Tax policy colloquium on Dorothy Brown's "Shades of the American Dream"

Yesterday we had a lively session, terminated by the clock when it was still going strong, on Dorothy Brown's "Shades of the American Dream."

The paper argues that the income tax rules for homeowners (exclude imputed rent, allow mortgage interest and real property deductions, disallow losses on sale but also exclude most gains) unfairly disadvantage African-Americans, who take less advantage of the rules than whites. They own comparatively fewer and less valuable homes, on average have lower marginal rates for the deductions, less frequently itemize deductions, and have disallowed losses a higher proportion of the time.

Home ownership differences remain even if one adjusts for income, though this appears to be mostly because, as between average African-American and white families with the same income for a given year, the latter is likely to have greater wealth.

There is a strong pre-2008 financial collapse flavor to the article (a problem for many of us if our articles are overtaken by events while in gestation), since it treats home ownership as a good thing that ought to be encouraged. I imagine that many of the lower-income people, both white and African-American, who bought homes in the last 10 years despite being pressed financially are now sorry that they did so.

Among the main issues that I raised was tax capitalization of the tax subsidy. If homes are more expensive by the full expected value of the tax benefits, then (a) all the whites who are getting these benefits actually aren't benefiting after-tax at all, (b) adding new tax benefits that non-affluent African-Americans could claim after buying a home might simply boost the price they would have to pay, potentially making them worse off if they faced liquidity problems (e.g., the need to pay 10 or 20% of the purchase price in cash).

I noted that marginal tax rate differences (along with itemizing versus non-itemizing) could lead to clientele effects that might change the analysis. For example, if I don't itemize or am in a low tax bracket and am bidding for a home against someone who gets more marginal value for the deductions, then all else equal that person will be willing to pay a higher price than I would. Given that homes are non-fungible assets being sold in what are often thin markets, this could lead to a reduction in the consumer surplus enjoyed by lower-bracket prospective home purchasers. E.g., one loses out on a home that otherwise one could have purchased at a favorable price, or alternatively one gets the home but has to pay a bit more. I thought Dorothy should consider and emphasize this issue a bit more, but I noted that housing markets may be sufficiently segmented by income to reduce its importance. E.g., even if people in the 15% tax bracket are buying homes, they probably aren't, much of the time, bidding on the same homes in the same neighborhoods as people in the 35% bracket.

In a similar vein, Alan Auerbach discussed how expected lack of home appreciation (e.g., buying housing stock in Rochester or Detroit when the city is well-known to be in long-term economic decline) may lower the purchase price, and permit one to receive a higher annual imputed rental value relative to the price than would have been available if appreciation were expected.

I was hoping Dorothy would engage more with these arguments than she did. They strike me as not implausible and also as pretty fundamental to the validity of the claims being made.

We also discussed a bit at the session what the financial meltdown tells us about the tax rules for home ownership. I think we've learned quite a lot. For decades, tax policy types thought we knew how bad the home ownership rules are. We recognized that they encourage enormous inefficiency in the form of substituting home consumption for other consumption simply because it's tax-favored by the exclusion of imputed rent plus the allowance of deductions for items (home mortgage interest and real property taxes) that are tax-arbitraged against it.

But we didn't know the half of it. We didn't fully realize how, when you throw in exclusion of nearly all sale gains plus a strong inducement to adopt maximum leverage, the tax system contributed to the real estate bubble and financial collapse of 2008. The wreckage is strewn everywhere, from the macro-economy to financial institutions to all the individuals who bought over-priced homes they can't afford and now have to deal with the back-end mess.

It's pretty clear to me how the tax rules ought to change, but unfortunately there is zero chance of this happening. Congress wants to shower new benefits (such as the first-time homebuyer credit) on homes that will keep prices too high and prevent rational adjustment. Obviously I don't want to exert strong downward pressure on homes right now, but that's the direction in which we ought to go with sufficiently deferred effective dates to permit adjustment for existing mortgage default problems.

The first big point is that, while there may be a modest rationale for encouraging home ownership relative to rental, there is absolutely no rationale for encouraging bigger or more expensive homes. The rationale for doing anything at all relates to positive externalities, e.g., caring more about the neighborhood and about upkeep that affects neighbors, although there also are arguments the other way (e.g., reduced mobility may increase adjustment costs partly borne by others when jobs migrate). The current tax rules fail to focus on just ownership because the benefits keep rising with home value until one reaches the $1.1 million ceiling on the debt principal that gives rise to deductible interest.

Step 1 would be to greatly lower the $1.1 ceiling. Step 2, convert it to a refundable fixed-percentage credit so that marginal rate differences between prospective buyers are eliminated. (Refundability aside, this is an old proposal - it was in the 1984 Bradley-Gephardt tax reform bill, and I believe it was also in the 2005 Tax Reform Commission's recommendations.) Step 3, sever the link to leverage, by making it a fixed dollar amount for each home (or for a percentage of purchase price up to a low ceiling) without regard to home mortgage interest paid.

But this leaves one other huge problem that the financial collapse reminds us is really important. A home is both a consumer asset and an investment asset. In theory, while a decline in home value from its being used ought to be non-deductible if we don't tax imputed rent (just as you don't to deduct the purchase price of a car for personal use that you eventually sell for scrap), investment gains and losses ought in principle to be fully taxed.

Thus, suppose you buy a home in 2006 for $200,000. Ignoring for simplicity its economic depreciation due to being used, suppose you end up selling it either for $300,000 in 2007 or for $100,000 in 2009. These $100,000 swings from the original purchase price are economic returns to investment that ought to be included, in the 2007 case, and deducted in the 2009 case.

It's common wisdom among tax policy types that, in some settings, having the income tax reach risk by including gains and deducting losses is potentially irrelevant. Thus, suppose I want to place a $100,000 bet with some counter-party on whether oil prices will rise or fall this year. It might make no difference whether the system took account of this bet or not. Thus, suppose we really want to bet $100,000, but that the gain is taxable and the loss deductible at 50%. Our response to exposing the risky outcome to the tax system might be that we simply double the nominal bet, from $100,000 to $200,000, so that after-tax we end up having the bet we really wanted.

Whatever one makes of this line of argument in other settings, it's largely inapplicable to home ownership. Here the problem is that lower and middle-income homeowners have a grossly under-diversified investment portfolio given how large a share they have sunk into home equity and the fundamental difficulties of hedging or diversifying that stake. So the insurance that the tax system could provide by including gains and deducting losses, rather than being irrelevant because people can achieve optimal hedging and diversification by themselves, actually responds to a market failure or missing market (or mistake in investment strategy by millions of people).

For a long time, this seemed less important because the real estate market was rising anyway. But now we have forcefully been reminded that there is downside as well as upside risk to home prices.

Allowing losses on home sales to be deducted while gains are not taxed strikes me as a huge mistake that could encourage new real estate bubbles in the future (or at a minimum continuing over-investment in home ownership). But taxing gains and allowing losses to be deducted upon the sale of a primary residence has a lot to be said for it. Given the lock-in problem for gains (and inducement to realization for losses), one could argue for doing it, on both sides, at capital gains rather than ordinary income rates, although this would reduce the insurance provided. One also might exempt it from the capital loss limitation (and also from having other capital losses allowed against it if a gain), given that it doesn't entirely fit the rationale for the capital loss limitation, which is that, without it, people would sell all the losers while holding all the winners in their asset portfolios. Finally, although this reintroduces some undesirable non-neutrality, one could consider permitting gain rollover when the sale price is promptly reinvested in a new home - the approach that the income tax law took before 1997, when it was changed to simply exempt up to $500,000 of gain. This in turn would increase the desirability of preventing the tax-free step-up in asset basis at death.

As a final detail, Richard Epstein, in his early days as a tax scholar rather than broad-ranging libertarian, wrote a Stanford Law Review article proposing to tax home gains and allow home losses with one adjustment, to capture the personal use element. This was to have home basis decline each year by the amount of tax depreciation typically allowed for real estate, only without the depreciation actually being deducted (given the tax arbitrage against excluded rental income). This annually declining basis would then be used to compute the fully allowable gain or loss on home sale.

There you have it: what I consider a pretty sound set of proposals for taxation of home ownership. I'd enact it today but with a deferred effective date or phase-in given the huge problems we now face with bad mortgages. The fact that it has so little chance of ever being seriously considered tells us something, I think, about the state of our political system and the broader likelihood that it is able to adopt sound policies that would bode well for our economic future.

My latest book is now available

My latest book, Decoding the Corporate Tax, is now available here on the Urban Institute Press website.

Not to lay it on too thick, but the cover blurbs are as follows. From David Weisbach:

"Decoding the U.S. Corporate Tax is a concise and clearly written review of the corporate tax structure and its economic and distributional consequences. The book covers perennial issues (such as corporate integration) as well as issues raised by the recent increases in capital mobility, the interaction of the corporate tax and corporate governance, and more. Reform of the corporate tax will be central to any significant long-term reform of our tax system. Shaviro provides a roadmap."

Joel Slemrod says:

"Right out of the blocks, Decoding the U.S. Corporate Tax by Daniel Shaviro is the indispensable guide to this most complex and politically divisive tax. It addresses the key issues with sophisticated economic and legal reasoning and a keen knowledge of how the world really works, yet makes its points clearly—and often amusingly—with a minimum of jargon. Start here to understand where corporate tax policy should head in a world marked by increasing globalization and financial innovation, and where it probably will end up instead.”

Harvey Rosen says:

“Daniel Shaviro has produced a clearly written, insightful, and comprehensive discussion of the economic and legal issues surrounding corporate taxation. It is sure to become a highly valued resource for both students and researchers.”

And Kevin Hassett says:

"Daniel Shaviro is a giant in the tax community because his analysis is always novel and always convincing. He understands that to develop a smarter and more efficient code, we must fully understand the code we have and why it emerged. Yes, the tax code is a horrific and comical mess, but a mess that has often been made for practical reasons. Decoding the U.S. Corporate Tax is a priceless addition to the literature and just cause for optimism—the hard work of fixing the tax code just got a lot easier.”

