Wednesday, September 30, 2015

Donald Trump tax plan: Is the glass 60% full or 40% empty?

From having seen preliminary revenue estimates of the Donald Trump tax plan, a rough back-of-the-envelope summary might conclude that it would reduce federal individual plus corporate income tax revenues, over a 10-year period, by about 40 percent.

A hater or "loser," I suppose, would say that Trump is proposing to go 40% of the way towards zeroing out the main source of federal government revenue, while also apparently planning to spend a lot of money on various things.

Or I suppose one could instead say: He's 60 percent NOT wiping out these revenues. After all, to drain 40% out of the glass is to leave 60% of it still there.

Perhaps a few tall shots of bourbon, from a 100% full glass, would be all that one needed to reach the conclusions that (a) these two alternative perspectives are equally valid, and (b) the second one is more uplifting and positive and nice. Why not be a yea-sayer, rather than a nay-sayer, when it's just two ways of saying the same thing?

All kidding aside, I am actually disappointed by the Trump tax plan. I had been wondering if he might actually live up to the hints he had been dropping that he didn't accept the Republican tax orthodoxy about adopting massive unfinanced and regressive tax cuts. But instead he just amped it up a few magnitudes. It's the already feckless Jeb Bush tax plan, converted into performance art.

What makes this all the more disappointing relates to the sense I had been getting that Republican voters, unlike Republican donors and elites, actually don't uniformly thrill to endless replays of George W. Bush 2001. And this may indeed still be true. But the Trump tax plan appears to rebut the premise that his being self-financing might lead to his exploiting the gap between the conservative elites and the Republican base on these issues. This is a shame because, in the long run, he might have helped to push the Republicans back towards the sort of empirically-based policy-making that they were engaged in as recently as the George H.W. Bush Administration (which, come to think of it, does not, these days, exactly stand as "recent" any more).

Letter to Congress on international tax policy

I've joined 23 other law professors, economists, and practitioners in signing this letter to Congress concerning international tax policy.  It argues against adopting a territorial tax system - especially if it's what I would call crude "cartoon territoriality," rather than a system that, whatever its name, seriously addresses profit-shifting and the use of tax havens to undermine U.S. tax revenues. It also calls for anti-inversion legislation, and criticizes both repatriation tax holidays (or deemed repatriations at too low a rate) and the proposed creation of a U.S. "patent box" regime.

Inevitably for a document with so many signatories, it doesn't convey the precise message and nuance that I might have chosen in a sole-authored letter. For example, while I'd like to repeal deferral and make U.S. companies' foreign source income currently includable, I would want the U.S. tax rate for such income to be significantly lower than that for U.S. source income, and I also don't believe in full foreign tax creditability. (See, for example, the brief discussion that I recently posted here.)

But one would never get 24 signatories, from the sorts of people (myself included) who signed this letter, without keeping it at a more general level that we all can accept, in the hope of maximizing the positive public impact. Insert here the standard reference to herding cats.

Memorial service for Marvin Chirelstein

This evening, at 6 pm, I will be paying my respects to the great Marvin Chirelstein by attending a memorial service in his honor that will be held at Columbia Law School. Details are available here.

Last February, I included some Chirelstein reminiscences here.  The comments on this post that several friends left are also worth checking - they contain more stories about him.

More Chirelstein stories are available at the Columbia website here.  Here are just a few of the most amusing bits:

One former Chirelstein student writes: I loved Chirelstein’s war stories, and his dry, oddball, self-effacing humor so much, I started jotting down his quotable quotes. Here are a few that folks may appreciate. On the first day of class: “Lectures stink, if you ask me. On the other hand, answering student questions takes a lot of work. It is far easier to fill an hour with babble, than answering your questions – which will be ill expressed.” On an opinion by Justice Stone: “Did Justice Stone write this opinion – he’s one of our boys, isn’t he? And we’re proud of him. Are we? I am. Whoever he was. Oh, there are portraits of him in the law school. Let’s adjourn and go look at his portraits. Handsome man that he was.” On an opinion by Justice Cardozo: “Cardozo’s language always makes me think of an overstuffed sofa. . . Unfortunately, Justice Cardozo's opinion contains so much soggy philosophy that its main thesis is difficult to locate. On his lecture: “Can you follow this lecture? I don't know how.” Reciting a problem in the casebook: “I can’t bring myself to recite it - it is so boring.” On the assignment: “Read these opinions with your eyes half-closed.” In response to a student question: “That’s the answer to your question. Don't ask anything further. Stifle your curiosity.” “This is what you have to know if you want to be a partner in the tax and estates department [chuckles] Pretty exciting life.” “You know what your trouble is? You don't smoke.” On a chart illustrating the operation of tax law: “My grandchild made this chart, which proves that Quintilian was right that a full deduction is the same as no tax on gain.” “As Leonidas said at the Battle of Marathon - the tax benefits are deferrable”

Another writes: You had the feeling he had just come from a smoke-filled boardroom where he was smoking a cigar and advising world leaders. It always seemed he was only sharing half of his wisecracks and secretly chuckling to himself at the rest while he weighed how much of his wit to share with the world. If I may add some quotes, which I still remember after 17 years... On the first day of class in 1997, "Welcome to law school. You are now middle-aged." On a complicated contract dispute between 2 parties: "Aren't you kind of starting to hate them both, Mr. Adams...?" On a contract case: "They had more printing machines than you could count in a week." On a litigant who had secretly obtained legal counsel, "Now this guy's been talking to a lawyer...can't you smell it?"

A third, who also had him for contracts, quotes him as saying: "Haven't you noticed that all these cases -- the pregnant cow, the tack in the blueberry pie -- all these cases have this dreamlike quality to them? It's like you're walking down the street and all the buildings are upside down but somehow that doesn't seem strange. Or you're underwater and yet you're breathing just as though it was the most natural thing in the world. In each of these cases there is something that is out of order and yet, you don't notice it. That's really all this course is about. There's not much to it really."

(What a contrast between this last one and the pomposity of, say, Professor Kingsfield in The Paper Chase - also a contracts teacher, but rather a more presumptuous one, not to mention lucky (if we ignore that he is a fictional character) to have predated the law and economics / law and other X, Y, or Z revolution that swept away the Kingsfieldian world, and yet that Chirelstein precociously understood and anticipated.)

Tuesday, September 29, 2015

A well-deserved honor / literary recommendation

A writer named Julie Schumacher has just won the 2015 Thurber Prize for American Humor by reason of her recent novel, Dear Committee Members. Among the better-known past winners are David Sedaris, Jon Stewart, the writers at the Onion, and Christopher Buckley.

I mention this because I've read Dear Committee Members and found it hilariously funny (the cliche "laugh-out-loud funny" was literally true).

