A collective action / externalities rationale for Keynesian stimulus

I'm no longer surprised by the frequency with which good economists - of course, not all of them - fail to understand and apply basic economics reasoning. In the fields I write about professionally, I'd have to say I'm grateful, as it's good for business.

A key reason for these failures is that people get lost in the forest and can only see the trees. They play with models, use math, etcetera, but forget the basic underlying intuitions. Or, they become prisoners of simplifying assumptions that are often (but not always) useful, and forget that these assumptions should only be used conditionally and when appropriate.

Today's example is Robert Barro, who has a Wall Street Journal op-ed today (available outside the paywall here) claiming that Keynesian economics, unlike "regular economics," can't possibly make sense. Thus, with regard to the claim that Food Stamps or unemployment benefits could boost demand and help ease the recession, he concludes:

"There are two ways to view Keynesian stimulus through transfer programs. It's either a divine miracle—where one gets back more than one puts in—or else it's the macroeconomic equivalent of bloodletting."

And elsewhere he says of the at one time uncontroversial Keynesian idea that giving money to the cash-constrained can be stimulative:

"How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?"

David Glasner responds to Barro as follows:

"But wait a second. What does Barro mean by his query: 'Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?' Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

Glasner then asks whether Barro agrees with the real business cycle theorists who explained that the Great Depression merely reflected millions of workers' rational decision to take a nice long vacation until productivity and therefore wages were higher.

Paul Krugman jumps in as well, and mentions some of the standard points from Keynesian economics for which there is empirical evidence, such as sticky prices and wages.

But I have long thought it reasonably clear (as discussed somewhere in here) that a very familiar tool can do a lot of the work here - collective action problems. Economic models often simplify the world, and in the right setting with good reason, by taking people's preferences as given and assuming away interdependence. But suppose I am deciding whether to spend money on a nice vacation. Even in an entirely rational setting and with a flexibly responding price system, this may depend on how well I expect my business to do over the next few years. Suppose people who are considering whether to patronize my business have exactly the same thought in mind. Their willingness to buy goods and services depends importantly on their confidence that others will be buying their own goods or services. So, when everyone gets scared or anxious, there is a coordination problem. If only everyone could agree to shake hands and continue opening their wallets a bit, the problem would ease, but instead it feeds on itself, as belt-tightening here prompts responsive belt-tightening there.

To throw in another common buzzword, there's an externality here, as each individual's belt-tightening causes others to lean more towards belt-tightening, creating collectively self-fulfilling prophecies about low earnings potential.

Against this background, Food Stamps and unemployment benefits, by getting people to spend more (albeit perhaps more because they were cash-constrained than due to the vacation problem above) can get things moving in the other direction. People whose businesses start doing better change their estimats about how much it makes sense for them to spend, and things may start going the other way.

Back in January 2009, Barro had a WSJ op-ed that was almost as skeptical about stimulus, in which he said:

"[Keynesian theory] implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system."

Seen through the above lens, however, the price system in a recession or depression may be getting it exactly right so far as revealed preferences are concerned. Resources are idle because there isn't enough demand for the production that is being forgone. And given all that the price system is working just fine.

But the seemingly efficient equilibrium is far inferior in human welfare terms to the alternative one that would result if people could coordinate shifting to a higher-expressed demand, higher-output equilibrium.

This presumably is what Glasner means when he says: "Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure?"

And this is why the view that the Great Depression was just a nice long holiday, as people awaited higher productivity that would increase their willingness to swap leisure for work, has never seemed very intuitively persuasive.

But the use of collective action problems and externalities that I suggest here lies outside conventions that economists are accustomed to allowing in their models (which commonly take revealed preferences as given rather than conditional and interdependent, and assume away externalities unless clearly demonstrable like that from pollution). Also, the use I suggest is admittedly a bit informal and ad hoc, which economists may rightly be on guard against. But it is coherent logically, plausible intuitively, and permits one to make more sense of the world. Barro's apparent inability to see that it might be relevant, and thus his entirely misplaced sarcasm about whether Keynesian economics could possibly make sense outside the realm of "divine miracle," is more disappointing than surprising.

A quick comment on corporate tax incidence

Lee Sheppard has an article in today's Tax Notes that riffs off Mitt Romney's "corporations are people" comment last week to address corporate tax incidence.

Lee criticizes economic models suggesting that labor bears the main burden of the corporate tax, in part by stating:

"It has even become fashionable to say that labor bears something like 40 to 80 percent of the economic burden of the corporate income tax. This defies common sense. We know that because if labor bore such a significant share of the corporate income tax, corporate managers would not devote so much time and effort to fighting it."

Here's why I believe Lee is wrong about this. The incidence claims are about the long-term difference between equilibria. For example, suppose a country raises its corporate tax rate, within a couple of years this reduces the amount of capital that would otherwise have been invested in the country, and this in turn causes wages to be lower than they would otherwise have been. Proof of the causation in this sequence would demonstrate that labor was bearing some of the corporate tax increase via the wage effect.

In politics, however, people mainly care about short-term transition effects. Thus, suppose that today (without any prior anticipation of this happening) we simply repealed the corporate tax. Ignoring the deficit problems that this would cause, along with the rampant avoidance of the individual income tax that it would empower, who would be the big transition winners? Obviously, shareholders at the moment that the change occurred (or rather was announced) would get a huge increase in share value from eliminating all company-level income tax liability. Managers no doubt would win big-time as well. Meanwhile, wages for the most part would not change immediately.

This not only explains the observable political alignment on corporate tax issues, but is entirely consistent or reconcilable with the long-term incidence story that focuses on labor and wages.

Lee also complains in her article about a recent vote by the American Economic Association not to require disclosure of funding sources. She believes that private funding has undermined the objectivity of research, along with intellectual balance in the corporate and international tax fields. Treading carefully here, as I am on friendly terms both with her and with some of the people whom she might conceivably have in mind, let me just say that I agree this is a serious problem, which cannot be dismissed simply by defending people's good faith and/or incentive to preserve their own intellectual reputations. What is more, from conversations I have had with a variety of people, I can definitively say that many in the field share Lee's concern, including people who do academic research and/or are not fully on her side in the underlying debates.

Death of Bernard Wolfman

I'm saddened by the death of emeritus Harvard tax law prof Bernard Wolfman, whom I had gotten to know at HLS conferences, and whom I always enjoyed seeing again.

On the academic side of things, the two articles of his that I know best - both diatribes, but in each case justifiably so - are (1) an attack on the Supreme Court's egregious Frank Lyon decision (which upheld a sale-leaseback tax shelter, based on a silly list of 23 factors and a bizarre insistence that 3-party deals are inherently better than 2-party deals), and (2) a critique of Justice William Douglas' tax jurisprudence, which bizarrely switched, I believe it was in 1948, from being routinely pro-government to anti-government (except for one subsequent case, called P.G. Lake, in which Douglas apparently decided that he hated oil company executives even more than the IRS).

Each has some apparent back story. In the Frank Lyon article, I believe one can discern that Wolfman was unhappy on ethical grounds about the behavior of the renowned Erwin Griswold, a tax prof who had been his colleague (and the Harvard Law School Dean) not to mention Solicitor General of the U.S., and who thus carried some clout when he represented the taxpayer before the Supreme Court. In this case, Griswold seems not to have done his best to inform the Supreme Court accurately of the tax stakes in the case (which pertained to tax rate differences, since one of the parties had tax losses that made depreciation deductions unusable). In the Douglas article, Wolfman does not try to explain the reason for the 1948 change of heart, but I wouldn't be surprised if he knew a story that the late Walter Blum once told me, to the effect that Douglas changed sides in tax cases after he was audited, apparently in relation to reimbursements for his wife's travel expenses when he gave speeches. I've never tried to check out this story, but Douglas actually has a somewhat foolish dissent in a case involving this issue that is in my co-authored Tax I casebook. If true, however, bad move by the IRS but not very edifying so far as Douglas is concerned.

One part of Bernie's career that may not be well-known, but that he once told me about at dinner, pertained to his service in World War II. He was in an infantry division on the German front after D-Day, and apparently would have been right at the spot where the Germans attacked in the Battle of the Bulge, except that he was evacuated a few days beforehand due to severe frostbite in his feet. This he attributed to the fact that the U.S. Army, trying to be thrifty, gave its soldiers on the German front - in the middle of what was apparently one of the coldest winters there in the 20th century - footwear that had been designed for fighting in the scorching deserts of North Africa.

Warren Buffett on taxing the rich

Warren Buffett has drawn considerable attention with his op-ed in Monday's NYT suggesting that tax rates be increased for people at the top of the income distribution:

"Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent....

"But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.

"My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice."

Some on the right gibe that, if Buffett wants to pay more to the federal government, that's fine; he can do so any time he likes by making a voluntary donation. But Buffett wants people in his income tier generally to pay more tax, not just himself personally, so the critique is wide of the mark. He can't unilaterally achieve the social effects of a higher tax rate on rich people generally all by himself, and it's not especially selfish to ask "Why should I be the only one to pay more?" Perhaps it's equally wide of the mark on the same ground, however, when people on the left complain that those on the right shouldn't take advantage of government subsidies that they argue should be repealed.

As I discussed in my recent Tax Notes article, the policy Buffett advocates of imposing significantly graduated rates at high income levels is in tension with what long was the predominant view suggested by the optimal income tax or OIT literature (which takes distributional concerns into account, not just efficiency). But that consensus is increasingly vanishing, even within the OIT framework. I noted this (and some reasons for the change in views) in my article, and since then the Peter Diamond and Emmanuel Saez's have further spelled out some of the main arguments in The Case for a Progressive Tax: From Basic Research to Policy Recommendations.