One reason I wrote this book was so I could assign it to students in Tax Policy and Corporate Tax classes, as otherwise there was nothing available that concisely and clearly explains the important economic models in the area, including why they're all over the map and why (though none of their alternative assumptions fully hold) they matter. Another reason was to argue that corporate integration, though all very well in principle, probably isn't the best place to focus corporate tax reform efforts these days, for reasons that readers of the full text (and particularly the last couple of chapters) can evaluate for themselves.

You can see the introduction here and the table of contents here.

My two favorite cartoons concerning the stimulus battle

One is by David Horsey, and the other is by Ed Stein.

Tax policy colloquium on Amy Finkelstein's “EZ-Tax: Tax Salience and Tax Rates”

Last Thursday, we discussed Amy Finkelstein's very interesting above-named article, which shows that adoption of EZ-Pass appears to lead to higher tolls, as well as to reduced consumer elasticity of response to the tolls, because not paying cash at the tollbooth reduces one's awareness of the charge. Oddly, EZ-Pass users appeared to over-estimate rather than under-estimate the toll they were paying, which might seem to make the empirical response backwards, except that it's consistent with the notion that people under-measure CHANGES in the toll. Also, more from our colloquy than from the paper itself, it seems that people simply were not thinking much about the toll because they didn't have to pay it in cash - one had to prod them to get an estimate of its likely level (raising a question of whether they were really thinking in terms of the cost estimates they eventually furnished).

Tentative conclusions: hard to doubt that EZ-Pass is good for us on balance as consumers, especially since its use as voluntary. Is it good for us as voters? (A key motivation of the paper was to test the Milton Friedman idea, a la withholding, that making tax payments less salient or noticeable leads to a bigger government.) Here the problem is that political choice has so many flaws (aggregation problems, externalities, collective action) that anyone trying to say whether one more defect, in the form of reduced understanding of one specific element, makes things better or worse faces severe second-best problems. Easy to be concerned about it if one has Milton Friedman-James Buchanan type priors, in which government systematically is too big and does too much. But public choice defects apply to supplying valuable public goods in addition to everything else, so unless one has the Friedman-Buchanan prior (or, rather, settled faith) it's hard to know where EZ-Pass-type reduced salience sends us relative to the optimum.

Hypocrisy?

After complaining about ineffective stimulus or non-stimulus proposals in the House bill, the Senate has not only eliminated some of the most unambiguously effective stuff, such as $40 billion to head off state and local government spending cuts (by definition "shovel-ready") - it has also put in a $70 billion alternative minimum tax (AMT) patch for 2009.

As anyone even minimally expert on these issues already knows, that is about as ineffective a stimulus provision as one could possibly have. The money goes mainly to upper-income individuals, who are unlikely to change their consumer spending much in consequence of it.

No doubt the House will accept it, however, in exchange for genuinely stimulative spending provisions.

The only principled defense one could offer of it is that it makes the true stimulus bill smaller, arguably reducing the deficit relative to having a full-size stimulus bill plus the AMT fix to boot (since no doubt it would have been adopted anyway). I happen to think that a smaller stimulus bill is wrong on the merits despite the long-term fiscal problem. But couldn't they try to make the case directly if that's what they believe?

Sad news

This made me quite sad. I didn't know him personally, and never bought one of his fabled peelers, but he was a riotous and delightful presence at the Union Square Greenmarket, which I haunt so incessantly during the summer and fall months (mainly for fresh fruit) that I'm worried they'll start charging me rent.

AALS call for papers on property & tax law intersections

Nancy Staudt of Northwestern Law School, an old friend who happens to have been the second-ever presenter at the NYU Tax Policy Colloquium (way back in January 1996), asked me to post the following item:

CALL FOR PAPERS

The Property and Taxation Sections of the AALS are seeking to co-sponsor a half day session at the annual AALS meeting next year (January, 2010) in New Orleans. If you are working on the intersection of these two areas of law and would like to present a paper--we would love to hear from you by February 28, 2009. Specifically, please send us a working title, a brief description of your paper, and a draft if one is available.

The papers will be published in Northwestern Law School's Journal of Law and Social Policy; therefore, we will only consider unpublished pieces for possible inclusion in the AALS panels.

If you are interested, please contact Professor Carol Brown, University of North Carolina Law School (carol_brown@unc.edu) and Professor Nancy Staudt, Northwestern University Law School (n-staudt@northwestern.edu). Please be sure to include both of us on your e-mail submissions.

[END OF POSTED ITEM] One obvious example of what they might have in mind involves takings law, which (as the literature shows) implicitly raises tax policy as well as property issues because it concerns who pays for government programs under particular circumstances (with myriad incentive, distributional, and political economy effects that should be familiar to writers in both areas.)

New York Times on-line forum on Geithner's and Daschle's tax problems

I was invited today to participate in an on-line New York Times forum concerning Geithner's and Daschle's tax problems. As you can see if you go there, the participant responses had a range that would do the movie Rashomon proud, ranging from "No Moral Turpitude" to "Fundamentally Corrupt."

I myself rated what they did as pretty bad - highly self-serving "mistakes" though short of fraud - and suggested that they voluntarily pay the Treasury what in effect would be self-imposed penalties.

Glamorous 5:30 am slot

I just did a 3 or 4-minute live radio slot on KCBS out of San Francisco, concerning the alternative minimum tax (AMT) patch in the Senate stimulus bill. Time of the appearance was a humane 8:30 am here in the East Coast, but as it was 5:30 am in the broadcast area I doubt there were all that many millions of listeners.

The topic was a $70 billion, one-year indexing patch to the AMT that news articles say the House is likely to accept.

I noted that the growth of the AMT is a big problem that everyone in theory wants to deal with (although no one wants to pay for it), that whatever its merits it really isn't stimulus, and that the continual one-year patches Congress uses to "fix" the AMT are like someone buying an expensive car on financing and pretending that all he has to worry about is this month's payment.

Tax policy colloquium with Ed Kleinbard on the JCT's tax expenditures pamphlet

Yesterday we had our third session of the year, with Ed Kleinbard (Chief of Staff at the Joint Committee on Taxation) concerning the recent JCT pamphlet(s) on tax expenditure analysis.

This is a topic I've written and thought about a lot, such as in Rethinking Tax Expenditures and Fiscal Language, 57 Tax Law Review 187 (2004) (draft version available here), reworked (and shortened) as chapter 8 of my recent book Taxes, Spending, and the U.S. Government's March Toward Bankruptcy. In brief, my main points include the following:

(1) The distinction between taxes and spending is purely formal rather than economically meaningful. Hence, a tax rule can't "really" be spending, as tax expenditure analysis posits.

(2) Since, however, people mistakenly treat it as meaningful, tax expenditure analysis can improve information by addressing labeling games, the canonical illustration of which (for me) is David Bradford's joke about making the government $50 billion smaller by replacing $50 billion of military spending with the $50 billion "weapons supplier tax credit" ("WSTC") thereby causing both taxes and spending, as conventionally measured, to drop by that amount even though absolutely nothing has changed in substance. As we discussed in the session, if you look at recent legislation, the WSTC idea looks prescient rather than like a joke.

(3) In the context of a general, distributionally motivated "tax" system such as the income tax, the way to come up with a coherent framework for improving information despite the underlying fiscal language problem is to identify allocative provisions that have been stuck into this mainly (in its rationale) distributional system. E.g., no one would think that the WSTC is an aspect of adjusting relative burdens based on ability; rather, it serves to affect economic activity, i.e., by permitting the government to acquire the specified weapons.

Following our interdisciplinary philosophy at the colloquium, Alan Auerbach was the lead commentator on this law-based paper (obviously well within his expertise, of course), whereas next week I will be the lead commentator on a very interesting econometrics paper, Amy Finkelstein's EZ-Tax: Tax Salience and Tax Rates. Ed Kleinbard was, as always, a lively, delightful, and illuminating discussant, although given his current eminence at JCT I need to treat his remarks as off the record. It did seem clear, however, that there is a relationship between how the JCT proposed to revise tax expenditure analysis (links below) and my analysis, although for institutional reasons the two must and do look significantly different. This puts me in the position of being an ungrateful whelp, so to speak, if I cavil and carp at exactly how they did it, although this of course was also my duty as a commentator.

Recent JCT publications on the subject, all worth a look, include the following:

A Reconsideration of Tax Expenditure Analysis (the piece we discussed at the colloquium)

Tax Expenditures for Healthcare (using the new structure to illuminate the issues in a much contested area)

Estimates of Federal Tax Expenditures for Fiscal Years 2008-2012 (using the new approach in lieu of the hoary old one).

So far, so good?

The stimulus bill as it passed the House does, it's true, contain the rule extending carrybacks for NOLs to 5 years. As I discussed here, this is probably a bad idea on balance, although the Tax Policy Center was generous enough to give it a B.

But at least the thoroughly silly proposal to reward private equity firms for buying back their debt at a discount instead of boosting employment did not make it into the House bill.

Nor did the even sillier proposal to enact another dividend repatriation tax holiday, only 5 years after the last one. (These are supposedly one-time-only special deals, although only the exceptionally naive would ever view them as such.)

If ever there was a proven policy failure, it is the 2004 dividend repatriation tax holiday. A leading paper analyzing it concludes: "Repatriations did not lead to an increase in investment, employment, or R & D - even for the firms that lobbied for the tax holiday stating these intentions. Instead, a $1 increase in repatriations was associated with an increase of approximately $1 in payouts to shareholders."

But that arguably is all the more reason to expect its repetition. After all, if insiders don't capture the benefits from it, instead of having these benefits diffused via generally stimulative extra economic activity, why on earth would they lobby for its repetition? So the fact that Holiday 2 did not make it into the House bill arguably is a surprise.

But not to despair, if you are irredeemably cynical and thus perversely welcome news of Congress living down to your lowest expectations. There is always the chance, I suppose, that these provisions will be added later on, such as on the floor of the Senate.

