Sunday, November 05, 2023

National Tax Association, 116th Annual Meeting

I enjoyed the National Tax Association's 116th Annual Meeting, which concluded in Denver yesterday. Due to the pandemic plus last year's hurricane threat in Miami, it was actually the first live NTA Annual Meeting since 2019 (!). This added to the pleasure this time around, as did (for me) the fact that I was awarded the Daniel M. Holland Medal for "lifetime achievement in the study of the theory and the practice of public finance."

I've posted the talk I gave at the award ceremony here. I also gave a talk about my recently posted article on medical expense deductions, and watched as my co-author, Daniel Hemel, did the honors regarding our joint work in progress, entitled Two-Level Games in International Taxation. (Not yet available for download, as we are still writing it.)

One of the more interesting presentations that I saw at NTA was one by Jim Hines, regarding an article (not yet posted in its current form) that appears to be a descendant of this one, which was then entitled "Evaluating Tax Harmonization." It's clever, ingenious, creative, and provocative - but, I believe, founded on premises that are simply wrong. That said, however, one might plausibly argue for its conclusions on very different, less "scientific," grounds.

As presented at NTA - but perhaps not to the same degree in the earlier or perhaps merely related draft that I have posted here faute de mieux - its basic premise is the following: nations that are setting their tax policies should be analogized to individuals who are making commodity choices that reflect their underlying preferences.

If you grant Jim this first step, it's all over and he wins. Since I was viewing the presentation at a conference hotel to which I had traveled from the airport, I was thinking of it in terms of one of those airport buses that you can sometimes board at, say, a resort hotel. Once you board the bus, it's done. You're going to the airport, whether you like it or not. But that doesn't mean you should board the bus to begin with.

Why (pace Jim) shouldn't we think of nations that are making policy choices in the same way that we think about individuals who are making commodity choices in a standard neoclassical economic framework? Point 1 is that, in the framework of collective choice by a given country's political actors who represent distinct interests, none of the actors has the incentive to pursue national welfare. Each is presumably pursuing her own interests or preferences or vision of national welfare. So there's a pervasive agency problem. Point 2: I think all political scientists would agree that nations' institutions for collective political choice do not generally produce the "correct" outcome in terms of their people's underlying preferences or welfare. This has been well-known for decades, if not centuries. And then Point 3: the nations themselves are not sensate. So if there are relevant "consumers" here, they are the people who reside in these nations. And not only do they not individually all share the utility functions or interests that Jim is effectively imputing to the collectivities, but they also differ in such dimensions as population. For example, the Turks and Caicos Islands' population is under 50,000, while China's exceeds 1.4 billion. (And indeed both are among the signatories of the OECD Inclusive Framework.)

So, in my view at least, the paper's basic framework is simply wrong. And, at least at the talk, I was hearing about how its analysis ostensibly reveals truths about worldwide welfare and efficiency and such things. It doesn't.

But now let's see what happens if we grant the paper's premise that nations setting, say, their corporate tax rates are like individuals making commodity choices in light of their preferences and underlying utility functions. As claimed by the paper, this does indeed lead to the firm conclusion that global tax instruments, such as the Pillar 2 global minimum tax, both (a) inefficiently reduce worldwide welfare, and (b) would need to have either very low rates (such as 4 percent) or very high ones (such as 27 percent) in order to be plausibly welfare-enhancing.

The paper very plausibly (in light of its underlying assumptions) models a given country as setting its corporate tax rate in the following way. To use my own simple notation, suppose that X% is the tax rate that it would prefer in the case of autarky. But it is subject to tax competition for mobile resources, even if countries aren't interacting strategically. Suppose then that it sets its tax rate at Y%, which is lower than X%, in light of tax competition and other countries' actual rates. 

In this scenario, there seems to be hypothetical room for collective gain, and indeed even perhaps for a Pareto improvement. Starting with just two countries, suppose that each interdependently agreed to raise its Y a bit, bringing their new Y's closer to their X's. This not only would bring each country closer to its autarkic optimum, but would be a subjective improvement even taking into account tax competition, since one's optimal Y goes up as other countries' tax rates rise.

The analysis therefore supports the view that all countries might gain if each raised its tax rate a little bit. And indeed, presumably only transaction costs and collective action problems (albeit, potentially very grave ones) stand in the way of this solution's emerging spontaneously.

