainty and optionality, if the tax rate in the year of realization might be different from that applying today. If all of us were therefore doing NDPF without realizing it, then I am reminded of the line in Moliere about the character who is thrilled to learn that he has been speaking prose all his life.

--Again, the paper kindly cites my 2007 Stanford article that actually mentions NDPF. But, as it happens, in writing that article I had already found my way to my main conclusions before learning about NDPF, and adding it to the article's back end, from feedback at a conference where I presented an early draft.

That article sought to show, and then engage with, the point that certain simple OIT models that were in widespread use among lawyers and economists led straightforwardly, and indeed ineluctably, to the linked conclusions that (1) the tax system should employ lifetime income averaging, and (2) a consumption tax is superior to an income tax. Under these models, your welfare and marginal utility depend purely on the present value of your lifetime earnings, which, with the aid of perfect rationality and complete capital markets, you are presumed to deploy such that you choose the lifetime consumption stream that has the greatest subjective value to you (and presumably, equalized marginal utility for the last bit of consumption in each period).

In short, that article first sought to explain why an "ideal consumption tax" is such a slam-dunk intellectual winner over an "ideal income tax" within the standard OIT model's contours. But then it moved on to (a) why the model's simplifying departures from reality should not be forgotten, and (b) how a fuller and more realistic view ends up defeating the presumed takeaways (or at least their certainty) regarding both lifetime income averaging and the ostensible superiority of consumption tax over income taxation.

(BTW, this heresy drew a stern, albeit amiable, written response from two friends and colleagues in the biz, also appearing in Stanford, to the effect that I was all wrong in backing off as I did the standard OIT conclusions. I believe, although I suppose I would, that, when one looks back at 2007 from the perspective of 2021, my side of the debate comes off pretty well, and indeed has been decidedly favored by the movement of the field since then.)

Anyway, back to the point after this perhaps self-indulgent detour. In that paper, I got where I was going initially without NDPF. I focused mainly on such issues as incomplete capital markets - which impede, for example, borrowing against one's reasonable expected future earnings - and limited rationality. NDPF, when I found out about it, was icing on the cake, but I had already gotten the most of the way there without it. This arguably weighs against viewing NDPF as such as being vital to the Hemel paper's main takeaways, although it weighs in favor of viewing the 3 big issues (as noted above) that the paper foregrounds as really important.

Whatever the framing, Hemel's paper and NDPF are above all about the relevance of time. Mirrlees' classic 1971 set-up for balancing efficiency against distributional considerations in the structure of an optimal income tax expressly leaves time out. It's about policy choice in a snapshot moment where people's utility functions, capacity to earn $$ through labor supply, and labor supply elasticity are fixed. You don't develop your "ability" in that model - it's just there, as a random draw from the box - nor can you save given that there's no other period.

Subsequent work in the classic OIT tradition then added time to the framework. For example, in Atkinson-Stiglitz (as applied to present vs. future consumption) and Chamley-Judd - often both commonly cited in the income vs. consumption tax debate - time is there all right, and it plays a central analytical role. But time is effectively uniform or flat. All periods are presumptively the same; they just come one after another. Thus, long-term or even infinite-horizon present value comparisons are king.

For example, it simply may not matter when within  your lifespan given $$ were earned (except insofar as this affects present value) or when you or your heirs choose to consume it. Perfect capital markets shift $$ as needed between periods. And the infinite horizon perspective means that there is no difference between the government's being committed to pay, say, $1 today or its present value equivalent in 5,000 years.

What NDPF and similarly minded work add is what one might call differentiated, rather than flat or continuous, time.

By ignoring per-period information, classic OIT effectively throws out valuable information. This made perfect sense as it was developing, as a strategy to simplify the issues being considered so that they would be more analytically tractable at a first cut. But to stick to that model even once its insights have been developed and duly absorbed, and to rule out the sorts of issues and information that NDPF emphasizes, is to handicap oneself for no good reason. And again, it can lead to one's asserting dubious conclusions with undue self-confidence.

In sum, NDPF doesn't tell lawyers: The economists used to be saying A, B, and C, but now they're saying D, E, and F. Rather, it offers them a more complicated picture (or choice between alternative pictures) in which the issues are more interesting and indeterminate than they had seemed to be before. This may make things more challenging, but it is also liberating.