My tax & accounting article comes out

The Georgetown Law Journal has now officially published my article, The Optimal Relationship Between Taxable Income and Financial Accounting Income. Here is the link, and the abstract is as follows:

The persistence of the book-tax gap, or excess of companies’ reported financial accounting income over their taxable income, suggests that accounting manipulation and tax sheltering remain significant problems, even in the aftermath of the “Enron era.” Some have therefore suggested making the United States a “one-book” country, in which the same income measure would be used for both purposes. This Article offers the first systematic exploration of the optimal relationship between the two income measures, based on the distinct purposes they serve and the significance of two distinct sets of incentive problems: those pertaining to corporate managers and those pertaining to the political decisionmakers who make the rules.

Absent these incentive problems, the two ideal measures would differ, reflecting that allocating tax burdens is not the same exercise as informing investors. The incentive problems cut in favor of uniformity, however, by supporting the creation of a “Madisonian” offset between managers’ and politicians’ twin quests for high accounting income and low taxable income. But this offset has more promise as a device to constrain managers than politicians, given the difficulty of binding Congress and the existing partial insulation of accounting rules from direct political influence. In light of the political incentive issues, pure one-book and two-book approaches may both be inferior to partial conformity, such as that which would result from generally requiring a 50% adjustment by large, publicly traded companies of taxable income towards financial accounting income.

Another tax stimulus proposal

Everett Ehrlich has written a paper on behalf of the U.S. Chamber of Commerce urging another business tax stimulus measure: permitting companies, for the next two years, to avoid paying tax when they repurchase their debts at a discount. Thus, to use his lead example, suppose a company that owes the banks a dollar gets to buy back the debt for only 75 cents. Under present law, the company would have twenty-five cents of cancellation of indebtedness income ("CODI"). The Chamber of Commerce proposal apparently would use a tax credit (though I don't know the exact mechanics - presumably based on the 35 percent corporate rate?) to negate this tax liability.

Ehrlich's paper reads like an intelligent and fair-minded effort, rather than as any sort of a hack advocacy piece. But I am skeptical on the merits. A starting point to keep in mind is that, under present law, insolvent companies avoid paying current tax on CODI. Instead, they have their tax attributes reduced - e.g., net operating losses or excess credits or basis of assets that would reduce their tax liability in future years. So apparently we are not talking about these companies, which avoid current tax anyway - unless the legislation would permit them to avoid having their tax attributes reduced, a benefit that would not give them any current cash but rather permit them to avoid taxes in future years if they continue operations and return to profitability. This doesn't sound like good stimulus, if the legislation would have this effect.

For companies that are not insolvent (or can't show it for federal income tax purposes), I find the whole thing a bit more perplexing. The scenario is that, even though are solvent, they get to repurchase their debts at a discount because of the general uncertainties in the business climate. Admittedly, it would be perverse if, absent the legislation, all that would happen is that companies headed down the drain would need to postpone their debt workouts until they were demonstrably insolvent. But how important is this scenario overall? Are desperate banks trying to settle right and left at a discount even with solvent lenders? Is the problem that the transactions effectively produce net taxable income because, while the CODI would otherwise be taxable, the bank's offsetting bad debt loss is useless in the face of an already big net operating loss?

From the stimulus standpoint, one wonders as well. A firm that uses cash on hand to pay down its debt on favorable terms doesn't use that cash for something else, such as hiring new workers. On the other hand, the bank has more cash on hand once it has sold back the debt. But is the bank more likely to lend it out again to someone who would use it productively than the debtor would have been to make such use itself absent the debt cancellation? I seem to recall all those stage 1 TARP funds simply disappearing, rather than being lent out again.

Even if one does excuse current CODI, I would hope that tax attributes are reduced, as with insolvent debtors under present law. Somehow I doubt that the proposal currently has this feature.

Certainly far from my first choice regarding how to achieve stimulus through business tax breaks - unless, as per my discussion of the NOL proposal in the previous post, it's a question of doing either this or something that's affirmatively worse.

UPDATE: More nefarious than I realized, apparently.

FURTHER UPDATE: Apparently this is all about relief for private equity firms, which are buying up their debt at a discount because they can't think of anything better to do with their cash. Just the guys who need relief & stimulus right now. They don't want taxable income, for which I can hardly blame them (I would welcome legislation exempting my salary, and would even promise to spend some of the tax savings), and they also don't want reduction of tax attributes. A proposal by Senator Baucus that would merely defer the private equity firms' tax liability is estimated to cost $26 billion over 3 years, but Senator Ensign wants to permanently forgive it. And why not. They've had a lot of stress lately.

Tax policy colloquium on Auerbach's "Understanding U.S. Corporate Tax Losses"

Yesterday, with the help of Bill Gentry (Williams College/Columbia Law School) as guest commentator, we discussed co-convener Alan Auerbach's paper (with Rosanne Altshuler & two Treasury economists), "Understanding U.S. Corporate Tax Losses." The paper analyzes a puzzle: why corporations had so many more tax losses during the relatively mild recession of 2001-02 than during the previous and otherwise comparable recession ten years earlier. At the end of the paper, the puzzle is left standing, but corpses of potential explanations that failed are strewn around the landscape. E.g., the greater losses were not caused by changes in the composition of firms, whether by age or size or industrial segment, nor were they caused by particular changes in the tax rules that may have had anomalous one-time effects on reported taxable income, e.g., the dividend tax holiday or temporary bonus depreciation. An obvious potential explanation, that divergence in C corporations' economic outcomes had increased, also bites the dust. Instead, it turns out that the key change was that companies' mean rate of return dropped, leaving more of those on the lower end of the spectrum with a return below zero (i.e., a loss).

The paper leaves us with the question of whether this reduced mean rate of return pertained just to taxable income, or instead to economic income. One way to try to get at this would be to look at financial statement income for the same period. But this would require examining a smaller universe of companies, since the data set for this paper went well beyond the publicly traded sector. Plus, the book-tax gap (ratio of book income to taxable income reported by the same companies) swung wildly all over the place in the early 2000s especially.

If the reduced mean rate of return, leading to lots of losses, pertained only to taxable income, then there is no need as a policy matter to do anything about it, except that one would want to take note of the fact that companies are apparently doing lots of tax sheltering (presumably leading to overkill when economic income is unexpectedly low). If the pattern pertains to economic income, however, the upshot would be that C corporation income appears now to vary more with the stages of the business cycle than it used to. An alternative interpretation, that the economic return to the corporate sector has dropped generally, is contradicted by the steep return to profitability in 2004. (Needless to say, results for 2008 and 2009 are likely to be gruesome.)

Steeper corporate income fluctuations, in turn, would raise the possibility that the asymmetry resulting from loss non-refundability is becoming socially costlier than previously, with the implication that perhaps it needs to be rethought (e.g., longer carrybacks, interest on NOL accounts, or the return of safe harbor leasing so companies can effectively sell their unused deductions). But that in turn may not be a big problem if the business cycle means that lots of companies promptly get the losses back from subsequent profitability, in a period when low interest rates mean that the deferral of recovery doesn't cost much in present value terms.

The sentiment in the room (mine but also others') was quite unsympathetic to the current proposal to extend the carryback period for NOLs from 2 years to 5. As per an earlier post here, for existing losses this is a one-time giveaway without favorable anticipation effects. And while rationalized as stimulus, it's a bizarre form thereof in which only companies that have been losing lots of money get federal handouts in order to increase liquidity. Mightn't it be better, if we're giving handouts to (presumably cash-constrained) businesses to promote new investment, to use a selection technique other than targeting companies that have lost money recently (or at least reported tax losses)? It's like having a prize competition, to stimulate productive activity, in which only proven losers are allowed to apply.

Another point that came out forcefully in the discussion was that NOLs are in some respects a bad way to reduce the asymmetry that otherwise results from nonrefundability. The problem is their being dribbled out over time (with a 20-year carryforward). This turns loss companies into zombies that people want to keep alive, stuffing them full of profit-making activities (if the metaphor isn't too disgusting) so that the income from those new activities won't be taxed. This can lead to significant efficiency costs if the zombies otherwise ought to be put out of their misery. Better, perhaps, to say that NOLs expire in 3 years going forward if they aren't used first, but that permissible use includes selling them to someone else who can use them in the 3-year window. That would limit the zombie problem to three years going forward. Of course, applying it to preexisting losses raises the same sort of transition problem (after-the-fact betterment of incentives) as extending the carryback period to 5 years. Plus, as a move towards effective full refundability, it raises the concern about excessive ability to make use of tax shelter losses. But the basic design seems better than what we have now, assuming it could be adjusted to be comparably generous rather than more so.

The best defense I heard of the 5-year NOL proposal was that other stimulus proposals to give business tax breaks are likely to be even worse (as well as costlier over the long run). The NOL proposal's current budgetary cost would in one respect exceed its long-term cost, given that some of the losses it permits to be used today would otherwise have been used in some future year. Better a moderately bad proposal, the argument went, than something likely to be long-term costlier and no more stimulative.

One of the best things about the session was the vigorous participation from around the room, including from numerous students in the class. I personally felt sluggish at the start (perhaps from having gone to a Knicks game the night before), but the audience promptly livened things up. Students played a big role in the discussion, even though we hadn't reviewed the paper in the morning session (as we were completing a review of basic public econ ideas). This was great to see, and if it continues we will have a great semester.

Happiest word in the English language

"Ex," when placed with a dash in front of the words "President George W. Bush."

I smiled when I saw this word today.

Matt Taibbi nails Thomas Friedman to the floor once again

To me, Friedman is so drearily unreadable that, despite subscribing to the Times plus frequently reading it on-line, I need bloggers to tell me what he actually says. Thank goodness for Matt Taibbi (print journalist but available on-line), whose review of Friedman's latest admittedly falls just a smidgen short of his all-time classic review of The World is Flat, which I linked when it came out and am happy to link once again.

First NYU Tax Policy Colloquium session

Yesterday was day 1 of the spring (can I call it that when it's 10 degrees outside?) 2009 NYU Tax Policy Colloquium. In the public afternoon session (we also meet with students in the AM), we covered my forthcoming paper, The Long-Term Fiscal Gap: Is the Main Problem Generational Inequity?

