Torture revelations

I've been staying away from the Bush Administration torture controversy as it really isn't anywhere near my area of expertise, but I must say, the new revelations that one motivation for torture may have been to generate "evidence" of al Qaeda-Saddam ties truly takes it to a new level.

It's Curry Time!!

My basketball-playing, basketball-fan son and I had been watching some Knicks games during the season, are now watching the NBA playoffs, and have developed a new phrase: "It's Curry Time!"™

(Based on the overweight, unmotivated, perpetually injured and indifferent Knicks player, Eddie Curry, who has about an $18 million annual salary but who played only about 5 minutes this year, during which time the Knicks were badly outscored.)

He's a big center, only he can't or won't run, jump, pass, catch a pass, rebound, or play defense. He can shoot from 5 feet away when he's healthy, but getting him the ball there is another question unless he's being defended by Ferdinand the Bull (as distinct from, say, Joakim Noah the Bull).

Curry Time!™ used to be the moment when a game was enough of a blowout that you would voluntarily put Curry in if you were the Knicks coach, just to showcase him (as if that could help) and rest someone else. Meaning, garbage time to the nth degree.

It's been redefined to mean the point in a game when the team with the lead could put in Curry if they had him, keep him in for the rest of the game, and still win.

At the end of the third quarter tonight, the Cavaliers were beating the Pistons by 27 points. I asked my son: "Is it Curry Time!™ yet?"

He thought it was still a bit too soon. Even with a 27 point lead, even with LeBron, the Cavs might not be able to hold this lead against a mediocre 8th seed with Curry in the game.

Turned out he was right. Even without Curry, though also without LeBron (whose presence would be a wash at best for Curry's), it's down to 11 points with 8 minutes to play.

Chicken game

Considering the shape that Chrysler is in, it would be amusing, if it weren't so contemptible, that the company opted for expensive private financing in lieu of cheaper bailout financing, in order to avoid limits on executive compensation.

I read some speculation that this was to make it easier for Chrysler to conclude the Fiat deal - although Fiat presumably doesn't care about current Chrysler executives' compensation levels (so the argument would have to be about people it brings in). But I would guess the Chrysler execs are simply gambling that the more they keep over-paying themselves, even if they needlessly increase the company's financial burdens (which are not their problem any more), the more they will end up taking home in the end given U.S. government reluctance to pull the plug and let them go. They are playing a chicken game with the federal government, and I would guess they're winning.

Moral hazard indeed.

This is the most "it figures, business as usual" story I've seen since FASB, responding to Congressional bullying, eased the mark-to-market rules for financial institutions in a manner that invites abuse of discretion, evidently reasoning that the markets have simply been plagued by too much transparency lately. (Yes, I know the argument for the change, but don't like either the short-term effects on rightfully skittish investors' confidence or the long-term effects on financial statements' reliability.)

Interesting new development

According to the Daily Tax Report (subscribers only, so this link may not work for all users):

"Edward Kleinbard is leaving the Joint Committee on Taxation after nearly 20 months as its chief of staff, lobbyists and congressional staffers said April 21.

"Kleinbard is expected to leave his post May 15. It is not clear who will serve as acting chief of staff. Last time there was a vacancy, Deputy Chief of Staff Thomas Barthold served as acting chief of staff for nearly two years.

"Prior to coming to Washington, Kleinbard was a partner with Cleary Gottlieb Steen & Hamilton LLP in Manhattan. Sources said Kleinbard will join the faculty of the University of Southern California Gould School of Law."

I personally wouldn't be surprised if Barthold becomes the permanent Chief, and that would certainly be a good outcome. I doubt that many outsiders of Kleinbard's or his predecessor George Yin's stature, be they leading practitioners or academics, would want the job at this point.

Some readers may know that I am a big fan of Kleinbard's scholarship and work, as well as a friend. At the JCT, he did a great job of advancing the ball on tax expenditures and in generally making the JCT issue pamphlets more serious intellectual contributions that merited broad reading.

Obviously the current political environment, even post-2006 and indeed post-2008, makes it hard for the JCT to play the substantive political role that it had decades ago, before the committee and member staffs got to their current size. Even the institutional independence that, say, the CBO chief but not the JCT chief currently has would be welcome from a policy standpoint, but it's hard to see why Congress would ever choose to grant it.

I anticipate that Kleinbard will be an outstanding academic success - smart move by USC Law School in signing him up.

NYU Tax Policy Colloquium on Mitchell Kane's Taxation and Global Cap and Trade

Neither I personally nor the colloquium have focused as much in the past as we are likely to in the future on the carbon taxes/cap and trade set of issues. (I've never written about these issues because I don't as yet see the angle or intellectual arbitrage opportunities using my skill set.) But yesterday Mitch Kane's paper provided a welcome step in the direction of focusing on them more.

Mitch's paper takes as given that we'd be doing cap and trade not a carbon tax, this being his assigned topic for a forthcoming NYU conference in Abu Dhabi. (Not to mention that current political noises center on cap and trade.) But every time one reads the papers or thinks about the issues it becomes clearer that, even though in principle the two approaches (with suitable ongoing adjustment to each) are interchangeable, in practice it's insane to go the Rube Goldbergesque cap and trade rather than carbon tax route.

My preferred way of thinking about the interchangeability is as follows. Under a carbon tax polluters pay as they go. With cap and trade, they prepay the tax before engaging in the polluting activities, and then use it up by doing the now-permitted carbon-emitting activity. Only, they can sell the taxes-paid voucher to someone else, and, if they want to pay more to emit more, they can't unless the government is willing to sell more prepaid tax vouchers. (Whereas in the carbon tax model you automatically can pay more to pollute more.)

There's a theoretical literature suggesting that the relative merits depend on whether one is more uncertain about the social cost of emissions (which the carbon tax ideally would reflect) or about supply and demand responses (which get reined in by cap and trade if the government keeps the permit supply fixed). But if you keep adjusting the carbon tax to control output levels, or the number of outstanding permits to keep their prices relatively constant, they start to look like each other. In terms of the political frictions if there are adjustment lags, I'd tend to think it makes more sense to take a stab at the social costs and set a carbon tax than to posit something about desired emission levels when the inputs, such as cost of abatement, have such a big effect (which one may not understand) on the optimal reduction in emissions for a given period.

The political reason for cap and trade, of course, is that it isn't called a tax. Only, everyone knows it's a tax (which obviously is what you need to make polluters internalize the social costs of their activities), so one doesn't really gain very much. Plus you get the insane and apparently irresistible political incentive to shower money on polluters by giving them permits for free rather than through auction. This reflects a failure to recognize that we are giving them prepaid tax vouchers without requiring them actually to pay the taxes first. The optics of carbon taxes would be unlikely to yield this result. And, as Alan Auerbach noted at the session, their profits are likely to go up in the post-permits because the reduced output enables them to raise prices. It's as if we organized them into a cartel by charging a tax to reduce output and letting them keep all the revenue. Only mingled corruption and confusion could produce such a result, but evidently they are not in short supply.

Mitch's paper discusses several of the tax issues in handling a cap and trade system. He argues that there is an essentially arbitrary choice between "pre-regulatory" and "post-regulatory" baselines in determining tax basis for permits that were granted for free, but we argued that this is better conceived of as a standard transition issue. (For handy reading on transitions, I suppose one could take a look at this.)

Mitch also focuses on the question of how to minimize inefficiency in the choice between permits and abatement, and offers two alternative approaches that he dubs "no clienteles" and "harmonious clienteles." Alan Auerbach argued, to my view entirely persuasively, that essentially what one needs is income tax neutrality (i.e., permits and alternative abatement methods all are taxed the same for each taxpayer), with marginal rate differences between taxpayers not distorting anything other than via the general work and savings effects of an income tax. This was related to but more demanding than the requirements for satisfying Mitch's "harmonious clienteles" scenario.

Tomorrow may rain so, I'll follow the sun

As you can perhaps see, Shadow (left) and Ursula (center) are doing a lot better these days, though Shadow remains a bit creaky. He's been scoring Passover gefilte fish lately. Buddy (right) spends his days proving that there's nothing like high spirits (and limited calories, despite his best efforts) to keep the mind clear and the body healthy.

Tax Policy Colloquium on Desai & Dharmapala, Investor Taxation in Open Economies

This past Thursday we discussed the above paper proposing "global portfolio neutrality," or GPN, as a new entry in the alphabet soup of proposed international tax norms (joining CEN, CIN, CON, NN, and NON). GPN holds that national as well as worldwide efficiency is maximized by causing individuals to face the same tax rate on their portfolio holdings no matter where they invest. It would be satisfied by purely residence-based taxation of individuals on their portfolio holdings. Given source-based taxation of passive income, such as withholding taxes on dividends, the authors argue for granting unlimited foreign tax credits (FTCs), including refundable FTCs for tax-exempts. They also apply GPN to inbound investment, and suggest, therefore, that we not tax sovereign wealth funds (SWFs) that are not otherwise taxable outside the U.S. on their worldwide holdings.

