NYU Tax Policy Colloquium on Manoj Viswanathan's Retheorizing Tax Progressivity, Part 2

 After the windup in my prior blogpost, here is more of the pitch concerning the paper itself, organized by its 4 main parts.

1. Why progressivity matters - Arguably, this section title should change to better tip off to readers its content and main takeaway. It argues that distribution is what matters, not "progressivity" within the contours of a tax system that is merely a subset of the broader fiscal system, and shows how the tax policy literature has moved over the decades in exactly this direction.

In earlier decades, the literature tended to discuss "ability to pay" and how it related to how progressive the tax system ought to be. For example, declining marginal utility (DMU) was understood as supporting rising absolute tax burdens as (say) one's income increased. If DMU rose fast enough, one would want average tax rates (ATRs), not just absolute tax liabilities, to rise with income, and this is how progressivity was typically defined.

As the paper notes, one problem in the "ability to pay" era was the lack of a clear basis just how fast (if at all) ATRs should rise with income. But another problem was that, as I noted in the prior blogpost, ATRs could be misleading absent a budget-neutral and indeed revenue-neutral comparison. One couldn't ignore the spending side in making informative distributional assessments.

Next in the tax policy literature, as the paper notes, came Blum and Kalven's famous early-1950s piece, The Uneasy Case for Progressive Taxation. After a whole lot of very sharp argumentation, Blum and Kalven famously conclude that the case for progressivity is best grounded in the aesthetic view that inequality is "unlovely." Viswanathan rightly notes that this presupposes focusing on overall distribution - although Blum and Kalven emphatically that one simply can't do a thing about the incidence of government spending, which instead should be treated for analytical purposes as if the revenues, rather than being used in any way, had simply been thrown into the sea.

That aspect of the Blum-Kalven analysis is now a bit dated, but mainly because the world has changed. They had in mind a bunch of tedious and unilluminating debates in the literature of the time about who benefits more from, say, police and national defense spending: the rich because they have more property to defend? The poor because the rich could hire private armies if they had to? While that point about the difficulty of allocating certain types of public goods spending remains valid, the changes in the federal budget since the early 1950s - e.g., the rise of Medicare and Medicaid - means that a lot of things on the spending side now can be meaningfully allocated.

Anyway, though, the Viswanathan paper rightly notes that Blum and Kalven are already, despite that disclaimer, moving towards a whole-budget view. Optimal tax theory (OTT), which it discusses next, then goes the rest of the way in that direction.

2. Definitional ambiguities - This very useful section of the paper includes the contribution it makes that I suspect will be best remembered: the introduction of the term "progressivity base." Defining such a thing is an application of devising vertical distributional measures more generally.

There is no one right answer to what the progressivity base for distributional assessments (including those of tax progressivity) should be. But we can see the concept at work, albeit without the name and sometimes without a clear expression of what is going or or why, in such circumstances as the following: (a) the Joint Committee on Taxation uses "expanded income" to measure the progressivity of given tax legislation, (b) NGO or other private-sector analysts use income or wealth to assess the progressivity of, say, property or consumption taxes.

If I had to list some of the more plausible progressivity base candidates, I would include at least: (a) expanded income (and at the limit Haig-Simons income, (b) wealth, (c) wealth plus the present value of expected future earnings, and (d) lifetime income including inheritance. A key issue here, of course, is the choice of time frame, e.g., snapshot versus a longer period.

Anyway, in a standard ATR computation the progressivity base supplies the denominator, and the numerator is something like taxes paid or accrued or borne economically. (Again, there are time frame issues here.) But I think the paper could call out at least one dubious entry in the field that it mentions. The Cato Institute argued recently that the 2017 tax act was progressive because poor people had a larger percentage reduction in tax liability than rich people. Thus, if a poor person's liability went down from $1 to zero (i.e., by 100%), while Jeff Bezos' liability went down by only 99.9% (e.g., from $100 million to $100,000), this would be a progressive change.

With all due respect to Cato - which not only does some good work, but indeed (on a personal note) once was kind enough to publish an article penned by me - I don't think this was their best moment. The change in my tax liability as a % of everyone's tax liability is simply not a good enough measure of a given tax enactment's effect on me - especially absent a full-budget, budget-neutral comparison - to be plausible as the numerator here. Its use in that instance smacks of trolling - as in, "we like the 2017 tax act for other reasons, but just to blow some smoke in the air we're going to use the only measure we can think of that yields the result we want." So I think it would make sense for the article to call them out on this, in the friendly hope of encouraging better work from them the next time.

