Romney's latest talking point about how policy should be directed by people who have had a "job"

Romney appears to be doubling down on his talking point about how Obama and lots of people in the Administration have never had a "job," by which he means a private sector business job. Apparently that is what you need to decide, for example, on the merits of the case for Keynesian stimulus, or to evaluate global warming, or for that matter to set our policy towards Iran.

Back in the 1990s, I was once called as a witness at some sort of House sub-committee hearing on raising the minimum wage. The Republicans were in the majority, and I was one of their two witnesses. The other was Doug Holtz-Eakin. I had been called because of a recent article I had written in the U of Chicago Law Review, in which I skeptically compared min wage increases to their equivalent in explicit tax and transfer terms (i.e., a tax on low-wage employment that was used to fund a subsidy to people with low hourly earnings, and with no focus on household income over any longer period). The article was balanced, and I noted that some of labor markets' peculiar features made it plausible that modest minimum wage hikes would have genuinely ambiguous employment effects (as suggested by then-recent empirical work by Card and Krueger).

The background for the hearing was that the Republicans were not having any of it, so far as a minimum wage increase was concerned, but that they didn't feel they could just not hold the hearing. (Obviously they would never hold it today.) So it was a day for the Democrats on the sub-committee to beat up the Republicans a bit, since this was an issue on which the Dems would definitely poll better. They had their own witnesses, including I believe Jared Bernstein.

Anyway, at some point the Democrats started saying stuff like: What do we need these academics here for. Let's get some witnesses who actually know something about the minimum wage - minimum wage workers! Holtz-Eakin, while trying to tamp down his reaction, couldn't help being a bit sarcastic and irate. He suggested to the Democrats that, if that was how they defined expertise (rather than, say, by asking experts about the state of empirical knowledge), why not just fire their staffs and have all the issues decided by people who don't know anything.

Then we had to sit through some stuff about how "you people" just "don't get it," which was funny for me because I certainly do want to help low-wage and unemployed people but would not assume that they know the most about how to raise employment and wage levels.

When it was over, outside the hearing room a leading Democrat (I believe it was John Dingell) winked at me as if to say, hey, don't take it personally, it's all just show biz.

But now we have Romney basing an entire presidential campaign on essentially the same type of definition of expertise, only it relies on the perspective of the bosses rather than the workers.

Gingrich's tax planning trick

According to Forbes (courtesy of the Tax Prof Blog), Newt Gingrich's tax return shows that he purported to avoid $50,000 of Medicare payroll taxes by using the so-called John Edwards Sub S tax shelter - a scam that Forbes says the IRS has "consistently and successfully attacked." The trick is to avoid the 2.9 percent Medicare payroll tax by forming a shell entity that supposedly employs you. Then, when others pay for your services, the money goes to the entity, which underpays you from a reasonable compensation standpoint. This ostensibly results in converting the lion's share of your compensation income into business profits, which do not face the Medicare payroll tax. If you actually need the cash, you can still ask the entity to pay it to you (and it will probably say yes to its 100% owner), but you label the payments as dividends, which also are exempt from the Medicare payroll tax (and indeed are tax-irrelevant, given that a subchapter S corporation is taxed as a flow-through entity whose profits accrued to you anyway).

Essentially, the trick is the same as if I were to make a deal with NYU whereby I formed a subchapter S corporation, charged NYU my entire salary, and then had my S corporation pay me just a pittance under the salary label. If this worked, I could avoid all payroll taxes (except on the pittance that I admitted was salary) - Social Security as well as Medicare. And I suppose NYU could avoid paying its half of the Social Security payroll tax. But needless to say this wouldn't actually work, in particular given the personal service corporation rules (Internal Revenue Code section 269A).

The John Edwards Sub S tax shelter typically comes closer to being legally defensible, avoiding the terms of section 269A and being contested by the IRS on "reasonable compensation" grounds, which in this setting is a version of substance over form. That is, if Gingrich the sub S owner were dealing at arm's length with Gingrich the star employee, he would have to pay himself pretty much the entire profits, since he is the asset. The IRS has had prominent recent wins lately in litigating this issue.

It's only fair to compare Gingrich's Sub S tax shelter to Romney's use of Caymans entities to avoid unrelated business income tax (UBIT) with respect to his pension investments. Romney's strategy appears clearly to work as a legal matter, and the tax he is avoiding (the imposition of UBIT on debt-financed exempt entity investments) has contested merits, which may be one reason why Congress has not revised the rules to defeat the strategy (an almost absurdly simple one, based on not "looking through" a meaningless blocker entity). Gingrich's tax planning trick strikes at the heart of taxing earned income under the rules that are supposed to apply to it. Like so many abusive tax shelters, it appears to be based on mischaracterizing actual transactions, rather than merely exploiting a legally relevant technical lacuna in the law. What is more, if audited, Gingrich (unlike Romney) might face a risk not just of losing the case, but of owing penalties.

New article on financial sector taxation

I have now posted on SSRN a first draft of my just-completed article, "The Financial Transactions Tax Versus (?) the Financial Activities Tax."

It is available for download here.

The abstract reads as follows:

The 2008 financial crisis has provoked widespread interest in developing new taxes to apply to the financial sector. In particular, the Staff of the International Monetary Fund has suggested enactment of a financial activities tax (FAT), while the European Commission has proposed a financial transactions tax (FTT). This article discusses the FAT and FTT models that have featured in historical and more recent discussion, and evaluates them in light of the objectives stated by the European Commission, along with broader tax policy considerations. It concludes that there is a strong case for enacting an FAT, and that two alternative versions of this tax have competing pluses and minuses. With respect to the FTT, it concludes that the rationales advanced by the European Commission are unpersuasive, but that an argument could perhaps made for the tax – subject to concern about its clear inefficiency at certain margins – based on the goal of discouraging the socially excessive pursuit of trading profits (or if better instruments for raising revenue and increasing progressivity are politically unavailable).

But enough about taxes and politics, what about the weather?

Every winter - even uncommonly mild ones, such as winter 2012 so far - I keep asking myself: Have we bottomed out yet? When does the average daily temperature stop falling and start to rise?

Today I finally thought to do an online search that would enable me to answer this question. According to the relevant link at weather.com, the average mean daily temperature in New York City declines from 34 degrees to 33 on January 1. Then on January 10, it drops another degree to 32. There it stays until January 24, when it rises back to 33. It goes to 34 degrees on February 4, 35 on February 11, and whee, up we go back towards ranges where human beings could biologically survive indefinitely even without clothing and shelter.

Bottom line, we are more than halfway through what is on average the very coldest stretch.

Romney Caymans tax planning follow-up

A Wall Street Journal article suggests that Romney's use of offshore entities in the Caymans, permits him to avoid the unrelated business income tax (UBIT), which can kick in when tax-exempt entities (such as pension funds) have debt-financed portfolio income.

This raises the question of whether we should view Romney (a) as having been engaged in disreputable tax avoidance behavior, demonstrating how the rich and well-advised can avoid intended income tax liability - or instead (b) as merely avoiding traps for the unwary and/or structuring his investments rationally and in a tax-efficient manner, as any well-advised investor would.

The question has no clear answer. Those who would like to plunge into the thickets a bit should definitely consult the article on using overseas entities that David Miller presented at the NYU Tax Policy Colloquium last year, which you can find here. At pages 40 through 48 of the article (following the numbers on the bottom of each page, rather than the overall document numbering at the link), he explains in detail both (a) the underlying UBIT rules and how they might have created a tax liability but for the apparently standard strategy that I gather Romney followed (investing through Caymans "blocker entities"), and (b) how the strategy eliminates the UBIT liability (which is pretty simple - the US tax-exempt doesn't itself borrow, but just gets dividends from its Caymans creature which does the borrowing).

The paper also tackles the further question of whether we should think there is anything wrong with allowing the strategy to work. The suggested conclusion (see pages 47-48) is that (a) Congress really did intend to apply the UBIT in situations where Romney's tax planning strategy permits him to avoid it, but (b) the provision that he is avoiding "was crafted less by prudent tax policy and more by politics," and hence one might not object strongly to its being avoidable.

UPDATE: I discuss the UBIT tax planning angle in a Christian Science Monitor article by Ron Scherer, available here.

What is Mitt Romney's effective or average tax rate?

He now says that it is 15%. But if that is his opening claim, I would say that the smart money is on an over-under that is considerably lower.

Romney appears to believe that he can get away with releasing only the 2012 return, which obviously is being prepared with current campaign circumstances in mind. I myself would regard it as preposterous if he is not compelled by political pressure to go several years back, in keeping with what is otherwise universal practice in presidential campaigns.

Would his tax returns for, say, 2007 through 2011 look about the same as that for 2012, given that he has been running for president (or preparing to) throughout this entire period? If he has made good decisions, clearly yes. But he appears so clueless about the difference between his circumstances and those of average voters that I suspect the answer is no. He may simply have figured: this (i.e., extremely aggressive tax planning) is how you do it, and how everyone does it.

But suppose he releases his tax returns. How should we interpret them? There will be a lot of discussion of what his average or effective tax rate is, and how that compares to that for more average taxpayers. Indeed, he himself engaged in this analysis by quasi-endorsing the 15% figure.