The paper is partly a response to an earlier paper by Michael Graetz and Itai Grinberg, which - at least as interpreted by Desai and Dharmapala, although Graetz, attending the session, did not entirely accept this interpretation - argues that the US should merely allow deductions for withholding taxes paid abroad. The Graetz-Grinberg argument, at least as reported, was as follows. As per the Desai-Hines norm of capital ownership neutrality (CON), who owns a given business actually may matter a lot, in the sense of affecting profitability, in the case of conducting an active business. But for portfolio holdings there presumably is no effect, since the holder is assumed to be passive and to play no operating role in the business. Hence, while merely allowing a deduction rather than an FTC for foreign withholding taxes would distort ownership decisions - discouraging the holding of foreign stock - this doesn't matter since ownership is irrelevant here.

Desai and Dharmapala respond that ownership does so matter, for reasons of optimal diversification. People in a given country who are already "long" the national macro-economy because their human capital is tied up in it should be eager to diversify via exposure to foreign macro-economy risks (which are somewhat but not perfectly correlated with our own) by holding foreign stock. (BTW, the "home bias" that we continue to observe in stock ownership patterns, though it is declining, arguably shows irrational under-diversification although there also are some rational proposed explanations for it.)

So far, so good. But the trickier part, for me, is their argument that GPN establishes, as a matter of unilateral national self-interest, providing FTCs for foreign withholding taxes so long as our withholding tax rate is about the same as those applying abroad.

They have a logical and internally consistent argument for this, which would take too long to explain here but can be found at pages 23-24 of their paper (available here under April 9). But I was skeptical on the grounds that:

(a) It isn't actually unilateral if withholding tax rates have to be about the same.

(b) FTCs create bad incentives, from the U.S. standpoint, both for our taxpayers (who need not seek to economize on foreign taxes in deciding where to invest if we'll offer a credit anyway) and for foreign governments (who can think of the tax cost as passed on to the U.S. Treasury).

(c) The reason D&D require that withholding taxes be about the same is that foreign inbound investment will replace the outbound (e.g., if Americans sell U.S. stocks to hold foreign stocks, then someone else has to buy the U.S. stocks). Hence, we automatically pick up withholding tax revenues to replace the lost revenues from offering FTCs. But Alan Auerbach and I argued that this amounted to assuming that capital flows must be symmetric by asset class, which isn't necessary even if symmetry holds overall.

A further issue I raised is that investors care about true diversification as to underlying economic characteristics. But the determination of source for dividends received is essentially formal - under U.S. law, depending almost purely on where the issuer is incorporated. Does selling GE stock to hold Siemens stock have anything to do with diversification if both companies are active in the same places to the same degree? Diversification by source, as determined by the tax system with respect to passive income, could at the limit be no more meaningful than making sure you hold both stocks that are printed on red paper and those that are printed on blue paper.

A final criticism I offered on these issues (although actually, at the session, I stated it first) is that GPN, like all of the alphabet soup norms, addresses only one margin (portfolio diversification) whereas there are many. For example, can one really discuss the tax treatment of passive income held by U.S. taxpayers without considering U.S. corporations, the outbound passive investment of which is taxable without deferral under subpart F.

Despite these criticisms, this was one of the best papers and sessions of the semester. Among its virtues was addressing the significance of tax rate differences among investors within a jurisdiction. But here, although I largely sympathized with the analytical bottom line, I of course found a way to carp and cavil all the same.

With respect to refundable FTCs for tax-exempts, my main critique was that, since FTCs create incentive problems from the national welfare standpoint, it's logical to limit them. The way we actually do so, by offering a 100% marginal reimbursement rate (MRR) until one hits the credit limit and then 0% thereafter, seems a bit arbitrary and unlikely to be optimal. But it's hard to say if, overall, we are too generous or not generous enough. Hence, in any given case (such as the tax-exempts) in which one proposes to scrap the limit and permit more FTCs to be claimed, it is hard to be sure whether we are going in the right direction or not.

Finally, with respect to sovereign wealth funds (SWFs), I agreed that it is likely to be in the U.S. national self-interest not to tax them on inbound investment IF we are effectively a small open economy without the market power to impose some of the burden of the tax on them. They're distinctive in that, for various other inbound investors, the withholding taxes we impose might (a) not exceed the tax rate they would face anyway, and/or (b) be creditable by their home governments. But SWFs can't take advantage of FTCs because, effectively, they ARE the home governments that would be providing the credit.

But it seemed odd to me to call this GPN, given that (a) from a national welfare standpoint we don't care about affording them better diversification, and (b) we'd be quite happy to tax them and distort their portfolio choices insofar as we have enough market power to stick them with some of the economic incidence of the tax.

Dismaying encounter

Earlier this week I had coffee with a former colleague, now eminent outside the legal academy, who was in town for a few days. He's very much to the right of me politically, but someone I've always respected as intelligent, thoughtful, and intellectually honest. Not a law and economics person, by the way.

The financial crisis came up and, while it's not his area of expertise, I must admit to being startled by what I heard. First off, he noted that the whole thing resulted from a regulatory failure. I agreed, but then it turned out that what each of us meant was rather different. He believes the entire thing was caused by the Community Reinvestment Act (apparently burrowing underground since 1976 until it finally exploded to deadly effect), with an assist from Fannie and Freddie.

He in turn was startled by my suggestion that failures in corporate governance, particularly in the financial sector, reflecting managerial opportunism and lack of transparency, could reasonably be thought by anyone to have had anything to do with the crisis. The only problem he could see in the financial and general corporate sectors that markets weren't completely able to handle was the "too big to fail" problem of government rescue.

He also believes that it is logically impossible for Keynesian stimulus to have any effect whatsoever, since what you spend here doesn't get spent there, and that there is absolutely no need to worry about the banks. If they all fail and money can be made by lending, then of course businesses will spring up right away and start doing it.

I have to confess that this exchange diminished my enjoyment of the meeting, but it was also more broadly dismaying. Level one is realizing the degree to which even intelligent people on the right can be completely divorced from reality on these matters. They go to trusted information sources, which have been making absurd and easily falsifiable claims about the current situation and the underlying issues. Level two is realizing how everyone does this to a degree. Because we all get our information from sources we have pre-coded as trustworthy and simpatico, we all may have a difficult time seeing what's right in front of our eyes.

One more reason to despair about public policy, even leaving aside all of the incentive and interest group problems that even by themselves are so crippling.

2010 NYU Tax Policy Colloquium - great news

I'm pleased to be able to announce that my co-teacher for the 2010 Tax Policy Colloquium will be Mihir Desai.

Sessions at U Va and NYU

I'll often blog about my talks or conference appearances and such, but have lately been too busy and backed up at work to spare the time. But at a certain point it gets so bad that it really doesn't matter any more at the margin if you ignore your main responsibilities for a bit. It can't get any worse, and is very far from getting noticeably better. So here goes.

Last Friday, I traveled to Charlottesville, VA to discuss Decoding the Corporate Tax at a Virginia Tax Study Group panel, kindly arranged by Michael Doran (who is leaving Virginia for Georgetown). My co-panelists were Ethan Yale (who is leaving Georgetown for Virginia) and Michael Schler. Nice discussion, and to my shock I actually succeeded in personally selling 11 of the books afterwards to people who I hope are now satisfied customers.

Ethan presented his own paper, describing a corporate tax reform proposal to tax corporate dividends like share repurchases (i.e., with basis recovery). I find this an interesting proposal to add to the existing menu, and think its merits depend in part on the significance of the corporate governance issues that might make the dividend vs. repurchase choice important. Then I described my book (overview plus brief description of policy proposals at the end) and Mike S. commented on both of our proposals.

I do like the policy proposals in my book, which are (1) lowering the corporate tax rate but with offsetting adjustments, (2) ceasefire-in-place international tax simplification, and (3) addressing corporate governance problems via the gap between taxable and financial accounting income. But I agree with the other two discussants that the book's main contribution over a long-term perspective is expositional, relating to the rich yet inconclusive economics literature and how to think about the subject, rather than to the proposals themselves.

So there we are, a nice and reasonably productive day in Charlottesville, VA; it's Friday at 4 pm, and I've just arrived at the airport to fly back to NYC. I need to fly back promptly as I have no overnight bag, no place to stay, and a commitment to appear the next morning, back in NYC, at an NYU Alumni Reunions panel with a couple of hundred scheduled attendees. The panelists are supposed to discuss tax policy in the Obama Administration, and as an added complication we have been too busy to finalize what we're actually doing.

In the Charlottesville airport at 4 pm, I learn that my flight to NYC has been cancelled, a victim of the East Coast storms last Friday, and indeed that the Charlottesville Airport (a very small one) is done for the day apart from (1) a couple of flights headed to points further south, plus just maybe (2) a flight to Philadelphia that was supposed to leave at 3:30 but is now tentatively scheduled for 7:15.

Lots of options at this point. Drive to NYC? Drive to Washington (2 hours) and take a shuttle in the morning? Airport hotel? Ask my hosts to find lodging? (They were very willing to help.) I chose Door Number 5, the flight to Philadelphia, and hoped for the best. Good call, as it transpired - it left earlier than expected and via 3 separate trains I made it the rest of the way back home only 3 hours late overall.