3. Calculational ambiguities - The article notes that, in assessing the numerator (tax burden), it would be desirable to adjust taxes paid to reflect determinations of incidence and deadweight loss, insofar as this was sufficiently feasible.

This is a very good point, although its feasibility in particular cases will vary. But to give a simple example, showing how both the numerator and the denominator may change, suppose that $100 taxable bonds pay $10 of interest, while otherwise similar but tax-exempt $100 municipal bonds pay $8 of interest, reflecting a $2 implicit tax. I gather that the JCT, under its "expanded income" measure, would include the $8 in the denominator. In principle, however, one should at least arguably include the $2 implicit tax in the numerator, and $10 in the denominator.

What about deadweight loss? E.g., X would have earned me $10 of income and generated $2 of true surplus (i.e., doing what I needed to to earn this income would have generated disutility that I value subjectively at $8.) But because the tax on it is $3, I don't do X, and earn zero instead of $10

True, we are unlikely this sort of question in practice, due to real world measurement difficulties, but in principle it should be addressed theoretically.

In practice, all of deadweight loss, externalities, and internalities may be very important to how we think about particular tax provisions or proposals, including distributionally. The difficulty of incorporating them into an ATR measure should not lead us to forget that they are important.

Here's a real world practical case. Suppose a soda tax is borne mainly by poorer people but improves their welfare, because they reduce their consumption of unhealthy glop. The revenues will show up as regressive, the lost subjective surplus from reduced consumption won't show up, and the increased welfare if people's health improves also doesn't show up. This is important stuff to think about, whether or not we can make any progress in deciding how to use it in an ATR measure.

A further topic that the paper identifies is macroeconomic effects. For example, suppose we accepted Kevin Hassett's 2017 claim that cutting the US corporate tax rate would raise workers' incomes by an average of $6,000 per household. I personally think that this claim was wildly wrong, but if it was indeed reasonably expected to happen, and within the relevant timeframe, then of course one should consider it.

There is a further procedural issue of whether we should allow such claims to affect respectable computations, if we fear that they will be misused. But perhaps the experience of the JCT in keeping the measurement of "dynamic" revenue effects within a reasonable and respectable range, by using plausible and internally consistent models, offers a favorable precedent for allowing macro estimates to be used here as ell.

A final big issue here is timeframe. For example, if a VAT was enacted in the US, the expected current year liability effect on people with a lot of wealth would be a whole lot smaller than the effect on the present value of their expected long-term liabilities. So time frame, along with the distinction between transition and permanent effects, is an issue that requires attention and clear statement (possibly along with alternative presentations).

4. Improving progressivity assessments - Among the issues this section of the paper currently discusses is earmarking, as in the case where one has a budget-neutral enactment because it raises revenues that are linked to a particular spending use. Earmarking is a tricky subject, both because there are multiple issues raised by its political economy and other merits, and because its reality in substance may be hard to gauge. For example, Social Security payroll tax revenues are ostensibly earmarked to pay for Social Security benefits, but are they really? Suppose Congress notionally "includes" a current year Social Security surplus when deciding how big a deficit for a given year to tolerate (i.e., they look at least implicitly at the unified, not the on-budget, deficit measure). And suppose future benefit payouts turn out not to depend so much on the stated measure of the Social Security Trust Fund. Then the earmarking's degree of reality may be open to fair debate.

Another thing that this section might do is offer guidelines for real-world tax progressivity measures that are done either by the Joint Committee on Taxation and other government entities, or by NGOs such as the Tax Policy Center, Cato, and, say, the folks at Penn-Wharton should they decide to enter this area (as they are certainly qualified to do, and my apologies if I am overlooking that they have already done so). One might lay out a set of alternative best practices - e.g., you could reasonably do any or all of A, B, C, or D, but you really shouldn't do E or F - without being overly restrictive or narrowly ideological. And one might also note how underlying theoretical constructions (e.g., noting incidence and deadweight loss issues, even if they can't be measured properly) might lead, in some circumstances, to systematically different results.

Clearly, addressing all the issues that I find interesting here would take multiple papers, and they surely don't all belong in this paper. But it already offers a very welcome advance, and it would be great to see follow-up papers, whether by Viswanathan or anyone else, that push the analysis further.

