In May 2011, I published an article with the above title, available here.
My main argument: while it made plenty of sense in the mid-1980s to implement a tax reform plan that financed significant rate cuts (making the overall plan revenue-neutral) by broadening the base, that approach simply does not make sense today. Given both the long-term U.S. fiscal gap and the worrying increase in high-end inequality since 1986, cutting the rates is simply not a sensible way to use the budgetary gain that could be generated through base-broadening - at least in the individual income tax, although for the corporate tax it's a closer call.
Whether or not the article had any direct influence, the view it takes appears to be gaining ground, at least on the Democratic side of the aisle. Senator Charles Schumer is quoted here as criticizing the 1986-style approach, which the Bowles-Simpson proposal employs in significant degree, for reasons that are similar to my own.
Along the same lines, you know the old line that everything happens twice, first as tragedy and then as farce. The 1986 reform certainly wasn't a tragedy, but you can see it being replayed as farce by the Romney campaign, which claims that the budgetary cost of high-end rate reduction would be completely offset by base-broadening measures that they almost entirely refuse to identify (although Romney's riff about the $17,000 ceiling was admittedly a step forward), notwithstanding the fact that it's been shown, as a matter of arithmetic, that the plan would fall at least $1 trillion short of paying for the high-end rate cuts over the next ten years.
The Reagan Administration in 1984 and 1985, rather than playing this cynical game, actually released two comprehensive proposals (the Treasury I and Treasury II plans) showing exactly how proposed rate cuts would be fully financed over a five-year period, on what was estimated to be a distributionally neutral basis. But this time around, it's apparently going to be done with faith, and trust, and a generous helping of pixie dust (a.k.a. implausible economic growth projections).
Tuesday, October 09, 2012
Friday, October 05, 2012
Follow-up on the financial transactions tax
Yesterday, as mentioned in the previous post, I participated in a panel discussion at the International Fiscal Association’s annual meeting (held this year in Boston), entitled: “Towards an EU Financial Transactions Tax?” The discussion was chaired by Malcolm Gammie of the UK, and the panelists, besides me, were (1) Manfred Bergmann of the European Commission, who is the principal author of the Commission’s financial transactions tax (FTT) proposal, (2) Francesco Guelfi, an Italian tax lawyer, (3) Axel Haelterman, a Belgian tax professor and tax lawyer, and (4) Urs Kapalle, a Swiss tax lawyer. Thanks are also due to Eric Roeder of the Max Planck Institute, who made sure the whole thing worked out.
A word on the state of the play for the European FTT: as an EU-wide proposal, it is dead as a doornail, having been conclusively rejected this past summer due to some member states’ unyielding opposition (the UK being a key player here). But a number of EU countries are adopting FTTs anyway. For example, Germany and France have already acted, and Spain may joint them soon. FTT proponents are hoping for coordinated adoption by a significant subset of EU countries. So the European FTT is alive, kicking, and potentially still relevant, even if the European Community as a whole is not going to act.
Wholly without regard to the merits, this is a tricky scenario to sustain. Everyone agrees that, given the mobility of financial transactions, a pretty wide scope is needed for them to work. On the other hand, insofar as countries follow the EC proposal’s structure of imposing the taxes on a residence basis, not just where the deal is executed, single-country FTTs (at least for relatively large countries) may actually succeed in generating non-trivial tax revenues, on an ongoing basis, at a relatively low administrative cost.
This, of course, doesn’t tell us that the proposals are a good idea – and not just because there will still be plenty of exit (the English may well be delighted to see FTTs on the books in Germany and France) but due to the broader efficiency costs of a cascading tax that is levied on a gross, per-transaction basis. Case in point: the European Commission estimated that its tax on derivatives would lower trading volume by 75%. They believe that this would mostly have reflected fewer deals, as opposed to tax avoidance via exit. This is not a result that one should like, to the extent that the parties to the eliminated derivative trades are consenting adults who are optimizing for themselves without hurting anyone else. So liking this result has to rest on believing that many of the eliminated transactions are bad ones, e.g., due to externalities (such as their increasing market volatility – except, it is hard to generalize, either theoretically or empirically, about how they affect volatility overall).
As noted in prior posts and in my article on the subject, I am not a huge FTT fan. The two points I see in its favor are as follows:
(1) I believe that there is too much trading, from a social standpoint, in that people invest too much effort in seeking trading gains at the expense of other traders.
(2) That issue aside, I view the FTT as an inefficiently designed tax on capital, borne mainly by investors in general. This hardly sounds like an endorsement so far, but suppose it is more politically feasible than better choices, that a given country has desperate revenue needs that would otherwise be politically hard to meet, and that at least the thing is fairly progressive (albeit more poorly designed than other progressive levies). Then I would hate to be a purist and say no, based on superior alternatives that are unavailable, unless the efficiency costs (relative to the revenue) are on the high end, rather than the low end, of the range that I think possible.
All this makes me in the end a bit agnostic about whether or not to adopt the FTT if the available alternatives are very highly constrained. Sorry to dodge a more definite answer here, but I am not running for office, and spouting a bottom line when one is unsure can turn into mere spitballing.
OK, what I probably would do if less constrained is (a) address income tax (and, outside the U.S., VAT) under-taxation of financial services, (b) adopt the “FAT-2” version of the financial activities tax, in response to apparently durable rents in the financial sector that make me very suspicious of what is going on there (see here for further details), and (c) maybe do something – through the income tax?? somewhere else?? – about the excessive trading issue.
One of the core problems with the FTT not only affects the merits of adopting it, but impedes figuring out how it should be designed. I thought I made this point more articulately at the IFA panel yesterday than I have managed previously, so here’s an effort to repeat what I said (at characteristically high words-per-minute volume) during the session.
Consider having an income tax, a consumption tax, or a carbon tax. In each case we know what we are trying to do and why, and this really helps to inform design choices. The income tax and the consumption tax are attempted (albeit imperfect) measures of material wellbeing, or ability, or ability to pay, or whatever you want to call it. It’s not that we want to discourage income or consumption, but we believe they have informational content about, or correlation with, something else. To a large extent though not 100%, we know what we mean by “income” or “consumption,” and this helps a lot – although not all the time – in making design choices for the system, albeit that we still need to consider a host of other issues (e.g., tax planning, compliance, and administrative costs, not to mention other types of information that are relevant to distribution).
Now take the carbon tax. We know what we don’t like: carbon’s effect on global warming. Happily (or not), all carbon atoms are relevantly the same. So we know what we are trying to tax and why, and this really helps in designing a carbon tax – leaving aside the issue of global cooperation, since the scope of the public good (moderating climate change) is global.
Now let’s turn to the FTT. What are we trying to tax and why? Even if on balance adopting the tax would have good consequences relative to not adopting it, it’s not clear what the “thing” we’re after is. And this makes it really hard, for example, to say how derivatives should be treated under the FTT.
Suppose that what we are after is excessive effort to seek trading gains. Even with just old-fashioned stock trading, it’s not entirely clear how good a proxy gross trading volume is for the thing we have in mind. For example, do we want to tax repos that involve financial instruments? These are transactions in which I “sell” you a financial asset for $X, but we agree that I will buy it back at a given time for $X + $Y, where Y is essentially an interest return. This is really just a way of doing a secured loan, which principally wouldn’t be taxed if it weren’t structured as a repo. (The repo, by contrast, is potentially taxed twice: when I “sell” to you, and when you “sell” back to me.)
Sure, we could put an economic substance rule regarding sales into our FTT, just as the U.S. income tax has (requiring that at least sufficiently clearcut repos be treated as loans, not sales), but no one wants to run the FTT that way – it is supposed to be administratively much simpler and more automatic.
OK, I assumed that we don’t want to tax the repo or the secured lending under the FTT, but suppose it is partly speculation by the lender regarding the asset value. Thus, suppose the lender really is to some extent betting on the value of the secured asset in making the secured loan. Thus, the return of $Y might actually be a speculative bet on the financial asset’s upside – say, with cash settlement rather than physical settlement at the back end, so that there isn’t an asset transfer (in the secured loan version) even then.
Admittedly, this example is a bit picayune. It probably wouldn’t stop us from adopting the FTT, if otherwise we liked it enough, all by itself. But when you start considering the taxation of derivatives, the fact that the underlying goal is a bit murky becomes a real impediment to figuring out how the FTT should operate.
Case 1 is a total return equity swap. Rather than my buying 150 shares of Apple stock for $100,000, and financing it with a loan, the bank and I agree that in one year’s time we will net the following two obligations: (a) I owe them the interest that a $100K loan would have earned them, plus the amount, if any, by which 150 shares of Apple stock declined in value during the year; (b) they owe me an amount equal to the dividends paid plus the share appreciation, if any, for 150 shares of Apple stock during the same one-year period.
Counter-party risk aside, this is economically equivalent to my buying the 150 shares for the $100K loan. So, if we don’t tax it under our FTT – or even, like the European Commission’s proposal, if we tax it at a much lower rate (relative to the $100K “notional principal amount”) than a stock sale – we are simply telling people to replace stock sales with total return equity swaps.
But what about all sorts of other derivative instruments (which can of course be mixed and matched with the above swap if you like)? E.g., an interest rate swap: in one year, I’ll pay you the amount that I would have owed you on a $100K loan at a fixed interest rate, and you’ll pay me the amount that you would have owed me on a $100K loan at a floating rate.
Had we done the actual transaction (the offsetting loans) rather than the swap, the FTT wouldn’t have hit us. So here the derivative is being taxed worse than the underlying, for no obvious reason. What’s more, it isn’t entirely clear that we have a good reason for wanting to tax this swap. Is this socially excessive speculation on the likely direction of interest rate movement? What if I am simply trying to hedge my other economic positions from my business, and the bank is hedging or swapping out everything as well?
Anyway, this discussion has gone on long enough for a blog post (or perhaps too long), but the main point I want to make here is that it’s hard to bridge the gap between the underlying reasons we might have for imposing an FTT and the questions of how to tax various derivative transactions, which (if they were taxed differently) would be run through the blender and the Obscurathon anyway.
A word on the state of the play for the European FTT: as an EU-wide proposal, it is dead as a doornail, having been conclusively rejected this past summer due to some member states’ unyielding opposition (the UK being a key player here). But a number of EU countries are adopting FTTs anyway. For example, Germany and France have already acted, and Spain may joint them soon. FTT proponents are hoping for coordinated adoption by a significant subset of EU countries. So the European FTT is alive, kicking, and potentially still relevant, even if the European Community as a whole is not going to act.
Wholly without regard to the merits, this is a tricky scenario to sustain. Everyone agrees that, given the mobility of financial transactions, a pretty wide scope is needed for them to work. On the other hand, insofar as countries follow the EC proposal’s structure of imposing the taxes on a residence basis, not just where the deal is executed, single-country FTTs (at least for relatively large countries) may actually succeed in generating non-trivial tax revenues, on an ongoing basis, at a relatively low administrative cost.
This, of course, doesn’t tell us that the proposals are a good idea – and not just because there will still be plenty of exit (the English may well be delighted to see FTTs on the books in Germany and France) but due to the broader efficiency costs of a cascading tax that is levied on a gross, per-transaction basis. Case in point: the European Commission estimated that its tax on derivatives would lower trading volume by 75%. They believe that this would mostly have reflected fewer deals, as opposed to tax avoidance via exit. This is not a result that one should like, to the extent that the parties to the eliminated derivative trades are consenting adults who are optimizing for themselves without hurting anyone else. So liking this result has to rest on believing that many of the eliminated transactions are bad ones, e.g., due to externalities (such as their increasing market volatility – except, it is hard to generalize, either theoretically or empirically, about how they affect volatility overall).
As noted in prior posts and in my article on the subject, I am not a huge FTT fan. The two points I see in its favor are as follows:
(1) I believe that there is too much trading, from a social standpoint, in that people invest too much effort in seeking trading gains at the expense of other traders.
(2) That issue aside, I view the FTT as an inefficiently designed tax on capital, borne mainly by investors in general. This hardly sounds like an endorsement so far, but suppose it is more politically feasible than better choices, that a given country has desperate revenue needs that would otherwise be politically hard to meet, and that at least the thing is fairly progressive (albeit more poorly designed than other progressive levies). Then I would hate to be a purist and say no, based on superior alternatives that are unavailable, unless the efficiency costs (relative to the revenue) are on the high end, rather than the low end, of the range that I think possible.
All this makes me in the end a bit agnostic about whether or not to adopt the FTT if the available alternatives are very highly constrained. Sorry to dodge a more definite answer here, but I am not running for office, and spouting a bottom line when one is unsure can turn into mere spitballing.
OK, what I probably would do if less constrained is (a) address income tax (and, outside the U.S., VAT) under-taxation of financial services, (b) adopt the “FAT-2” version of the financial activities tax, in response to apparently durable rents in the financial sector that make me very suspicious of what is going on there (see here for further details), and (c) maybe do something – through the income tax?? somewhere else?? – about the excessive trading issue.
One of the core problems with the FTT not only affects the merits of adopting it, but impedes figuring out how it should be designed. I thought I made this point more articulately at the IFA panel yesterday than I have managed previously, so here’s an effort to repeat what I said (at characteristically high words-per-minute volume) during the session.
Consider having an income tax, a consumption tax, or a carbon tax. In each case we know what we are trying to do and why, and this really helps to inform design choices. The income tax and the consumption tax are attempted (albeit imperfect) measures of material wellbeing, or ability, or ability to pay, or whatever you want to call it. It’s not that we want to discourage income or consumption, but we believe they have informational content about, or correlation with, something else. To a large extent though not 100%, we know what we mean by “income” or “consumption,” and this helps a lot – although not all the time – in making design choices for the system, albeit that we still need to consider a host of other issues (e.g., tax planning, compliance, and administrative costs, not to mention other types of information that are relevant to distribution).
Now take the carbon tax. We know what we don’t like: carbon’s effect on global warming. Happily (or not), all carbon atoms are relevantly the same. So we know what we are trying to tax and why, and this really helps in designing a carbon tax – leaving aside the issue of global cooperation, since the scope of the public good (moderating climate change) is global.
Now let’s turn to the FTT. What are we trying to tax and why? Even if on balance adopting the tax would have good consequences relative to not adopting it, it’s not clear what the “thing” we’re after is. And this makes it really hard, for example, to say how derivatives should be treated under the FTT.
Suppose that what we are after is excessive effort to seek trading gains. Even with just old-fashioned stock trading, it’s not entirely clear how good a proxy gross trading volume is for the thing we have in mind. For example, do we want to tax repos that involve financial instruments? These are transactions in which I “sell” you a financial asset for $X, but we agree that I will buy it back at a given time for $X + $Y, where Y is essentially an interest return. This is really just a way of doing a secured loan, which principally wouldn’t be taxed if it weren’t structured as a repo. (The repo, by contrast, is potentially taxed twice: when I “sell” to you, and when you “sell” back to me.)