This left time the next morning to plan and then execute the panel on Tax Policy in the Obama Administration. Greg Jenner, whom I've known since we both worked on the Tax Reform Act of 1986, was my main co-discussant on the topics for our half of the panel. We ran through most of the Obama budget proposals, other than business & international (which went to our co-panelists), and although Greg is at least technically a Republican (albeit the honest and intellectually responsible kind that's all too rare these days) we agreed about a lot. Both of us either need more meds, or are rightly reading the long-term fiscal situation as extremely threatening.

Act now while supplies last

My new book, Decoding the Corporate Tax, is now available directly from both Amazon and Barnes & Noble (albeit with the wrong title).

Tax policy colloquium on Lily Batchelder's Savings Incentives with Insurance Objectives: A Bankrupt Approach?

Last Thursday we discussed Lily Batchelder's new draft paper (still a work in progress), which argues that savings incentives in the tax code are poorly designed to advance insurance objectives for poorer individuals. She notes low responsiveness to the rules in present law, and their generally providing larger incentives to higher-income individuals who arguably are saving enough already. Thus, she proposes either (a) changing defaults so people automaticallty save for retirement through their employment, but with opt-out and no tax benefit for saving, or (b) a refundable saver's credit that's phased out based on income. Absent opt-out, the savings accounts would automatically convert shortly before retirement to fixed real life annuities.

Alan Auerbach and I were more inclined than Lily to think of saving enough and having enough insurance of various kinds as very different things. Suppose you know with certainty (a) your entire future earnings profile, (b) your exact life expectancy, and (c) anything you need to know about consumer prices, your consumption preferences, and rates of return on saving until the day you die. In this scenario there's no uncertainty about any of these inputs, hence no need whatsoever for insurance so far as any of them are concerned. Yet it would still be vital to save enough to smooth your lifetime consumption path optimally, and people who were myopic or had self-control problems would fall short of optimizing. Hence, we might want to require or induce more saving in order to increase their welfare (and also to save us from having to "rescue" them later on if they depart too far from the optimal path).

Likewise, consider in these terms Social Security. In large part it is simply a device to force a minimum level of retirement saving given one's lifetime income (net of taxes and transfers, including its own). Indeed, though it is always called social insurance for purely formal reasons (e.g., its purporting to have dedicated financing, which in fact aren't much like insurance premiums), its sole insurance feature (redistribution in the program aside) is the fixed real life annuity.

Suppose that we knew everyone's exact lifespan. We'd still need Social Security, but we'd be able to substitute term annuities, equal in length for each retiree to her remaining lifespan, for the life annuities. Now it wouldn't be insurance at all, yet it would still be pretty similar to what we now have. So insurance is not really a huge part of Social Security, despite the semantic convention that supposes it to be a core case.

If we limited the "social insurance" label to programs that actually are economically insurance, and furnished by the government due either to adverse selection problems or people's under-appreciating the value of being insured, the preeminent case would be the income tax plus welfare system, which provide insurance against income risk. But these of course are the programs that no one calls insurance and that indeed were the very ones the inventors of the "social insurance" label were trying to distinguish from their favored programs. (See my Social Security book for a fuller discussion.)

Anyway, the main payoff of all this to Alan and myself was disagreeing about the extent to which savings incentives and insurance objectives should actually be considered a natural match.

The other main quibble we had pertained to the proposal for default saving with free opt-out. Lily wants the opt-out, rather than mandatory saving beyond that in Social Security, because otherwise we might be requiring someone to over-save relative to what was truly optimal for them. Our objection was that we don't really have good reason to tilt the default towards more saving unless one thinks people are otherwise likely to be saving too little. But if we think they mostly are, why allow the opt-out?

The reason for allowing it would be clear if we expected the "right" people to opt out while the ones we wanted to save more stayed at the default level. But what if it was the other way around? It's hard to know why the opt-out would be exercised primarily by those who actually would be saving too much otherwise, rather than by those who want to under-save relative to what's optimal.

The real problem with Twitter

To do it right takes too long. How can you be interesting, fun, & worth reading in only 140 characters without taking all day? (time’s up)

Tax policy colloquium on Emmanuel Saez's "Details Matter"

Last Thursday, we started our post-spring break Tax Policy Colloquium final stretch run with Emmanuel Saez's "Details Matter: The Impact of Presentation and Information on the Take-Up of Financial Incentives for Retirement Saving." The paper analyzes a large-scale real world field experiment with H&R Block in St. Louis several years back, in which randomly selected but generally lower-income customers were offered a cash incentive for establishing an IRA account with Block. Some got no incentive, a second group got a 50% match (e.g., put in $600 and Block would add $300 to the account), and a third group got a 33% credit (e.g., put in $900 and Block would send you a check for $300).

Take-up of the IRAs was generally low, even though the two incentive plans offered free money given that, despite early withdrawal penalties, one would come out ahead if one closed the account in a year. This point was not emphasized, however, and the low take-up even with incentives reinforced the difficulty of encouraging what we might think is optimal retirement saving by lower-income workers. (Either that, or else they perhaps rightly didn't like this particular savings vehicle, which had high annual fees relative to value for small accounts.)

The main finding of the study was that the match proved more popular than the credit, even though, as the above example shows, they are arithmetically equivalent IF putting down more cash now (typically out of one's refund) and waiting two weeks for a check that one then has to cash is assumed to be cost-free.

In part, people seem to have responded to the nominally larger size of a 50% match compared to a 33% credit, even though they're actually identical since the base for computing the percentages differs as between the two of them. But there's also some reason to think that people like the match structure better than the credit structure even when they're effectively identical. My proposed explanation was that the match looks like free money, while the credit looks simply like a price break, which still leaves the question of whether the price is good enough to justify a purchase. Or, hyperbolic discounting could be doing the work if people think of the match as immediately effective (though in fact it takes a couple of weeks, and one is saving the money in the account anyway) and the cash back as in the future. Neither of these is a rational explanation, of course.

I more generally wonder to what extent incentives (at least relative to applying the regular income tax treatment of saving) can generate the sort of retirement preparation that we believe is in most cases optimal. One is appealing to rational calculation in a setting where it's generally thought not to work so well. Beyond the use of defaults so people have to opt out of retirement saving, I think the better answer lies in a Social Security-style mandatory approach(government takes money from you now and gives it back with interest later, or else simply makes you wait for transfers later). This isn't perfect either (e.g., as Louis Kaplow notes, it can affect work incentives, given the preference for immediate consumption, even if one demonstrably gets fair value back). But I see it as more promising than the income-conditioned saver's credit or match approach that motivated the Saez experiment.

Fraud and cheating synergies

From an ABC News story on AIG renegade executive Joseph Cassano, the infamous head of their Financial Products Division:

"Cassano set up some dozens of separate companies, some off-shore, to handle the transactions, effectively keeping them off the books of AIG and out of sight of regulators in the U.S. and the United Kingdom.

"'This is the other very important issue underneath the AIG scandal,' said Blum. 'All of these contracts were moved offshore for the express purpose of getting out from under regulation and tax evasion.'"

This is pretty much the point Mihir Desai makes in his work on taxes and corporate governance. Once there is a planning excuse for complex structures, they can be used for multiple nefarious purposes, e.g., tax fraud, avoiding internal and market as well as formal regulatory oversight, looting the company, etcetera.

Complex structures kill transparency. At the limit, they make corporate governance impossible and genuinely profitable activity by publicly traded companies a pipe dream. To some extent, this is a problem of financial not "real" activity, as the latter is much easier to observe. E.g., Apple Computers and General Motors both are presumably well-judged by the market because to a considerable extent one can see how well or poorly they are doing. But even companies engaged in real productive activity often have such large finance wings (think GMAC historically, or GE's recent problems) that the virus of non-transparency extends well beyond the pure banking and finance sector.

Payback from China continues

The head of China's central bank is now calling for the dollar to be dethroned as the world's reserve currency and replaced by a new IMF-controlled benchmark.

I doubt anything will come of this right away, and if I were the Chinese I might not even want immediate adoption of this proposal (which could devalue their vast dollar holdings), but this may well be the way we are headed. The U.S. has simply been over-exploiting the economic value of being the reserve currency, and at some point the golden calf perishes, so to speak.

My guess is that the Chinese are trying to scare us into taking more responsible measures so as to head off this kind of scenario. It's a tricky game, since until they've lowered their dollar holdings they don't really want to scare the world's investors more than they scare us - it has to be the other way around for them to benefit. But the fact that they are doing this shows how concerned they understandably are. And I don't know how responsive political constraints will permit U.S. policymakers to be, though I don't doubt that high-up Obama Administration officials have heard and understood the message.

Reasons to visit Washington

My family went site-seeing in Washington D.C. while I was going to a conference at the Washington University in St. Louis. Conceptual togetherness even when apart? They returned with this lovely photo, which they rightly surmised that I would enjoy.

On the same theme, I got to talk while at WULS with a former senior economist in the Nixon and Reagan Administrations, a very nice and interesting man. At lunch one day, I couldn't resist asking him about Nixon. He said Nixon was exceptionally intelligent but a strange person with an overwhelming aversion against ever taking the simple, direct, straightforward route to any objective. For example, if there was a public document to release, Nixon would insist on leaking it somehow as a means of rewarding friends in the media or punishing foes. Reagan, he said, was very pleasant but clearly regarded everyone working for him in the government (even people as high up as Jim Baker) as hired hands - you could see the contrast when Jimmy Cagney and Patrick O'Brien came in for a White House film screening and were greeted very differently.