The basic premise sounds like a stunt. It's not just an epistolary novel, but one consisting solely of letters of recommendation (for jobs, academic promotion, grants, etc.) penned by a creative writing professor who is cracking up. Try writing something like that, if you want a technical challenge. Yet Schumacher (apparently effortlessly) pulls it off, keeping the plot moving forward and drawing you in - aided, of course, by the fact that the lead character invariably writes wildly inappropriate letters that are quite unlikely to accomplish their apparent objectives.

Per the description at Schumacher's website:

Jason Fitger is a beleaguered professor of creative writing and literature at Payne University, a small and not very distinguished liberal arts college in the midwest. His department is facing draconian cuts and squalid quarters, while one floor above them the Economics Department is getting lavishly remodeled offices. His once-promising writing career is in the doldrums, as is his romantic life, in part as the result of his unwise use of his private affairs for his novels. His star (he thinks) student can’t catch a break with his brilliant (he thinks) work Accountant in a Bordello, based on Melville’s Bartleby. In short, his life is a tale of woe, and the vehicle this droll and inventive novel uses to tell that tale is a series of hilarious letters of recommendation that Fitger is endlessly called upon by his students and colleagues to produce, each one of which is a small masterpiece of high dudgeon, low spirits, and passive-aggressive strategies.

This is certainly accurate, but scarcely does justice to how delightful it is.  As someone else once said about a novel, it was "funny and fast-paced, a great summer quick read. I devoured it on a plane to [in my case, Santa Fe]."

Wednesday, September 23, 2015

Yogi Berra, public utility

Sad to hear of Yogi Berra's death, although I admit that I have never gone to the Yogi Berra Museum, despite its being just 12 miles past the Lincoln Tunnel.

The great quotes, many of which I gather he actually did say, are truly a cultural resource. Despite their over-familiarity, I couldn't resist opening my international tax book with one of them ("When you come to a fork in the road, take it"), and closing it with another ("It's hard to make predictions, especially about the future").  But my favorite is probably the justly famous restaurant quote ("Nobody goes there any more; it's too crowded"),

I'm old enough to remember Berra's baseball days, albeit just as a manager, not a player. I faintly remember the infamous Phil Linz harmonica incident while he was managing the 1964 Yankees, but he also was on hand for the Mets' dizzying charge to the 1973 World Series.  (Ed Kranepool once said, at a Mets fan club gathering I attended, that the Mets would have held on to defeat the Athletics had Yogi stuck with his initial plan to pitch George Stone in Game 6, and give the tired Tom Seaver an extra day of rest for Game 7 if needed, but who knows.)  I suppose his Mets connection made it easier for me to regard him as an actually benign part of what I otherwise (fairly or not) deem the toxic waste dump of Yankees history.

Thirty-five Yogi quotes are available here, and there are plenty more here.

Short international tax paper posted on SSRN

I have just posted on SSRN a short paper (less than 3,000 words) entitled "The Two Faces of the Single Tax Principle." It's available for download here.

I prepared it for a symposium, entitled "Reconsidering the Tax Treaty," that will be held at Brooklyn Law School on October 23, 2015. Registration info for this symposium is available here.

The abstract for the paper goes something like this:

This short paper ... examines the “single tax principle,” arguably underlying bilateral tax treaties, in connection with evaluating the treaties’ future role in the development of international tax law and policy. It distinguishes between “upside” departures from the single tax principle, which occur when the same dollar of income is taxed more than once, and “downside” departures, which occur when it is not taxed at all.

The paper argues that a focus on barring upside departures from the single tax principle can be quite misguided. While over-taxing cross-border activity, relative to that occurring in one country, may be undesirable, this should not stand in the way of letting residence countries tax foreign source income at a reduced rate, in lieu of wholly offsetting source country taxes via foreign tax credits. As for barring downside departures from the single tax principle, such as by addressing stateless income, while this often is desirable from a given country’s unilateral national welfare standpoint (and is even more clearly worth pursuing multilaterally), the issues raised are more complicated than adherence to the single tax principle might appear to suggest.

Tuesday, September 22, 2015

U.S. international taxation: source rules, the origin basis, and the destination basis

My last post offered a rumination prompted by my teaching a class in Corporate and International Tax Policy. This time around, the sand in the oyster (as I’d like to think) comes from teaching Survey of U.S. International Taxation.

Yesterday in this class, I was slogging through the main source rules in U.S. international tax law. These are the rules that determine, for U.S. income tax purposes, whether a given taxpayer has U.S. source income or foreign source income (FSI).

Foreign taxpayers are potentially taxable in the U.S. only on what we classify as U.S. source income. As for U.S. taxpayers, be they individuals or resident corporations, source matters because they need sufficient FSI to claim all otherwise available foreign tax credit. So U.S. taxpayers may actually not care about source determinations, if they do not have to worry about running into the foreign tax credit limitation. (In some settings, however, the factors that underlie source determinations overlap with something that typically matters a lot more – whether a given increment of income is going to be treated as U.S. source income of a U.S. entity, or FSI of an affiliated foreign entity.)

Anyway, teaching the source rules can be deadly for all concerned because the rules are so tedious and empty. They follow the usual “cubbyhole” approach of tax law – you have a bunch of categories, so for each item on your tax return you decide where to shove it, and that determines how the source question will be handled.

For example, the source of dividend and interest income depends (in the general case) on the residence of the payor. Dividends and interest paid by, say, Apple or GE yield U.S. source income, whereas those paid by, say, Tim Hortons or Siemens yield FSI.

For personal services, source depends on where you render the services. But for rents and royalties, it depends on where the use occurs. For sales of personal property (other than business inventory), it generally depends on the residence of the seller. For example, if I sell a painting the gain is U.S. source, but, if Pablo Picasso sells it, it’s FSI.

Ho-hum. A natural question to ask about these rules is why they come out as they do, and what they are trying to implement or accomplish. No short answer, of course, and even the long answers aren’t very satisfying. One of their annoying features in practice is that, in many cases, the same thing economically can be structured to fit into one cubbyhole or another.

A classic example that we discussed in yesterday’s class was the Wodehouse case. Yes, that Wodehouse – Pelham Grenville, aka P.G., aka Plum. While Wodehouse was living in the French Riviera (and/or in German prison camp after France fell in 1940), he wrote Uncle Fred in the Springtime – one of my absolute favorites, a hilarious masterpiece – and also Money in the Bank, which is great fun although not quite as top-drawer for him – and sold their North American (i.e., mainly U.S.) rights for $40,000 each. So what was the source of his income?

Economically, this really was income received for personal services. He sat there in his little French cottage (or the less commodious German arrangements that followed for him until 1945) and beavered away, so to speak, ultimately to the great joy of his many readers. This would mean that he had FSI, not taxable by the U.S. But as a matter of legal form this characterization had no chance.