Sure, we could put an economic substance rule regarding sales into our FTT, just as the U.S. income tax has (requiring that at least sufficiently clearcut repos be treated as loans, not sales), but no one wants to run the FTT that way – it is supposed to be administratively much simpler and more automatic.
OK, I assumed that we don’t want to tax the repo or the secured lending under the FTT, but suppose it is partly speculation by the lender regarding the asset value. Thus, suppose the lender really is to some extent betting on the value of the secured asset in making the secured loan. Thus, the return of $Y might actually be a speculative bet on the financial asset’s upside – say, with cash settlement rather than physical settlement at the back end, so that there isn’t an asset transfer (in the secured loan version) even then.
Admittedly, this example is a bit picayune. It probably wouldn’t stop us from adopting the FTT, if otherwise we liked it enough, all by itself. But when you start considering the taxation of derivatives, the fact that the underlying goal is a bit murky becomes a real impediment to figuring out how the FTT should operate.
Case 1 is a total return equity swap. Rather than my buying 150 shares of Apple stock for $100,000, and financing it with a loan, the bank and I agree that in one year’s time we will net the following two obligations: (a) I owe them the interest that a $100K loan would have earned them, plus the amount, if any, by which 150 shares of Apple stock declined in value during the year; (b) they owe me an amount equal to the dividends paid plus the share appreciation, if any, for 150 shares of Apple stock during the same one-year period.
Counter-party risk aside, this is economically equivalent to my buying the 150 shares for the $100K loan. So, if we don’t tax it under our FTT – or even, like the European Commission’s proposal, if we tax it at a much lower rate (relative to the $100K “notional principal amount”) than a stock sale – we are simply telling people to replace stock sales with total return equity swaps.
But what about all sorts of other derivative instruments (which can of course be mixed and matched with the above swap if you like)? E.g., an interest rate swap: in one year, I’ll pay you the amount that I would have owed you on a $100K loan at a fixed interest rate, and you’ll pay me the amount that you would have owed me on a $100K loan at a floating rate.
Had we done the actual transaction (the offsetting loans) rather than the swap, the FTT wouldn’t have hit us. So here the derivative is being taxed worse than the underlying, for no obvious reason. What’s more, it isn’t entirely clear that we have a good reason for wanting to tax this swap. Is this socially excessive speculation on the likely direction of interest rate movement? What if I am simply trying to hedge my other economic positions from my business, and the bank is hedging or swapping out everything as well?
Anyway, this discussion has gone on long enough for a blog post (or perhaps too long), but the main point I want to make here is that it’s hard to bridge the gap between the underlying reasons we might have for imposing an FTT and the questions of how to tax various derivative transactions, which (if they were taxed differently) would be run through the blender and the Obscurathon anyway.
Wednesday, October 03, 2012
IFA travels
I am currently at the International Fiscal Association's annual meeting, which is being held this year in Boston. These days I tend not to go to conferences unless I am one of the speakers, but as it happens I am one at the IFA. I am appearing on a panel tomorrow to discuss financial transactions taxes, as well as alternatives such as the financial activities tax. Our seven-person panel had a 5 (!) hour meeting today to plan our 2-hour panel tomorrow - the IFA norm for panels emphasizes rigorous advance preparation, verging on scripting. But it was actually reasonably enjoyable and interesting, especially considering how long we all were there.
Turning to the panel's subject, I am not a huge fan of the financial transactions tax compared to the alternative tax instruments of my choice, but if it is the FTT or nothing, I would certainly consider saying yes to it, either for the EU (the issue in tomorrow's panel discussion) or the U.S. Given our political system's severe dysfunctionality and our revenue needs, along with the fact that (as Keynes argued back in 1935) there seems to be too much effort invested in seeking stock profits at the expense of rival investors, and finally given that the FTT is fairly progressive (albeit as an oddly designed tax on saving and investment), there is something to be said for it if we rule out all the alternatives (progressive consumption tax, VAT, carbon tax, financial activities tax, etc.). And I do respect the very serious effort that the European Commission folks put in trying to design it appropriately. That said, there certainly are lots of problems, such as in how to treat derivative transactions, as well as the prospect of cascading inter-business taxes that could prompt financial market disintermediation. But tomorrow I will be more analytical than bottom line.
The IFA's annual meeting is an interesting sociological event that I have never attended before. A few thousand people attend, mostly European and Third World, mostly practitioners but with a few academics and NGO or government types. I know a lot of people here in numerical terms, not that many in percentage terms, and it is obviously a huge networking event for tax professionals who want to meet their peers in other countries. I gather that it used to be mostly OECD, but now countries such as South Korea and India are huge players as well. Probably lots of interesting dynamics that I cannot myself directly observe.
Turning to the panel's subject, I am not a huge fan of the financial transactions tax compared to the alternative tax instruments of my choice, but if it is the FTT or nothing, I would certainly consider saying yes to it, either for the EU (the issue in tomorrow's panel discussion) or the U.S. Given our political system's severe dysfunctionality and our revenue needs, along with the fact that (as Keynes argued back in 1935) there seems to be too much effort invested in seeking stock profits at the expense of rival investors, and finally given that the FTT is fairly progressive (albeit as an oddly designed tax on saving and investment), there is something to be said for it if we rule out all the alternatives (progressive consumption tax, VAT, carbon tax, financial activities tax, etc.). And I do respect the very serious effort that the European Commission folks put in trying to design it appropriately. That said, there certainly are lots of problems, such as in how to treat derivative transactions, as well as the prospect of cascading inter-business taxes that could prompt financial market disintermediation. But tomorrow I will be more analytical than bottom line.
The IFA's annual meeting is an interesting sociological event that I have never attended before. A few thousand people attend, mostly European and Third World, mostly practitioners but with a few academics and NGO or government types. I know a lot of people here in numerical terms, not that many in percentage terms, and it is obviously a huge networking event for tax professionals who want to meet their peers in other countries. I gather that it used to be mostly OECD, but now countries such as South Korea and India are huge players as well. Probably lots of interesting dynamics that I cannot myself directly observe.
Tuesday, October 02, 2012
Doubling down on my personal economic plan
"Want to increase your productivity? Study says: Look at this adorable kitten," says the link on Ezra Klein's Wonkblog.
In that case, I am expecting double enhancement of my productivity (which I could really use, given all the speaking and writing commitments that I've accepted recently). The gray one is Gary, and the black-and-white one is Sylvester.
In that case, I am expecting double enhancement of my productivity (which I could really use, given all the speaking and writing commitments that I've accepted recently). The gray one is Gary, and the black-and-white one is Sylvester.
Friday, September 28, 2012
The political downside of evasiveness
Joe Biden is telling seniors that Romney will increase taxes on Social Security benefits, in order to help finance the high-end income tax cuts that Romney claims he can enact on a revenue-neutral and distributionally neutral basis.
Biden is basing this on an Obama campaign memo that says it it would be “impossible for Romney to pay for his plan without also cutting deductions [sic] that the middle class relies on,” including the exclusion for Social Security.
For good measure, the Obama campaign memo adds: “It’s no surprise coming from Mitt Romney, who has written off half of America — including seniors — for receiving a government benefit, even if they spent a lifetime earning it” (a reference, of course, to Romney's infamous "47%" slur).
Would Romney actually do this? Who knows? It's unmistakable that he would have to take a meat axe to a whole bunch of other popular items that he refuses to identify by name, such as the home mortgage interest deduction and the exclusion for employer-provided health insurance, in order to get anywhere close to the target. And if that is the nature of the exercise - as it would have to be, purely as a matter of arithmetic - then why wouldn't Social Security benefits be on the chopping block? It wouldn't be a first, after all. The benefits became partly taxable in 1983, and additionally so in 1993, albeit in each case only for people with sufficient adjusted gross income (which sounds like the dreaded "redistribution"). And making them fully taxable would indeed increase the percentage of Americans who are paying some federal income tax, which many Republicans have said is an important policy goal (a position that Romney's "47%" riff implies that he shares).
Even if Romney and his advisors secretly plan not to increase income taxation of Social Security benefits, they have no right to complain when others speculate to the contrary. You can't advertise the good news (the rate cuts), refuse to say anything whatsoever about the bad news (the pay-fors), do so on a basis that is not credible (that they don't want to dictate the entire legislative package in advance - which is wholly consistent with listing the areas you are willing to cut) - and then feel ill-used when the other side fills in the blanks.
Biden is basing this on an Obama campaign memo that says it it would be “impossible for Romney to pay for his plan without also cutting deductions [sic] that the middle class relies on,” including the exclusion for Social Security.
For good measure, the Obama campaign memo adds: “It’s no surprise coming from Mitt Romney, who has written off half of America — including seniors — for receiving a government benefit, even if they spent a lifetime earning it” (a reference, of course, to Romney's infamous "47%" slur).
Would Romney actually do this? Who knows? It's unmistakable that he would have to take a meat axe to a whole bunch of other popular items that he refuses to identify by name, such as the home mortgage interest deduction and the exclusion for employer-provided health insurance, in order to get anywhere close to the target. And if that is the nature of the exercise - as it would have to be, purely as a matter of arithmetic - then why wouldn't Social Security benefits be on the chopping block? It wouldn't be a first, after all. The benefits became partly taxable in 1983, and additionally so in 1993, albeit in each case only for people with sufficient adjusted gross income (which sounds like the dreaded "redistribution"). And making them fully taxable would indeed increase the percentage of Americans who are paying some federal income tax, which many Republicans have said is an important policy goal (a position that Romney's "47%" riff implies that he shares).
Even if Romney and his advisors secretly plan not to increase income taxation of Social Security benefits, they have no right to complain when others speculate to the contrary. You can't advertise the good news (the rate cuts), refuse to say anything whatsoever about the bad news (the pay-fors), do so on a basis that is not credible (that they don't want to dictate the entire legislative package in advance - which is wholly consistent with listing the areas you are willing to cut) - and then feel ill-used when the other side fills in the blanks.
Wednesday, September 26, 2012
More honest than usual, but still not making sense
Today on the campaign trail, Romney appears to have been a hair more candid than usual about his tax reform plans, but he still isn't making sense. Speaking to what the reporter called a "crowd of mostly middle-class onlookers," he apparently warned people "not to expect too much tax relief under his administration":
"'We have got to reform our tax system,' Romney said at a morning event here. 'Small businesses most typically pay taxes at the individual tax rate. And so our individual income taxes are the ones I want to reform. Make them simpler. I want to bring the rates down. By the way, don't be expecting a huge cut in taxes because I'm also going to lower deductions and exemptions. But by bringing rates down we will be able to let small businesses keep more of their money so they can hire more people.'"
It's good that he's admitting he won't cut middle-class voters' taxes, although this should have been obvious given that he claims to have a plan that is revenue-neutral overall and that he doesn't claim would actually raise high-earners' taxes.
But if small business owners (when unincorporated) pay tax as individuals, and if individuals aren't getting tax cuts due to the reduced deductions and exemptions, how exactly do "small businesses [get to] keep more of their money so they can hire more people"? Romney is contradicting himself.
OK, perhaps what he means to say is that they will keep more of the next marginal dollar, because the marginal tax rate is lower, and thus will have an incentive to hire more people - as distinct from having more money in their pockets with which to hire more people. Even aside from the lack of evidence that lowering middle-class (or high-end) marginal rates has significant effects on the level of hiring or of general economic activity, it is not necessarily true that this will affect incentives to increase the scale of one's business operations.
Suppose that a given small business owner would partly use the extra income from expanded operations to increase forms of consumption that are currently tax-subsidized. Examples could include getting a larger house or upgrading one's health insurance plan. A rate cut that was financed by scaling back those deductions wouldn't necessarily increase the marginal incentive to invest.
Similarly, I recall studies of the 1986 tax reform act that found overall work incentives largely unaffected. What declined was merely the distortion as between consumption or investment choices. Reducing such distortions may be a good thing, but it does not directly stimulate the economy or create more jobs.
"'We have got to reform our tax system,' Romney said at a morning event here. 'Small businesses most typically pay taxes at the individual tax rate. And so our individual income taxes are the ones I want to reform. Make them simpler. I want to bring the rates down. By the way, don't be expecting a huge cut in taxes because I'm also going to lower deductions and exemptions. But by bringing rates down we will be able to let small businesses keep more of their money so they can hire more people.'"
It's good that he's admitting he won't cut middle-class voters' taxes, although this should have been obvious given that he claims to have a plan that is revenue-neutral overall and that he doesn't claim would actually raise high-earners' taxes.
But if small business owners (when unincorporated) pay tax as individuals, and if individuals aren't getting tax cuts due to the reduced deductions and exemptions, how exactly do "small businesses [get to] keep more of their money so they can hire more people"? Romney is contradicting himself.
OK, perhaps what he means to say is that they will keep more of the next marginal dollar, because the marginal tax rate is lower, and thus will have an incentive to hire more people - as distinct from having more money in their pockets with which to hire more people. Even aside from the lack of evidence that lowering middle-class (or high-end) marginal rates has significant effects on the level of hiring or of general economic activity, it is not necessarily true that this will affect incentives to increase the scale of one's business operations.
Suppose that a given small business owner would partly use the extra income from expanded operations to increase forms of consumption that are currently tax-subsidized. Examples could include getting a larger house or upgrading one's health insurance plan. A rate cut that was financed by scaling back those deductions wouldn't necessarily increase the marginal incentive to invest.
Similarly, I recall studies of the 1986 tax reform act that found overall work incentives largely unaffected. What declined was merely the distortion as between consumption or investment choices. Reducing such distortions may be a good thing, but it does not directly stimulate the economy or create more jobs.
Monday, September 24, 2012
Should Romney pay a lower tax rate than the rest of us?
I have seen two lines of argument in the last couple of days, to the effect that Romney's low effective tax rate, compared to that of people much less affluent than he is, might actually be just fine. But each is wrong in important ways.
The first is Romney's own argument, which he advanced here, to the effect that "one of the reasons why the capital gains tax rate is lower is because capital has already been taxed once at the corporate level, as high as thirty-five percent."
Those who have seen me direct a lot of snark at Romney in recent weeks (albeit in my view deservedly so) may be surprised to hear that I agree that, in principle, he has a point. Only, I suspect that in practice the argument is incorrect as applied to him.
Suppose Romney holds Apple stock, and that Apple is generating huge profits, on which it pays U.S. tax at a 35 percent rate. It never pays dividends, but when he sells his Apple stock he enjoys capital gains, by reason of these profits. Then he has a point. (A longer discussion might be needed if one raises the point that the incidence of the corporate tax may be shifted to workers - but then we have to raise similar questions regarding the true incidence of income taxes that are directly paid by the owners of proprietorships and partnerships.)
