The problem with DOMA is discrimination, not states' rights

Not to look a gift horse in the mouth, but Justice Kennedy's apparent view, in yesterday's oral argument about DOMA, that it might be unconstitutional based on states' rights, strikes me as really weak (and I am restraining my impulse to offer a more vitriolic description).  I will be glad if he supplies the fifth vote to overturn DOMA, and if he wants to do it this way, rather than invoking discrimination, I suppose one should be glad overall.  (Just as, in the healthcare litigation, I was glad that Chief Justice Roberts found a way to uphold the law, although I considered it completely ludicrous to view the mandate, unlike Medicare's far more aggressive intervention in the healthcare market and people's choices, as beyond Congress's commerce clause powers.)

But still, if Kennedy ends up supplying the fifth vote in a separate opinion relying on states' rights - and I realize that I may be jumping the gun in assuming that he will - it's worth noting how intellectually flimsy his avowed stance would be.

Let's put the apparent Kennedy position this way.  He appears to be inventing a new constitutional provision called the Reverse Supremacy Clause.  Under this fictional clause of the U.S. Constitution, once the states have expressed their policy judgment in a particular area, the federal government is constitutionally bound to accept that judgment, and cannot reach a different one on the same issues when it is designing federal legislative programs such as Social Security, Medicare, and the federal income tax.

OK, so all 50 states plus the District of Columbia have this legal status called marriage.  It matters for various state law purposes, such as property rights and the operation of  rules governing the workplace.  The states do this based on policy judgments responding to the fact about human beings that we often form family or household bonds involving couples.

The federal government also has various rules that make policy judgments regarding the legal significance under various programs of such couples or families or households as it chooses to recognize.  For example, the income tax requires joint returns (or use of the married filing separately route, rather than single or head of household) for individuals who are married, a determination that generally is made under state law.  Likewise, Social Security and Medicare offer certain spousal benefits.

Certain transfer programs that provide aid to the poor look beyond state law marriage to assign legal consequences to other measures of couple or household status.  And federal immigation law, I gather, disregards state law marriages that it classifies as shams, without any implication that it is adjudicating the state law validity of these marriages.

For that matter, there is an amusing federal income tax case, I believe from the 1970s,involving a couple that got divorced every December and remarried early the next year, using the tax savings from not having to file a joint return to fund a nice vacation.  For federal income tax purposes, the divorces were held to be sham transactions, and thus the two individuals were required to file jointly or as marrieds filing separately.

OK, so suppose Congress were to say: We favor joint filing for certain types of couples, but we want to define the relevant couples in our own way.  So we will count, say, everyone (and only those people) who (1) are cohabitants for at least 6 months out of the year, (2) commingle their funds or their consumption expenditures in a non-arm's length manner, and (3) are deemed to have some sort of requisite state of mind regarding their relationship.  Perhaps the legislative history might add that state law marriage is evidentiary of whether one is in a couple for federal income tax purposes, but that any resulting presumption can be overridden by factors A, B, and C.

This law might be administratively unworkable, but can anyone seriously maintain that it would violate states' rights?  Why can't Congress define couples as it likes, solely for purposes of federal programs?  When the states decide how to define legally relevant couples for purposes of their own rules, do they really take away Congress's discretion to do the same thing for purposes of its rules?

But then we get Justice Kennedy saying that “The question is whether or not the federal government, under our federalism scheme, has the authority to regulate marriage.”  The only alternative I see to viewing this as an invocation of the fictional Reverse Supremacy Clause is to say that he is applying some sort of unrationalized "all or nothing" rule, under which, if Congress chooses mainly to rely on state law definitions, it can't selectively depart from them.

But how can one possibly defend that view, leaving aside the discrimination problem?  Why shouldn't Congress be able mainly to rely on state law marital status most of the time (thus reaping significant administrative benefits), but modifying the relevant definition for federal purposes however it likes, so long as it is advancing legitimate federal policy objectives?

Needless to say, the problem with DOMA - and the reason I would vote to hold it unconstitutional - is that the distinction it makes, in determining which couples to recognize, is discriminatory and does not advance a valid federal purpose.  But this has nothing to do with the fact that it otherwise relies on state law.  Similarly, Congress could not constitutionally deny Social Security benefits to interracial couples, whether the definition that it otherwise applied was based on state law or on the hypothetical scheme that I set forth above.

Tax policy colloquium, week 8: Leslie Robinson's "Internal Ownership Structures of Multinational Firms"

On Tuesday, Leslie Robinson of the Tuck Business School at Dartmouth presented the above-titled paper, co-authored with her colleague Katharina Lewellen, and available here.

This continued our annual tradition of having a paper by an accounting professor (we also try to do one each year by a political scientist, this year to be Larry Bartels on April 23), along with some economists, a mix of junior and senior law professors, and often a tax practitioner. 

The paper looks at multinational firms' internal structures.  In particular, when do they have "complex" structures in which, rather than having the U.S. parent directly own, say, a sub in every country where it operates (this would be a "flat" structure), they have tiered structures in which some subs own other subs.  The aim is to get a sense, from the overall empirics regarding "owner subsidiaries" and the particular vertical pairings that one finds, regarding what might be the likely causation, be it tax or something else, for internal complexity.

One unfortunate limit in the data is that one can't observe which firms are "hybrids," i.e., firms that the taxpayer elects to treat for U.S. tax purposes as legally non-existent branches of their direct owners.  Hybrids are useful so that one can, say, pay interest from a Germany subsidiary of an ultimate U.S. parent into the Caymans for German tax purposes, without the U.S. thereby saying: Aha, receipt of interest by the Caymans affiliate means that the U.S. parent has subpart F income.

The paper finds evidence of both tax motivations and others in the use of complex internal structures.  But a lot of the others were probably also tax.  For example, affiliates that trade with each other often have a vertical ownership structure.  But those dealings may be tax-motivated transfer pricing.   And affiliates with a lot of cash on hand tend to invest equity in other affiliates.  But they may have had cash on hand due to profit-shifting games within the group, and then they use the cash to own other affiliates directly so that it doesn't have to be repatriated taxably to the U.S. parent first.

A natural policy response would be to entirely ignore internal structuring of multinational firms, and tax the entire global entity (whether it has a U.S. parent or not) as a unitary business.  For U.S. firms, this could involve replacing deferral with a lower tax rate for foreign source income generally (since the question of what tax rate we want to impose on foreign source income is distinct from that of whether internal firm structure should matter).  It might also involve wholly ignoring intra-firm cash flows of all kinds (who borrows from each other or a third party lender, who pays royalties to whom, etc.).  This would put us in a formulary apportionment world, which isn't ideal either.  But I see that (if done right) as a way of making the effective election to shift profits costlier than it is when we take account of meaningless intra-firm entity lines and events.

A different type of response would be to tax-penalize complex structures directly, on what I call the Three Stooges rationale.

(Moe hits Curly on the head.  Curly: "Whatja do that for?  I didn't do nothin'!"  Moe: "That's in case you do something later when I'm not around.")

This could either involve directly relating U.S. tax burdens to some measure of complex rather than "flat" internal structuring, or more consistently giving adverse tax consequences to intra-group cash flows, including those that use hybrids.  The corporate literature on "pyramiding" and responses thereto may be of interest here.

Free at last (!?!?!?!?!)

I have just completed what might be a full draft of my book-in-progress, Fixing The U.S. International Tax Rules.  It took 4 years and 4 fresh starts - whereas usually, once I have a book clearly in mind, I can write it in a few months.  The total damage is about 100,000 words, which is perhaps a bit on the long side.  But even at that length, there were a number of topics that I needed to keep fairly brief.  It is much more directed to how we should think about international tax policy than to pitching a particular solution, although I do try to relate the ideas discussed to concrete implementations.

It's not quite a completed draft just yet, as I need to read the whole thing over again, with an eye to its unity, consistency, and non-repetitiveness, among other key attributes.  The constant reloads and start-and-stop character of the process make this especially necessary, although they have also induced me to do a lot of re-reading and editing as I went along.

I'll be presenting the book at a conference in Hebrew University this June.  (My 3 discussants are probably glad to know that they will see it soon.)  And I have not as yet committed to a publisher.  I won't be posting it on SSRN, but hopefully it will be out as soon as 2014.

Some, but not all, of what I consider its more novel aspects are foreshadowed in articles that I have published over the last few years on foreign tax credits and U.S.corporate residence electivity.  But I have rethought some of the ideas in those articles, and the book is almost 100% new work, as opposed to being a cut-and-paste job.

Tax policy colloquium, week 7: Desai and Dharmapala's "Competitive Neutrality Among Debt-Financed Multinational Firms

On Tuesday we did our last Tax Policy Colloquium before NYU's one-week spring break.  Our speaker was Dhammika Dharmapala, presenting a draft of the above-titled work that he and Mihir Desai are co-authoring.  No link here, as he asked us to take it down afterwards because it is still in very preliminary form.