Before one swoon too much over Buffett's nobility (though I do indeed find his stance praiseworthy), a caustic comment from David Miller may be in order. David notes that Buffett's "Berkshire Hathaway stock appreciated by $3 billion last year and, unless he is extraordinarily patriotic, there will never be any income tax paid on his unrealized appreciation. So his tax rate on the economic income he earned last year is more like 0.22% ($6.9/$3.039.9). Even if his tax rate on recognized income was increased to 100%, the tax on his economic income would be a little more than 1% ($39.9/$3.039.9). A mark-to-market tax on appreciation at a 15% rate would have raised $450 million in 2010 from Warren Buffett alone!"

David is the author of A Progressive System of Mark-to-Market Taxation, under which current year mark-to-market taxation of publicly traded securities such as Berkshire Hathaway stock would indeed be required, so this is no idle or random suggestion. Buffett presumably will never pay tax on the appreciation due to Code section 1014, which gives assets a tax-free basis step-up at death.

On the other side of the ledger, it is certainly fair to note that Berkshire Hathaway appears to pay tax at something like a 30 percent rate on its financial accounting income, if I am correctly interpreting this. I myself would count this as paid by Buffett, to the extent of his stock ownership. While there are disputes about the economic incidence of the corporate tax, similar questions could be raised about non-corporate business taxes that the owners pay directly.

I myself, if generally empowered to specify tax code changes, would opt both for corporate integration (so that Buffett wouldn't be taxed at two levels on BH's income - though, as it happens, I would prefer to concentrate the tax liability at the shareholder level, without regard to the payment of dividends) and for greater high-end rate progressivity.

Another point well known to those who have been following the budget debate, but perhaps worth mentioning here, is that solving the long-term U.S. fiscal gap realistically requires not just revenue increases from the top end of the income distribution, but extending significantly down the income scale to at least the middle-middle. With an aging population and retirement programs that serve important social purposes (and also are baked in to people's behavior and expectations), raising taxes just at the top will not be sufficient. But raising them at the top as part of the short-term budgetary response (if anything happens from the Gang of Twelve deliberations) would certainly be a start.

If Obama were shrewd ...

... then, instead of denouncing the S & P downgrade (tempting though that must be given their embarrassing track record and the $2 trillion computational blunder), he would have said "Yes, it's terrible that the Republicans have caused this. This shows how right I was about not endangering our credit, about the need for more revenue and a balanced grand bargain, etcetera."

As things stand, he risks making himself the downgrade's sole owner in the U.S. public mind, without necessarily having any effect on market confidence (downgraded debtors are expected to complain).

But the heading of this post makes it alternative history, along the lines of "What if Lee had won the battle of Gettysburg?".

Middle Earth alternative history

I've been greatly enjoying Kirill Yeskov's The Last Ringbearer. This is an alternative history / sequel to Lord of the Rings, written from a pro-Mordor, anti-Gandalf/Aragorn/elves viewpoint that is actually highly persuasive (if one can say this about a fictional world). It reviews what we thought we knew but didn't (due to our having only a biased winners' history) about the end of the Third Age, followed by a quest that aims to restore the balance that Gandalf et al had destroyed.

More information, including what I gather are legal downloading options, is available here.

Standard & Poor's expected Treasury bond downgrade

I agree with the S & P downgrade (if advance reports are accurate) in substance. That is, the U.S. has a significant chance of default because of political dysfunction, in particular the Republicans' recently demonstrated callousness about our credit standing and their unwillingness to increase tax revenues under (apparently) any circumstances.

But it's certainly not obvious that the market should care about the downgrade. When major U.S. companies issue bonds, S & P actually has some inside information if they've been consulted during the rating process. There may be conflicts of interest and the smart guys on the other side may snow them, but at least they get to see things that aren't publicly available. As I noted in an earlier post, this is not true in the government bonds setting.

Here's a somewhat farfetched theory as to why the market may care. S & P's willingness to downgrade, as a bid to enhance their "brand," is evidence that they think people in the audience for their performance will consider the downgrade credible. So if I am in the bond market, it is a bit of a Keynes beauty contest thing - someone with a real (reputational) stake has decided that others who are in the bond market will view this as a credibility-enhancing play. Note that pessimists may not directly participate in the market as much as optimists if the market is incomplete because it is costly to go short.

Nonetheless, I'd be unsurprised if there is no market response to the downgrade.

Obama's next two chances to capitulate

Both are set for September 30, when House Republicans can both cause a government shutdown (as Stan Collender explains) and force the gas tax to expire unless whatever demands they can think of are met.

By the way, there is no need to limit these demands to spending cuts. There will probably lots of unrelated demands as well. (Healthcare, oil drilling, reversing other regulations they don't like, any tax changes such as a dividend holiday that they happen to favor, etcetera.)

Given what happened the last time around, what would be the argument within Republican circles against playing these to the hilt? After all, neither involves threatening to destroy the full faith and credit of the U.S. government. And even if Obama genuinely plans to stick to his guns this time (not that I'd actually expect him to, closer to zero hour, even if he sincerely believes that he will), how could he possibly communicate this credibly to the Republicans?

Three mistaken views contrary to blaming White House incompetence for the debt debacle

It's much more fun to be counter-intuitive than to repeat the obvious. So, when we see overwhelming evidence of egregious and pathetic political failure by the Obama White House, there is no shortage of theories defending them (or at least saying that their political ineptitude was, as an appeals court might say in affirming a trial court judgment, harmless error).

Theory One is that he wanted more spending cuts than Democrats are comfortable with. So the Republicans gave him cover. As in: "See what they're making me do?"

Verdict: True that he had this motivation. Perhaps even true that it influenced his feckless negotiating "strategy." But surely he did not want to get rolled, and so publicly and humiliatingly rolled, by the utter failure of his oft-repeated insistence on getting revenues as well as spending cuts. So bottom line: False.

Theory Two is that he simply had a weak hand to play. Sure, he might not have played it well, but even a competent politician and negotiator wouldn't have done much better.

Verdict: 100% false. The public supported his preference for "balanced" cuts and tax increases. Now, admittedly, public opinion is often close to irrelevant in Washington. But he had a decent hand and failed to play it. Point one: the constitutional option and related gambits, all of which would have gained support from Washington's beloved "strong leadership" meme. Point two: skillful politicians can do much better with hands that are much worse than what he had here. Think Clinton in 1995 after he lost the 1994 election. Or for that matter consider the Republicans taking him on in 2009. If either had performed as abysmally as he did, people would have said: "They just had a bad hand. Nobody could have won with that."

Just because he lost doesn't mean he had an inevitably losing hand. In many ways it was a good hand.

Theory Three is that he's cleverly positioning himself in the center, and letting the Republicans be seen as extremists.

Verdict: Mostly false. People also respect strength, commitment, self-confidence, and success. His pathetic showing is not going to win him the 2012 election. He's disheartened his base, millions of whom will likely stay home. Clinton positioned the Republicans as extremist (when they weren't nearly as far around the bend as they are today) without making himself look like a pathetic loser.

The evidence that Obama has very little understanding of the most basic political tactics and strategy is pretty overwhelming. This is a guy who believes that you start a negotiation by offering LESS than you want, not more so that you can give ground and still do well overall.

Jon Stewart had some rather obvious fun with the December press conference clip where he said that of course the Republicans wouldn't risk the full faith and credit of the U.S. government, so there was no need to negotiate a debt ceiling deal back then. And for the past 6 months his minions have apparently been telling reporters that of course the Republicans will agree to new revenues, because reasonable people can't disagree that it's part of the problem.

He also appears to be strangely arrogant and uneducable about his woefully naive view of political competition. The Bourbons famously "learned nothing and forgot nothing." Obama will evidently learn nothing and forget everything.

Recent talk at Oxford summer symposium

I recently noted here my trip to Oxford in early July to present a paper and otherwise participate in an international tax conference. But in the press of events (even my summers are busy these days), I forgot to create a link to the slides from my talk.

At this year's Oxford conference, I presented a talk based on my forthcoming Tax Law Review article, The Rising Tax-Electivity of U.S. Corporate Residence, using revised and condensed slides. A link to the new slides is available here.

I have recently (and FINALLY, after months of intervening obligations, for the most part voluntarily if in some cases ambivalently self-imposed) gotten back to working on a completed revised version of my long-in-progress book on U.S. international taxation. At this point, I think I finally have it conceptualized properly. And I believe that this time, unlike in Decoding the Corporate Tax, which I admittedly like but which was basically (and avowedly) an accessible literature review, I'm making significant new contributions to how people should think about the field. The tax-electivity piece is one of the detours that I voluntarily set for myself because I felt that I needed to get my ideas in better shape first, and (along with my recent foreign tax credit work) it offers in passing some, though by no means all, of the ideas that I plan to detail in the new book.

Obama at the car dealership

"There's one thing you should understand before we start talking price. I need this car, and I know you want to be fair to me. We're both better off if we're both happy afterwards.

"I don't have transport - I sent the cab away, and I didn't bring my cellphone. So I promise you right here and now that, no matter what happens, I am not going to another dealership. Again, I need this car, and I know you want nothing more than a satisfied customer.

"So here's what I'm going to do. The sticker price is $24,995? Great. I am offering you $26,000. That's fair, so there's no need for you to hold out for more. Why bargain when we can go right now and just sign the papers?

"What do you say? Deal?"

If we had a parliamentary system ...