The revolving door at Treasury

Today's NYT story by Jesse Drucker and Danny Hakim, concerning the revolving door between the big accounting firms and  the Treasury Department (as well as the IRS and Capital Hill tax staffs), offers a case study in the difference between "shocking" (which it is) and "surprising" (which it isn't, to those who are familiar with how Washington works).

The people discussed in the article are generally not quite in my world, but close to it (e.g., potentially co-panelists at certain types of conferences), with whom I happen to value having cordial relations. But perhaps if those who did the sorts of things described in the article were a little more afraid of grand jury investigations and the like - although nothing improper will ever be provable - they would act with a bit more discretion. They are creating at least the appearance of impropriety, and embracing systemic, even if one chooses not to say personal, corruption.

The theory behind allowing this is that the government ostensibly benefits from getting talented and knowledgeable tax people to work for it for a few years, despite paying them far below a market salary. But it's rare to get something for nothing in this world, and the article raises the question of whether it's worth renting the technical skills and issue familiarity at the cost of outsourcing policy choices, in a classic case of regulatory capture by the directly regulated at the expense of the general public.

I have personal experience with an earlier stage of the revolving door, that struck me as less corrupt than what we see happening today. I wonder if there are any lessons to be learned from it, or if it simply reflects a prior state of the world in which current trends had not yet as fully developed.

I entered law practice in 1981. After 3 years at a DC tax specialty firm, I jumped to the Joint Committee on Taxation, despite not realizing that the process leading to the Tax Reform Act of 1986 was about to start, because I thought it would be more fun, exciting, and educational than staying in practice, which I had come to realize was probably not for me. I definitely had tax academics in mind as the next step down the road, although I don't think that I clearly saw my way there yet.

I got to know a lot of similarly junior staffers (who nonetheless had significant responsibilities, as did I) at both JCT and Treasury who had very similar profiles to mine, apart from the fact that almost none of them were similarly interested in academics. Like me, most of them planned to, and did, stay for only 3 years or so, after which they generally returned to private practice. This was mostly at law firms - accounting firms weren't as big a player back then in the tax lawyer market as they subsequently became.

But here's the thing. Most of us entered the government without really having strongly developed specialties (beyond, say, a field as general as corporate, international, or pensions) or as yet our own clients. We generally were associates, too junior to be up for partner in the next couple of years. The great majority who were not aspiring academics anticipated that, on their return to the private sector, they would go back in with partnership being at worst a year or two down the road and presumed to be on offer unless things really didn't work out. But it generally wouldn't be at the same law firm.

My own sense of things was as follows. I was definitely performing before an audience of expert tax lawyers who were evaluating me. (There was generally no reason for them to know that I planned to go into academics, rather than back into private practice.) They'd come into meet with me if I was working on something in their area and they didn't have the muscle to see someone more senior with greater clout. They were evaluating me to ask themselves such questions as: was I smart, was I technically competent, and also was I fair-minded, i.e., not too reflexively hostile. But they also didn't want a pushover (at least in the evaluative sense - obviously they would have liked  to get everything  they were asking for!), because in that case they wouldn't have respected me.

So my incentive, had I been planning to return to private practice, would have been to show them that I was the type of person they'd like on their team - not that I was already on their team.

That strikes me as a bit different than the process that Drucker and Hakim portray in their article. Why the change? I think it's partly about the growth and professionalization (in a bad sense) of the whole process, along with the rising role of the big accounting firms. But I think it's also about the seniority level of the people who are joining the government for 3-year stints. These more senior people know way more than we did upon coming in. (I knew very little, as my practice experience had focused significantly on a couple of very fun and interesting but fact-specific cases.) But we were ready, willing, and able to learn, and we generally lacked the sorts of standing commitments that our successors today, especially at the Treasury Department, evidently often have.

I think tougher anti-revolving-door rules are needed, perhaps forbidding going back too fast to the same employer (broadly defined, to cover both one's prior employer and one's clients through that employer). But I wonder if also a change in hiring practices, to focus on more junior people who are just two or three years out of law school, might help as well. Or has the world changed sufficiently to make that merely naive?