I hope it's not terrible of me to say: I really do like this paper. I've written about these issues a number of times, but am not just repeating myself - I think my understanding of them, and also my capacity to explain them crisply, has benefited from the multiple rounds. And I see the issues somewhat differently than I used to. Apart from being more pessimistic about the politics and more agnostic about the generational equity issues than I was earlier on, I think I have a fuller handle now on what the normative issues really are, how various measures might relate to them, etcetera. (Analytics are ultimately more interesting to me than the bottom line.)

Discussion at the afternoon session (from Alan Auerbach and Mihir Desai plus various members of the audience) focused on international issues that I perhaps ought to have covered more, as well as on questions of what an abrupt course change would look like, when it might happen, why it hasn't happened yet, and how much worse the current financial crisis has made it. Alan estimates that the financial crisis has worsened the existing fiscal projections by as much as 25 percent, which is more of an impact than one might have expected. Mihir considers it possible that the abrupt course change could end up having characteristics of an efficient one-time capital levy.

One important point we all agreed on, but which lots of the liberal bloggers (including Paul Krugman) appear to have a lot of trouble with, is that there is no contradiction between believing that a lot of stimulus is currently needed and that we have grave long-term fiscal problems that ought to be addressed ASAP (other than being subject to business cycle concerns). By analogy, even had the U.S. fiscal situation been really awful in December 1941, it would nonetheless have been right to conclude that we should fight an enormously costly two-front world war and seek to finance it only over the long term. The value of the war spending would have exceeded the cost even in much graver fiscal circumstances. And the same holds today for well-conceived stimulus measures that have a sufficient chance of generating the hoped-for benefits. But to say that we can and should spend, say, $800 billion or $1.4 trillion if the payoff is high enough, and thus run staggering budget deficits over the next couple of years, in no way negates the long-term problem and the need to start heading away from the cliff (rather than towards it) as soon and as smoothly as we can.

While the afternoon session had lots of familiar people and the feeling of a reunion, there's always the element of getting to know the new class. They appear to be both good students and motivated, but the chemistry of a new class can take a couple of weeks. I'm hopeful that the usual good vibe (for want of a better word) will gel (to mix the metaphors as badly as possible) in reasonably short order.

Get well soon

Ursula, the lovely little creature shown here in two views, stopped eating and drinking late last week, evidently feeling very sick, and she got severely dehydrated. We had to bring her to the veterinary hospital, where she has been getting IV fluids for the last few days. Still too early to tell if she has acute kidney disease or merely a treatable infection. We already have to give our elder statesman, Shadow, regular fluid shots under the skin (which he mainly tolerates, being extremely placid and good-tempered), but a second recipient may soon be in the offing. Before you know it we'll be operating our own veterinary clinic.

Ursula is very young for kidney disease (age 7). We adopted her from an animal shelter, thinking she was a standard brown tabby plus something-or-other mutt, but uncanny likenesses from a cat book have since persuaded us that she is probably what's called a wild Abyssinian (a breed that was created by crossing Abys with Singapore street cats). The only breed cat we've ever owned, a Somali (Aby offshoot with a mutant gene for bushy tails) died before age 2 of kidney disease. I don't know if this should put us off Abys, breeds generally, or neither.

Ursula is a moderately shy but exceptionally affectionate cat whose good opinion has to be earned (unlike Shadow, who likes everyone from the moment he meets them). Having her sick is a tough way to start the new year.

UPDATE: Ursula is back home, but the long-term prognosis remains unclear.

Out with the old, in with the new

My Tax I students from last semester will probably be glad to hear that I have submitted my grades. I am even gladder to reflect on the closely associated fact that I have finished grading their exams.

Grading exams is by far the worst part of a law prof's work - nothing else is even close. The tedium of reading 80-plus answers to the same question, one after the other, and having to keep one's critical faculties engaged enough to scribble down a reasonably fair number at the end, verges on indescribable.

This week, my classes for the spring semester begin. I'm co-teaching Tax Deals with Mihir Desai, and the Tax Policy Colloquium with Alan Auerbach. The former should be a really interesting experience, involving the Scholes-Wolfson framework and lots of actual deals brought in by leading NYC tax practitioners, although it's all coming together a bit at the last minute. The latter I am very hopeful will be good as always (from my biased perspective at least), and our paper schedule for it is as follows:

1. January 15 – Daniel Shaviro, NYU Law School. “The Long-Term Fiscal Gap: Is the Main Problem Generational Inequity?”
2. January 22 – Alan Auerbach, Berkeley Economics Department and NYU Law School. “Understanding U.S. Corporate Tax Losses.”
3. January 29 – Edward Kleinbard, Joint Committee on Taxation. “A Reconsideration of Tax Expenditure Analysis.”
4. February 5 – Amy Finkelstein, MIT Economics Department, “EZ-Tax: Tax Salience and Tax Rates.”
5. February 12 – Dorothy Brown, Emory Law School, “Shades of the American Dream.”
6. February 19 – Yoram Margalioth, Tel Aviv University Law School and NYU Law School, “Taking a Closer Look at Capital Export Neutrality.”
7. February 26 – Leslie McCall, Northwestern University Sociology Department, “American Policy Preferences in the Era of Rising Inequality.”
8. March 5 – Michael Doran, University of Virginia Law School, “Managers, Shareholders, and the Double Corporate Tax.”
9. March 12 – David Duff, University of Toronto Law School, “Tax Fairness and the Tax Mix.”
10. March 26 – Emmanuel Saez, Berkeley Economics Department. “Details Matter: The Impact of Presentation and Information on the Take-Up of Financial Incentives for Retirement Saving.”
11. April 2 – Lily Batchelder, NYU Law School.
12. April 9 – Mihir Desai, Harvard Business School and NYU Law School.
13. April 16 – Mitchell Kane, NYU Law School.
14. April 23 – Thomas Brennan, Northwestern Law School, “Certainty and Uncertainty in the Taxation of Risky Returns.”

All colloquium sessions will meet from 4-6 pm on Thursdays in Furman Hall 120 at NYU Law School. People outside NYU are welcome, although to get past the security guards they should let me know in advance by e-mail. Interested individuals can also contact me to get on our e-mail distribution list for weekly papers.

Bush economic policy post-mortems

From today's Washington Post, here are Bush's very best economic reviews, coming as they do from people on the conservative / Republican side.

From former McCain economic adviser: Doug Holtz-Eakin:

"The expansion was a continuation of the way the U.S. has grown for too long, which was a consumer-led expansion that was heavily concentrated in housing ... There was very little of the kind of saving and export-led growth that would be more sustainable ... For a group that claims it wants to be judged by history, there is no evidence on the economic policy front that that was the view," Holtz-Eakin said. "It was all Band-Aids."

From Mark Zandi, also an informal McCain adviser:

"It's sad to say, but we really went nowhere for almost ten years, after you extract the boost provided by the housing and mortgage boom. It's almost a lost economic decade."

From AEI's Kevin Hassett, who also advised the McCain campaign:

"On tax reform, I think they themselves were not very interested in it .... [T]he economy was caught up in a storm while he was president, but it wasn't his fault .... In the end, to the extent there ends up being a defense of the Bush presidency [on economic issues], that's about the best you can get."

Again, these are the relatively good reviews. The bad ones probably wouldn't be allowed in a family newspaper.

UPDATE: I should have noted that Ed Lazear, who is still working for Bush, was quoted in the Washington Post article as saying that the Administration's economic record was great except for the last quarter.

Uh, Ed - that reminds me of the guy who said about the plane that crashed after its engine failed 8,000 feet up in the air - "They were doing just great until the last second, when they hit the ground and blew up."

I once tangled with Lazear at a National Tax Association meeting, where he argued, I thought unpersuasively, that the Bush Administration's tax policy was both (a) highly progressive and (b) highly fiscally responsible. We'll let the historians sort that one out, but I don't think it will take them very long.

Health club morons

Here's the sort of thing that ruffles my otherwise sunny disposition.

My health club is always crowded in early January - the marginal attendees either are working off their holiday weight or else haven't abandoned their New Year's resolutions yet. There is a particular type of elliptical machine I favor, and 4 of the 5 were in use when I got there this morning. I was about to start using the fifth, when a woman who was standing about 8 feet away from it, talking earnestly on her cellphone (BTW, the sign in the room says "No cellphones"), came up to me and said: "I'm still on that machine."

Clearly this was not literally so. But I walked away rather than start a dispute. She lingered close to the machine for a moment, then retreated to her post 8 feet away and resumed her animated conversation. Seething a bit, I went upstairs to do something else, and when I came back down five minutes later she was gone.

Obama's proposal to extend the carryback for NOLs

I have mixed feelings about this part of Obama's proposed stimulus package. On the one hand, if not for pervasive income mismeasurement by the tax system it would be madness not to treat losses as fully refundable. Otherwise, one discourages risk-bearing (since the government in effect says "heads we win, tails you lose") and offers inefficient incentives for corporate conglomerates (so one activity's losses can be deducted against another's gains). But with pervasive income mismeasurement and tax sheltering opportunities, it's more problematic. Imagine what Enron would have done had losses been refundable.

So extending NOL carrybacks is a move towards refundability, with mixed merits, but it happens after the fact for losses that have already occurred. This takes care of the tax planning problem for losses to date, but also eliminates the significance of making planning decisions more neutral ex ante (at least for those past decisions).

Perhaps another factor to consider here is that, as discussed in Alan Auerbach's recent paper (with Rosanne Altshuler) that we will be discussing at the NYU Tax Policy Colloquium on Thursday, Jan. 22, losses at the corporate level have become more common, predating the recession and apparently reflecting an economic shift towards greater divergence in business outcomes. That presumably strengthens the case for refundability by showing that it's more of a problem.

From the standpoint of Keynesian stimulus, the issues are somewhat different. Unclear to me that handing $$ to companies that happen to have experienced big losses recently is necessarily the best way to encourage further economic activity. If they have been losing money lately, are they the ones who would invest and hire more if someone handed them money? Is being cash constrained their big problem? Are they the ones to whom handing dollars would be most stimulative? (As opposed to consumers, or else the businesses - if any exist these grim days - that actually would run out and hire & invest if only they had the cash in hand.)

I'm reminded of TARP's fiasco in handing money to banks that did not respond by lending it out again because they didn't want to lend, didn't consider it a good move in the current economic environment, as opposed to being cash-constrained or simply paralyzed by the state of their balance sheets.