... then not only would the party in power after the 2008 election have been able promptly to pass legislation that it wanted, and not only would we have avoided the perverse incentive structure whereby one of the parties has veto power without responsibility, and no incentive whatsoever to cooperate on anything (a point brilliantly grasped by Senator McConnell), but the Democrats would now be able to kick out their leader and elect a new one via party caucus.

Perhaps my mood on this is too dark, but I am thinking that it's about time for people in the Obama Administration who don't want to be associated with its cowardice and ineptitude to start resigning.

A prediction

Obama's next abject surrender is only months away, if that. When the trigger in the plan comes due, he will agree with the Republicans that there can't be big defense cuts, and they will get their way on the rest once again. Meanwhile, there will presumably be a government shutdown surrender on his part before the end of the year.

Even if he wins the 2012 election, it seems obvious that he will capitulate again on the Bush tax cuts (and of course he ostensibly wants to extend all but the top bracket cuts, although that too I take simply to be timorous advance surrender dating all the way back to 2008).

Two points on which Krugman is clearly right: it will hurt the economy, which now will be viewed as entirely Obama's fault; and rewarding blackmail like this is exceptionally dangerous. Sometimes you need to bite the bullet or it will only get worse (even leaving aside the clear alternatives to surrender or default that he ruled out from the start). That would take courage, however, a quality that (along with foresight) Obama appears entirely to lack.

This is why we're risking macroeconomic disaster

Commentators are increasingly recognizing that the Reid and Boehner plans are similar, and that both would be significantly recessionary. David Frum recognizes why the difference is apparently worth fighting over:

"The Boehner plan promises to identify big cuts in discretionary spending over the next nine years. But wait a minute. Discretionary spending is appropriated spending. Congress can cut appropriations through the budget process anytime it wants. Why not just … do it? How is it a big win to declare a commitment to do it over a decade to come?

"The answer to that last is that the ordinary budget process requires some cooperation with the Senate and the president. And it was that cooperation that stuck in House Republicans’ craw. The big benefit of the Boehner plan is that it is seen to be imposed – and the current GOP mindset is that it’s better to gain less by show of force than to get more by negotiation."

This is what it comes down to. The Republicans' core goal has very little to do with policy, but rather is to impose a humiliating surrender on Obama and the Democrats. Meanwhile, the Democrats are more than willing to surrender in policy terms, even though the American public (unlike the Democrats themselves) takes the Democrats' side substantively (e.g., with regard to the mix between tax and spending changes). But the Democrats don't want to accept crushing humiliation in the form (as opposed to the content) that the final agreement takes.

Over this dispute - whether the Republicans should be allowed to openly humiliate the Democrats - we face the threat of an economic disaster that could be ten times worse than what happened in 2008.

Shorter John Boehner

Lindbergh guilty of the child's death because he dragged his feet paying the ransom.

Sleeping in high places

Ursula is owling again, as we call it, and also having a nap. The beauty sleep strategy appears to be working.

I am not thrilled by the "Gang of Six" tax plan

The Gang of Six plan is unlikely to go anywhere anyway. But, while I realize that political constraints mean one must lower one's standards pretty severely in reaching a judgment, and while I recognize that there may be some good people involved with this who are trying to be constructive, I am unimpressed.

Herewith is the tax portion of the Gang of Six plan in its current form, with comments from me in caps.

"Simplify the tax code by reducing the number of tax expenditures and reducing individual tax rates, by establishing three tax brackets with rates of 8–12 percent, 14–22 percent, and 23–29 percent." I SEE ABSOLUTELY NO REASON FOR LOWERING MARGINAL INCOME TAX RATES WHEN WE HAVE A HUGE FISCAL GAP AND RISING HIGH END INCOME INEQUALITY. SEE MY DISCUSSION HERE OF THE 1986-STYLE TAX REFORM MODEL'S OBSOLESENCE. AND NEEDLESS TO SAY, NO BRAVE WORDS HERE ABOUT WHICH TAX EXPENDITURES TO CURTAIL.

"Permanently repeal the $1.7 trillion Alternative Minimum Tax." ONCE AGAIN, HOW BRAVE THEY'RE BEING - TAX CUTS ARE TRUMPETED, TAX INCREASES DISCUSSED ONLY IN THE MOST GENERAL TERMS.

"Tax reform must be projected to stimulate economic growth, leading to increased revenue." MEANINGLESS IN CONTEXT, AND LIKELY TO BE RELATIVELY TRIVIAL, UNLESS THEY ARE TALKING, AS I DON'T THINK THEY ARE, ABOUT SOMETHING LIKE SHIFTING TO A CONSUMPTION TAX. NOTE THAT REDUCED PROGRESSIVITY MIGHT TEND TO INCREASE ECONOMIC GROWTH, BUT THAT'S A TRADEOFF, NOT UNAMBIGUOUSLY GOOD. IT'S ALSO HARD TO EVALUATE THE GROWTH EFFECTS WITHOUT REFERENCE TO THE "SPENDING" SIDE OF THE PACKAGE.

"Tax reform must be estimated to provide $1 trillion in additional revenue to meet plan targets and generate an additional $133 billion by 2021, without raising the federal gas tax, to ensure improved solvency for the Highway Trust Fund." ONCE AGAIN, WHO NEEDS DETAILS?

"If CBO scored this plan, it would find net tax relief of approximately $1.5 trillion." INSIDE-THE-BELTWAY CODE FOR LOSING REVENUE RELATIVE TO SIMPLY LETTING THE BUSH TAX CUTS EXPIRE. BUT WHY EXACTLY WOULDN'T WE JUST LET THEM EXPIRE? (I REALIZE THAT THIS IMPLICATES THE OBAMA ADMINISTRATION, NOT JUST THE REPUBLICANS.)

"To the extent future Congresses find that the dynamic effects of tax reform result in additional revenue beyond these targets, this revenue must go to additional rate reductions and deficit reduction, not to new spending." WHY WOULDN'T THE TAX SYSTEM'S HYPOTHETICALLY ENHANCED EFFICIENCY SUGGEST USING IT MORE, NOT LESS? THIS IS JUST A VACUOUS SOP TO REPUBLICANS, WHO I DON'T THINK WILL BE IMPRESSED.

"Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families." ALREADY BACKING OFF THEIR SUPPOSED KEY REVENUE SOURCE. ONCE AGAIN, THE WAY THEY STRESS THE EXTENT TO WHICH THEY'RE NOT CUTTING, RATHER THAN WHAT THEY WOULD CUT, WHILE POLITICALLY UNDERSTANDABLE, HELPS SHOW THE HOPELESSNESS OF THE ENTERPRISE.

"Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries." I AGREE, BUT ONCE AGAIN THIS IS A DESCRIPTION OF WHERE THE BUDGETARY IMPROVEMENT ISN'T COMING FROM.

"Maintain or improve the progressivity of the tax code." MIGHTN'T THIS SUGGEST NOT REDUCING THE TOP INDIVIDUAL RATES? IF RATES ARE FLATTER BUT TAXES STILL RISE JUST AS SHARPLY WITH INCOME AS BEFORE, THEN (A) EFFECTIVE MARGINAL TAX RATES HAVEN'T ACTUALLY DECLINED, AND (B) PERHAPS PHASE-OUTS ARE BEING USED TO CREATE HIDDEN MARGINAL TAX RATES.

"Establish a single corporate tax rate between 23 percent and 29 percent, raise at least as much revenue as the current corporate tax system, and move to a competitive territorial tax system." ONCE AGAIN, ALL THE DETAIL IS ABOUT TAX CUTS, FROM REDUCING THE CORPORATE RATE AND ELIMINATING THE TAX ON U.S. COMPANIES' FOREIGN SOURCE ACTIVE BUSINESS INCOME. WHAT ABOUT THE U.S. MULTINATIONALS' TRANSITION GAIN FROM SHIFTING TO EXEMPTION GIVEN THEIR $1.2 TRILLION OR MORE OF FOREIGN EARNINGS THAT ARE ALREADY OUT THERE? AND AGAIN, WHERE ARE THE TAX INCREASES? FOR EXAMPLE, DO THEY PLAN TO COMBINE MAKING CORPORATE DEPRECIATION LESS GENEROUS AS A PAY-FOR WITH BEING MORE PRO-GROWTH? AND WHAT ABOUT U.S. COMPANIES' ABILITY TO REPORT U.S. PROFITS AS ARISING IN TAX HAVENS? NO WORD OF ADDRESSING THAT.

To some extent, I think the disingenuous gobbledygook here (to put it unkindly) reflects a deliberate, well-meaning, and not entirely foolish strategy. E.g., the thought may be that if Republicans were to agree in principle to raising revenues relative to the baseline in which the Bush tax cuts are extended, one huge obstacle to the revenue-raising changes would have been eliminated. But I consider it naive to think that this would actually work. Once the rubber hit the road, the Republicans would go right back to their anti-tax absolutism. And even if they didn't, the taxpayers affected by particular revenue-raising proposals would continue to make the task impossible.

Hard though it might be - and I admittedly don't think that ANYTHING will work politically; our system is just too dysfunctional - I think you have to try to lead with a bit more of the bad news, rather than leaving it all for later. If today, against the urgent backdrop of potential August 2 default, you can't even say what you'd be willing to do to raise some people's taxes, what exactly is supposed to make it easier down the road?

Short article on tax reform and the risk of a U.S. budget catastrophe

As is discussed here, the University of Louisville Law Review is holding a Symposium on Federal Deficit Reduction on October 22, 2011. I have agreed to speak at the event, and relatedly to submit a short paper for publication in the symposium issue. Short as in, strict 25 page limit.