An initial question is whether to benchmark the number we end up with against average taxpayers' income tax liabilities, or their income plus payroll tax liabilities. And if we include payroll tax liabilities for average taxpayers, should that include the employer share? (This would require grossing up the income measure to which one's tax liability is being compared.)

There certainly is an argument for including payroll tax liabilities. But it is true that, when you earn wages that are subject to the Social Security portion of the payroll tax, you may also be earning expected retirement benefits from Social Security. (Technical note: you only pay Social Security tax on your first $110,000 of wages, and the formula for determining retirement benefits counts only your 35 highest-earning years, excluding amounts earned that were above the tax threshold.) So arguably your net payroll tax liability is lower than your gross payroll tax liability. Then there's also the lifetime perspective (Social Security and Medicare benefits versus payroll tax liabilities overall in present value, rather than current year). This is an important perspective but obviously well beyond what we can imagine focusing on here.

Now let's get to Romney's income tax return itself. One possibility would be to compare the bottom line income tax liability to his adjusted gross income (AGI). This may be the source of his 15% estimate, if he is paying mainly capital gains tax based on the highly controversial income tax treatment of "carried interest" paid to private equity managers.

But suppose he also has a bunch of tax shelter losses that reduce AGI. Then there would certainly be a strong case for grossing up AGI, for purposes of the effective rate measure, to reflect the noneconomic character of such losses.

Suppose further that, since so much of his income took the form of capital gains, he used an aggressive "strategic trading" strategy to generate offsetting losses. The basic trick is as follows. You hold a huge stock portfolio, figuring that some will go up in value while others go down. You then hold the winners and sell the losers, generating sizeable capital losses. In one sense, these are not fake - the stocks you sold actually did generate the losses claimed. But it may radically misrepresent your overall portfolio results.

Strategic trading has the potential to wipe out income tax liability for rich people with large stock portfolios. It is combated by the capital loss limitation, which limits individuals' net capital losses claimed to $3,000 per year. But this is not a constraint insofar as the income you want to shelter is taking the form of capital gains.

Thus, there would be an argument for grossing up Romney's income measure, for purposes of the effective tax rate computation, to disregard capital losses, insofar as we suspect that this is going on. But the right answer depends on the rest of his stock portfolio, which will not be directly observable from his tax return.

A related issue, which came up in public discussion of Warren Buffett's effective tax rate, pertains to unrealized asset appreciation generally. It's a bedrock rule in our tax system that this stuff generally isn't taxed. But it is a part of economic income, so if you are interested in tax liability relative to that, it oughtn't to be ignored.

Now let's take the unrealized appreciation issue one step further. Suppose Romney has huge unrealized gains that have accrued economically overseas, in particular in tax havens, without being currently taxable in the U.S. Suppose that his not including all this stuff in his income reflects the very aggressive, but (under current law) perhaps legally defensible, tax planning that reports I have seen on-line suggest is characteristic of Bain investments. This, like tax shelter losses, might be viewed as unrealized appreciation plus. Excluding it would give a false picture, making his tax liability seem higher than it really is as a percentage of economic income.

Finally, let's consider a deduction that would reduce taxable income but not AGI. I have seen reports suggesting that he gives millions of dollars in annual charitable donations to the Mormon Church. At least if they're done in cash rather than reflecting tax gimmicks such as the use of appreciated property, this really does reduce his remaining cash out of pocket. But on the other hand, it is a voluntary and discretionary outlay, best viewed as how he chose to spend his economic income rather than as a reduction thereto. And it does reduce his contribution to the public fisc. So arguably the income measure that we use to compute his effective tax rate should not be reduced (relative to AGI) by his charitable contributions. But on the other hand, the size of his charitable contributions may be relevant to the characterological conclusions that we would draw from getting to see his tax returns.

There are some complex issues here, not all of which have an absolutely clear right answer, and not all of which would be entirely illuminated if he consented to the level of disclosure that all other major presidential candidates have accepted for decades. But I say, release the returns and we can let the debate begin.

Tax policy colloquium on 1/17/12 - Michelle Hanlon paper on offshore investment

Yesterday was the first session of the 17th (!) NYU Tax Policy Colloquium. I am doing it with Alan Auerbach again, for the 3-½th time, and we have 27 students (the max allowed). Our Week 1 guest was Michelle Hanlon, with respect to her paper (co-authored with Maydew and Thornock), Taking the Long Way Home: Offshore Investments in U.S. Equity and Debt Markets and U.S. Tax Evasion.

The paper seeks to get a handle empirically on the existence and magnitude of illegal tax evasion by U.S. individuals that takes the following form. You want to invest in U.S. securities without paying U.S. income tax, so you establish a corporation in a tax haven (say, the Cayman Islands) and have it invest in U.S. securities. But you ignore the fact that such "round-tripping" gives you current year tax liability (or its present value equivalent) under the passive foreign investment company (PFIC) rules, obviously counting on the prospect that the U.S. tax authorities will not learn of your ownership interest in the offshore company.

Since researchers, no less than the IRS, can 't directly observe this illegal activity, one needs an empirical strategy to try to estimate it. The Hanlon paper finds two main things. First, when relevant U.S. tax rates go up (such as for individuals' ordinary income or long-term capital gains), inbound investment to the U.S. from tax havens tends to go up. The suggested explanation is that the higher tax rate increased U.S. investors' incentive to engage in fraud, but did not directly affect investors from other countries. Hence the surmise that perhaps the increased inbound capital flow may actually reflect round-tripping, and associated tax fraud, by U.S. investors.

Second, when certain agreements are reached between the U.S. and a tax haven country that may indicate an increased probability of detection for fraudulent evasion of the PFIC rules, inbound capital flows to the U.S. from the haven tend to decline. Once again, the surmise would be that, if only U.S. investors are being affected, it is a decent surmise that they are responsible for the change.

The paper makes a nice contribution by shedding some light on this issue, but it remains hard to tell just how much fraudulent round-tripping is going on. For example, one could concoct a scenario in which the U.S. tax rate increase induces U.S. investors shift to municipal bonds and tax-favored housing. So they sell securities to non-U.S. investors, who may invest through tax haven entities if they have other reasons for doing it this way.

Also, a higher U.S. tax rate could lead to round-tripping that is not associated with tax fraud. A paper that David Miller presented at the colloquium last year explored the various reasons why U.S. investors may choose to use tax haven entities, even when fully complying with the law (including the PFIC rules). For example, this structure may enable them to avoid itemized deduction disallowance or limitation rules that only apply to individuals. So we could potentially have the round-tripping story that the paper shows, minus the implication that it is mainly about tax fraud.

Likewise, suppose that there are U.S. taxpayers who have figured ways to engage in legal tax avoidance with respect to the PFIC rules, rendering them inapplicable in circumstances where one might argue that as a matter of policy they ought to apply. Once again, we would have the round-tripping story without the fraud.

Insofar as the data do indeed show non-trivial levels of tax fraud, the issue of what to do about it remains. Open questions include what sort of revenue estimate one might get for particular crackdown measures, and how things will change when the Foreign Account Tax Compliance Act (FATCA) takes effect next year.

Still, the paper presents a suggestive initial look at an area where there have been large gaps in our empirical knowledge.

Martin Luther King Day

Though I was only 10 years old at the time, I well remember my shock, dismay, and disbelief (sorry for the cliched word choice, but those are the ones that fit) when Martin Luther King was shot. I learned of it from my parents (who must have had the TV or radio on), I would think in the early evening.

Recently I was reading a very compelling book, Hampton Sides' "Hellhound on His Trail," about Dr. King's last days, the assassination, James Earl Ray, and the FBI's pursuit. When reading about the horrific deed itself, even all these years later, I found myself getting choked up as if it had just happened.

At the time of King's death, his primary mission of combating legal segregation was pretty much done. He was struggling to define and advance a secondary mission, pertaining to poverty and economic opportunity as well as to U.S. military involvement abroad, but in a much more fragmented political environment, with fewer allies or good choices, and with less of a clear sense of how (or towards what ends) to proceed. But he certainly didn't think he was done.

The issues in his secondary mission faded from politics for a while in the decades after his death, and probably he would have had a hard time changing that. But today they arguably are even more pressing than in 1968. Something to think about on a day devoted to his remembrance.

Financial sector taxation

I have just completed a first draft of a paper, entitled "The Financial Transactions Tax Versus (?) the Financial Activities Tax," that I will be submitting within the week for inclusion in a conference volume to be published by the International Bureau of Fiscal Documentation (IBFD). The underlying conference is the one in Amsterdam that I attended last month, which I discussed in an earlier blog entry here.

Once I've looked it over a bit more, I'll be posting it (with an abstract) on SSRN. I may also consider publishing it in either U.S. or International Tax Notes, which the conference organizers have given me clearance to do.

Further details, including abstract and an SSRN link, to come shortly.

I'll also be presenting it (leaving aside the point that speakers don't actually present their papers) at the NYU Tax Policy Colloquium on Tuesday, February 28, as we had to make a change in our previously announced schedule.

Those quiet rooms where we can discuss tax policy

"QUESTIONER: Are there no fair questions about the distribution of wealth without it being seen as envy, though?

"ROMNEY: I think it’s fine to talk about those things in quiet rooms and discussions about tax policy and the like."