Washington University Law School budget conference

I am sitting in a hotel lounge (better-appointed than the available ones at the airport) waiting for the departure time of a flight out of St. Louis, where I just spent the last two days at a budget conference organized by Cheryl Block of WULS. Lots of interesting sessions, on topics ranging from automatic budgetary changes (such as entitlements cuts) to restore fiscal sustainability, to how the Presidential and legislative budget processes do and should function (e.g., use of budget resolutions or automatic sunset rules), to the practical political feasibility of "saving" Social Security surpluses, to the relevance of the tax expenditure debate, to issues of capital budgeting (amortizing items with long-term benefit) and how to measure the budgetary cost of bailouts.

I was there to present my current paper on the fiscal gap, its generational equity and efficiency consequences, etc. I'll probably get to rewrite this paper, using more recent CBO estimates and changing the emphasis a bit, as Cheryl is planning to create a conference volume, or perhaps something better than a conference volume in that it emphasizes organizing new knowledge without being limited to what people happened to present.

One thing that became clear to me in re. my paper is that the financial crisis has opposite implications for the apparent relevance of my paper than I realized when I started writing it. As I noted in a prior post about someone's colloquium paper, it can be kind of awkward or inconvenient when current events, such as the financial crisis, overtake one while one is writing a given paper (e.g., if one is lauding universal home ownership). When the financial crisis hit while I was in mid-draft, I had a bit of the feeling that it was rhetorically inconvenient because the short-term emphasis has to be on pulling the economy out of its nosedive, rather than immediately restoring long-term balance. So while I could rightly point out in my draft that the financial crisis makes the long-term problems worse, I had to acknowledge that the current mess has to be dealt with first.

But especially in lieu of the Chinese prime minister's recent remarks about U.S. solvency, it became clear to me (perhaps with a little help from my friends) that the positive links between the two issues are stronger than I had recognized. If you're going to be borrowing $2 trillion a year for the next few years, you had damn well better take steps to reassure prospective lenders that you are on a course to assure your own long-term solvency.

One way of putting it is that the Washington MSM conventional wisdom, as usual, is 180 degrees wrong. Obama isn't tackling too much - healthcare and energy policy/ cap and trade permits are actually even more urgent given the crisis than they would be otherwise. Rather, he is tackling too little, in that he hasn't done enough so far to show that the U.S. will be trying to tack back towards the path of solvency. Which is not to say that his or his advisors' political judgment was wrong if they concluded this would be unfeasible. But certainly in terms of the correct policies to follow, by failing to address long-term solvency sufficiently yet (apart from a couple of tantalizing hints), one could argue that he needs to put more on his plate, not less.

AIG bonus update

I now feel a bit more knowledgeable about the AIG bonus situation than the last time I posted about it, so here are some follow-up thoughts:

1) Words sure matter. If they hadn't called these things "bonuses," obviously no trouble. The underlying situation seems to have been as follows. These guys were getting what I'd call fake or misdirected incentive compensation. Fake in that, as we actually learned in the event, if the payoff from the incentive payments disappeared they would simply be compensated in some other way instead. So to a degree it was, as usual, "heads we win, tails you lose." Once there were no profits from their trading to share they simply got paid a flat fee instead. That said, I gather the salary cut they got was more than 50%, so there wasn't zero "incentive" element. But of course the incentive was misdirected even insofar as they actually faced variance, since the profits they shared in were akin to that from insuring 100% of New Orleans' hurricane risk before Katrina and hence taking home lots of money each year until it hit, whereupon the company got wiped out without actually being able to pay on its customers' insurance claims. Not a great incentive structure to induce people to pretend for a while the company is making money through these things.

2) Given the fixed pay they were receiving in lieu of "incentive" pay, there really was a retention element. Specifically, rather than getting paid more regularly they'd have to stay around for several months at a time in order to get their pay for the period only when it was over. So in that sense it wasn't really a bonus, so much as a plan to make them stay on instead of quitting sooner to get the salary they were otherwise earning (which wouldn't otherwise have been called a bonus, hence eliminating the entire political blowup).

3. Why pay these guys to stay? Who'd want them? What could be their opportunity cost of staying given (a) what they had done and (b) the down economy in financial services especially. I gather there actually is a decent answer to this question. While it's hard for me to judge how hard it would have been for someone else to unwind the AIG positions, these guys had economic value to other employers until the unwind was completed, for the simple reason that, having constructed the positions, they knew what the positions were. Someone who wanted to squeeze AIG (or rather the federal government) on the other side of the transactions could have made money off knowing just what the positions were. Or at least so I'm told. So by this light it was prudent to pay these guys something to stick around so they wouldn't quit and use their knowledge to help someone else cash in (along the lines of Long-Term Capital Management, which got hosed in the unwind some years back partly because counter-parties had figured out their positions and knew they had liquidity needs that would make them sell right away for whatever they could get in a thin market.

So there's underlying bad behavior at various levels here, but arguably the bonuses (a) weren't really that and (b) were worth paying from the government's position. Though I should stress that none of this interpretation is based on my own personal & direct knowledge - it comes rather from what I've read and heard, so in legal trial terms it's hearsay.

4. I gather that the blowup over the "bonuses" is already creating extreme reluctance by private parties to participate in ongoing and new government bailout programs that might subject them to similar firestorms in the future. Then again, given the extremely dim view that many have, for example, for Geithner's new bank bailout program (e.g., see Krugman here), maybe that's not as bad as it sounds. Suppose it forced the adoption of better-conceived bailout policies.

5. The 90% tax may conceivably face a serious constitutional challenge notwithstanding Larry Tribe's assurances to the contrary. Not a surprise, perhaps, as Tribe can be a bit political in his bottom line constitutional judgments. One source of possible trouble could be a NY state case from a few years back, Pataki v. Con Ed, in which a provision denying rate adjustments to the Con Ed shareholders for the blunders that had led to the Indian Point nuclear power plant problems was struck down as a bill of attainder. Obviously, the 90% tax is being drafted with an eye to avoiding the same fate, by causing it to apply more generally. But in the Con Ed case, the court cited legislative history showing that the legislators were specifically angry at Con Ed for its bad deeds and wanted to inflict punishment (hardly unreasonably, but that's not the point when the question of law is bill of attainder). Needless to say, the record of enactment for the 90% tax (if it goes through) is hardly lacking in evidence that the legislators were specifically interested in nailing AIG. Not to say that this is necessarily fatal, and it is presumably being drafted with a keen eye to the problem, but there's precedent for treating the clear intent as adverse evidence on the constitutionality question.

How did people understand the brain before computers?

On the tennis court recently, I had been playing very well, then I lost my strokes and floundered horribly for a couple of sessions, then I was able to find them again and played very well this week.

The analogy that seems utterly compelling to me is that of a computer file somewhere in your system that you need to locate and access quickly in order to run a particular program in real time. Maybe with the additional detail that it needs to be on your "Recent Applications" list in order for you to find it effectively. But one couldn't have conceptualized it this way until PCs came into common usage.

AIG bonus tax

I was angered by the AIG bonuses. Sure, it's a bit of a pop symbolism issue, but I found it odious that these Typhoid Marys of finance - who ought to be unemployable for life, other than asking if you want fries with that, after all that they've done to their shareholders and the world economy - should get all those million dollar bonuses out of federal money, supposedly so they won't leave, when some already have and the rest probably should. Plus my anger reflected my belief that over-the-top executive compensation, as it's developed in the last decade, has not just been wasteful and misguided, but a primary cause of the global economic disaster. Burning the money would have been better for the U.S. and world economy than letting the people in these sorts of positions "earn" it by pulling monkeyshines that involved phony income plus all too real downside economic risk.

But a 100% "tax" on a specific group of individuals with respect to items paid before enactment of the "tax" certainly makes me uneasy. (Scare quotes because - though I am no constitutional law expert - the narrowly targeted 100% rate seems to put it on the wrong side of the amorphous line between a tax and a Fifth Amendment taking.)

Frankly, it doesn't bother me in the slightest if the 100% tax applies just this one time to just these people. They would appear to deserve it many times over. But one can never be sure that one isn't creating a precedent with legs. Might the device someday be used against someone else who just happens to be unpopular?

I'd actually like to make an example of these guys - as the French would say, "pour encourager les autres," as well as for general public morale. But I'd prefer a better way of doing it, such as investigating them for looting and fraud, which might have been amply justified even without the bonuses.

This is how it starts

Alternative title: "Well, duh."

From the New York Times:

"The Chinese prime minister, Wen Jiabao, spoke in unusually blunt terms on Friday about the 'safety' of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to offer assurances that the securities would maintain their value.

"Speaking ahead of a meeting of finance ministers and bankers this weekend near London to lay the groundwork for next month’s Group of 20 summit meeting of the nations with the 20 largest economies, Mr. Wen said that he was 'worried' about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely....

"In January, Mr. Wen gave a speech criticizing what he called an 'unsustainable model of development characterized by prolonged low savings and high consumption.' There was little doubt that he was referring to the United States."