A second view held that he was getting royalties for the U.S. use of the intellectual property that he had created through his labors.  This was also true, unless we adopt View #3 below, and it would mean that he had U.S. source income.

A third view held that he had sold personal property, i.e., his U.S. rights. At the time, this would mean he’d have FSI, as a foreign national selling such property. (The law has no changed since then, so that he would lose under this view because he was selling a piece of the copyright, rather than other personal property.)  But under tax law at the time, he would win if one regarded all of the North American rights, but no other rights, as sufficiently an item of separate “property” to avoid its being treated as a mere advance sale of royalties. Obviously, whenever one sells property that will yield expected rents or royalties, one is in effect selling them in one lump, and yet in some cases this works as a matter of tax characterization – e.g., to create capital gains rather than ordinary income, where that is the issue presented. (The inevitably unsatisfying line-drawing cases here assess when capital gains "carve-outs" will work for tax purposes versus not working.)

What are all these source rules even about? The framework I came up with, for purposes of trying to make it more than just a list, involved the distinction between origin-based and destination-based rules for carving up the tax base when there are multi-jurisdictional transactions.

Suppose initially that you have just one jurisdiction and no cross-border trade. So everything produced there is also consumed there. Each item’s point of origin – where it was produced – is the same as its point of destination – where it was consumed. Leaving aside the intertemporal issues raised by the choice between income taxation and consumption taxation, it makes no difference whether one taxes everything on the origin basis or the destination basis. The source of each item is the same either way.

Now suppose we allow for cross-border trade. Individuals who live in the jurisdiction now can swap some of their production for others’ production. Given trade’s reciprocity, the value of what they produce still equals (in market terms) the value of what they get to consume.  But tax bases defined, in source terms, using the origin basis and the destination basis tax bases no longer include exactly the same items. Exports but not imports are treated as domestic source via the origin basis, while imports not exports are treated as domestic source via the destination basis.

The equivalence underlies standard thinking about international trade. For example, export subsidies are pretty much the same as import tariffs. And this often has tax policy implications. For example, a destination-basis VAT is not distorting trade by reason of its exempting exports and taxing imports. By contrast, an origin-basis income tax that departs from its standard approach by including targeted export subsidies is getting just what it deserves when the World Trade Organization strikes down the subsidies.

How do the source rules relate to this? To some extent, they can be divided into those that are (at least kind of) origin basis, and those that are destination basis.

The rule that the source of dividend and interest income depends on the residence of the issuer makes these what I would call fake origin-basis rules. They’re origin basis in the sense that where the money came from – the residence of the counterparty that paid it to you, i.e., where it “originated” or the use of the underlying funds occurred – determines the source. What makes these rules only fake origin-basis is that there are need not actually be any significant connection connection between the payor’s formal residence (e.g., as a legal entity) and any actual set of facts about where the associated use of the underlying funds occurred.

The rule for personal services is clearly an origin-based rule. Wodehouse wrote his comic masterpieces in England and then France (before moving ultimately to Long Island), so that’s where the production occurred, and then his work was exported to the U.S. among other markets.

The rule for rent and royalties is, by contrast, a destination-based rule. Revenues from consumer use under the U.S. copyright to Uncle Fred in the Springtime would face a well-designed destination-basis U.S. VAT, but would not face income taxation here if we relied on where the production activity occurred.

Finally, the rule for sales of personal property is probably best-viewed as origin-based, insofar as it’s actually one or the other. It looks at the person who sold the property, and who thus perhaps “produced” the gain from sale (even if only in the sense of picking something that would appreciate in value). In a Wodehouse-type case, of course, this is especially clear, as he actually created the property that he is selling through his personal efforts.

It’s a truism that, for reasons I’ve discussed elsewhere, an income tax pretty much has to use the origin basis as its main method, whereas a consumption tax can use either the origin-basis or the destination-basis.  But nonetheless real world income taxes often use destination-basis rules, such as when determining the source of income from cross-border transactions. A good example, apart from certain of the source rules that I’ve discussed above, is the use of sales factors in formulary apportionment. These cause a business that is active in multiple jurisdictions to be taxed, in a given jurisdiction, based at least partly on its sales to consumers and others in that jurisdiction.

Why does the U.S., along with other countries in their source rules, build as much destination basis as it does into its source rules? Well, suppose initially we were thinking of this in a standard international trade context. Here it’s a bit like having an import tariff, on top of taxing domestic production even when exported. Import tariffs can be domestically popular, as a political matter, even when they’re good policy. But they can actually be good policy, from the standpoint of residents’ economic welfare, where the jurisdiction has market power, e.g., because importers would be enjoying rents (in the economic sense, as distinct from that of “rents and royalties” under the source rules). So one isn’t surprised to see, say, the U.S. adopting rules that might permit it to tax P.G. Wodehouse on his work in that French Riviera cottage, given that it led to the situation where U.S. consumers would pay for the reader’s privilege (at zero extra marginal production cost to him).

Does our mix between origin-basis and destination-basis source rules mean that we are effectively imposing tariffs on certain imports? Perhaps in some cases, but my sense of the rules’ overall tenor is somewhat different, for three main reasons.

First, destination-basis rules tend to apply to outbound as well as inbound transactions. Computer engineers in California who design IP to generate rents and royalties abroad would therefore be generating FSI even without access to the full panoply of tax planning tricks that have flourished in the last couple of decades.

Second, to the extent that different countries measure source consistently, the importer’s domestic source income under a destination-basis rule will be FSI in the exporting country. In such a case, the latter country may offer exemption or foreign tax credits that eliminates “double taxation” (or, more meaningfully, combined relative over-taxation).

Third, by structuring carefully, taxpayers have considerable ability to decide which rule will apply to their business income. Add in all the other tax planning opportunities that they have, and “stateless income” may loom considerably larger as an issue than tariffs. Indeed, even just the ability to choose between origin-based and destination-based rules may significantly move the effective overall regime in that direction.

Debt versus equity ruminations

One of the two classes that I’m teaching this semester, Corporate and International Tax Policy (the other is Survey of U.S. International Taxation) occasionally prompts me to think in general terms about familiar topics. Last week the topic was debt versus equity in the corporate tax setting.  Preparing for the class led me to think about the following:

It’s either a sign of mental health or schizophrenia – I’m not sure which – if you can believe two inconsistent things at the same time. This is very true of the tax policy issues raised by debt and equity, or more generally by the variegated taxation of financial instruments. Each of the two competing lead stories has some truth. Yet they can’t simultaneously be true (except each and inconsistently in part). And the truer one story is, the less true the other one is.

