Monday, December 18, 2023

2024 NYU Tax Policy Colloquium

In a prior post, I had mentioned that the 2024 NYU Tax Policy Colloquium might need to shift to a new time, due to changes in the law school's scheduling blocks to accommodate multiple objectives. It now turns out that there will be less change than I had been thinking might be necessary.

We will still be meeting on Tuesdays (in fall 2024), and the start time has been moved slightly earlier, to 4:15 pm (ending at 6:15 pm, and followed by a small group dinner. There is a small chance that it will end up being moved earlier still, to a 4 pm start time.

We'll also be meeting in a new (for us) room, a bit out of the way in Furman Hall (across the street from the main law school building where we have always met in recent years), but in a true seminar room rather than a cavernous lecture theater.

Wednesday, November 29, 2023

NYU Tax Policy Colloquium, Edward Fox on banks vs. credit unions and corporate tax incidence

Yesterday, in the last session of the 2023 NYU Tax Policy Colloquium, Edward Fox co-presented his paper (co-authored by Benjamin Pyle), Who Benefits From Corporate Tax Cuts? Evidence from Banks and Credit Unions Around the TCJA. (I'm not linking it here because it's a preliminary draft that the authors plan to post when it's a bit further along.)

But just as initial background first, I've now completed 28 (!) years of running the colloquium, which for the first 25 years I always did with a co-convenor. Next year I'll be doing it solo again, and also with just 6 rather than 13 public sessions, but there is going to be a time change. Owing to NYU Law School's changing around the course scheduling blocks for reasons that are not germane here, it's highly likely that we will be meeting on Mondays, rather than Tuesdays. The time of the sessions will also change, either to 4:45-6:45 pm or to 2:35-4:35 pm, depending in large part on feedback that I am seeking from people who are on my email distribution list, or indeed from any prospective attendees. (If that includes you, please feel free to email me about your scheduling preferences.) BTW, if I had my choice, I'd still use the old time slot (going back a few years) of 4-6 pm, but that unfortunately is not available, as law schools need as a practical matter to coordinate their class meeting times across the curriculum.

Okay, enough of those not so fascinating prelims, on to the paper. It is motivated by the quest for a natural experiment that would offer insight regarding what one could broadly call the "incidence of the corporate tax" - or, more narrowly and carefully, as the paper recognizes, on the short-term incidence of the particular corporate tax cuts that Congress enacted in 2017. The natural experiment that it finds is in the small to medium-sized banking sector, in which taxable C corporations (among other taxable players) appear to compete with credit unions. The point of the comparison being: the taxable banks that meet this description are subject to the corporate tax, the rate of which was lowered in 2017 from 35% to 21% (among other changes adopted in 2017). Whereas, credit unions are federally tax-exempt, whether you look before or after 2017. So there is presumably some sort of competitive equilibrium in the sector, which then gets disrupted by the tax change for wholly exogenous reasons. One can then pursue a difference-in-difference analysis to see what happened, after duly checking on what else might have been happening at the same time (including, but not limited to, elsewhere in the TCJA), and with the look forward running only through 2019, given the pandemic's disruption of everything. With all that said, I'll offer responsive comments in 3 buckets.

1) Credit unions versus banks: The paper, while noting relevant literature, doesn't attempt to deeply theorize the competitive equilibrium between banks and credit unions, for a logical reason. However it works, why would the 2017 tax act change it? But this equilibrium is peculiar enough that I think it's worth a brief look.

Credit unions and similarly-sized banks have similar business models, except that the latter make relatively more business as opposed to consumer loans. That said, each tries to make money by holding deposits that pay comparatively low interest, and making investments (chiefly loans) that earn comparatively high interest. The spread, of course, reflects the payment and other services that they provide. Depositors typically get fixed returns on their deposits, and these are generally insured by the FDIC for banks, and the NCUA for credit unions. But the business inevitably has a variable return, depending on how well it does (including via pertinent legal changes, such as the 2017 corporate tax rate change for banks). For banks these variable returns go to shareholders. For credit unions, they at least in principle (but often not so proximately in practice) go to depositors, such as through patronage dividends or eventual liquidation claims.

One big difference, therefore, is that only the banks have shareholders. The second is that credit unions are tax-exempt, rather than facing (in the case of C corp banks) the federal income tax rules for C corporations. Let's briefly further consider each of these two differences:

     a) Why have shareholders? Normally, shareholders in a business supply a cushion that protects debt-holders against downside risk, thus benefiting the latter (who might be averse to such risk if they are seeking fixed returns). But in the case of banks and credit unions, FDIC/NCUA deposit insurance may substantially mitigate this downside risk. So, what are the shareholders "for"? Or, to put it more clearly, how do debt-holders, such as depositors, benefit from ceding both upside and downside variability to someone else, when the downside is already covered by another institutional arrangement. Or, if two otherwise identical financial institutions were offering prospective depositors otherwise identical terms, how would the institution with shareholders compensate the depositors for having taken away the variable upside risk? (Note that, with complete markets, the depositors could simply sell this upside variable return for a fixed amount reflecting its expected value, to counterparties whose preference for such variability exceeded their own - but this may be unfeasible in the credit union setting.)

Possibly, shareholders "pay" for themselves by improving corporate governance, which can be an especial problem for credit unions if the depositors are less able than shareholders to monitor management. And even with NCUA protection, credit union default might be a tough blow for depositors if that process is costly, protracted, unpredictable, etcetera. But still, it is not as obvious as it would be in the absence of deposit insurance why an equity tier is commercially useful and valuable.

For that matter, might governance concerns go both pro- and anti-credit union? For example, absent the shareholder class, might credit unions be actually and/or perceptually less likely - despite defects in managerial oversight - to play little tricks such as using hidden fees to extract $$ from depositors? 

     b) Tax exemption: Suppose that a bunch of depositors could band together (or pay an entrepreneur to assemble them) in such a way that the banking business they could fund by pooling their deposits could be either taxable or tax-exempt. Obviously, they would prefer the latter, so that the business's pretax returns, which presumably are expected to be positive (and even if negative, there are issues of nonrefundability) would not be reduced by payments to the federal income tax authorities. Thus, if being classified as a tax-exempt "credit union" was purely an election - requiring neither a lack of shareholders nor that one qualify under relevant legal criteria, such as those which generally require a "common bond" between members - then presumably all banks would happily elect to be called credit unions. So the existence of taxable banks reflects limits on (or costs to) the practical availability of the undoubted benefit of being tax-exempt rather than taxable. Credit unions have in theory a competitive advantage in attracting depositors, but practical factors, including both the (comparative) governance issue and the other legal requirements, apparently prevent them from conquering the field.

The bottom line here is that this is a complex, interesting, and distinctive business sector. How banks and credit unions ought to and do compete with each other is not pellucid, and will depend in practice on matters of institutional detail, although it is true that the 2017 tax act did not obviously change or disrupt any of this, other than via the C corporation rate changes (along with its other changes, which the paper argues tend not to have enormous, or at least direct, implications here).

2. The paper's main results: There are two principal ones. First, credit unions were paying depositors higher interest rates both before and after the 2017 act. But after the act, the gap narrowed, with banks increasing relative interest rates paid to depositors by 0.8 basis points.

Second, 74% of the banks' gain from the tax cut went to capital holders - 52% to shareholders, and 22% to depositors. The paper recognizes that it is ambiguous how we should classify the depositors, given that they are both capital holders and customers. But other players, such as borrowers (another class of customer) and employees, apparently don't gain anything. There is also some evidence of the tax cuts' leading to increased physical capital investment, such as in real estate, although with too low a confidence interval to support reporting this as a "result."