A bit of the abstract may help to explain what issues the paper tackles and what conclusions it reaches.  For starters:

"Debt plays an important role in the financing of multinational corporations (MNCs). Interest expenses are typically tax-deductible in most corporate income tax systems, and there has been a growth of interest in recent years in the tax treatment of debt and its consequences. This paper discusses the optimal form that interest deductibility and associated restrictions should take in a multi-jurisdictional setting. We straightforwardly extend existing neutrality norms in international taxation to serve as a benchmark."

They use "competitive neutrality" as their benchmark, but they could just as well have used "capital ownership neutrality" (CON), which Desai in particular has written about before (along with Jim Hines).  For convenience, I will characterize them as using CON even though they keep on saying "competitive neutrality."

I must confess to not being happy with this approach, for reasons that my forthcoming international tax book will explain in more detail.  Complaint 1: It's a global welfare norm, and thus not necessarily of interest to policymakers (or citizens) in any particular country.  I think the way to go is by starting with unilateral national welfare (i.e., what's best for the particular country that is setting its rules for inbound and outbound investment, if no other country responds to its choices), and then asking how strategic interactions with other countries may change the analysis.

If you instead identify a best approach from the global welfare standpoint, it's conceivable that countries could execute a Pareto deal to achieve it, leaving everyone better-off.  Conceivable, but not too bloody likely.

OK, in principle it doesn't matter where you start, so long as you end up in the right place.  So why not begin with global welfare, as Desai and Dharmapala do, and then proceed towards national welfare by examining opportunities for cooperation?  But the problem is this.  As the paper shows, there are just so many margins that one could think about, in trying to maximize global welfare, that starting there almost inevitably lands one in a morass.  National welfare turns out to be simpler, or at least more readily simplified for basic analytic purposes, most of the time.  But again, that's jumping into my book and would need fuller illustration than I can provide here.

In their colloquium paper, Desai and Dharmapala are interested in particular in the question of how CON plays out when it is impossible to achieve accurate "tracing" of interest expense to the outlays that are related to them at the margin.  So you have the basic scenario that a taxpayer can, say, borrow in a high-tax country and invest the funds in a low-tax country.  This can cause negative-present-value projects on a pre-tax basis to make a whole lot of sense (from the taxpayer's perspective) after-tax.  Under CON, they want to achieve global tax neutrality for all multinationals with respect to the question of who borrows (anywhere) in order to hold a particular asset (somewhere).

The paper concedes that there are other relevant margins, such as those pertaining to the choice between debt and equity and to the choice of negative-present-value projects.  But they want to isolate the CON thread for separate analysis, on the view that this is worth knowing even if in the end one will have to optimize overall at all of the margins, which probably requires failing to fully optimize at any one of them considered in isolation.

More damaging still, in my view, is the fact that this is only CON between multinationals.  They concede that their approach might result in tax bias as between multinationals and purely national firms.  For example, suppose GE and an Indonesian firm would both pay tax on factory production in that country at the Indonesian rate, but that only GE can borrow in such a way as to get interest deductions at the higher US rate, rather than the Indonesian rate.  You could then get the scenario where GE is tax-favored relative to the Indonesian company.  In such a case, satisfying CON for their purposes, by reason of treating, say, GE and Siemens the same, might be an empty achievement.

OK, one might argue that GE and the Indonesian firm are likely to be active in different sectors, and thus not competing directly.  But even apart from the fact that these two sectors may be competing for global capital, suppose GE wants to use the Indonesian firm in its global production processes, and is deciding whether to buy it or use arm's length contracting.  CON as used in the paper therefore appears to fall quite short even apart from its being just one of many global efficiency strands and its not being of direct interest to any national policymaker.

Putting out of mind (for just a moment) all those limitations, where do they believe it leads?  They note that, generalizing the approach taken in a rather notorious paper on interest deductibility by Jim Hines, suppose the U.S. agreed to provide 35 cents of subsidy per dollar of interest expense by all multinationals investing anywhere in the world.  That would achieve CON, but it doesn't appear to be politically feasible (gee, I wonder why).  So they look at alternative approaches, including one in particular that they expressly describe as a thought experiment rather than a concrete proposal.

Suppose that all countries in the world agreed to impose a worldwide debt cap that functioned as follows.  While in general each multinational's affiliates in a given country would deduct their in-country interest expense, all countries would impose a worldwide debt cap, restricting the amount of the in-country interest deductions to the multinational group's total worldwide third-party interest payments.  Desai and Dharmapala argue that this would satisfy CON (in the between-multinationals sense) so long as the multinationals had enough taxable income in each country where they borrowed to deduct all of the locally incurred interest expense.

They concede that this might both create a huge global tax bias in favor of debt at the expense of equity, and make negative-present-value projects worth undertaking after-tax.  But they argue that one could address those concerns, without undermining the CON result, by having all countries agree to cap the allowable interest deduction at the same arbitrary fraction of global third-party interest expense.  Hence, at least for thought experiment purposes, they appear to regard their proposal as potentially meritorious across all of the relevant margins, so long as policymakers around the world pick the same arbitrary fraction in light of the proper weight of all the competing objectives.

While the proposed thought experiment solution is not unclever, I in the end can't help but regard the paper, with all due respect to its authors, as very effectively (though inadvertently) illustrating the argument in my forthcoming book that much of the international tax policy literature has gone badly off the rails.  I am skeptical that "alphabet soup," or the use of a single-bullet global welfare approach to guide the analysis, can lead anywhere that is very useful, no matter how intelligently it is executed.  And when I say "useful," I mean either in the sense of leading to important theoretical insights or of generating practical proposals that policymakers might find useful.  I hope and even believe that very different types of approaches to international tax policy analysis will become increasingly prevalent over the next few years.

Corporate tax reform?

In an earlier post I expressed both political and substantive skepticism about the current prospects and merits of 1986-style individual income tax reform, which would feature lowering the rates in exchange for broadening the base.  But there has also been much talk about doing this just in the corporate income tax.  Does that have greater merit?

Let's start again with the political feasibility question, then turn to the actual merits.  I am skeptical about this one's prospects as well, though not for exactly the same reasons.  Starting with the partisan political environment, I actually find it plausible that House Ways and Means Chairman Camp could come to an agreement with the Obama Administration, if they were the only principals.  But since they are not, the general stance of the Republican Congressional leadership is inevitably part of the equation.

But there's a bigger problem.  What does the deal look like, even if they have a common vision and are prepared to deal?  Taxation of the U.S. business sector is unusual, compared to that of our peer countries, because of how it is split between the corporate income and the individual income tax (the latter for partnerships, S corporations, proprietorships, and LLCs that elect to be taxed as partnerships).  So if you broaden the base to pay for lower corporate rates, while keeping the rest of the tax system the same, you must either actually raise taxes in the non-corporate business sector or have the tax treatment of the same item (e.g., depreciation) differ between the sectors.  Plus, disparities in how much the shareholder-level part of the corporate tax actually matters make it difficult to decide how one could be aligning everything neutrally.

Now to my skepticism about the merits.  The U.S. corporate income tax is a compound beast.  It contains a lot of separate elements that, in principle, we would want to tease out and treat distinctively, but we don't and in some cases can't, once we have an entity-level tax that gloms them all together.

What is the core reason for wanting to lower the corporate tax rate?  The answer is global tax competition.  What we have in mind here, above all, is mobile capital held by foreigners who can invest wherever they like.  Under "small open economy" assumptions about their investment opportunities in the U.S. we might actually want to tax their earnings here (other than rents) at zero.

But that is only one piece of the U.S. corporate income tax base.  A second is mobile capital held by U.S. individuals.  They, too, can invest anywhere.  But in principle, under the worldwide residence-based individual income tax, we ought to be able to require them to pay U.S. tax no matter where they invest.

In practice, this is not so easy due to the realization requirement and their ability to invest abroad through non-U.S. entities (although the passive foreign investment company or PFIC rules should catch them when they hold a foreign stock or bond portfolio through, say, a Caymans entity).  But we certainly have good reason to want to apply the full U.S. rates to income that they earn through a corporate entity, including when it's a U.S. entity and/or it earns U.S.-source income.  So for them we want a higher rate, but you can't have the tax rate in an entity-level corporate income tax depend on who is the owner.

Then a third element is labor income that U.S. individuals earn through corporate entities.  This is the issue of owner-employees under-paying themselves, and here we definitely want to charge the full U.S. rate.  But we automatically lose this, if we lower the U.S. corporate rate, unless we adopt tough associated reforms such as a Scandinavian-style "dual income tax."

So what ought the U.S. corporate rate to be?  The answer is, it should be different for each of these elements, and also different depending on how we evaluate the burden of shareholder-level taxation (which may end up being zero for people who wait for basis step-up at death, but for others may be significant).

The point here is not that we definitely shouldn't lower the U.S. corporate rate, but that it's a complicated question because we should as to some elements and shouldn't as to others, yet in effect must pretend that one size fits all, at least in the absence of other changes that I don't believe are really on the table.