Idea 1 holds that the tax bias between debt and equity – usually, though not always, involving a relative tax preference for debt – creates damaging economic problems when people pick the wrong instrument (as judged on a pre-tax basis) for tax reasons. For example, excessive use of debt might create undue systemic default risk.

Idea 2 says instead: C’mon, people can make whatever economic arrangements they like, and label them “debt” or “equity” as they like.  It just takes a bunch of lawyers writing 12-factor memos and concluding that, more likely than not, the taxpayer’s preferred characterization of a given arrangement would stand up if closely examined by the IRS.  So the real problem isn’t economic distortion, given the fact that people can dress up their arrangements with whatever they like – it’s electivity of tax treatment.  For example, tax-exempts use “debt,” thereby zeroing out the entity-level tax on their share of the business income. Meanwhile, taxables, if their marginal rate exceeds that at the entity level (which lowering the corporate rate would make far more common) use “equity” and avoid owner-level realization, thus electing into a lower tax rate environment.

Obviously, these two stories can’t both be entirely true at the same time – they contradict each other.

Relatedly, here are two different ways of viewing the universe of financial instruments:

Idea 1 holds that 2 fixed points, classic fixed return debt and classic common-shares equity, retain enormous importance in financial markets, thus creating the above-referenced Idea 1 distortions.

Idea 2 holds that financial instrument choice is an undifferentiated, multidimensional continuum.  For example, how fixed versus variable, on the upside and the downside, is the expected return? Options, default risk, payment variables, etcetera, can all result in slicing and dicing this pretty fine.  Likewise, classic differences between “debt” and “equity” such as enforceability for the former and voting power for the latter can perhaps be made to vary continuously in their actual economic significance.  With a multidimensional continuum in which investors can point whatever point they like, a one-dimensional “debt versus equity” continuum may be unlikely to affect them very much, other than in requiring that they pay lawyers (along with accountants and others) to fine-tune things, and accept perhaps a very slight risk of serious IRS challenge.

The two Idea 1’s reinforce each other, as do the two Idea 2’s. The analytical problem is that, while both sets of ideas appear to have some truth, each undermines the other. So even if we agree (as I do) that we have a debt-equity problem, it’s not entirely certain just how (as a matter of relative weighting for the two sets of competing concerns) we should think about the problem.

Friday, September 18, 2015

Radio chat

I just spent five minutes talking on-air with Boston radio host Barry Armstrong, on a show called The Financial Exchange on Money Matters Radio. This was prompted by my being quoted in yesterday's NYT article by James Stewart regarding the carried interest rule, and in particular Donald Trump's role in prompting Republicans to oppose it.

In our colloquy, Armstrong noted that it has generally been Democrats, not Republicans, who have wanted to require hedge fund managers to pay income tax at ordinary rather than capital gains rates on their hundreds of millions of dollars of what is economically labor income. In the interest of being fair, I noted that the hedge fund managers who want to retain their tax breaks do not entirely lack Democratic friends, especially in states such as New York and California.

When Armstrong asked about Trump's bringing this issue to the fore as a Republican, I noted that Trump is not exactly wedded to Republican tax orthodoxy. And whatever one can say against him (yes, I know), he is certainly not a puppet of Republican donors - to use the term that he has thrown at Jeb Bush.

A missed opportunity for Trump at the debate the other night (although perhaps it wouldn't have played well with the audience) involved the following.  He was asked about his calling Bush a puppet of the donors, and he didn't try to back it up.  But no clearer case of puppetry could be imagined than Bush's proposing a $3.4 trillion tax cut over 10 years, more than half of it going to the top 1%, despite overwhelming empirical evidence, from repeated experiments, that it won't yield the growth payoff he claims, and also the political fact that the Republican voter base is not actually thirsting for such a thing (so it's not driven by voter preferences). Bush has of course adopted Trump's position on the carried interest rule, evidently as a fig leaf, but, as I noted in an earlier post, that shouldn't really fool anyone regarding the Bush proposal's predominant character and effects.

UPDATE: Here is the audio link for the interview.

Thursday, September 17, 2015

New York Times article on carried interest

James Stewart's article in today's NYT, "Criticized by Trump, Carried Interest Loophole is Vulnerable," notes how Donald Trump's decision to denounce the rule that permits mega-rich hedge fund managers to pay tax on labor income (economically speaking) at capital gains rates, has helped contribute to a rising pro-repeal quasi-consensus.

Just the other day, of course, Jeb Bush put repeal of the carried interest rule into his giant tax cut - evidently to drape a populist fig leaf over a predominantly pro-plutocratic proposal.  The Stewart article also notes evidence that Congressional Republicans are quite willing to accept repeal of the rule, in the context of a larger bipartisan deal, "as long as they get something from Democrats in return."

I'm quoted in the article as saying the following:"The group that benefits [from the provision] may be small, but they're rich and they give a lot of money [to politicians] .... To everyone else it can seem a vague talking point.  It's classic interest group politics." I had in mind here, of course, the classic Mancur Olson point about concentrated interests having more political clout than diffuse interests, even when the latter have far more voters behind them.

Despite the formidable political forces that continue to back the carried interest rule, I agree with others quoted in the article to the effect that its days may soon be over.  To some extent, it is a hostage to broader events.  I still view standalone repeal as highly unlikely, so the question is what packages that might include it will have decent legislative prospects, presumably in 2017 or thereafter.  And no one really knows that yet.

In any event, however, there is now a kind of structural asymmetry pushing against the carried interest rule, potentially with enough force to outweigh the structural imbalance in its favor that arises from interest group politics.  This is the fact that the issue's symbolic heft has come to outweigh, perhaps greatly, its actual practical significance.

The rule's survival, despite predominant criticism since Vic Fleischer first brought it to public attention in 2004, aptly symbolizes, even more particularly than interest group politics, the plutocratic turn that many (including me) believe U.S. politics has taken in the twenty-first century.  But repeal of the rule wouldn't rebut plutocracy's continued prevalence.  Symbolic hot-button issues only matter so much on the ground. So, while I would welcome its repeal - unless the "price" exacted was too high, as in the Jeb Bush fig leaf scenario - the broader political and economic significance that repeal would have can easily be overstated.

Wednesday, September 16, 2015

Fun science reading

Recently, when I had a bit more spare time than I have now, I quite enjoyed reading this article about Jupiter's and Saturn's migrations in the early history of the Solar System, and this book about the history of oceans - on the early through modern and future Earth, early Venus and Mars, outer planets' moons, possibilities in other solar systems, etc.

Only problem with the latter - it's horribly depressing to read about what is happening to our oceans now, and not entirely joyous to read about what the Sun's future has in store for us a billion years down the road.`

George W. Bush, I feel your pain

An amusing article in Monday’s NYT asks: “When did Jeb Bush become the smarter brother?” It quotes “[e]xperts on the Bush family [as] say[ing that] it’s an old idea, but [that] it may not be correct.”