I guess I should thank Mitt for this, what with the 2012 Tax Policy Colloquium starting in 3 days and all. We certainly plan on discussing distribution and tax policy in our quiet room in Vanderbilt Hall. This may be our first ever explicit endorsement by a leading presidential candidate.

Outside our quiet room, however, the comment has rightly attracted the mockery that it deserves.

Though it's shooting fish in a barrel, let me briefly explain why. Government economic policies matter because they can affect how well off people are. Each person might end up with more or with less, depending on what policy is adopted and on how it works out. It is analytically convenient to divide all this into issues of efficiency and distribution. Efficiency is the size of the pie. Distribution is how the slices are divided between different people. You're always facing distribution issues unless it is a pure Pareto (and hence efficiency) case in which someone could gain without anyone else losing. Those issues are pretty easy to resolve - it's not hard to like policies that would make someone better off and no one worse off. The rest of the time, distribution is a key part of the story, and often this is about richer individuals as opposed to poorer ones.

So there are two basic dimensions in economic policy, and one of them, which is involved almost single time, Romney says can't be discussed in public. Would he hire an architect to design his 11,000 square foot house, and say "We can only talk about the size of the house, and not about how we are going to divide up the space between the rooms"?

Another point, of course, is that the government cannot help but affect distribution. It's not a matter of deciding whether or not to simply retain the (wholly fictional) preexisting, non-government distribution. We aren't living in a state of nature, we're in an actual political and economic world with centuries of government policy and ongoing effects on everyone. The question isn't whether to address distribution or not, but what it's going to be, and how different distributional outcomes will be traded off given efficiency (size of the pie) differences between them.

Then of course we have Romney proposing huge tax law changes, not just for the quiet rooms but for the actual halls of Congress, that would include vast, unfinanced tax cuts for people like himself, and apparently tax increases for the bottom 50 percent. But he evidently thinks, from his political handlers, that the "envy" talking point will permit him to dodge discussion of what he wants to do distributionally.

And of course it's not just tax policy. The legal environment in which Bain Capital operated led to a set of transactions around the country that had various efficiency and distributional consequences, which are certainly fair game for discussion. Now, as it happens, I might agree with Mitt that allowing takeovers, refinancings, and plant closings is better than trying to ban them - although we should (a) seek to ensure well-functioning capital markets, without which all bets are off about the ability of a free market economy to yield value-increasing outcomes, (b) keep in mind the effects of tax biases that may have helped drive the transactions, such as that for debt over equity, and (c) consider what policies could help the people who are the casualties of the process. Is that envy too?

If you cannot defend your own policies in terms that have some connection to how you might actually rationalize them to yourself, and instead show the world that you can only defend them publicly in terms that are laughable and (since you must know better) insulting, then perhaps you are in the wrong business.

A critique of Bain Capital

The film denouncing Mitt Romney's work at Bain Capital, which apparently is playing in South Carolina but is also available here via youtube, may appear at first glance to be longer on story than coherent critique. But in fact it makes a specific claim about Romney's private equity career that deserves broader attention and assessment.

The claim is that Bain's business model under Romney was as follows. They would buy a business and boost its short-term profitability through measures that did not actually increase, and might indeed reduce, its long-term profitability. A specific example mentioned is demanding swifter production at the cost of much lower quality, which could increase sales for the first six to twelve months but then destroy a product's reputation and longer-term sales. Another is slashing wages, where they were previously higher for "efficiency wage" reasons, generating immediate savings but over a longer period reducing workforce productivity (e.g., due to higher turnover costs, change in the quality of the workforce, and morale effects).

The short-term profit jump would immediately be cashed out via higher debt, in many cases accompanied as well by a public stock offering. Bain would then cash out, leaving the business to fail because profits, once they reverted to lower levels, couldn't handle the debt burden.

While I don't know for sure that this story is (at least generally) true, it hangs together and makes logical sense. Note that, in bankruptcy, it might make sense to break up the business rather than simply refinance and keep it going, even if before the arrival of Bain Capital this would not have made sense even with a high debt overhang. Once they have destroyed intangible value (goodwill, workforce in place, etcetera), the company they purchased is no longer optimally using resources.

Obviously, the story requires a healthy dose of asymmetric information and capital market gullibility to get off the ground. (The suckers, after all, are not just the workers but also the lenders and the public offering stock purchasers.) But this is entirely believable. Think of Goldman conning its customers, AIG offering what was effectively an insurance product that it would never be able to make good if the insurance was needed, or mortgage securitizations that offered sham diversification benefits and were priced based on credit ratings that they did not deserve. Bain, under this view, is simply one more member of the rogue's gallery of players that found ways to generate enormous profits by causing the U.S. economy to work worse, not better.

This of course would be a story not of capitalism's "creative destruction," but of destructive destruction and the use of information asymmetries (pertaining here to the short-term profitability jumps that apparently drove the ability to borrow and drain out cash) to undermine the sound functioning of capital markets. And the extent to which it is true certainly deserves serious scrutiny in the months ahead.

On the road again

I am sitting in Charlotte Airport, en route to Gainesville, Florida and the University of Florida Law School, where I am scheduled to give a talk this afternoon on international tax policy. I will be using (as a handout) the slides from my talk in Brazil, which I posted here early last month, but for discussion purposes minus thr Brazil parts.

2012 NYU Tax Policy Colloquium schedule with paper titles

Just 12 days from now, the 2012 NYU Tax Policy Colloquium will be getting under way. I'll be doing it this year with Alan Auerbach. I've previously posted the schedule with speakers and dates, but here for the first time I can do so with almost all of the paper titles (some of which, however, are still tentative). Anyway, it will go something like this:

1. January 17 – Michelle Hanlon, MIT Sloan School of Management. "The Effect of Repatriation Tax Costs on U.S. Multinational Investment Efficiency."

2. January 24 – Amy Monahan, University of Minnesota Law School. "Will Employers Undermine Health Care Reform by Dumping Sick Employees?"

3. January 31 – Alex Raskolnikov, Columbia Law School. “Not Close Enough: Accepting the Limits of Tax Law and Economics.”

4. February 7 – Victor Fleischer, University of Colorado Law School. "Tax and the Boundaries of the Firm."

5. February 14 – Heather Field, Hastings College of Law. "Binding Choices: Tax Elections & Federal/State Conformity."

6. February 28 – Dhammika Dharmapala, University of Illinois Law School. “Taxes and the Real Option of Delaying Incorporation.”

7. March 6 – Edward Kleinbard, USC Law School.

8. March 20 – Susan Morse, Hastings College of Law. “Worldwide Corporate Income Tax Consolidation and a Corporate Offshore Excise Tax."

9. March 27 – Stephen Shay, Harvard Law School. “Unpacking Territorial.”

10. April 3 – Jon Bakija, Williams College Economics Department.”Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data."

11. April 10 – Lane Kenworthy, University of Arizona Sociology Department. "Getting taxes right: What can we learn from the comparative evidence?"

12. April 17 – Yair Listokin, Yale Law School. “’I Like to Pay Taxes’: Lessons of Philanthropy for Tax and Spending Policy” (with David Schizer).

13. April 24 – William Gale, Brookings Institution. “Fiscal Therapy.”

14. May 1 – Rosanne Altshuler, Rutgers Economics Department, and Harry Grubert, U.S. Treasury Department. “A New View on International Tax Reform.”

New York Times article on corporate stock options

In today's Times, David Kocieniewski has an article noting how the revival of stock prices has led to a new explosion of executive stock options offering huge payouts to high-ranking executives. The article emphasizes the entity-level tax angle, which is that, when the executives exercise their options - typically at a huge profit, even if their companies have failed to outperform the stock market - the companies get huge deductions that may zero out their taxable income.

The natural reply to make to this critique is that there is no tax angle after all, if the executive is taxed at the same marginal rate as the company. (And note that even a company facing a low average rate on its income, due to other tax planning such as causing its U.S. income from intangibles to be treated as arising in tax havens, may face a 35% marginal rate in the effective range.) Thus, if Steve Ballmer gets a $100 million stock option and both he and Microsoft face 35% marginal rates, then its $35 million tax saving is offset by his $35 million tax bill. Denying it the deduction but taxing the underlying income only once - by allowing him to receive it tax-free - would lead to an identical after-tax result on both sides of the transaction if it responded to the change in rule by paying him $65 million.

I doubt many readers of this blog entry will consider this either a novel or a hugely surprising point. Indeed, it is made repeatedly, and at times vituperatively, by readers of the NY Times article who posted comments discussing it. So let em just add two further lines of discussion here.

First, I would certainly agree that the executive comp discussed in the article is a huge problem, even if it isn't a tax problem. The issues it raises are twofold: distributional and corporate governance. As to the former, rising executive comp over the last 20 years is a huge contributor (both directly and indirectly) to rising U.S. income inequality during this period. Conventional economic theory would suggest that this merely reflects that the execs are adding more value, so even if you dislike the distributional result it would be gratuitously inefficient to attack rising executive comp as such. I happen to think that conventional economic theory is wrong in this case, but that would require a lengthy discussion of its own that doesn't really fit well here.