3. Interpreting the results (including as evidence regarding the broader incidence of the U.S. corporate tax): I find both of these results intriguing, but their import is not entirely clear. Starting with the first, as noted above it is challenging to try to understand the competitive equilibrium between banks and credit unions. How does one compete when offering lower interest, especially given the deposit insurance in both cases? Do the banks offer more in other ways, such as ATM availability and other payment services? If so, then why? Does this relate to governance? But, in any event, why would the banks increase the relative interest paid just because the equity tier has gained from a tax cut? True, the depositors are literally capital-holders, in that the $$ they deposit are then lent out to yield profits from the positive interest rate spread. But if they just have a fixed $$ stake that they can easily move from one bank to another at any time, without this depending on the business's distinctive features or variable returns, then why wouldn't the "customer" relationship predominate economically?

As for corporate tax incidence more generally - or even just the incidence of gain from a very particular corporate tax rate cut that was embedded in a complex system and combined with other (on balance, unfunded!) tax law changes - we clearly have a relevant datum here, pertaining to the banks within the survey. But I wonder about generalizability, even just as to the 2017 act.

One point is that (as I discussed here in re. Kim Clausing's paper earlier this semester), the presence or absence of rents seems likely to play an important role in corporate tax residence. Small to medium-sized banks seem unlikely to have significant rents - although, I suppose who knows if they hold market power in geographically segmented local markets?

A second point is that this is pretty much a snapshot story, looking only through 2019 given the pandemic's motivating curtailment of the study period. There may often be a significant gap between transition and long-term incidence, and we may have reason to care about both. As an example, suppose one believed that workers bore the incidence of the corporate tax, via its affecting investment levels that in turn affect productivity that in turn affect wages. This effect might take years to emerge. In such a case, the surprise enactment of a corporate rate cut (which itself is not exactly what happened in 2017) would be expected to give shareholders a transition gain, dissipating only over time as capital deepening lowered marginal pretax rates of return and increased wages.

As transition versus long-term incidence goes, maybe banks versus credit unions would settle out relatively fast? E.g., if it is mainly a matter of deposits moving around (at least, assuming attentive depositors!). Certainly, it might perhaps operate a bit faster than a mechanism in which big new factories are being built or a lot of fancy machines acquired and placed in service. But again, one needs a lot of knowledge about institutional detail in order to game all this out. So, while this is a valuable and informative case study in any event, the question of its broader relevance requires greater reflection and knowledge than I was able to bring to its being one of this semester's colloquium papers.

As a final word, thanks to my students, who were great and very much involved and committed at all times, and to the authors plus the public sessions' attendees. The NYU Tax Policy Colloquium is an institution that I care about, but insofar as it succeeds my efforts can only be a very small piece of the reason why.

Wednesday, November 15, 2023

NYU Tax Policy Colloquium, Ajay Mehrotra on the lack of a U.S. VAT

 Yesterday, at our penultimate public session for 2023, we discussed a pair of items (one already published, and one an early partial draft) by Ajay Mehrotra discussing U.S. tax history, and in particular our distinctive fiscal character.

As the papers note, the U.S. tax system, considered in isolation, is unusually progressive by peer country standards, but also unusually small. So Americans are not "over-taxed" (as some liars like to assert) by peer standards. But the broader U.S. fiscal system is unusually lacking in progressivity.

Nearly everyone but us has a national-level VAT or something quite similar, and peer countries almost invariably have more generous social spending. The US is unusually unequal, both before and after considering taxes and transfers.

How might one explain the correlation between our lack of a VAT and of generous social spending? Without more, the causal relationship between the two could be explained in any of the following ways:

a) No VAT -> less generous social spending, as the latter therefore lacks adequate funding.

b) Less generous social spending -> no VAT, as the latter therefore isn't fiscally needed.

c) Exogenous factors -> no VAT and less generous social spending.

It's plausible that each of these has some degree of truth. Be that as it may, the broader project's aim is ask why there is no US VAT, using case studies to look at different periods, and reflecting a normative as well as descriptive interest in both sides of the ledger. By using case studies, it explores questions of fortuity and path dependence, on the view that there may have been particular periods when the U.S. tax policy Overton window was potentially open to VAT (or VAT precursor) adoption, although it never ended up happening.

I see 3 topics of particular interest in responding to the papers, set forth as follows below.

1) American exceptionalism: Consider the following two alternative views of American history:

a) America is unique, due to factors X, Y, and Z. Therefore, of course we have no VAT and relatively low social spending.

b) It's all a matter of historical contingency. On several historical occasions, a VAT could have happened, but it just didn't for one very particular reason or another. For example - relying on the case studies' details - suppose TS Adams had happened to find a powerful sponsor in 1921 in his efforts to enact a proto-VAT. Or suppose that, in 1942, FDR had happened to want a national consumption tax (as Treasury Secretary Morgenthau was suggesting) rather than just a huge expansion of the income tax to help fund World War II. Or suppose that in Richard Nixon's first term, when his Administration was studying and floating proposals to enact a VAT to replace state and local property taxes in funding public education, he had managed to make a deal to this effect with Congressional Democrats. Then our country would be at a very different place fiscally today.

Evaluating these very different views is made difficult by the fact that history only happens once. But one can plausibly have a theory that mixes American exceptionalism with contingency such that, if we could run history forward 100 times (with the butterfly effect allowing it to proceed independently each time), one might predict that the US would end up with a VAT more rarely than other countries, but not necessarily zero times.

In effect, one might think of US enactment of a VAT as requiring the poker equivalent of drawing an inside straight, rather than merely having two of a kind. So perhaps we'd get a VAT 10 or 20 times out of 100, rather than 0 or (obviously) 100. Meaning that, if one accepts this view, American exceptionalism and contingency are both at work here.

That said, I have in mind the X, Y, and Z factors that help to explain why a US VAT was ex ante so unlikely (even if not impossible). I'd characterize them as follows.

X is the power of white supremacy in American history. Fueled by our history of slavery (followed by apartheid) and Native American genocide, and kept bubbling as well by our history of immigration by people who were socially coded as non-white, we have had a lack of social solidarity that undermines political support for social spending. White voters don't want to fund (as they see it) large benefits that they view as going to "them" rather than to "us."

Y is America's anti-state, anti-tax, and individualist tradition, reflecting Revolutionary War era resistance to British rule along with the frontier experience. 

Z is our having a political system with multiple choke points, biased towards inertia. Whereas in a parliamentary system the ruling majority can pretty much do what it likes, here one has the president, House, and Senate (not to mention the courts), each potentially run by a different party, and with lots of outside players and divergent views that can impede policy innovation even when all are at least nominally controlled by the same party.

A particularly keen example of Z in the case studies is the Nixon Administration's apparent interest, during the Trickster's first term, in enacting a VAT that would replace state and local property taxes in funding public education. This had a lot of underlying causes, including political and constitutional challenges to divergent levels of local funding, and the era's highly controversial disputes over busing. But its enactment would have required some sort of a deal between the Administration and the Democratic leadership in the House and Senate. Plus, it was apparently effectively vetoed early on by state and local governments' opposition, reflecting that by this time (as opposed to 25 years earlier) they had significant state and local sales taxes that they viewed as being threatened by a national VAT.

2. "BIASED" FISCAL DESIGN: The published paper argues that the US fiscal system is designed as if it had been intended to make taxes as visible and salient as possible, and benefits as invisible as possible. Hence, voters are predisposed to hate taxes and to believe that they don't purchase one anything.

Key words here are "as if ... intended." The claim is not one of intentionality but of end result. It's based on the facts that:

(a) on the tax side, the federal income tax is highly visible and salient, with April 15 filing, unaided by the likes of Ready Return. VATs, by contrast, are collected piecemeal and arguably less salient.

(b) on the social policy side, benefits are frequently delivered via tax expenditures and through private-public partnerships that make the government's role in benefit provision (e.g., for healthcare and housing subsidies) relatively invisible. 