I've completed a draft, entitled "Tax Reform Implications of the Risk of a U.S. Budget Catastrophe," taking the form of a VERY swift run through the questions of why we face a potential budget catastrophe, how it might affect one's thinking about income tax reform, and what new taxes might be introduced (e.g., a VAT, carbon tax, financial transactions tax, and/or financial activities tax).

I'll probably post it on SSRN on due course, but am holding off for now because the current draft pretends that there is no impending default crisis with regard to the debt ceiling. The reason for the pretence is that it would be silly to spend time writing about it until we see how it comes out, which will be after my time window for completing the draft but well before the piece is ultimately published. Once that happy time comes, I hope to update and post the draft in fairly short order.

Newly published article

My article "The Case Against Foreign Tax Credits," 3 Journal of Legal Analysis 65-100 (2011) has now officially come out, and is available on-line here.

Forthcoming book with articles (including mine) on taxation and the financial crisis

The Oxford University Press is publishing "Taxation and the Financial Crisis," edited by Julian Alworth and Giampaolo Arachi. The book is a compilation of articles, including my solo-authored "The 2008 Financial Crisis: Implications for Income Tax Reform" and my co-authored (with Douglas Shackelford and Joel Slemrod) "Taxation and the Financial Sector."

The OUP link for the book is here. SSRN versions of the above articles are here (for the solo piece) and here (for S-S-S).

The pub date isn't until January 2012 or so, but both OUP and Amazon allow advance-ordering. (I know, that's big of them.)

Simon Johnson on debt default

Simon Johnson, whom I consider quite good in his analysis of the financial sector, offers the following view of what the debt default that the Republicans are threatening would look like:

"A government default would destroy the credit system as we know it. The fundamental benchmark interest rates in modern financial markets are the so-called risk-free rates on government bonds. Removing this pillar of the system—or creating a high degree of risk around U.S. Treasurys—would disrupt many private contracts and all kinds of transactions. In addition, many people and firms hold their rainy day money in the form of U.S. Treasurys. The money-market funds that are perceived to be the safest, for example, are those that hold only U.S. government debt. If the U.S. government defaults, all of them will "break the buck," meaning they will be unable to maintain the principal value of the money that has been placed with them.

"The result would be capital flight—but to where? Many banks would have a similar problem: A collapse in U.S. Treasury prices (the counterpart of higher interest rates, as bond prices and interest rates move in opposite directions) would destroy their balance sheets. There is no company in the United States that would be unaffected by a government default—and no bank or other financial institution that could provide a secure haven for savings. There would be a massive run into cash, on an order not seen since the Great Depression, with long lines of people at ATMs and teller windows withdrawing as much as possible.

"Private credit, moreover, would disappear from the U.S. economic system, confronting the Federal Reserve with an unpleasant choice. Either it could step in and provide an enormous amount of credit directly to households and firms (much like Gosbank, the Soviet Union's central bank), or it could stand by idly while GDP fell 20 to 30 percent—the magnitude of decline that we have seen in modern economies when credit suddenly dries up.

"With the private sector in free fall, consumption and investment would decline sharply. America's ability to export would also be undermined, because foreign markets would likely be affected, and because, in any case, if export firms cannot get credit, they most likely cannot produce....

"The Republicans are right about one thing: A default would cause government spending to contract in real terms. But which would fall more, government spending or the size of the private sector? The answer is almost certainly the private sector, given its dependence on credit to purchase inputs. How much could it fall? Take the contraction that followed the near-collapse of the financial system in 2008 and multiply it by 10.

"The government, on the other hand, has access to the Fed, and could therefore get its hands on cash to pay wages. With the debt ceiling unchanged, this would require some legal sleight of hand. But the alternative would clearly be a collapse of U.S. national security—soldiers and border guards have to be paid, the transportation system must operate, and so on. Issuing money in this situation would almost certainly be inflationary, but the Fed might conclude otherwise, because the United States has never been in this situation before, credit is now imploding, and the desperate credit-expansion measures implemented in 2008 proved not to be as bad as the critics feared.

"So this is what a U.S. debt default would look like. The private sector would collapse. Unemployment would quickly surpass 20 percent. The government would shrink, but it would remain the employer of last resort."

2012 NYU Tax Policy Colloquium schedule with dates

We now have our schedule apparently set, as follows:

1. January 17 – Michelle Hanlon, MIT Sloan School of Management

2. January 24 – Amy Monahan, University of Minnesota Law School

3. January 31 – Alex Raskolnikov, Columbia Law School

4. February 7 – Victor Fleischer, University of Colorado Law School

5. February 14 – Heather Field, Hastings College of Law

6. February 28 – Dhammika Dharmapala, University of Illinois Law School

7. March 6 – Edward Kleinbard, USC Law School

8. March 20 – Susan Morse, Hastings College of Law

9. March 27 – Stephen Shay, Harvard Law School

10. April 3 – Jon Bakija, Williams College Economics Department

11. April 10 – Lane Kenworthy, University of Arizona Sociology Department

12. April 17 – Yair Listokin, Yale Law School

13. April 24 – William Gale, Brookings Institution

14. May 1 – Rosanne Altshuler, Rutgers Economics Department, and Harry Grubert, U.S. Treasury Department.

All sessions will meet on Tuesdays from 4:00 to 5:50 pm in Vanderbilt 208, NYU Law School.

2012 NYU Tax Policy Colloquium speakers

The 2012 NYU Tax Policy Colloquium, which I will be co-teaching with Alan Auerbach, is taking shape. It will be held in NYU Law School from 4 to 6 pm on Tuesdays, from January 17 through May 1 with the exception of February 21 and March 13.

While the exact match of speakers to dates is still ongoing, our speaker list, in alphabetical order, is as follows:

1) Rosanne Altshuler, Rutgers Economics Department, and Harry Grubert, U.S. Treasury

2) Jon Bakija, Williams Economics Department

3) Dhammika Dharmapala, University of Illinois Law School

4) Heather Field, Hastings College of Law

5) Victor Fleischer, University of Colorado Law School

6) William Gale, Brookings Institution

7) Michelle Hanlon, MIT Sloan School of Management

8) Lane Kenworthy, University of Arizona Sociology Department

9) Ed Kleinbard, USC Law School

10) Yair Listokin, Yale Law School

11) Amy Monahan, University of Minnesota Law School

12) Susan Morse, Hastings College of Law

13) Alex Raskolnikov, Columbia Law School

14) Stephen Shay, Harvard Law School.

Oxford international tax conference

I'm back in the NYC area after 4 quick days at the annual summer conference of the Oxford University Center for Business Taxation.

The travel part had its annoying moments. The Dial 7 Carmel car service told me I needed to assume that the ride from Greenwich Village to Newark on the evening of July 4 would take 2 hours. I seriously doubted this, but figured they must know best. Actual trip time: 20 minutes. Very few people leave NYC through the Holland Tunnel or fly out of Newark on a holiday. So I got to Newark more than 3-1/2 hours before my scheduled overnight red-eye flight. Thanks a lot, Dial 7.

The way back was awful in the opposite direction. It took me nearly 4 hours to get home from Newark, counting from the time when my plane landed but was still on the runway. This was partly due to a huge passport & customs backlog from simultaneous flights (although the INS or Customs people did a good job considering the underlying problem). But this time, when I wanted a fast car trip, there were immense Holland & Lincoln Tunnel backups, this being early Friday evening. Suffice it to say that I got quite vexed, and all the more so because my 3 (?) year-old iPhone is showing extreme battery fatigue and thus I was unable to call home saying I was on my way.

It was nice to see lots of old friends at the conference itself. Attendees were a mixed group - mainly economists but also a number of lawyers and accountants. Mainly Europeans but also lots of North Americans, Australians, and several from Asia. Ed Kleinbard and I were the only lawyers to present papers (Stateless Income from him, Corporate Residence Electivity from me), and it was odd how we agree about a great deal yet offer significantly different reform ideas. He wants a worldwide tax without deferral but still retaining foreign tax credits; I'd go for exemption with a transition tax on U.S. companies' existing unrepatriated earnings plus significant improvement of the source rules, in particular to apply to worldwide groups, whether American-headed or not, based on the concept of a unitary business. A key difference in perspective is that he is more focused on data concerning existing U.S. companies, whereas I am more focused on thinking about incentives & opportunities that tax-concerned players may have in the future.

Dhammika Dharmapala presented his co-authored paper (with Mihir Desai) proposing that transfer pricing continue to be used, in lieu of switching to formulary apportionment, but with one big change: the company's internal transfer prices, ostensibly used for purposes such as executive compensation, would be determinative in lieu of looking at ostensibly comparable arm's length prices.

Nearly everyone in the room agreed that (a) the comparable price method is seriously flawed (actually, 2 people disputed this, but they were thinking more about the method in principle than in actual recent practice) and (b) if one is continuing to use a transfer price approach in lieu of switching to formulary apportionment (and in practice the two overlap), then the internal numbers that Desai and Dharmapala want to rely on should indeed be examined as relevant evidence.

As it happens, the discussion brought out the fact that these numbers aren't nearly as widely available as D & D posit. While it may be true, as they assert, that companies need to keep track of internal value (or a decent estimate thereof) for substantive investment and/or compensatory purposes, the dividing lines they use in allocating internal income often have nothing in common with the legal entity lines that the U.S. tax authorities would want to see for transfer pricing purposes. For example, they may break down their "true" internal transfer prices by line of business or by geographical region, rather than on a per-country separate-entity basis.