If I were Wen, I'd be worried too.

This is how a nation's credit reputation starts unraveling.

Tax policy colloquium on David Duff's "Tax Fairness and the Tax Mix"

Yesterday we had our ninth session of the year, and last before spring break, discussing the above article by David Duff, who has long been at the University of Toronto Law School but is moving to the University of British Columbia Law School, in Vancouver. (In weather terms, this is a bit like trading Boston for Seattle, which sounds pretty good to me after the 3-and-counting monstrously brutal winter months that we've had here in New York.)

The paper posits that different fairness norms apply to different elements in the tax structure. On reading the paper, this struck me as requiring one to deny or disregard the fungibility of money. But, as often happens at the colloquium lunches in advance of the sessions, we discerned that he actually meant something a bit different.

David classifies himself in philosophical terms as a liberal egalitarian, opposed to the welfarist and libertarian traditions, but he disclaims what at times can be the vindictive face of liberal egalitarianism - its suggestion, in some proponents' hands, that we should turn our backs on people who have made mistakes, rather than trying to help them out, because somehow this "respects" them more as moral agents. I personally am quite willing to suffer "disrespect" in the form of compassionate rescue if I ever need it. Another occasional implication of liberal egalitarianism that he disclaims is that equalizing opportunity downward is just as good as doing so upward. (This led to the retort at one conference I once attended that the best possible way of implementing equal opportunity is through global thermonuclear war - then we'd never have to worry again about some people having better opportunities than others.) What he does mean by liberal egalitarianism, however, was less clear - though this was partly our fault not his, because as usual we didn't get to the phantom "Topic 3" on our discussion list.

The paper perplexed me a bit by arguing that, wholly without regard to distributional issues, a VAT with an exemption amount would be the right way to pay for public goods. To me, it would seem that the only reason for having high earners pay more than low earners is distributional. David gets there by following Blum and Kalven to the effect that we should totally ignore benefit from public spending and pretend it was wasted, for purposes of deciding who should pay. He then argues for equalizing individuals' total sacrifice, as a loosely libertarian-style privileged baseline - from which (unlike the libertarians) he would then be willing to redistribute as well, but in his mind through a fundamentally different exercise.

I argued in response, inter alia, that "total sacrifice" is incoherent. E.g., just because we can't measure benefits going the other way doesn't mean that we should counter-factually pretend that they're zero. More generally, there simply is no meaningful baseline of "public goods without financing" - his revision to the libertarians' supposed state of nature - from which to measure total sacrifice. Nor would I find the exercise normatively motivated even if I thought it was coherently definable. But to each his own, and one need not always agree to have a civil and productive discussion.

We may have waited too long to clone Shadow ...

Followers of my cats will be glad to hear that Ursula, knock on wood, is doing a lot better. She's overcome her kidney infection and now just needs a couple of water shots a week. She's silky and active as ever, and has a better appetite than she's had for months if not years.

Ursula is cautious and doesn't like strangers, but it's nice to be one of her favorites. If she hears me on the floor exercising (attempting to stave off the 6 main injuries I periodically get from playing tennis), she will come up, purring and fluttering, rolling on the floor, bashing her head against my hand, leg, or head, etcetera. She also seems to really like it when I shave - perhaps the electric shaver sounds as if I'm purring.

She's remarkably astute about figuring out when I'm on the verge of grabbing her for a water shot. Turn your head for one second and she's gone. Luckily, she only has about 5 main hiding places. Once I get her, she simply issues a piteous mew and shrinks down, rather than fighting, but with her heart beating madly. There are no hard feelings afterwards, however.

Shadow, at age 18, is not doing so well as Ursula at age 7.
At this point he has diabetes, kidney disease, an ear infection, and either hyper- or hypo-thyroidism, each requiring extensive treatment that he bears in good spirit. He has little appetite or energy, and his litter box consistency has disastrously declined, but he still has one of the great temperaments I have ever known from an individual of any species. I fear we are in the endgame with him, and that is generally not pretty.

Should the U.S. restate past years' GDP?

At one point during my book session at the Urban Institute today, I made the comment that, just as the SEC sometimes makes companies restate past years’ income which turns out to have been partly sham, so maybe the U.S. should have to restate GDP for the last few years. Think about it – the financial sector was nominally producing 8% of the total, and much of this appears in retrospect to have been wealth transfers unaccompanied by the actual performance of services or creation of value.

E.g., suppose a firm made tons of money by purporting to insure 100% of New Orleans’ hurricane risk. The premiums go into GDP on the view that they are not just transfer payments but reflect the value of the insurance. Then Katrina hits and the firm goes bust since it’s totally unable to cover the undiversified risk. Was there ever really national income from the insurance premiums, or was this (take your pick) theft or the equivalent of a transfer payment?

That, of course, is basically the story of AIG. “We didn’t know a hurricane would actually hit New Orleans – our climate model, based on the previous 5 years’ results, showed no severe hurricanes in New Orleans whatsoever.”

OK, I’m engaging in a bit of snark here, not to mention argument by anecdote. But the underlying point is a serious one. Think of all the CDOs that were being swapped around for billions of nominal dollars. There was perhaps some genuine value creation mixed in there – diversifying within mortgages and creating risk tranches wasn’t entirely worthless – but due to the bubble economy the market prices grossly outweighed the actual value creation.

If there’s one thing we try to avoid in measuring GDP, it is making subjective evaluations of value rather than simply looking at prices and transactions. But what ultimately matters is the subjective underlying stuff – the actual creation of things people value. If there’s one thing we’ve learned in the bubble economy of the last few years – other than the facts that transparency is far lower and managerial incentive problems far graver than we realized – it is that prices really can go far, far away from the underlying subjective fundamentals that we care about.

I don’t, of course, seriously propose that we restate past years’ GDP. But it’s important to keep in mind that, even before the crash hit, we were not as rich as we thought we were, and in judging this conventional economic measures can lead us far astray.

Urban Institute event on Decoding the Corporate Tax

This morning, I attended a book event at the Urban Institute discussing my corporate tax book. Good crowd, maybe about 80 people, apparently plus a webcast audience. My PowerPoint slides for my portion of the event are available here.

Greg Ip of the Economist was the moderator, and the discussants were Rosanne Altshuler of Urban/Rutgers Economics, Dan Halperin of Harvard Law School, and Pam Olson of Skadden Arps (formerly Assistant Secretary of the Treasury for Tax Policy).

While the discussants naturally focused on the policy proposals I make at the end of Decoding, I mainly devoted my comments to an overview of the whole thang, as I believe its main and most enduring value relates to the broad question of how one should think about and understand the corporate tax.

Rosanne emphasized the difficulties of deciding where to head in U.S. international taxation as between the worldwide and territorial approaches, and noted that her burden-neutral proposal (with Harry Grubert) to repeal deferral, which I propose to extend to foreign tax credits as well, needs a lot more fleshing out than any of us have given it as yet. She also noted the importance of the U.S.’s having an usually high marginal corporate tax rate by worldwide standards, even if our effective rates are considerably more within the norm.

Dan made an excellent point that the book at least rhetorically underplays a bit, namely that many of the problems raised by corporate integration would apply as well to lowering the U.S. corporate rate. For example, effects on debt-equity choices, the use of corporate tax preferences, and whether we want to use the corporate tax in order to impose an indirect levy on tax-exempts such as Harvard University (his example) really are common to both. This leaves, however, the difference that lowering the entity-level rate applies to inbound investment by foreign corporations, and affects incentives to transfer-price international income into, as opposed to out of, the United States.

Pam addressed corporate governance issues and book-tax conformity in income measurement. While she questioned my exact proposal (50% conformity between taxable income and an adjusted measure of book income), she joins what I think is a growing consensus (at least outside the accounting profession) that the gap between companies’ book and taxable income is too troubling to be dismissed with the airy statement that, gee, the two systems are just different.

Greg asked me about a comment I had made in chat before the start to the effect that I questioned the Obama Administration’s budgetary claim to have $200 billion of revenue to be garnered out of “reforming” deferral by U.S. multinationals. I explained that I was skeptical that the money will turn out to be there either as a matter of legislative politics or straight revenue-raising, and that it’s questionable how much more money we can try to get out of U.S. multinationals when the underlying thing we are taxing – the decision to classify one’s investments as made through a U.S. corporate resident – is so trivial and, over the long term, easily changed.

Tax policy colloquium on Michael Doran's "Managers, Shareholders, and the Double Corporate Tax"

Yesterday's discussion returned to more traditional law school tax policy fare, concerning corporate integration and the Bush Administration's partly failed 2003 attempt to accomplish it via dividend exemption. Michael's thesis in his paper is that the political economy story developed in prior work, such as the well-known article by Jennifer Arlen and Deborah Weiss, needs to be revised. Arlen-Weiss emphasize agency costs, in the form of managers not really caring about the transition windfall to shareholders that unanticipated adoption of dividend exemption would provide, and preferring instead to get incentives for new investment plus an excuse not to incur tax burdens by making dividend distributions.