Now let's briefly consider the pay-fors.  There is certainly some garbage in the U.S. corporate income tax base that it would be great to get rid of (although arguably the revenue gain should go to lowering the long-term U.S. fiscal gap).  But consider, say, accelerated depreciation.  While cost recovery disparities create inter-asset distortions, it's not all bad to have the system closer to a consumption tax rather than an income tax base, in terms of incentives for new investment.  And as a transition matter, if we lower the rate and pay for it by slowing down depreciation, then to a degree we have combined a windfall gain for old investment (which deducted accelerated depreciation at a higher rate and now gets to include the associated income at a lower rate) with what is effectively anti-stimulus for new investment in the middle of a continuing jobs crisis.

Gary is a basketball fan

He appears to be quite interested in the Knicks-Thunder game.

Skepticism about "fundamental tax reform"

Today we had a special lunchtime event at NYU Law School.  Victor Thuronyi of the International Monetary Fund, an old friend with whom I worked on the Tax Reform Act of 1986 (he was on the Treasury staff, while I was at the Joint Committee on Taxation), discussed his plan for enacting a "supplemental expenditure tax" (SET) as part of an overall tax reform plan.  The SET is basically a consumed income tax, aka an individual-level cash flow consumption tax, that he would use to pay for rate reductions in the existing income tax.  You can read about it here.

I myself find it easier to imagine a VAT being added to supplement the income tax than as SET (as in the Michael Graetz tax reform plan).  But I question the premise that both Thuronyi and Graetz advance, to the effect that the revenues raised by the new tax should be "spent" on reducing income tax revenues.  Considered in isolation, that might be a good idea, but what about other budgetary uses for the funds when we appear to have a long-term fiscal gap to worry about once the horrible employment situation of the last few years has passed into history.

But both plans are certainly welcome as expansions to the list of ideas that are people are talking about.

I was a commentator at Victor's session today, as was David Miller, and here is a fleshed-out portion of the part of my remarks in which I addressed, not so much Victor's plan as such, as the issue of whether we need 1986-style "fundamental tax reform."  This, of course, is a topic that I have also addressed here.

Shaviro remarks (3/6/13) on 1986-style "fundamental tax reform"

Everyone loves tax reform in theory, though not so much in practice. And of course tax policy types tend to love it, and why wouldn’t we? But I want to verge on heresy by throwing a bit of cold water on the idea.

Obviously I’d like to “reform” the tax system, in the sense of changing it to be better. And there is so much wrong with the current system that identifying things we could improve is a bit like shooting fish in a barrel.

But I have become a real skeptic about what I call 1986-style tax reform. Let me first define it, then say why I have become so skeptical about it.

1986-style reform typically involves lowering the rates and broadening base, under a constraint of maintaining revenue neutrality and distributional neutrality relative to prior law. By the way, in 1986 the top group for purposes of assessing distributional neutrality was people with income of $250,000 or more.  Today, even adjusting for 27 years of price-level changes, we might want to look distinctively at much higher-up groups (such as the top 1%, 0.1%, and 0.01%).

In 1986, I agree that this tax reform model was a good one.  The parties disagreed about the revenue and distributional parameters, but were capable of agreeing about some other stuff. So they did what they agreed about, while agreeing to a ceasefire in place for the rest.  Note, by the way, that the top rates they were lowering rates were 50% and 46% for corporations - considerably above where we are today.

Today, I don’t see the politics working as well, for two reasons.  First, the relationship between the parties is obviously very different than it was in the mid-1980s. But second, consider what Congressman Richard Gephardt notoriously said in 1986 (as quoted in the subsequent Birnbaum-Murray book, "Showdown at Gucci Gulch."  Biographical note: Gephardt was a cosponsor of the well-known Bradley-Gephardt tax reform plan, but then went completely MIA when the 1986 Act started marching towards enrollment,  Anyway, he said: “It’s not that good an issue.” And he was right as a political matter.  The 1986 Act only went through, despite widespread public hostility or indifference, due to what economist Henry Aaron called the "dead cat" problem.  None of the main leaders responsible for shepherding it through (President Reagan, James Baker when he became the Treasury Secretary, Dan Rostenkowski in the House, or Bob Packwood in the Senate) wanted the "dead cat" of having killed tax reform on his doorstep.  Even though the public disliked the tax reform bill, it was all too ready to assume that anyone who killed it was a tool of the interest groups and/or an ineffective leader.  So the political dynamic worked, but it was a very odd one and hard to replicate.

That's just about the feasibility of 1986-style reform, which flies in the face of the political science maxim that concentrated special interests tend to beat out diffuse general interests.  But again, perhaps so what.  Here are several reasons for being, at a minimum, only mildly rather than greatly upset (and, in some cases, affirmatively relieved) if 1986-style reform doesn't happen:

(1) Let’s not exaggerate the benefits.  At a first approximation, if you broaden the base but lower the rates, work incentives are the same as before.  The economic payoff is to distortion between rival consumption and/or investment choices.  That can be a nice payoff, but it doesn't, for example, project to greatly increased ecnomic growth.

(2) Complexity costs for average individual taxpayers, which these plans often seek to reduce (e.g., by repealing the alternative minimum tax) often are not as great a concern as they used to be.  Two words (or is it actually just one?): TurboTax.

(3) 1986-style reform often treats a high rate and a broad base as substitutes. You use revenue gain from the latter to buy out of the former.  Economically speaking, however, they are complements.  The broader the base and thus the harder the tax is to avoid, the lower the efficiency costs of having a higher rather than a lower rate.

(4) What does it even mean to say, 1986-style, that revenues will remain the same? Given the point that targeted tax breaks serving allocative purposes may (more or less rightly) be viewed as tax expenditures, any such claim is based on form, not substance.  It might be more accurate to say that both "taxes" and "spending" have declined (although these terms aren't very meaningful to begin with) if we, say, repeal the home mortgage interest deduction to pay for lower rates.

(5) Should everything have the same tax rate?  The theory of optimal commodity taxation explains why the answer to this question is no under realistic parameters that are relevant here. Rather, unless you've done more fundamental reform, items that are more elastic typically should be taxed at lower rates than those that are less elastic.  The revenue-maximizing rate for capital gains, at least under present law (with a realization system and tax-free basis step-up at death) is probably below 30%.  That for wage income may be a lot higher.  Or consider the argument that, so long as we have an income tax that's collected at the entity level for income earned through a corporation, the corporate rate should be lower than the individual rate.  (This reflects the fact that corporate income is a proxy, albeit an imperfect one, for globally mobile capital.)  Finally, consider the argument I will make in my forthcoming international tax book that the optimal U.S. rate for foreign source income of U.S. companies is lower than the domestic rate, even if not so low as zero (as it would be under a territorial system), and that everyone kind of knows this although plenty of people (including experts) confuse themselves by relying on the foreign tax credit to lower the effective tax rate on the foreign source income.

(6) Given the long-term fiscal gap that we face, it's questionable whether we should do a whole lot of heavy lifting in our tax system design that has zero net payoff in terms of returning to sustainability.  In addition to diverting scarce "reform capacity," a 1986-style might give away "low-hanging fruit" by "spending" the budgetary gain from base-broadening (or new taxes such as the VAT or SET) on wish lists other than restoring long-term sustainability.

(7) If you are concerned about high-end distribution, why would you want to cut the top individual rate?  Arguably we should be thinking instead about increasing it.

Tax policy colloquium, week 6: Darien Shanske's Modernizing the Property Tax

Yesterday at the colloquium, Darien Shanske of the University of California at Hastings Law School presented his paper, Modernizing the Property Tax.

One great thing about the paper and the topic was as follows.  I have been doing the colloquium for 18 (!) years now.  At this point, it's pretty rare to get a new topic or something I haven't seen come down the pike before.  But this was pretty novel for me - probably our first real property tax paper ever, and Darien is effectively using his energy and imagination to reinvigorate a topic that for decades has seemed moribund.  So I very much welcomed and enjoyed this.

Herewith some thoughts about two of the main sets of issues that the paper raises:

1. ARE REAL PROPERTY TAXES A GOOD LOCAL FINANCE TOOL?

Paper likes them & wants to reverse their decline. E.g., it argues that they nicely correct for the federal income tax exclusion of imputed rent. Renters are taxed at the federal level, homeowners at the local level through the real property tax, & this division of the tax base could make sense as fiscal federalism.

I’m skeptical both about this division-of-the-tax-base claim & about the general merits of the real property tax at the local level.

Some points to the contrary:

(1) Since the local real property tax reaches ALL real property, arguably it fails to adjust for the federal imputed rent exclusion. E.g., it doesn’t address the home vs. rent disparity. Both pay at the local level, even & the incidence of the local real property tax is probably on renters).

So renters, unlike homeowners are taxed at both levels, & the federal disparity may not be reduced by local real property taxes.

Likewise, home use vs. non-residential use of real property isn’t addressed by subjecting both to local real property tax.

(2) Suppose the real property tax is a pure benefit tax at the margin. E.g., an extra dollar of tax means an extra dollar of garbage pick-up or other local amenities. Then it’s not really a tax, but a service fee, and again charging it at the local level does nothing to offset the federal exclusion.