NYU Tax Policy Colloquium on Manoj Viswanathan's Retheorizing Progressive Taxation, part 1

This past Tuesday at the colloquium, we discussed the above paper by Manoj Viswanathan. If I had to give a two-sentence summary / overview / elevator pitch for the paper, it would be: The notion of tax progressivity relates to things that are important, although it doesn't frame them in the best possible way. Given, however, that people are going to be discussing progressivity in any event, they ought to be clearer about how they are defining it, what underlying assumptions this presupposes, and how all that relates to the conclusions that they draw.

This is a very useful and needed project design, and one that the paper is ably carrying out. It brought to mind a similarly motivated paper that I once wrote concerning tax expenditures. The author might consider, however, pushing further by more aggressively defining and advocating "best practices" in the progressivity measurement business. That is, while a key feature of the paper is its demonstrating that there is no single "right answer" regarding how to define and measure progressivity, it could (a) say "these are some plausible approaches to particular design choices, no one of which is indisputably the best, and (b) call out blatant misuses of the concept.

I'll comment in 5 parts: a background section that I will include here, and then a response in turn to each of the paper's sections 1-4, which I will put in a follow-up (i.e., Part 2) blogpost.

Background - Tax progressivity is a measure or concept that has to do with distributional issues pertaining to inequality. To evaluate such issues, one needs to apply vertical measures of people's relative economic positions. For tax progressivity itself, this involves in particular applying what the paper very usefully calls a progressivity base.  That is, to evaluate the progressivity of, say, the federal income or a state property tax, we look at the tax burdens borne by people at different vertical levels of one's measurement framework (i.e., the progressivity base), which need not be the same as the particular system's choice of tax base.

Often, progressivity analyses are engaged in a  comparative statics exercise - that is, comparing State of the World A to State of the World B. These might differ due to the passage of time (e.g., the tax system has become either more or less progressive, reflecting legal and/or economic changes in the interim). Or the question might be how particular legislation would affect it or has done so.

Such comparative exercises work best with a fully specified counterfactual. This is especially a problem if we ask how progressive the tax system "is." (Compared, at least implicitly, to what? No tax system? No government? A uniform head tax or flat tax to pay for everything?)  But even when we are looking at, say, current law vs Proposed Set of Tax Changes XYZ, we really need a budget-neutral, or perhaps even revenue-neutral, counterfactual in order to avoid being potentially very misleading.

For example, consider the large tax cuts enacted in 2001, 2003, and 2017. They were designed to offer tax cuts at pretty much every income level. But these tax cuts were generally small at the bottom and large at the top. Given that these tax cuts would need, pretty much as a matter of basic arithmetic, to be funded eventually in some way (e.g., through higher taxes or lower spending than would have applied in their absence), do we really need to get into some of the measurement games that enliven (to put it kindly) the debate? Or is it pretty clear that people at the bottom, or their kids or grandkids, were pretty definitely losing overall, while those higher up were very likely winning?

In a budget-neutral and indeed revenue-neutral comparison, typically rising average tax rates (ATRs) as one vertically ascends are what you need for the system to be "progressive" within common nomenclature. The ATR is a fraction in which the numerator is something like tax liability or tax burden, and the denominator is the underlying distributional measure (i.e., the progressivity base).

In a non-revenue-neutral comparison, however, a focus on ATRs may prove highly misleading. Consider, for example, the fact that most of the US's peer countries have less progressive tax systems, but more progressive fiscal systems, than we do. Suppose that we became more like them, by reason of adopting a VAT and using the revenues to better fund healthcare, childcare, education, etcetera. Our tax system would now look less progressive, focusing on ATRs, but our overall fiscal system would probably now be far more progressive than it had previously been. Or at least, to put it differently, after-tax-and-spending distribution would now be less unequal than it had been before the change.

By contrast to ATRs, marginal tax rates (MTRs) are merely a technical tax design feature that would lack the distributional significance of ATRs. Thus, suppose that (in the spirit of a Mirrlees OIT model) we applied 100% MTRs at all income levels, so that all national economic production was nationalized and then paid out in uniform demogrants. This might be a very bad system, but it would NOT fail to be duly "progressive" because its MTR structure was flat!

Still, under various fairly common design features, rising MTRs may be necessary to create rising ATRs.

As a sidenote, when we speak of "progressive consumption taxes" (such as here), we typically are referring purely to the technical MTR structure. But this reflects that consumption taxes, such as those remitted by sellers, typically have a completely flat MTR structure (at least as to consumers, if not as to consumer goods). So the word "progressive" here calls attention to a distinctive design choice.