So let's move on to corporate governance. A large part of the appeal of stock options to inside players as an executive comp tool lies in the opportunity that the options offer to facilitate looting of publicly traded companies, if you want to put it as rudely and crudely as possible. Or. if you want to put it more politely, stock options are a really crucial tool for overpaying mediocre executives - not all of whom can be above-average, after all. Even without any tax angle at all, the options offer a wonderful excuse to compensate the mediocre as if they were geniuses, by allowing them to ride the overall rise in the stock market to claim huge payouts that they pretend reflect their own influence on the stock price. (And if the stock market goes down rather than up, no problem - the company simply reprices the options and gives the executives another chance. So it is rather like getting to place huge bets on the roulette wheel where it's someone else's money, and where if red doesn't come up this time you get to try again and again.)

While this is a serious corporate governance problem, to a degree one could argue that the tax system actually helps, rather than making things worse. High-ranking executives might be happier still if stock options were nondeductible, assuming that this meant that they would also be treated as tax-free to the grantee. Returning to the Ballmer-Microsoft example, in such a state of the world they could announce the value of the grant (at exercise) as only $65 million, yet it would produce the same end result as giving him $100 million under current law.

Indeed, taxpayers like this result so much that they are often apparently quite willing to risk paying MORE tax overall if this permits them to steer as close to it as present law permits. As a starting point for explaining this, note that options could in principle be taxed earlier still - when they are granted, rather than when they are subsequently exercised via a purchase of the company's stock at the option's strike price.

Why aren't executive stock options taxable when granted? After all, they may have significant option value even if they are not yet "in the money." The reason that they usually are not taxable when granted is that they usually remain subject to a "substantial risk of forfeiture" (rather than having irrevocably vested), rationalized on the ground that they represent contingent compensation for future services that might affect the stock price and thus the option value.

Under the relevant Code provision, however, employees can elect to have the options valued and included (as well as deducted by the company) in the year when they are granted. If they make this election, the option is valued as if the risk of forfeiture did not exist.

This in turn led for years to the following tax planning trick. I elect to have my option valued and included / deducted in the year when it's granted. But I claim that the option value is zero, reflecting that it is not yet in the money (i.e., the stock price doesn't yet exceed the exercise price). In fact, the claimed value is ludicrous, since the person claiming the zero value would very likely refuse to sell the option, if this were permissible, even if offered many thousands (or perhaps millions) of dollars for it.

The IRS was so upset about this trick that it issued a regulation providing that, if the option's value isn't sufficiently "ascertainable" (which basically requires that it have an observable market price), taxpayers can't go the election route here. So the IRS effectively forces many taxpayers, contrary to their preferences and an arguably fairer reading of the statute itself before the regulation was issued, to wait for taxable income at a later point.

The funny thing about this, in turn, is that, once the employee has recognized taxable income (and the employer a matching deduction), further appreciation is taxable to the employee (though generally at just the capital gain rate) without a matching employer deduction off any kind. So the low valuation "scam" that taxpayers prefer and the IRS prevents may actually be a route to higher, rather than lower, overall taxation.

What could possibly be going on here? Well, probably several things. For one, if the company has net losses (as may be common in the start-up period even without tax haven games and the like) then the employer deduction doesn't actually make up in full for the employee inclusion. For another, if you hold the stock until death then the deferred tax on post-taxability appreciation permanently disappears. Perhaps a few people are myopic and just want to defer the employee-side day of reckoning. Executives who are trying to hide the ball regarding how much they are actually getting paid don't want to pay tax sooner since it's inconvenient to have to rely on gross-up to make themselves whole.

Bottom line, without condemning today's article in the Times there are still some interesting angles to pursue, though it's possible that the editors would consider them too esoteric for a page 1 placement. But perhaps still worthy of page 1 in the business section?

Wonky teaser for my FAT versus FTT article

Bruce Bartlett's newly posted Tax Notes column criticizing financial transactions taxes (FTTs) reminded me that, while James Tobin is often considered the FTT's grandfather due to his 1970s advocacy of a tax on currency exchange transactions, John Maynard Keynes offered a seemingly very similar rationale for a tax on securities trades. However, I may argue in my paper that, insofar as the rationales can be teased apart, Keynes' actually stands up better today than Tobin's.

As the year winds down ..

I'll be spending a significant portion of the winter break writing a short article (based on my talk at the Amsterdam conference earlier this month) called "The Financial Transactions Tax Versus the Financial Activities Tax." I conclude, however, that the article's title states a false opposition, since a financial activities tax (FAT) should be passed in any event, whereas a financial transactions tax (FTT) might or might not be desirable on balance - whether or not there is an FAT - based on issues entirely distinct from the overall treatment of financial sector firms and the risk of another 2008.

The one time I baffled my Amsterdam audience with American slang

In general, I thought my Amsterdam talk went smoothly and was well-received. But at one point, with reference to bankers who make bets that have positive expected returns for them because they don't bear the downside tail risk, I unthinkingly said something about how sometimes it comes up snake eyes. Alas, pretty much no one in the predominantly Dutch audience knew what this meant, and several asked me afterwards. But they agreed that the Americanism for rolling a pair of ones in craps is striking and apt.

Amsterdam conference on bank taxation

Yesterday was the conference day in Amsterdam at which I delivered my talk on the FTT versus the FAT (see previous entry). The FTT, aka (in an absurd misnomer, whether one Iikes the tax or not) the "Robin Hood tax," did not, for the most part, receive a lot of love. Not surprisingly, representatives of banks and hedge fund-type asset managers were, shall we say, restrained in their enthusiasm for the measure. But academics were mostly skeptical as well, for good reason, notwithstanding the contrarian instincts that a couple of us had.

By the way, although for convenience I'll continue calling the European Commission's proposal an FTT, it is really an STT, or securities transaction tax, as stock trading (other than primary issuance) is the core item covered, and things such as currency exchange (the original Tobin tax target) and debt transactions are excluded.

An FTT is potentially extremely avoidable. For example, as is well known, geographically. A telling example arose when Sweden enacted an FTT a few years back, even though all the financial actors that would have been charged with collecting the tax said they would avoid it by going to London. This of course is a standard taxpayer threat, not always fulfilled in practice, but lo and behold, when the tax was enacted 60 percent to 80 percent (depending which estimate you take) did indeed go to London virtually overnight.

Then of course there is the issue of using derivatives. Why sell stock, for example, if you can use a swap instead. So a modern day FTT is a joke unless it can reach derivative transactions, by interpreting them as versions of some underlying "primary" transaction.

The Commission's response to this problem has been to try to pitch the proposal broadly. While it can't reach transactions that wholly leave the European tax net (e.g., say an American pension fund would have used German bankers to purchase developing world equities, but decides instead to use a U.S. broker), but the design tries to push having some sort of European connection as hard as it can.

Likewise, derivative transactions ostensibly are reached by basing the tax (though at a lower rate than for other transactions) on the highest (in effect) notional principal amount one can come up with in defining the direct transactional equivalent. (Unclear, of course, whether this is coherent or feasible.)

Exceptions for debt and insurance, which are excluded from the reach of the tax, would likely offer fertile tax planning grounds for avoidance efforts, especially if some EU countries decided to compete with each other for the hosting privilege by, say, broadening their state law definitions of insurance.

The Commission's STT would reach a lot of inter-bank transactions (often taxing both sides), and ostensibly would thus apply even to deemed transactions between branches of the same company or corporate group. Indeed, the Commission may regard this as a strength of the proposal, as it ostensibly counters the critique that customers rather than the banks themselves are being taxed. Some pointed out that this sort of cascading tax within the productive process is exactly what the VAT was supposed to end. (And it is of course contrary to any well-informed economic view about how to make business taxation less rather than more inefficient.)

As the next to last speaker on a long day, I was able to modify and fill out my commentary (from the previous blog entry) a bit, such as by noting that what I see as the best case for some sort of an STT (to discourage socially excessive pursuit of zero sum trading gains) would face many of the same problems but require a very different design. I might want to emphasize taxing trades with customers rather than internal cascading, but then again, what is a "customer" for this purpose? Surely it should include people who are seeking trading gains through a business entity (whether via share ownership or compensation arrangements), which potentially brings back the cascading issue. (And, just because integrated businesses, as distinct from those dealing with each other at army's length, are engaged in zero sum battles over division of the surplus, does that mean we want to comparatively tax-favor them? That wholly contradicts the Coase principle of hoping they will pick the arrangements that are best on a pretax basis.) So perhaps I have to settle for an STT just on sales to customers, though including some legal entities such as shells and pension funds, and without here affirming that it would actually be worth doing in the end.

A financial activities tax or FAT on banks, using a VAT-like design but perhaps with rising marginal rates to address bigness, rents, or suspected hidden tail risk (with the choice importantly affecting key design features) seems considerably easier both to design and to rationalize persuasively.

Amsterdam slides: The Financial Transactions Tax Versus the Financial Activities Tax

My slides on the FTT versus the FAT, to be presented this Friday at the Amsterdam Centre for Tax Law's conference on taxing the financial sector, are available here.

One topic I don't address in the slides, because I didn't think it was within my topic assignment, concerns the question of FTT feasibility. An FAT is pretty much feasible. The only really troubling question (and I admit it's a significant problem) is defining the set of financial sector firms to which it would apply. In particular, what does one do about the issue of financial firms that are in effect embedded in non-financial firms?