Still, the paper could have made a modest but unambiguously positive contribution by emphasizing that these numbers may sometimes be available and could well be illuminating. Instead, however, it swings for the fences and claims a lot more. This led at Oxford to a decidedly mixed reception. (The reception would have been worse, except there was a widespread view in the room that Dharmapala was not the party most responsible for the paper's aspects of reckless over-claiming.)

The paper purports to identify a brand-new inefficiency that policymakers need to take very seriously in thinking about transfer pricing. It is as follows: The company accurately transfer-prices for its own internal purposes because it MUST do so in order to make rational economic decisions. But then the darn U.S. government comes along and forces the company to use transfer prices for U.S. tax purposes that place too much income in the U.S. and less, say, in Ireland, Luxembourg, or Singapore. The result is that the U.S. share of taxes on the company's worldwide activities is too high. This in turn causes the poor duped company to think the American operations are less profitable than they really are, because it subtracts taxes ultimately levied that the U.S. affiliate should never have had to pay. The company therefore under-invests in the U.S. and under=pays U.S. executives, while over-investing in Ireland and over-paying its Irish executives, because the U.S. transfer pricing shift has duped it into misjudging the actual economics of its worldwide operations. (NOTE: A careful reading of the paper might suggest modifying this story a bit - e.g., is the point that the company isn't duped but responds rationally to the U.S. over-tax? I only had a chance to read it very quickly and then listen to the presentation.)

But I think I have it right. If so, this is not a real world empirical story that I for one find enormously compelling. I don't agree that companies are in the main constrained to transfer-price accurately (even given the admitted difficulty of getting away with two distinct sets of books). And even if we see a given number in their books, we can't really tell how they are actually using all available information to make their various decisions. What's more, even if it's boring conventional wisdom to say the transfer pricing problem goes the other way (with income being shifted from high-tax countries to tax havens), every now and then the CW is correct. Sometimes the dog actually did bite the man, not the other way around. I would also find it quite startling if the companies couldn't figure out what is going on economically even if the U.S. forces the adoption of transfer prices that diverge from what the company sincerely believes is correct. The new inefficiency that the paper detects is one that I don't expect to hear a lot more about. And more generally, identifying ostensibly brand-new inefficiencies and coming up with new magic bullet solutions isn't always all that it's cracked up to be.

One other presentation at the conference gave me considerable pleasure, albeit purely as an observer and consumer. Unfortunately, I need to be a bit circumspect in describing it. Suffice it to say that a senior and well-known (though not to me personally) empiricist who is clearly passionate about econometrics, and who presents as having very high self-regard in this area, made a seemingly dazzling presentation that the likes of me couldn't assess very well, purporting to find strong empirical results on a contested issue. The commentator who followed to offer a response was very junior, and in tone very modest and understated, along the lines of "I wonder what X would look like if you had tested for that," or "it would be good to have run a control concerning Y, and I wonder what the results would have been." But by the time the commentator was about 2 minutes in (out of 10 minutes total), I realized that something rather extraordinary was going on. The paper was having its throat cut, and huge hunks of flesh were being torn out of it while its blood gushed onto the pavement - all by reason of one gentle knife thrust after another. By the time the full 10 minutes had passed, I would not even say the bloody carcass was lying on the ground twitching - what was left of it came closer to being an inert corpse. The author whose paper had gotten this treatment was scowling and head-shaking, but it got no better when the question period began. In sum, it felt like seeing Ali knock out Liston the first time in 1964, only without the underdog's having any braggadocio whatsoever. From my seat in the peanut gallery, I thought it was great fun, and all the more so because (not previously knowing the commentator) I had so little seen it coming.

Off to Oxford tomorrow

Never a dull moment. Having just returned from St. Maarten, and then worked over the pre-July 4 weekend to finish some projects with deadlines, I am flying to England late on the night of July 4th so as to attend a tax conference at the Saad Business School in Oxford, where I will present my paper on corporate residence electivity. Back in the USA on Friday.

Punting on the river like (though probably not quite like) Lewis Carroll, dinner in an Indian restaurant, and Blackwell's Bookshop await.

Wrong again, Doug

Doug Holtz-Eakin, pooh-poohing an extended payroll tax holiday that might provide needed stimulus (though admittedly a very ninetieth-best way of doing this) says that, as a matter of economics, it doesn't matter whether you do it on the employer or the employee side. As a matter of economics, this is incorrect.

Standard economic models of tax incidence show that, at equilibrium, it doesn't matter whether you change the tax hit on the employer side or the employee side, because that only affects legal incidence, without transforming the factors that determine economic incidence. But in the short run (i.e, in transition to the equilibrium), it unmistakably DOES matter which side you do it on.

Suppose wages are sticky in the short run, whether for psychological reasons reflecting nominal prices or simply because people have existing short-term contracts. For example, suppose I have a contract with my employer specifying that it will pay me $12 per hour through the end of the year. This is undoubtedly an incomplete contract - it doesn't provide, for example, that this is conditioned on assuming continuation of current payroll tax policy, such that we will agree to the same "true" after-tax wage no matter which side Congress might pick for a payroll tax holiday. If the payroll tax is cut on the employee side, I pocket the increased after-tax income. No renegotiation until the next go-round (where it would more likely occur if the holiday were ongoing or expected to recur) Likewise, if the payroll tax is suspended on the employer side, it pcokets the extra change.

True, supply and demand are going to be affected, but the point is that to a considerable degree all this takes time to unfold.

So while Doug is likely right about permanently changing the payroll tax on one side or the other (leaving aside details such as the fact that minimum wage laws don't adjust for payroll tax nominal incidence), he is clearly wrong about the economics of, say, another one-year payroll tax holiday that is enacted with little advance notice and great uncertainty in advance about whether it would in fact happen.

There's a distributional difference in who pockets the money, and also a stimulative difference since the workers may on average have higher marginal propensity to consume than the owners of the businesses that would pocket the transition gain the other way around.

To be sure, it's still a far-from-great stimulus choice, given that even the richest workers get the payroll tax holiday as to their wages up to the Social Security tax cap, plus the fact that high-earners get more than those earning less than the cap amount.

I also realize that it's not going to happen, as the Republicans have finally located a class of tax cuts that they don't like - those that would be potentially stimulative in the run-up to 2012.

But nonetheless, let's try to discuss it honestly without misapplying standard economics truisms (about long-term incidence) outside their proper realm of application.

A site for sore eyes on vacation

Same species as a much-beloved pet I had some 40 years ago (not being allowed a cat or dog). OK, he wasn't quite equivalent, but nonetheless preferable to nearly all possible alternatives to those two supremely pet-adapted species.

I read recently that iguanas are no longer a legal pet in NYC, but that they are considered surprisingly intelligent and with distinctive personalities (which fits my memory). Don Ig Juan, as my father named him, was easygoing and friendly. He loved tuna cat food most of all, blueberries second, and would wait eagerly for me to finish my own breakfast and come to hand-feed him. It's true that he would rather pompously nod his head up and down, dewlap under the neck extended out, when he saw his reflection (another male iguana) in the mirror. But then he would lose interest, apparently realizing that the mirror rival wasn't real.

We ended up giving him to the Staten Island Zoo, leaving me a lifelong fan of this attractive and interesting species, although the fella or gal in this photo skittered off into the canopy below, having no reason to appreciate my bona fides.

A bit of unintended tax history on vacation

I am currently on vacation for a week in the delightful Caribbean island of St. Martin (for the French part) and St. Maartin (for the Dutch part). This is apparently the world's smallest island to have two separate sovereigns, as the French vs. Dutch division remains operative to this day (and dates back continuously to 1648).

It turns out that the Dutch part of the island (we are staying in the French part but plan to go to a beach on the Dutch part tomorrow) used to be part of the Netherlands Antilles, which is famous in U.S. tax planning history as, in effect, the Cayman Islands of an earlier era.

Until the late 1980s, and thus overlapping with my earliest professional years, the Netherlands Antilles was THE place of choice to have a tax haven affiliate for U.S. international tax planning purposes. As it happens, the reason had to do with the application of a U.S.-Dutch tax treaty, whereas the Caymans often "works" today for entirely non-treaty reasons. But still, the word "Netherlands-Antilles" means something to me that it probably wouldn't if I were 10 years younger.

Banana republic watch

Today's New York Times article about the push for another repatriation tax holiday shows how ill-functioning our political system is. Tax holidays work best if they are credibly "once and once only" offers. The last tax holiday was only 6 years ago, and we are already potentially doing it again?

As the article mentions, the predominant academic consensus from last time around is that it mainly led to dividends and share buybacks, not extra jobs et al. Money is fungible. And while in principle even the shareholder payouts might be considered stimulative, one would not expect the recipients to have a very high marginal propensity to consume.

Another banana republic aspect to this is the emphasis being placed on the point that the taxes raised by the dividend tax holiday would lower the budget deficit. Yes, but in expected present value terms they would increase the long-term U.S. fiscal gap, as to a considerable degree companies would simply take a small hit today (including a potential accounting hit for supposedly "permanently reinvested foreign earnings") on the view that it was cheaper than paying the full tax in the future.

For this reason, enacting the dividend tax holiday as a way of lowering the current year budget deficit is like improving your current cash flow by going to the local pawnbroker who charges 20% a month, or like a farmer selling the seed corn to raise extra funds. From a budgetary standpoint it is childish, shortsighted, and irresponsible.

Compare to all this the idea that we might shift to an exemption system for U.S. companies' foreign source active business income, but accompanied by (a) greatly improving the source rules so that they apply to all multinationals (taking account of all their affiliates around the world) on a unitary, residence-neutral basis and (b) enacting a one-time transition tax for U.S. companies' pre-effective date unrepatriated foreign source income, with payment of this tax perhaps to be deferrable but effectively with interest. A well-functioning political system would be considering changes like that instead of replicating the behavior pattern of an impatient toddler.