2021 NYU Tax Policy Colloquium Week 1: Brooks and Gamage on drafting a constitutional wealth tax, Part 2

 My prior post discussed the apportionment issues in the very interesting Brooks-Gamage paper that we discussed at the NYU Tax Policy Colloquium this past Tuesday. Herewith "everything else"- or rather, a few comments on just some of the many issues discussed elsewhere in the paper.

2.  SOME ISSUES DISCUSSED IN THE PAPER OTHER THAN APPORTIONMENT

What I will do here is simply summarize several of the main arguments in the paper, and then offer brief response to them.

1) The paper's "Indirect Tax Canon" - The main route that Pollock found to invalidating the US federal income tax as a "direct tax," in violation of the Constitution's requirement that direct taxes be apportioned between the states, went something like this? A property tax (or at least a real property tax) is widely agreed to be an example of a direct tax. Taxing the income from property is tantamount to taxing the property itself. Hence, an income tax that includes the income from property is really just a property tax, at least in sufficient part to allow 1895's 5 right-wing ideologues (who were 5 in number) to strike the whole thing down.

The paper agrees with the 5 right-wingers from 1895 that there is an equivalence here. Modern scholarship has similarly talked a lot about the similarity between an income tax and a wealth tax, in terms such as the following: Say I have $100 of wealth that earns $5/year. A 20% income tax on the $5 annual flow, and a 1% wealth tax on the value that reflects the present value of all expected annual flows, not only raise $1/year each (at least, under the stated facts), but are simply very similar and to a degree interchangeable.

But here's the problem: If A is the same as B, then B is also the same as A. Is any seemingly indirect tax that could be stated as a direct tax thereby forbidden without apportionment? What about the fact that, equivalently, the direct tax version could be restated as an indirect tax? Why must everything that MIGHT be put in the form of a direct tax therefore qualify as such, rather than going the other way around (which is far more supportable based on pre-Pollock precedent)? The paper therefore sets forth the Indirect Tax Canon, which holds that, whenever Congress reasonably characterizes a tax as indirect, it should be so construed, even if one could also have stated it as a direct tax. They argue that (i) the pre- and post-Pollock precedents, (ii) the apparent original purpose of the apportionment clause and the Framers' broader intention regarding empowerment of the federal tax authorities, and (iii) common sense and workability all support the proposed canon.

Comment: This makes sense to me. But I believe that the current Supreme Court has shown signs of following what I would dub the "Modified Direct Tax Canon." This holds that, whenever a tax could be formally stated as either direct or indirect, they will choose whichever characterization permits them to get the policy result they want.

The PPL case from 2013 arguably foreshadows this approach. In that case, the Supreme Court determined that a UK tax was an income tax, rather than a wealth tax, and hence could qualify for foreign tax credits when paid by US multinationals. There were dueling amicus briefs by reputable academics, both pro and con creditability, and both sides noted that the UK tax could equivalently be stated and  thought of as either one. Each then gave nuanced rationales for following one characterization rather than the other.

For Justice Thomas on behalf of the Court, this was a super-easy case. Because it COULD be an income tax (this being one of the two equivalent forms), it WAS an income tax. Why? Apparently because Justice Thomas hated the UK "Labour Government" that had enacted  the tax. I have never seen any other US court case in which the political party of a foreign government that happened to have enacted a law raising US legal issues has been so emphasized, for absolutely no discernible reason behind unstated personal animus.

The funny thing about it is that Thomas didn't hurt the Labour Government by upholding creditability. Indeed, surely it was good for them because it meant the US Treasury, rather than companies that might have ongoing business in the UK, would be bearing the tax to the extent that credits were available. But he wasn't trying to hurt the Labour Government - he was trying to express contempt for them.

I view PPL, not as precedent here, but as evidence that right wingers on the Supreme Court will use the equivalence of direct and indirect taxes in order to make sure that they can always get the result they like.

2. Pollock was a rogue case, that did not merit respect and has not received it. In addition to being clearly wrong based on prior precedent, when it was decided, it was poorly reasoned, reflected clear political bias rather than proper judicial behavior, and was confused and incoherent. I should note, the paper doesn't so much lay all this out in detail, as it has other fish to fry, as offer some supportive evidence and allow one to infer the rest.