With respect to the FTT, one problem is international considerations, which are likely to be a lot more troubling than those presented by the FAT. Domestic banking activity, which the latter tries to reach, is a more stable and less elusive category than the former's reach of domestic financial transactions (or even those conducted by domestic taxpayers).

But in addition, the wonderful world of derivatives presents a huge challenge for the FTT. I know people are aware of this, and contemplate taxing derivative transactions under the FTT equivalently to the "primary" (or whatever one calls it) transactions that they replicate. But it may often be impossible to determine this equivalence, since there may be multiple renderings of what is equivalent to a given derivative transaction. This is likely to be a big problem even if regulators are able to observe everything that is happening, which is a big question in itself. I believe that other panels at the Amsterdam conference may be directly addressing this issue, but it did not appear to be the focus of the more bigthink-oriented panel on which I was asked to participate. It is certainly important, however.

Part of my responsibility in connection with the proceedings is to write (by the middle of January) a short article that will be published in a conference volume that the Amsterdam Centre for Tax Law is planning. I will of course post it on SSRN, and I also have permission to do something with it in the U.S., such as submitting it to Tax Notes. But I don't know yet if I will consider this suitable. (I'd have to see what I write in order to evaluate this - the issues being both how happy I am with it and whether it seems sufficiently in-context for U.S. publication.)

That photo surfaces again

A number of friends and acquaintances have mentioned to me, over the last couple of days that this 1992 photo of me with (now)-Justice Elena Kagan has surfaced again, this time in the latest issue of New York Magazine.

Someone was kind enough to say that I don't look much different today despite the nearly twenty year interval. But I suppose that, if only the photo were doing all of the aging for both of us, Dorian Gray-style, perhaps I would feel better still. As it is, I can certainly tell the difference between then and now, even if it doesn't all show.

If it's Friday, this must be the Netherlands

Okay, I admit to having overextended myself a bit these past couple of months. But I am hoping my body will accept the last few insults (such as time zone changes and overnight flights) without getting too angry at me.

Although I returned from Brazil only yesterday (Monday, December 5), an evening flight on Wednesday, December 7, will take me to Amsterdam early on Thursday, thus giving me a day to time zone-adjust before I present a talk on Friday at the Amsterdam Centre for Tax Law's Conference on Taxing the Financial Sector. This time, I am just one voice in the crowd, rather than the headliner.

Why did I accept, notwithstanding the events' close proximity? Well, for a few reasons, even apart from my being generally more temperamentally inclined towards yes than no. One is that the conference looks interesting and has a good group of people that is different from those I have been seeing lately at other conferences. Another is that the topic is quite interesting, and different from international tax, which has been my main focus in recent months. Plus, I haven't been in Amsterdam since 1983, and wouldn't mind seeing the Van Gogh Museum and Rijskmuseum again, as well as the Anne Frank House for the first time, not to mention having some rijstaffel and strolling around the canals and all that, even in what is likely to be fairly dismal weather.

The background for the conference is that people in Europe are debating various tax instruments for the financial sector. Unlike in the U.S., such taxes can actually be enacted, at least here and there. The International Monetary Fund Staff advocated a financial activities tax (FAT), which is essentially an excess profits tax on banks (reaching high-end employee compensation as well as profits that remain after paying all that swag). But the European Commission has endorsed a financial transactions tax (FTT) in lieu of the FAT. An FTT is a tax on securities transactions (other than initial stock issuance).

It's unclear to me, even after reading the European Commission's work on the subject, exactly why they prefer the FTT to the FAT. There is probably a political backstory, at which I can guess, but as an American (and thus an outsider to the European debates) I certainly don't know anything about this firsthand.

My own prior work, as well as blog posts, explain why I consider the FAT a better choice than the FTT. But, as my slides will show when I post them here in the next couple of days, I actually do see a decent rationale for enacting a modest FTT in addition to (not instead of) an FAT - or more precisely, independently of whether or not an FAT is enacted. Only, this rationale for an FTT has nothing to do with those offered by the European Commission, or with addressing past or expected future financial sector defalcations, or indeed with responding in any way to the threat of future bank failures reflecting undue risk-taking incentives that are likely to lead in the future either to costly bailouts or to further macroeconomic catastrophes (or perhaps, like last time, to both).

More on this shortly.

Reprieve

Today I flew back from Sao Paulo to engage, among other things, in the grim task of going to the veterinarian in order to assess how my favorite little gal, Ursula, is doing.

The state of the play when I left for Sao Paulo was: Not so good. A couple of years ago, she just barely survived a kidney infection that left her with damaged but still for the most part functioning kidneys. But she had worsened again from a new infection, needing to be hospitalized and placed on IV, which in turn had transitioned to no-heroic-measures. Here is how she looked in the vet's office a few days ago.











So when I went to see her today (with spouse), having pretty much just gotten off the plane from a redeye flight, my understanding was that it was not impossible that we would need to be saying goodbye to her very soon. To my relief, however, she looked pretty good - there is plenty of energy and fight left in the little gal yet, at least for now. So she has returned back home, where she is eating and rubbing her head against people while purring loudly in the accustomed manner. No telling how long this will last, however, and she will be needing daily water shots.

I hope Ursula wouldn't mind if she knew that I was cozying up with some other animals while I was in Sao Paulo. Kind of burying my sorrows, I suppose.

Deborah Paul comments on Avi-Yonah dividend deductibility proposal for corporate integration

Some time back (on October 4 of this year), I was a commentator, along with Deborah Paul of Wachtell, Lipton, Rosen, and Katz, on a paper by Reuven Avi-Yonah of U. Michigan Law School concerning dividend deductibility as a corporate integration method. A link for Reuven's paper is available at my blog entry here, and my comments at the session are available here.

Debbie Paul, whose comments I thought were quite good, has now published a written version on SSRN. It is available here.

Conference in Sao Paulo, Brazil

I'm in the Sao Paulo airport, awaiting my overnight flight back to the U.S. after a very enjoyable few days here.

My talk, from the PPT slides posted in my previous entry, appeared to go well apart from the obvious distress that I caused the live-simultaneous translators. It took three of them to handle my talk (of perhaps about an hour?). They were dropping like horses on the Pony Express overnight delivery run, and seemed to think I was talking a bit fast. Not the first time I've heard this critique, but the live audience, which was 99 percent listening in English, appeared to be getting it fine. I later observed that quite a few of the Portuguese speakers at the conference, who were likewise being translated live (I believe, just for me), spoke every bit as fast as I do. But the translators told me afterwards (between shudders at the memory of the exhausting experience) that, for every 10 words or so of English speech, you on average need 13 or 14 words to say the same thing in Portuguese.

Anyway, people seemed interested in the talk. Brazil is an interesting case. At one time in the past a territorial country in re. outbound multinational investment, they have gone opposite to much of the rest of the world by shifting to a fairly tough worldwide system, with no deferral, tough formulaic transfer pricing rules, and anti-tax haven rules for foreign tax credit use (cross-crediting). They also have a 34 percent corporate rate, and are asking some of the same questions as people in the U.S. re. what to make of trends elsewhere.

Apparently, their shift in the other direction reflected that the government was looking for tax revenue and acted, whether for better or worse, without a lot of political debate about the usual set of international tax policy issues. But now Brazilian academics and civil society are getting interested, not in a particular change that they've already picked out, but in thinking about the issues more.

I offered the sort of analysis I've been arguing for in international tax policy lately, but without purporting to say "you should definitely do X." Rather, in addition to the structure of the analysis I noted some empirical issues that might help in evaluating what was best.

I also ended up commenting on a couple of other panels, first more on international taxation and then concerning transparency. I also participated in an informal seminar at a very nice separate location (on Ihla Bella, an accurately named island 3-plus hours from Sao Paulo), on issues of how the Internet et al has affected legal issues such as those pertaining to intellectual property. I suppose you could say I took somewhat of a modified Frank Easterbrook "law of the horse" type position.

I can't really say enough about what a warm and hospitable reception I received from the Brazilian and other (such as Argentinian) participants in these various events. I got a cultural impression of greater personal warmth and also taste for having a good time (such as with live music and very late evenings) than one would expect in a get-together of, say, North Americans or Europeans.

Slides for my talk in Sao Paulo on international tax policy

A pdf of the slides for my keynote lecture at the NEF's Third Annual Colloquium in Sao Paulo, entitled "Rethinking International Tax Policy," is available here.

Upcoming talk this week

This Wednesday morning, at the horrifying time of 4:45 AM, I will be heading to the airport en route to Sao Paulo, Brazil, where I will be the keynote speaker on Thursday, December 1, at the Third International Colloquium, to be held at the Center for Fiscal Studies (called the NEF due to its name in Portuguese), which is affiliated with the University of Sao Paulo Law School. The NEF is a think tank that aims to bring together academics, government representatives, the private sector, and civil society organizations to advance public thinking about tax reform.

A Portuguese-language schedule for this colloquium is available here. Prior keynote speakers were Richard Bird in 2009 and Vito Tanzi in 2010.

My talk will be called "Rethinking International Tax Policy," which I consider adequately descriptive, albeit not, as titles go, especially original or inspired. (How many "Rethinking ..." papers have there been on various legal subjects in the last 20 years?) But I am hoping that the content will be more original than the title.