So this idea is not necessarily bad policy, but it might not be especially good stimulus.

Life versus the movies

On Christmas Eve we watched the 1951 Alastair Sim version of A Christmas Carol. Scrooge as portrayed by Sim (pre-redemption) forcefully, unremittingly reminded me of Cheney. But Cheney is both far worse and utterly irredeemable.

Someone (me?) should write a satirical Christmas Carol knock-off starring Cheney. Rumsfeld as Marley? Casting or plot ideas, anyone?

For greater efficiency, eliminate the middleman

I realize I'm repeating myself from a post a couple of years ago, but wouldn't it be more efficient in baseball to eliminate the middleman (the players) by simply permitting the Yankees to purchase wins and championships directly?

E.g., it's the bottom of the 9th inning of game 162 with the Red Sox (or better yet the Rays) in new Yankee Stadium. Winner of the game makes the playoffs. Yanks trail 10-0. Joe Girardi comes out to talk with the home plate umpire, carrying a small piece of paper - a certified check.

Omigod!! The Yankees just purchased 11 runs for $55 million!! The home plate umpire (like the ref in football upon resolution of a replay challenge) announces what has happened. The Yankees win the pennant!! The fans go crazy!! What a comeback!! Greatest team ever!!

The cult of home ownership

Good article in today's Times about how the Bush Administraton helped light the fuse under the current economic meltdown by pushing universal home ownership and hence encouraging bad mortgage loans.

Needless to say, there's plenty of blame to go around. Just look at the tax code, both its decades-old features and the Clinton Administration-directed changes thereto that I noted in a recent entry here. The only thing distinctive about the Bush Administration's adding a bit more gas to the fire is the lack of fit with its ostensibly pro-market attitudes.

But I must say, I've never gotten this political cult of homeownership. True, there is some at least slight evidence of positive externalities from home ownership in some settings because people are more committed to the location. (This can have nasty playouts as well, however, e.g., more assiduous racial exclusion.) But on the other hand, investment in more economically productive assets, e.g., via stock ownership, might have positive social externalities as well. Plus, home ownership is often (usually?) a really lousy investment choice from a personal standpoint. It's wildly under-diversified, if you're not rich enough to have a home plus lots of other assets, and leveraging it creates huge downside economic risk (as we've seen).

Once the dust settles, perhaps the government should seek from now on to discourage home ownership, encouraging those who aren't enormously investment-savvy to hold more diversified asset portfolios that are much less leveraged.

What was Madoff doing?

One of the big questions about Madoff's insane scam is how he thought he would get away with it. Ponzi schemes are inherently unstable, and yet there are indications that he was running this one for decades.

I've read nothing in the media really explaining what he was up to, or why he crashed at this point, perhaps because no one knows. But I would presume the following:

1) He tried to create a Ponzi scheme that would be sustainable over a long period of time by controlling his growth rate. One reads all this stuff about how he used the exclusivity vibe and wouldn't accept just anyone's money. With the rate of return he offered, all he needed to do was grow by a little over 10 percent a year (plus whatever he was taking off the top), and perhaps he felt he could do this for a very long time by showily accepting only so much a year in new accounts. Arguably, this design and his careful and controlled execution of the growth rate made this the cleverest and best-executed Ponzi scheme ever. Perhaps with luck it could have lasted until he died at a normal age.

2) What finally brought him down now? The stock market collapse didn't do it directly, since actual asset prices verged on being irrelevant to the scheme. Presumably, the bad times dried up his new capital and caused suddenly cash-poor investors to want redemptions, leading to a run on the bank.

All this reinforces Krugman's point that Madoff's operation wasn't all that different from what the rest of Wall Street was doing. E.g., pocketing insurance premia that are simply money in the bank until you finally have to pay and can't (the story of AIG) is pretty much the same wine in a different bottle.

Perverse satisfaction?

Today's New York Times notes that a tax break for homeowners, enacted in 1997, may have contributed to the housing bubble that (coupled with pathological defects in our financial markets) did so much to bring us to our grim current economic situation.

Specifically, Congress in 1997, acting at the behest of President Clinton, provided that up to $500,000 of home appreciation would be tax-free on sale. Clinton was practicing silly but no doubt poll-tested populism, boasting that, due to the rule, middle class Americans would never again face capital gains tax on their homes.

Now let's roll the tape forward 11 years. According to the Times:

"[M]any economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.

"Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for 'fueling the mother of all housing bubbles.'

"By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one.

"Together with the other housing subsidies that had already been in the tax code — the mortgage-interest deduction chief among them — the law gave people a motive to buy more and more real estate. Lax lending standards and low interest rates then gave people the means to do so.

"Referring to the special treatment for capital gains on homes, Charles O. Rossotti, the Internal Revenue Service commissioner from 1997 to 2002, said: 'Why insist in effect that they put it in housing to get that benefit? Why not let them invest in other things that might be more productive, like stocks and bonds?'”

I happen to know a couple of people who got into the business of buying fixer-uppers, doing renovation work, and then selling for tax-free capital gain, thus achieving exemption for their labor income. There, at least, there was productive activity - but still distortion of economic choice by the tax incentive.

One further idiotic incentive effect was that, as soon as your home begins to approach $500,000 of appreciation, you have an incentive to sell it immediately and buy a new home for the current market price, so that you can run the exemption from zero all over again. Happily (?), however, that is no longer a problem in today's market.

Whenever something like this comes out about special tax breaks that don't merely create perverse incentives but seriously aggravate major economic problems, I have to admit to feeling a twinge of, well, perverse satisfaction that the rules I spend some of my time studying are at least important. Plus I duly note that the problems come from failure to heed the recommendations (e.g., for a relatively broad-based and neutral tax) that nearly 100 percent of the experts in my field would make. An unworthy sentiment, to be sure, but I'm only human.

Another big example is the role of the tax system in overly entrenching employer-provided health insurance as the dominant mode of provision, to the degree that, while few would advocate building on employer-provided insurance if we were starting fresh, many believe that at this point we need to just accept it as an entrenched feature. Thus, for example, one of the big criticisms of Senator McCain's healthcare plan was that it would have undermined employer-provided insurance without sufficiently putting something else in its place.

The home exemption story is admittedly a bit more complicated than just being a case of stupid Clinton-era populism. Prior to the 1997 enactment, people could generally roll over gain when they sold one home and bought a new one (for at least as much money) within a two-year period. Plus, gains on home sale were otherwise taxable while losses were nondeductible, creating apparent (and some actual) tax bias. The underlying problem is that a "correct" approach would have treated gains and losses symmetrically (leaving aside the issue of taxpayer choice whether or not to sell) when they resulted from market swings, while disallowing recovery only for declines in home value that resulted from home use. Richard Epstein, before he became a libertarian icon, actually wrote an article on this, suggesting that the basis of homes be reduced by depreciation (which would not, however, be deductible since it reflected personal rather than business use), with gain or loss relative to the adjusted basis being equally recognized. That is actually a pretty logical approach, within a standard income tax accounting framework, and the failure to do it, meaning that in some cases properly deductible investment losses were being disallowed, may have helped contribute to the 1997 silliness.

Still, the predominant message here remains: stupid tax breaks interacted with other defects in our economic system to help create the current horrific circumstances we face. It's happened before, and it will happen again.

That didn't take long

In 2004, Congress enacted a temporary dividends received deduction for U.S. multinationals that repatriated foreign earnings. Under the temporary DRD, the tax rate on dividends from foreign subsidiaries effectively was lowered from as high as 35 percent to just 5.25 percent, but only for dividends during a 12-month time window.

Every tax expert I know whose views on this proposal were sounded - except for those being paid to support it - thought it was a bad idea, despite the acknowledged case for permanently lowering the tax on U.S. multinationals' foreign earnings. The problem lay in the provision's being temporary, and thus creating lock-in when the rate went back up because people would anticipate and wait for the next tax holiday.

As it happened, there was an extraordinary level of response to the tax holiday, more than experts or revenue estimators had expected because it had been thought that companies with lots of perfectly legal and effective tax planning tricks might not be sufficiently worried about the repatriation tax even to pay 5.25 percent to get their earnings home for tax purposes. It's also generally thought that the claim that the repatriations would create U.S. jobs proved predictably bogus. (See Lisa M. Nadal, "Bailouts Disguised as a Tax Cut?", 121 Tax Notes 1230, 12/19/08.)

As Nadal notes, the same companies that successfully pushed for the tax holiday in 2004 are now already seeking a reprise. That didn't take long.

In an important sense, the policy here is entirely backwards even apart from its temporariness, which Nadal suggests could be rationalized this time around in terms of the ongoing liquidity crisis in the U.S. economy. (For myself, in order to accept the liquidity argument for another tax holiday, I'd need to see good evidence that it cost-effectively addresses the credit crunch despite being aimed at just a small clientele of U.S. companies that happen to have trapped foreign earnings that they want to repatriate.)

What makes the policy backwards is that the case for exemption (or a low U.S. tax rate) for foreign source earnings is strongest for new investment, not old investments that have already been made. Retroactively exempting the profits from old investment creates a transition windfall without actually changing the past anticipated incentives, which by now are water under the bridge. A temporary rate cut for dividends, unlike a permanent one, is pretty much guaranteed to apply only to old investment.

True, enacting two tax holidays in 5 years would tend, all else equal, to lower the expected future U.S. tax rate on new investment, since why couldn't the holidays just keep on happening. But counting on holidays is a distortionary and uncertain way to reap tax savings, and who knows if they'll actually keep coming as the U.S. heads out of the recession at some point (one hopes) and ever closer to the point of long-term fiscal distress.

I'm on the verge of writing a book or article on U.S. international tax policy, and one point I want to emphasize in it (akin to the same point made by "new view" skeptics concerning corporate integration) is that in theory there should probably be negative transition relief - i.e., the transition gain from escaping the expected level of tax on past outbound investment probably ought to be eliminated by a one-time tax or its equivalent. (For more on these sorts of transition issues, see my 2000 opus, if I may call it that, When Rules Change.)