I like the Arlen-Weiss paper, though my views differ a bit in emphasis since I give greater relative importance to (a) the "populist" problem of people thinking that corporations are "people" and should pay tax plus shareholders are wholly separate people and should also pay tax, plus (b) the interest group problem in which managers are aligned with shareholders to prefer targeted tax breaks for their own industries rather than a general corporate-sector improvement in tax treatment. [Actually, diversified shareholders might rationally prefer general corporate tax reform after all, but as shareholders of a given company their interests arguably are aligned with managers regarding targeted giveaways.] But this isn't a big disagreement, just a difference in shading or emphasis.

Anyway, Michael posits that the Arlen-Weiss story is too simple [note: Jennifer Arlen might not agree with how her story is characterized] and needs to be overhauled to give much more pride of place to the issue of heterogeneity. Lots of different players are affected by corporate integration in different ways. E.g., for a given integration proposal, those in some industries might be aided while others are hurt, depending on differences in industry, effective tax rate, shareholder clientele base, etc. Michael reviews the 2003 story, and sees it as all about heterogeneity creating gridlock, rather than the managers defecting from being the shareholders' faithful agents.

As lead commentator, Alan Auerbach emphasized that heterogeneity exists on all sorts of issues yet legislation happens, and presumably exists worldwide with respect to corporate integration yet it has frequently happened everywhere else around the world (albeit that it's been in retreat lately in Europe due to EU problems). So why is this issue special and why is the U.S. different on this issue?

Further discussion pushed us (or at least me) towards the view that the 2003 issue is a bit of a simpler story (and less of a change to Arlen-Weiss) than generalized heterogeneity. The 2003 dividend exemption would have been a substantial blow to the value of corporate tax preferences because it only offered dividend exemption to previously taxed corporate income. This meant that, if you used tax preferences to avoid corporate-level tax, you would get hit at the shareholder level by distributions. Companies that use lots of tax preferences (such as the low-income housing credit) screamed bloody murder and got House Ways and Means Chair Thomas on their side, whereupon it was game over. The proposal went to a 15% rather than a 0% dividend rate, and the feature requiring previous corporate-level tax payment on the distributed income disappeared.

As a general matter, I happen to like reducing the value of corporate-level tax preferences. But it seems clear that, due to this feature, the 2003 dividend exemption was not pure corporate integration. It was corporate integration PLUS corporate-level base-broadening. A pure corporate integration approach would have been "ceasefire in place" regarding the value and usefulness to taxpayers of corporate-level preferences. It's no big surprise that base-broadening faces heavy political obstacles, so what we really had in 2003 was a standard interest group story, much more than a broader heterogeneity story about corporate integration or dividend exemption in general.

CLARIFICATION: After sidebar conversations with a reader who disagreed with my apparent statement that "pure" corporate integration means keeping the preferences, I should emphasize that what I meant above is not (a) that "pure" integration means having tax preferences, but rather (b) that, given where we are now, changing the corporate tax rules purely on the integration dimension would mean ceasefire in place as to the tax preferences. Again, I'd greatly prefer corporate integration with smaller tax preferences than with the same ones, but I would then regard myself as having changed two dimensions.

One further interesting point that came up in the discussion concerned the reasons for U.S. exceptionalism with regard to the double corporate tax. People in the audience noted that U.S. shareholding in public companies is much more diversified than, say, in Europe, where family corporations play a much bigger role. So the publicly traded sector in the U.S. does less to fight for corporate integration than it would in the family firm scenario (basically for Arlen-Weiss reasons). But then it was further noted that there are plenty of closely-held businesses in the U.S.; only, they can generally avoid falling into the C corporation tax world, even if they want limited liability for owners, as they can elect to be taxed on a flowthrough basis as S corporations, or can be LLCs that elect to be taxed as partnerships. Other countries don't have the S corporation route as such. So the hypothesis is that the U.S. is less politically unusual than it seems (or rather is unusual only in having a distinctive institutional twist). If this view is correct, we have simply let the closely held firms opt out of the double tax on the side and hence faced less political pressure to let out the rest.

Amazon availability

Decoding the Corporate Tax is now available on Amazon, though bn.com isn't up yet.

An Amazon purchaser reminds me that the price of the book is just barely high enough to ensure free shipping even if you don't purchase anything else. Such a deal.

Paging Walter Blum

Walter Blum, an eminent tax scholar and professor of law at the University of Chicago when I arrived there in 1987 who was also a great mentor to me, used to say to his Tax I class, at the beginning of Day 1, that the Dean had just raised his salary. But the problem was that this would put him in a higher tax bracket. Didn't this mean that he should ask the Dean to rescind the raise?

Wally was a classic (though humane) Socratic-style teacher, so for this to work he had to find someone who would actually get it wrong and believe that the answer was yes, whereupon he could poke gentle fun for a while until the point emerged that this was just the marginal rate on the last dollar he earned - so he'd be ahead after tax from an extra dollar of salary no matter what.

Among the reasons I would never try this myself, in my Tax I class, is that I know I would get the right answer, preventing the gambit from working for me pedagogically as it did for Wally. Given this problem, a Chicago colleague once asked Wally how he made it work. He answered "I just look around the room until I see someone who I know is going to get it wrong." (This at the start of the first class of the semester, mind you.)

Well, apparently Wally was not the only one capable of finding someone who would get the marginal rate question wrong. ABC News found someone as well, and decided to hire her and give her a platform as a reporter on budget issues. Emily Friedman, it's time for your closeup. She has now posted a column guilty of exactly this fallacy, and therefore positing that lots of rich families will respond to the Obama budget plan by trying to drive their incomes below $250,000.

You even can vote, if you like, on whether doing this is "fair"!

Jon Chait of the New Republic calls this the dumbest news report he's ever seen, admittedly a high standard.

As hilarious as Friedman's bonehead blunder itself is the classic reportorial method she uses to establish it. The article starts with a bunch of interview quotes from people who evidently are guilty of the marginal rate fallacy and are consequently making plans to get rid of clients and patients, etcetera. Then she quotes an expert who discusses the feasibility of getting below $250,000, but then says it won't really matter if you're at $249,999 or $250,001. This is not well explained or picked up on, however. Then Friedman goes with another "expert" who posits that Obama's proposal will lead to class warfare. Finally, back to the bonehead taxpayers who misunderstand how the proposal works, to close with a heart-tugging bit about how they're overtaxed.

In conventional mainstream media terms, the article is fine. After all, it is merely a viewpoint (albeit a true one) that the Obama tax plan would work as it actually works. It is also a viewpoint that it works differently from how it actually works. Friedman names her sources and leads with the ones who are more fun. Even if she knew the right answer, I suppose it wouldn't be "objective reporting" by her lights if she said so.

Tax policy colloquium on Leslie McCall's "Americans' Social Policy Preferences in the Era of Rising Inequality."

Last Thursday, we followed our recent once-a-year tradition of having a paper by a political scientist, in this case Leslie McCall of Northwestern & Princeton concerning American public attitudes towards progressive redistribution. Main takeaways: (1) Americans are more redistributive (and less different in this regard from Europeans) than has widely been thought, (2) in general, concern about income inequality grew in the 1990s with actual inequality, and (3) such concern tended not to produce support for more progressive income tax rates or a larger welfare system because people were skeptical about those two institutions. Instead, it was largely channeled into support for education (believed, perhaps erroneously, to lead towards more equal results) and regulatory issues such as immigation, the minimum wage, and CEO pay.

Generally the story was convincing, although there's only limited data (from large-scale surveys undertaken over the last 20 years). Some of the points we made at the session concerned (a) the difference between addressing the rich and aiding the poor in how people in the middle think about inequality, (b) the importance of whether one's own income is rising or stagnant to how one thinks about those who are getting a lot richer, and (c) the lack of any strong reason for expecting, not withstanding the median voter hypothesis, that our political system will produce increased redistribution even if the median voter wants it.

The recession hits home

The first restaurant I chose for one of our upcoming post-Tax Policy Colloquium dinners turned out to have gone out of business. I first went to it almost 20 years ago. It had been a West Village fixture, and it did a large remodeling not that long ago.

The second place I tried, which as recently as last summer was one of the hot spots in the Meatpacking District, is only open 3 nights a week now. Evidently they're hunkered down and trying to survive the storm. I don't think they'll make it.

Some quick preliminary thoughts on President Obama's federal budget

1) Changing the official baseline to include the costs of patching the AMT and funding the Iraq and Afghanistan wars greatly increases the honesty and transparency of the document. As time goes on, it’s going to be interesting to try to give fair credit while also noting the inevitable instances in which there is still less than 100% straightforwardness and candor. GW B*sh – I don’t think I should print in full here ugly 4-letter curse words – set the bar for honesty so low – 20 feet underground or so – that it’s hard to get back to normal evaluation. And I feel it’s the job of someone like me to hold the new Administration’s feet to the fire a bit, and demand more than one could really politically expect. But they should also be credited for the dramatic change in norm.

2) It’s true that putting the above things into the baseline means one doesn’t have to pay for them in order to maintain the acknowledged baseline. But that perhaps would set the bar a little too high at this early stage.

3) While there are serious empirical questions about the revenue to efficiency payoff from raising top marginal rates, my own judgment is to be fine with going back to 39.6%. Reducing the tax benefit from top-bracket itemized deductions is a step in the right direction as well.