I agree that our tax and "spending" institutions generally have this character. But an exception worth noting is the employer contribution to payroll taxes, which could hardly be less visible to workers than it is.

Also, tax expenditures' role on visibility and salience is a bit complicated. Yes, they hide the "spending" a bit. But they also hide the "tax" that funds the "spending" a bit. Thus, suppose we are comparing the the home mortgage interest deduction to a system in which the government first collected the forgone revenue through the tax system, then paid out explicit cash subsidies to existing law's beneficiaries from the deduction. This would cause, not just "spending," but also "taxes" to be optically higher than in the (by hypothesis) substantively identical system that we actually have.

The paper notes the following comparison between US and peer countries' taxes as a percentage of GDP. US taxes are typically at about 25.5% of national GDP, as compared to 33% in the UK, 38% in Germany, and 45% in France.

But our tax expenditures are 5.8% of GDP. Adding them to the 25.5%, we'd now be at 31.3%, bringing us significantly closer to the other 3, although we'd still rank below them. True, their percentages would rise as well if their tax expenditures (admittedly a fraught category to define) were added to collected taxes. But, if they use tax expenditures less than we do, which I believe to be the case, we'd still be closer after making the adjustment than before.

3. VATs and overall progressivity: Suppose one wants to make the US fiscal system more progressive. While enacting a VAT would do so, if the revenues therefrom were used to fund enhanced social spending (e.g., for education and healthcare) that sufficiently helped lower-income individuals, one could make the overall system more progressive still by using progressive taxes to fund the same thing.

Just to illustrate this, I've seen estimates suggesting that a 10%, fairly broad-based VAT would raise about $3 trillion over 10 years. By way of comparison:

--The Warren and Sanders wealth taxes - if allowed by the Supreme Court, which would require a change in the Court's membership - would raise $4 trillion over 10 years according to the proponents, and $2 trillion over 10 years according to the Tax Foundation.

--According to a 2019 article by Lily Batchelder and David Kamin, one could raise $4.5 to $5 trillion over 10 years through such tax changes, directed at the top 1 percent, as the following: higher individual and corporate rates, higher capital gains rate, realization at death, and higher rates plus lower exemption amounts under estate and gift taxes.

So it's not just about the revenue. That said, there are 2 main types of arguments for using a VAT in lieu of (or in addition to) the above alternatives. The first are arguments about efficiency and economic growth, while the latter are arguments about political feasibility.

I myself, if made the temporary fiscal tsar with some hope that my choices would persist, would add a VAT to the mix, for reasons of both (relative) efficiency and long-term political economy. But I would also revisit the existing and other proposed taxes in order to ensure that overall progressivity (giving due weight to concerns about efficiency and growth) was at the level, or achieved the set of tradeoffs, that I considered best. But, since no fiscal tsar job appears to be on offer for me at present, I don't see the need fully to decide and specify exactly what I would hypothetically do.

Sunday, November 05, 2023

National Tax Association, 116th Annual Meeting

I enjoyed the National Tax Association's 116th Annual Meeting, which concluded in Denver yesterday. Due to the pandemic plus last year's hurricane threat in Miami, it was actually the first live NTA Annual Meeting since 2019 (!). This added to the pleasure this time around, as did (for me) the fact that I was awarded the Daniel M. Holland Medal for "lifetime achievement in the study of the theory and the practice of public finance."

I've posted the talk I gave at the award ceremony here. I also gave a talk about my recently posted article on medical expense deductions, and watched as my co-author, Daniel Hemel, did the honors regarding our joint work in progress, entitled Two-Level Games in International Taxation. (Not yet available for download, as we are still writing it.)

One of the more interesting presentations that I saw at NTA was one by Jim Hines, regarding an article (not yet posted in its current form) that appears to be a descendant of this one, which was then entitled "Evaluating Tax Harmonization." It's clever, ingenious, creative, and provocative - but, I believe, founded on premises that are simply wrong. That said, however, one might plausibly argue for its conclusions on very different, less "scientific," grounds.

As presented at NTA - but perhaps not to the same degree in the earlier or perhaps merely related draft that I have posted here faute de mieux - its basic premise is the following: nations that are setting their tax policies should be analogized to individuals who are making commodity choices that reflect their underlying preferences.

If you grant Jim this first step, it's all over and he wins. Since I was viewing the presentation at a conference hotel to which I had traveled from the airport, I was thinking of it in terms of one of those airport buses that you can sometimes board at, say, a resort hotel. Once you board the bus, it's done. You're going to the airport, whether you like it or not. But that doesn't mean you should board the bus to begin with.

Why (pace Jim) shouldn't we think of nations that are making policy choices in the same way that we think about individuals who are making commodity choices in a standard neoclassical economic framework? Point 1 is that, in the framework of collective choice by a given country's political actors who represent distinct interests, none of the actors has the incentive to pursue national welfare. Each is presumably pursuing her own interests or preferences or vision of national welfare. So there's a pervasive agency problem. Point 2: I think all political scientists would agree that nations' institutions for collective political choice do not generally produce the "correct" outcome in terms of their people's underlying preferences or welfare. This has been well-known for decades, if not centuries. And then Point 3: the nations themselves are not sensate. So if there are relevant "consumers" here, they are the people who reside in these nations. And not only do they not individually all share the utility functions or interests that Jim is effectively imputing to the collectivities, but they also differ in such dimensions as population. For example, the Turks and Caicos Islands' population is under 50,000, while China's exceeds 1.4 billion. (And indeed both are among the signatories of the OECD Inclusive Framework.)

So, in my view at least, the paper's basic framework is simply wrong. And, at least at the talk, I was hearing about how its analysis ostensibly reveals truths about worldwide welfare and efficiency and such things. It doesn't.

But now let's see what happens if we grant the paper's premise that nations setting, say, their corporate tax rates are like individuals making commodity choices in light of their preferences and underlying utility functions. As claimed by the paper, this does indeed lead to the firm conclusion that global tax instruments, such as the Pillar 2 global minimum tax, both (a) inefficiently reduce worldwide welfare, and (b) would need to have either very low rates (such as 4 percent) or very high ones (such as 27 percent) in order to be plausibly welfare-enhancing.

The paper very plausibly (in light of its underlying assumptions) models a given country as setting its corporate tax rate in the following way. To use my own simple notation, suppose that X% is the tax rate that it would prefer in the case of autarky. But it is subject to tax competition for mobile resources, even if countries aren't interacting strategically. Suppose then that it sets its tax rate at Y%, which is lower than X%, in light of tax competition and other countries' actual rates. 

In this scenario, there seems to be hypothetical room for collective gain, and indeed even perhaps for a Pareto improvement. Starting with just two countries, suppose that each interdependently agreed to raise its Y a bit, bringing their new Y's closer to their X's. This not only would bring each country closer to its autarkic optimum, but would be a subjective improvement even taking into account tax competition, since one's optimal Y goes up as other countries' tax rates rise.

The analysis therefore supports the view that all countries might gain if each raised its tax rate a little bit. And indeed, presumably only transaction costs and collective action problems (albeit, potentially very grave ones) stand in the way of this solution's emerging spontaneously.

But now let's turn to an actual global minimum tax like that in Pillar 2, which is set at a very intermediate 15%, rather than being very either very low or very high. Now what happens, given the heterogeneity of prior corporate rates that are presumed to reflect very heterogeneous preferences, is that some countries have to raise their rates a lot (even from 0%), while other countries don't have to raise their rates at all.

The analysis now deploys a standard, and very plausible, assumption in microeconomic rational consumer models. If I am forced to depart from my preferred choices by just a little, the welfare cost to me is likely to be very slight. By contrast, if I am forced to depart from it by a lot, the welfare cost to me is likely to be very high. Moreover, the welfare cost may grow (say) quadratically rather than just linearly. So, if the amount by which I am forced to depart from my preferred choice (say) doubles, my loss of welfare more than doubles. E.g., perhaps it quadruples.