In sum, when used with proper care, progressivity assessments that are based on how ATRs change as one vertically ascends the progressivity base. But one has to do this carefully (e.g., using budget-neutral comparisons and looking at both taxes and spending), in order to address the risk of being badly misled.

New minimum tax proposal for companies' book profits

Reportedly, the Senate Democrats are nearing an agreement on a corporate minimum tax  that would apply in lieu of some things that Senator Sinema opposes, e.g., generally raising the corporate rate.

I am not entirely a fan of minimum taxes, as discussed here. But when political constraints limit what can be enacted, the best shouldn't be the enemy of the sufficiently good. I do think there's a strong case for increasing U.S. corporate tax burdens relative to where the 2017 act left them - as a new article of mine that is coming out in Tax Notes next Monday (November 1) will discuss. So let's consider the merits of doing it in the particular way that the emerging agreement envisions.

The following are the key features that were listed in a fact sheet. The items from the fact sheet are in bold, with comments of mine in regular font.

The Corporate Profits Minimum Tax would:

•   Apply to roughly 200 companies that report over $1 billion in profits - These probably include many of the leading suspects that are currently earning what look like large rents and paying low taxes. Thus limiting the tax's reach might be viewed as equivalent to imposing graduated corporate rates, which is not generally the best approach. And the exemption amount is surely above the level that one would adopt purely on administrative grounds. Setting it that high is presumably a political  constraint. (I am presuming that it is indeed an exemption amount, to avoid large "cliff" effects when one goes a dollar over the threshold.)

•   Create a 15% minimum tax on the profits that these giant companies report to shareholders - I suggested here that there may be grounds for assigning some tax liability to book income, not just the income measures devised by legislators. I have since backed off this a bit, since my friends in the accounting profession are so vehemently and almost unanimously opposed to it (although I suspect that there might be a bit of NIMBYism going on there). But in any event this is the direction in which the international tax world is moving, since politically book income nas become the fallback of choice for minimum taxes, faute de mieux. With flawed political institutions setting corporate tax bases, there is certainly a kind of second-best case for doing this. The minimum tax (as opposed to low-rate supplemental tax) design feature is one that I'd probably on balance recommend against, but again that's not to overstate the problems caused by it.

•   Preserve the value of business credits – including R&D, clean energy, and housing tax credits – and allow credits for taxes paid to foreign countries - These credits vary in their meritoriousness. I hope the foreign tax credits aren't 100% (i.e., dollar-for-dollar domestic tax reduction for foreign taxes paid, leading to a "marginal reimbursement rate" of 100%, for reasons that I wrote about, for example here. But there are already precedents (such as GILTI) for applying a less than 100% MRR, so I am hopeful that it is also the case here.

•   Include some flexibilities for companies to carry forward losses and claim a minimum tax credit against regular tax in future years - This is certainly a desirable feature, as it offsets the arbitrariness of annual accounting.

•   Raise hundreds of billions in revenue over 10 years - Again, while the details will be key, raising that sort of money from these taxpayers is indeed a direction in which I believe we should generally be going.

• Bottom line, I look forward to seeing further details, but even if some political compromises were necessary, I am hopeful that this will prove to be a meritorious proposal on balance. More to come.

The Beatles Get Back project so far

 I am enough of a fanatic to have been anticipating with great interest the Peter Jackson project regarding the Beatles' January 1969 Get Back / Let It Be sessions. The 3-part, 6-hour movie is due out late next month on Disney+ channel (for which I will need to get a month's subscription). But earlier this month the accompanying book came out, as did the expanded box set CD reissue. I've now read the former, and listened to the latter on Spotify.

Some thoughts about the project so far:

1) Although 6 hours sounds like a lot, and Peter Jackson has earned some mistrust by blowing up The Hobbit into three bloated, pompous, and tone-deaf movies, I think there's likely to be enough good material here for the thing to be of great interest, at least to fans. One of the virtues is that, as Jackson has been saying, there is a built-in dramatic structure. Part 1, the Beatles gather for the project in Twickenham Film Studios, blows up when George Harrison suddenly quits the band. But it has been hampered by their difficulty in figuring out, much less agreeing, just what sort of end product they are after. Then in Part 2, the Beatles in Apple Studios, they rebuild the project and their focus with the help of Billy Preston. Finally, in Part 3, they triumphantly take to the rooftop (and also fill out the set of finished album tracks the next day).