But from an interest group standpoint, the bad stuff creates the strongest political pressures for a favorable change, precisely because it plays out in targeted transition gain rather than generalized improvement of incentives.

UPDATE: A reader points out that Larry Summers recently estimated at a public forum that there are $3 trillion of untaxed profits of US multinationals sitting out there abroad. A one-time transition hit on the $3 trillion, plus international tax reform (of some kind) going forward, might be an interesting idea, a few years down the road.

Cat pandering

Couldn't resist posting this shot of Buddy, a.k.a. the "bad little bunny."

Elmer Fudd wouldn't have liked him, nor Yosemite Sam nor Marvin the Martian, but we actually cherish his foibles.

Reasons to be cheerful

1) I've finally gotten to the end of a huge to-do list that's been hounding me, and frequently growing faster than I could cross things off it, since mid-July. While a new to-do list, possibly a lot worse than the last, is starting to loom and will be having its malign way with me by early January, for the moment I can't or shouldn't do most of those things yet.

2) Expanded 2-CD reissue of Pavement's Brighten the Corners. I got in the mood by spending a few days with the reissue of Wowee Zowee. So far the added material sounds pretty good.

3) Today I was hitting better on the tennis court, and my suspect elbow didn't fall off. My once-reliable forehand, no less than the elbow, has been playing nasty tricks on me lately.

4) Creative gift ideas for certain others, suitably restrained but nonetheless (I hope) thoughtful, have recently occurred to me.

5) I could be in a jury room right now if the case I was picked for hadn't settled.

Meanwhile, back at the ranch ...

Aided by my enforced downtime (with fewer time-wasting temptations) during jury duty, I have completed a draft of a short article (under 6,000 words) entitled "Internationalization of Income Measures and the U.S. Book-Tax Relationship." It is in part a highly compressed reprise of the line of analysis here (forthcoming shortly in the Georgetown Law Journal), although it also addresses the question of how cross-border convergence in defining taxable and financial income might affect the tradeoffs I identify. I anticipate its appearing some time in 2009 in a National Tax Journal forum on book-tax differences.

A brief conclusion, which probably will also serve as the abstract, goes as follows:

"Taxable income and financial accounting income are measures that use the same name but serve different purposes, leading to some differences in how they might ideally be defined. However, concern about managerial incentive problems may support integrating them, either to increase the economic accuracy of amounts reported or to reduce the resources that managers expend on reducing taxable income and increasing reported earnings. Political incentive problems, on the other hand, arguably support separating the measures, so that legislative eagerness to control the tax base need not promote politicization of accounting standards. The case for a largely one-book system may grow stronger, however, if pressures for international convergence in defining income on both the tax and accounting fronts lead to reduced politicization of both."

I'm not going to post it on SSRN just yet, but anyone interested in reading the current draft version can contact me off-line.

Jury duty

Today I showed up in Chinatown for jury duty, which I had put off twice (out of town the first time, teaching my Tax I class the second). Wouldn't you know it, I got picked for a jury. Civil trial, and I am hoping it will be very short or perhaps even settle. It's likely to an interesting episode albeit with tedious stretches, but I will begrudge the lost time. More when I am free to speak - no need to test here the rules against jurors discussing still-pending trials.

Meanwhile, I see that the Tax Deals class I will be co-teaching with Mihir Desai in the spring has seen its enrollment shoot up from zero (because initially it had not been listed in time) to 8 on Friday, to 21 at the start of today, to full capacity of 25 by the time I was being picked for that jury. Nice to see that there is live interest out there.

UPDATE (Thursday, 12/11): I am now officially off the hook, as the case settled.

Jury duty involves a whole lot of waiting around, and going to the courthouse then leaving again when they conclude that they don't need you for a while. But at least in the Manhattan New York State court (I've heard differently about the Bronx), they make extraordinary efforts to keep people in the jury pool reasonably happy. The building has wireless, carrels are available, the court personnel are gracious and polite, they try to minimize inconvenience, etcetera. Indeed, I even got a Juror Appreciation Week coffee mug. The jury pool seemed to mirror the Manhattan population, though perhaps with a slight tilt towards the affluent and professional sector. This may help explain the consistent courtesy and (up to a budget-constrained point) catering to our comforts.

On Monday afternoon, 19 of us were randomly called for a civil case that we ended up learning about in some detail from the attorneys during the voir dire. Apparently, a financial institutions executive driving a Mercedes had hit a pedestrian. The victim and plaintiff, according to the defense attorney, was a gracious and lovely woman "of a certain age," which turned out, as best I could tell when I saw her later, to mean in her mid to late 60s.

Ouch. Even though apparently there was no DUI issue, this does not sound like a case that you would want to send a jury. But of course it depends on how hard the plaintiff was pushing for disputable damages. The defense attorney spent a great deal of time during the voir dire explaining how nice and lovely the plaintiff was, and how he hoped we nonetheless could (a) understand his sad duty to impeach her on cross, and (b) retain our objectivity and award only modest damages if we were skeptical about her claims, apparently involving dental work.

Apart from the defense attorney's trying to precondition us to fight our expected pro-plaintiff sympathies, the main focus of the voir dire was on whether anyone had civil suit or car accident experiences that would make them biased. Three people claimed they would be unduly biased due to personal experiences of this kind, but all three appeared to me primarily motivated by the understandable desire to avoid being picked. Another three people appeared to have too little English language comprehension to be feasible jurors. This left 13 of us for 8 slots (6 jurors plus two alternates). The chosen ended up including not just me but another lawyer and also a doctor (who might have ended up being our go-to juror on medical testimony).

The 8 of us ended up spending Tuesday sitting in a small room, then being sent home for a few hours, then going to the courtroom and sitting around a bit more before being told that the trial would start Thursday morning. Today, we sat around for about a half hour and then were called in by the judge and told that the case had settled.

On the way out, the defense attorney greeted me as professor. I expressed surprise that I had been chosen for the jury, and he said that he, too, had been surprised that they (i.e. he and the plaintiff's attorney) had picked me.

I hope my certificate of service arrives promptly, as the feds have already sent me a juror questionnaire and thus are likely to summon me soon.

Someone's got to take out the trash

Amazing article in today's Times about Moody's.  They used to refuse any compensation from the issuers they were rating, because this would create a conflict of interest and undermine their credibility.  Then they decided to be compensated by those businesses.  Then they went public and got caught up in short-term earnings mania.  Then they started rating trash instruments as AAA, and when good customers complained about a lower rating they would raise it.  Meanwhile, they were basing projections on scenarios in which, say, there was no estimated chance that housing prices would generally decline.

One can try to explain this in a rational behavior scenario.  Greedy cashing out on the Moody's side by officers with short time horizons, collective action problem on the shareholders' and investors' sides so no one steps forward to be the one to question them seriously.  But assuming individually rational behavior that plays out like this doesn't really help the neoclassical approach, because you get to wildly socially irrational outcomes anyway.

End of the semester

I have just completed teaching my last Tax I class of the fall 2008 semester. I'm always ambivalent when this happens. Certainly, having more free time until the next semester is welcome; teaching has elements of being a chore and isn't necessarily the main reason one goes into this line of work. But a semester-long class is kind of a living thing that the professor & students share and that can be fun; you really get to know each other though just in this formalized setting. And I felt we had pretty good relations and some fun together plus a sense of shared enterprise. I enjoyed teaching this class, and the next time inevitably will be different; possibly not as good since these things inevitably vary each time around.

As a parting gesture various students brought in items of fruit on the last day. This referred in part to a couple of early twentieth century Supreme Court tax cases that (following Marvin Chirelstein) I mocked for their labored and unhelpful metaphors about "fruit and tree": Eisner v. Macomber, saying that only the fruit is income; and Lucas v. Earl, saying that the fruit can only be taxed to the tree on which it grew. Other references behind the gesture: someone brought in an apple earlier in the semester, and when I forgot it he brought in a persimmon the next time; also, I've mentioned my mania for the Union Square farmer's market when fresh fruit is in season. So the gesture was literarily rich; multiple layers of reference.

Anyway, here was my net haul: 4 bananas, a persimmon, a few lychees, a pomegranate, a kiwi, a pineapple, a mango, an orange, a tangerine, a Clementine, an Asian pear, a Comice pear, and a potato (perhaps because in French it's a "pomme de terre"?). Plus an NYU canvas bag so I can carry my loot home.

Luckily I do not plan to respond by asking them on the exam whether this haul is taxable income. Detached generosity? (I'd like to think so.) Might section 102(c) apply? (No, they aren't the employer.)

Final chapter of the class saga, other than the exam, is recruitment to the lifestyle. We tax profs are all alike. We are hoping people will be interested enough to take more classes in the subject, and perhaps to give more thought than they had expected to tax policy as a subject or tax practice as a career. I'd certainly be happy to see people from this class again over the next few semesters. On this angle, on verra.

Dinosaur poem I once wrote for my kids

Maybe ten years ago or so or more, I wrote them this little doggerel number while we were at Rye Playland early in the summer.  I recently spotted it in my closet.  With apologies to Robert Bakker (for his dinosaur novel Raptor Red), and for the historical inaccuracies regarding which species actually coexisted with velociraptors:

The duckbill herd had drunk its fill

Thought Raptor Red: "It's time to kill."

Her sisters three were close at hand

And by the grove they made their stand

The duckbill herd was acting shy

And sticking close as they went by

A flash of claws, a snarl of teeth

The sisters leaped, and pinned beneath

A duckbill chick, who soon was still

The herd all honked and fled downhill

And stomped beneath their thundering feet

An acrocanthosaur who'd planned to eat

The raptors' kill as stolen meat

The raptors stretched and ate their fill

And lay down in the grass until

Another acro spied their prize

But by that time no meat was left

Except some for the pterodactyls and the flies.

Loser culture

Why are the U.S.-owned car companies so bad?  Presumably the reason is ingrained corporate culture.  They spent decades as oligopolists, protected from foreign competition because World War II had leveled the rest of the industrial world.  Plus, barriers to entry in the car business prevented domestic turnover a la Microsoft supplanting IBM.  By the time significant foreign competition arrived in the 1970s it was too late - the corporate culture had ossified beyond repair.