To which, these days, one is sarcastically inclined to add: “Yuh think?”

The explanation that these experts offer for the long-time family myth is as follows: George W. was far more socially skilled than Jeb, as well as being more of a wild child when he was growing up:

“Thus, when the family considered the brothers’ futures, ‘it wasn’t that Jeb was oozing an arching intellect or compelling profundity as he grew up. It was just that, in juxtaposition with his more careening brother George Walker Bush — the one who drank, who ran into problems with the police, whose fraternity was accused of hazing and branding pledges — Jeb appeared more stable.’”

Now, let’s not mythologize George W. too much. I still believe that he was an absolutely terrible president, and that one reason for what I regard as his many failures is that he was extremely anti-intellectual and hostile to both knowledge and reasoning, not to mention averse to reading policy briefs of more than a page. But while these are serious defects, they are ones that an intelligent person – and clearly he was, at the least, capable of being tactically and personally shrewd – can have.  Not just for reasons of temperament, but perhaps all the more so if, in his tight family as he grew up, people were always letting him know that they thought his kid brother was smarter than him.

But it is amusing how, in Jeb’s case, what apparently were merely defects (lack of social skill) or intelligence-neutral temperamental differences (being less energetic and volatile) led to the assumption that he must be smart.

Although my family and family history are quite different from those of the Bush boys, I must say, I can feel George W.’s pain (especially now that he has been out of office for so long).  My family, perhaps like the Bushes’ despite the radical differences between an early-twentieth century immigrant Jewish family and one long ensconced within the New England Yankee elite, greatly valued what it deemed to be evidence of intelligence and seriousness.  It also highly valued the arts – perhaps unlike the Bush family, despite George W.’s recent embrace of painting – to the extent that I like to say: If Bill Gates and the third violinist in the Philharmonic Orchestra had been brothers, people in my extended family grouping would have thought: “It’s a shame that Bill didn’t turn out as well as his brother.”  But I digress.

How do people judge if you’re “smart” when you’re a kid, in a family that intensely values this attribute?  Partly through direct evidence, such as conversational acuity, or what you can tell people you are reading, or grades.  But also partly through negative or indirect evidence that gets interpreted based on broader stereotypes.  I always was quite aware, for example, that any level of proficiency, or at least interest, that I might have in sports potentially counted against me, especially among relatives outside my immediate family.

Now that the NYT has actually reported, based on insiders’ first-hand testimony, that Jeb’s reputation as the “smart” one reflected his deficits, not his accomplishments, perhaps we can hope for an end to idiotic and lazy reporting elsewhere in the paper about Jeb’s “cerebral” debate style and “wonky” inclinations. This is, after all, a man who never heard of Chiang Kai Shek (a very famous person when he was growing up, even leaving aside who his father was), and who is apparently unaware that the Social Security retirement age is no longer 65, due to legislation that passed in 1983 (!).

Nah, an end to lazy reporting based on stereotypes is probably too much too hope for.

But in the meantime, paint on, George W. And if you still feel any rivalry with your brother, perhaps (whether you will admit it to yourself or not) you are not feeling entirely disappointed by his recent struggles.

Tuesday, September 15, 2015

A few (admittedly speculative) thoughts concerning the Jeb Bush tax proposal

Others have noted that more than half of the tax cuts that Jeb Bush is proposing – even excluding the distributional impact of cutting corporate rates – would go to people in the top 1 percent of the income distribution.

I would guess that a “fractal” pattern continues to hold inside the top 1 percent – i.e., that those in the top 0.1 percent benefit far more from the tax cut (even as a percentage of income) than those towards the bottom of the top 1 percent. For example, both the corporate tax rate  cut to 20 percent, and the proposed new 20 percent top rate for interest income, would likely make it considerably easier for them, than for many of the pikers just below them, to avoid the 28 percent individual rate.  Also, those at the very top would almost certainly be hit relatively less by the proposed 2 percent of AGI cap on itemized deductions – especially given that charitable deductions would be excluded from the cap.

To some extent, differential planning flexibility might create something of a “bubble” top rate – 28 percent for high-paid professionals and the like, then effectively dropping down to 20 percent for those who are rich enough to keep most or all of their income out of the 28 percent ordinary income bracket.  (The issue of those at the very top not even needing to realize taxable income is there as well, of course, but is not attributable to this plan in particular.)

It’s also quite clear that, whatever the long-term incidence of corporate taxation in steady state, the transition incidence of the rate cut would inure predominantly to the benefit of those who are at the top distributionally.

I also would expect non-corporate businesses that now pay the 39.6% and 35% corporate rates to rush to incorporate more frequently.  Often these may be domestic businesses that don’t have the same sort of global mobility as the big U.S. (and foreign) multinationals - potentially undermining the story in which the long-term incidence of taxing such companies might be shifted to lower-paid labor. The new incorporators might often effectively be earning labor income as an economic matter – but at the very highest end of the wage scale.

Some of these issues with the proposal could probably be addressed to a degree (for example, via a "dual income tax" addressing the use of 20% corporations as a labor income tax shelter).  But they won’t be addressed if the first-cut distributional effects are an intended feature, not a bug.  And making them a feature, not a bug, would surely be to the taste of those whom I would think are the proposal’s main intended audience.  I would guess that its main targets, apart from imperfectly attentive Beltway pundits who reflexively like all putatively 1986-style tax reform, are the high-end campaign contributors whose donations reportedly have slowed in recent months.  If it's mainly aimed at Iowa and New Hampshire voters (even those on the Republican side), then it is more politically naive than I would have expected, even given the Bush campaign's many stumbles to date.

One last point concerns the budgetary effects.  As Bill Gale has noted, claims by Bush supporters that the $3.4 trillion 10-year static revenue cost would be two-thirds offset through dynamic effects “would require the growth rate to rise by at least 0.5 percentage points per year.  This seems like quite an optimistic scenario, given that the evidence that income tax cuts can boost economic growth rates is weak.“

Gale has elsewhere noted (in joint work with Andrew Samwick) that tax cuts which raise the federal budget deficit - as these surely would; I haven’t heard much from the Bush camp about commensurate spending cuts – are likely to raise interest rates and reduce national saving, “creat[ing] a fiscal drag on the economy’s ability to grow.”

So conceivably (it seems to me) the true overall dynamic effect of the Bush plan and Bush budget, for the federal budget as a whole, might even end up lying in the opposite direction – towards a larger, rather than smaller, than $3.4 trillion revenue loss - although this depends on the full details on both the tax and spending sides. Think Kansas under Sam Brownback, if you want a handy analogy.