4) The Making Work Pay credit in the current stimulus package reaches too high in the income range to be effective stimulus – it would be much more cost-effective if cut off sooner. Its permanent retention in the budget raises different sorts of issues. Essentially, it lowers marginal tax rates (MTRs) in the lower brackets by a more convoluted mechanism than simply cutting down the Social Security payroll tax. Budgetary accounting in the Social Security Trust Fund is the reason for the indirect methodology. Despite the Making Work Pay credit’s name, I think of its rationale as stronger in distributional than efficiency terms (i.e., it benefits recipients more than it improves overall work incentives since it will often be inframarginal).

5) Turning to the items listed as loophole closers:

--I’m certainly fine with the carried interest change, much discussed in this blog and elsewhere a couple of summers ago, but the devil is in the details – it could easily be (mis-)drafted to accomplish nothing. Senator Schumer a couple of years ago proposed applying the change more broadly than just to hedge funds and the like – e.g., to real estate and oil and gas partnerships. Viewed by many at the time as a deliberate poison pill, this was also clearly a desirable change in the proposal if actually adoptable. I don’t know yet how broadly the Administration is proposing to implement the change.

--Eliminating various oil and gas company preferences also is all to the good. An amusing bit of history for me is the proposal to raise two to six million dollars per year, starting in 2011, by eliminating the oil and gas “working interest” exception to the passive loss rules. I was working on the Joint Committee of Taxation staff in 1986 when this exception was added to the Senate Finance Committee tax reform bill. Trivial though it was, we were told that failing to adopt it would change the committee vote on fundamental tax reform from 20-0 in favor – all to the tune of speeches about how this was the greatest tax bill in history – to at least 11-9 against. I’m almost reminded of the old joke about academics, saying that the fights are so bitter because the stakes are so low.

--Repealing LIFO inventory accounting is probably a good thing as well, despite the view that LIFO provides indirect partial inflation indexing.

--Codifying the economic substance doctrine gets a revenue estimate (rising swiftly to almost a billion dollars in 2019) that seems to be a bit high, given that I regard the change as almost a ceasefire in place, apart from its (a) preventing courts from saying there is no such doctrine and (b) tilting the scales a bit towards a tougher rather than a looser interpretation of the doctrine. I believe past revenue estimates were even higher, however.

--“Implement international enforcement, reform deferral, and other tax reform policies” gets scored at $70 billion for the next 5 years and $140 billion for the five years after that. Sounds a bit ambitious. Most academics in the international tax policy area, including me, are skeptical about both the merits and the feasibility of attempting significantly to increase the taxes paid by U.S. multinationals on investment abroad. Corporate residence (since the outbound taxes only apply to what are treated as U.S. resident corporations) is too weak a reed to bear so heavy a weight. This one bears close watching as the details emerge.

--Extend low tax rates for dividends and capital gains, but put them at 20 percent rather than 15 percent. This is about where I would go as well. As per my book,, while there’s little rationale for the corporate double tax, and in particular for taxing dividends (other than as a backstop to the corporate level tax), it’s probably better to focus any tax reduction on the entity rather than the shareholder level. Capital gains are one case where Laffer curve considerations actually do emerge within the politically and administratively feasible set of tax rates. 20 percent is still well below the revenue maximizing rate (and one would want to be below that). They score this as a revenue loss because the baseline is expiration of the Bush tax cuts, but presumably the change from 15 to 20 percent raises non-trivial revenue.

Upcoming D.C. panel on "Decoding the Corporate Tax"

Here is a link for a forthcoming event in Washington, D.C., at the Urban Institute (2100 M Street) on Wednesday, March 11, from 9:00 to 10:30 am, discussing my new book on corporate taxation.

Official description of the event is as follows:

Significant reform of the U.S. tax system must include changes in the complex and inefficient way we tax corporations. What direction should reform take? Many have embraced the idea of integrating the corporate and individual tax. But in his forthcoming Urban Institute Press book, Decoding the U.S. Corporate Tax, Daniel Shaviro argues that there are more promising directions for 21st century corporate tax reform. He considers significantly lowering the corporate rate, embracing international tax simplification, and requiring partial conformity between tax accounting and financial income. Panelists will debate these provocative ideas in a lively discussion of Shaviro’s prescriptions for corporate tax reform.
Panelists:
• Rosanne Altshuler, Senior Fellow, Urban Institute and codirector of the Urban-Brookings Tax Policy Center
• Daniel Halperin, Stanley S. Surrey Professor of Law, Harvard Law School and Urban-Brookings Tax Policy Center (visiting)
• Gregory Ip, U.S. economics editor, The Economist, (moderator)
• John Samuels, General Electric, Vice President and Senior Counsel for Tax Policy
• Daniel Shaviro, Wayne Perry Professor of Taxation, New York University School of Law

Interview concerning my new book

A brief NYU interview concerning my new book, Decoding the Corporate Tax, is now available here.

AEI session on Viard (ed.), Tax Policy: Lessons from the 2000s

This morning I appeared as a discussant at an AEI book panel in Washington, concerning the above book. I offered comments on 3 excellent papers, by (1) Alan Viard and John Diamond concerning unfinanced tax cuts, (2) Dhammika Dharmapala concerning the 2003 dividend tax cuts, and (3) Alan Auerbach and Kevin Hassett concerning the dividend tax cuts and bonus depreciation.

Power Point slides for my comments, which I tried to make reasonably lively, can be found at the upper right hand side of the webpage here. Among other things, I explore the "Three Bears" theory of the stimulative effects of bonus depreciation, and disagree with Laurence Kotlikoff (a commentator on one of three papers) regarding the definition of rationality.

U.S. fiscal situation

Having found the time to read the Auerbach-Gale fiscal gap paper more carefully than when I recently posted about it, the following points seem especially pertinent:

(1) We have a really huge fiscal sustainability problem that the financial crisis has made significantly worse, but that the stimulus legislation, if its provisions generally expire in a couple of years as expected, affects only slightly. In my recent article about the fiscal gap, what I considered the most reasonable projections (in terms of projected current policy for future years) from the perspective of mid-2008 placed it at $103 trillion, whereas a similar Auerbach-Gale estimate now places it at $118 trillion. This may not be entirely apples to apples, however. Current stimulus initiatives are trivial compared to this if they are indeed temporary.

(2) Paul Krugman and his acolytes like to say that we don’t really have a budget crisis, but rather a healthcare crisis. My common response has been – why would it be just one or the other, when clearly it’s both? The twin crises relate to each other like overlapping circles in a Venn diagram. Medicare, Medicaid, and other healthcare subsidies fit into both, but each also has lots of independent elements (e.g., Social Security and unsustainable tax cuts for the fiscal crisis, employer-provided plans’ long-term feasibility for the healthcare crisis). Against this background, Auerbach and Gale note that the Bush-era tax and spending changes added about as much to the fiscal gap as everything attributed to healthcare does. (This may involve counting Medicare prescription drugs towards both, as it was a Bush-era policy change.)

(3) Deficit accounting for TARP and other Fed or Treasury interventions presents an interesting topic that perhaps has received too little attention. Two alternative methods, as always when we are thinking about deficit accounting versus true long-term accounting, are cash flow on the one hand and economic accrual on the other. The Fed’s activities appear to be getting accounted for on the basis of whichever is lower as between the two. TARP is being accounted for on a present value basis, with only the present value subsidy being added to the deficit. This led to $461 billion of TARP outlays as being scored at only $184 billion, reflecting the present value of expected future recoveries. Fair enough, but the Fed has also extended more than $1 trillion in financial support to banks, corporations, etc., scored at zero on the view that these are just loans, but in fact exposing the Federal government to significant downside risks that presumably have a present value (these are not arm’s length commercial loans) and yet that are ignored for deficit measurement purposes.

(4) It’s stunning to read in Auerbach-Gale that the market for 5-year senior U.S. Treasury bonds is now, for the first time in known history, pricing in a non-trivial default risk. They estimate the market’s perceived default risk for Treasury bonds – within the next 5 years, mind you – at about 6 percent. This estimate admittedly reflects disputable assumptions, e.g., about the percentage recovery people expect in the event of a Treasury default. Arguably, the true figure is either higher or lower. But the world is changing faster than we thought if the prospect of a U.S. Treasury default is already starting to affect world financial markets.

At this point, nasty world capital market events such as a run on the dollar can no longer reasonably be considered impossible even within the relatively short term.

But seriously folks

The busier you are, the more you need to waste time. Today, facing numerous pressing tasks, I started from a link at aldaily.com and found my way to an ancient Greek joke book, the oldest known & extant one, which actually can be read on-line here.

Samples of ancient Greek humor, which certainly ought to make us feel better about our own comic tradition, include the following:

An Abderite saw a eunuch talking to a woman and asked if she was his wife. When he replied that eunuchs can’t have wives, the Abderite asked, ‘So is she your daughter then?’”

An egg-head doctor was seeing a patient. ‘Doctor’, he said, ‘when I get up in the morning I feel dizzy for 20 minutes.’ ‘Get up 20 minutes later, then.’

A student dunce is voyaging on a very stormy sea. When his slaves start to wail, he tells them; "Don't worry - in my will I set you all free!"