Comment: I'll just add one thing here: a quotation from it that shows what sort of exercise it was. Here goes: "The present assault upon capital is but the beginning. It will be but the stepping stone to others, larger and more sweeping, till our political contests will become a war of the poor against the rich - a war constantly growing in intensity and bitterness. If the court sanctions ... [this tax], it will mark the hour when the sure decadence of our present government will commence."

All this for a 2%tax on income above a given threshold! 

Let me rephrase the Court's argument: "HELP! The commies are coming! The commies are coming!" This sort of rabid (and as it proved empirically false), nakedly political, exercise does not make for a precedent that one should be eager to respect.

3) Pollock has subsequently been substantially overruled, not just by subsequent cases but also bt the 16th Amendment, which authorized the income tax.

Comment: I don't have the time or space here to address this very interesting set of arguments, but a point that other tax law scholars should notice and think about pertains to the paper's view of the famous words in the 16th Amendment - income "from whatever source derived" - as not just allowing income to be defined broadly, but also as very specifically rebutting the line of argument that Pollock used to say that a tax on property income is really a property tax - because the income is "derived" from the property, hence making it a direct tax even if it initially seems to be indirect.

Although there is lots more, I think I will stop here. But a final note I will add is that, if my pessimism about the current Supreme Court is justified - if they are as lawless, willful, and politically / ideologically driven, at the expense of honest legal reasoning, as I believe - this has implications for how folks on the other side from the Court should go about things.

The rule of law is an instrument for opposing sides agreeing to regulate their political competition by agreeing to some basic rules of the game, to mutual advantage if both sufficiently comply. Even if it has always been true that both liberal and conservative justices tend to come out in favor of their own views a surprisingly high percentage of the time, when they are committed to reasonably honest and good faith legal reasoning - an aspect of the rule of law there is both a selfish detriment and a selfish benefit. The selfish detriment is that you accept that sometimes you won't be able to get the result you want, because the legal reasoning exercise couldn't reasonably get you there. The selfish benefit is that sometimes this same constraint applies to the folks on the other side. Both sides may benefit overall from the mutual constraint, which adds to predictability, limits gyrations, etcetera.

If both sides were doing this in secret, this would be a prisoner's dilemma. But since they can to a degree observe each other (ex post rationalizations notwithstanding), they can work their way to a decent equilibrium in which methods such as tit-for-tat, or the loss of respect from more neutral third-party observers, supply the motivation to act at least moderately honestly and honorably.

But what if one side simply rejects any notion of limiting themselves by plausible and good faith legal reasoning? The other side really just cannot keep on playing the same old game if they are the only ones still honoring it. That leads straight to systematic exploitation of the good actors by the bad ones. It's not sustainable if the bad actors are set in their ways.

Welcome to the United States in 2021.

2021 NYU Tax Policy Colloquium Week 1: Brooks and Gamage on drafting a constitutional wealth tax, Part 1

 This past Tuesday (on September 14), Jake Brooks and David Gamage jointly appeared at the colloquium (Gamage by Zoom) for a discussion of their paper, The Indirect Tax Canon, Apportionment, and Drafting a Constitutional Wealth Tax. 

This was the first of our seven public colloquium sessions for the year (the other 6 meetings are just with the enrolled students, and generally serve to gear us all up for the public session). It was the first time we've had a "hybrid, " live plus Zoom colloquium, although last year we were all-Zoom. I thought the hybrid aspect went decently well, although Zoom participants could only see the stage (with Jake Brooks and myself), rather than all of the speakers. I gather that the acoustics were also mainly okay, although the fact that all live participants were wearing masks surely did not help in this regard. [Footnote: I hate masks, necessary though I agree that they are.]

I look forward to our having more remote attendees in the future, including perhaps from even faraway time zones. (We had a few Zoom attendees from well outside NYC on Tuesday, although technically I think they were all in EST.)

We conducted the discussion on Tuesday in two distinct segments. The first was the paper's discussion of using apportionment to render a wealth tax constitutional after all if the Supreme Court were to hold that it was a "direct tax" and thus unconstitutional otherwise. The second topic was "everything else."