In sum, this is a fundamentally frivolous proposal economically – even if it has a few nice bells and whistles, such as ending the step-up in asset basis at death.  As nice bells and whistles go, however, the widely-noted carried interest part is hardly even worth mentioning.  While it hits a current political sweet spot, it’s truly trivial in scope compared to everything else, especially in combination with the proposed 20 percent and 28 percent top rates. The stakes in carried interest today are often 20 percent capital gains rate versus 39.6 percent top individual rate.  The "losers" if the law is changed might not even need to pay 28 percent - they might be able to find new ways under the Bush plan to keep it at 20 percent, even without reporting long-term capital gains.

ADDENDUM: Just as a point about balance, while I was significantly less critical than this, overall, with regard to Hillary Clinton's recent capital gains proposal - reflecting that she did not propose to blow a highly regressive $3.4 trillion hole in the budget - I was certainly very far from being in the tank for it.  Indeed, I agreed with Victor Fleischer that it quite "misses the mark," and even verges on being "pointless," insofar as its intended effects on corporate governance are concerned.

Thursday, September 10, 2015

Battle of the downloads

In our biz, download numbers often are used to a degree in rankings, whereas if you have a content-based view of quality you might view things differently. Chasing downloads can also distort incentives that relate to quality, subject matter choice, etcetera, in much the same way that general readership blogs can become less interesting because they are looking for clickbait.

So it is easy to take a dim view of the download-counting phenomenon, even though  it is of course true that writing things that interest people and that they want to read is surely a good thing, all else equal.

Taking a dim view is one thing, not caring is another. Plenty of us (including me) look at our download counts even if we might pretend to be above it. And I know people who will refuse to send you a PDF of their paper or let you post it for a seminar, insisting instead that every reader download it to pad the count.

And then of course there's the problem with complaining about it. You sound like a whiner, which is fair enough since, if you're bothering to complain, you probably are in fact being a whiner.

But every now and then one gets a clean shot without whining (or at least without as much whining), so I'm going to take mine.  Let's do Shaviro versus Shaviro,  The other day, I posted two new SSRN links, one to a short NTJ book review of Ed Kleinbard's recent book, and the other to an article for an edited volume on timing and legislation, called "The More It Changes, the More It Stays the Same? Automatic Indexing and Current Policy."   Let's call these "Shaviro 1" and "Shaviro 2."

So far, in the download war, Shaviro 1 (no doubt aided by a Tax Prof link) is beating Shaviro 2 by 71-9. Now admittedly, if I were someone other than myself but in the same biz, I would be considerably more likely to read Shaviro 1 than Shaviro 2, For example, while Shaviro 1 isn't an ad hominem piece, it has potential ad hominem interest to the prospective downloader, in that it reviews a book written by a prominent peer. And what fun for the readership (though not for either Kleinbard or me) if, say, it attacked the book rather than praising it, started a feud, etcetera.

But I do consider Shaviro 2 more than 9/71 as worthy of a readership as Shaviro 1. Now, I did it no favors, in the earlier posting, by initially forgetting to include the subtitle after the colon, which perhaps made it sound a bit too Delphic.  So why don't I try again here, by "teasing" the first 3 paragraphs (minus footnotes):


            The ancient Greek philosopher Heraclitus famously remarked that you cannot step into the same river twice, to which a disciple supposedly replied that you cannot do so even once. Both remarks may shed light on the problem of specifying how legislation should apply over a period of years, in relation to the aim of keeping what I will call “current policy” constant as time moves forward.  Heraclitus reminds us of the difficulty of truly being in the same place at different times, if everything is continually changing around oneself.  The disciple could be viewed as casting doubt on the notion that there is such a thing as a well-defined place, even the first time around.
            Despite these warnings from the ancient world, two simple ideas about policy across time may initially seem uncontroversial.  The first is that, if (and insofar as) two different years are relevantly the same, the policies that apply to them should be the same.  The second is that, in order for the policies applying in different years to be the same, their nominal terms may need to differ. The classic, and seemingly no-brainer, illustration of both ideas is indexing the dollar amounts in particular statutes for inflation.  Annual inflation indexing has been in place since 1981 for the marginal rate brackets in the U.S. federal income tax, and since 1972 for U.S. Social Security benefits.  Obviously, or at least apparently obviously, it results in keeping income tax and Social Security policy substantively the same across time.  Absent inflation indexing, Congress would frequently have to amend the law – changing nominal dollar amounts in the statutes – in order to keep the actual policy the same.
            We will see, however, that keeping current policy the same is more complicated and perplexing than it may initially seem.  Indeed, a closer look even just at inflation indexing in the income tax and Social Security reveals broader issues, pertaining to both motivation and implementation. The dissonance only widens when one turns to other actual or possible types of automatic indexing in the income tax and Social Security.

UPDATE (9/15/15)
After a Tax Prof link to "Shaviro 2," the score is 76 to 29.

Tuesday, September 08, 2015

Two new articles (both short) posted on SSRN

I have just posted on SSRN that I wrote earlier this year.

The first is a short book review, which just appeared in the National Tax Journal, of Ed Kleinbard's recent book, We Are Better Than This."  My book review is available here.

Second, during the summer I wrote a short article entitled "The More It Changes, the More It Stays the Same? Automatic Indexing and Current Policy."  It's available here. Its abstract is as follows:

This projected chapter in Fagan and Levmore (eds.), THE TIMING OF LEGAL INTERVENTION (forthcoming, Edward Elgar Publishing) addresses issues associated with automatically indexing fiscal policies, such as those in the U.S. income tax and Social Security systems. Under indexing, a statistical measure - pertaining, for example, to inflation, wage levels, life expectancy, or income inequality - is used to determine changes to nominal legal rules that then take effect automatically. One possible reason for favoring automatic indexing is that it may keep the underlying policy, by some metric, "the same" as empirical circumstances change. While indexing often makes sense, from the standpoint of a policymaker whose long-term preferences it would keep in place barring further legislative action, identifying the set of "current policies" that one might want to perpetuate (or change) can be surprisingly difficult. The paper explores broader conceptual issues pertaining to policy continuity and competing objectives when legislation remains on the books indefinitely, with particular reference to examples drawn from the history of the U.S. income tax and Social Security.

Wednesday, September 02, 2015

Arnold Harberger's famous 1962 article on corporate tax incidence

This semester I am teaching Survey of International Taxation (a 3-hour class on U.S. international tax law) and Corporate and International Tax Policy (a 2-hour seminar on main issues in these fields).  In the latter class, tomorrow we will be discussing corporate tax incidence, with Arnold Harberger's famous 1962 article on the topic offering an analytical starting point.