But now let's turn to an actual global minimum tax like that in Pillar 2, which is set at a very intermediate 15%, rather than being very either very low or very high. Now what happens, given the heterogeneity of prior corporate rates that are presumed to reflect very heterogeneous preferences, is that some countries have to raise their rates a lot (even from 0%), while other countries don't have to raise their rates at all.

The analysis now deploys a standard, and very plausible, assumption in microeconomic rational consumer models. If I am forced to depart from my preferred choices by just a little, the welfare cost to me is likely to be very slight. By contrast, if I am forced to depart from it by a lot, the welfare cost to me is likely to be very high. Moreover, the welfare cost may grow (say) quadratically rather than just linearly. So, if the amount by which I am forced to depart from my preferred choice (say) doubles, my loss of welfare more than doubles. E.g., perhaps it quadruples.

It should now be clear why the intermediate global minimum tax rate in Pillar 2 creates so much welfare loss in the paper's model. Previously low-tax countries (again, modeled as if they were individual consumers) must accept enormous departures from setting the corporate rates that they prefer (with or without there being other low-tax countries). Meanwhile, those that already had rates of at least 15% need not change their rates at all (and indeed may now feel emboldened to increase them in the direction of X%). So the global minimum tax requires huge adverse departures from some, and no adverse departures whatsoever (and indeed, perhaps allow a small increase in welfare) for others. But with the more than linear welfare losses as one is increasingly forced away from acting as one prefers, the net welfare gain is large, compared either to doing nothing or having everyone agree to a small increase in their previous Y's.

By contrast, a global tax rate that was either very low or very high would impose either little pain on anyone, or at least some pain on everyone. (This is just the intuitive version; the paper specifically derives the alternative optimal solutions based on its model, its data, and, ahem, a second order Taylor approximation.)

Okay, so the bus is now at the airport. So, if you boarded it back at the hotel, you now must agree that Pillar 2 is terrible because the global minimum tax rate must either be very low or very high - but definitely not in the middle - in order to create overall welfare gain.

But what if you didn't board the bus to begin with, because (as I do) you rejected the basic analogy between (a) countries making collective political choices based on their politics, and (b) rational consumers making individual choices based on their preferences? Then nothing whatsoever has been convincingly demonstrated.

Still, the paper's conclusion admittedly has some intuitive force. Suppose we think that, as a general matter, the people in what we observe as low-tax countries do indeed collectively benefit (relative to alternatives) from those countries' having a low-ish rate, while those in high-tax countries collectively benefit from those countries' high-ish rates. After all, it seems clearly true that the genuinely optimal corporate tax rate (all things considered) would be higher in the US than in the Turks and Caicos Islands. After all, we're a much bigger country with more market power. So, despite all the pervasive political choice failures (at least, from an ideal standpoint) everywhere, perhaps there is some (or even a lot of) plausibility to the claim that a Pillar 2-like instrument hurts some countries a lot and others not at all. 

To be engaged in a true welfare analysis, we would still need to be looking at individuals, not collective national entities. So the above doesn't immediately translate into even a softer version of the paper's basic claims.

But one may also be intuitively inclined (despite the departure from a rigorous welfare analysis) to think of national-level actors as having moral duties to deal "fairly" with each other. E.g., suppose one subscribes to the norm of inter-nation equity. From this standpoint, one might indeed find the optimal scenario that the paper envisions more intuitively appealing than imposing large departures from preferred policies on some countries, along with no such departure at all from others. And one might conceivably object to the Pillar 2 project as something that big countries are imposing on small ones because they have greater global political power. Then one might reasonably applaud the paper's conclusions, despite rejecting its particular analysis.


Janet R. Mack said...

Congratulations on your well-deserved recognition with the Daniel M. Holland Medal at the National Tax Association's 116th Annual Meeting! Your achievement adds a personal touch to the event's significance, especially considering the challenges of the pandemic and hurricane threats. As an SA Online Exam Help USA - Online Exam Takers In The USA, your success serves as inspiration, showcasing the diverse accomplishments within academic circles. It's a testament to resilience and excellence, providing motivation for others navigating their studies in the dynamic landscape of online education.

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