Brazil is an interesting country, and also has fairly distinctive international tax rules, which I will mention in passing, although I certainly would not claim any more than a very general and superficial familiarity with them.

I have PowerPoint slides for the talk, and will post a pdf of them here on Thursday, if my iPad and wireless access cooperate. I've completed them and thus, I suppose, could post them now, but in general I don't like scooping my own talks at conferences in this way.

Cruel practical jokes

I would never actually do this, but when I see one of my cats sniffing the seat of a soft chair while turning slowly around, preparatory to curling up for a nap, it occurs to me: What if some cruel practical joker had sprayed coyote scent (at a level undetectable by humans) on the spot?

NTA Annual Meeting in New Orleans, part 4

The final panel in which I participated in New Orleans was one at which I presented my article on rising U.S. corporate residence electivity.

Since this article is verging on old and cold (i.e., it's based on a talk that I gave in September 2010, and appeared in the Tax Law Review earlier this year), I decided to use the talk as a vehicle for pushing forward a bit, and including thoughts that I have been developing in the last few months while working on my international tax book in progress. Hence, I called my talk "The Rising Tax-Electivity of U.S. Corporate Residence (... and Beyond)," and used the last couple of slides to push farther than I have thus far in print (other perhaps than earlier powerpoint slides that I have posted at this blog) on how I am thinking these days about how we should tax U.S. multinationals' foreign source income.

The slides are available here. I should note one difference between the version that I am posting and the one that I actually used in New Orleans. The latter included a slide asserting that Desai and Hines are "in error" insofar as they assert that the asserted national welfare norm of national ownership neutrality (NON) supports exempting U.S. companies' foreign source income. But, as Jim Hines noted at the session, there is no error either in identifying NON as a relevant margin at which distortion is undesirable (all else equal), or in asserting that NON supports exemption.

What I would regard as in error is saying that U.S. national efficiency would be maximized by basing our international tax policy on NON. I would argue that this, by over-focusing on one margin when in fact there are many to consider, would affirmatively diverge from minimizing the overall economic distortion caused by the U.S. federal income tax system. Even given this point, however, Desai and Hines are only in error if they do in fact assert that NON establishes that exemption is the most efficient international tax policy for the U.S. to follow.

Now, some may feel that they do effectively assert this, but the articles in which they introduced NON to the literature acknowledge that there are broader efficiency issues to consider. Thus, I decided to remove the "error" claim before posting the slides.

NTA Annual Meeting in New Orleans, part 3

As noted in earlier blog entries, I wanted to offer a brief account of the other two panels in which I participated at the NTA Annual Meeting in New Orleans. Herewith the first additional entry, concerning a panel at which I commented on two empirical papers on international taxation.

The first paper on which I commented was Eric Allen & Susan Morse, "Firm Incorporation Outside the U.S.: No Exodus Yet," which is available here. Allen and Morse use hand-collected data (a phrase in general usage that I nonetheless find charmingly antiquarian, since I would assume people mostly do it with computers) to make a very useful rifleshot finding that contributes to our understanding of U.S. incorporation practices.

As I noted in my residence electivity article, if the U.S. pushes worldwide taxation of U.S. companies especially hard, one might expect rising foreign incorporation by U.S. start-ups. The article notes anecdotal evidence, offered to me by leading practitioners, explaining why in their experience home incorporation remains the norm in most business sectors, even for the potential multinationals of the future. Home incorporation turns out to have significant advantages in the start-up phase. Plus, so long as one places one's valuable international property abroad for tax purposes, the U.S. regime generally is not all that onerous anyway. But I noted suggestive evidence from an article by Mihir Desai and Dhammika Dharmapala that tax haven incorporations have risen in recent years. Might this be the start of a trend? Both I and the authors of that article stroked our chins (metaphorically speaking) and said yes, it's just possible that it might be.

Allen and Morse lay this to rest, however, by finding that the recent tax haven incorporation boomlet appears to reflect almost exclusively action involving start-ups from China and Hong Kong. U.S.-headquartered companies are not contributing to it at any significant level.

Good to know this. Now, I noted that this finding doesn't rebut the possibility that rising tax-elasticity of overseas investment by U.S. companies might still be a current trend and a problem, operating along other margins (e.g., new equity issuances, and clientele effects regarding who ends up investing where). Nonetheless, Allen and Morse have made a very nice contribution by making this new finding about tax haven start-ups, and I imagine that they will be cited regularly for this (certainly by me).

The second paper on which I commented was "Taxes and the Clustering of Foreign Subsidiaries," by Scott Dyreng, Brad Lindsey, Kevin Markle, and Douglas Shackelford, which is not yet available on-line. This paper notes that the empirical literature to date on how U.S. (and other) multinationals (MNEs) shift income between affiliates has generally operated under the assumption that all company choices regarding where to place an overseas affiliate are made independently.

For example, if Acme Products U.S. decides to place a controlled subsidiary in the Netherlands, this is assumed to have absolutely no effect on whether it will also put one, say, in Belgium, France, Germany, Ireland, or the Bahamas (to name just a few where we know that in fact there might be interacting causation). The literature adopts this view, not because anyone actually believes that affiliate choices are independent, but because we don't know how they interact with each other.

The Dyreng-Lindsey-Markle-Shackelford paper attempts to figure out relationships by coming up with "expected" correlations between where one has an overseas affiliate in the absence of a tax motivation, and then comparing this to the actual correlations that are found. E.g., if one found lots and lots of MNEs with affiliates in Germany plus the Caymans, this might suggest that the pairing is tax-motivated unless there are other grounds for expecting it.

The difficulties in deriving findings on this very interesting topic (which potentially would help inform policymakers), include the following:

--It's hard to say what correlations would be expected absent tax considerations. For example, should companies be expected commonly to have affiliates in neighboring countries? Leaving tax aside, one could imagine that a Netherlands sub is either a substitute or a complement for one in Belgium. On the one hand, the MNE is active in the area and thus might want to go to more countries that are nearby. On the other hand, perhaps the Netherlands is close enough to Belgium to reduce the need for a specifically Belgian sub if one starts being active there.

--Likewise, tax-induced relationships between affiliates may turn on either substitution or complementarity. E.g., being in one tax haven may either make a second tax haven less needed than otherwise, or else make the second one all the more valuable, as in "Double-Dutch-Sandwich" type schemes that require laundering profits through several successive locations. In addition, by going to one tax haven, a company may provide evidence that it is the type of company that likes to use tax havens. So, if it was also in other tax havens at "unexpected" levels, this might reflect endogeneity rather than complementarity.

--The real action may involve multi-jurisdictional clustering, not just two-country pairings. But that makes testing for empirical relationships even harder.

--Suppose that having a sub in Bermuda is a substitute for having one in the Caymans for companies following Strategy A, but a complement for those that are following Strategy B. Then one might fail to find net correlations that reflect tax planning, but it would still be going on in case after case.

The authors are quite aware of all these problems, and are struggling ingeniously to refine their empirical strategy. I look forward to the end result, as it could be both interesting and useful. But in the interim, virtue (choosing an interesting project even though it is hard) may serve as its own unfair punishment.

Great news for NYU Law School

We at NYU Law School will be adding a new member to our tax faculty next year, David Kamin, a recent grad who is currently working on tax and budget policy at the White House. Details here. David is going to be an outstanding academic as well a great colleague, and I'm very excited that he will be joining us.

Nudge nudge, wink wink

No, that can't be. Is demure little Ursula actually winking at the camera?

NTA Annual Meeting in New Orleans, part 2

Herewith some quick notes on one of the three panels in which I participated at NTA New Orleans. I guess you could call me a triple threat, as I moderated once, presented once, and was a commentator once.

The moderating gig was for a panel on corporate tax reform, with Rosanne Altshuler, Peter Merrill, and Martin Sullivan. As background, at a session the day before, it became clear to me that Rick Perry jokes have not yet reached their sell-by date, although I would imagine it won't be much longer. There are only so many changes you can ring on the theme of having three things to say and forgetting the third.

But it occurred to me at that prior day's session that I had a fairly good Rick Perry joke in mind that I could use at the corporate tax reform panel. I won't try to re-create it word for word here, but suffice it to sketch out the basic idea, which was that, if Rick Perry, rather than Herman Cain, had been the candidate who was pushing the 9-9-9 plan, he would have forgotten the third 9.

Anyway, at the discussion panelists noted that international is really the key issue even if we are thinking about domestic corporate tax reform. At least for now, Congressional Republicans, no less than the Administration, are committed to revenue neutrality if they lower the domestic corporate rate (say, to 25 percent) and also so if they enact some version of a territorial system that exempts at least a substantial swathe of foreign source active business income. But international looms at center stage even just with respect to the first of these ideas.

In this connection, I mentioned a central conundrum that I gather has been baffling policymakers from both parties. On the one hand, we keep hearing about corporate tax avoidance, such as in newspaper articles about the likes of Google and GE. On the other hand, the revenue estimators and those conversant with them keep telling the policymakers that it is extremely difficult to finance a lower corporate rate through base-broadening. How can both of these propositions be true? Shouldn't we be able to make the "headline babies" pay more through base-broadening?