(3) We may like the Tiebout-type benefits of local taxes. But these don’t require that the tax be directly on real property. Anything that’s tied to residence will do. E.g., consider income taxes that the state collects on behalf of the locality, on top of its own income tax (a la New York State and NYC / Yonkers). Not clear that this is less of a benefit tax at the margin than a real property tax, in which not just site value but also the value of improvements is being reached.

(4) Paper likes the local property tax for salience of the tax-benefit link. A la Tiebout, but operating through voice rather than exit. But why wouldn’t a local income tax that the state collects & remits for the locality work the same way? And with the real property tax, when the owner isn’t a resident you probably lose the political salience point. E.g., even if renters bear the tax, they don’t see it listed as a specific item, whereas they would be able to see the local income tax as a separately listed item.

(5) OK, there are 2 things I like about the real property tax. First, the locality can collect it by itself. But note what a bad job they tend to do with valuation. Second, a tax on site value has elements of being a lump sum tax that isn’t distortionary, if owners can’t affect site value. But taxing the improvements still is narrow & distortionary.

SO: I’m left with little reason to mourn the relative decline of the real property tax, & perhaps little motive to restore it to its formerly higher relative level. 

2.  DARIEN'S PROPOSAL

I will emphasize 3 of his proposals in particular. Note that they are largely distinct (i.e., could be adopted or not separately).

(1) Monthly property tax withholding that isn’t just through escrow for people with mortgages, but for everyone and chiefly through employment.

(2) Liquidity insurance: current real property tax liability is reduced when income declines, including from pre-planned retirement rather than surprise job loss. The avoided taxes are due with interest when you sell.

(3) Retrospective revaluation: when sell, assume value change from purchase price occurred ratably, and re-determine past year’s property tax liabilities. E.g., buy for $100K, sell in 3 years for $133.1K. This is 10%/year, so assume the value was $110K, then $121K. If a positive adjustment, collect with interest at closing. Can ratably impute negative as well as positive returns.

I question the first two, but I mainly like the third.

My responses:

(1) While moving towards monthly rather than annual payment may generally be good, escrow already covers 60% of homeowners, tilted towards those who most likely to be cash-constrained and/or to need help managing their cash flows.

(2) I question shifting this task to employers. Not just a burden they may not want, based on information they don’t automatically have, but also the employee may not want to share this information with them. Paper notes problems such as states without an income tax & commuters between states. When you add this to people who aren’t employed (including retirees), could be a mess.

(3) I question the liquidity insurance feature. Distinguish 2 situations: unexpected shock such as losing your job, planned step such as retirement.

For the former, there is generally a case for cushioning the downturn, due to the rigidity of pre-planned spending patterns. This is what unemployment insuranc purposese (UI) is all about. But why have such a program apply distinctively for real property tax? And note the efficiency tradeoff that UI generally involves (other than in the current down economy) since it increases incentive to lose job & reduces incentive to find a new one.

For retirement, I don’t see the rationale at all. Why “insure” against a planned & deliberate act? Note that the proposal might also strengthen the tax incentive to retire, or perhaps even to move to high-property tax communities when you retire.

Part of the paper’s rationale for the liquidity insurance is political economy – e.g., local residents who are seniors opposing funding for local improvements or schools. But this may reflect their self-interest, not just liquidity concerns.

(4) Under both liquidity insurance & retrospective revaluation, I’m concerned about the plan to collect amounts due at sale. Can lead to default / liquidity problems if loan to value ratio is high. Note also that people often want to reinvest by buying a new home. So this proposal is anti-smoothing, whereas the first proposal is pro-smoothing.

(5) Otherwise, I mostly like retrospective revaluation because it’s objective market evidence in a very flawed process. But 2 quick comments:

--Is extra tax due upon sale the usual case? Paper sometimes appears to assume this. But it depends on assessed value vs. actual value. Today perhaps a practice of under-valuation, as a way to curry favor with local voters or due to Proposition 13-style limits. But the new rule might encourage states to value high rather than low, figuring it solves the default problem & that they can say: don’t worry, you’ll get your money back.

--If TPs are myopic or don’t consider the tax inevitable or would face a liquidity crunch upon sale due to the maturation of deferred tax liabilities, the end result may be increased lock-in. Whereas Proposal #1 makes real property tax payments smoother, this may make them less smooth.

There and back again

I've just completed taking seven airplane flights in five days, and all of them were on time.  I guess the sequester wasn't an immediate problem for air travel after all.  (Perhaps due to the 30-day requirement for furloughing airport personnel.)  Or, per my prior post on the topic, I suppose the travel gods were still satisfied with the 2-day layover they had handed out to me when I was in Los Angeles at the start of February, and decided to let me off easy this time.

But just by a hair, as it happens.  If today's weather in the Midwest had gotten there a day earlier, I might still be stuck out there, fuming and/or cooling my heels (if one can do both simultaneously) as another winter storm rages through.  That would have caused me to miss today's NYU Tax Policy Colloquium, where we are discussing Darien Shanske's paper, Modernizing the Property Tax.  More on that, of course, in a subsequent post (since, just to get the counter-factuals straight, I am in fact back here).

How do you get into the position of taking 7 flights in 5 days?  It's quite easy, actually.  All you need to do is accept two speaking gigs within a few days of each other, neither of which is reachable from New York (or the other place) through a direct flight.  So, starting in New York last Thursday, I first flew through Atlanta to Tallahassee, where I presented my Henry Simons paper last Friday at the FSU Law School's 100 Years of the Income Tax conference.  On Saturday I then flew through Atlanta and on to Chicago.  On Sunday, I did the final outbound leg, to Champaign, IL, where on Monday I presented this year's Anne Baum Elderlaw Lecture at the University of Illinois Law School.  The lecture was based on my paper, Should Social Security and Medicare Be More Market-Based?  Then last night I made it back to NYC through Chicago.

The slides for my Simons talk in Tallahassee are here.  In case anyone is keeping score, they have been slightly revised, not only since I posted an earlier version for my USC talk on Simons, but also since I gave the talk at FSU.  The slides had a couple of small errors that I decided to fix.

I'm not sure if I should consider this a compliment or not, but a commentator at the FSU session, praising the Simons article's literary style, compared me to a skillful nurse-practitioner who is giving you a shot, and who manages things so smoothly that you don't even notice it when the needle goes in.  OK, it was all in good fun, but I am not sure what he meant by the needle.  I am straight-up in my academic writing.

The slides for my Social Security / Medicare talk are here.  This is a first-time posting.  While the slides have a lot of content and were made for a one-hour talk, they are certainly a quicker read than the article, and cover most of the same bases.

Both the slides and the paper for my Social Security / Medicare project, while perhaps less fun than the Simons project, exceed it in analytic content.  The Illinois paper is also more relevant to current policy debate - for example, the battle over Medicare design (traditional system versus Ryan plan) that played a major role in the 2012 presidential election.

Not to whine here, but I get the sense that my work on Social Security and Medicare (as well as on budget deficits) gets less attention than when I am writing about the income tax or tax reform.  People evidently find it less credible that one with my biography and public credentials would be adding value on those topics than when the issue is straight-up tax.  But the issues are really all fundamentally of the same character (apart from the fact that I make no claim to be a healthcare expert). So please read up if you are interested, although I don't mean to beg.

Another musical post

The version of Fiona Apple's "Get Him Back" on the official release is pretty good, but this unreleased version might be even better.  You can also easily find live versions on youtube.  The dark, concise story that it tells powerfully combines outwardly directed anger with inwardly directed insight.

Tax policy colloquium, week 5: Should we raise high-end tax rates to 70 percent?

Yesterday at the colloquium we discussed Peter Diamond's paper, co-authored with Emmanuel Saez and published recently in the Journal of Economic Perspectives, entitled The Case for a Progressive Tax: From Basic Research to Policy Recommendations.

The paper makes 3 recommendations: (1) apply marginal tax rates that are both graduated & higher than present law to very high earnings (e.g., perhaps 70% for the top 1%, which kicks in at about $400,000, (2) for low-earners, subsidize earnings but then apply high marginal tax rates in the phase-out rate, (3) what the paper calls “capital income” should be taxed.

Herewith some thoughts about Topics 1 and 3. (It is already a bit on the long side without including Topic 2, on which in any case I had less to say.)

1. Optimal tax rates for high-earners

1. The fact that this paper talks about higher rates at the top, perhaps on the order of 70 percent, is a valuable public service. Whether or not one agrees in the end (or thinks it politically feasible even if one agrees), it expands the range of “permissible” debate, and this is a good thing both intellectually and politically. Diamond and Saez are also to be commended for caring about real world policy debates, as opposed to wanting to play with complicated mathematical models for their own sake (which can be fun, but is less public-spirited).

2. The paper argues that the tax policy aim with respect to people at the top should be almost pure revenue maximization, without regard to the marginal disutility that a high tax rate imposes on them (via both taxes paid and deadweight loss). More specifically, it shows that assuming a very low social weight for these marginal utility losses, rather than a zero weight, wouldn’t change the conclusions very much.