Cultural overlap notwithstanding (since the Greeks are our precursors), the human genome must have a sequence somewhere for corny jokes.

Upcoming appearances

I was just interviewed regarding my new book Decoding the Corporate Income Tax for the NYU Law website. I'll post the link when it's up.

This Wednesday, I'll be at the American Enterprise Institute for a book panel from 9:00 to 10:30 concerning their newly published paper collection, Alan Viard (ed.), Tax Policy: Lessons from the 2000s. I'll be commenting on 3 articles, all good contributions to the literature, by (1) Viard and John Diamond concerning unfinanced tax cuts, (2) Dhammika Dharmapala concerning lessons learned from the response to the 2003 dividend tax cut, and (3) Alan Auerbach and Kevin Hassett concerning lessons learned from the dividend tax cuts and the temporary adoption of partial expensing for business equipment.

On Wednesday, March 11, I'll be at the Urban Institute for a book panel concerning Decoding. Further details soon.

Gov. Bobby Jindal's family values

One is hardly surprised by Governor Jindal's eagerness to position himself for the 2012 Republican nomination contest by showily turning down a tiny piece of the stimulus funding. But it's sobering to think that there will likely be children going to bed hungry because he decided to grandstand with regard to unemployment benefits.

Musical and literary update

I've been listening lately to Amy Rigby (among lots of other things), having come across reviews of her new album with Wreckless Eric, which I still don't have (though it's attractively priced as an Amazon mp3 download). Sampling her older stuff, initially I had to get past the fact that stylistically it really isn't anything new - Dylan '66/Byrds folk-rock and late-70s powerpop are among the obvious influences. But she's a great songwriter, witty and acid with a great voice (by which I don't mean her singing voice, although that's very good too). She's in the singer-songwriter genre, but is much less confessional than a portraitist giving a kaleidoscopic view of a demographic (woman in late 20s through 40s dealing with everything internal and external). Radically changing mood and outlook from one track to the next.

Reading for pleasure isn't always easy during a semester, what with the weekly demands of classes, faculty obligations, presentations and conferences, etcetera, but I've just finished, and greatly enjoyed, the Arthur Schlesinger diaries. If you know a fair amount about (and are interested in) the U.S. political scene from the 1950s through the end of the twentieth century, the diaries offer a really engaging inside look, intimate with and opinionated about lots of the big players, and freshened by the lack of foreshadowing since Schlesinger the diarist (unlike a historian writing after the fact) couldn't tell what was going to happen next.

Tax policy colloquium on Yoram Margalioth's "Employing Statistical Stigma as a Welfare Ordeal"

Last Thursday, we discussed Yoram Margalioth's "Employing Statistical Stigma as a Welfare Ordeal." In the welfare literature, stigma, leading to low take-up of benefits by eligible individuals, has been viewed as purely a bad thing, to be minimized, not only because it inflicts a bad experience on benefit claimants but because it discourages claiming by intended beneficiaries. The paper argues that a special type of stigma (whether or not that's the right name for it) can have desirable properties as a screening device, helping to focus claiming of benefits on the people who really ought to get them, thus permitting greater aid to those people.

Traditional stigma, in the paper's account, is the feeling of being a failure because one is unable to support oneself. As a matter of empirical description, I felt the paper overly viewed this as something purely internal, i.e., if I'm a prospective claimant I hate feeling like a failure, but exposure to others doesn't make it any worse. I would think that, as a common psychological matter, bad as it is to feel like you have failed, letting others know makes it far worse. Better to lick one's wounds in private.

The paper agrees that traditional stigma appears to have no good sorting functions in the form of discouraging claimants who ought to be ineligible but aren't given the imperfection of screening via eligibility rules. But it argues that another type, which it called "statistical stigma," can serve as a helpful screen. Suppose we have a benefit program for people with low earning ability but that some who don't need the benefits manage to con their way in. But suppose that people in the neighborhood both (a) have greater information about ability levels than the government can hope to get in screening for eligibility, and (b) will dislike false claimants, either directly for cheating in a government program or on the view that this is the evidence of broader dishonesty that might infect the claimant's other social dealings. Then being known locally as a claimant would tend to have positive screening characteristics, because those who truly were high-ability would tend to get stigmatized as suspected cheaters more, all else equal.

The point holds intellectually within its defined terms, and skepticism at the session focused mainly on the question of how well it applies to real world settings. We felt it was generally most likely to play a role in cases such as parking in disabled spaces in the shopping center. Among the issues potentially challenging its broader applicability were those of heterogeneity (in neighborhood values, in claimant temperament, etc.) and of traditional stigma's potentially outweighing statistical stigma in various welfare-type settings.

Institutional Foundations of Hackery

The blog post title above is a backhand reference to the title of my recently published book, Institutional Foundations of Public Finance, co-edited with Alan Auerbach, and collecting the excellent papers from a 2006 conference at NYU Law School in honor of David Bradford. But the topic I have in mind is considerably less edifying than David's work or that of any of the authors in that volume. We in academics have it easy, what with tenure plus our internal review mechanisms and prestige competitions. Personal taste aside, I actually find that I have strong career incentives to be honest in following ideas and arguments wherever they properly lead. One earns more respect that way. In our biz, not just hackery, which deserves any punishment it ever gets, but predictability is sometimes penalized - perhaps unduly, since, while it's genuinely a fault, avoiding it through quirky, whimsical schtick can be even worse.

But in other parts of the policy-talk world, hackery can get entrenched like the battling armies at the Marne, grinding up anyone who dares to stick his head up or rather his neck out. (Sorry, too tired to think of a better metaphor.)

Getting to the point, I've been distressed lately by what I hear concerning Bruce Bartlett, who publishes regularly, and generally very interestingly, but has not had a think tank job since the National Center for Policy Analysis fired him in 2005 for daring to criticize George W. Bush.

Bruce is a strong traditional conservative, believing in Reagan-era principles such as free markets and limited government, who became convinced not just of the odiousness of the George W. Bush Administration (from conservative as well as liberal principles), but also of such heresies, from the standpoint of his "base," as the case for a VAT to prevent fiscal collapse and more recently the macroeconomic need for a large-scale stimulus program. Whether he's right or wrong - and I'd say he's usually right - you simply aren't allowed to say these things if you're otherwise on the conservative side. They may not kill you, but they certainly won't hire you.

In much of the media and think tank worlds - certainly on the conservative side, but I suspect it's not entirely limited thereto - the career path that pays is to be a hack, and to stick to the party line, never honestly evaluating issues but saying what you're expected to say.

I'm hoping and tend to believe it's better on the left, but it depends where one looks, and perhaps over time we will see. Certainly there are places where, for example, one might have to watch what one says about Social Security's long-term financing.

The institutionally entrenched command to obey top-down military discipline, or perhaps I should call it Maoist group conformity, not only is unedifying, but leads to debased and dishonest public discourse that literally risks destroying our country. Without honest debate one cannot consistently make sane choices, much less affirmatively good ones.

Perhaps Obama will make some good choices, though even then he'll have to sell them. But rational policymaking needs to have deeper roots than a particular president or it simply won't happen regularly enough.

2-9/10 cheers for flu shots

I got one last fall. Late last week, I suddenly felt what seemed to be a cold coming on. Then it turned into a couple of days of wipeout, with low fever but well short of the three-alarm job I remember from 9 years ago. Given the relative mildness, I was wondering if it was actually a bad cold rather than the flu, since one really expects a bit more from the latter (pounding headaches, dizziness, loss of appetite, weeks of exhaustion, etcetera). Not that I'm complaining or anything. Still, the typology felt more flulike.

Today I read that (a) the Northeast has been having a flu resurgence in the last couple of weeks, and (b) the shot often gives a 70% reduction in severity, rather than making you immune. So now I feel confirmed that I had the flu after all, and that the shot, while short of perfection, may have saved me from a couple of really brutal weeks.

Make sure you get those shots next year, kids.

Bad weather ahead

From the abstract of the new Auerbach-Gale article, The Economic Crisis and the Fiscal Crisis: 2009 and Beyond:

"In 2009, the federal deficit will be larger as a share of the economy than at any time since World War II. The current deficit is due in part to economic weakness and the stimulus, and in part to policy choices made in the past. What is more troubling is that, under what we view as optimistic assumptions, the deficit is projected to average at least $1 trillion per year for the 10 years after 2009, even if the economy returns to full employment and the stimulus package is allowed to expire in two years.

"The longer-run picture is even bleaker. We estimate a fiscal gap – the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt/GDP ratio at its current level –about 7-9 percent of GDP, or between $1 trillion and $1.3 trillion per year in current dollars.

"Recent trends in credit default swap markets show a clearly discernable uptick in the perceived likelihood of default on 5-year U.S. senior Treasury debt, a notion that was virtually unthinkable in the past. While it is difficult to know exactly how to interpret these results, it is clear that – although fiscal policy problems are usually described as medium- and long-term issues – the future may be upon us much sooner than previously expected."

As Margo Channing (Bette Davis) put it in All About Eve: "Fasten your seatbelts. It's going to be a bumpy [ride]."

A step towards more honest budgetary accounting

The Obama Administration deserves generous plaudits and hosannas for this.