Harberger, of course, is among the leading candidates for the title of "greatest living economist who has not won the Nobel Prize."  And the incidence article is surely one of his two signature contributions (the other being "Harberger triangles" and the welfare loss from monopoly).

As I discuss in my book Decoding the U.S. Corporate Tax, there are many things that, with the benefit of fifty years' hindsight (and changes in both economies and legal institutions), one could view as understandably dated in Harberger's corporate tax incidence article.  For example, it treats the corporate tax as creating two business sectors, the corporate one that is taxed and the non-corporate one that is not taxed.  Today, we might say instead that there are two (and indeed more than two) distinct business tax regimes, and that the corporate one - counting both the firm and shareholder levels, as well as all tax rules that apply distinctively to corporations (e.g., the tax-free reorganization rules and various compensation rules) - is sometimes worse from a tax standpoint, and sometimes better.  (The "better" scenario would be more common, of course, if there were a greater spread between the top individual rate and the corporate rate.)

Also, the article avowedly has no theory as to why some businesses are incorporated while others aren't, and adopts the concededly over-simplifying assumption that the corporate tax is, in effect, a special levy on all business sectors other than agriculture and real estate.  Economists writing about corporate tax incidence today find it necessary to consider business sectors with a mix of corporate and non-corporate firms, and are more likely to model the split as reflecting, say publicly traded versus private, and perhaps as turning on the trade-off between self-owned entrepreneurial and public markets-funded managerial systems of internal governance.

What I regard as the article's greatest and most lasting insight is as follows. Taxing the normal return to capital income - an important part of the corporate tax  base, although rents and owner-employees' undistributed labor income are also important - might initially seem to raise incidental / distributional issues that are not distinctively interesting here in particular.  Since high-income individuals save both absolutely and proportionately more than others, the incidence of such a tax will clearly be progressive in a static, one-country scenario, where saving is inelastic.  By contrast, if saving is highly elastic, and drops significantly in the presence of a tax on capital income, the bottom line may change.  E.g., high-income individuals' marginal pre-tax return to saving may go up, and workers' productivity / wages may decline by reason of the reduction in capital investment.  But again, this is too familiar an analysis to be especially interesting in the setting of taxing corporate income in particular.

Harberger 1962's great insight was that all this may change when, because there are both corporate and non-corporate business sectors, only some capital income is being taxed.  In his particular model, savers generally bear the tax, but only for a peculiar and idiosyncratic reason.  It just happens to be the case, in his model, that the non-corporate sectors (agriculture and real estate) are less able to substitute between capital and labor as productive inputs than the corporate sectors.  So, when the corporate income tax drives capital from the corporate to the non-corporate sectors, the demand for labor increases more in the former than it declines in the latter.  So workers "win" and business owners who must pay them "lose."

No one today would think that this particular analysis gives us the answer about corporate tax incidence in 2015.  Indeed, Harberger is among those who completely rejects its current applicability.  But what remains true and important in Harberger 1962 is the point that differentially taxing capital income, depending on firms' business structure, has unpredictable incidence effects that one cannot really understand without a better grasp than anyone in the world actually has about the determinants, and both the tax and non-tax consequences, of the business structure choice.

Unfortunately, this is an insight that Harberger himself may have lost sight of later on, when he argued that rising capital mobility meant the corporate tax was now borne by workers.  This is certainly plausible, and it may be right, but the very point of tax and business heterogeneity that Harberger 1962 emphasizes means that further evaluation is needed and that, until we have a convincing model (which may be unattainable given the sheer messiness of the underlying realities) significant uncertainty may remain.

Tuesday, September 01, 2015

Letter to FASB regarding the accounting treatment of deferred U.S. taxes

I am one of eight signatories of a letter that has just been sent to the Financial Accounting Standards Board, urging it to repeal APB 23, the rule that allows U.S. companies to designate particular foreign earnings as indefinitely reinvested abroad, thus allowing U.S. deferred tax liabilities to be ignored rather than being deducted from reported earnings at full value.

APB 23 has terrible tax policy effects, as it creates lock-in for foreign earnings insofar as managers who have taken advantage of it don't want to create negative adjustments (or to undermine their ability to make other APB 23 designations in the future).  But it also is absurdly discontinuous (causing deferred U.S. taxes to jump from being deducted at full value to being wholly ignored) and excessively discretionary - as I feel I can say, despite not being an accountant, both from having talked to accountants and from the overlap between accounting and legal rule design with respect to income.

I would be (pleasantly) surprised if FASB took notice of this letter in any way.  But I see it as a useful contribution to public debate about the issues (including before Congress), and wish to thank those who took the lead in creating this letter.

Anyway, here is the text of the letter (which, it is not hard to tell, reflected the lead input of individuals more knowledgeable about financial accounting than I am):

                                                                                                                              August 31, 2015

Financial Accounting Standards Board
Norwalk, Connecticut

Dear FASB Members,

                We encourage Members of the Financial Accounting Standards Board to repeal Accounting Principles Board Opinion No. 23, the rule that allows a company to make a designation of indefinitely reinvested earnings (IRE) to suppress a U.S. deferred tax liability (DTL) that otherwise would be reported as contingent on the repatriation of deferred foreign earnings.[1]

                We are concerned that APB 23 IRE designations undermine accounting credibility and contribute to bad tax policy.  The designations are an incentive to reduce domestic economic activity and the U.S. tax base by encouraging investment in low tax jurisdictions.  Further, the designations invite real or perceived management conflicts of interest, creating vulnerability for IRE reversals (including reversals that have already occurred) that damage public accounting. [2]

                While pending legislative action could moot company interest in IRE designations, it is important for FASB to recognize that the accumulation of foreign deferral attributable in part to APB 23 has contributed to the advocacy for another repatriation holiday and/or replacing current law with a more territorial system.  There may be no better example of the power of accounting than this case in which suppression of a DTL for book purposes (about which some accountants and others have had concerns from the beginning) could end up forcing a corresponding tax law change to exempt foreign earnings from U.S. tax, a result that might not be a possibility if APB 23 had not been adopted or the Opinion had been implemented more rigorously.

                In addition to APB 23’s effects on tax policy, we note three non-exclusive accounting concerns, none of which was addressed in detail when APB 23 was approved 43 years ago or since:

1.       As the “Quad B” dissenters to APB 23’s adoption warned in 1972,[3]  the suppression of DTLs under APB 23 may misinform investors looking at book income by mixing restricted earnings (i.e., income for which IRE designations are made) with unrestricted earnings.
2.       APB 23 requires management to assert the unknowable in order to achieve the book income advantage of suppressing a DTL.[4]  Companies cannot reliably assert, whether as a probability or a possibility, that certain income will not be repatriated in the next 20 or 30 years (which is how “indefinitely” needs to be defined for accounting consistency).[5]  Changes in management, business circumstances, and shareholder needs make such assertions impractical (as demonstrated by recent big and small reversals of IRE designations by companies including Avon, eBay, Pfizer, and General Electric). Prudent accounting requires use of the DTL, which is ideal for accommodating long-term book/tax differences, to remind investors of the inevitable cost of repatriation. 