But consider the following:
(1) Often corporations are not actually taxed at anywhere close to a 35% rate on their actual economic profits. Apple, for example, is notorious for causing a lot of its global taxable income to show up in tax havens such as the Caymans and Bermuda. So I believe Apple faces a very low effective rate of tax. By the way, its financial statements overstate what it actually pays, since it declines to take any accounting credit for the deferral of US taxes by keeping profits abroad. (Most publicly traded companies, by contrast, are desperately eager to take maximum accounting credit for the game.) Obviously, Apple isn’t really the point here. But when big U.S. companies are in general paying tax at a very low rate, Romney’s point loses a lot of its force.
(2) How did Bain make money? To a large extent, by lowering target companies’ tax bills by loading them up with debt that generated huge interest deductions. As is well known, the US corporate income tax code creates a huge bias in favor of debt over equity, because interest payments (and indeed mere accruals of interest) are deductible while dividends aren’t. Given that very aggressive leverage was apparently a key element in Bain’s acquisition strategy, it’s a bit funny that Romney could say he is being taxed a second time, when to a large extent the cause of the profits that show up in his carried interest payouts is that he is reaping the benefit of the value increase that they achieved by reducing the target companies’ U.S. income tax liabilities.
(3) In any case where Bain made money OTHER than by increasing the target companies’ taxable profits, the profits that Romney is being taxed on may not actually have been taxed at the corporate level. E.g., suppose Bain buys a target company cheap and then sells it for a big profit. Suppose this was through smart trading rather than lowering the target company’s tax bill – i.e., suppose Bain recognized that it was undervalued. The trading profit, at the expense of other stock market investors, from buying low and selling high is totally distinct from the taxation of the target’s actual firm-level activities. In effect, Bain has won a side bet with other investors. There is nothing wrong with that, but the fact that some traders win and reap profits at the expense of other traders has nothing to do with the tax on Apple’s actual economic activity. No reason not to tax at 35% the work that smart traders do in making money by outsmarting the other traders.
In sum, for once Romney has made an argument that actually is intellectually defensible to a degree. But I suspect that it would be very substantially rebutted if one looked at the companies that actually funded Romney's millions of dollars in Bain payouts.
OK, on to Dylan Mathews over at the Ezra Klein blog, who has a blog post with the admirably (but as it happens misguidedly) contrarian title: "Why Romney's tax rate should be low." Noting that many economists believe that there should be zero taxation of capital income, he concludes that "the disagreement among economists isn’t about whether people like Romney are paying too little. It’s about whether or not they’re paying too much."
This is not quite correct. What many economists, along with such fellow travelers from the tax policy world as me, often assert is that the "normal risk-free return to waiting" should be tax free. (This is typically about 1 percent per year.) Amounts that are labeled as investment returns or capital income should NOT be exempt, under this view, to the extent that they represent, for example, either extra-normal returns or labor income tha has been labeled by the tax system as capital income.
Mathews partly recognizes the labeling problem, noting that it is "hard, in practice, to distinguish wage and investment income. Romney is a great example of this. His income as head of Bain Capital counted, technically, as investment income, but he got it for doing a workaday job. A zero tax rate on investment income would provide a huge incentive to pretend wage income is investment income." But the problem goes beyond labeling. As I and many others have noted in writing about progressive consumption taxes (see, for example, my 2004 article here), the whole point of the progressive consumption tax exercise is roughly to match income tax progressivity without inefficiently discouraging saving.
The idea is NOT for Romney to pay less, but for his share of the tax burden (a) to be set appropriately given distributional goals that are independent of the choice of tax base, and (b) not to vary in present value terms by reason of how much of his vast wealth he chooses to save rather than invest in a given year. To make the argument work, you must either (a) be willing to look at the infinite horizon (e.g., the taxation of Romney's great-great-grandchildren when they finally consume the last of his wealth), or (b) accept the view that taxes that are deferred indefinitely but that grow at a market interest rate, and thus do not lose present value by reason of being deferred, are as-if-paid.
But the point is not at all for people like Romney to pay lower tax rates than workers. It is for people at his economic level who consume more to pay the same tax over time as people at his economic level who consume less. This is an important distinction, easily missed in label-dominated debates about the existing income tax.
The first is Romney's own argument, which he advanced here, to the effect that "one of the reasons why the capital gains tax rate is lower is because capital has already been taxed once at the corporate level, as high as thirty-five percent."
Those who have seen me direct a lot of snark at Romney in recent weeks (albeit in my view deservedly so) may be surprised to hear that I agree that, in principle, he has a point. Only, I suspect that in practice the argument is incorrect as applied to him.
Suppose Romney holds Apple stock, and that Apple is generating huge profits, on which it pays U.S. tax at a 35 percent rate. It never pays dividends, but when he sells his Apple stock he enjoys capital gains, by reason of these profits. Then he has a point. (A longer discussion might be needed if one raises the point that the incidence of the corporate tax may be shifted to workers - but then we have to raise similar questions regarding the true incidence of income taxes that are directly paid by the owners of proprietorships and partnerships.)
But consider the following:
(1) Often corporations are not actually taxed at anywhere close to a 35% rate on their actual economic profits. Apple, for example, is notorious for causing a lot of its global taxable income to show up in tax havens such as the Caymans and Bermuda. So I believe Apple faces a very low effective rate of tax. By the way, its financial statements overstate what it actually pays, since it declines to take any accounting credit for the deferral of US taxes by keeping profits abroad. (Most publicly traded companies, by contrast, are desperately eager to take maximum accounting credit for the game.) Obviously, Apple isn’t really the point here. But when big U.S. companies are in general paying tax at a very low rate, Romney’s point loses a lot of its force.
(2) How did Bain make money? To a large extent, by lowering target companies’ tax bills by loading them up with debt that generated huge interest deductions. As is well known, the US corporate income tax code creates a huge bias in favor of debt over equity, because interest payments (and indeed mere accruals of interest) are deductible while dividends aren’t. Given that very aggressive leverage was apparently a key element in Bain’s acquisition strategy, it’s a bit funny that Romney could say he is being taxed a second time, when to a large extent the cause of the profits that show up in his carried interest payouts is that he is reaping the benefit of the value increase that they achieved by reducing the target companies’ U.S. income tax liabilities.
(3) In any case where Bain made money OTHER than by increasing the target companies’ taxable profits, the profits that Romney is being taxed on may not actually have been taxed at the corporate level. E.g., suppose Bain buys a target company cheap and then sells it for a big profit. Suppose this was through smart trading rather than lowering the target company’s tax bill – i.e., suppose Bain recognized that it was undervalued. The trading profit, at the expense of other stock market investors, from buying low and selling high is totally distinct from the taxation of the target’s actual firm-level activities. In effect, Bain has won a side bet with other investors. There is nothing wrong with that, but the fact that some traders win and reap profits at the expense of other traders has nothing to do with the tax on Apple’s actual economic activity. No reason not to tax at 35% the work that smart traders do in making money by outsmarting the other traders.
In sum, for once Romney has made an argument that actually is intellectually defensible to a degree. But I suspect that it would be very substantially rebutted if one looked at the companies that actually funded Romney's millions of dollars in Bain payouts.
OK, on to Dylan Mathews over at the Ezra Klein blog, who has a blog post with the admirably (but as it happens misguidedly) contrarian title: "Why Romney's tax rate should be low." Noting that many economists believe that there should be zero taxation of capital income, he concludes that "the disagreement among economists isn’t about whether people like Romney are paying too little. It’s about whether or not they’re paying too much."
This is not quite correct. What many economists, along with such fellow travelers from the tax policy world as me, often assert is that the "normal risk-free return to waiting" should be tax free. (This is typically about 1 percent per year.) Amounts that are labeled as investment returns or capital income should NOT be exempt, under this view, to the extent that they represent, for example, either extra-normal returns or labor income tha has been labeled by the tax system as capital income.
Mathews partly recognizes the labeling problem, noting that it is "hard, in practice, to distinguish wage and investment income. Romney is a great example of this. His income as head of Bain Capital counted, technically, as investment income, but he got it for doing a workaday job. A zero tax rate on investment income would provide a huge incentive to pretend wage income is investment income." But the problem goes beyond labeling. As I and many others have noted in writing about progressive consumption taxes (see, for example, my 2004 article here), the whole point of the progressive consumption tax exercise is roughly to match income tax progressivity without inefficiently discouraging saving.
The idea is NOT for Romney to pay less, but for his share of the tax burden (a) to be set appropriately given distributional goals that are independent of the choice of tax base, and (b) not to vary in present value terms by reason of how much of his vast wealth he chooses to save rather than invest in a given year. To make the argument work, you must either (a) be willing to look at the infinite horizon (e.g., the taxation of Romney's great-great-grandchildren when they finally consume the last of his wealth), or (b) accept the view that taxes that are deferred indefinitely but that grow at a market interest rate, and thus do not lose present value by reason of being deferred, are as-if-paid.
But the point is not at all for people like Romney to pay lower tax rates than workers. It is for people at his economic level who consume more to pay the same tax over time as people at his economic level who consume less. This is an important distinction, easily missed in label-dominated debates about the existing income tax.
Kim Clausing on signaling, tax return disclosure, and toads
I am happy to present Kim's piece here as a rare guest entry, as follows:
Romney’s Tax Returns and The Economics of Signaling : Why Small Toads Still Croak
by Kimberly Clausing, Reed College
Presidential candidates may well be like rival toads competing for mates.
When toads compete for mates, they face important strategic decisions regarding whether to fight over mates or continue searching. Wanting to take on smaller rivals and avoid larger ones, toads gauge the wisdom of fighting each other in part by hearing each others’ croaks. Deep croaks belong to larger toads since toad vocal cord length is associated with toad size. This raises a puzzle, though, for one might think larger toads would croak and smaller toads would stay quiet, yet most toads tend to croak, whether or not their voice is deep.
The economics of signaling can help explain this puzzle. As soon as the largest toads croak, that gives the next largest toads an incentive to croak since otherwise they’d be assumed to be the average size of the remaining pool of toads. Once somewhat large toads croak, medium sized toads have an incentive to croak lest they be assumed smallish, and the situation unravels until nearly all toads are croaking.
This situation is a useful example of the full disclosure principle at work. As long as some individuals benefit from revealing beneficial characteristics of themselves, others are forced to disclose their less stellar characteristics, lest they be assumed to be a representative member of the remaining pool. Such models of signaling have been used to understand features of labor market search and hiring procedures.
However, for signals to be effective and provide reliable information, they must be costly to fake. That’s why a college degree is a useful way of demonstrating job qualifications, and a croak is a useful way to tell the size of a toad. It is also why people do not rely too much on what a Presidential candidate says they are going to do as a guide to what policies they will actually pursue. Talk of tax cuts is cheap, after all, while Medicare and Social Security are expensive, and there is a budget to be balanced, eventually.
One useful way to gauge a candidate’s stance on tax policy might be to look at their tax returns. These returns demonstrate a host of useful information: How much does the candidate earn, and how might that affect their attitude toward taxes? What is the composition of the candidates income? Is it mostly labor income or mostly capital gains and dividends? How were the candidates finances structured: Did they pay what was due? Did they engage in elaborate schemes to reduce their tax burden? Did they comply with the law?
Candidates for office have long shared many years of tax returns in order to allay citizen concerns and curiosity regarding these questions. Indeed, Candidate Romney’s own father was a pioneer in the practice of releasing many years of tax returns, and Romney asked his Vice-Presidential short-list for ten years of returns. Yet Mitt Romney steadfastly refuses to provide the public with more than two years of tax returns.
How are we to understand this refusal? Does Romney think that his tax returns are so bad that disclosure is really worse than nondisclosure, even knowing that the public must be assuming that there is something unpleasant in there? Analysts have already discussed all sorts of unsavory possibilities, including taking advantage of tax amnesties for fraudulent non-disclosure of offshore income, that Romney actually paid zero income taxes in 2009, or that he engaged in very aggressive tax sheltering. Of course, without the returns, it is impossible to say which theory is correct, or whether some other theory is true, or what the true reason for the nondisclosure may be.
However, there are some hints that come from both the economic theory of signaling and the behavior of toads in the animal kingdom. If Romney is a rational strategist, surely he would release the returns unless he thought there was something in there that was genuinely worse than what we are already assuming. In the case of animal behavior, that would make Romney an awfully small toad.
Friday, September 21, 2012
Effective tax rate comparison
As noted in earlier posts, I am a bit reluctant to use the effective tax rate number in discussing Romney's tax returns because of what it leaves out, namely losses and deductions that may have significantly reduced his adjusted gross income (AGI) in some years, and that were not necessarily plain vanilla true economic losses. But let's play the game anyway, and compare Romney to a moderate-income individual.
Say you were married with two children and had $60,000 of AGI in 2011, all of it wages. You would thus have about $34,000 of taxable income after taking the standard deduction and personal exemptions. You’d pay about $4,250 of income tax. But you would also pay $4,590 of payroll taxes, at the 7.65 percent rate (counting the employee share only). So that would add up to about $8,840 of income plus payroll taxes on $60,000 of AGI, for an effective tax rate of about 14.7 percent.
Romney, by contrast, paid a 14.1 effective tax rate for 2011. True, he doesn’t include payroll taxes in his effective rate computation. But for him they are trivial given the wage cap plus the fact that the payroll tax doesn’t apply to his capital gains and investment income.
Say you were married with two children and had $60,000 of AGI in 2011, all of it wages. You would thus have about $34,000 of taxable income after taking the standard deduction and personal exemptions. You’d pay about $4,250 of income tax. But you would also pay $4,590 of payroll taxes, at the 7.65 percent rate (counting the employee share only). So that would add up to about $8,840 of income plus payroll taxes on $60,000 of AGI, for an effective tax rate of about 14.7 percent.
Romney, by contrast, paid a 14.1 effective tax rate for 2011. True, he doesn’t include payroll taxes in his effective rate computation. But for him they are trivial given the wage cap plus the fact that the payroll tax doesn’t apply to his capital gains and investment income.
The letter from Romney's tax lawyer
The Romney campaign also published a letter from the Romneys' tax lawyer, R. Bradford Malt at Ropes & Gray, LLP. Ropes & Gray is a prominent and reputable Boston law firm, which many would call the leading firm there. While I don't know Mr. Malt personally, he apparently is the Chairman of their Management Committee and founded their private equity practice.
Among the main points in his letter, other than previewing things from the PriceWaterhouseCoopers letter (which it preceded by several hours), are the following:
(1) He explains the point about not claiming more than $1.75 million of allowable charitable contribution deductions, noted by me in an earlier post, so that the effective tax rate on the return wouldn't dip too low.
(2) He states that all of the investments within certain trusts "are managed on a blind basis by me, the trustee. I have sole responsibility for making, holding, and disposing of the investments."