As a junior tax associate at a D.C. law firm in the 1980s, I went out to Detroit a couple of times on a case, and had lunch with mid-level execs in the company canteen.  It was obvious even back then that they were utterly lost and knew it.  A lot of big paunches and thinning white hair but no ideas, enthusiasm, or hope.

Hard to see how a rescue or managed bankruptcy changes this.

Studied ambiguity?

For what it's worth, I gather from the Tax Prof Blog that the artificial intelligence program at Gender Analyzer rates this blog as (only?) 61 percent likely to be written by a man, making it the closest to gender-neutral among a group of tax blogs other than the Tax Prof Blog itself, which comes in at 52%. Then again, two of the tax blogs come out opposite from the correct answer, perhaps saying more about the AI model than about the particular bloggers involved.

Preparing to pivot

The tricky move the Obama Administration faces in budget policy is to go lax in the short run, given the need for stimulus to fight off recession, but then to steer back towards fiscal sustainability, with the drop-dead date possibly having been moved up from, say, the early 2020s to the late 2010s. 

According to today's Times, they are already thinking about this, with Jason Furman consulting with Congressional "Blue Dogs" about budget rules, "including a potential law requiring balanced budgets to formalize the pay-as-you-go approach favored by the coalition."

I'm increasingly convinced that balanced budgets and annual pay-as-you-go aren't really the right way to go about this.   The focus should instead be on a combination of short-term (five or ten year) plus long-term (infinite horizon) balance, or at least constraints on making things worse, given the distinct political pathologies that can lead to violation of either.  There are also tricky design questions involving the choice between super-majority rules and automatic changes (such as sequesters) if targets are missed.

More on this as things develop if it gets anywhere.  But the basic underlying task of designing constructive budget rules is tricky to say the least, and more art than science given the political economy aspects.

There's got to be a metaphor in here somewhere

But even if not, an amusing photo.

Yes, those are baby skunks that she has evidently adopted.

Confession of a deficit hawk

Before the financial crisis hit, the U.S. appeared to be headed towards a fiscal calamity, probably no later than the early 2020s. The likely doomsday date has surely moved several years closer, perhaps to some point in the late 2010s.

I nonetheless accept the need for something like Obama's Economic Recovery Plan, and also agree that this is the time to do healthcare. But even if all this goes well, the really tricky part will be navigating back towards fiscal responsibility, after having opened the federal wallet wide and benefited from doing so.

In a really optimistic scenario, the political credibility rightfully gained in 2009 will create genuine political capital, not Bush 2004-style fool's gold, that can actually be used to do unpopular things that are unlikely to have any Republican support.

Which do you want first, the bad news or the good news?

Bad news, you say? The Dow fell 445 points today.

The good news is that it can only happen 17 more times, then we'll be done.

If I were a billionaire

Certainly, under those circumstances, I'd be tempted to consider paying $50,000 to have our 18-year-old cat Shadow cloned, although I gather the cat cloning business isn't going so well. People raise ethical questions about cat cloning, rightly enough given all the unwanted strays, but Shadow, with his astonishingly good temperament (if we could recreate it), surely is a special case.

Today I found another use for that mythical money, upon reading that a mere $10 million could bring to life a reconstituted woolly mammoth. That would be an easy call for me if I had a billion. And sign me up as well for the reconstituted Neanderthal that (whom?) the article discusses - ethical questions be damned when you think of how astonishing this would be.

Before getting too excited, I should note that, while I haven't yet checked today's stock prices, as of yesterday they didn't appear to be heading me in the direction of a billion dollars. Indeed, these days zero is starting to look a lot more likely.

Rangel corporate rate cut proposal

From Bloomberg, courtesy of Tax Prof:

"New York Representative Charles Rangel said he's revising his tax overhaul proposal to reduce U.S. corporate tax rates to 28 percent, down from the current rate of 35 percent .... [to be financed] by targeting special-interest provisions that favor some industries and companies over others.

"Only Japan has a higher marginal corporate tax rate among developed nations, the Treasury Department said last year. When state taxes are factored in, U.S. corporations pay about 39 percent on their last dollar of profit.

"Obama has said that the effective tax rate paid by U.S. companies is much lower once they claim deductions, credits, and other adjustments to taxable income. In 2006, for example, American companies paid an average effective tax rate of about 23.7 percent, according to a study by Ernst & Young LLP."

Tax preferences that Rangel says are on the chopping block include the domestic production incentive, LIFO accounting, some stuff for multinationals, and something in the carried interest realm.

A few points to keep in mind here: First, cutting the corporate rate and broadening the base is generally an unambiguously good idea (keeping in mind, however, that for outbound investment this depends on whether a worldwide tax is optimal, as seems unlikely given its resting on the weak reed of corporate residence).

Second, a fully financed domestic corporate rate cut (i.e., not necessarily financed by corporate base-broadening) is also highly likely to be a good idea in the setting of worldwide tax competition.

Third, even if the effective tax rate paid by U.S. companies on domestic investment is low, a high marginal rate is still a problem - not just for the general reasons why base-broadening plus rate-cutting is desirable, but also because in various cases it will be the marginal rate, not the effective rate, that drives particular decisions in the realm of worldwide tax competition. (An example is transfer pricing incentives to treat marginal dollars as foreign source rather than U.S. source.)

Here's hoping Rangel gets somewhere on this, although it is more out of his playbook than Obama's.

Act now while supplies last

My latest article, The Long-Term U.S. Fiscal Gap: Is the Main Problem Generational Inequity?, is now available on SSRN here.

Abstract is as follows:

Current U.S. budget policy is unsustainable because it violates the intertemporal budget constraint. While the resulting fiscal gap will eventually be eliminated whether we like it or not, the big issue in current budget debate is whether the ultimately unavoidable course corrections should start now or be left for later. This paper argues that concerns of generational equity, which often are relied on by those demanding a prompt course correction, do not convincingly settle the issue, given empirical uncertainties about future generations' circumstances. However, efficiency issues create powerful grounds for urging a course correction sooner rather than later, on three main grounds: to eliminate the risk of a catastrophic fiscal collapse, achieve the advantages of tax smoothing, and smooth adjustments to the consumption made possible by various government outlays. Political economy considerations suggest that the risk of a catastrophic fiscal collapse may be significant even though in principle it could easily be avoided.

Colloquium presentation at Loyola LA

Yesterday I presented my forthcoming budget policy paper, The Long-Term U.S. Fiscal Gap: Is the Main Problem Generational Inequity? [to be posted on SSRN & linked here shortly], at Loyola Los Angeles.

Ted Seto offered excellent comments in which he showed, to my surprise, that I am not at the most pessimistic end of the spectrum concerning where U.S. budget policy is headed over the next 10+ years. He suggests that I add to my "doomsday scenario" (the ugly mess if the U.S. tiptoes too close to outright default) both (a) the collapse/replacement of the dollar as the worldwide reserve currency, clearly to our detriment and to that of other countries as well if a good replacement currency (such as the Euro) doesn't seamlessly emerge, and (b) the geopolitical consequences of economic troubles that might lead to the rise of extremist political regimes in hard-hit countries around the world, a la what happened in the Great Depression, only now with widespread nuclear weapons.

JCT Tax Expenditure estimates

I've commented in the past on the great work that's been going on at the Joint Committee on Taxation seeking to improve the usefulness of the tax expenditure concept by wresting it free of the irrelevant side-debate with which it was long intertwined concerning efforts to define a "normal" tax base.

The JCT has now issued what I believe are its first new set of annual five-year estimates using their revised methodology.

This advance deserves attention, and over time I hope will get it.

Stanford Law School conference on the tax gap

This past Saturday I was a commentator, at the Stanford Law School's tax gap conference, on a paper by Joe Bankman, Stuart Karlinsky, and Susan Morse concerning why cash businesses cheat (based on field interviews with people who spoke freely because it was confidential).

In my comments, I described the paper's chief finding as quite similar to that of a recent scientific study that addressed the question: Why do the female spiders in some species eat their mates?

As a news article on the study explains:

"[Previous s]tudies have suggested various complex evolutionary reasons involving costs and benefits to the species, sperm competition and esoteric sexual selection schemes.

"But it turns out that the motivation for this creepy cannibalism is much simpler. It's all about size. The males are much smaller. Big females eat their puny mates simply because a) they're hungry and b) they can."

That, in a nutshell, is the Bankman-Karlinsky-Morse finding. Cash businesses often cheat because (a) they're hungry (that is, they'd rather have more money than less) and (b) they can. It's not about deep feelings concerning the government, social reciprocity norms, etcetera.

Empirical evidence cited in the paper suggests that cash businesses, on average, pay tax on only half their income, versus 99% for employees. This is clearly a big efficiency problem as well as a revenue problem, amounting to a huge tax preference for one set of activities over another. Talk about excessive incentives for entrepeneurship. And while part of the under-reporting comes from hand-to-mouth small operators, it also extends well up the income scale.

Why hasn't enforcement been better? It's inherently hard to observe cash businesses' transactions, but not impossible, especially in the modern computer age. Political will and under-powered government incentives to find the revenue are important as well. Aggressive data mining operations, perhaps involving private firms that will be compensated by the Treasury based on how much their suggested approaches end up yielding, could do a lot to address the problem, and perhaps in the next few years we will see movement in this direction. Even if the reported income percentage from cash businesses were raised just a bit - say, from 50% to 60% to 70% - that would raise revenue while actually reducing economic distortion.

Once again, an economic downturn isn't the absolute best time to start doing this, but it might be an ideal time to lay the groundwork to start doing it in the next phase of the business cycle.

Audacious stunt by the Treasury Department

Today's Washington Post reveals a truly audacious stunt that the Treasury Department pulled in late September, essentially repealing on its own motion Code section 382 as applied to banks. The ruling through which it did this is available here, and it appears to be aptly described as flat-out repeal of the provision so far as banks are concerned.

Background for non-tax geeks (or tax non-geeks): companies can't deduct their net losses (you pay zero tax, but don't get a refund, whether your income for the year is zero or minus $10 billion). But losses thus rendered unusable can be carried over to other taxable years and used to offset taxable income in those other years. Loss companies therefore stagger around carrying "net operating losses" (NOLs) that they can use whenever they have offsetting positive taxable income, but in some cases they are unlikely to have such income any time soon or perhaps ever.

