Wednesday, December 24, 2008

Life versus the movies

On Christmas Eve we watched the 1951 Alastair Sim version of A Christmas Carol. Scrooge as portrayed by Sim (pre-redemption) forcefully, unremittingly reminded me of Cheney. But Cheney is both far worse and utterly irredeemable.

Someone (me?) should write a satirical Christmas Carol knock-off starring Cheney. Rumsfeld as Marley? Casting or plot ideas, anyone?

Tuesday, December 23, 2008

For greater efficiency, eliminate the middleman

I realize I'm repeating myself from a post a couple of years ago, but wouldn't it be more efficient in baseball to eliminate the middleman (the players) by simply permitting the Yankees to purchase wins and championships directly?

E.g., it's the bottom of the 9th inning of game 162 with the Red Sox (or better yet the Rays) in new Yankee Stadium. Winner of the game makes the playoffs. Yanks trail 10-0. Joe Girardi comes out to talk with the home plate umpire, carrying a small piece of paper - a certified check.

Omigod!! The Yankees just purchased 11 runs for $55 million!! The home plate umpire (like the ref in football upon resolution of a replay challenge) announces what has happened. The Yankees win the pennant!! The fans go crazy!! What a comeback!! Greatest team ever!!

Sunday, December 21, 2008

The cult of home ownership

Good article in today's Times about how the Bush Administraton helped light the fuse under the current economic meltdown by pushing universal home ownership and hence encouraging bad mortgage loans.

Needless to say, there's plenty of blame to go around. Just look at the tax code, both its decades-old features and the Clinton Administration-directed changes thereto that I noted in a recent entry here. The only thing distinctive about the Bush Administration's adding a bit more gas to the fire is the lack of fit with its ostensibly pro-market attitudes.

But I must say, I've never gotten this political cult of homeownership. True, there is some at least slight evidence of positive externalities from home ownership in some settings because people are more committed to the location. (This can have nasty playouts as well, however, e.g., more assiduous racial exclusion.) But on the other hand, investment in more economically productive assets, e.g., via stock ownership, might have positive social externalities as well. Plus, home ownership is often (usually?) a really lousy investment choice from a personal standpoint. It's wildly under-diversified, if you're not rich enough to have a home plus lots of other assets, and leveraging it creates huge downside economic risk (as we've seen).

Once the dust settles, perhaps the government should seek from now on to discourage home ownership, encouraging those who aren't enormously investment-savvy to hold more diversified asset portfolios that are much less leveraged.

Saturday, December 20, 2008

What was Madoff doing?

One of the big questions about Madoff's insane scam is how he thought he would get away with it. Ponzi schemes are inherently unstable, and yet there are indications that he was running this one for decades.

I've read nothing in the media really explaining what he was up to, or why he crashed at this point, perhaps because no one knows. But I would presume the following:

1) He tried to create a Ponzi scheme that would be sustainable over a long period of time by controlling his growth rate. One reads all this stuff about how he used the exclusivity vibe and wouldn't accept just anyone's money. With the rate of return he offered, all he needed to do was grow by a little over 10 percent a year (plus whatever he was taking off the top), and perhaps he felt he could do this for a very long time by showily accepting only so much a year in new accounts. Arguably, this design and his careful and controlled execution of the growth rate made this the cleverest and best-executed Ponzi scheme ever. Perhaps with luck it could have lasted until he died at a normal age.

2) What finally brought him down now? The stock market collapse didn't do it directly, since actual asset prices verged on being irrelevant to the scheme. Presumably, the bad times dried up his new capital and caused suddenly cash-poor investors to want redemptions, leading to a run on the bank.

All this reinforces Krugman's point that Madoff's operation wasn't all that different from what the rest of Wall Street was doing. E.g., pocketing insurance premia that are simply money in the bank until you finally have to pay and can't (the story of AIG) is pretty much the same wine in a different bottle.

Friday, December 19, 2008

Perverse satisfaction?

Today's New York Times notes that a tax break for homeowners, enacted in 1997, may have contributed to the housing bubble that (coupled with pathological defects in our financial markets) did so much to bring us to our grim current economic situation.

Specifically, Congress in 1997, acting at the behest of President Clinton, provided that up to $500,000 of home appreciation would be tax-free on sale. Clinton was practicing silly but no doubt poll-tested populism, boasting that, due to the rule, middle class Americans would never again face capital gains tax on their homes.