(3) "During the 20-year period covered by the PWC letter, Gov. and Mrs. Romney paid 100 percent of the taxes that they owed."
As to point 3, it would be pretty shocking if Romney's tax lawyers at Ropes & Gray didn't believe this. But it is very far from being self-verifying. Keep in mind that, for the last 10-plus years, there have been a number of very aggressive tax reporting practices that became commonplace in the private equity world. One was using lowball valuations of special, non-publicly traded stock. Another was aggressively converting (or purporting to convert) ordinary income from fees into capital gains, via late-in-the-day conversion of an impending fee right into a fund payment right that is supposedly risky enough to warrant treating the ultimate realization as a capital gain. I don't doubt that Mr. Malt believes in good faith that anything of this nature on the Romney tax returns was legally correct. But that is not to say that either the IRS, or numerous tax experts who are not representing people in the private equity industry, would agree.
Among the main points in his letter, other than previewing things from the PriceWaterhouseCoopers letter (which it preceded by several hours), are the following:
(1) He explains the point about not claiming more than $1.75 million of allowable charitable contribution deductions, noted by me in an earlier post, so that the effective tax rate on the return wouldn't dip too low.
(2) He states that all of the investments within certain trusts "are managed on a blind basis by me, the trustee. I have sole responsibility for making, holding, and disposing of the investments."
(3) "During the 20-year period covered by the PWC letter, Gov. and Mrs. Romney paid 100 percent of the taxes that they owed."
As to point 3, it would be pretty shocking if Romney's tax lawyers at Ropes & Gray didn't believe this. But it is very far from being self-verifying. Keep in mind that, for the last 10-plus years, there have been a number of very aggressive tax reporting practices that became commonplace in the private equity world. One was using lowball valuations of special, non-publicly traded stock. Another was aggressively converting (or purporting to convert) ordinary income from fees into capital gains, via late-in-the-day conversion of an impending fee right into a fund payment right that is supposedly risky enough to warrant treating the ultimate realization as a capital gain. I don't doubt that Mr. Malt believes in good faith that anything of this nature on the Romney tax returns was legally correct. But that is not to say that either the IRS, or numerous tax experts who are not representing people in the private equity industry, would agree.
Romney's meaningless new disclosure regarding his 1990-2009 tax returns
While Romney's 2011 income tax return is unlikely to contain any surprises once it has been more carefully scrutinized, I thought the content and omissions from the letter he released from PricewaterhouseCoopers (PWC) were much more significant.
Here are the key paragraphs from PWC's letter to Romney, with my comments interspersed:
"Each year during the period [from 1990-2009], there were federal and state income taxes owed...."
COMMENT: Okay, this is a flat rebuttal of the suggestion that he ever paid zero in a year during this period. Despite the well-known principle "Trust, but verify" - and the fact that we are being asked to accept this without verification - I am inclined to accept the claim, on the view that PWC wouldn't want to risk issuing a signed letter with a false statement.
"The lowest of any annual 'effective federal personal income tax rate' for any year during the period is 13.66%. As you requested, we computed each annual 'effective federal personal income tax rate as total taxes divided by adjusted gross income as shown on the federal income tax returns as prepared.
"The average of the annual 'effective federal personal income tax rates' as computed based on the returns as prepared during the period is 20.20%."
COMMENT: While I am willing to accept this true, it is uninformative, one could even say evasive, and deliberately so. The problem is that we don't know if he accomplished this by having high adjusted gross income (AGI) and taxes paid, or low AGI and taxes paid.
Suppose we are considering 1998 or 2004, it doesn't really matter which year, and that Romney's effective tax rate for that year was 15%. Using pretend numbers for simplicity, this is consistent with both of the following two possibilities:
(a) Romney reported AGI of $100,000 and paid $15,000 of tax;
(b) Romney reported AGI of $10 million and paid $1.5 million of tax.
These would both yield effective tax rates of 15% under the PWC methodology, but they simply are not the same thing. In case (a), there would be a strong inference of massive tax sheltering, such as by having big losses from tax shelter transactions. In case (b), we might figure that the capital gains rate did most of the work, aided by the charitable contributions deduction.
The front page of the website where the Romney campaign has posted the tax returns and PWC letter states the following:
“Governor Romney's tax returns show:
“First, as a successful businessman, Governor Romney has not only added value to our economy through his investment and business activity, but he has paid millions in taxes every year to the U.S. government.”
That would answer my point if true, but it simply is not verified, or in any way addressed, by the PWC letter. And it is hard to reconcile with 2009, when he had zero net capital gain. In that year, it seems unlikely that his tax liability was as high as $1 million. (Look at the 2010 and 2011 returns, but supposing that they had zero capital gains, and note that qualifying dividends, which would still be there, only get a 15% rate.)
To compute the effective tax rates, PWC needed to pull two numbers from the tax return for each year in the period: AGI and income tax liability. Why not simply disclose those numbers? It would have wholly answered this line of inquiry - although there would still be a number of other issues to wonder about. The effective tax rate calculation permits us to see the tax benefits that he derived from (1) paying tax on much of his Bain income at the capital gains rate, (2) for years starting after the 2003 Bush tax cuts, the 15% dividend rate, and (3) the charitable contributions deduction. But it fails to reveal any tax benefit that he derived from (1) using tax planning to keep economic income off the tax return, and more importantly (2) generating either capital or ordinary loss deductions. So it is pretty inadequate disclosure, and entirely unnecessarily so given that they had the fuller information at hand but chose not to release it. Even if that information did come out, there would still be further questions. For example, did he claim capital gains treatment for what were effectively late-in-the-day fee conversions that arguably did not pass muster legally? And what about the possibility that he dramatically undervalued stocks that were placed in his IRA or gifted to his sons? That wouldn't be revealed by the AGI and taxes paid disclosures either. But those disclosures would be a start that he evidently has decided would be a bridge too far.
Here are the key paragraphs from PWC's letter to Romney, with my comments interspersed:
"Each year during the period [from 1990-2009], there were federal and state income taxes owed...."
COMMENT: Okay, this is a flat rebuttal of the suggestion that he ever paid zero in a year during this period. Despite the well-known principle "Trust, but verify" - and the fact that we are being asked to accept this without verification - I am inclined to accept the claim, on the view that PWC wouldn't want to risk issuing a signed letter with a false statement.
"The lowest of any annual 'effective federal personal income tax rate' for any year during the period is 13.66%. As you requested, we computed each annual 'effective federal personal income tax rate as total taxes divided by adjusted gross income as shown on the federal income tax returns as prepared.
"The average of the annual 'effective federal personal income tax rates' as computed based on the returns as prepared during the period is 20.20%."
COMMENT: While I am willing to accept this true, it is uninformative, one could even say evasive, and deliberately so. The problem is that we don't know if he accomplished this by having high adjusted gross income (AGI) and taxes paid, or low AGI and taxes paid.
Suppose we are considering 1998 or 2004, it doesn't really matter which year, and that Romney's effective tax rate for that year was 15%. Using pretend numbers for simplicity, this is consistent with both of the following two possibilities:
(a) Romney reported AGI of $100,000 and paid $15,000 of tax;
(b) Romney reported AGI of $10 million and paid $1.5 million of tax.
These would both yield effective tax rates of 15% under the PWC methodology, but they simply are not the same thing. In case (a), there would be a strong inference of massive tax sheltering, such as by having big losses from tax shelter transactions. In case (b), we might figure that the capital gains rate did most of the work, aided by the charitable contributions deduction.
The front page of the website where the Romney campaign has posted the tax returns and PWC letter states the following:
“Governor Romney's tax returns show:
“First, as a successful businessman, Governor Romney has not only added value to our economy through his investment and business activity, but he has paid millions in taxes every year to the U.S. government.”
That would answer my point if true, but it simply is not verified, or in any way addressed, by the PWC letter. And it is hard to reconcile with 2009, when he had zero net capital gain. In that year, it seems unlikely that his tax liability was as high as $1 million. (Look at the 2010 and 2011 returns, but supposing that they had zero capital gains, and note that qualifying dividends, which would still be there, only get a 15% rate.)
To compute the effective tax rates, PWC needed to pull two numbers from the tax return for each year in the period: AGI and income tax liability. Why not simply disclose those numbers? It would have wholly answered this line of inquiry - although there would still be a number of other issues to wonder about. The effective tax rate calculation permits us to see the tax benefits that he derived from (1) paying tax on much of his Bain income at the capital gains rate, (2) for years starting after the 2003 Bush tax cuts, the 15% dividend rate, and (3) the charitable contributions deduction. But it fails to reveal any tax benefit that he derived from (1) using tax planning to keep economic income off the tax return, and more importantly (2) generating either capital or ordinary loss deductions. So it is pretty inadequate disclosure, and entirely unnecessarily so given that they had the fuller information at hand but chose not to release it. Even if that information did come out, there would still be further questions. For example, did he claim capital gains treatment for what were effectively late-in-the-day fee conversions that arguably did not pass muster legally? And what about the possibility that he dramatically undervalued stocks that were placed in his IRA or gifted to his sons? That wouldn't be revealed by the AGI and taxes paid disclosures either. But those disclosures would be a start that he evidently has decided would be a bridge too far.
Romney's 2011 income tax return
OK, so today Romney released his 2011 income tax return, plus a statement from his tax lawyer and another statement from PricewaterhouseCoopers (PWC), which has been his tax return preparer for the last 20 years. What do we learn from all this?
First point: the 2011 tax return is NOT the big story here. Rather, it's what seems to be disclosed, but mainly isn't, about his 1990-2009 tax returns. I will get to that in a follow-up blog post.
In the 2011 return, he turns out to have paid about $1.9 million of taxes on $13.7 million of income, for an effective tax rate of 14.1%.
The amusing thing here is that he deliberately underclaimed charitable contribution deductions. The Romneys donated just over $4 million to charity, but deducted only $2.25 million - even though they apparently would have been entitled to the whole thing - in order, as his tax lawyer's statement puts it, to "conform to the Governor's statement in August ... that he paid at least 13% in income taxes" for every year. The underlying glitch may have been that he expected more taxable income when he made the charitable contributions than he ended up with. His estimated taxable income and tax payment exceeded the actual. So his people may have over-estimated the size of the charitable deduction he could claim without violating the self-imposed 13 percent rule.
Some may have fun with the fact that Romney stated publicly in January that he pays every dollar in tax he owes, but not a penny more, and that he wouldn't be qualified to be president if he overpaid. In fact, he deliberately didn't take $1.75 million in deductions to which he was legally entitled. So by his own overheated terms, one could say that he is now established that he isn't qualified to be president.
But of course that's just a silly "gotcha," not anything that really matters particularly - except for one thing. It certainly does show that 2011 is an atypical tax return year for him, reflecting the political scrutiny that he knew he would face from releasing it. That's fine, but it means we can't infer much about pre-2010 returns from what he did in 2011.
Nothing more on the 2011 return for now. I've started looking through it, but it's more than 300 pages. Instead I will post a follow-up entry on what strikes me as the more important disclosure today - his lawyer's statement and the letter from PWC.
First point: the 2011 tax return is NOT the big story here. Rather, it's what seems to be disclosed, but mainly isn't, about his 1990-2009 tax returns. I will get to that in a follow-up blog post.
In the 2011 return, he turns out to have paid about $1.9 million of taxes on $13.7 million of income, for an effective tax rate of 14.1%.
The amusing thing here is that he deliberately underclaimed charitable contribution deductions. The Romneys donated just over $4 million to charity, but deducted only $2.25 million - even though they apparently would have been entitled to the whole thing - in order, as his tax lawyer's statement puts it, to "conform to the Governor's statement in August ... that he paid at least 13% in income taxes" for every year. The underlying glitch may have been that he expected more taxable income when he made the charitable contributions than he ended up with. His estimated taxable income and tax payment exceeded the actual. So his people may have over-estimated the size of the charitable deduction he could claim without violating the self-imposed 13 percent rule.
Some may have fun with the fact that Romney stated publicly in January that he pays every dollar in tax he owes, but not a penny more, and that he wouldn't be qualified to be president if he overpaid. In fact, he deliberately didn't take $1.75 million in deductions to which he was legally entitled. So by his own overheated terms, one could say that he is now established that he isn't qualified to be president.
But of course that's just a silly "gotcha," not anything that really matters particularly - except for one thing. It certainly does show that 2011 is an atypical tax return year for him, reflecting the political scrutiny that he knew he would face from releasing it. That's fine, but it means we can't infer much about pre-2010 returns from what he did in 2011.
Nothing more on the 2011 return for now. I've started looking through it, but it's more than 300 pages. Instead I will post a follow-up entry on what strikes me as the more important disclosure today - his lawyer's statement and the letter from PWC.
Thursday, September 20, 2012
The fact checkers strike again
Apparently I wasn't the only person who noticed the untruth of Romney's claim that redistribution is "foreign" and not part of the U.S. tradition. Louis Jacobson at Politifact has the story and issues the failing grade, "pants on fire."
A very partial U.S. history of "redistribution"
Courtesy of the Tax Policy Center, here is a complete historical record of the top U.S. marginal tax rates for individuals since the origin of the modern income tax 99 years ago:
1913 7.0% 1947 86.45% 1981 69.13%
1914 7.0% 1948 82.13% 1982 50.00%
1915 7.0% 1949 82.13% 1983 50.00%
1916 15.0% 1950 91.00% 1984 50.00%
1917 67.0% 1951 91.00% 1985 50.00%
1918 77.0% 1952 92.00% 1986 50.00%
1919 73.0% 1953 92.00% 1987 38.50%
1920 73.0% 1954 91.00% 1988 28.00%
1921 73.0% 1955 91.00% 1989 28.00%
1922 56.0% 1956 91.00% 1990 31.00%
1923 56.0% 1957 91.00% 1991 31.00%
1924 46.0% 1958 91.00% 1992 31.00%
1925 25.0% 1959 91.00% 1993 39.60%
1926 25.0% 1960 91.00% 1994 39.60%
1927 25.0% 1961 91.00% 1995 39.60%
1928 25.0% 1962 91.00% 1996 39.60%
1929 24.0% 1963 91.00% 1997 39.60%
1930 25.0% 1964 77.00% 1998 39.60%
1931 25.0% 1965 70.00% 1999 39.60%
1932 63.0% 1966 70.00% 2000 39.60%
1933 63.0% 1967 70.00% 2001 38.60%
1934 63.0% 1968 75.25% 2002 38.60%
1935 63.0% 1969 77.00% 2003 35.00%
1936 79.0% 1970 71.75% 2004 35.00%
1937 79.0% 1971 70.00% 2005 35.00%
1938 79.0% 1972 70.00% 2006 35.00%
1939 79.0% 1973 70.00% 2007 35.00%
1940 81.10% 1974 70.00% 2008 35.00%
1941 81.00% 1975 70.00% 2009 35.00%
1942 88.00% 1976 70.00% 2010 35.00%
1943 88.00% 1977 70.00% 2011 35.00%
1944 94.00% 1978 70.00% 2012 35.00%
1945 94.00% 1979 70.00%
1946 86.45% 1980 70.00%
Even in the Coolidge years, when the top rate was only 25%, the income tax was highly progressive, since in those days (and indeed for the entire twentieth century history of the income tax until World War II) it only applied to high-income individuals, due to the exemption amounts that took most Americans entirely outside the system.