Two grounds are offered for this low social weight: low Ui, and low wi. The former refers to the affected taxpayer’s marginal utility. For example – to draw on someone well above the merely $400,000 level – Warren Buffett probably would experience next to no change in his daily personal circumstances if his tax bill went up by $10 million – it’s not as if he’d have to cut back on anything that he likes doing. By contrast, low wi refers to the social weight that one places on Buffett’s, as opposed to someone else’s disutility. Some versions of welfarism – but not utilitarianism – give less weight to the welfare of people at the top than people at the bottom.

In terms of the robustness of the paper’s conclusion, it makes a big difference which of these two factors one is relying on. For example, it is, not obvious that Ui is effectively zero until one is well above the $400,000 level. Someone at the level very likely can think of things to do with an extra dollar that would be relevant to personal welfare. By contrast, low wi in the social planner’s mind for everyone in the top 1% takes care of the problem all by itself. So a utilitarian, who treats wi as the same for everyone, cannot as easily agree that pure revenue maximization is the proper aim until one gets closer to the Warren Buffett level.

I personally find utilitarianism more persuasive than the versions of welfarism that use egalitarian weighting, although I also view declining marginal utility as a very real and significant phenomenon. (I am aware, of course, that many others view it more skeptically than I do.) Utilitarianism necessarily follows if one favors (as I do) the Harsanyi framework, in which one looks behind the veil and seeks to maximize expected utility under the hypothetical assumption that one is equally likely to be any of the people in the society. In consequence, I may need to go somewhat higher than $400,000 of annual income before I am ready to sign on to setting marginal tax rates based purely or mainly on revenue maximization.

3. Today’s extreme high-end wealth concentration really re quires us to think about the possibility of resulting externalities. The paper doesn’t discuss externalities, and understandably so as they are very hard to evaluate, much less measure precisely. However, they may be very important. Indeed, significant negative externalities from extreme high-end wealth concentration could reasonably lead a utilitarian to support marginal tax rates at the top that were actually above the revenue-maximizing level (just as a pollution tax may be set above the revenue-maximizing point, given that its aim is to price the harm appropriately).

Negative externalities to high-end wealth concentration could relate to the effects on relative status and social power, and in particular on political economy concerns. A society with an exceptionally wealthy elite that has, in effect, taken a rocket ship away from everyone else may be especially prone to rent-seeking and destructive insiderism. It gives us the astonishing politics of a Great Recession in which Washington seems not to care about persistently high unemployment. These types of concerns might conceivably call for a more than revenue-maximizing rate at the very top, insofar as the behavioral response was to earn less rather than simply do more tax planning.

In fairness, I should note that there are also claims of positive externalities from high-end wealth concentration. Suppose, for example, that exceptionally wealthy consumers fund the development of new technologies that at first are prohibitively costly for everyone else, but over time become cheaper and result in greater consumer surplus being enjoyed by the bottom 99 percent (be it from something like HDTV or advances in healthcare).

4. The paper suggests that the proper response to high-income taxpayers’ greater tax planning ability is simply to broaden the base, expand anti-tax planning rules, and increase enforcement efforts. All those are perfectly good suggestions, and the paper is right to observe that the availability of tax planning is somewhat endogenous to the design choices we make. But I would think that tax planning flexibility is almost bound to be greater for high-earners, especially (though not uniquely) under a realization-based income tax. After all, they are bound to have greater flexibility, liquidity, and risk tolerance, along with access to better advice, than everyone else. This probably needs to be kept in mind when evaluating what is likely to be the revenue-maximizing rate at the high end.

2. Taxing capital income

1. The paper devotes a lot of time to arguing that “capital income” should be taxed. I found this discussion baffling, because I do not regard “capital income” as a coherent category. OK, we can talk about the usual things (a la the Jake Brooks paper in Week 3) such as returns to waiting, risk, embedded labor income or inframarginal returns, etc. But in practice it seems to mean “income of people who happen to be at least incidentally using some capital.”

I gather that what the paper has in mind is categories that tend to be classified as “capital income” under current income tax law. For example, income earned by or through corporations, along with dividends and capital gains. But only a fool would argue that, say, support for a consumption tax approach means that we should exempt those items under our existing system. That would mean in practice that, say, Steve Jobs would have gotten classified as a very poor individual who only earned $1 a year. (I gather that the paper is expressly meant to respond to fools who are making such arguments, however.)

When people discuss whether we should tax “capital income,” what they typically mean is the risk-free return to waiting, which a well-designed income tax reaches and a well-designed consumption tax generally exempts. Again, the paper appears to be responding to the fact that idiots write Wall Street Journal op-eds in which they argue for exempting capital gains, corporate income, and dividends under the existing system. But I wasn't convinced that an article in the Journal of Economic Perspectives needs to respond to Wall Street journal op-ed writers who are aiming at the broad public rather than at JEP readers.

2. Once we are talking about “capital income” under the existing system, it becomes a bit questionable whether we can really have a 70 percent rate, as the other part of the paper argues. The revenue-maximizing rate for capital gains, under the existing system with its realization requirement and tax-free step-up in basis at death, is probably more on the order of 30 percent. Likewise, taxing dividends and corporate income generally at 70 percent might be more than a bit questionable. To be sure, the paper does say that “capital income” doesn’t necessarily have to be taxed at the same rate as everything else, just not at zero given (among other things) the difficulty of telling the two types of income apart. But this certainly was not the best-developed part of the paper.

3. The paper criticizes the well-known (in the public economics literature) Chamley-Judd and Atkinson-Stiglitz-based lines of argument, to the effect that the return to waiting should be taxed at zero. The Chamley-Judd literature shows that a positive tax on waiting leads to exploding tax rates on greatly deferred consumption, which becomes a major problem if you have infinite-lived consumers (such as multigenerational households) optimizing over unlimited time. The paper rightly argues that relevant time perspectives are likely to be a lot shorter. The Atkinson-Stiglitz literature shows that, if it is most efficient to tax alternative commodities the same, then one can fruitfully think of present consumption and future consumption as involving alternative commodities. Taxing future consumption at a higher rate is inefficient, at least at this particular choice margin, because it distorts the inter-temporal choice.

The paper says: Ah, but reliance on Atkinson-Stiglitz to support exempting the return to waiting requires that consumers be homogeneous with respect to saving. Another way of putting the point is that, although the inefficiency at the margin is clear, there may be other reasons for taxing the return to waiting, e.g., in response to heterogeneity.

4. Before turning to those other issues, a general background point is worth making. Optimal taxation is about how best to respond to an information problem (since we lack information about ability and, underlying that, marginal utility). So of course information about people’s saving, or the relative timing of earning and consumption, is potentially relevant. A consumption tax that treats this as irrelevant is failing to use potentially pertinent information. Of course, this by itself doesn’t tell us if/when saving should increase or reduce one’s lifetime tax liability in present value terms.

4. The paper notes a couple of good arguments that potentially make it plausible to tax saving. In particular:

(a) saving may be a “tag” that is correlated with ability. Even as between two individuals with the same observed earnings, the saver may have other attributes (e.g., foresight, planning depth, and self-control) that translate to being better-off in ways that cannot be directly observed.

(b) the income effect of saving means that one can better afford to reduce one’s labor supply – in effect creating a negative revenue externality from saving that undermines use of the tax system to provide insurance against earnings volatility.

5. Getting back to the first point in this section, no good argument for a positive tax rate on the return to waiting arises from the difficulty in distinguishing between labor income and capital income. No good consumption tax model requires so distinguishing. For example, if you use expensing as under the Blueprints cash flow consumption tax that David Bradford and the Treasury Tax Policy staff developed in the 1980s, the issue disappears altogether. Same point if one uses the X-tax. If anything, administrative arguments weigh heavily against continued use of the income tax, especially if it relies on realization.

NYU Forum on "Cliffs Forever? Tax Reform and the Future of Fiscal Policy

Last Wednesday (February 20), I participated in a lunchtime panel session at NYU Law School about the fiscal cliff deal, the sequestration controversy, and how we should think about tax reform and long-term budget policy.  My colleagues on the panel were Rosanne Altshuler, Josh Blank and David Kamin.  You can view a complete video of the session here.

Live and learn about U.S. airline travel

Suppose, just hypothetically, that you were scheduled to take Flight A from New York to Chicago, followed by Flight B from Chicago to Champaign, IL - say, on American Airlines, although I suspect the policy is universal. Then you re-route other travel so that you will already be in Chicago and don't need Flight A. Suppose you call up the airline to cancel Flight A, so that they won't cancel the entire rest of your roundtrip reservation when you don't show up for it.

The question I want to ask is: Do you get hit with a change fee? If you had a nonrefundable, etc. ticket, do they charge you, say, $150 for "changing" your itinerary, when the only thing you are doing differently is LESS of the same?

The answer, apparently, is Yes.

Sequester blues

Not to be self-centered or something, but my concern about the sequester has just shot up exponentially for wholly selfish reasons.