Now let's roll the tape forward 11 years. According to the Times:

"[M]any economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.

"Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for 'fueling the mother of all housing bubbles.'

"By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one.

"Together with the other housing subsidies that had already been in the tax code — the mortgage-interest deduction chief among them — the law gave people a motive to buy more and more real estate. Lax lending standards and low interest rates then gave people the means to do so.

"Referring to the special treatment for capital gains on homes, Charles O. Rossotti, the Internal Revenue Service commissioner from 1997 to 2002, said: 'Why insist in effect that they put it in housing to get that benefit? Why not let them invest in other things that might be more productive, like stocks and bonds?'”

I happen to know a couple of people who got into the business of buying fixer-uppers, doing renovation work, and then selling for tax-free capital gain, thus achieving exemption for their labor income. There, at least, there was productive activity - but still distortion of economic choice by the tax incentive.

One further idiotic incentive effect was that, as soon as your home begins to approach $500,000 of appreciation, you have an incentive to sell it immediately and buy a new home for the current market price, so that you can run the exemption from zero all over again. Happily (?), however, that is no longer a problem in today's market.

Whenever something like this comes out about special tax breaks that don't merely create perverse incentives but seriously aggravate major economic problems, I have to admit to feeling a twinge of, well, perverse satisfaction that the rules I spend some of my time studying are at least important. Plus I duly note that the problems come from failure to heed the recommendations (e.g., for a relatively broad-based and neutral tax) that nearly 100 percent of the experts in my field would make. An unworthy sentiment, to be sure, but I'm only human.

Another big example is the role of the tax system in overly entrenching employer-provided health insurance as the dominant mode of provision, to the degree that, while few would advocate building on employer-provided insurance if we were starting fresh, many believe that at this point we need to just accept it as an entrenched feature. Thus, for example, one of the big criticisms of Senator McCain's healthcare plan was that it would have undermined employer-provided insurance without sufficiently putting something else in its place.

The home exemption story is admittedly a bit more complicated than just being a case of stupid Clinton-era populism. Prior to the 1997 enactment, people could generally roll over gain when they sold one home and bought a new one (for at least as much money) within a two-year period. Plus, gains on home sale were otherwise taxable while losses were nondeductible, creating apparent (and some actual) tax bias. The underlying problem is that a "correct" approach would have treated gains and losses symmetrically (leaving aside the issue of taxpayer choice whether or not to sell) when they resulted from market swings, while disallowing recovery only for declines in home value that resulted from home use. Richard Epstein, before he became a libertarian icon, actually wrote an article on this, suggesting that the basis of homes be reduced by depreciation (which would not, however, be deductible since it reflected personal rather than business use), with gain or loss relative to the adjusted basis being equally recognized. That is actually a pretty logical approach, within a standard income tax accounting framework, and the failure to do it, meaning that in some cases properly deductible investment losses were being disallowed, may have helped contribute to the 1997 silliness.

Still, the predominant message here remains: stupid tax breaks interacted with other defects in our economic system to help create the current horrific circumstances we face. It's happened before, and it will happen again.

Monday, December 15, 2008

That didn't take long

In 2004, Congress enacted a temporary dividends received deduction for U.S. multinationals that repatriated foreign earnings. Under the temporary DRD, the tax rate on dividends from foreign subsidiaries effectively was lowered from as high as 35 percent to just 5.25 percent, but only for dividends during a 12-month time window.

Every tax expert I know whose views on this proposal were sounded - except for those being paid to support it - thought it was a bad idea, despite the acknowledged case for permanently lowering the tax on U.S. multinationals' foreign earnings. The problem lay in the provision's being temporary, and thus creating lock-in when the rate went back up because people would anticipate and wait for the next tax holiday.

As it happened, there was an extraordinary level of response to the tax holiday, more than experts or revenue estimators had expected because it had been thought that companies with lots of perfectly legal and effective tax planning tricks might not be sufficiently worried about the repatriation tax even to pay 5.25 percent to get their earnings home for tax purposes. It's also generally thought that the claim that the repatriations would create U.S. jobs proved predictably bogus. (See Lisa M. Nadal, "Bailouts Disguised as a Tax Cut?", 121 Tax Notes 1230, 12/19/08.)

As Nadal notes, the same companies that successfully pushed for the tax holiday in 2004 are now already seeking a reprise. That didn't take long.