2) The box set CD is a bit of a disappointment because it's overly focused on the end product, i.e., the album they ended up with (plus tracks that appeared on later Beatles or solo albums). It thus misses out on the various byways that they engagingly fooled around with during the sessions - e.g., some very enjoyable versions of oldies (both their own and others'), some of the early tracks they wrote but never seriously recorded, etc. There's a couple of hours of really fun, if informal and a bit ragged, stuff that has been bootlegged but not will not be getting any official and sonically cleaned-up release.

3) The box set does perform a service by finally releasing the long-bootlegged Glyn Johns proposed Get Back album, which the Beatles rejected at the time. This torpedoed version of the project often has great charm, and is true in some ways to the spirit of the sessions. But it appears to have repeatedly missed out on including the best takes of various original songs.

4) The book with its pages of dialogue is often pretty interesting - some online reviewer compared it to an off-Broadway play. It helps that John, Paul, and George are often articulate and witty.

5) Even in Twickenham, when they are going around in circles a bit, you can see how strong the chemistry between Lennon and McCartney remained. But the tensions do appear to a degree. For example, when John is not around Paul says how odd it might seem in 50 years to learn that the group broke up because someone got mad about Yoko sitting on a speaker. And he discusses John's turning away and that there's nothing they can do about it. Meanwhile, John waits until Paul is not in the room to tell George that he should really meet with Allen Klein.

6) George is a very active and often skeptical participant in discussing the plans for the sessions. And he's a bit of a bystander when John and Paul are goofing around. But, apart from the famous (and here somewhat expanded) "I'll play whatever you want me to play" spat with Paul, he doesn't voice his frustrations, so his quitting seems to come out of nowhere.

7) It's been much-noticed that the original Let It Be movie focused on dysfunction, while the Peter Jackson version is expected to focus on how joyful the sessions often were. It seems from the book as if both versions have some validity. They're still great friends and collaborators, and the tensions are palpable at times yet usually subterranean. 

8) The audacity of the project still in some ways amazes. Here's a group that had just finished a 5-month slog through recording a 90-minute double album, at which they had experienced both the joy of playing live together again (as they had not really done in the Sgt Pepper era) and the first emergence of irreconcilable differences. The White Album had come out less than 6 weeks ago when they first showed up in Twickenham, and of course was #1 on all the charts, when they start working every day in the midwinter to accomplish at warp speed a new project that they haven't figured out for themselves (nor do they have songs ready when it starts). So they put all this extraordinary pressure and strain on themselves, partly at Paul's behest but seemingly with some buy-in from the others, because they ... Well, this part isn't 100 percent clear. As good an explanation as any is that they are mourning their lost youth, much of it spent playing together, and are trying to see if they can, yes, get it back, right here and right now.

NYU Tax Policy Colloquium on Blouin-Krull, Does Tax Planning Affect Organizational Complexity: Evidence from Check-the-Box, part 2

My prior blogpost offered background concerning check-the-box (CTB) in the international realm. It sought to explain why the adoption of CTB amounted to a partial indirect repeal of the US subpart F rules. Partial because it only undermined the rules' deterrence of foreign-to-foreign tax planning, as opposed to its continued application to the earning of net passive income abroad. Indirect because the rules were still on the books, but now one could easily avoid them through the properly implemented use of transparent / disregarded foreign entities. 

These two aspects of CTB inspire the 2 big topics in the paper that we discussed at the colloquium yesterday. The first is how CTB affected organizational complexity (e.g., from the incentive to add transparent entities to one's organizational schema in order to effectuate foreign-to-foreign tax planning that would escape subpart F). The second is how it affected US companies' worldwide and US tax liabilities with respect to foreign source income (FSI), along with their US tax liability with respect t domestic source income (DSI).

The paper is based purely on data preceding the enactment of the 2017 US tax act. Given, however, that the 2017 act retained subpart F, that should not prevent it from being highly relevant to what US companies might be doing today. To be sure, the 2017 act's tax rate change, enactment of dividend exemption, and enactment of GILTI et al might have important effects on US companies' precise marginal incentives and choices, but the basic subpart F parameters did not themselves change.