Casey Mulligan follow-up

Casey Mulligan complains that, in my preceding post, I misread his article because the first and last paragraphs mention the nontaxation of imputed rent point. The references are perhaps a bit oblique, but I take his point and apologize for the snark.

That said, I still find his analysis inadequate because I really don't think one can assess the home mortgage interest deduction independently of the imputed rent issue. Denying the interest deduction would be an indirect partial repeal of the exclusion, partly reducing its scope (good) but also potentially creating fresh distortions that would not follow from a more direct, even partial, repeal (bad).

I think the good from denying the deduction would outweigh the bad. I would merely have disagreed with Mulligan, rather than finding his analysis as snark-worthy as I did, had he addressed this issue. But, in my view, treating the under-taxation of home ownership in other respects as effectively irrelevant to analysis of the home mortgage interest deduction was a disservice to the readers of his NYT blog entry.

UPDATE: To put it another way, Mulligan says that the Treasury doesn't lose revenue from the mortgage interest deduction as such, assuming deduction and inclusion by the borrower and lender at the same marginal tax rate. OK, fine. But the Treasury does lose an opportunity to recoup some of its losses from the imputed rental exclusion, and that's the whole point of the argument for mortgage interest disallowance.

There is no joy in Mudville - Casey Mulligan has struck out

Thanks again to a link in the Tax Prof Blog, I see that Casey Mulligan of the University of Chicago Econ Department is saying that the home mortgage interest deduction is no big deal, hence no particular reason to repeal it. He focuses mainly on the point that "one person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income."

My god, but Mulligan has missed the boat on this one. William Turnier pretty much makes the point, back in the Tax Prof blog link, by referencing the Haig-Simons definition of income and calling the home mortgage interest payment consumption-related.

But I would make it a bit clearer still. The problem isn't really the home mortgage interest deduction as such, although it may encourage the sort of excessive home leverage that helped contribute to the 2008 financial crisis. The real problem is the fact that homeowners get to exclude imputed rental income because it isn't derived from an observable market transaction. The home mortgage interest deduction merely builds off that. Its allowance would be uncontroversial if imputed rental income were included.

One can't seriously discuss the home mortgage interest deduction without understanding its relationship to the underlying imputed rent exclusion. This is really basic stuff. Mulligan ought to know, not just before he blogs about the issue in the New York Times, but as a supposedly informed professional in the field of public economics.

He further embarrasses himself by adding the following: "In contrast, consumer durable goods do not enjoy the interest deductions that housing and business capital do. Someone who takes out a car loan to purchase a personal automobile cannot deduct the interest payments from her taxable income, even while the Internal Revenue Service may be collecting taxes on the interest income of the lender. In this regard, tax policy discourages investment in consumer durable goods relative to investment in housing and businesses."

Mulligan apparently is unaware that the personal use of a car generates an economic return that the tax system excludes from income, whereas returns to business investment are at least in principle taxed. Again, this is really elementary stuff. Anyone who purports to do public economics and to have opinions about the tax system ought to know it.

The University of Chicago Law School has a pretty good tax faculty, whose members I am sure would have been happy to bring Mulligan up to speed. But if you don't know that you don't know, I guess it's hard to find out.

Very interesting fight among Senate Republicans

With thanks to Tax Prof Blog for the link, I note with considerable interest a current battle in the Senate, in which I gather Republicans' votes will be front and center. Senator Tom Coburn is seeking the elimination of ethanol subsidies that include income tax expenditures, but is being opposed by Grover Norquist due to the no-new-taxes pledge, signed by 40 of the Senate's 47 Republicans and constituting, in my view, a tourniquet around the throat of long-term (and perhaps even short-term) U.S. fiscal sustainability.

Oh, yes. Norquist is on board with eliminating tax expenditures for ethanol, but only so long as Congress ALSO repeals the estate tax. Good one, you Lenin-lover, you.

Coburn's view, which is unambiguously logically correct, is that, even if you are categorically opposed to "tax increases," this has to be defined with at least some modicum of intellectual coherence, such that repealing what are effectively "spending" provisions smuggled into the tax code won't count as tax increases for this purpose. (See more on this point in my recent Tax Notes article, which is available here.)

An alternative view to the one that both Coburn and I take would mean one only cared about the form of particular policies on the books, not about actual economic substance.

I gather that Coburn's plan is not expected to pass. Indeed, the Obama Administration, earning a profiles-in-courage award as usual, apparently opposes the elimination of ethanol subsidies. Nonetheless, it would be a huge positive step if more Republicans adopted the Coburn view (which also was discernible in Congressman Ryan's budget document). Coburn thus deserves great praise on this score, even apart from the ethanol subsidies issue itself (on which he likewise is siding with the angels).

UPDATE: The Coburn amendment failed by one vote. That is, it won (under majoritarian rules) by 59-40, but this left it one vote short of the threshold needed to permit closure and thus avoid filibuster. And of course the Senate these days codes it as a loss if you merely win by a borderline landslide.

I wonder, however, if the amendment was guaranteed to lose by one vote no matter what. The Democratic and/or Republican leaderships may have decided (perhaps even cooperatively) to let as many people as possible vote for it, so they could score a good-guys stance with the voters, so long as it didn't actually prevail. This once happened with the balanced budget amendment in the 1990s - it lost by one vote, but reportedly would have lost by one vote even if it had attracted 10 more "true" supporters.

Pawlenty's tax cut proposal in perspective

The best available revenue estimate for Tim Pawlenty's crazy proposal to enact massive tax cuts, with only minimal specified financing, places the revenue cost at more than $1 trillion per year by 2014, the second year when it would be fully in place. The estimated annual cost would be more than $1.6 trillion by 2021.

Among other changes, Pawlenty would repeal the AMT and the estate tax, lower the top individual rate to 25% and the corporate rate to 15%, and eliminate the tax on interest, dividends, and capital gains. The main pay-for appears to be as follows: "Let’s grow the economy by 5%, instead of the anemic 2% currently envisioned."

This reminds me of the line from Shakespeare's Henry IV, Part I, where Glendower says "I can call spirits from the vasty deep," and Hotspur replies "Why, so can I, and so can any man / But will they come when you do call for them?"

If Pawlenty wants to dream, then I say why not call for 40% annual economic growth? Or perhaps 325%? If we're talking magical wish lists, why stop at so measly a number as 5%? Pawlenty evidently lacks the true courage of his claimed convictions.

On a more serious note, Economy Watch estimates that U.S. GDP in 2014 might be just over $17 trillion. While this obviously doesn't count the Pawlenty tax cut (which presumably would raise GDP if people were sufficiently myopic not to worry about future tax levels or default risks), it's worth noting, just for rough back-of-the-envelope purposes, that the revenue cost of the projected Pawlenty tax cut for 2014 is more than 6% of that amount. And the annual revenue-cost-to-GDP ratio very likely would stay at that level if we myopically ran forward the projections without taking into account the catastrophic budgetary effects that it would very swiftly have. So the infinite horizon estimate might also be in the neighborhood of 6% or more of GDP.

Just for comparison purposes, according to the most recent study by Alan Auerbach and William Gale, the most likely estimate of the long-term U.S. fiscal gap (under optimistic assumptions about healthcare growth) places it at between 6 and 7 percent of GDP.

So we are currently on a disastrous fiscal path, which everyone agrees cannot be permitted to continue, and at a very rough estimate Pawlenty, bottom-feeding for votes in the Republican nominating process, proposes roughly to double the size of the problem.

Personally I find his recklessness and irresponsibility thoroughly despicable, and all the more so because it is likely to prove politically contagious.

Yuval Levin wants tax rates to be both high and low

I've seen several references today to an article in National Affairs called "Beyond the Welfare State," by Yuval Levin, who appears to be a relatively thoughtful conservative with actual interest in ideas. So I decided to give it a glance.

Not to be too critical, but I did notice this bit from his recommendations near the end of the piece:

What he calls the "conservative vision" would "begin with a simple and predictable tax system, with a broad base and low rates ....

"Second, essentially all government benefits — including benefits for the elderly — should be means-tested so that those in greater need receive more help and those who are not needy do not become dependent on public support." Etcetera.

Not to say one couldn't support both of these ideas. But does Levin realize that means-testing benefits is economically equivalent to raising (perhaps significantly) people's marginal tax rates in the benefits phase-out range?

Utterly astounding, and indeed nauseating

Nobel Laureate economist Peter Diamond has withdrawn his candidacy to be a member of the Federal Reserve Board of Governors, a victim of Republican obstructionism. Apart from the fact that he is a great economist, whose work (for example, on Social Security) I personally have benefited from reading, his expertise on labor markets could not possibly be more central to the Fed's mission of stabilizing the economy by addressing both inflation and unemployment.

The Republican Senators who blocked his candidacy apparently claim that labor market expertise (and by extension, unemployment) is irrelevant to the Fed's mission. I hope they will have the honesty to campaign for public office, in 2012 and thereafter, on the basis of this view of unemployment's policy irrelevance. No one who is even minimally economically literate could deny the Fed's vital role in addressing business cycle-related unemployment. In many people's view (including mine), the Fed has been doing far too little on this score. The blocking of Diamond's appointment follows a broader pattern that raises serious questions about the Republicans' good faith interest in permitting the state of the U.S. economy to improve.