The answer, of course, is that base-broadening, as conventionally conceived in terms of explicit tax preferences, has only a very limited overlap with multinationals' (MNEs') modern tax avoidance techniques. They mainly exploit structural weaknesses in the income tax, and above all the ease of transferring economic value that arises from people's activity in the US (such as when Google-bots create valuable IP in California, or wherever it is they work their magic) so that the resulting taxable income will appear in someplace low-tax and far away, such as Bermuda.

Thus, aggressively addressing problems with the source rules - or enacting worldwide taxation without deferral for suspect classes of foreign source income - is crucial to revenue neutrality here, as well as to ensuring that the domestic US corporate tax base - which vitally backstops the income tax on individuals for high-flying owner employees - is not entirely gutted with respect to MNEs, leaving it to fall just on domestic businesses (which might then become takeover targets by reason of the tax synergies).

One last point worth noting here, before I adjourn to the next post to discuss the other other panels I was on, is that it's extremely misleading to hear the constant refrain about how the US is "out of step" because everyone else has shifted to exemption. This statement is only true if one is extremely simplistic in using a one-zero scale to classify each international tax system as either US-style or territorial.

What such a classification misses is that most "territorial" countries make some effort to address the Google-style problems that many U.S. advocates of territoriality appear eager to embrace or at least ignore. In other words, the putatively territorial countries impose tax on a lot of "foreign source income" as to which there are grounds for suspecting that it is actually domestic source.

For example, a number of territorial countries limit exemption to foreign source income that is earned in other high-tax countries. The rationale arguably is not what it seems - that one wants domestic companies to pay more rather than less tax abroad - but rather that income which shows up in a tax haven probably wasn't actually earned there, and thus may well have been earned at home.

In my view, limiting exemption to investment in other high-tax countries is the wrong response to the problem, for the same reason that I question the foreign tax credit. From a national welfare standpoint, there is nothing wrong, and indeed it is affirmatively desirable, for one's companies (if owned by domestic individuals) to pay less tax abroad rather than more. Thus, I would counsel alternative means of in effect "tagging" the ostensibly foreign source income that is relatively likely to represent game-playing that erodes the domestic tax base. For example, rules concerning intangibles and intellectual property, as well as interest expense, may be able to serve the tagging function without incentivizing resident companies to pay "just enough" tax abroad to avoid the rule and consequent full domestic taxation.

More on this in due course as I try to advance my still not-entirely-formed thinking about source issues.

NTA Annual Meeting in N'Awlins, part 1

I spent the last two days, and indeed all day both days, at the National Tax Association's annual meeting, which was held this year in New Orleans. All told, I participated in three sessions and attended (depending on how you count) as many as nine others, including an award session for lifetime accomplishment honoring Alan Auerbach, as well as a lunch on Friday in which Peter Diamond gave a keynote address on how policymakers ought to assess the current macroeconomic situation.

Diamond made, to my mind, a compelling and verging on unanswerable case for the proposition that policy makers ought to be VERY concerned about persistent cyclical unemployment, and not, under current circumstances, at all concerned about the immediate prospects for inflation. OK, this is a very familiar point to anyone who reads the New York Times. But in addition to making it well he explained his view, which I largely share, that the long-term fiscal gap, while a significant long-term problem, is not an immediate crisis.

In the course of doing this, he focused on the projected path of the U.S. publicly-held debt to GDP ratio, which is not projected to get really hairy for at least 15 years.

This led to a question after his speech by a well-known (at least within the field) and somewhat idiosyncratic economist who has done important work relating to how we should think about long-term budgetary issues, but who has not previously been named in this blog post (hint hint). This individual strongly holds the view that public debt is an entirely, and I mean 100 percent, meaningless measure and that only the infinite horizon fiscal gap has any economic meaning whatsoever. Hence, in his view, if the infinite horizon fiscal gap, under our best forecasts of current Medicare, Social Security, & Medicaid policy et al, indicates fiscal unsustainability, then it is utterly irrelevant how fast the public debt rises. In his view, if there is a present value of, say, $20 trillion for expected 22nd century unfunded Medicare outlays, the fiscal problem this represents is literally indistinguishable from the case where the U.S. issues (for zero cash) $20 trillion of additional public debt today. If you say: Ah, but we could change Medicare policy before the 22nd century actually gets here, he will answer: So what, it is equally true that we could renounce $20 trillion of explicit debt. Only naive formalists, he is certain, could see any difference whatsoever between the two. (What is more, to him this is a matter of logic or science, not empirics. He alternates between saying that the empirics MUST match up with the economic logic, and that if they don't, then so much the worse for them.)

Diamond, who is familiar with these arguments by this individual, gave them somewhat short shrift. This brought to my mind e-mail debates that I have had with this individual on exactly this topic. In these debates, he repeatedly, and one could almost say a bit indelicately or even tactlessly, told me that the only reason I don't realize that he is correct is because my training as a lawyer has left me cognitively unable to see past mere semantics and form. This struck me as not just ad hominem but affirmatively incorrect, given that (I am pretty sure) at least 99 out of 100 economists would agree with me and not with him. (Indeed, perhaps all 100 unless he was included in the group.)

Anyway, I saw this individual afterwards, and could not resist noting that Diamond shares my view rather than his. I said, while this doesn't prove that we are correct, surely it does suggest that my view doesn't just rest on my being a lawyer.

"Oh, Diamond isn't very serious about the economics of this," he replied - perhaps not quite breezily, which in any case would be clichéd writing on my part, but certainly dismissively.

Speak of non-falsifiable propositions ...

Today's Occupy Wall Street developments

I was distressed to learn today of Mayor Bloomberg's ugly and under-handed quasi-military police action in Zuccotti Park last night. It is exactly the sort of arrogant, sneaky, bad-faith, and self-pleasing venture, complete with police violence and concerted efforts to muzzle live press coverage, that one would expect of such colleagues of his in the media and government businesses as fellow oligarch Silvio Berlusconi. I am hoping that mayoral recall petitions (if there is such a procedure in NYC) will start to circulate.

That said, while I was disappointed by the ruling just issued by the New York State Supreme Court to the effect that, while OWS people must be allowed back into the park, they cannot reestablish a permanent encampment with tents and such, I did feel upon reading the ruling that it appears legally reasonable.

The OWS people need to be very smart now about how best to keep public attention focused on the issues of wealth distribution, rigged crony capitalism, and government policymakers' indifference to the interests of the "99 percent" that I gather motivate them - and how to retain broader public sympathy for themselves and their issues when the other side is just looking for excuses to demonize them - in a tough situation and when they no doubt are upset. Played correctly, it could end up having given them the perfect exit strategy from having to stay in Zuccotti Park (perhaps with ever-dwindling forces) all through the winter. But the next step is crucial, and it's unclear how well their collective decision structure can handle it.

Slides from prior post

In case you saw my last post (on the University of Chicago Tax Conference, where I discussed foreign tax credits) while the link to (a pdf version of) my slides was still broken, I've fixed it, but you can also find them here.

Foreign tax credit discussion in Chicago

I flew to Chicago last night in order to appear on a foreign tax credit panel this morning at the 64th Annual University of Chicago Tax Conference. As I said at the start of my remarks this morning, I was glad to appear there, not just because it's an excellent conference (though it is - surely the best practitioner-led tax conference that I know of anywhere), and not just because I saw many old friends and acquaintances all around the room (although I did, some going back more than 25 years and whom I don't see regularly), but also because the conference was originally inspired and led by the great Walter Blum, whom I had the privilege to know when I started teaching at the University of Chicago Law School in 1987, and who was kind enough as to serve as a mentor (as well as being a friend) back in those days.

Less than 24 hours in Chicago, and I dodged a couple of bullets - first yesterday, when my flight to Chicago was canceled shortly before I was going to leave for the airport. I was re-booked to get there today, long after my session had ended, but I was able to scramble and find another flight. Then today I came extremely close (in distance terms, perhaps a couple of millimeters) to losing a contact lens down the sink in my hotel room. This could have left me a bit like Piggy in Lord of the Flies, albeit in a much friendlier setting.

But then I was able to catch an earlier flight home and was even upgraded to first class (the fruits of just how much travel I have been doing on United and Continental over the last year). I feel so much less like a head of cattle when I get an upgrade.

But perhaps of more interest was the session itself. Phil West of Steptoe & Johnson (a leading international tax practitioner, and former International Tax Counsel at the Treasury) was the main presenter on the subject "The Future of the Foreign Tax Credit." Lowell Yoder of McDermott Will & Emery chaired and organized the panel, as well as whipping it into shape over Giardano's pizza, and the other commentator was Michael J. Caballero, who is currently the International Tax Counsel.

Phil gave a very useful overview of where the foreign tax credit has been, and where it might be conceivably be heading, with a particular eye on a number of recent and ongoing controversies, enactments, and proposals, on many of which Michael commented. But my assigned task, which Phil very kindly gave the audience highly favorable word about, was to shed a different light on discussion of the foreign tax credit (and international tax issues generally) than perhaps one generally hears.

I welcomed this (as who wouldn't, in my shoes) in part because, as I have tediously yammered here from time to time, I really do believe that I have rethought the international tax field in an important way, previewed to some extent in recent articles that I have published but not to be fully laid out until my international tax book comes out (and I would be lucky to finish writing it by, say, mid to late 2012, what with the welter of conflicting obligations that I've either been handed or deliberately accepted).