The NOLs are a tax asset, however, potentially making the companies (even if otherwise they are dogs) attractive to companies that have profits they would like to shelter. Section 382 greatly limits this little game by sharply reducing the ability to use the losses when you (i.e., another company) acquire a loss company.

The policy merits of this provision are decidedly mixed. For starters, why should losses be nonrefundable? An alternative approach to existing law would say that, if $10 billion of taxable income generates $3.5 billion of tax liability, then a $10 billion loss should generate a $3.5 billion negative tax, i.e., payment by the Treasury to the unfortunate taxpayer. Absent such a rule, the tax law discourages risk-taking and increases effective tax rates via a "heads we win, tails you lose" approach to tax liability. This is unambiguously bad policy (ignoring a complicating consideration that I'll add in a moment), and recent research by economist Alan Auerbach suggests that it has increasing adverse effects on corporate tax burdens because of greater dispersion in economic outcomes that makes losses more common.

There is, however, one decent rationale for loss nonrefundability. It serves as a backstop on the extent to which companies can derive tax benefit from generating fake tax shelter losses. Consider Enron. They were losing tons of money, but creating tons of positive taxable income through sham transactions that they used to generate bogus financial accounting income. They then offset the fake income with fake losses from preposterous tax shelters. But they could only use the shelters to drive their taxable income to zero. Absent nonrefundability, they could have kept on going and forced the government to pay them huge sums annually through the tax system.

Nonrefundability is thus defensible, which is not to say that it is clearly correct or unproblematic, so long as we remain unconfident that claimed tax losses are true economic losses. Section 382 then serves as a backstop by preventing the use of mergers as an endrun around the loss limit (create fake losses, then sell them to someone who can use them). It is a bad provision insofar as it tightens the constraint on using real losses that ought to be refundable, a good one insofar as it limits the abuse scenario, and a bit of a good one insofar as it prevents otherwise inefficient and socially undesirable mergers from being done simply for tax reasons (as the price of getting to buy the losses).

What's the balance of merits overall? Hard to say. But it is troubling to see the Treasury unilaterally repealing it as to banks, really beyond its proper authority (at least in normal circumstances) even if they can get away with it.

Even given the financial crisis, I don't think they should have flat out repealed section 382 as to banks. More limited relief, directed to the current financial situation and the next few years, would have made more sense and been less fundamentally improper. Perhaps policy enthusiasm for the broader repeal played a role.

Then again, given the change in Administration, it's plausible to me that the overreach will be allowed to stand just for now (again, perhaps justifiably given the financial crisis) and then reversed. And/or Congress can reverse it with deferred implementation of the rule restoring the provision's applicability to banks.

It will be interesting to see, in the years ahead, whether the Treasury reverses other Bush-era regulatory giveaways to corporate taxpayers, as there were indeed a lot of them and some at least were dubious (though often also defensible) on policy grounds. A recession might not be the right time to do any of this, but the new Administration should be around for a while, and the current Treasury has certainly left us here with a precedent for sharply reversing course, just because one wants to, when the time seems right.

Go West, young (?) man

Later today I'm headed to California, where I will first, on Saturday, comment at a Tax Gap conference on a paper by Joe Bankman, Stu Karlinsky, and Susan Morse concerning cash businesses. Then, on Monday, I will go to Loyola Los Angeles and present my paper (from the GWU conference that I blogged recently here) concerning the long-term U.S. fiscal gap. The forum is Loyola's tax colloquium, hosted by Ted Seto. That paper will also shortly be posted on SSRN, whereupon I will offer the link to it here.

I'm also planning to say something here, at some point soon, concerning U.S. tax and budget policy under the Obama Administration, given the fiscal gap on the one hand, the still-cratering economy on the other, and some of the tax policy issues that the Administration either may or must be taking on soon (e.g., outbound investment by US multinationals, expiring Bush-era tax cuts, etc.). But that will take a bit more time (though I write these entries super-fast) than I will have available for the next few days.

Obama wins

Eight years of unrelieved ugliness are almost over.

Perhaps the most important thing, in the long run, is that the Republicans return to sanity so that we have two reasonably responsible parties, as any well-functioning democracy needs. They have been stark raving mad for 14 years now, relentlessly undermining civil society and seeking to destroy honest public discourse along with the rule of law. I am very pessimistic about this in the short run, but more hopeful as one looks past, say, 2012.

Some important things, perhaps healthcare reform, arguably can be accomplished by just one party. Likewise, rejecting endless war, to the utter exclusion of moral suasion and "soft power," as our primary foreign policy tool. Other important goals, such as addressing the fiscal gap, clearly do require both parties. And still others, such as fundamental tax reform, ain't gonna happen nohow anyway.

In any event, however, kicking them out tonight was a start.

Election Day

I got to the polling place at 6:25 AM - lines around the block, hundreds of people, I've never seen anything close on Election Day even more towards prime time. But the line moved well, and in 35 minutes I was done.

The guy behind me on line was saying he hadn't voted since Perot. The woman he was talking with said she tries to vote each time, but in the past didn't always see a clear choice. "But with all the corruption, it seems like every day there's a new scandal ..."

Seven and a half long years of lies, corruption, incompetence, malevolence, and endless insults hurled at New Yorkers and others like us - indeed, at anyone around the world who isn't a small town white religious conservative Republican - are evidently more than enough to bring out the fighting spirit in this town, and elsewhere, I am sure, as well. I think people around the country who are sick to death of it all will brave long lines if they have to, even in places like New York where the statewide outcome is a given.

Nate, don't fail me now

On Election Eve, Silver at fivethirtyeight.com has it up to 98.1 percent.

This will make it easier to sleep tonight.

I'm planning to vote by 6:30 a.m., but just the once.

EARLY AFTERNOON ELECTION DAY UPDATE: If Silver's estimates are treated as reliable (and they assume lack of overall systematic bias in the polling data), Obama gets 264 electoral votes from states that the model treats him as having a 100 percent chance of winning. (Pennsylvania, with 21 electoral votes, is among those states.) He would go over 270 if he got Colorado's 9 EVs (98%), Virginia's 13 (97%), Ohio's 20 (88%), or Florida's 27 (73%). Nevada's 5 (95%) would get him to 269, presumably good enough for the win given (a) Democratic control in Congress plus (b) the persuasive significance of his popular vote edge, assuming it holds.

Obviously, these various probabilities, even if we take them at face value, are unlikely to be entirely uncorrelated.

While some might take comfort from these numbers, they also provide a panic guide if Virginia doesn't fall briskly into place in the hour after 7 pm (as this might undermine confidence in the entire projection).

The flat tax isn't flat

Freddie, a thoughtful conservative blogger not previously known to me but linked by Andrew Sullivan, says the following about McCain's "socialism" attack:

"I think we could have an election that involves a major debate about the progressive income tax, but in order to have it, we'd have to have a candidate who is actually opposed to progressive taxation. The alternative to progressive taxation is a flat tax, and John McCain is not a flat tax supporter. If this 'spread the wealth around' argument is an argument with actual substance, instead of pure political opportunism, it has to be waged by people who are actually opposed to progressive taxation, in favor of a flat tax. John McCain, as much as he may want to limit the slope of the tax line, isn't in favor of a flat tax; it's not in his policy proposals at all. Could you have a simple 'let's have a more regressive tax scheme than we currently do' argument? Sure. But that can't be this scorched-earth, progressive taxation equals socialism argument the McCain campaign is making. It just doesn't make sense to have this extremist argument when the candidate making it isn't on one of the extremes."

Freddie has a point, but he doesn't go far enough. First of all, if you are truly anti-redistributive, a uniform head tax is as good a candidate as the flat tax, and perhaps better, for your preferred tax norm. Hard to choose between them on anti-redistributionist grounds when (absent a meaningful non-government baseline) we don't really have a way to measure the relationship between benefit and rising income.

But in any case the flat tax isn't actually flat. It has a zero bracket, which means that it has a progressively graduated marginal rate structure. Historical tidbit: when the Supreme Court struck down the income tax (pre-Sixteenth Amendment) in the infamous 1896 Pollock v. Farmer's Land case, it held that a flat tax with a huge zero bracket and one very low rate (maybe 2.5% or so?) was unduly progressive, violating equal protection and indeed being, in the Court's view, socialistic.

To believe in flat rate taxation as a matter of principle - leaving aside the formalism and incoherence of a principle that's based only on the revenue side of the budget without regard to the outlay side - you just cannot believe in a zero bracket. Otherwise, as the old joke goes, we have already established what you are (i.e., a "socialist" under the inane and intellectually bankrupt pretend view of the McCain campaign) and are merely haggling over the price.

Economist Christine Romer on fiscal policy

From an interview (along with her husband David Romer) in a Federal Reserve Bank of Minneapolis publication, the Region:

"What's very striking is that we had a pretty sensible long-run fiscal view in the 1950s - the budget should be balanced over the medium run, but not each and every year and not in exceptional circumstances ....

"But views took an unfortunate turn in the 1960s and 70s. Policymakers started to believe that budget balance was not important even over an extended horizon, and that tax cuts would pay for themselves. And views took another wrong turn in the 1980s, when policymakers added notions such as the starve-the-beast hypothesis that tax cuts would force spending cuts. I think these are wrong turns that we haven't corrected yet - as evidenced by our ever-worsening long-term fiscal outlook."

The Romers' empirical work has refuted the starve-the-beast hypothesis as applied to the last few decades, and showed instead that what tax cuts lead to is subsequent tax increases. (I've also seen empirical work suggesting that tax cuts tend to be accompanied by spending increases, since fiscal discipline is either tight or slack - although here the theory is correlation with an underlying common cause, not necessarily direct causation).

Astonishing historical factoid from the Romer interview: taxes were apparently raised at the beginning of the Korean War BEFORE significant money was actually being spent on it, simply because they knew that the high expenditure levels were coming. That is like hearing tidings from another planet, inhabited by a farsighted species entirely unlike our own.