Apportionment logically comes second as a discussion topic, and indeed that is how the paper is organized. But the novelty of the paper's approach to this issue, which I think the authors would agree is its most important new contribution, supports putting it first for our purposes.

1. APPORTIONMENT

Two points have generally attracted near-consensus in the literature discussing the possible enactment of a federal wealth tax. The first is that, if  the infamous 1895 Supreme Court case, Pollock v. Farmers' Loan & Trust Co., is binding precedent, then a federal wealth tax is a "direct tax" under the Constitution, making it unconstitutional unless duly apportioned between the states. The second is that so apportioning a federal wealth tax is impossible and unacceptable, with the consequence that applying Pollock would be a death knell for such an enactment.

On the first of these two standard claims, the paper adds context and background regarding Pollock's status (well-known to the cognoscenti) as a truly rogue case by a blatantly political Supreme Court that did not care about precedent, history, or the basics of coherent legal reasoning. It also argues that Pollock has been subsequently overruled in large part, not just by subsequent cases but also (beyond just the boundaries of the income tax, they argue) by the Sixteenth Amendment. But I will return to this in Part 2 of this discussion.

More notably, the paper also rejects the second of the above claims. It argues not only that apportionment between the states has frequently been done before - albeit, not for some time - but also that it can politically, practically, and reasonably be done today, with regard to the wealth tax or even certain expansions to the income tax that the current right-wing Supreme Court might strike down.

Apportionment is a bit of an intricate thing, so a simple hypothetical may help to present clearly what we are talking about here.

Apportionment hypothetical: Suppose there are just 2 states, New York (NY) and Alabama (AL). Each has a population of 10 people. Congress enacts a 10% wealth tax on wealth above a statutory threshold, yielding the following toy example:

                        Population     People Subject to WealthTax            $$ Subject to Wealth Tax

NY                       10                                3                                                 $500

AL                        10                                2                                                 $300

Unapportioned Wealth Tax: Absent apportionment, this 10% tax on wealth above threshold would raise $50 from New York and $30 from Alabama, for a total of $80.

Apportioned Wealth Tax: If the Supreme Court held that this was a direct tax requiring apportionment, then,the two states' equal populations would mean that equal $$ had to come from each. Thus,  assuming it was still raising $80 of total revenue, both NY and AL taxpayers would need to supply $40.

Solution: The standard response would be to say: In that case, the wealth tax rate must be 8% in NY and 13.3% in AL, thus raising $40 from each. But this is assumed to be crazy. A higher tax rate in the state that, at least only counting $$ above  the threshold, is poorer??

Drawing on 19th century precedents, the paper suggests instead doing something like the following:

(a) 8% wealth tax in both jurisdictions, raising $40 in NY and $24 in AL.

(b) To make up AL's shortfall, raise an additional $16 there through, say, a federal tax on AL's real property base, using AL valuations, and perhaps exempting, say, the bottom 5 (or whatever) of AL's taxpayers, based on their personal income or wealth,

(c) What's unfair here, they argue, is not AL's taxpayers paying higher rates on something as such - given federalism, taxpayers in different states pay different net state and local tax rates all the time - but rather, AL's not getting the money from this extra $16 federal tax. This does indeed relate to the apparent reasons for the apportionment rule, which related to the feds using tax bases that applied unevenly in practice, such that some states ended up contributing excessively (in relative terms) to the common federal purse. So they say, all we need to do is give Alabama $16 (or so back), in a manner that is sufficiently independent of and unlinked to the $16 levy here that the Supreme Court will not in good faith be able to group this return of the $$ with the extra $16 levy and disregard the latter as a sham.

The solution they propose, therefore, is that Congress also enact a fiscal equalization program between states like that which countries, with federal systems, that are more civilized than the US already have. AL, as the poorer state, would be losing in a certain sense relative to NY under the apportioned wealth tax, but winning under fiscal equalization, so overall it would be doing fine. And, we should take the fiscal equalization into account in deciding whether things are fair and just, but the Supreme Court must ignore it because they have no authority in this sort of context to look at EVERYTHING in the federal fiscal system - just at the particular tax instrument that is being tested under an apportionment requirement.