Book report

I've been greatly enjoying Evan Connell's "Mr. Bridge" (when I was in Singapore) and now "Mrs. Bridge." The odd thing about these novels is that, on the surface, they are exactly the sort of thing that would be (and was) made into a Merchant-Ivory movie. They bring to mind Updike territory, although they read as if they were written earlier (reflecting that they are set 30 years earlier and in a much more conservative time, albeit one that is already changing).

Yet underneath and in truth, "Mr. Bridge" and "Mrs. Bridge" are savage and pitiless (albeit empathetic), offering exceptionally dark comedy.

Summer weather

Today's weather in NYC is more or less perfect - summer-like but not too hot - and I would certainly sign up for it 365 days a year (leaving aside the drought issue if it never rained). Unfortunately, as it happens I will have to be indoors working most of the day (a rarity for me on weekends).

People here sometimes say (be it rationalization or Stockholm syndrome) that they prefer the Northeast's varying seasonal weather to constant daily perfection. In response, I will generally dial up the sarcasm module and say yes, I agree, and for the same reason I find it so BORING if I'm healthy all the time. Isn't it more fascinating to get the flu occasionally for a couple of months, throw in back spasms and broken bones every now and then, break out in an itchy rash if everything is getting too comfortable, and perhaps even have the occasional digestive meltdown? That way, there's never a dull moment.

Perfect health and perfect weather are nonetheless just fine for me. There are plenty of other means out there for keeping one's life interesting.

Debt ceiling solution?

The Fourteenth Amendment to the U.S. Constitution states that '[t]he validity of the public debt of the United States, authorized by law ... shall not be questioned." I recently read something on-line suggesting that President Obama interpret this clause, when the crunch hits, as giving him the power to avoid a default by authorizing debt issuance in excess of the statutory ceiling. And I suppose he could throw in national security powers amid the threat of a national disaster as an extra justification for acting.

If I were in the White House and wearing a political rather than a legal hat, I would definitely recommend that this be done at the right time - not too far in advance, which would be a political disaster, but just at the crunch point, when it could be described as vital for U.S. national security, etcetera. This might then get all the pundits salivating about bold and decisive leadership. And after everything else we have seen from the Executive Branch in the last decade, or maybe I should say the last 50 to 60 years (the brief early 1970s retrenchment aside), it would hardly be discordant with the fundamentals of how our government now operates. After all, if the president can wage an undeclared war in Libya without Congressional authorization, as everyone seems to think he can, then, although these are separate legal questions, it's hardly an unprecedented power grab.

Would the action be constitutionally correct? I am admittedly skeptical. But the above clause was apparently adopted in anticipation of the concern that members of Congress from the ex-Confederate states would seek to compel default on U.S. public debt, or at least Civil War veterans' pensions (expressly mentioned in text from the clause that I skipped). So we are back in a recognizable scenario of concern that Congress will deliberately default, although to be sure the amendment doesn't mention delegating powers to the President to avoid questioning of the debt.

Constitutionally correct or not - and in the context of a potentially disastrous global and national economic crisis I think there is a colorable claim here - I can't see that anyone would have standing to contest it. The House, which presumably would not be joined by the Senate, seems unlikely to have standing or to be able to avoid "political question" problems, although with 5 hardcore Republicans on the Supreme Court who knows. But even if the House could get an injunction, Boehner et al would have to think twice about seeking to enjoin debt issuance and thereby directly triggering not just a global economic catastrophe but (as the White House could spin it) non-payment of our troops and needy seniors.

While there could subsequently be a legal issue concerning the enforceability of the debt issued at the President's say-so in excess of the statutory ceiling, one would probably expect that by then the debt would have been retrospectively validated.

If I were President Obama, I would not use the threat of doing this as leverage in the debt negotiations. Rather, I would spring it as a surprise at the last moment, in effect after baiting the trap. Dramatic 9 pm EST speech from the Oval Office with all the trimmings. Mention not just default and its consequences but the need to pay our troops, keep Social Security and Medicare operating, etcetera. Make the issue one of whether our troops and seniors should be paid or not.

Again, I am speaking here to what I would recommend as a political advisor. As a legal advisor, if asked to opine on what is the best view of the law, not what's the most that one could get away with, I would have a much harder time recommending this. But how many political actors in Washington do business this way any more? Even Supreme Court Justices all too often clearly don't. It's hard to play by different rules than everyone else without seriously handicapping yourself. And also I think a voluntary U.S. debt default is potentially a true global calamity. Being a bit tricky with one's legal interpretations in a true ticking time bomb scenario is a lot more justifiable than doing so just for political gain.

Apocalypse soon?

It's distressing when we have a ticking time bomb in the form of the debt limit problem, and today:

(a) McConnell said no deal without massive Medicare cuts, which almost certainly is a response to Tuesday's election. The evident idea is that the Democrats must surrender the ability to flog the Republicans on the Ryan plan, or else he is unwilling to surrender his hostage (i.e., the U.S. and world economies).

(b) Ryan said that any increase in tax revenues is absolutely, unconditionally unacceptable because to him this is a matter of "economic doctrine."

Quick observation on Tuesday's election result

Did voters in upstate New York punish Republicans and the Paul Ryan budget for (a) honestly acknowledging that currently projected healthcare expenditure growth is unsustainable, or (b) proposing to throw poor people off the bus, to be joined by seniors once my age cohort reaches retirement age (but in the cynical hope that current seniors would shrug since they're exempted), in part to help make way for massive tax cuts for the top 1 percent of the income distribution?

If (b), I'd say they deserve the voter response they got. If (a), they are getting the same unfair punishment for acknowledging an aspect of reality that the Democrats faced in 2010.

My hunch is that, if one carefully queried the voters, one would find that it's at least two-thirds (a). But since I think the Republicans deserve what they got for (b) - especially given their 2010 election demagoguery, their threatening to block cost-saving under the current structure, and for that matter their enacting an unfunded Medicare prescription drug benefit in 2003 - my sympathy is extremely limited.

My new Tax Notes article on tax reform

Yesterday, Tax Notes published the article that I've mentioned here several times, "1986-Style Tax Reform: A Good Idea Whose Time Has Passed."

A link is available here.

The abstract goes something like this:

"The Tax Reform Act of 1986 combined base-broadening (such as the curtailment of tax expenditures) with tax rate reduction, in a manner that was designed to be revenue-neutral and distribution-neutral. It thereby established an influential model for tax reform that continues to be cited frequently today. This report argues, however, that while 1986-style tax reform was a good idea in its time, it is no longer appropriate in current circumstances, for three main reasons. First, if tax expenditures are properly viewed as spending through the tax code, then a revenue neutrality norm, in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts, is intellectually incoherent. Second, the long-term U.S. fiscal gap makes rate-cutting, in particular for individuals, potentially imprudent. Third, if one wants to address rising high-end income concentration in the U.S. since 1986, the option of raising, rather than reducing, the top marginal income tax rates may need to be squarely considered."

Scofflaw?

Though the rule is no cats on the dining room table, it's hard to get too upset with Seymour when he is such a handsome and placid fellow.

I'm back from Singapore, and have more or less readjusted to NYC time. In my absence, summer seems to have arrived in a schedule sense (students have graduated and the place has emptied out for the summer, though I have a LOT of things to do) though unfortunately not in a weather sense.

I'll be on sabbatical this fall, and teaching the Tax Policy Colloquium with Alan Auerbach next winter. During the balance of 2011, I have work-related trips scheduled to Oxford, Louisville, Los Angeles, Vienna, and Sao Paulo, plus no doubt a couple more that aren't currently coming to mind.

Final full day in Singapore

Tomorrow (Friday) is my final full day in Singapore. In addition to teaching my eighth and final marathon-length class over an 11-day span (ah, the narcissism and melancholy of spending too much time as a performer), I will be giving a late-morning hour-long talk to people at the NYU@NUS program generally. At the last minute (i.e., tonight), I have grown verging on enthusiastic, at least given my overall state of near-burnout and fatigue, about this talk.

When I was asked to give this talk, I had nothing more definite in mind than to reprise the main themes of my forthcoming Tax Notes paper, "1986-Style Tax Reform: A Good Idea Whose Time Has Passed." Forthcoming, I should add, this Monday, May 23. I will post a link on this blog as soon as I can; I'm pretty sure this can be done with Tax Notes articles once they're out.

The problems with the approaching talk were twofold (apart from simultaneous classroom preparation). First, although few people have seen my new paper as yet and I haven't widely discussed it, it's been on my mind over the last few months and I've discussed bits and pieces or ideas from it on numerous occasions (e.g., at my Senate Finance testimony earlier this month). Thus, to me it no longer feels quite as fresh as it might at this point. Second, it's U.S.-centric, hence not ideal for a talk in Singapore, especially to people who aren't any more tax-focused than they are U.S.-focused.

But I've been idly discussing Singapore-specific factors with various people during my brief stay here, and now feel qualified (at least for a fairly casual talk to a moderate-sized audience) to take things in a fresher and more locally pertinent direction. Hence, my lunch talk is now entitled (in my own mind; I didn't get to tell the organizers in time for any signage to reflect it), "Tax Reform: Singapore Versus the U.S."

As I've mainly written it out, I'll consider posting the talk's main contents here if, after the session is done, I still feel good about it. This, however, may have to wait until next week, as I am taking a 19 hour flight back home on Saturday morning.

Weekend in Singapore

When not preparing for my next class, going on various food, shopping, and cultural excursions (I've seen all the main Singapore tourist sites in past years), or going to the pool and the gym at my residence hotel, I've been reading James Ellroy's powerful and disturbing My Dark Places, which I picked up in the Borders here on Orchard Road. I may have to read more Ellroy, such as the well-regarded L.A. Quartet, though I wonder if it's possible that My Dark Places is his best.