It should now be clear why the intermediate global minimum tax rate in Pillar 2 creates so much welfare loss in the paper's model. Previously low-tax countries (again, modeled as if they were individual consumers) must accept enormous departures from setting the corporate rates that they prefer (with or without there being other low-tax countries). Meanwhile, those that already had rates of at least 15% need not change their rates at all (and indeed may now feel emboldened to increase them in the direction of X%). So the global minimum tax requires huge adverse departures from some, and no adverse departures whatsoever (and indeed, perhaps allow a small increase in welfare) for others. But with the more than linear welfare losses as one is increasingly forced away from acting as one prefers, the net welfare gain is large, compared either to doing nothing or having everyone agree to a small increase in their previous Y's.

By contrast, a global tax rate that was either very low or very high would impose either little pain on anyone, or at least some pain on everyone. (This is just the intuitive version; the paper specifically derives the alternative optimal solutions based on its model, its data, and, ahem, a second order Taylor approximation.)

Okay, so the bus is now at the airport. So, if you boarded it back at the hotel, you now must agree that Pillar 2 is terrible because the global minimum tax rate must either be very low or very high - but definitely not in the middle - in order to create overall welfare gain.

But what if you didn't board the bus to begin with, because (as I do) you rejected the basic analogy between (a) countries making collective political choices based on their politics, and (b) rational consumers making individual choices based on their preferences? Then nothing whatsoever has been convincingly demonstrated.

Still, the paper's conclusion admittedly has some intuitive force. Suppose we think that, as a general matter, the people in what we observe as low-tax countries do indeed collectively benefit (relative to alternatives) from those countries' having a low-ish rate, while those in high-tax countries collectively benefit from those countries' high-ish rates. After all, it seems clearly true that the genuinely optimal corporate tax rate (all things considered) would be higher in the US than in the Turks and Caicos Islands. After all, we're a much bigger country with more market power. So, despite all the pervasive political choice failures (at least, from an ideal standpoint) everywhere, perhaps there is some (or even a lot of) plausibility to the claim that a Pillar 2-like instrument hurts some countries a lot and others not at all. 

To be engaged in a true welfare analysis, we would still need to be looking at individuals, not collective national entities. So the above doesn't immediately translate into even a softer version of the paper's basic claims.

But one may also be intuitively inclined (despite the departure from a rigorous welfare analysis) to think of national-level actors as having moral duties to deal "fairly" with each other. E.g., suppose one subscribes to the norm of inter-nation equity. From this standpoint, one might indeed find the optimal scenario that the paper envisions more intuitively appealing than imposing large departures from preferred policies on some countries, along with no such departure at all from others. And one might conceivably object to the Pillar 2 project as something that big countries are imposing on small ones because they have greater global political power. Then one might reasonably applaud the paper's conclusions, despite rejecting its particular analysis.

Wednesday, October 25, 2023

NYU Tax Policy Colloquium, Kim Clausing's Capital Taxation and Market Power

Yesterday at the colloquium, Kim Clausing presented Capital Taxation and Market Power, which focuses on the importance of extra-normal returns that are earned these days, especially by big multinational companies such as the FAANG crew (Facebook, Apple, Amazon, Netflix, Google).

Extra-normal returns are important not just to rising high-end inequality in the US and around the world, but also analytically. For example, as I discuss here, they can reverse both the efficiency and the incidence analysis of entity-level corporate income taxes. They can also reduce the need for income rather than consumption taxation at the entity level, even if one is pro-income tax as to the taxation of individuals.

I see the paper as raising 4 main types of issues, as set forth below.

1) What are extra-normal returns, and what gives rise to them?

Their most pertinent features are:

(a) at the risk of belaboring the obvious, their being by definition high, hence something to care about.

(b) their being generally non-scalable, unlike risk-bearing or making investments that merely earn the normal return. Thus, Jeff Bezos presumably could not have responded to the existence of the tax system by making 2 Amazons, rather than just one.

(c) their being potentially highly efficient to tax. But this depends on understanding what gives rise to them.

Suppose we call them rents, and think of rents as free money that falls from the sky. Then taxing them at even a 99% rate does not induce substitution and is perfectly efficient. But this may not be an entirely credible way to think about them.

Rents are also sometimes defined as amounts in excess of one's reservation price. Thus, consider LeBron James, whose salary for playing this year is nearly $50 million. If he would play for just $5 million, then the extra $45 million is a rent and could be taxed away without affecting his behavior. (Note that this perhaps unrealistically ignores the scalability of LeBron's effort level - he works very hard, all year round, to be ready to play.) But in any event it is hard to know people's reservation prices.

The paper mentions the distinction between rents and quasi-rents. The latter, like the former, are defined in the literature in multiple ways. The paper notes that observed (ex post) extra-normal returns can reflect compensation for risk, implying the possibility of a normal return (any risk premia aside) ex ante. One wouldn't judge rates of return on the New York State lottery by just looking at the winners' return on investment. Quasi-rents are also sometimes defined as being merely temporary, or as being enjoyed ex post (with no further effort being required) once they have been successfully created. And there, I think, we are on to something more general.

I think of seeming rents as generally quasi-rents that are conceptually the products of labor income. Which doesn't mean that they're generally either deserved or the products of toil and "sweat equity." But they generally involve one's having done something or made some particular choice in response to one's opportunities. This could involve something that's socially productive, or rent-seeking efforts to create and defend monopoly power, or anything in between. But good or bad, deserved or not, I'd say they're geneally not entirely free money, and therefore that, when we're taxing them, we are still in the world of comparing distortions from the use of alternative instruments.

2. Implications of taxing extra-normal returns

This is not to dispute that taxing extra-normal returns that are conceptually labor income (even if viewed by the tax system as capital income) may have efficiency as well as distributional advantages. But it's no longer a slam dunk. The issues that one might think about here include the following:

Time: How should we evaluate the appeal of taxing returns that are ex post rents? It's the familiar time consistency issue, but in a distinctive setting. As Keynes said, in the long run we're all dead, and one also might ask to what extent (and how generally) one is actually going to discourage new investment and labor effort if the setting for the ex post taxation is a distinctive one.

Elasticity of labor supply: How tax-discouragable are the would-be Jeff Bezoses of the future? I am inclined to think: not very, but admittedly this calls for empirical investigation.

Externalities: As the paper discusses, these are at least plausibly rife, on both the positive and negative sides. E.g., positive externalities (or the creation of consumer surplus) from innovation, versus inducements to rent-seeking and monopolistic behavior.

Political economy: There are theoretical reasons for positing that companies like those in the FAANG group would be prone to being overtaxed. For example, insofar as they earn non-rival, location-specific rents that are actually quasi-rents, each country might have an incentive to grab (once it is repeated everywhere) "too much." But if the companies are politically very powerful - including US companies outside the US - then the main problem may lie the other way, in terms of their securing favors that include low taxation. I am inclined to think that, in practice, the latter problem significantly outweighs the former one, but again this may be context-dependent and in need of verification.

3. Tax versus non-tax instruments

Both tax and other scholars (e.g., in antitrust and IP) are, to an undesirable degree, siloed in their own disciplines. This happens for good reasons - it's not that easy to become an expert in something - but it can have bad effects when the alternative instruments are interchangeable and interact with each other.

The paper notes that some of the problems it proposes addressing through taxation (e.g., higher taxes on those who may have monopoly power) can potentially be addressed through such alternative instruments as antitrust or IP rules. There may be both substantive and political economy differences between the alternative approaches. E.g., tax and antitrust may raise distinct political and administrative issues; tax may be more continuous and antitrust more of an on-off switch; and a tax approach to monopoly merely seizes some of the profits earned by limiting supply rather than directly preventing it. While clearly this paper could not sensibly have taken on the alternative-silo issues in any detail, they do merit being more fully addressed somehow.