Yes, I already knew that the sequester is one more example of how  dysfunctional our political system is.  I mainly blame it on the Republicans' taste for brinkmanship in support of policy choices that the American public opposes.  They contested the 2012 presidential election on the grounds that they are pushing in the sequester fight, and they decisively lost despite getting millions of votes from people who don't actually support their program of cutting Social Security and Medicare rather than allowing any high-end tax increase.  (What they agreed to in the fiscal cliff deal was actually a gigantic tax cut, relative to 2013 law on the books, and this was indeed crucial to their accepting it.)

We saw in the debt limit fight, before the Republicans decided to fold, that what they actually want is not to cut Social Security and Medicare, but to force President Obama to propose cuts that they can then "accept" and then use subsequently as campaign fodder against the Democrats.  Demanding that the other side propose the cuts you actually want, so that you can subsequently campaign against them, is a pretty high ask, even for extortionary bargaining.

Anyway, I knew how foolish this whole battle is, and that it is likely to cost about 700,000 jobs along with associated disruption.  But only belatedly have I woken up to my own short-term stake in the sequester.  Without quite endorsing Mel Brooks' view that it's comedy if it happens to you and tragedy if it happens to me, I will admit that personal stakes tend to focus one's attention.

I have two quick business trips coming up right around the zero hour.  On February 28, I am flying through Atlanta to Tallahassee in order to attend an FSU Law School conference on the 100th anniversary of the income tax, at which I will be presenting my Henry Simons paper.  That trip should be fine - there's always a chance of bad weather, but probabilistically the odds of a big blizzard are declining as we march through this grim and gray February.  (OK, admittedly it's sunny right now, albeit much too cold.)  But then on March 1 the sequester hits.  On Saturday, March 2, I am scheduled to fly through Atlanta back to NYC, arriving quite late.  On Sunday, March 3, I fly out again, through Chicago to Champaign, Illinois, where on Monday, March 4 I am presenting my Social Security and Medicare paper as this year's speaker at the annual Ann Baum Lecture at the U of Illinois Law School.  Then that night, I fly back through Chicago to NYC, where the next morning I am co-teaching the NYU Tax Policy Colloquium (and I am indeed the lead discussant for that day).

I'm also using multiple airlines - Delta for the Tallahassee trip, and American Airlines for the trip to Champaign, even though I usually fly United.  Without the sequester it all should work out, but as things stand one really wonders.

I certainly share the general view that neither side in the Washington standoff has any current choices that it prefers to letting the sequester hit with full force on March 1.  And if that happens, airplane delays will be highly likely - the New York Times says that the furloughs of federal airport personnel will make it just like a bunch of really bad weather days.  And even if the Administration could scramble to make all this less bad - which they might not have the legal discretion to do - that may not be their preferred course.  The drama of people like me fuming as they sit on the floors of overcrowded airports may be considered preferable to the slower and less visible drip-drip-drip of misguided meat-cleaver austerity.

It will be more interesting than I'd really like to see how all this ends up playing out.

UPDATE: I've decided to tempt fate less, as I see it, by flying from Tallahassee to Chicago and leaving out the intermediate NYC stop.  But there is still plenty of room for the travel gods to toy with me again.

And, on a pleasanter note ...

Gary and Sylvester don't appear too worried either about the sequester or indeed much of anything else.  Despite their vigorous play at various hours of the day and night (being still just seven months old), you can see that they are still getting their beauty sleep, and that it is definitely working.

NYU Forum on the approaching sequester and government shutdown deadlines

Today, along with Rosanne Altshuler, Joshua Blank, and David Kamin, I participated in a lunchtime discussion at NYU of the sequester and associated issues (what happened earlier this year, what might happen over the next few months, what ought to happen in tax, spending, and budget policy).  All of us were skeptical or worse about the desirability of abrupt spending cuts in the current macroeconomic climate, the desirability of any immediately implemented deficit reduction in the short term, and both the likelihood and desirability of 1986-style tax reform in which one broadens the base but gives away the net revenue by lowering the rates.

My closing words were something to the effect of:  Things may conceivably get a lot better for our country over the next few years, but if so it will be despite, not because of, our political system.

UPDATE: There may be a video of this event available soon, in which case I will plan to post a link.

On the road again

Today I am at Tulane Law School to present a lunch talk (Presidents' Day notwithstanding) regarding my paper, Should Social Security and Medicare Be More Market-Based?  I've made slides for the 50-minute talk regarding this paper that I will be presenting at the University of Illinois Law School on Monday, March 4 (two weeks from today), which I'll post in due course, but I won't be using them today anyway, as the format is more NYU Tax Policy Colloquium-like (Shu Yi Oei will present or summarize the paper, and I'll then offer a brief response before we move on to discussion).

Our next NYU Tax Policy Colloquium session won't be tomorrow, but the following Tuesday (Feb. 26), as NYU follows a Monday schedule tomorrow to make up for the Monday holidays.  The speaker will be Peter Diamond.

Meanwhile, I am stunningly close, at long last, to completing my book Fixing the U.S. International Tax Rules.  It's taken me four years, and four fresh starts after the initial one.  I've never had this experience before - all my books have gone pretty fast once I had conceptualized them - but this time I struggled with the proper normative framework and analysis, reflecting that the defects in the literature have forced me to do a whole lot of fresh thinking (not comparably necessary, say, when I wrote my book Decoding the U.S. Corporate Tax).

My international tax book will be discussed in a conference at Hebrew University Law School this coming June.  I will also need to look for a publisher.  I had been thinking that I might like to use the Urban Institute Press, which published Decoding, but their publishing operations have apparently been scaled down.  A good university press is presumably the best way to go.  I hope and believe that the book will have significant readership and sales, with good potential for use by classes, both in law schools and elsewhere, that are studying tax policy and/or international taxation.  But it certainly isn't aimed at mainstream commercial publishers.

Bearded no more

Anyone who has seen me in the last 7 weeks or so could observe that I grew a beard over the Christmas vacation.  Just about everyone kept telling me that I looked like Lincoln, or else Daniel Day Lewis playing Lincoln.  This morning I shaved it off, so now (although I don't have a mirror in front of me at the moment) I am pretty sure that I look like this.

Tax policy colloquium, week 4: Lilian Faulhaber's “Tax Expenditures, Charitable Giving, and the Fiscal Future of the European Union"

Yesterday at the colloquium we discussed Lilian Faulhaber's above-titled paper on certain recent tax cases in the EU and their possible broader implications.  The cases concern tax benefits for charity, such as deductions by donors for charitable gifts.  The European court, which in a distressing instance of acronym inflation has redubbed itself the CJEU (Court of Justice of the European Union) in lieu of being just the ECJ (European Court of Justice), also appears to have gotten badly muddled in adjudicating issues that, if they arose in the U.S. involving federal constitutional challenges to state-level tax rules, we would say involved claims of discrimination against interstate commerce.  As many commentators have noted, the EU's "four freedoms" jurisprudence amounts to pretty much the same thing, at least if you also throw the "right to travel" in the U.S. Constitution.

This is a much vexed area in both U.S. and European jurisprudence.  I weighed in on one piece of it more than twenty years ago in an AEI monograph, "Federalism in Taxation: The Case for Greater Uniformity."  Used copies are available from Amazon, and indeed you can choose between the paperback edition, available for 1 cent here, and the hardcover, which is available for $139.75 here.  Perhaps your choice will depend on who's paying,  But I digress.  In this monograph, I argued, mainly on political economy grounds, for income tax base conformity in state income taxes, even though variation in tax rates is a healthy aspect of fiscal federalism.

Just one more preliminary point before we get to the matter in hand.  It's often said, with good reason, that one of the big problems in academics is that no one takes the time to read anyone else's work.  This is overstated, of course, but by no means wholly untrue.  The problem is that, when there's some big dispute in a topic that isn't closely related to your own current research interests, then, even if you know you ought to look into it more closely just to stay up-to-date, the opportunity cost of taking the requisite time can feel prohibitive.  I am therefore unfortunately not in a position to determine what my own take would be (if fully versed) on a recent U.S. tax academic debate about CJEU tax jurisprudence - the smackdown (so to speak) between Michael Graetz and Al Warren on the one hand, and Ruth Mason and Michael Knoll on the other hand.

As partly summarized here, Graetz and Warren argue that the then-ECJ has been blundering around in a "labyrinth of impossibility" in its anti-discrimination tax jurisprudence, because it can't or won't coherently choose between "capital export neutrality" (CEN) and "capital import neutrality" (CIN) in assessing challenges to a given tax rule.  Thus, suppose Germany has a higher tax rate than Italy, and there is some issue concerning cross-border investment from Germany to Italy.  If the CJEU adjudicates the dispute by picking a supposed comparable out of a hat and then asking whether the provision at issue is discriminatory, we know one thing for sure.  The investment CAN"T be taxed the same both as a low-tax purely Italian investment, and as a high-tax purely German investment.  So once the court has picked its preferred comparable (without explaining its choice), it has effectively dictated the outcome of the inquiry, without either providing useful guidance for the next case or persuading savvy readers that it actually has a coherent rationale in mind.