Singapore ruminations

At the moment, by a strange quirk, it is both my birthday and my younger son's. His comes the day before mine, but as I am in Singapore, where the clock is 12 hours ahead of NYC time, and as it's still before 12 noon, we are currently having a joint birthday, only we won't get to communicate about it directly in simultaneous real time.

Perhaps it's not ideal to be spending one's birthday so far from home and loved ones, but I suppose there are compensations, ranging from my observation that lizards are Singapore's squirrels (they dash into the trees when you approach, then skitter around to keep the trunk between you and them), to a bizarre dream in which I was explaining to Willard Scott (!) that the early Neil Diamond song "Girl, You'll Be a Woman Soon," which was playing on his sound system at a garden party where he was offering people desserts, is better known from the cover version in Pulp Fiction (the only explanation I can offer for this dream is that I had been listening to early Neil Diamond recently and love that song, although it's rather off-kilter, un-PC by today's standards, and strange), to my plan to treat myself to a 5 pm viewing of "Source Code" at the nearby cinema (last showing before it disappears here), followed by a tasty and cheap if quick and informal dinner for one at a local food court (the chicken rice and Malaysian noodles are both excellent, but tonight I may look for something Indian).

Teaching a 3-plus hour daily class under current circumstances, in a small group that one really needs to engage directly (and they seem willing enough), while still adjusting to the time zone change and having had so little time since the end of the NYU semester, can feel a bit challenging even if (I hope) they don't see you sweat. It feels like being a stand-up comic who has dozens of familiar routines lodged somewhere in his cerebellum but hasn't gotten to rehearse them enough recently. Time management (too fast versus too slow), dealing with how I liked talking about a given issue 3 years ago as opposed to now, and balancing spontaneity against control, are among the challenges for which one might prefer to be in better-rested, better-rehearsed, more midseason form. But first days are always the most unsettling; in just a few minutes I'll be venturing forth for Day 2. And not long after that, while my birthday will continue for another 12 hours, my son's will be over.

UPDATE: Felt much better about the Day 2 class, plus I must have been a good boy, as I actually got an in-class birthday cake from the very kind people who run the program here.

Off to Singapore

Tomorrow I am flying to Singapore, where I will be teaching a class (U.S. Personal and Business Income Tax Law), in the NYU @ NUS program at the National University of Singapore, over the 2-week period from May 10 through May 20. 3-1/4 hours per day over 8 days - definitely a grueling journey for faculty and students alike. The readings will include greatest hits from the Tax I casebook of which I'm a co-author (with Klein, Bankman, and Stark), as well as selections from Decoding the U.S. Corporate Tax and my book in progress on U.S. international taxation. We'll also read materials on tax shelters (including some famous U.S. cases) and, if we have time on the last day, discuss fundamental tax reform from a U.S. perspective.

As on my prior two visits to teach at NYU @ NUS, I'm looking forward to meeting the students, as well as to sampling Singapore's great food (such as from street hawkers and at Zam Zam on Arab Street in Little India).

May 3 Senate Finance Committee hearing on tax fairness

Yesterday, I testified before the Finance Committee of the U.S. Senate on fairness or distribution issues in the federal income tax system. You can view a stream of the entire proceedings here, and you can read my full written testimony here or here (the latter corrects an erroneous number from the testimony I actually submitted). In addition, the shorter written remarks that I prepared for my 5-minute slot, and then delivered more or less verbatim (taking exactly 4:57!), are available here.

My remarks emphasized three main points:

(1) Rising high-end income concentration may influence how one thinks about high-end tax rates, in particular as part of a broader tax reform process. In the 1986 tax reform process, people thought about high-end distributional neutrality as purely a function of making before-and-after comparisons for two groups: those earning from $100,000 to $200,000, and those earning more than $200,000. A much more nuanced approach to the high end may be necessary today (e.g., the Fiscal Commission Report looked at the top 20%, 10%, 5%, 1%, and 0.1%).

(2) The big-ticket tax expenditure items (such as home mortgage interest deductions, the employer-provided health insurance exclusion, and charitable deductions), tend to provide benefits that rise relative to income until close to the top of the income distribution, when they start falling as a percentage of income. This makes it quite difficult to achieve distributional neutrality 1986-style at the very top unless one starts addressing items such as the 15% dividend rate, which (a) doesn’t hit wage earners at the very top and (b) arguably isn’t a tax expenditure given the double corporate taxation issue.

(3) If tax expenditures are equivalent to spending through the tax code (as asserted by both the Fiscal Commission and the Ryan Budget plan, and as best illustrated by David Bradford’s weapons supplier tax credit example), then repealing them is not in substance a “tax cut,” and hence doesn’t need to be accompanied by tax rate cuts even if one has some view about tax revenues and the size of government. The ONLY reason to cut individual income tax rates, especially in the face of the long-term fiscal gap, is if the equilibrium one prefers (and can get to) includes lower rates, a point on which I am quite skeptical. More on this in my May 23 Tax Notes piece, “1986-Style Tax Reform: A Good Idea Whose Time Has Passed.”

At the hearing, the Republicans had a coordinated theme decrying the fact that, according to a Joint Committee on Taxation estimate, in 2009 51% of all households paid zero in income taxes. 51 percent is ostensibly a “tipping point” (although in fact it reflected the temporary impact of the recession), and is said to be a concern because you have no “skin in the game” if you pay no income tax, and thus ostensibly will vote under the “fiscal illusion” that government spending is free.

I would question how much political influence we should attribute to Americans who are too poor to pay income tax. Political scientists such as Hacker and Pierson would presumably say, try zero as a good baseline estimate of their influence. If I were looking at a fiscal illusion that government spending is somehow “free,” I would start my analysis with deficit financing. Plus, as I commented at one point, it is a mistake to focus on just one year and just one tax.

One of the Republican Senators at the hearing dismissed the significance of payroll taxes in this regard by noting that they are associated with providing Social Security and Medicare benefits at retirement, rather than going into general revenues. But more specifically, he called payroll taxes merely an “insurance premium.”

If payroll taxes are insurance premiums rather than taxes, and Social Security / Medicare benefits are insurance payouts rather than government spending, I suppose we will need to restate our budgetary accounts a bit.

Another coordinated theme on the Republican side of the aisle was that it's simply wrong to have the income tax system do anything whatsoever to affect distribution. It should simply be about raising revenue to pay for government outlays, period. Anything else is immoral. I replied that, if this is the case, we should definitely have a uniform head tax, under which Bill Gates would pay the same amount of tax as a homeless person. And if this is wrong (and I noted that Margaret Thatcher, who had been lauded earlier in the hearing, ran into some problems with a head tax), and we indeed want to tax something such as income based on some such notion as ability to pay, then we are all really playing the same game, and there is nothing left to complain about at a philosophical level.

I think it came out sounding a bit less harsh than that, but hopefully the point was clear.

One of the Democratic Senators invited me to take some pretty open potshots at the degree of good faith in the tax part of the Ryan budget, but I declined to impugn motives, and simply said that I felt its rate cuts were unwise and that its base-broadening remained entirely unspecified. But I granted that it's a lot easier to criticize popular but bad policies if you have my job than if you are a member of Congress.

Last 2011 NYU Tax Policy Colloquium

Last Thursday, Cheryl Block presented her work in progress, “Tax Justice and the Equitable Distribution of Bailout Costs,” as our last paper of the semester.

The paper posits that public anger over the financial sector bailout, along with reasons for thinking that the anger might in various respects have been justified, suggests the possibility that ability to pay principles don’t provide the best guide to thinking about how the costs of the bailout would equitably be distributed. E.g., is the view that the financial sector ought to pay a distinctive view that we need to think seriously about?

Cheryl agrees that there may be important incentive reasons for making the people who caused (and may again cause) a bailout to be necessary pay for the expected costs of their behavior. Not only ex ante, before they act, but even ex post, if the lesson that is learned will impress itself upon future actors. But she wants to leave the efficiency analysis to one side, for purposes of considering the equity issues as well.

My main criticism of this is that there is a considerable overlap between giving people proper incentives and deciding whether they are blameworthy or not. Our intuitions (in the realm of “distributive desert”) about punishing the guilty, etcetera, have a lot of overlap with the idea of giving people proper incentives (and not minding what they decide if they had the right incentives to consider harm to others, etc.). So it is difficult to pursue this analysis independently of efficiency even if one concludes that one’s (or at least my) admitted emotions of distributive desert (a.k.a. retribution) should be preferred to, say, utility maximization where the two, despite their considerable overlap, prove to be in conflict.

Also, I would say that the financial sector as such can’t pay since it’s not a human being. When we say this we presumably have particular individuals in mind – e.g., in this case, the managers and other highly-paid employees in the financial sector, along with their pals in the rating agencies, captured regulatory agencies, etc.

Just because it’s been a very busy semester, I was relieved to have it come to an end, even though so much of it is very interesting and fulfilling. The students were great and their degree of interest and involvement was exhilarating. Things have hardly let up for me since, however – I testified today before the Senate Finance Committee on equity issues in the income tax (more on this shortly), and am off on Saturday to teach in Singapore for 2 weeks. Pretty fast turnaround there, admittedly adding a bit to the stress, although I am hopeful that the Singapore class will go well too.

Next year (January through April 2012), I’ll be teaching the colloquium on Tuesdays with Alan Auerbach. I’m very much looking forward to doing it with Alan. Thanks to Mihir Desai for collaborating with me in the enterprise over the last two years.