1) CTB and Organizational Complexity

     a. Empirical Evidence

 

One would expect CTB to have encouraged US companies to create more foreign affiliates, especially in tax haven countries. It should also have encouraged them to increase their foreign-to-foreign intra-group cash flows. One might also speculate that it would have decreased foreign-to-US parent cash flows pre-2017. There would be less previously taxed income that one might as well repatriate given that it has already been hit by subpart F. And, cross-crediting maneuvers responding to subpart F liability might not now as often be necessary.

The paper finds very strong correlations between the promulgation of CTB and multiple measures of organizational complexity. For example, post-CTB as compared to pre-CTB, US companies have far more foreign affiliates in far more countries - and especially in tax havens - along with longer corporate chains, more chains with 4+ tiers, and greater sales dispersion under the Herfindahl index.

While all this is consistent with concluding that CTB had the expected effects, the authors recognize that it does not necessarily establish causation. During the same period (i.e., pre- vs. post-CTB's adoption at the end of 1996), a lot of other things might have pushed in the same direction. For example: ongoing globalization, falling travel and communications cost, increased global production chains for economic as well as tax reasons, the rise of e-commerce, the big accounting firms' rising role in customized global tax planning, the rise of highly valuable IP associated with various global brands that were even friendlier to profit-shifting and the use of tax havens than "old economy" factory production, etc., etc.

In addition to its tables showing pre- vs. post-CTB aggregates, the paper contains a Figure that shows the year-by-year trend line for various parameters of organizational complexity. This one arguably doesn't look as I might have expected insofar as CTB was driving the change. It shows a fairly steady rate of increase throughout the period, with no particular inflection point for CTB's adoption at the end of 1996 (or for the enactment of section 954(c)(6) in 2005). I might have expected CTB to yield a sharper rate of increase right when it came into effect. In addition to having been hard to anticipate, as it arose as a byproduct of a Treasury project aimed mainly at domestic entity classification, it strikes me as not being super hard to exploit promptly. The measures it encourages (e.g., creating transparent entities that link tax haven jurisdictions and "real" source" jurisdictions) are not super hard either to figure out or to implement. Then again, maybe the knowledge did need time to disseminate past the most well-informed circles, plus there may have been concern that Treasury would take it back (as it tried to do, only to be scared off by the lobbyists and their Congressional friends). And also perhaps taking full advantage requires first converting more DSI into FSI, which might not be easy to do overnight. So perhaps there is an explanation (other than that CTB wasn't having large standalone effects) for the relatively smooth upward drift of complexity indicators without particular inflection points.

A couple of other tables in the paper - although likewise showing just correlation, not causality - might further support the inference that here the correlation was indeed causal. Companies that did more of the sorts of things that CTB encourages had greater tax liability reductions than their peers. In terms of explaining this intuitively, it is plausible both that (i) these changes indeed drove a significant piece of the tax liability reductions, and (ii) were sufficiently well-recognized by the firms as to support the inference that they were doing it deliberately for tax reasons once the adoption of CTB had cleared the decks of certain subpart F concerns.

    b. Normative Implications

All else equal, encouraging greater organizational complexity is surely a bad thing. It may increase deadweight loss (DWL) both by imposing various costs (e.g., filing fees, hiring various lawyers and accountants, arranging various in-house cash flows after determining their optimal amount, etc.) and by reducing the companies' transparency, which might increase agency costs.

CTB increased DWL insofar as it caused these things to be done more than previously. But it is very hard to quantify, or even estimate with any confidence, how high or low the marginal DWL would have been. So how to trade this problem off against other considerations, or merely just how much to disvalue it, is far from clear.

A further normative complexity is the following. While DWL, considered in isolation, is always bad, causing undesired tax planning to require increased DWL can possibly be preferable to the alternatives This is why, for example, economic substance rules may desirably (on balance, all else equal) impede aggressive tax sheltering that one wishes one could stop directly. Thus, suppose one believes that subpart F's discouraging effect on foreign-to-foreign tax planning was good US policy and should not have been scaled back. CTB's doing so indirectly, rather than more directly through repeal of the undermined provisions, might limit the net harm relative to the case of outright and direct repeal.

2) CTB's Effects on US and Foreign Tax Revenues

    a. Empirical Evidence

The paper finds significant declines, post-CTB, in US multinationals' worldwide effective tax rates. This decline is incremental to the effects of declining statutory rates abroad.

It also finds that US multinationals' effective worldwide tax rates on their FSI declined, not just absolutely, but also relative to that on their DSI.

And it finds a more than 50% decline in US multinationals' effective U.S. tax rates on their FSI.