The underlying point is that "neutrality" across all margins is impossible, once Germany and Italy don't have the same tax rules in all relevant respects (i.e., both rate and base).  Now, if I were a CJEU judge, even leaving aside the fact that I think CEN and CIN are worthless standards, the use of which should be discouraged and perhaps even criminally punished (OK, I'm exaggerating here for effect), I'd like to think I could do better.  In my view, an often key focus of the inquiry should be, not into the phantom of neutrality at one arbitrarily chosen margin or another, but rather into the underlying political economy concern that countries (or U.S. states) may be overly inclined to engage in covert protectionism.  But this is neither to claim that this rubric will prove suitable all the time, nor that it will always yield clear answers, nor to dispute the Graetz-Warren analysis both of what the CJEU has actually been doing, and of the impossibility of developing any single-bullet approach that will be consistently satisfying even just on efficiency grounds.

Knoll and Mason argue that the CJEU both can follow a coherent standard and has in fact done so, based on an inquiry into what they call "competitive neutrality,” which, in the labor market setting, "prevents states from putting residents at a tax-induced competitive advantage or disadvantage relative to nonresidents in securing jobs."  Graetz and Warren respond skeptically regarding both the efficacy and the actuality of this claimed single-bullet approach.

Anyway, on to yesterday's paper.  Faulhaber convincingly argues that the CJEU has blundered in assessing claimed "four freedoms" violations in 4 related charity-related contexts, the easiest of which to parse is the following.  In a case called Persche, the CJEU ruled that Germany could not deny charitable deductions for donations that provided alms in Portugal, given that it would have allowed the deduction had the alms been provided in Germany.  This supposedly burdened the "free movement of capital."

To see how misguided this is, suppose we agree up front that the charitable deduction is a subsidy for doing good things (positive externalities, public goods creation, etc.) - rather than being an aspect of measuring income.  Some people like to spend money in fancy restaurants, others like to give it to charity, and both expenditures are instances of consumption by the donor.  Doing one rather than the other offers no differentiating information regarding how well-off one is, what is likely to be one's marginal utility of a dollar or Euro, etc.  Or to put it differently, I might want to insure behind the veil against my having low rather than high earnings ability, but it's hard to see why I'd want to insure against having a taste for charitable giving rather than for something else.  So the only potentially satisfying rationale for charitable deductions is to encourage and thereby increase the amount of the gifts.

The benefit of getting the deduction is therefore akin to what we often call "spending," to use the wrong but more popular terminology than the one I prefer (which is that it's an "allocative" rule that's been placed inside a mainly "distributional" system).  So, if Germany has a 33 percent marginal tax rate and allows charitable deductions, my gift of $150 to a charity ends up costing me $100 and Germany $50.  It is therefore effectively identical to the case in which Germany offers 50 percent matching grants for charitable gifts, so I directly give the charity $100 and Germany throws in an additional $50.

There is absolutely no question that Germany has, and under principles of fiscal federalism should have, the right to spend tons of money on its own, say, public schools, while spending zero on Portugal's public schools.  So why should the outcome be any different just because Germany chooses to use the charitable deductions technology in a particular case?  The only difference of real interest is that Germany, when it uses the charitable deduction, is effectively decentralizing the decision process regarding who gets what, permitting taxpayers to decide where particular Euros from the Germany Treasury go, at the price of being willing to put some of their own skin in the game.  This might be a good technology or a bad one, in one setting or another - a topic that has its own little literature, and which we've covered in past years' colloquia, but it has no discernible relationship to the "free movement of capital."  So the CJEU is chasing phantoms of supposed discrimination, and is merely arbitrarily burdening the use of a particular form of "spending."

In the U.S., by the way, though the issue is apparently unclear, states should have no constitutional difficulty in limiting charitable deductions to in-state activity, although many do not bother to do this, as they simply "piggyback" onto the federal measure of such deductions, which of course permit, say, a New Yorker to claim a charitable deduction for giving in Montana.  And obviously, the federal charitable deduction itself is automatically operative across state borders.  But as it is implicitly federally financed, this does not create a potential "race to the bottom" problem between New York and Montana in their willingness to allow what I would call subsidy spillovers.

There is a U.S. Supreme Court which held that Maine could not deny charitable deductions to in-state charitable activity that mainly benefited out-of-staters who were visiting.  But that is very different from saying that Maine would be required to subsidize wholly out-of-state activity, just because it was providing subsidies in-state.

Faulhaber's paper nicely analyzes the underlying problem.  One minor disagreement is that the paper frames the issue as one of "negative harmonization," and compares it to the issue of the EU's developing a "common consolidated corporate tax base" (CCCTB), which is an example of the approach I endorse in my AEI paper of creating identical tax bases even if there are different tax rates.  But I regard these issues as quite different.  For example, in the charitable deduction setting, no one is suggesting that all EU countries must "harmonize" their rules in the sense of having the same rule - rather, they are just being forbidden (however misguidedly) to adopt one particular approach that supposedly is improperly discriminatory.  And once you have fiscal federalism in mind, no general case for greater rather than lesser harmonization emerges (e.g., my argument was founded on particular political economy claims).

Where else might the same problem arise in subsequent CJEU jurisprudence?  Faulhaber notes that, say, home mortgage interest deductions that were limited to in-state would tend not to create the issue, because if a German buys a house in Portugal he or she probably becomes a Portuguese resident.  But tax benefits for vacation homes, which the U.S. allows, might create the issue.  The analysis is not necessarily the same, however, depending on how one parses the rationale for the tax benefit.

Likewise, suppose a U.S. state offered itemized deductions for a resident taxpayer's medical expenses, but only if they were incurred in-state.  I would be far more skeptical of this than of allowing an in-state limitation for charitable deductions.  The difference is that the medical deduction is probably best rationalized as a distributional rule (since healthcare outlays are relevant to wellbeing and marginal utility, even if unrelated to measuring "income").  So this would be less akin to, say, subsidizing only one's own public schools rather than those everywhere in the country, and more like, say, New York's deciding that only the cost of buying New York apples (rather than those from Michigan) can be deducted by New York State apple juice producers.

Perhaps, however, I am proving the Graetz-Warren point by resorting so freely to argument by analogy.  These generally are not issues with clear and easy or first-best answers.

UPDATE: In discussing the Graetz-Warren verus Knoll-Mason debate in the literature on the CJEU, I appear to have given less than equal time to the latter side (although I was trying to be clear about not taking a stand).  Just to even things out a bit, here is a link to an article in which Ruth Mason further explains her view of what the CJEU has done and could do.

I hope the weather gods are satisfied now

Scheduling travel from New York City to - well, anywhere - can be a bit chancy during the winter months.  I learned this once again last week in connection with my trip to USC Law School to present my paper, The Forgotten Henry Simons, at a conference there, organized by Nancy Staudt, commemorating (whether or not celebrating) 100 years of the U.S. federal income tax.

(As per my previous post, you can find the article here, and a pdf version of the pptx slides for my talk here.)

The conference took place last Thursday and Friday (February 7-8), validating once again (at least from a selfish point of view) my decision a couple of years ago to shift the NYU Tax Policy Colloquium from Thursdays to Tuesdays.  This way, I have at least a sporting chance of attending conferences that meet at the end of the week without running into direct conflicts unless the weather gets really bad.

The last time I went to USC to give a talk - at a budget conference organized by Beth Garrett and Howell Jackson some years back - I ran into the same problem of a gigantic East Coast snowfall impeding my return.  That time around, I ended up getting home 2 days late, after various flight booking adventures that took me through Chicago and Washington on my way back to New York City.

This time, at least the process was a little smoother.  I found out last Thursday, right after I finished my Simons presentation, that my flight home on Friday had already been canceled.  Rebooking was delayed, and I correctly guessed that United would be getting me back to NYU no earlier than today (Monday).  So I jumped on Expedia and bought a flight home on Sunday via San Francisco, which worked pretty well although I didn't get home until after midnight.

Comical tension right at the end, as I struggled to complete the purchase on my laptop immediately prior to the start of a talk at the USC conference by Larry Summers.  I had visions of Summers getting annoyed if he saw me pounding away on a laptop during his talk, instead of listening to him.  And I didn't want to wait the 2-plus hours until the talk plus follow-up festivities were done, as I suspected that the best remaining tickets were going fast.  Indeed, even by the time I started the Expedia process some of the better tickets had already been sold.  But it all worked out.

Fortunately, my extra time in L.A. was not wasted, given friends there.  Indeed, I got to visit both the Norton Simon Museum, for the first time ever, and Disneyland, for the first time since 1989 or so.