This might be done by enacting the straight-up wealth tax, but with back-up provisions implementing this thing instead if the Supreme Court, as expected given its right-wing political slant, upholds the applicability of Pollock to a modern federal wealth tax. Or maybe a tricky way of doing it is to enact the back-up proposal first - and then, a week later, enact the federal wealth tax, saying that it repeals the apportioned version, but conditional on its not being itself held a direct tax. This might have formal or technical advantages under Byrd Rule angles that I don't personally know much about.

We had an interesting discussion about all this on Tuesday, which even continued to a degree by emails between some of the participants afterwards. But, for present purposes, I will settle for offering the following discrete comments. (I am hoping that this blogpost will help the paper's analysis enter the broader dialogue for consideration by lots of people outside this particular space.) Anyway, here with the comments:

1) What with the lack of an explicit link (or one at the margin) to fiscal equalization, this might still be a hard sell politically. Also, if we did fiscal equalization just right but then added this, we would in effect now be giving AL, as the poorer state, too little. But then again, the US has no explicit fiscal equalization program today (although it does of course effectively transfer $$ between states).

2) While the best shouldn't be the enemy of the good, it is possible that this proposal, as it ended up operating, would be less to the taste of wealth tax proponents than the program that they preferred. A key feature is getting the make-up revenues from people below the top threshold where the wealth tax would otherwise have exclusively applied.

3) In this example, AL is by hypothesis both the poorer state and the one that gets socked with the extra $16 under apportionment. But a state that, in a pure wealth tax, would pay "too little" and thus get hit up for extra would not necessarily win under fiscal equalization that went from richer states to poor states. Suppose Minnesota (MN) is richer than Louisiana (LA) per capital because it has more middle class folks and fewer oppressed poor. But suppose as well that LA has more super-rich people (its oppressing plutocrats), or more precisely more $$ per capital held by rich people that is subject to the wealth tax. In short, while LA is richer at the top, MN is more affluent overall. Then MN would have to pay the supplemental tax under apportionment, AND fiscal equalization transfers might be expected to flow from MN to LA.

4) The paper also discusses doing this for income tax enactments that a right-wing Supreme Court might strike down under the authority (such as it is) of Eisner v. Macomber, with its ludicrously constitutionalized realization requirement. Suppose Senator Wyden's proposal to tax people above a certain threshold on a mark-to-market basis were struck down by the current Supreme Court - as they would no doubt be slavering to do, and I note that (ever since Barrett joined the Court as right-winger #6) their reluctance to do whatever they want has certainly declined. Applying apportionment here might be trickier, as the rest of the income tax would still presumably be valid. But that is not to say that it would be impossible, e..g, based on "stacking" the income from this provision on top of everything else in the tax code in order to determine its marginal revenue yield that then needed to be equalized relative to population.

5) More on this in Part 2 (which will be a separate blog post), but a Supreme Court that was acting in bad faith, as I for one certainly believe that the current majority does, would surely find a way - or perhaps, many ways - to strike it down, simply because they don't like it. The paths they might use, if so minded, might include at least the following:

a) Despite the clear precedents in favor of amalgamating the separate pieces of a given enactment - as here, where NY pays "too much" under the wealth tax proper and AL pays "too much" under the property tax add-on - they'd look at each part separately and ruled that both, albeit in opposite directions, violated apportionment. Why would they do this? A better question might be: Why wouldn't they do this?

b) They could call the extra piece a sham given fiscal equalization, even if the offset was imprecise and the two were not actually linked at the margin,

c) They could say that the interstate competitive pressure on AL to rebate fiscal equalization $$ about equal to the extra property tax placed them under an improper constraint, analogous to the reasons for the Court's holding that states must be allowed to reject free Medicaid $$ under the ACA.

d) No matter how the residual tax to even up the pure wealth tax part worked, they could say: Sorry, but you didn't do it just right, so the whole thing is invalid! Again, why wouldn't they do this?

In my next blogpost, Part 2 on the Brooks-Gamage paper, I will address selected aspects of "everything else" in the paper apart from apportionment.

Let me just say, however, that people who are interested in the prospects for a federal wealth tax - if not this year, than under a future Congress that has not loosed the shackles of a runaway right-wing Supreme Court - should definitely read the article for themselves.