Once again, the findings pertain to correlation, not causation. But here, despite similar independent contributing factors to those I noted in 1 above, it may be intuitively more plausible that CTB may have been doing a lot of the work here. At least to my mind, it simply looms larger in the universe of plausible explanations that naturally suggest themselves.

Purely as a mechanical matter, there are just 3 main ways that the US tax rate on US companies' FSI could have declined during the period. (I leave aside such further explanations as declining FSI from US companies' foreign branches, on the view that this seems unlikely to have been a quantitavely significant contributor.)

These three main mechanical explanations are (1) reduced subpart F income, (2) reduced taxable repatriations (since this is pre-2017 act), and (3) increased use of cross-crediting to reduce foreign tax liability.

Of these possibilities, (3) seems unlikely to have helped much. If anything, declining foreign tax rates seem likely to have increased its scope.

(2), reduced repatriations, is a plausible contributor. The rise of permanently reinvested earnings (PRE) that US companies pinky-swore they would never be repatriating would have tended to reduce (and to reflect reduced) repatriations. Plus the 2004 foreign dividend tax holiday is shown by several papers to have apparently reduced repatriations once it expired, due not only to the release of pent-up demand but also rising expectations that it would soon happen again. But, while reduced repatriations during the period surely is a plausible ground for the reduction in US tax liability on FSI, the amount involved may simply have been too small to yield reductions as great as those that the paper finds.

This leaves reduced subpart F income as a likely major culprit, and here it is highly plausible that CTB would have been playing a major role.

    b. Normative Implications

It is telling, although not surprising, that the paper finds reduced US tax liability on US companies' FSI once CTB comes into play. It would have been startling not to find this result.

Absent far more repatriation than was occurring, and thus far greater marginal importance for US foreign tax credit claims, there is perhaps only one plausible way that this could not have happened. That would be if, given investors' ability to escape the US tax net by not using US companies (in particular, to invest abroad), the tax burdens that the US system would have been imposing if not for the indirect partial repeal of subpart F would have been above the Laffer Curve peak.

While this by itself is probably not plausible, at least in the short run and as applied to the period under study in the paper, tougher issues are raised in a very long-term projection. Also, a set of rules that raise revenue may nonetheless be bad for national welfare, if the associated deadweight loss is great enough (also taking due account of distributional effects). So the fact that CTB did what it apparently did - that is, reduce US tax revenues from US multinationals' FSI - the broader normative debate of course continues.

There is also, however, a plausible source of revenue loss from the repeal of CTB that the paper's methodology would not have caught. That is the revenue loss from increased conversion of DSI into FSI, now that the repeal of CTB makes it easier to on-shift the reported profits from peer countries to tax havens.

Here too, of course, there are Laffer Curve / broader desirability issues that have fueled decades of international tax policy debate. This will not change any time soon, but the Blouin-Krull paper does indeed offer suggestive evidence on some of the parameters.

NYU Tax Policy Colloquium, week 6: Jennifer Blouin's Does Tax Planning Affect Organizational Complexity: Evidence from Check-the-Box: part 1

 Yesterday at the colloquium, Jennifer Blouin presented the above-titled paper (coauthored by Linda Krull). Unfortunately, I can't post a link to it here, as there are issues relating to data use permission that I hope will be cleared up soon. But the broad contours that I can discuss may nonetheless be of interest.

This blogpost will purely focus on the legal background to the paper's empirical analysis, which I will discuss in a separate blogpost, part 2, which will follow shortly.

At the end of 1996, the US Treasury issued the by now infamous check-the-box (CTB) regulations, allowing taxpayers simply to elect, for specified legal entities both in the US and abroad, whether such entities would be treated for US federal income tax purposes as corporations or flow-throughs. In the domestic realm, this was a completely uncontroversial simplification. The prior legal regime for classifying, say, limited liability companies (LLCs) under state law had grown to combine tedious burden creation with near-electivity as an effective matter, plus an almost complete lack for the government to try to police the boundary (given, for example, publicly traded partnerships were being taxed as C corporations anyway).

The tricky part that may have reflected a Treasury stumble occurred in the international realm. US companies, by checking the box "open" for specified foreign entities that had only a single owner created "hybridity" of an extremely convenient sort for foreign entities that could be used in overseas tax planning. Previously, one couldn't do this without some effort to tailor things just right, often leaving residual uncertainty about whether one would succeed in getting the desired effects. But now it was easy and automatic.