4. Tax proposals in the paper

The paper notes several interesting tax law issues as to which its analysis might support changes in the rules (e.g., pertaining to tax-free reorganizations, international taxation, and the tax treatment of large pass-through entities that may be earning extra-normal returns). But the most novel one is to restore graduated rates in the corporate tax, on the view that companies with very large amounts of income may tend to have a higher proportion of extra-normal returns. This would be accompanied by rules requiring consolidation, at least for tax rate purposes, when commonly owned companies were nominally separate. While there are many possible objections to such a rule, I agree that it should be on the agenda of current debate (including for political economy reasons, if smaller companies have especial political clout in Congress).

Wednesday, October 11, 2023

NYU Tax Policy Colloquium: Jeremy Bearer-Friend's Race-Based Tax Weapons, Part 2

 My prior post offered some background regarding the 4 case studies in Jeremy Bearer-Friend's paper. This one will focus on the paper's terminology of race-based (and other, such as class-based) "tax weapons" - a proposed takeaway from the analysis, and well worth discussing although I like case studies (including these) whether or not they have specific takeaways for contemporary readers.

The paper defines a tax weapon as a provision reflecting use of the tax system to harm political rivals. A tax weapon is race-based insofar as the targets are people in particular racial or ethnic categories. (It views a yacht tax that a progressive government might impose as a class-based tax weapon.) Again, this is a proposed analytical category, rather than necessarily being grounds for condemnation. And it views the Texas poll tax and Thatcher Community Charge examples as showing that a tax weapon can be race-based even if it doesn't facially use race or ethnicity as a category. 

This is obviously so as to the Texas poll tax, given how it was deliberately used to disenfranchise Black (although also poor white) voters through the discretion applied by its local enforcers. But for the Thatcher Community Charge, I think the case is a bit more complicated.

In support of viewing the Community Charge as a race-based tax weapon, the paper adduces the following points:

(1) By massively shifting tax liabilities in a regressive direction, it greatly shifted burdens from white to nonwhite taxpayers, given underlying racial economic inequality in the UK.

(2) Other details of the tax could also be seen as reflecting implicit targeting. For example, the Community Charge was generally higher in urban jurisdictions where nonwhite individuals disproportionately lived, than in disproportionately white rural jurisdictions. And, since (although a head tax) it was collected through households, it resulted in a higher charge on nonwhite households, which on average had more adults in residence.

(3) There is evidence strongly suggesting that the sainted (in some circles) Thatcher held racist views.

In response, let's start with #2. If I correctly understand the Community Charge, 3 adults (say) would pay the same tax whether they lived in one household, two, or three. So the fact that nonwhite adults were more often found in the same household didn't make the tax worse for them - this was, rather, a product of its being a head tax rather than a property tax in which more affluent individuals would pay more (and businesses would pay, too). I'm also not sure about urban versus rural, as the former presumably spent more, too.

In terms of #3, yes I agree that the perhaps not so sainted Thatcher appears to have been a racist. This comes as no surprise, whatever virtues one might conceivably ascribe to her in other respects.

But #1 is at the heart of the matter. And here, I think, we face a tricky issue. Let's start with what the Community Charge was. Both its central point and its main effect was to shift tax liabilities massively downwards in the social scale - to make the UK fiscal system far less progressive. There was also an element of Mitt Romneyesque "47 percent" thinking. By making poorer individuals pay for community-level spending, the thought was that this "skin in the game" would cause the governments to spend and do a lot less. Part and parcel of Thatcher's efforts at the national government level to greatly shrink government's role relative to that of the private sector.

Did that promise to have large adverse effects on racial equality? Absolutely yes, given distribution in the UK (and US) both then and now. Could one in good faith support such a policy without being a racist? Also absolutely yes, although I myself would oppose it even in a society without racial inequality, and all the more strongly in a society with such inequality. Does the fact that one could in theory support it without being a racist mean that it is cleared of being a race-based tax weapon? Not necessarily, although I have not yet discussed (but will below) the broader "tax weapon" terminology.

Certainly in the United States (which I know best), but also I gather in the UK, race is so utterly central a cultural and sociological category that one simply can't ignore it. It's like the proverbial elephant in the room. Moreover, race and class are so poisonously intertwined that it verges on impossible for an American to have a view about taxes, social spending, and progressivity that doesn't have race as at least an important background factor in one's emotional responses. E.g., one important reason why the US has so much less progressive an overall fiscal system than our peer countries is that race causes a lot of policymakers and voters to think of poor people as "them" rather than as "us."

So, yes, I see the point to viewing the Community Charge in the UK, or flat tax proposals et al here, as having a racial character, and as in practice strengthening white supremacy, even though they are not just (or directly) about race and may be supported by particular individuals who are not even unconscious racists.

But as to calling them race-based tax weapons, there are also further issues around the question of whether "tax weapon," race-based or otherwise, is a useful new terminological category. Note, by the way, that the above analysis could be extended to call all progressivity-reducing measures (even just as between 2 potential tax reform proposals, neither of which is present law) race-based tax weapons. This in turn would raise questions as to how much we gain from the terminology, either analytically or politically.

The paper proposes "tax weapon" as a useful addition to the standard categories of (to quote the paper) revenue, redistribution, and regulation. Let's modify this terminology slightly to consist of revenue, distribution, and regulation. (Removing the "re" from "redistribution" so that we don't have an implicit baseline such as pretax income.) Tax weapons are distributional, so what is the distinguishing feature? Perhaps animus? I.e., wanting to harm a particular group as distinct from just not wanting to help them as much as one wants to help other groups that are more to one's taste? Or, targeting that can't be explained just on conventional broader grounds? But this in turn might work better for race than class, given that a focus on, say, ability to pay, or on the negative externalities that one attributes to economic inequality, is pretty much straight-up distribution policy.

Perhaps "tax weapon" is best viewed as an intensifier for what one deems especially odious and extreme distributional policies. For example, when it's used (as in the Texas poll tax example) to achieve massive Black disenfranchisement, or (as in the California example) to place huge tax burdens on non-voting immigrants, or (as in the Kenya example) to require multiple weeks of labor that is effectively unpaid given the underlying poll tax obligation, then we need to signal that this is not business as usual. Likewise, perhaps, when (as in the UK community charge example) one is aiming at a really large downward shift in tax burdens. But I myself don't find it enormously helpful analytically. Plus, if we imagined for a moment that academic discourse can affect public political outcomes, the effect on political rhetoric wouldn't necessarily be positive. The "weapons" rhetoric could potentially do ill as easily as harm. E.g., imagine that all efforts to increase tax liability at the top of the distribution were now subject to being pilloried as "class-based tax weapons." (Although how much difference this would make, compared to rhetoric about "class warfare" and "envy is unclear.)

Still, an interesting paper and topic, both for itself (the case studies) and for the broader reflections about tax, class, and race that it encourages.

NYU Tax Policy Colloquium: Jeremy Bearer-Friends Race-Based Tax Weapons, part 1

Yesterday at the colloquium, we discussed with Jeremy Bearer-Friend his new article, forthcoming in the UC-Irvine Law Review, entitled Race-Based Tax Weapons. This is a case study (but also drawing broader policy-relevant conclusions) of the following four twentieth century "poll taxes" imposed by Anglophone governments:

1) The poll tax that Texas imposed beginning in 1903 to prevent Blacks, and to a lesser extent poor whites, from voting. This was a uniform head tax of $1 per adult male that actually pre-dated the Civil War (at which point it was payable only by whites). Low as this may sound in terms of modern dollar values, at the beginning of the 20th century the bottom 76% of the Texas population only earned about $60 per year.  So, proportionately speaking, if you were earning $60,000 today it would be like paying $1,000.