In an important sense, the policy here is entirely backwards even apart from its temporariness, which Nadal suggests could be rationalized this time around in terms of the ongoing liquidity crisis in the U.S. economy. (For myself, in order to accept the liquidity argument for another tax holiday, I'd need to see good evidence that it cost-effectively addresses the credit crunch despite being aimed at just a small clientele of U.S. companies that happen to have trapped foreign earnings that they want to repatriate.)

What makes the policy backwards is that the case for exemption (or a low U.S. tax rate) for foreign source earnings is strongest for new investment, not old investments that have already been made. Retroactively exempting the profits from old investment creates a transition windfall without actually changing the past anticipated incentives, which by now are water under the bridge. A temporary rate cut for dividends, unlike a permanent one, is pretty much guaranteed to apply only to old investment.

True, enacting two tax holidays in 5 years would tend, all else equal, to lower the expected future U.S. tax rate on new investment, since why couldn't the holidays just keep on happening. But counting on holidays is a distortionary and uncertain way to reap tax savings, and who knows if they'll actually keep coming as the U.S. heads out of the recession at some point (one hopes) and ever closer to the point of long-term fiscal distress.

I'm on the verge of writing a book or article on U.S. international tax policy, and one point I want to emphasize in it (akin to the same point made by "new view" skeptics concerning corporate integration) is that in theory there should probably be negative transition relief - i.e., the transition gain from escaping the expected level of tax on past outbound investment probably ought to be eliminated by a one-time tax or its equivalent. (For more on these sorts of transition issues, see my 2000 opus, if I may call it that, When Rules Change.)

But from an interest group standpoint, the bad stuff creates the strongest political pressures for a favorable change, precisely because it plays out in targeted transition gain rather than generalized improvement of incentives.

UPDATE: A reader points out that Larry Summers recently estimated at a public forum that there are $3 trillion of untaxed profits of US multinationals sitting out there abroad. A one-time transition hit on the $3 trillion, plus international tax reform (of some kind) going forward, might be an interesting idea, a few years down the road.

Saturday, December 13, 2008

Cat pandering

Couldn't resist posting this shot of Buddy, a.k.a. the "bad little bunny."

Elmer Fudd wouldn't have liked him, nor Yosemite Sam nor Marvin the Martian, but we actually cherish his foibles.

Friday, December 12, 2008

Reasons to be cheerful

1) I've finally gotten to the end of a huge to-do list that's been hounding me, and frequently growing faster than I could cross things off it, since mid-July. While a new to-do list, possibly a lot worse than the last, is starting to loom and will be having its malign way with me by early January, for the moment I can't or shouldn't do most of those things yet.

2) Expanded 2-CD reissue of Pavement's Brighten the Corners. I got in the mood by spending a few days with the reissue of Wowee Zowee. So far the added material sounds pretty good.

3) Today I was hitting better on the tennis court, and my suspect elbow didn't fall off. My once-reliable forehand, no less than the elbow, has been playing nasty tricks on me lately.

4) Creative gift ideas for certain others, suitably restrained but nonetheless (I hope) thoughtful, have recently occurred to me.

5) I could be in a jury room right now if the case I was picked for hadn't settled.

Thursday, December 11, 2008

Meanwhile, back at the ranch ...

Aided by my enforced downtime (with fewer time-wasting temptations) during jury duty, I have completed a draft of a short article (under 6,000 words) entitled "Internationalization of Income Measures and the U.S. Book-Tax Relationship." It is in part a highly compressed reprise of the line of analysis here (forthcoming shortly in the Georgetown Law Journal), although it also addresses the question of how cross-border convergence in defining taxable and financial income might affect the tradeoffs I identify. I anticipate its appearing some time in 2009 in a National Tax Journal forum on book-tax differences.

A brief conclusion, which probably will also serve as the abstract, goes as follows:

"Taxable income and financial accounting income are measures that use the same name but serve different purposes, leading to some differences in how they might ideally be defined. However, concern about managerial incentive problems may support integrating them, either to increase the economic accuracy of amounts reported or to reduce the resources that managers expend on reducing taxable income and increasing reported earnings. Political incentive problems, on the other hand, arguably support separating the measures, so that legislative eagerness to control the tax base need not promote politicization of accounting standards. The case for a largely one-book system may grow stronger, however, if pressures for international convergence in defining income on both the tax and accounting fronts lead to reduced politicization of both."