3.       The inconsistency of ABP 23 with Financial Accounting Standards No. 52 further muddles book income reporting and creates inequities across companies. FAS 52, which requires currency translation of certain foreign-denominated items for book reporting, does not permit the kind of broad company discretion to suppress a bad book result that is allowed by APB 23 (which can enhance book income by suppressing  DTLs) even though there are similarities in company decision-making for repatriation and currency conversion.[6]

                Because of the interaction between accounting rules and tax law, we believe both would be served by repealing APB 23, and we would be happy to discuss ideas for transition that would minimize disruption and complexity.  At the very least, FASB would well serve the public and itself by addressing tax and accounting controversy surrounding the Opinion.


Patrick Driessen
Revenue Estimator, Federal Government (retired)

J. Clifton Fleming, Jr.
Ernest L. Wilkinson Professor of Law
J. Reuben Clark School of Law
Brigham Young University

Jeffery M. Kadet
CPA (retired) and Adjunct Lecturer
University of Washington School of Law

Edward D. Kleinbard
Johnson Professor of Law and Business
University of Southern California Gould School of Law

David L. Koontz
CPA (retired)

Robert J. Peroni
Fondren Foundation Centennial Chair for Faculty Excellence and Professor of Law
University of Texas School of Law

Daniel N. Shaviro
Wayne Perry Professor of Taxation
New York University School of Law

Stephen E. Shay
Senior Lecturer
Harvard Law School

[1] FASB’s decisions on February 11, 2015, to require disclosures of pre-tax earnings sources and further information about tax expense, APB 23 reversals, and IRE designation amounts for certain countries are helpful but in our opinion do not address fundamental issues.

[2] With over $2 trillion of IRE designations, roughly $500 billion of DTLs have been suppressed just in the last decade under APB 23 since the 2004 repatriation holiday.  These numbers are so large relative to other financial statement entries that it would not take much in the way of reversals to cause noticeable effects.  The DTL suppressions under APB 23 by many U.S. multinationals exceed their existing DTLs, deferred tax assets, and approach the magnitudes of inventories and accounts receivable entries.  For example, in 2014 Apple’s own estimate of $23.3 billion of suppressed DTLs (associated with IREs of $69.7 billion) exceeds its $6.5 billion of DTAs, $20.6 billion of net property, plant, and equipment,  $17.5 billion of accounts receivable, and approaches its $29.0 billion of long-term debt.  While Apple’s ratio of APB-23-suppressed DTLs to total assets may be relatively large at 10 percent ($23.3/$231.8) compared to other companies, a perusal of companies (e.g., General Electric) suggests that ratios of about 5 percent are routine.

[3] While 14 Members of the APB viewed the Opinion as an improvement in accounting accuracy, the “Quad B” dissenters to APB 23, Messrs.  Bevis, Bows, Broeker, and Burger, cited noncomparability in noting that “(APB 23) validates a practice … completely contrary to the underlying concepts of deferred tax accounting … by sponsoring the idea that certain earnings may be accounted for on an accrual basis while the related income taxes are accounted for on the cash basis” (APB 23: Accounting for Income Taxes – Special Areas, April 1972, section 33, p. 6). Also, the cash treatment of taxes under APB 23 is optional, so a company has total accounting control (i.e., the choice between cash and accrual) of future U.S. residual taxes.

[4] APB 23 requires “… evidence of specific plans for reinvestment … which demonstrate that remittance of the earnings will be postponed indefinitely” (ibid., section 12, p. 4).  It might be reasonable for management in its guidance to say that company value will be enhanced if certain earnings remain unavailable to shareholders for a few years. However, the higher standard that should prevail for suppressing a DTL under APB 23 should be consistent with the maximum time arc of other DTLs such as those arising from depreciation, because for investors looking at above-the-tax-footnote financial statements DTLs are effectively homogeneous.  If a company believes it might repatriate in year 19 but under its interpretation of indefinitely for APB 23 only looked 5 or 10 years out and therefore suppressed the potential DTL associated with an IRE, and yet the same company or a competitor is carrying DTLs for depreciation (or, say, pensions) that will not expire for 20 years, that is inconsistent and confusing to investors trying to gauge earnings quality.  Also, many companies have added to the distortion by asserting that certain earnings are “permanently” reinvested overseas – this term is not found in APB 23, and its use raises even a more fundamental question of how current company management could ever assert such permanence.

[5] Once it is recognized that indefinitely needs to cover at least 20 years, it would be difficult for any company to make an IRE designation because current management cannot control circumstances or future management’s actions.  Another concern is that the current flexibility that company managements have under APB 23 creates a conflict of interest. This is because the prevalence of equity-based compensation encourages a company’s management to lower tax expense so as to increase after-tax earnings and share price. Also, were this attestation made transparent, it could be Pyrrhic for whomever makes it because if U.S. management in 2015 openly stated that over $2 trillion of foreign earnings would be unavailable indefinitely (which should be defined as a minimum of 20 years, as DTLs used for depreciation can last 20 years or more, ditto for DTAs) to shareholders there likely would be a revolt that would install new management.  As another example of a test that is not applied under APB 23, the company should be foresighted about interest rates and how they affect the hurdle rate with respect to repatriation, because the correlation between the secular decline in interest rates and the recent huge IRE buildup is not coincidental. Are low interest rates to be expected for the next 20 years, and if not, how would this affect the company IRE decision? 

If certain earnings are indefinitely unavailable to shareholders because of an IRE designation, it might be asked whether the designated earnings should be recorded as unrestricted book income when earned overseas in the first place because of the company’s self-imposed mobility restriction.  From an investor’s perspective, APB 23 would be more internally consistent and prudent if instead of suppressing the DTL and thereby mixing inferior restricted earnings with other types of earnings, the ruling required a special designation of overseas earnings not intended for repatriation with the main financial statements excluding (or footnoting) such earnings.  

[6] FAS 52 permits some flexibility in presentation of adverse results, but it does not allow a company to ignore currency translation just by promising that it would not convert currency under unfavorable circumstances (i.e., what APB 23 allows). This inconsistency can lead to the odd result that some companies are badly hurt by hypothetical currency conversion while other companies are helped by APB 23 designation and hypothetical nonpayment of U.S. residual tax. The decision about when to convert foreign-denominated earnings into U.S. dollars seems just as discretionary for companies as the timing of repatriation; earnings currency conversion is also a step in repatriation.