After the Civil War and 13th Amendment, it was expanded to apply to all men aged 21-60. The big 1903 innovation was to tie it to voting - you couldn't vote if you hadn't paid it - and to make it payable at a different time and place than that of the elections themselves, with the aim of excluding disfavored voters from the ballot, rather than of collecting it from them.

2) A short-lived 1921 California poll tax of $10 (equaling the return to 30 hours of minimum wage labor) per male aged 21 to 60 who was an alien. Reflecting animus towards Chinese, Italian, and Japanese immigrants (the three most numerous immigrant groups at the time), it was struck down within a year by the state's Supreme Court.

3) A poll tax that the British Empire imposed in Kenya in 1934, to be paid solely by "natives" (defined as men who were of African, rather than European or Asian, extraction) with an eye to forcing them to work on English-owned plantations for at least 23 days in order to generate the cash that they would need to pay the tax.

4) The uniform "Community Charge" that Margaret Thatcher's UK government imposed in Scotland in 1989, then expanded after a year to England and Wales. It replaced property taxes that the local governments had previously levied to fund their outlays. It was a per-person head tax on adults, charged on a per-day basis, depending on the number of days that they spent in a given jurisdiction. Because of its extreme regressivity, as compared to property taxation, it caused mass protests in the UK that brought down the Thatcher government.

In contrast to these 4 examples, I don't think poll taxes / uniform head taxes are much on the agenda these days, which is certainly a good thing. But demogrants (i.e., uniform per-person payments to members of the eligible group) can be viewed as reverse head taxes. One might also say the same for refundable child credits, although these would only go to parents, not  everyone.

Of the 4 poll taxes in the case study, #2 and #3 are expressly targeted at particular racial groups, while #1 and #4 are facially neutral. The article argues, however, that all should be classified as "race-based tax weapons." Moreover, it points to this essential underlying similarity as demonstrating that racism and white supremacy can be advanced by formally neutral or uniform rules, no less than by those that are overtly racist.

This claim is surely correct, albeit in tension with the US Supreme Court's increasing focus on formal neutrality (for example, in school admissions) rather than on substantive effects on racial inequality. But in my next post I will address the broader analytics of identifying race-based (or other, such as class-based) tax weapons as an important new substantive category in tax policy analysis. This will include asking whether or not, and to what extent, we should group Example #4 above with the first three.

Medical deductions article

My medical deductions article, forthcoming in the Tax Law Review, has indeed gone live here.

The abstract goes as follows: 

Recent decades have seen explosive growth in the availability and efficacy of assisted reproductive technologies (ART) – for example, egg extraction and storage, egg donation, intracytoplasmic sperm injection, in vitro fertilization, and surrogacy. ART greatly enhances millions of lives – not least those of the tens of thousands of people (in the United States alone) who owe their own births to it each year – but it can be extremely costly. Moreover, ART is just one current within a broader ocean of potentially transformative but often very costly) technological advances in the provision of healthcare. However welcome the rise of these technologies may be, they present challenges regarding how their provision should be funded, other than by the prospective users themselves.

Taking on a narrow piece of this broader puzzle, this paper concludes that, under the US federal income tax, medical expense deductions for ART expenses should be available in certain situations where the IRS and the courts – possibly reflecting anti-LGBTQ bias – have recently determined otherwise. More importantly, however, it seeks to situate both the ART debate, and that concerning broader advances in healthcare technology, within an analytical framework that may aid fuller and more definitive inquiries by others.

Tuesday, October 10, 2023

New article on medical deductions in the income tax

Three weeks ago, I posted an article on SSRN entitled "Assisted Reproductive Technologies, Other New Frontiers in Medicine, and the Income Tax's Role as a Back-up Health Insurance System." It's forthcoming in the Tax Law Review.

The abstract goes like this: 

As I knew would happen, SSRN's AI bots embargoed it (nearly 3 weeks ago) on the ground that it might be offering medical advice. It isn't, but they are not very advanced or bright just yet. The article is therefore stuck indefinitely in purgatory (I know this from experience), although I hope to get it liberated therefrom when I take the time (which I don't really have) to call SSRN and discuss the situation with a live human.

This happened once before, when a paper of mine which had absolutely not the remotest connection with anything medical got embargoed because its title included the words "Ancillary Benefits," which is a term used in health insurance although I wasn't using it that way.

Despite the embargo (e.g., it's not listed as one of my papers), the link for it appears to work. So if interested you can try this.

Monday, October 09, 2023

Book (including an article of mine) on Stanley Surrey

Duke Law School's Law and Contemporary Problems journal has just published a new issue, entitled The Legacy of Stanley S. Surrey, edited by Ajay Mehrotra and Lawrence Zelenak. It responds to the recent re-surfacing of Surrey's memoirs, still in progress (but mostly complete) when Surrey died in 1984, and then published (with useful annotations) through Mehrotra's and Zelenak's efforts. Surrey remains a figure of particular interest, and was certainly the most influential U.S. tax law academic ever.

The entire issue is available online here. I won't issue shout-outs for particular chapters, as that would seemingly diminish the ones I didn't list, but there are a number of particular interest.

My chapter, entitled "Moralist" Versus "Scientist": Stanley Surrey and the Public Intellectual Practice of Tax Policy, is available here.

Sunday, October 08, 2023

Michigan conference on Friday, October 6, discussing the "International Tax Revolution"

Two days ago I spoke at an international tax conference at the University of Michigan Law School, discussing OECD-BEPS Pillars 1 and 2. The video link is supposed to be here,  but it appears not to work without permission. If you can view it, my remarks begin at 4:43:34.

The speakers in the morning session were mainly academics who had worked on OECD-BEPS during government or NGO stints, and they were mainly upbeat about its prospects (at least, Pillar 2) and merits (at least, compared to prior law).

The speakers in the afternoon session were considerably more negative. While I was one of the afternoon speakers, I was not one of the more negative ones. My remarks were more on the positive than the normative side, discussing how one might think about the underlying international tax politics that may affect the Pillars' acceptance or rejection around the world.

But I will mention two of the negative comments that were made during the afternoon session that I briefly rebutted during my remarks. I won't name the speakers (although you can find it on the video, if it's accessible), because, as they're friends, I feel I'd owe them a bit more context and description of their side of the debate before expressing my disagreement publicly.

The first of these two negative comments, pertaining to Pillar 1, went something like this. Suppose we are considering some situation such as the UK's desire to tax Facebook / Meta's profits from ads sold to reach UK users. The UK currently does this through a digital services tax, but Pillar 1 is designed to replace this. Why should the UK be able to reach these profits, the speaker asked? Its claim that "value creation" occurred in the UK is ludicrously false [a point with which I agree], as it really happened in the US, where people who live and work there created and are tending to the IP.

Here my next move would be to say: So what if there was no value creation in the UK? There is a kind of bilateral monopoly situation here, involving the profits Meta can earn in the UK that is non-rival to its simultaneously earning profits elsewhere too. It's silly to moralize about who is "entitled" to what share of bilateral monopoly profits, so why should we presume that the US should be the only party able to tax it. Rather, let us hope that the two parties find a way to work it out amicably, keeping in mind both that Meta has generally been greatly undertaxed on the quasi-rents that it earns around the world, but could potentially be over-taxed if every nation starts grabbing as much as they can of the quasi-rents based on presuming that they are actually rents.

My panel colleague, who is an economist, instead argued that, since value creation occurred in the US, as a matter of proper political incentives only the US should be allowed to tax the profits. It has an incentive not to overtax them but to do things "right," whereas source or market countries such as the UK have every reason to overtax.