I'm not going to post it on SSRN just yet, but anyone interested in reading the current draft version can contact me off-line.

Monday, December 08, 2008

Jury duty

Today I showed up in Chinatown for jury duty, which I had put off twice (out of town the first time, teaching my Tax I class the second). Wouldn't you know it, I got picked for a jury. Civil trial, and I am hoping it will be very short or perhaps even settle. It's likely to an interesting episode albeit with tedious stretches, but I will begrudge the lost time. More when I am free to speak - no need to test here the rules against jurors discussing still-pending trials.

Meanwhile, I see that the Tax Deals class I will be co-teaching with Mihir Desai in the spring has seen its enrollment shoot up from zero (because initially it had not been listed in time) to 8 on Friday, to 21 at the start of today, to full capacity of 25 by the time I was being picked for that jury. Nice to see that there is live interest out there.

UPDATE (Thursday, 12/11): I am now officially off the hook, as the case settled.

Jury duty involves a whole lot of waiting around, and going to the courthouse then leaving again when they conclude that they don't need you for a while. But at least in the Manhattan New York State court (I've heard differently about the Bronx), they make extraordinary efforts to keep people in the jury pool reasonably happy. The building has wireless, carrels are available, the court personnel are gracious and polite, they try to minimize inconvenience, etcetera. Indeed, I even got a Juror Appreciation Week coffee mug. The jury pool seemed to mirror the Manhattan population, though perhaps with a slight tilt towards the affluent and professional sector. This may help explain the consistent courtesy and (up to a budget-constrained point) catering to our comforts.

On Monday afternoon, 19 of us were randomly called for a civil case that we ended up learning about in some detail from the attorneys during the voir dire. Apparently, a financial institutions executive driving a Mercedes had hit a pedestrian. The victim and plaintiff, according to the defense attorney, was a gracious and lovely woman "of a certain age," which turned out, as best I could tell when I saw her later, to mean in her mid to late 60s.

Ouch. Even though apparently there was no DUI issue, this does not sound like a case that you would want to send a jury. But of course it depends on how hard the plaintiff was pushing for disputable damages. The defense attorney spent a great deal of time during the voir dire explaining how nice and lovely the plaintiff was, and how he hoped we nonetheless could (a) understand his sad duty to impeach her on cross, and (b) retain our objectivity and award only modest damages if we were skeptical about her claims, apparently involving dental work.

Apart from the defense attorney's trying to precondition us to fight our expected pro-plaintiff sympathies, the main focus of the voir dire was on whether anyone had civil suit or car accident experiences that would make them biased. Three people claimed they would be unduly biased due to personal experiences of this kind, but all three appeared to me primarily motivated by the understandable desire to avoid being picked. Another three people appeared to have too little English language comprehension to be feasible jurors. This left 13 of us for 8 slots (6 jurors plus two alternates). The chosen ended up including not just me but another lawyer and also a doctor (who might have ended up being our go-to juror on medical testimony).

The 8 of us ended up spending Tuesday sitting in a small room, then being sent home for a few hours, then going to the courtroom and sitting around a bit more before being told that the trial would start Thursday morning. Today, we sat around for about a half hour and then were called in by the judge and told that the case had settled.

On the way out, the defense attorney greeted me as professor. I expressed surprise that I had been chosen for the jury, and he said that he, too, had been surprised that they (i.e. he and the plaintiff's attorney) had picked me.

I hope my certificate of service arrives promptly, as the feds have already sent me a juror questionnaire and thus are likely to summon me soon.

Sunday, December 07, 2008

Someone's got to take out the trash

Amazing article in today's Times about Moody's.  They used to refuse any compensation from the issuers they were rating, because this would create a conflict of interest and undermine their credibility.  Then they decided to be compensated by those businesses.  Then they went public and got caught up in short-term earnings mania.  Then they started rating trash instruments as AAA, and when good customers complained about a lower rating they would raise it.  Meanwhile, they were basing projections on scenarios in which, say, there was no estimated chance that housing prices would generally decline.

One can try to explain this in a rational behavior scenario.  Greedy cashing out on the Moody's side by officers with short time horizons, collective action problem on the shareholders' and investors' sides so no one steps forward to be the one to question them seriously.  But assuming individually rational behavior that plays out like this doesn't really help the neoclassical approach, because you get to wildly socially irrational outcomes anyway.