Does anyone still care to defend Romney's ludicrous and false claims that the entire concept of redistribution is "foreign," and that it has "never been a characteristic of America"?
1913 7.0% 1947 86.45% 1981 69.13%
1914 7.0% 1948 82.13% 1982 50.00%
1915 7.0% 1949 82.13% 1983 50.00%
1916 15.0% 1950 91.00% 1984 50.00%
1917 67.0% 1951 91.00% 1985 50.00%
1918 77.0% 1952 92.00% 1986 50.00%
1919 73.0% 1953 92.00% 1987 38.50%
1920 73.0% 1954 91.00% 1988 28.00%
1921 73.0% 1955 91.00% 1989 28.00%
1922 56.0% 1956 91.00% 1990 31.00%
1923 56.0% 1957 91.00% 1991 31.00%
1924 46.0% 1958 91.00% 1992 31.00%
1925 25.0% 1959 91.00% 1993 39.60%
1926 25.0% 1960 91.00% 1994 39.60%
1927 25.0% 1961 91.00% 1995 39.60%
1928 25.0% 1962 91.00% 1996 39.60%
1929 24.0% 1963 91.00% 1997 39.60%
1930 25.0% 1964 77.00% 1998 39.60%
1931 25.0% 1965 70.00% 1999 39.60%
1932 63.0% 1966 70.00% 2000 39.60%
1933 63.0% 1967 70.00% 2001 38.60%
1934 63.0% 1968 75.25% 2002 38.60%
1935 63.0% 1969 77.00% 2003 35.00%
1936 79.0% 1970 71.75% 2004 35.00%
1937 79.0% 1971 70.00% 2005 35.00%
1938 79.0% 1972 70.00% 2006 35.00%
1939 79.0% 1973 70.00% 2007 35.00%
1940 81.10% 1974 70.00% 2008 35.00%
1941 81.00% 1975 70.00% 2009 35.00%
1942 88.00% 1976 70.00% 2010 35.00%
1943 88.00% 1977 70.00% 2011 35.00%
1944 94.00% 1978 70.00% 2012 35.00%
1945 94.00% 1979 70.00%
1946 86.45% 1980 70.00%
Even in the Coolidge years, when the top rate was only 25%, the income tax was highly progressive, since in those days (and indeed for the entire twentieth century history of the income tax until World War II) it only applied to high-income individuals, due to the exemption amounts that took most Americans entirely outside the system.
Does anyone still care to defend Romney's ludicrous and false claims that the entire concept of redistribution is "foreign," and that it has "never been a characteristic of America"?
Wednesday, September 19, 2012
Don't know much about history
Stuck with making the best of an ugly mess, Romney is trying to make hay of an apparently rather anodyne 1998 video clip in which Obama says something nice about "redistribution."
Romney's response: "I know there are some who believe that if you simply take from some and give to others then we’ll all be better off. It’s known as redistribution. It’s never been a characteristic of America."
Has Romney ever heard of the enactment of the U.S. income tax, which was all about redistribution? (Or at least progressivity - the term "redistribution" can unduly beg the question of whether there was a pre-tax, pre-government distribution.)
Has anyone ever told him that the top U.S. income tax rate was increased to 67% in 1917, remained at least 56% through 1923, and was 63% or higher from 1932 through 1981, and higher than 90% from 1950 through 1963? Good or bad policy, that's a pretty substantial slice of American history.
In short, his claim that this has "never been a characteristic of America" is clearly false. I'd say he was deliberately attempting to rewrite history, but that would require assuming he knows something about it.
UPDATE: I saw another link in which he said on Fox News that redistribution is "foreign," not American. I guess the evil "foreigners" whom we must cast out of our history books include FDR, Truman, Eisenhower, Kennedy, Johnson, and Nixon, just for starters.
Romney's response: "I know there are some who believe that if you simply take from some and give to others then we’ll all be better off. It’s known as redistribution. It’s never been a characteristic of America."
Has Romney ever heard of the enactment of the U.S. income tax, which was all about redistribution? (Or at least progressivity - the term "redistribution" can unduly beg the question of whether there was a pre-tax, pre-government distribution.)
Has anyone ever told him that the top U.S. income tax rate was increased to 67% in 1917, remained at least 56% through 1923, and was 63% or higher from 1932 through 1981, and higher than 90% from 1950 through 1963? Good or bad policy, that's a pretty substantial slice of American history.
In short, his claim that this has "never been a characteristic of America" is clearly false. I'd say he was deliberately attempting to rewrite history, but that would require assuming he knows something about it.
UPDATE: I saw another link in which he said on Fox News that redistribution is "foreign," not American. I guess the evil "foreigners" whom we must cast out of our history books include FDR, Truman, Eisenhower, Kennedy, Johnson, and Nixon, just for starters.
Was Romney in the 47 percent (in 2009 or any earlier year)?
He doesn't want us to know, and thus is refusing to release any of his pre-2010 tax returns. But his 2010 return demonstrates that he zeroed out his capital gain in 2009.
To get all the way to zero, he would have needed to use tax shelters, most likely abusive ones because the U.S. income tax laws comprehensively address loss-generation schemes. We know that an audit committee he headed at Marriott in the early 1990s signed off on use of the infamous Son-of-BOSS tax shelter. (Given the issue of how to address the claimed tax benefits for financial accounting purposes, they really could not have dodged the issue if they were doing their job.) His 2010 return appears to suggest something in the ballpark of the illegal CDS tax shelter (although we don't know for sure what it involved). We know that he had a mysterious one-time infusion of foreign tax credits in 2008, indicating the possibility of an abusive transaction.
As I've noted in earlier posts, Romney is no longer entitled to the benefit of the doubt on any of this, even insofar as it clearly would have been irrational for him to zero out by using abusive tax shelters once he started running for president. This is a guy who kept his Swiss bank account - suggesting little sensitivity to the question of appearances, even if (as I noted in an earlier post) it's plausible that he didn't do significant U.S. tax planning through this account.
Even if Romney did pay some U.S. federal income tax every year, there are compelling reasons to think that he has understated his correctly determined tax bill by many millions of dollars over the last fifteen or so years. The biggest indicator is evidence suggesting that he drastically undervalued stocks that he contributed to his IRA and gifted to his sons. Secondarily, there is the issue of whether he improperly treated management fees from ordinary income as deferred capital gain, by reason of at the last moment converting them into virtually risk-free fund allocation rights.
Even if he had the good sense not to put himself in the 47 percent for any year - which, at this point, is contrary to my admittedly speculative best guess - he probably shouldn't be lecturing people who haven't paid any income tax, typically due to lack of income and in some cases the tax benefits for having children, when there is good reason to believe that he himself has fallen millions of dollars short of meeting his own legal obligations under the tax code.
UPDATE: I see that Harry Reid has picked up this theme as well. But I am relying more on the details of what we can discern from the known record, and I am not relying on claims of access to non-public information.
To get all the way to zero, he would have needed to use tax shelters, most likely abusive ones because the U.S. income tax laws comprehensively address loss-generation schemes. We know that an audit committee he headed at Marriott in the early 1990s signed off on use of the infamous Son-of-BOSS tax shelter. (Given the issue of how to address the claimed tax benefits for financial accounting purposes, they really could not have dodged the issue if they were doing their job.) His 2010 return appears to suggest something in the ballpark of the illegal CDS tax shelter (although we don't know for sure what it involved). We know that he had a mysterious one-time infusion of foreign tax credits in 2008, indicating the possibility of an abusive transaction.
As I've noted in earlier posts, Romney is no longer entitled to the benefit of the doubt on any of this, even insofar as it clearly would have been irrational for him to zero out by using abusive tax shelters once he started running for president. This is a guy who kept his Swiss bank account - suggesting little sensitivity to the question of appearances, even if (as I noted in an earlier post) it's plausible that he didn't do significant U.S. tax planning through this account.
Even if Romney did pay some U.S. federal income tax every year, there are compelling reasons to think that he has understated his correctly determined tax bill by many millions of dollars over the last fifteen or so years. The biggest indicator is evidence suggesting that he drastically undervalued stocks that he contributed to his IRA and gifted to his sons. Secondarily, there is the issue of whether he improperly treated management fees from ordinary income as deferred capital gain, by reason of at the last moment converting them into virtually risk-free fund allocation rights.
Even if he had the good sense not to put himself in the 47 percent for any year - which, at this point, is contrary to my admittedly speculative best guess - he probably shouldn't be lecturing people who haven't paid any income tax, typically due to lack of income and in some cases the tax benefits for having children, when there is good reason to believe that he himself has fallen millions of dollars short of meeting his own legal obligations under the tax code.
UPDATE: I see that Harry Reid has picked up this theme as well. But I am relying more on the details of what we can discern from the known record, and I am not relying on claims of access to non-public information.
Tuesday, September 18, 2012
Romney on foreign policy
There is another astonishing nugget from the Romney video, discovered by Joshua Marshall at Talking Points Memo. Romney notes that the hostage rescue disaster in the Iranian desert dominated the 1980 presidential election campaign, and says: "If something of that nature presents itself, I will work to find a way to take advantage of it."
"Presents itself" is an interesting word choice. We usually say that of opportunities - good things.
And not everyone, perhaps not many people in either the Democratic or Republican parties, would view international catastrophes, in which our country has been hurt and humiliated, mainly as things that - evidently without a moment's delay, as we saw in the Libya crisis last week - they could "work to find a way to take advantage of."
"Presents itself" is an interesting word choice. We usually say that of opportunities - good things.
And not everyone, perhaps not many people in either the Democratic or Republican parties, would view international catastrophes, in which our country has been hurt and humiliated, mainly as things that - evidently without a moment's delay, as we saw in the Libya crisis last week - they could "work to find a way to take advantage of."
Meanwhile, back at the ranch ...
... I finally have an adequate working title for the article that I am writing for my lecture on "elder issues" next March at the University of Illinois Law School: "Should Social Security and Medicare Be More Market-Based?"
Romney's erroneous equation
Romney's 47 percent comment is based on a claim of equivalence between the following 4 groups:
(1) People who paid no federal income tax in a given year,
(2) People who are on the dole, supported by government handouts rather than providing economically for their own needs,
(3) Obama voters, and
(4) People who "refuse to take personal responsibility and care for their lives."
The first is a meaningless statistic. It doesn't count other federal taxes, other state and local taxes, or other years. It also is based on treating spending-equivalent provisions in the income tax differently from those that are administered by the federal government outside of the income tax law.
This last is a pretty broad concept, by the way. Suppose that, in a given year in the late 1990s, Romney had economic income of $100 million, used tax shelters and the carried interest rule and all the rest to pay taxes of $2 million on taxable income of $10 million, and in effect received $3 million of subsidies via the entity-level tax savings from loading up target companies with debt (treated more favorably than equity) plus reneging on pension guarantees that were taken over by the PBGC. Would that make him a moocher?
Are retirees moochers if they worked all their lives but are now getting Social Security and Medicare? Are they moochers if the value of their benefits exceeds that of their tax contributions to the programs? But didn't they work all their lives? And, anyway, isn't the Romney campaign currently engaged in full-throated denunciation of supposed Medicare cuts?
A further obvious point is that (2) above is not equivalent to (1). Not paying federal income tax in a given year does not indicate that one is predominantly supported by federal transfers, on either an annual or a lifetime basis.
Likewise, (3) is not equivalent to (1) or (2). Consider in particular Romney's support among seniors and people in the poorer states. And consider the negative correlation between income or wealth on the one hand, and voter turnout on the other. For that matter, what about all the affluent, taxpaying Obama voters?
By the way, my effective tax rate is at least twice as high as Romney's, probably more than that if we could see more years of his tax returns. Does that make him a 50 percent moocher?
On (4), I will just note that merely having an extremely privileged background, and being so sheltered that you are totally unfamiliar with how millions of Americans live their lives (even after campaigning for most of the last 6 years), is not by itself nearly sufficient to get one to believing what Romney said. (And again, this is what he said about 47% of the country, not about the exceptional case or the overall incentive strucure in our fiscal system.) To believe what he said, you also need to have pathologically low empathy and curiosity, and it helps as well if you have uncommonly low intelligence. (A number of conservative bloggers have noted how stupid, ignorant, sophomoric, and uninformed his comments are. People like Ryan, Gingrich, and even Santorum, whatever one thinks of them overall, almost invariably sound smarter, more thoughtful, and better-versed. At some point, the presumptions from his private equity background and his flunkies' encomia to his never-observed brilliance have to give way to the evidence of one's own ears.)
One of my takeaways, among others, is that, contrary to what we sometimes all believe, just because you're rich doesn't mean you're smart. Plenty of idiots have stumbled into large fortunes. Borrowing reams of money through target companies so that you can then divert the borrowed funds into your own pocket, leaving others to hold the bag if the target can't bear the carry, doesn't take great intelligence in an era when banks were making billions of dollars worth of foolish loans. It's like buying real estate in NYC, in the era when property values were shooting through the roof, and then deciding that you must be a genius because your properties appreciated like all the rest.
There, he insulted me, so now I've insulted him.
(1) People who paid no federal income tax in a given year,
(2) People who are on the dole, supported by government handouts rather than providing economically for their own needs,
(3) Obama voters, and
(4) People who "refuse to take personal responsibility and care for their lives."
The first is a meaningless statistic. It doesn't count other federal taxes, other state and local taxes, or other years. It also is based on treating spending-equivalent provisions in the income tax differently from those that are administered by the federal government outside of the income tax law.
This last is a pretty broad concept, by the way. Suppose that, in a given year in the late 1990s, Romney had economic income of $100 million, used tax shelters and the carried interest rule and all the rest to pay taxes of $2 million on taxable income of $10 million, and in effect received $3 million of subsidies via the entity-level tax savings from loading up target companies with debt (treated more favorably than equity) plus reneging on pension guarantees that were taken over by the PBGC. Would that make him a moocher?
Are retirees moochers if they worked all their lives but are now getting Social Security and Medicare? Are they moochers if the value of their benefits exceeds that of their tax contributions to the programs? But didn't they work all their lives? And, anyway, isn't the Romney campaign currently engaged in full-throated denunciation of supposed Medicare cuts?
A further obvious point is that (2) above is not equivalent to (1). Not paying federal income tax in a given year does not indicate that one is predominantly supported by federal transfers, on either an annual or a lifetime basis.