The reason I hope the weather gods are satisfied now is that I have several trips in the offing.  On Monday, February 18, I am scheduled to give a lunch talk at Tulane Law School, in New Orleans, regarding my paper, Should Social Security and Medicare Be More Market-Based?   On Friday, March 1, I am presenting my Simons paper at an FSU Law School conference commemorating 100 years of the income tax.  On Monday, March 4, I am presenting my Social Security / Medicare paper as the annual Baum Lecture on Elder Law at the University of Illinois Law School.  Both of the latter two trips (to Tallahassee, FL, and Champaign, IL) require changing planes, and I'll be returning to NYC in between them as it would take two changes of plane to get from Tallahassee to Champaign.  Thus, there is plenty of scope here for further travel disruption if the weather continues to be bad.  Perhaps I should sacrifice a placatory goat to Qimasch, or Ahshqi, or whomever else is the operative unruly spirit?

Slides regarding my Henry Simons paper

While my recent working paper, "The Forgotten Henry Simons," is fairly short and punchy, these slides, which I used to organize my talk on the paper at the USC Law School Tax Conference last Thursday, are shorter and punchier still.

I felt that the presentation went off pretty well, and was glad to see that legal historians in attendance thought that it was interesting.

Travel update

Today I flew to Los Angeles, where tomorrow (Thursday) I will be presenting my paper on Henry Simons at a USC Law School tax conference commemorating 100 years of the income tax.

If I do say so myself, this is not only one of my shorter papers but (I think) a fairly entertaining one, in which I tried for more flair than seems appropriate for some other topics.  I have prepared fairly punchy slides conveying the high points, which I will post here when I get a chance, probably early next week.

Looking forward to seeing lots of old friends at the conference.

UPDATE: My talk went well, but due to the East Coast storm I am stranded in L.A. through Sunday, rather than heading home on Friday.

A rare (at least lately) musical post

Fiona Apple's new album, which I like, got me listening to her previous records, which I also like.  Heartfelt, piano-pounding singer-songwriters aren't always my thing.  But if you compare her, say, to Carole King, not only does she do pretty well (although King at her early peak was great), but it even makes the modern era come off pretty well compared to back then.  Apple is fanciful and all over the place in a good way that one might not have found from her precursors, or at least the commercially viable ones.

Here's a version of one of her best songs, from the Letterman show, with an amusing but somewhat sad short interview at the end.

Tax Policy Colloquium, week 3: Jake Brooks' "Taxation, Risk and Portfolio Choice: The Treatment of Returns to Risk Under a Normative Income Tax"

Yesterday we discussed Jake Brooks' above-titled article on income and consumption taxation (available here).  It's situated in a literature that is very familiar to tax academics, but much less so, unfortunately, to students who are new to the field.  This is the Domar-Musgrave literature concerning whether an income tax, and/or a consumption tax, can in theory tax risky returns.

The standard models that are used always involve a risky asset (e.g., one that might with equal probability reap a 30% profit or a 10% loss) plus a risk-free asset with a very low but certain return.  One might start with the portfolio allocation that the taxpayer would prefer in a no-tax world, then we impose the tax, which lowers the after-tax gain and loss from the risky asset, in effect providing insurance against the variance that the taxpayer evidently didn't want.  One can then demonstrate, that if the taxpayer responds by holding more of the risky asset and less of the risk-free asset (and, if necessary, borrowing at the risk-free rate in order to hold more of the risky asset, she can wholly undue the insurance effect.  Under the consumption tax, she can get back to exactly where she was before.  Same story under the income tax, except that her after-tax return is reduced, even after the portfolio shift, by the product of the risk-free rate and the income tax rate on the entire portfolio (even if the taxpayer ends up holding no risk-free assets).

Moral of the story in the standard account: neither tax affects risky returns, and the only difference between the two is that the income tax reaches the risk-free rate of return.  So that is the fundamental difference between the two systems.

Obviously, this is a very abstract and simplified presentation (and I haven't even actually presented it here), with lots of underlying assumptions.  Among other things, one assumes that the tax (either one) has a flat rate and allows full loss offsets (that is, net losses are refundable at the tax rate).  The reason for that assumption, which obviously doesn't hold for real world income tax systems, is that one is trying to look at what the choice of tax base does, not at what the actual system does in light of its various features (such as rate structure and treatment of net losses) that are distinct from the tax base choice as such.

I think that almost all of the underlying issues can be demonstrated much more simply.  Suppose you and I had wanted to bet $1 million on the Super Bowl.  But then it turns out that gains are taxed, and losses are refunded at a 50 percent rate.  (Forget about the rule in the actual Code that gambling losses are disallowed, reflected that they are viewed as a cost of consumption - the Super Bowl bet is a stand-in for a business venture, although in this example it's a financial instrument with counter-parties, rather than a one-party bet against Nature.)  The obvious thing for us to do, given that we apparently want to bet $1 million after-tax, is to cancel out the seemingly mandatory insurance by betting $2 million, rather than $1 million.

Under either  an income tax or a consumption tax with a 50 percent rate, we end up in exactly the same place, i.e., with $1 million in after-tax stakes.  Question that I'll hold off on for a moment: Is there anything wrong with that?  But to complete the picture about income taxes versus consumption taxes, suppose that bettors need collateral to secure their potential obligations, and that the income tax, but not the consumption tax, places a very low fee on the amount of the collateral.  (Which, by the way, would not increase under the revised bet if capital markets were functioning well - and there is no point to speculating about the hyper-counterfactual question of how well they actually would function in this fictional world.)

Jake's paper reflects the view that it's unfortunate if taxpayers can negate the mandatory insurance by scaling up the bet.  This would be a difficult view to defend if we think purely in terms of consumer sovereignty - that is, by supposing that the two individuals know what is best for themselves and that there are no externalities.  However, one can imagine lots of reasons why we might not want to let them fully scale up the bet, if there indeed was any way we could prevent it (which of course appears implausible under the terms of the hypothetical, but can't as easily be ruled out for more complicated real-world circumstances that we actually care about).

For example, suppose the bettors misunderstand the risks they face, or are systematically over-confident.  Or suppose that some people usually win the bets and others usually lose, due to "ability" differences that we can't otherwise observe.  Or suppose losers will end up on the dole.  Or suppose that the bets create a socially costly diversion of effort from genuinely productive activity to unproductive "arm's races" between bettors to outsmart each other.  (This relates to a real-world story about the stock market, in which investors have a strong incentive to try to trade based on new information one second before everyone else learns it.)

For any of those reasons, we might be glad if the tax system was able to prevent the bettors from wholly undoing the otherwise mandatory insurance that it provides.  (It is a tradeoff, however, if there is also deadweight loss from limiting the bettors' ability to do what they want.)  And again, in the real world circumstances that are actually relevant - including, for example, graduated rates, loss limits, and incomplete financial markets - retaining an after-tax impact may actually be feasible.

OK, so much for the basic story.  What about income tax versus consumption tax?  The paper argues that the former has better chances than the latter of limiting scale-up to reverse out the insurance feature of both taxes.  I tend to disagree.  Stated in terms of my little story with the Super Bowl bet, the paper makes two arguments.  First, the income effect of the tax on the collateral will make the bettors more risk-averse.  As they are poorer, they no longer want to bet as much as $1 million after-tax.  The paper also calls this voluntary reduction in the size of the bet a "tax."    However, I wouldn't call it a tax, as there's no burden from adjusting one's behavior to do what one wants given one's circumstances.  I also question treating the shift from a consumption tax to an income tax world as having income effects, since one might expect them to be budget-equivalent.  The paper offers some responses to this view, and readers are invited to judge for themselves.

Second, the paper argues that investor departures from full rationality in the standard neoclassical sense may lead to incomplete cancellation of the insurance under an income tax, but not (at least to the same degree) under a consumption tax.  Thus, in terms of my example, suppose that the bettors really hates losing more than $1 million from a given "transaction" before-tax, even though after-tax should be all that matters.  Then in both scenarios they might be reluctant to scale up fully.  But suppose further that, in thinking about the "transaction" to which they apply this pre-tax loss aversion, they score the income tax's collateral fee as a part of the overall return.  Then they will scale up a bit less under the income tax than under the consumption tax.

Obviously, my little hypothetical will not help us to think about whether, in the analogous real world situations that the paper actually has in mind (where the tax on the risk-free return from the entire portfolio is playing this role), this is an important and realistic element indicating that the income tax and consumption tax, in their real world versions with all the departures from the hypothetical's assumptions, will actually play out differently.  I am skeptical, but again you can read the paper if you want a contrary view.

Richard III: National Portrait gallery painting vs. facial reconstruction

I've long been interested in Richard III, whose very striking (as well as sensitive and thoughtful-looking) National Portrait gallery portrait in London helped inspire Josephine Tey's enjoyable The Daughter of Time. Thus, I was delighted by the news of the apparent finding of his skeleton beneath a Leicester, U.K. parking lot.

Today, the researchers issued a pictorial reconstruction of his face, from work on the skeleton.  For my money, it looks a lot like the painting - further evidence supporting its authenticity, if the researchers weren't cheating, which admittedly might be a concern.  (Note:  All existing paintings of Richard were done some years after his death, but, due to similarities between them, it's believed that they may reflect a common source, such as a lost contemporaneous painting.)

You be the judge.  The first one is the painting from the National Portrait gallery, while the second one is the reconstruction:

They certainly look similar to me.