Friday, December 05, 2008

End of the semester

I have just completed teaching my last Tax I class of the fall 2008 semester. I'm always ambivalent when this happens. Certainly, having more free time until the next semester is welcome; teaching has elements of being a chore and isn't necessarily the main reason one goes into this line of work. But a semester-long class is kind of a living thing that the professor & students share and that can be fun; you really get to know each other though just in this formalized setting. And I felt we had pretty good relations and some fun together plus a sense of shared enterprise. I enjoyed teaching this class, and the next time inevitably will be different; possibly not as good since these things inevitably vary each time around.

As a parting gesture various students brought in items of fruit on the last day. This referred in part to a couple of early twentieth century Supreme Court tax cases that (following Marvin Chirelstein) I mocked for their labored and unhelpful metaphors about "fruit and tree": Eisner v. Macomber, saying that only the fruit is income; and Lucas v. Earl, saying that the fruit can only be taxed to the tree on which it grew. Other references behind the gesture: someone brought in an apple earlier in the semester, and when I forgot it he brought in a persimmon the next time; also, I've mentioned my mania for the Union Square farmer's market when fresh fruit is in season. So the gesture was literarily rich; multiple layers of reference.

Anyway, here was my net haul: 4 bananas, a persimmon, a few lychees, a pomegranate, a kiwi, a pineapple, a mango, an orange, a tangerine, a Clementine, an Asian pear, a Comice pear, and a potato (perhaps because in French it's a "pomme de terre"?). Plus an NYU canvas bag so I can carry my loot home.

Luckily I do not plan to respond by asking them on the exam whether this haul is taxable income. Detached generosity? (I'd like to think so.) Might section 102(c) apply? (No, they aren't the employer.)

Final chapter of the class saga, other than the exam, is recruitment to the lifestyle. We tax profs are all alike. We are hoping people will be interested enough to take more classes in the subject, and perhaps to give more thought than they had expected to tax policy as a subject or tax practice as a career. I'd certainly be happy to see people from this class again over the next few semesters. On this angle, on verra.

Wednesday, December 03, 2008

Dinosaur poem I once wrote for my kids

Maybe ten years ago or so or more, I wrote them this little doggerel number while we were at Rye Playland early in the summer.  I recently spotted it in my closet.  With apologies to Robert Bakker (for his dinosaur novel Raptor Red), and for the historical inaccuracies regarding which species actually coexisted with velociraptors:

The duckbill herd had drunk its fill
Thought Raptor Red: "It's time to kill."
Her sisters three were close at hand
And by the grove they made their stand
The duckbill herd was acting shy
And sticking close as they went by
A flash of claws, a snarl of teeth
The sisters leaped, and pinned beneath
A duckbill chick, who soon was still
The herd all honked and fled downhill
And stomped beneath their thundering feet
An acrocanthosaur who'd planned to eat
The raptors' kill as stolen meat
The raptors stretched and ate their fill
And lay down in the grass until
Another acro spied their prize
But by that time no meat was left
Except some for the pterodactyls and the flies.

Monday, December 01, 2008

Loser culture

Why are the U.S.-owned car companies so bad?  Presumably the reason is ingrained corporate culture.  They spent decades as oligopolists, protected from foreign competition because World War II had leveled the rest of the industrial world.  Plus, barriers to entry in the car business prevented domestic turnover a la Microsoft supplanting IBM.  By the time significant foreign competition arrived in the 1970s it was too late - the corporate culture had ossified beyond repair.

As a junior tax associate at a D.C. law firm in the 1980s, I went out to Detroit a couple of times on a case, and had lunch with mid-level execs in the company canteen.  It was obvious even back then that they were utterly lost and knew it.  A lot of big paunches and thinning white hair but no ideas, enthusiasm, or hope.

Hard to see how a rescue or managed bankruptcy changes this.

Studied ambiguity?

For what it's worth, I gather from the Tax Prof Blog that the artificial intelligence program at Gender Analyzer rates this blog as (only?) 61 percent likely to be written by a man, making it the closest to gender-neutral among a group of tax blogs other than the Tax Prof Blog itself, which comes in at 52%. Then again, two of the tax blogs come out opposite from the correct answer, perhaps saying more about the AI model than about the particular bloggers involved.