Likewise, (3) is not equivalent to (1) or (2). Consider in particular Romney's support among seniors and people in the poorer states. And consider the negative correlation between income or wealth on the one hand, and voter turnout on the other. For that matter, what about all the affluent, taxpaying Obama voters?
By the way, my effective tax rate is at least twice as high as Romney's, probably more than that if we could see more years of his tax returns. Does that make him a 50 percent moocher?
On (4), I will just note that merely having an extremely privileged background, and being so sheltered that you are totally unfamiliar with how millions of Americans live their lives (even after campaigning for most of the last 6 years), is not by itself nearly sufficient to get one to believing what Romney said. (And again, this is what he said about 47% of the country, not about the exceptional case or the overall incentive strucure in our fiscal system.) To believe what he said, you also need to have pathologically low empathy and curiosity, and it helps as well if you have uncommonly low intelligence. (A number of conservative bloggers have noted how stupid, ignorant, sophomoric, and uninformed his comments are. People like Ryan, Gingrich, and even Santorum, whatever one thinks of them overall, almost invariably sound smarter, more thoughtful, and better-versed. At some point, the presumptions from his private equity background and his flunkies' encomia to his never-observed brilliance have to give way to the evidence of one's own ears.)
One of my takeaways, among others, is that, contrary to what we sometimes all believe, just because you're rich doesn't mean you're smart. Plenty of idiots have stumbled into large fortunes. Borrowing reams of money through target companies so that you can then divert the borrowed funds into your own pocket, leaving others to hold the bag if the target can't bear the carry, doesn't take great intelligence in an era when banks were making billions of dollars worth of foolish loans. It's like buying real estate in NYC, in the era when property values were shooting through the roof, and then deciding that you must be a genius because your properties appreciated like all the rest.
There, he insulted me, so now I've insulted him.
Monday, September 17, 2012
Romney versus the "47 percent"
As Brad Plumer explains on Ezra Klein's blog, only "6.9 percent of households ... are non-elderly and have incomes less than $20,000 per year and aren’t paying the payroll tax .... [and thus] pay neither income taxes nor payroll taxes."
That's a far cry from 47 percent. What's more, this group votes with much lower frequency than the members of more affluent households. So even if one otherwise accepted Romney's "moocher class" theory, we're talking less than 5 percent of this November's likely voters, not 47 percent.
I think what's coming out here is the anger of someone who doesn't feel he should have to ask people for their votes, just as he feels he doesn't owe them any disclosure of his finances or of what policies he would follow. Contempt for the public, for democratic institutions, and for all people who disagree with him or offer insufficient deference is not a good basis for establishing trust.
That's a far cry from 47 percent. What's more, this group votes with much lower frequency than the members of more affluent households. So even if one otherwise accepted Romney's "moocher class" theory, we're talking less than 5 percent of this November's likely voters, not 47 percent.
I think what's coming out here is the anger of someone who doesn't feel he should have to ask people for their votes, just as he feels he doesn't owe them any disclosure of his finances or of what policies he would follow. Contempt for the public, for democratic institutions, and for all people who disagree with him or offer insufficient deference is not a good basis for establishing trust.
Paul Ryan on why the Romney campaign won't offer any tax reform details
Today Congressman Ryan reiterated that the Romney campaign does not plan to discuss what specific tax breaks it would eliminate in order to fund dramatic rate reduction and maintain existing high-end tax burdens. Unfortunately, his explanation is deceptive rather than credible, and relies on deliberate up-is-downism.
Ryan starts out by saying: “I’m very familiar with how to make successful tax reforms take place. Ronald Reagan and Tip O’Neil did it in 1986 but we haven’t done it since 1986 for lots of reasons, which is we don’t want to presume to say, ‘Here’s exactly our way or the highway take it or leave it Congress.’”
Note, however, that “exactly our way” versus being willing to negotiate is simply not the issue here. All the Romney campaign needs to do, in order to add credibility and permit better-informed assessment (by both voters and experts) of its supposed tax reform plan, is to offer a hit list of things that it views as on the table. For example: home mortgage interest deductions, the exclusion for employer-provided health insurance, charitable contributions, etc. (And, by the way, everyone knows these items have got to be on the list - all that's really going on here is the effort to preserve deniability and prevent the Obama campaign from accurately describing the plan in order to attack it.)
By contrast, the Reagan Administration, in the run-up to the 1986 tax reform, issued a detailed plan (the famous “Treasury I” plan, which came out in December 1984), while acknowledging from the start that it knew Congress would do what it wanted rather than rubberstamp the plan. Reagan publicly laid out a few broad principles, such as protecting the home mortgage interest and charitable deductions but little else.
True, the Treasury I plan only came out after the 1984 presidential election, and that was no accident. Obviously, they weren’t going to let the Mondale campaign have a go at the list of items that they were prepared to repeal. But Reagan's 1984 reelection campaign did not rest on the promise that he would push for the Treasury I rate cuts.
Romney, by contrast, is expressly campaigning on the basis that he will enact substantial rate cuts, which he claims he will fully finance in such a way as to preserve existing high-end progressivity. This makes it far more disingenuous to decline to offer any details whatsoever.
Ryan then adds: “… [W]e have to be able to work with Congress on those details, on how to fill it in and, more to the point, we don’t want to cut some backroom deal that they did with Obamacare where we hatched some plan behind the scenes and they spring it on the country.
“We want to do this in front, in the public, through congressional hearings with Congress so that we can get to the best conclusion with a public participation. That’s the process that works the best to ultimate success gets this done. That’s why we’re doing it this way.”
Here is where the up-is-downism becomes quite bald. He calls the Romney campaign's offering absolutely no guidance regarding what tax items it has in mind an example of doing things "in public" and not "spring[ing] it on the country." As the saying goes, that takes a bit of "brass."
The plan, after all, insofar as there is one, is to ram things through on a strict party-line basis and hope to survive the unpopularity of what they've done, in the 2014 Congressionals, based on macroeconomic improvement that they are hoping will take place in any event.
I would likely have sympathy with much of the base-broadening in the Romney tax reform plan, if they were willing to say what it is, although I oppose the rate cuts and thus the plan as a whole. Anyone who supports such base-broadening, but who realizes that it is politically unpopular, is naturally drawn to think about how one could surmount or finesse public opinion. But I hope that I would view what they are doing as a bridge too far away from democratic deliberation and public political accountability, even if I liked their overall policies much better than I do.
Ryan starts out by saying: “I’m very familiar with how to make successful tax reforms take place. Ronald Reagan and Tip O’Neil did it in 1986 but we haven’t done it since 1986 for lots of reasons, which is we don’t want to presume to say, ‘Here’s exactly our way or the highway take it or leave it Congress.’”
Note, however, that “exactly our way” versus being willing to negotiate is simply not the issue here. All the Romney campaign needs to do, in order to add credibility and permit better-informed assessment (by both voters and experts) of its supposed tax reform plan, is to offer a hit list of things that it views as on the table. For example: home mortgage interest deductions, the exclusion for employer-provided health insurance, charitable contributions, etc. (And, by the way, everyone knows these items have got to be on the list - all that's really going on here is the effort to preserve deniability and prevent the Obama campaign from accurately describing the plan in order to attack it.)
By contrast, the Reagan Administration, in the run-up to the 1986 tax reform, issued a detailed plan (the famous “Treasury I” plan, which came out in December 1984), while acknowledging from the start that it knew Congress would do what it wanted rather than rubberstamp the plan. Reagan publicly laid out a few broad principles, such as protecting the home mortgage interest and charitable deductions but little else.
True, the Treasury I plan only came out after the 1984 presidential election, and that was no accident. Obviously, they weren’t going to let the Mondale campaign have a go at the list of items that they were prepared to repeal. But Reagan's 1984 reelection campaign did not rest on the promise that he would push for the Treasury I rate cuts.
Romney, by contrast, is expressly campaigning on the basis that he will enact substantial rate cuts, which he claims he will fully finance in such a way as to preserve existing high-end progressivity. This makes it far more disingenuous to decline to offer any details whatsoever.
Ryan then adds: “… [W]e have to be able to work with Congress on those details, on how to fill it in and, more to the point, we don’t want to cut some backroom deal that they did with Obamacare where we hatched some plan behind the scenes and they spring it on the country.
“We want to do this in front, in the public, through congressional hearings with Congress so that we can get to the best conclusion with a public participation. That’s the process that works the best to ultimate success gets this done. That’s why we’re doing it this way.”
Here is where the up-is-downism becomes quite bald. He calls the Romney campaign's offering absolutely no guidance regarding what tax items it has in mind an example of doing things "in public" and not "spring[ing] it on the country." As the saying goes, that takes a bit of "brass."
The plan, after all, insofar as there is one, is to ram things through on a strict party-line basis and hope to survive the unpopularity of what they've done, in the 2014 Congressionals, based on macroeconomic improvement that they are hoping will take place in any event.
I would likely have sympathy with much of the base-broadening in the Romney tax reform plan, if they were willing to say what it is, although I oppose the rate cuts and thus the plan as a whole. Anyone who supports such base-broadening, but who realizes that it is politically unpopular, is naturally drawn to think about how one could surmount or finesse public opinion. But I hope that I would view what they are doing as a bridge too far away from democratic deliberation and public political accountability, even if I liked their overall policies much better than I do.
Thursday, September 13, 2012
No comment needed
While I obviously can't independently verify this, it has been reported here that Romney did indeed ask Ryan for 10 years of tax returns, not just 2.
The link between Romney's Libya misadventure and his tax returns
I have been as stunned as everyone else by Romney's willingness to lob scurrilous and demonstrably false charges on the very evening when U.S. embassy personnel were murdered abroad. Morality aside, it shows a stunning disinhibition and lack of the most elementary judgment regarding how people would react to his so transparently viewing the tragedy as a great opportunity for him to score political points.
Richard Nixon was not exactly known for his high moral character, but ask yourself this: Would he ever have been so stupid and clumsy? Of course not. He knew how to lay on the unction when that was the indicated course. Nixon may have been many things, but he was definitely not a fool.
You need to have serious psychological and intellectual impediments to understanding how other people are likely to react, in order to pursue the course Romney did the other night. And, of course, the comical thing about it is that his so aggressively pursuing his electoral self-interest (international crisis be damned) was in fact the very worst thing he could have done from the standpoint of actually promoting that self-interest.
What happens when you take a person with this sort of temperament (aggressiveness, disinhibition, stunning lack of judgment about what other people would think) into the tax planning realm? I think one can draw a pretty fair inference that he is NOT someone who would avoid aggressive and even fraudulent tax shelters because it would be stupid to do them. No one in his right mind would have pushed things too far, in the tax reporting realm, in 2007, 2008, or 2009. Why not pay some tax? This would not have to be a matter of over-reporting income, but simply of not aggressively seeking tax losses, sham foreign tax credits, and the like.
But that evidently is not how Romney thinks. And he has told us this flat out. While all too understandably refusing to release his tax returns, given what we might find there, he has boasted publicly about not paying a penny more than he has to.
In sum, this is not a person who would ease up on the aggressive tax sheltering simply because doing it might be viewed by most people as stupid and irrational. I am getting the sense that he's a one-trick pony, and that stupidly aggressive is simply what he does.
Richard Nixon was not exactly known for his high moral character, but ask yourself this: Would he ever have been so stupid and clumsy? Of course not. He knew how to lay on the unction when that was the indicated course. Nixon may have been many things, but he was definitely not a fool.
You need to have serious psychological and intellectual impediments to understanding how other people are likely to react, in order to pursue the course Romney did the other night. And, of course, the comical thing about it is that his so aggressively pursuing his electoral self-interest (international crisis be damned) was in fact the very worst thing he could have done from the standpoint of actually promoting that self-interest.
What happens when you take a person with this sort of temperament (aggressiveness, disinhibition, stunning lack of judgment about what other people would think) into the tax planning realm? I think one can draw a pretty fair inference that he is NOT someone who would avoid aggressive and even fraudulent tax shelters because it would be stupid to do them. No one in his right mind would have pushed things too far, in the tax reporting realm, in 2007, 2008, or 2009. Why not pay some tax? This would not have to be a matter of over-reporting income, but simply of not aggressively seeking tax losses, sham foreign tax credits, and the like.
But that evidently is not how Romney thinks. And he has told us this flat out. While all too understandably refusing to release his tax returns, given what we might find there, he has boasted publicly about not paying a penny more than he has to.
In sum, this is not a person who would ease up on the aggressive tax sheltering simply because doing it might be viewed by most people as stupid and irrational. I am getting the sense that he's a one-trick pony, and that stupidly aggressive is simply what he does.
Monday, September 10, 2012
Awww ...
I couldn't resist posting pictures of the two six-week-old kittens that we have just adopted, to join (after a sequester period) the two more senior cats in our household.
UPDATE: The black-and-white one is Sylvester; the gray tabby is Gary. Their main activities include purring, mewling, playing, nuzzling, scampering around, exploring, eating, and sleeping.
Saturday, September 08, 2012
Summer is gone
I've already taught more than 10 percent of my fall semester class (3 sessions out of 28). Seminar size for what is normally a lecture (Individual Income Tax), which has some real advantages in getting (and I hope keeping) people interested.
Meanwhile, I've once again had to drop for the time being my book on international income taxation, midway through chapter 5 out of what will probably be 7 to 8 chapters, because I realized that two articles I had promised for talks I am giving in early March will not get done in time otherwise. The one I am writing first, for an endowed lecture on elder law issues at the University of Illinois Law School, concerns Social Security and Medicare. I will be looking in very general terms at the Obama Administration and Ryan House Budget Medicare plans, plus at Bush-style private accounts for Social Security, but my main focus will be big-picture conceptual, based on the analysis in my books, Making Sense of Social Security Reform (from 2000) and Who Should Pay for Medicare? (from 2004). There will be some neat stuff in this article, for example, making use of Paul Samuelson's famous 1958 article on Social Security to frame a few issues on how to think about the programs.
The other article, for a conference at FSU Law School concerning 100 years of the federal income tax, will involve looking at some of the classic early U.S. income tax thinkers (Seligman, Haig, Simons, Fisher, T.S. Adams, and such) with an eye to how "we" think about things now as opposed to how they thought about things then.
I've also agreed to write a short post-election article in November for the Canadian Tax Journal regarding the 2013 political outlook in the U.S. on tax and/or budget issues.
When I get invitations to write things and such, my attitude seems to be a bit like what the Steve Martin character expected of Monica in the sadly overlooked (but very funny) movie, Dead Men Don't Wear Plaid.
I don't appear to have followed Monica in this regard.