One doesn't always feel that way about one's work (except perhaps if one is only loosely tethered to reality), even if one likes it, because it is hard to pull off that sort of thing very often, or indeed perhaps at all. But given that I do believe that I've done it this time around, it felt very good to get a strong confirmatory feeling from a lot of the audience - not that anyone there is necessarily chargeable with agreeing with me, but that people seemed to see the significance and, at least, plausibility of viewing the whole field rather differently than in the traditional international tax policy literature.

The first time I previewed these ideas, at a conference in North Carolina back in January 2010, I was distressed not to feel that what I had to say had gone over. But I've thought it through better, learned to say it better, and perhaps people have had more of a chance to think about it.

I also felt like I was in pretty decent form today. Just as NBA players (these are people who used to play something like "professional basketball" back in the distant past when there was such a thing) have good days and bad, so I felt like my jump shot was connecting a bit today. But not to worry, one can always count on worse days as well as better ones.

Anyway, here are the slides from my talk, which in many cases (I hope readers, like the conference attendees, can tell which ones) are borrowed from Phil West's talk, with my comments just added at the bottom to express my response to the standard approach that Phil was very ably laying out.

I should be able to post a fuller PPT version of what I have to say in early December, after giving a 45-minute talk on international taxation as a headliner at a conference in Sao Paulo, Brazil.

English-Al Jazeera story on corporate tax loopholes

I appear more prominently in this one; wish they could have edited out the inadvertent grimace, but I guess that's on me.

CNN Situation Room corporate tax story in which I briefly appear

The CNN story from last night discussing corporate tax avoidance, in which I briefly appear, is available on-line here. I appear near the end, and am quoted in relation to the political prospects for corporate tax reform.

My tax reform talk at yesterday's AAA-CPA Fall Meeting

As kindly linked by the Tax Prof Blog, my talk at the AAA-CPA Fall Meeting yesterday had the following description:

"Dissatisfaction with the U.S. federal income tax has led to widespread discussion of fundamental tax reform including the possibility of replacing it with a consumption tax. What different forms could such a reform take? What are the best arguments for it and against it? And what are its political prospects for enactment? Among the alternatives that Professor Shaviro will discuss are a national retail sales tax, X-tax or flat tax, and a consumed income tax, and he will consider how these proposals’ chances might be affected both by Congressional politics and by the long-term budgetary problems facing the U.S."

This was not a new paper, as I've written extensively on this subject before, such as here. But a pdf version of my slides for the talk, offering a handy if somewhat condensed outline, is available here.

TV update

In addition to taping a short interview with CNN's Situation Room show regarding the Citizens for Tax Justice report on corporate tax dodgers, I also ended up going to the Al Jazeera English studio in midtown to do a short TV interview with them on the same subject. (Each will apparently be used, probably a short snippet only, in a feature story on the CTJ report.)

Extra bonus, while leaving the Al Jazeera studio I met the German film director Werner Herzog, who introduced himself to me while we were both waiting for the elevator. I told him that I am very eager to see his 3-D film on the Lascaux cave paintings, and he noted that it is still playing in Greenwich Village.

The CNN and Al-Jazeera interviews followed somewhat different paths. For CNN, the main question was, is the bottom line of the CTJ report (showing massive though varying levels of U.S. tax avoidance by U.S, companies) accurate and credible? I said yes, and that the CTJ findings are no surprise to knowledgeable people, although no doubt there would be plenty to quibble regarding how they did the measure and in particular cases. On Al Jazeera, same bottom line reason for interviewing me (seeking independent expert assessment of the main CTJ findings), but more interest in questions such as, how does this pattern relate to the concerns of the "Occupy Wall Street" movement.

UPDATE TO THE UPDATE: I haven't been able to determine what ran on English Al-Jazeera. But I've seen the CNN story by Mary Snow (which ran tonight at 5:36 pm EST). I only made it on-screen for a very short soundbite saying that the politics of the 1986 Act can't be replicated today because compromises between the parties are dead. But the producers may also have viewed me as validating that the CTJ study is intellectually respectable (although they ran a he-said she-said on CTJ vs. GE, the latter of which used counter-argument rather than denial).

Perhaps the most interesting aspect of the CNN coverage was how Occupy Wall Street has changed the narrative frame that a major network uses in approaching a story like this. I view this as evidence that OWS is having a significant (whether or not lasting) impact on the framing of public debate, of a sort that companies such as GE are unlikely to welcome.

TV appearance today?

I'll shortly be leaving my office to give a talk this afternoon at a meeting of the American Association of Attorney-Certified Public Accountants, entitled "Can, Should, and Will the Federal Income Tax Be Replaced by a National Consumption Tax?" While my slides are fairly skeletal in proportion to the length and coverage of the talk, I will post them here tomorrow, time permitting.

On the way there, I am stopping by at CNN headquarters for a short interview, a snippet from which may appear this evening on CNN's The Situation Room. The topic will be the newly issued Citizens for Tax Justice report, "Corporate Taxpayers and Corporate Tax Dodgers, 2008-2010."

Just as a preview, I believe that, while one could (and in the right setting should) nitpick and question various aspects of the report's analysis, the bottom line claims are important and have a significant degree of truth.

NYU-UCLA Tax Policy Conference on Tax Law and Healthcare Reform

This afternoon, weather permitting (the East Coast will be rainswept all day), I am flying to Los Angeles, in order to participate in tomorrow's NYU-UCLA conference concerning tax policy and healthcare reform.

I'll be chairing the fourth and final panel, entitled "Health Care Reform and the Long-Term Fiscal Outlook." The papers, which will eventually appear in the Tax Law Review, are (1) Howard Gleckman, Healthcare and the Long-Term Fiscal Outlook, (2) Daniel Kessler, "Reforming Medicare," and (3) Mark Pauly, "The Real Burden of Tax-Financed Medical Care in the United States."

I won't have slides or a formal presentation, so there will likely be nothing to post here on Monday. During the session, however, I will be offering quick comments and reactions after the three presentations, mainly to focus and jump-start the broader discussion.

Everyone knows that the projected path of healthcare growth is at the heart of the grim long-term U.S. fiscal situation, and the question is what to do about it. I suspect that a central issue throughout the panel will relate to the basic fundamentals of why there is such a large government role (around the world) with respect to healthcare provision and financing, and how one should think about the relative defects of government provision on the one hand and market provision on the other. Plus, what happens when you mix them in different ways.

Healthcare's unique characteristics (especially when, but not only because, we decide that everyone should get basic care) inevitably will play a central role in this conversation. It hasn't been seriously disputed in economic circles for decades that, in a whole lot of consumer areas (say, cars or shoes or breakfast cereral), markets generally do better than government provision from the standpoint of efficiency and responsiveness to consumer demand. But is healthcare different, and if so then to what extent and in what ways? And if a critique of how markets work in the healthcare sector does not necessarily rebut pessimism about the informational and incentive issues raised by government involvement, then how do we navigate between various competing problems?

A few quick points about Perry's tax plan

Perry's tax plan is in many ways the usual nonsense, not really worth addressing seriously. For example, it's clearly a huge revenue-loser, is a huge tax break for the wealthy, etcetera.

This is all par for the course. But here are a few particular points about his plan's distinctive quirks that are worth emphasizing.

First, the idea of an election between the simple system and current law is simply nonsense. Goodbye simplicity. People with tax planning capacity are going to be running the numbers to see which is better. Does anything with the slightest bit of common sense really think a well-advised taxpayer going to opt for the postcard return even if, due to base-broadening, it turns out this would increase his or her tax liability by several thousand dollars a year? Adding elections adds complexity, it generally doesn't reduce it.

Second, why even bother having a flat tax if you are going to retain big itemized deductions, such as for home mortgage interest, charitable contributions, and (if I am reading the under-specific language correctly) state and local tax deductions?

Third, how can he purport to combine a flat tax (and simplification) with phasing out the itemized deductions for people who earn more than $500,000? True, this increases the progressivity of the plan, at least relative to providing the deductions and not phasing them out. But this effectively adds higher tax rates to people in the phase-out range, albeit eventually declining back to 20% once all the deductions are gone. And with this feature, that is going to be some postcard.

Fourth, can anyone seriously doubt that the exemption for dividends and capital gains will be exploited by tax planners, on behalf of owner-employees, to avoid paying even 20% on what is effectively wage income?

Fifth, how exactly is he going to broaden the base of the corporate tax to pay for lowering the corporate rate to 20%? Note that some of the key items often called corporate tax preferences disappear under a consumption tax - and at the individual level the so-called flat tax is in fact a consumption tax. Is he going to get rid of accelerated depreciation and LIFO accounting for inventory? Under a consumption tax, the purchase price of items such as equipment and inventory would be expensed. So, unless he wants to confine the shift from an income to a consumption tax to the individual level, and still inexplicably apply income tax-style accounting just to the corporate tax, I certainly don't see what sort of base-broadening he has in mind at the corporate level. To the contrary, it seems likely that he would want to make changes that would reduce corporate taxable income at the same time that he wants to lower the corporate rate.

So the Perry plan in many ways makes less sense than Cain's 9-9-9 plan.