The mistake my good friend makes here is practicing political science without a license. He seems to think that we have individuals from a rational behavior model acting based on self-interest. But suppose the UK faces political constraints (Meta political clout & money, fear of the US response) that push against its overtaxing the profits. And suppose the US is inclined to undertax them due to interest group politics, which may empower our multinationals. In short, it is an uncertain empirical claim that assigning the tax rights exclusively to the US will lead to better outcomes. Not to mention, if the UK wants to tax these profits (an unsurprising state of affairs, especially when it observes the US not doing so), so what if we have a political economy argument telling them to back off. What if they don't want to? Then we have a problem we need to solve, hopefully reasonably amicably and not too inefficiently, in any event.

Another panel colleague expressed extreme skepticism that moderating tax competition between countries via Pillar 2 would slow down their economic competition. Countries can simply substitute subsidies, such as via direct spending, for lower taxes. (An observation that actually underlay the European Court of Justice's battle against state aid.) So there's no point to the whole thing and it won't get us anywhere that's helpful.

Now, this observation might actually prove to be correct. We will see. But it does invite the retort: If non-tax subsidies are such a great substitute for tax subsidies, why don't we see more of them already? The rationale for seeking to moderate economic competition for MNC investment (and nominal profit allocation) by moderating tax competition is that the latter is an especially fruitful (i.e., low-perceived cost) way to do it politically. This in turn brings us to the longstanding debate regarding whether tax expenditures are used, not just out of random convenience, but because they are optically less "costly" than their direct-spending substitutes. Here I tend to believe that the answer is often to a degree somewhat Yes. Hence, it is not impossible or even implausible (although I wouldn't claim much more than that) that Pillar 2 might ease overall economic competition regarding multinationals' locational choices.

Wednesday, September 27, 2023

Tax Policy Colloquium,: Rebecca Kysar's The Global Tax Deal and the New International Economic Order, Part 2

On to issues in 2 & 3, in response to Kysar's The Global Tax Deal and the New International Economic Order.

2. How can we explain emerging multilateralism in international tax policy, given the barriers to successful cooperation? In the prior blog post, I was discussing the factors affecting support for tax multilateralism in a single country, focusing primarily on the US. However, even if countries want to act cooperatively, this may be hard to pull off.

At least two considerations may tend to make it a tough uphill climb. First, countries often have very distinctive or even conflicting interests. For example, one has both developed and developing countries. Net capital importers versus exporters. The US versus the EU with respect to the latter's taxing the big US multinationals. Second, there can often be zero-sum conflicts. For example, do we get a given dollar of tax revenue, or do you?

The paper mentions the common interests that countries also have (e.g., from the tax competition prisoner's dilemma perspective). While I agree that this is part of the story, I'd also add a second factor.

A standard story about irreconcilable differences (especially if not steeped in contemporary IR theory) might rest on two background assumptions that are not always true. The first is that each country has a clear national interest. The second is that a country's political actors proceed in good faith to advance this interest, as faithful agents for the country as a whole.

This is not always a bad framework to use. For example, it can help one to understand Ireland's decision, in the early stages of the Pillar 2 process, that its best play (all things considered) was to go along and secure a place inside, rather than outside, the tent. Or consider Poland's and Hungary's making financial demands of the EU before they would withdraw their objections to Pillar 2.

But for a more complicated story, consider US domestic politics. The Biden Administration and Congressional Republicans fundamentally disagree about where the national interest in international tax policy lies. (And this is not a Trumpist phenomenon - the divide has been around for decades, and a version of it can also be seen in the academic literature.)

Without getting into all the details here, as will be explored in a paper that I am currently co-authoring with Daniel Hemel (the title will be something like Two-Level Games in International Tax), domestic players routinely use the foreign realm as an arena through which they can respectively try to advance their own sides' prospects in domestic political fights. [We'll have an OECD-BEPS case study in our paper, but also one from 1957, involving Stanley Surrey and the battle over the "tax sparing" provision in a draft treaty with Pakistan. We might also have had a 1920s League of Nations case study, involving the likes of ERA Seligman and TS Adams, but we concluded that we weren't sufficiently sure-footed in the literature to be certain that the story we thought we saw was actually right.]

International tax cooperation is made easier in one dimension by these two-level games, which can foster cooperation and common interests between the players on each side (in re. how to tax business) in multiple countries.

3. A new international economic order? In using those words, at least in the current draft, the paper might seem to be claiming more than it actually is. Things are still clearly in flux, although Pillar 2 (but not Pillar 1) appears to be doing fairly well even if US cooperation is, at best, not in the immediate offing. But the claim is that, with the decline of the neoliberal "Washington Consensus," concerns about distribution between and even within countries are now very much on the agenda internationally. And there is also some hope that they may come to be negotiated out to a degree, using compromise to build broad agreements.

A different way to put it might be to say that the international tax policy agenda has changed, and that topics once deemed off-limits are now widely (if not universally) agreed to be on the table. If pro-democracy forces prevail around the world - as is by no means certain - one might even see, at some point, a new and improved such order gradually emerging, at least until the next set of shocks leaves us unmoored again.

NYU Tax Policy Colloquium, session 2: Rebecca Kysar's The Global Tax Deal and the New International Economic Order: Part 1

Yesterday, at the colloquium's second public session of the semester, Rebecca Kysar (who is visiting at NYU) presented the above-titled paper. It reflects, not just her longstanding international tax policy interests, but also her recent stint at the U.S. Treasury Department, where she was deeply involved in the international negotiations over Pillar 2 (the global minimum tax).

The paper focuses on an apparent paradox that is suggested by the 2021 global accord on implementing Pillar 2. In the trade policy realm, multilateralism has notoriously been giving way to go-it-alone protectionism or narrower regional and other alliances. Yet tax seemingly shows a newfound rise in multilateral cooperation (perhaps little noticed by international scholars outside the tax realm itself). How might one explain the disparity? The paper posits that in both cases - trade and tax - the trigger was public dissatisfaction with the distribution of the gains (as well as losses) from globalization, creating populist anti-business sentiment.

My main thoughts about the issues that the paper raises can be grouped into three main categories:

1) Multilateralism in tax versus trade: Again, multilateral cooperation appears to be falling in trade yet rising in tax, reflecting how populist anti-business sentiment has operated in each realm. But I would note an important difference in how it operates, at least in the US.

Trade: Standard economic theory holds that free trade helps all countries. While some individuals will be losers from it, the idea is that in each country gains will exceed losses. Hence, a given nation could in theory compensate the losers and reap a Pareto improvement from allowing free trade.

As it happens, this scenario does not always apply. For example, a country with monopsony power can benefit from optimal tariffs, and (as I and others have noted with respect to the digital economy), from taxing location-specific rents. In a scenario where lots of countries had the capacity to levy optimal tariffs, multilateralism could in theory yield a global welfare improvement from their all agreeing not to do it. But that scenario has not been at central stage in motivating backsliding from free trade.

Why does one need multilateralism with respect to "regular" (non-optimal) tariffs? It's seemingly unnecessary, as one can unilaterally decide not to harm oneself (and others) by imposing them.

The answer comes from interest group politics. Gains from free trade (e.g., to all consumers) are often more diffuse than losses (e.g., in a declining industry). So multilateralism's main role, in this story, is to secure the adoption of policies that would benefit each country even without reciprocity. I.e.: "I'll forgo my self-harming tariffs if you'll forgo yours.")

The decline of this model isn't just due to interest group politics, which we've had all along. Current bipartisan U.S. dissatisfaction with free trade reflects related political trends in each party.

On the Democratic side, not just politicians but the commentariat have concluded that concentrated losses (which generally don't get much compensation) are not just an interest group issue but one that matters. For example, we may care about workers in failing industry who lose their livelihoods because the skills they have developed no longer have value.

It's also thought that the economic gains from free trade are concentrated at the top. In principle, one could offset this by commensurately ramping up progressive redistribution. But in practice it works the other way. When the top rises, so does its political power, and hence it may pay less tax than if the rules remain fixed, not more.