Meanwhile, I've once again had to drop for the time being my book on international income taxation, midway through chapter 5 out of what will probably be 7 to 8 chapters, because I realized that two articles I had promised for talks I am giving in early March will not get done in time otherwise. The one I am writing first, for an endowed lecture on elder law issues at the University of Illinois Law School, concerns Social Security and Medicare. I will be looking in very general terms at the Obama Administration and Ryan House Budget Medicare plans, plus at Bush-style private accounts for Social Security, but my main focus will be big-picture conceptual, based on the analysis in my books, Making Sense of Social Security Reform (from 2000) and Who Should Pay for Medicare? (from 2004). There will be some neat stuff in this article, for example, making use of Paul Samuelson's famous 1958 article on Social Security to frame a few issues on how to think about the programs.
The other article, for a conference at FSU Law School concerning 100 years of the federal income tax, will involve looking at some of the classic early U.S. income tax thinkers (Seligman, Haig, Simons, Fisher, T.S. Adams, and such) with an eye to how "we" think about things now as opposed to how they thought about things then.
I've also agreed to write a short post-election article in November for the Canadian Tax Journal regarding the 2013 political outlook in the U.S. on tax and/or budget issues.
When I get invitations to write things and such, my attitude seems to be a bit like what the Steve Martin character expected of Monica in the sadly overlooked (but very funny) movie, Dead Men Don't Wear Plaid.
"One thing about Monica: the words 'I can't' weren't in her vocabulary."
"Monica, I want you to do something for me."
"I can't."
"I guess she had added them since the last time I'd seen her."
I don't appear to have followed Monica in this regard.
Thursday, September 06, 2012
Clinton's speech
I pretty much never watch political speeches, given by either side. I tend to find them stupid and boring, I can't stand the canned applause lines, etcetera. But I saw the last half or more of Bill Clinton last night, and greatly enjoyed it. My god, what a talent and what a performer (albeit talk show style rather than orator style). Great stuff wholly apart from my predominantly agreeing with it. Remarkable to see the amount of content, his ability to make it clear, the dead-perfect tone when he was criticizing the Republicans, the skill at lecturing without pomposity or condescension, his comfort in his own skin, and his ability to be wonk plus regular guy at the same time without a sweat. The University of Arkansas certainly lost a great law professor when he decided to become governor instead.
I once met Clinton (in 2003 or so) on the Acela train from DC to New York City. There was a blizzard, which is probably why he didn't fly. He either decided to walk through the train for its own sake, or else was headed for the dining car. So a couple of Secret Service guys came into my car first (but they seemed pretty relaxed). They later confirmed to me that it's a pretty easy gig, because everyone likes him. Then I saw this huge guy with a red face and white hair come in, looking very much like himself. He came down the aisle, chatting and shaking hands with everyone along the way. (Perhaps due to the blizzard, the train was fairly empty.)
Being Clinton on the train is a lot to live up to. But he radiates this remarkable charisma even when you have a relatively trite conversation. He knew NYU Law School because he had done a couple of events here (which I had skipped), and at the end I told him "We miss you more every day" (Bush's follies having gotten to me by this point). He gave that chuckle and it was on to the next person a few seats down.
I once met Clinton (in 2003 or so) on the Acela train from DC to New York City. There was a blizzard, which is probably why he didn't fly. He either decided to walk through the train for its own sake, or else was headed for the dining car. So a couple of Secret Service guys came into my car first (but they seemed pretty relaxed). They later confirmed to me that it's a pretty easy gig, because everyone likes him. Then I saw this huge guy with a red face and white hair come in, looking very much like himself. He came down the aisle, chatting and shaking hands with everyone along the way. (Perhaps due to the blizzard, the train was fairly empty.)
Being Clinton on the train is a lot to live up to. But he radiates this remarkable charisma even when you have a relatively trite conversation. He knew NYU Law School because he had done a couple of events here (which I had skipped), and at the end I told him "We miss you more every day" (Bush's follies having gotten to me by this point). He gave that chuckle and it was on to the next person a few seats down.
Saturday, September 01, 2012
Price cut for Getting It (Kindle edition)
My law firm novel Getting It (to which I am tentatively planning a sequel, set twenty-five years later, if I ever have the time) is now available here on Kindle for only $3.03.
"Young D.C. lawyer Bill Doberman, who fancies himself the James Bond of the Potomac. is a liar, a conniver, a phony, a hypocrite, and a cad – and those are his good points. But will they be enough to win him the much desired booby prize of partnership at Ashby & Cinders?
"He will need all his skills to out-compete the dour Lowell Stellworth, languid yet fanatical master of the lengthy footnote, while also dodging hostile senior partners, posing as an arts connoisseur, and keeping his two girlfriends at the firm from finding out about each other. All this in the hope of qualifying at the end for even longer hours and a pay cut."
"Young D.C. lawyer Bill Doberman, who fancies himself the James Bond of the Potomac. is a liar, a conniver, a phony, a hypocrite, and a cad – and those are his good points. But will they be enough to win him the much desired booby prize of partnership at Ashby & Cinders?
"He will need all his skills to out-compete the dour Lowell Stellworth, languid yet fanatical master of the lengthy footnote, while also dodging hostile senior partners, posing as an arts connoisseur, and keeping his two girlfriends at the firm from finding out about each other. All this in the hope of qualifying at the end for even longer hours and a pay cut."
Monday, August 27, 2012
Why didn't the IRS and Treasury do more about aggressive tax planning techniques of the sort that Romney appears to have used extensively?
As I've noted in prior posts (and many others have noted as well), there is strong if indirect evidence supporting the surmise that Romney - wearing his Bain hat, rather than acting as a lone wolf - may have engaged in a lot of aggressive and legally questionable tax planning in recent years, including (1) aggressive structuring to convert ordinary income management fees into capital gain shortly before they accrued, (2) using total return equity swaps to avoid the U.S. withholding tax on dividends paid to Caymans entities, (3) mysteriously acquiring a huge gob of foreign tax credits in 2008, and (4) using aggressive under-valuation to transfer valuable assets to his sons and his IRA without getting hit by gift taxes or contribution limits.
Keeping in mind that the practices here were widespread among high-flying financial sector people, I've gotten the question: Why did the IRS allow this stuff to happen, given that often (albeit depending on the particular facts) it was so legally questionable?
There are several likely answers to this. When it comes to these sorts of things, the IRS and Treasury are under-staffed, often are behind the curve regarding what is happening on Wall Street, may be subject to political influence regarding overall audit and regulatory priorities, and also may very reasonably have concluded that they had higher-priority fires to put out first. For example, there is no doubt that the IRS and Treasury, albeit initially slow off the mark, eventually put a great deal of effort into addressing abusive tax shelters that involved ginning up huge fake losses with little or no economic substance, through marketed deals that typically had nothing to do with the taxpayer's actual business. This was not only relatively easy to do (both in terms of getting taxpayer lists and winning the actual cases) but was an urgent high priority. By contrast, even once the government understood what sorts of games people on Wall Street were playing to minimize tax liability, attacking it was bound to be hard work with only a more limited payoff. For example, these techniques really were limited to people at the top, whereas marketed tax shelters can extend much further down, and each case might turn on its particular facts and circumstances (whereas, say, Son-of-BOSS cases were generally all the same).
Of course, this is not to let the IRS and Treasury entirely off the hook. They probably should have been much more active in issuing shot-across-the-bow notices and rulings, giving examples of aggressive tax planning transactions that do not work. (An example is the 2010 ruling about total return swaps that I mentioned in a prior blog post, which ought to have been issued years earlier.) Once something becomes common practice and has not been challenged over a period of years, putting the toothpaste back in the tube can be quite difficult.
But to be sure, all this is easy for me to say, sitting at my law school desk in 2012. The press of daily events and the "fog of war" can make it more difficult in real time.
Plus, of course, the "audit lottery" is inevitably pervasive. Even for that tiny percentage of taxpayers that actually does face at least a minimal audit, the IRS may frequently fall short of spotting all or even many of the key issues that full knowledge would have suggested pursuing.
What do we learn from the standpoint of tax law design? Although I consider the foreign tax credit over-generous, and although capital gains do indeed get a lower tax rate than ordinary income (reflecting that taxpayers often find it easy not to realize them), the tax planning at issue here generally has less to do with the enactment of special tax preferences by Congress than with basic structural soft spots in the body of our income tax system. For example, the questions of who owns a particular asset, what exactly is its value at a given point in time, and whether a given transaction has economic substance and/or is subject to meaningful downside economic risk - all variously at the heart of the four tax planning tricks that I referenced above - are inherently hard to answer, especially given taxpayers' inevitable information advantages regarding their own detailed circumstances.
Neither presidential campaign has proposals out there that would address these basic problems (although one side might be less unlikely - albeit very far from certain - to countenance expanded enforcement with regard to the financial sector's tax planning fun and games). The issue here is less tax reform, in the standard sense of broadening the base, than either shifting to a progressive consumption tax or else, perhaps, having a much more mark-to-market-based income tax.
Keeping in mind that the practices here were widespread among high-flying financial sector people, I've gotten the question: Why did the IRS allow this stuff to happen, given that often (albeit depending on the particular facts) it was so legally questionable?
There are several likely answers to this. When it comes to these sorts of things, the IRS and Treasury are under-staffed, often are behind the curve regarding what is happening on Wall Street, may be subject to political influence regarding overall audit and regulatory priorities, and also may very reasonably have concluded that they had higher-priority fires to put out first. For example, there is no doubt that the IRS and Treasury, albeit initially slow off the mark, eventually put a great deal of effort into addressing abusive tax shelters that involved ginning up huge fake losses with little or no economic substance, through marketed deals that typically had nothing to do with the taxpayer's actual business. This was not only relatively easy to do (both in terms of getting taxpayer lists and winning the actual cases) but was an urgent high priority. By contrast, even once the government understood what sorts of games people on Wall Street were playing to minimize tax liability, attacking it was bound to be hard work with only a more limited payoff. For example, these techniques really were limited to people at the top, whereas marketed tax shelters can extend much further down, and each case might turn on its particular facts and circumstances (whereas, say, Son-of-BOSS cases were generally all the same).
Of course, this is not to let the IRS and Treasury entirely off the hook. They probably should have been much more active in issuing shot-across-the-bow notices and rulings, giving examples of aggressive tax planning transactions that do not work. (An example is the 2010 ruling about total return swaps that I mentioned in a prior blog post, which ought to have been issued years earlier.) Once something becomes common practice and has not been challenged over a period of years, putting the toothpaste back in the tube can be quite difficult.
But to be sure, all this is easy for me to say, sitting at my law school desk in 2012. The press of daily events and the "fog of war" can make it more difficult in real time.
Plus, of course, the "audit lottery" is inevitably pervasive. Even for that tiny percentage of taxpayers that actually does face at least a minimal audit, the IRS may frequently fall short of spotting all or even many of the key issues that full knowledge would have suggested pursuing.
What do we learn from the standpoint of tax law design? Although I consider the foreign tax credit over-generous, and although capital gains do indeed get a lower tax rate than ordinary income (reflecting that taxpayers often find it easy not to realize them), the tax planning at issue here generally has less to do with the enactment of special tax preferences by Congress than with basic structural soft spots in the body of our income tax system. For example, the questions of who owns a particular asset, what exactly is its value at a given point in time, and whether a given transaction has economic substance and/or is subject to meaningful downside economic risk - all variously at the heart of the four tax planning tricks that I referenced above - are inherently hard to answer, especially given taxpayers' inevitable information advantages regarding their own detailed circumstances.
Neither presidential campaign has proposals out there that would address these basic problems (although one side might be less unlikely - albeit very far from certain - to countenance expanded enforcement with regard to the financial sector's tax planning fun and games). The issue here is less tax reform, in the standard sense of broadening the base, than either shifting to a progressive consumption tax or else, perhaps, having a much more mark-to-market-based income tax.
Friday, August 24, 2012
Has Romney paid all the U.S. federal income taxes that he legally owes?
The answer is probably no.
Here's Vic Fleischer on a management fee conversion trick that Bain appears to have done, and that many reputable tax lawyers believe is bogus and could not withstand legal challenge.
And here's James Stewart in the New York Times (to appear in the Saturday print edition tomorrow), quoting me in re. why Romney's high foreign tax credit for 2008 - a sharp outlier relative to his credits in adjoining taxable years - raises strong suspicions that he did some sort of a tax shelter transaction in that year involving the effective purchase of credits with minimal economic substance.
My statement in the article that Romney's big foreign tax credit in 2008 "makes no sense to me at all" relates to the point that high foreign taxes are incredibly easy to avoid if you have passive income and/or access to Bain's extremely aggressive and complicated tax planning technologies. For example, all those Caymans entities create huge opportunities to avoid any significant foreign taxes, even with associated operations in countries that have income tax systems.
So I find it hard to believe that the Bain investors actually paid significant foreign income taxes in 2008 - and not just because this seems to have been a once-only extraordinary event. Rather, it appears far more plausible to me that they did one of those fake off-the-rack deals that the IRS generally challenges. Admittedly, taxpayers sometimes win these cases, requiring legislation to shut down foreign tax credit-generating tax shelters. But in general the government has done very well in anti-tax shelter litigation over the last five to ten years.
I am quoted in the article as saying that I consider the foreign tax credit hugely over-generous (which doesn't necessarily mean that tax burdens on U.S. companies' foreign source income should be higher - just that the statutory rate, rather than the credit, should be used to create the desired burden level). But it is true that, when you actually bear foreign income taxes that are creditable, you are not actually benefiting. Thus, suppose we conclude that the U.S. should not provide 100 percent reimbursement (via the credit) for income taxes that a U.S. company pays to Germany, because this eliminates the company's incentive to try to reduce German taxes (which from the U.S. national standpoint are purely a cost, as we don't get the money as we would from our own tax collections). Even though, in this setting, I would call the foreign tax credit over-generous, the taxpayer isn't getting away with anything, because paying a dollar of income tax to Germany costs you just as much as paying it to the U.S.
But if Bain, as I strongly suspect, acquired its 2008 foreign tax credits through some sort of super-aggressive tax shelter transaction, this scenario would not hold. The whole point of abusive tax shelters involving foreign tax credits is to get the credit without actually bearing the foreign tax cost.
Here is an example that would not actually work (or even come close) as a matter of U.S. income tax law, but that captures the economic heart of what these transactions do. Suppose that I were allowed unlimited foreign tax credits whenever I made any income tax payment to a foreign government, even if it wasn't actually my tax liability. Now suppose that J.K. Rowling came to me and said, "I owe the U.K. government $10 million of income taxes this year. But I will pay you $5 to pay this entire liability for me."
End result before U.S. tax: J.K. Rowling pays me $5, and I pay the U.K. government the $10 million that she would otherwise have paid. But if I can claim foreign tax credits for this full amount, the U.S. government gives me back the $10 million, and I end up ahead by $5 (minus the U.S. tax on that amount). So U.S individuals as a whole, via the effect on federal income tax receipts, lose $9,999,995.