A bit of further background before noting how the hybridity worked: The main play related to subpart F, aka the US controlled foreign corporation (CFC) rules. Subpart F can make certain foreign source income (FSI) that is earned abroad by US companies' CFCs currently taxable to the US companies, via treatment as a presumed dividend back to the US parent that is then deemed to have been reinvested abroad. The subpart F income therefore ceases to be either deferred to the US parent under pre-2017 US law, or exempt subject to GILTI under 2018-and-on US law.

Conceptually speaking, subpart F has two parts. First, by taxing to the US parent the passive income (such as portfolio interest and dividends) that it has earned through its CFCs, it prevents US companies from earning such income tax-free by the simple expedient of earning it offshore (i.e., as FSI of its CFCs).

Subpart F's second part (conceptually speaking) is deterrence of profit-shifting abroad. For example, what are called the base company sales rules provide that one will have subpart F income if one, say, routes sales to one's operating CFCs in high-tax countries in such a way as to cause the taxable income to arise in a shell CFC that is located in a low-tax country. This might, for example, involve the use of transfer pricing games to ensure that the shell CFC, rather than the operating CFCs, ends up with a significant piece of the taxable profit despite its doing little or nothing. 

In effect, subpart F's second conceptual part discourages certain foreign-to-foreign tax planning. In the above scenario, for example, the taxpayer might have been using, say, a Luxembourg CFC to drain off foreign profits that would otherwise have accrued to its German, French, and UK CFCs. Such foreign tax minimization may be pointless, however, if it draws US taxes under subpart F that eliminate the worldwide tax saving. Two possible outcomes are that (a) the US company does all this anyway, saving foreign taxes but increasing its US tax liability due to subpart F, and (b) the US company decides against doing it, in which case there is no subpart F income but it is paying the higher taxes in Germany, France, and the UK that it would otherwise have avoided.

Obviously, there is a big question as to why the US would seek to deter this tax planning. We don't get the revenues, insofar as they accrue to Germany, France, or the UK rather than to us. But not all of the rationales for doing it are founded on cooperation or reciprocity or altruism. The anti-foreign-tax-planning piece of subpart F may also indirectly increase US tax revenues, by reducing the payoff to companies of replacing US source income with FSI (since the latter may be much easier to on-shift to a tax haven).

With all this in background, consider intra-group interest flows. Suppose, for example, that a Caymans affiliate of the US parent lends $$ to a German affiliate, and the latter then pays interest to the former.  This reduces the German CFC's taxes (assuming Germany allows the interest deductions despite, e.g., its thin capitalization rules), without any Caymans offset given that it's a tax haven. But it leads to subpart F income, which looks like Type 1 (passive income -> subpart F income) but is actually Type 2 (foreign tax planning triggers US tax liability, even though the group's net interest income from the transaction is zero).

And here is where we circle back to CTB. Because it treats a single-owner checked-open foreign entity as transparent (i.e., as merely a branch with no separate tax existence) for US tax purposes, US multinationals can play a fun "hybridity" game to get the best possible tax results in the above transaction. In the above example, Germany allows the interest deductions, but the US does not apply subpart F to the interest flows to the Caymans entity, because there has been no transaction. The US regards the German and Caymans affiliates as the same entity, and you can't, for tax purposes, pay interest to yourself.

In effect, CTB therefore amount to the partial indirect repeal of subpart F. What I call its "part 1" application to tax gross passive income earned abroad through CFCs remained intact. But what I call its "part 2" application to deter foreign-to-foreign tax planning was effectively repealed for all US companies that went to the trouble (and it wasn't much) of inserting transparent entities into its structure as needed to prevent subpart F from observing the cash flows that this tax planning involved.

One last bit of background on all this: In 2005, Congress enacted Code section 954(c)(6), which has always had an expiration date but has continually been extended (at present, through 2026). Without running through all the details here, this effectively replicates CTB's effective repeal of what I call part 2 of subpart F without requiring transparency of the entities that are being used to do it. But it still does require one to do the things (involving the use of entities in both tax haven and non-haven foreign jurisdictions) that subpart F would otherwise have discouraged.

Okay, back to the Blouin-Krull paper. It aims to illuminate certain effects of the adoption of CTB (and perhaps later section 954(c)(6)) in the international realm. These are of two kinds: effects on US firms' organizational complexity, and on the firms' US and worldwide tax liability with respect to their US source and foreign source income. But I will use a separate blogpost for that discussion.