Again, this transaction would not even come close to working under U.S. federal income tax law. But its bottom line is economically similar to the types of sham deals that I suspect Bain may have done in 2008. And if such deals could have been successfully challenged, then Romney may not have paid all the U.S. federal income taxes that he legally owed.
As usual, I feel half-apologetic about the degree of speculation that I am engaging in here. But it's Romney's unprecedented tax return secrecy, and the inferences reasonably derived from it, that makes such speculation necessary.
Here's Vic Fleischer on a management fee conversion trick that Bain appears to have done, and that many reputable tax lawyers believe is bogus and could not withstand legal challenge.
And here's James Stewart in the New York Times (to appear in the Saturday print edition tomorrow), quoting me in re. why Romney's high foreign tax credit for 2008 - a sharp outlier relative to his credits in adjoining taxable years - raises strong suspicions that he did some sort of a tax shelter transaction in that year involving the effective purchase of credits with minimal economic substance.
My statement in the article that Romney's big foreign tax credit in 2008 "makes no sense to me at all" relates to the point that high foreign taxes are incredibly easy to avoid if you have passive income and/or access to Bain's extremely aggressive and complicated tax planning technologies. For example, all those Caymans entities create huge opportunities to avoid any significant foreign taxes, even with associated operations in countries that have income tax systems.
So I find it hard to believe that the Bain investors actually paid significant foreign income taxes in 2008 - and not just because this seems to have been a once-only extraordinary event. Rather, it appears far more plausible to me that they did one of those fake off-the-rack deals that the IRS generally challenges. Admittedly, taxpayers sometimes win these cases, requiring legislation to shut down foreign tax credit-generating tax shelters. But in general the government has done very well in anti-tax shelter litigation over the last five to ten years.
I am quoted in the article as saying that I consider the foreign tax credit hugely over-generous (which doesn't necessarily mean that tax burdens on U.S. companies' foreign source income should be higher - just that the statutory rate, rather than the credit, should be used to create the desired burden level). But it is true that, when you actually bear foreign income taxes that are creditable, you are not actually benefiting. Thus, suppose we conclude that the U.S. should not provide 100 percent reimbursement (via the credit) for income taxes that a U.S. company pays to Germany, because this eliminates the company's incentive to try to reduce German taxes (which from the U.S. national standpoint are purely a cost, as we don't get the money as we would from our own tax collections). Even though, in this setting, I would call the foreign tax credit over-generous, the taxpayer isn't getting away with anything, because paying a dollar of income tax to Germany costs you just as much as paying it to the U.S.
But if Bain, as I strongly suspect, acquired its 2008 foreign tax credits through some sort of super-aggressive tax shelter transaction, this scenario would not hold. The whole point of abusive tax shelters involving foreign tax credits is to get the credit without actually bearing the foreign tax cost.
Here is an example that would not actually work (or even come close) as a matter of U.S. income tax law, but that captures the economic heart of what these transactions do. Suppose that I were allowed unlimited foreign tax credits whenever I made any income tax payment to a foreign government, even if it wasn't actually my tax liability. Now suppose that J.K. Rowling came to me and said, "I owe the U.K. government $10 million of income taxes this year. But I will pay you $5 to pay this entire liability for me."
End result before U.S. tax: J.K. Rowling pays me $5, and I pay the U.K. government the $10 million that she would otherwise have paid. But if I can claim foreign tax credits for this full amount, the U.S. government gives me back the $10 million, and I end up ahead by $5 (minus the U.S. tax on that amount). So U.S individuals as a whole, via the effect on federal income tax receipts, lose $9,999,995.
Again, this transaction would not even come close to working under U.S. federal income tax law. But its bottom line is economically similar to the types of sham deals that I suspect Bain may have done in 2008. And if such deals could have been successfully challenged, then Romney may not have paid all the U.S. federal income taxes that he legally owed.
As usual, I feel half-apologetic about the degree of speculation that I am engaging in here. But it's Romney's unprecedented tax return secrecy, and the inferences reasonably derived from it, that makes such speculation necessary.
Thursday, August 23, 2012
The incidence of Medicare cuts
Another topic that's been getting attention on the campaign trail is the Romney campaign's insistence that the Obama Administration imposed a $700 billion Medicare cut in order to finance healthcare reform. Some attention has gone to the comically overt hypocrisy of this claim, given both that Congressman Ryan supported exactly the same cuts until he was named the VP nominee-designate, and that the Republicans apparently are planning capped-growth voucherization of Medicare.
But another part of the story here is that the $700 billion in Obama Administration cuts were not directly on seniors' benefits, but rather were on payments to Medicare providers. To make the distinction clear, suppose we have two alternative sets of Medicare changes. Under the first, seniors must pay $700 billion more than previously (via co-payments, annual charges for Medicare coverage, etc.) for particular services. Under the second, seniors pay the same as previously, but healthcare providers' reimbursements are slashed by $700 billion.
Under the Romney campaign's approach, both of these changes would be described as a $700 billion Medicare cut. But they are obviously quite different. The direct incidence of the first change falls on seniors, while the direct incidence of the second change falls on healthcare providers.
Okay, another term for direct incidence is "nominal incidence." For example, the nominal incidence of the Social Security payroll tax is 50% on the employee, 50% on the employer. Economists generally agree, in this setting, that this split of the nominal incidence has no long-term effect on the true economic incidence of the tax (i.e., who really bears it economically, in the sense of ending up with less money). As it happens, workers are generally thought to bear pretty much the full economic incidence of the Social Security tax, even though the nominal incidence is split 50-50 with the employer.
Does this reasoning apply in the Medicare case as well, and show that the Romney campaign is correct to treat the direct or nominal incidence of Medicare cuts as irrelevant? In a word, no.
The main reason for this is the difference between short-term and long-term incidence. Consider the payroll tax "holiday" that we have had for the last couple of years. The nominal incidence was to benefit the worker (i.e., their payroll tax liabiliies, rather than those of the employers, were reduced by the holiday). But this probably did place a much larger share of the tax cut into their pockets, rather than into the employers' pockets, given that it would take time for wages to adjust in such a way as to make it all the same in the end.
For the same reason, even if the long-term incidence of the corporate tax falls on workers rather than either on shareholders or an investors generally, an unanticipated overnight repeal of the U.S. corporate tax would confer a windfall gain on shareholders. Their stock would immediately gain value from eliminating the expected corporate tax liabilities, and only over time would it all wash out via investment changes.
In the Medicare setting, this "transition" point is extremely important. The healthcare sector is characterized by massive sunk cost investment, whether we're looking at a medical research and technology firm, or at a 40-year-old doctor who is not realistically going to change his profession. So there is a huge difference, persisting for many years, between the economic incidence of (a) giving healthcare providers less and (b) making seniors pay more.
What's more, since the healthcare sector is experiencing an unsustainable growth rate that we know will need to be addressed at some point, it is already clear that some combination of (a) and (b) will have to be enacted over the long run. And when you take something out of one side's hide today (relative to the prior state of the law), you are not necessarily affecting the manner in which the two sides would be expected to split the impact of future necessary retrenchments.
In sum, we have here a case where the seemingly "naive" view, that nominal incidence is the same as true economic incidence, actually does pretty well as a shorthand description of what is happening. Hence, the Romney campaign is being extremely misleading, and not just hypocritical, when it claims that the Obama Administration has imposed a huge hit on seniors via the $700 billion in Medicare cuts.
But another part of the story here is that the $700 billion in Obama Administration cuts were not directly on seniors' benefits, but rather were on payments to Medicare providers. To make the distinction clear, suppose we have two alternative sets of Medicare changes. Under the first, seniors must pay $700 billion more than previously (via co-payments, annual charges for Medicare coverage, etc.) for particular services. Under the second, seniors pay the same as previously, but healthcare providers' reimbursements are slashed by $700 billion.
Under the Romney campaign's approach, both of these changes would be described as a $700 billion Medicare cut. But they are obviously quite different. The direct incidence of the first change falls on seniors, while the direct incidence of the second change falls on healthcare providers.
Okay, another term for direct incidence is "nominal incidence." For example, the nominal incidence of the Social Security payroll tax is 50% on the employee, 50% on the employer. Economists generally agree, in this setting, that this split of the nominal incidence has no long-term effect on the true economic incidence of the tax (i.e., who really bears it economically, in the sense of ending up with less money). As it happens, workers are generally thought to bear pretty much the full economic incidence of the Social Security tax, even though the nominal incidence is split 50-50 with the employer.
Does this reasoning apply in the Medicare case as well, and show that the Romney campaign is correct to treat the direct or nominal incidence of Medicare cuts as irrelevant? In a word, no.
The main reason for this is the difference between short-term and long-term incidence. Consider the payroll tax "holiday" that we have had for the last couple of years. The nominal incidence was to benefit the worker (i.e., their payroll tax liabiliies, rather than those of the employers, were reduced by the holiday). But this probably did place a much larger share of the tax cut into their pockets, rather than into the employers' pockets, given that it would take time for wages to adjust in such a way as to make it all the same in the end.
For the same reason, even if the long-term incidence of the corporate tax falls on workers rather than either on shareholders or an investors generally, an unanticipated overnight repeal of the U.S. corporate tax would confer a windfall gain on shareholders. Their stock would immediately gain value from eliminating the expected corporate tax liabilities, and only over time would it all wash out via investment changes.
In the Medicare setting, this "transition" point is extremely important. The healthcare sector is characterized by massive sunk cost investment, whether we're looking at a medical research and technology firm, or at a 40-year-old doctor who is not realistically going to change his profession. So there is a huge difference, persisting for many years, between the economic incidence of (a) giving healthcare providers less and (b) making seniors pay more.
What's more, since the healthcare sector is experiencing an unsustainable growth rate that we know will need to be addressed at some point, it is already clear that some combination of (a) and (b) will have to be enacted over the long run. And when you take something out of one side's hide today (relative to the prior state of the law), you are not necessarily affecting the manner in which the two sides would be expected to split the impact of future necessary retrenchments.
In sum, we have here a case where the seemingly "naive" view, that nominal incidence is the same as true economic incidence, actually does pretty well as a shorthand description of what is happening. Hence, the Romney campaign is being extremely misleading, and not just hypocritical, when it claims that the Obama Administration has imposed a huge hit on seniors via the $700 billion in Medicare cuts.
The Bain document drop
While press and blogosphere attention is rapidly focusing on Gawker's very interesting (but massive) Bain document drop, I am not sure how much time I will have to join in the fun. There are a lot of documents there, and while I am confident they contain some very interesting nuggets, these are likely to require a broader context (e.g., comparing them to other public information). Plus, I am just back from vacation, I'm trying to finish a chapter of my international tax book, my first fall class meets 8 days from now, various other things that take my time are coming up over the next few weeks, etcetera, etcetera. I know, cue the violins - it's not so terrible, but it may indeed keep me from digging in very much. Hopefully others will make up for my shirking. (I won't name names, but certain people at Tax Notes and at particular West Coast law schools come to mind.)
In any event, Gawker is off to a nice start, by noting such details as the Bain entities' use of total return equity swaps, apparently or at least possibly to support owning dividend-paying U.S. stocks as an economic matter while claiming not to own them for U.S. federal income tax purposes. An example of such a swap would be as follows. Suppose I think GE stock would be a good investment, but I don't want to own it for tax purposes because the Caymans entity through which I am investing would owe withholding tax on any dividends that GE paid. So I arrange a swap with a bank that has the following terms. One year from today, it will pay me the interest that I would have owed it on a $100 million loan. It will pay me an amount equal to the dividends that I would have derived during the same year had I owned $100 million of GE stock. In addition, it will pay me the amount by which $100 million of GE stock appreciated during the year (or I will pay it a similarly determined amount if GE's stock price goes down). The bottom line is that, counter-party credit risk aside, this is economically equivalent to borrowing $100 million at the specified interest rate in order to hold $100 million of GE stock for a year.
This use of total return equity swaps, such as to avoid the U.S. dividend withholding tax, was very widespread for more than a decade, and may not be dead yet, although the IRS issued a shot-across-the-bow Notice concerning the practice in 2010. But taxpayers who engaged in it to avoid the dividend withholding tax were coming perilously close to committing tax fraud, in cases where the economic equivalence to direct ownership was too great. (For example, in a lot of these deals even the exact timing of dividend payments had to be replicated in the swap.) Given that considerations of economic substance are relevant to ownership determinations for U.S. federal income tax purposes (i.e., "tax ownership"), the only leg that taxpayers had to stand on in some of these cases was common practice and the apparent lack of IRS enforcement (not a very strong leg if the correct application of the law was clear).
How far out on the limb were Bain-affiliated foreign entities that were making money through total return equity swaps, and claiming not to owe U.S. withholding tax? And what should we make of this, for purposes of the presidential campaign, if what they were doing, while legally dubious, was common practice? Fair questions for discussion, I'd say, and good examples of why Gawker is performing a valuable public service here.
In any event, Gawker is off to a nice start, by noting such details as the Bain entities' use of total return equity swaps, apparently or at least possibly to support owning dividend-paying U.S. stocks as an economic matter while claiming not to own them for U.S. federal income tax purposes. An example of such a swap would be as follows. Suppose I think GE stock would be a good investment, but I don't want to own it for tax purposes because the Caymans entity through which I am investing would owe withholding tax on any dividends that GE paid. So I arrange a swap with a bank that has the following terms. One year from today, it will pay me the interest that I would have owed it on a $100 million loan. It will pay me an amount equal to the dividends that I would have derived during the same year had I owned $100 million of GE stock. In addition, it will pay me the amount by which $100 million of GE stock appreciated during the year (or I will pay it a similarly determined amount if GE's stock price goes down). The bottom line is that, counter-party credit risk aside, this is economically equivalent to borrowing $100 million at the specified interest rate in order to hold $100 million of GE stock for a year.
This use of total return equity swaps, such as to avoid the U.S. dividend withholding tax, was very widespread for more than a decade, and may not be dead yet, although the IRS issued a shot-across-the-bow Notice concerning the practice in 2010. But taxpayers who engaged in it to avoid the dividend withholding tax were coming perilously close to committing tax fraud, in cases where the economic equivalence to direct ownership was too great. (For example, in a lot of these deals even the exact timing of dividend payments had to be replicated in the swap.) Given that considerations of economic substance are relevant to ownership determinations for U.S. federal income tax purposes (i.e., "tax ownership"), the only leg that taxpayers had to stand on in some of these cases was common practice and the apparent lack of IRS enforcement (not a very strong leg if the correct application of the law was clear).
How far out on the limb were Bain-affiliated foreign entities that were making money through total return equity swaps, and claiming not to owe U.S. withholding tax? And what should we make of this, for purposes of the presidential campaign, if what they were doing, while legally dubious, was common practice? Fair questions for discussion, I'd say, and good examples of why Gawker is performing a valuable public service here.
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