Absent sufficient policy responses to the concentrated losses and wealth rise at the top, there is no theoretical reason to assume that the US is always better-off by reason of free trade's full operation. Thus, limiting free trade in some instances may serve as a kind of political second-best.

On the Republican side, where support for free trade was seemingly more hard-wired by both ideology and the interests of the donor class, its political downturn was initially forced on the party by Trump. But by now many others in the party have deduced that tariffs or other free trade barriers can be a political winner. This reflects electoral realignments, driving members of the white so-called working class (often not blue-collar at all) into the party's base.

Indeed, both sides have by now long since noted that voters who feel hostile towards free trade are often to be found in swing states that can turn elections. So there is a strong political impetus to move away from free trade, and thus to reject multilateral cooperation that helps to sustain it.

Tax: A very influential view holds that multilateral cooperation is needed to prevent multinational companies (MNCs) from engaging in tax avoidance. Tax competition yields a prisoner's dilemma, and multilateral cooperation is needed to address it.

Just as in trade, however, the need for multilateralism has been disputed. At least for large political entities with market power (e.g., the US and EU), there is some significant ability to impose tax unilaterally on either a corporate residence basis or that of "source" (using the scare quotes to detach from existing source rules). Just as with trade, therefore, multilateralism might be needed at least in part for domestic political reasons, such as overcoming domestic political opposition from the MNCs.

Either way, however, tax differs from trade in that here anti-business populism supports rather than opposes multilateral cooperation. Cue here all the headlines about Apple, Amazon, Facebook/Meta, etcetera earning huge profits and paying little tax, along with the results of public opinion surveys on the topic.

Does this difference in the political implications of anti-business populism explain the seeming paradox at the heart of the paper? To a degree, yes. But there is a big difference. US public political support for making MNCs pay more is far weaker and less politically consequential than that for protectionism. I would that it has verging on zero influence on the outcome of any election. At the most, doing the MNCs' political bidding may very slightly increase voters' perception that a particular politician is not on their side.

International tax policy in the US is mainly just an insiders' game for elites inside the Beltway. So the only reason anti-business populism matters at all in the Washington tax policy realm is that it has changed the views of Democratic (but not Republican) elites. [As an aside, the Republicans did in 2017 enact GILTI and the BEAT, but this reflected that they were being forced by budget limits to choose between the MNCs and business interests that they liked even more - viz., the odious pass-through rules.]

Hence, for anti-business populism to affect US international tax policy, the Democrats must be firmly in control of the legislative and/or regulatory process. And there's kind of an intensity or unanimity handicap here, since the Republicans are more fervent on this side of the debate than the Democrats on theirs, reflecting the MNCs' interest group influence on both.

SO: anti-business populism helps to explain both of the trends that the paper notes. But it's much stronger in trade than tax; hence, we are much more decisively moving away from multilateralism in the firner than towards it in the latter.

This is a US story. Is anti-business populism in tax stronger politically in, say, the EU than here? Probably so, reflecting that Europeans are less drunk on the anti-tax cocktail than are Americans, and also view the big American MNCs as "them' rather than as "us."


Sunday, September 17, 2023

NYU Tax Policy Colloquium, week 1: Christine Kim's Taxing the Metaverse

 On this past Tuesday, the NYU Tax Policy Colloquium had its first "public" session of the year, thus completing the kickoff to our Year 28. Christine Kim was our guest, discussing her paper Taxing the Metaverse.

The paper defines the Metaverse as virtual worlds in which there is "economic activity," defined as consuming, creating, accumulating, or trading digital items with "real economic value." That in turn is defined as arising when the items can be converted into, or at least measured in terms of, a taxable currency such as U.S. dollars or crypto. [In the rest of this post, I will use "$$" to denote U.S. dollars.]

Some examples include the following:

1) Second Life: In this onlife simulation one can get "Linden dollars" in several different ways. You can earn them through business transactions in the sim world, or buy them for $$, or get some if you subscribe to Second Life rather than playing it for free. You can also sell Linden dollars for $$ on Paypal.

2) World of Warcraft: This online game requires paying a monthly subscription fee. But when you are there, you can earn "gold" inside the system, and make $$ by selling it or various types of items to other players.

3) Nonfungible tokens (NFTs): These are unique items that one can create digitally through Blockchain and then sell for $$ to whoever wants them. One can think of them as akin to, say, trading cards or unique art objects such as paintings.

Then a non-example, under the above definition: To brush up my French, which I learned to a decent degree in my pre-college years but have since spent a lifetime forgetting, I spend a little time most days on Duolingo, doing very gamified 5- or 10-minute French lessons. My "achievements" earn me "lingots." But, so far as I can tell, all I can do with these lingots is buy "streak freezes." Duolingo records how many days in a row I have done at least 1 lesson, but with a streak freeze I can take a day off and Duolingo won't treat it as breaking my consecutive-days streak. This presumably falls well short of "economic value," since I can't get $$ for my lingots or, so far as I know, get anything that is actually valuable for them. (I wouldn't pay any actual cash for a streak freeze.)

In the first three of these items, however, there sometimes is significant economic value. While most Second Life players don't get anything significant via Linden dollars, apparently someone became a millionaire that way. And there are a few World of Warcraft players who do pretty well. NFTs also have become big $$ generators for some individuals.

The paper is concerned with the big hitters from metaverses like these, not just for their own sake but on the view that there may be a lot more of this in the future. Mark Zuckerberg is not the only person who has guessed or bet that the Metaverse (consisting of all the individual metaverses) will become big in the future. For example, I found online a KPMG report positing that, by 2030, "we could be spending more time in the metaverse than in the real world. People will be applying for jobs, earning a living, meeting with friends, shopping, even getting married using the virtual capabilities of the metaverse."

I am not sure how capacious the "we" in this statement actually is. But suppose we have people making money as virtual real estate brokers on Second Life rather than as actual ones in physical reality. Or that, instead of being a tennis pro in the real world, one makes a living selling shields or whatever in WoW. Or that artists who would have made real-world paintings are instead selling NFTs. (This is already happening to a degree.) Then there might conceivably be greater urgency than there is today regarding taxing the Metaverse in a sufficiently similar manner to how we tax activity in the physical world.

At the consumer level, presumably the above "we" will continue to need actual food, a place to stay, etc. But suppose that one was perfectly happy to keep one's "real" consumption minimal, such that, like Hamlet without the bad dreams, one could "be bounded in a nutshell and count [one]self a king of infinite space." The paper aims to address today's heavy hitters in #1-3 above, with an eye towards preparing for this possible future.

Current tax treatment of Metaverse "income" generally involves taxing people when they get actual $$. The paper advocates generally taxing them sooner, i.e., on an accrual rather than a realization basis.

I see the paper as raising 3 main topics: (1) How should we evaluate taxing Metaverse "income' in general?, (2) Should we generally tax it sooner as the paper advocates?, and (3) How should tax jurisdiction over Metaverse items be allocated between countries?

1) How should we evaluate "taxing the Metaverse"? The paper sees a case for taxing anything in the Metaverse  that looks like income under the Haig-Simons definition, or that seems analogous to items in IRC Code section 61. I'd advocate going one turtle deeper and examining the efficiency and equity consequences of taxing versus not taxing it. (People sometimes add a third category to this, administrability, but I regard this as an aspect of the efficiency analysis.)

From an efficiency standpoint, deadweight loss results from tax-motivated substitution. But even a pure Haig-Simons income tax, as conventionally defined, doesn't tax everything. E.g., it reaches work (and market consumption) but not leisure. Thus a key question, with regard to taxing Metaverse items, is the extent to which they are serving as substitutes for taxable rather than nontaxable activity. For example, playing Second Life instead of reading books and going jogging is generally less of a concern than becoming a virtual real estate broker within it instead of an actual-world one.

Note also that earning WoW gold that offsets one's periodic subscription costs is probably less of a clearcut concern than earning $$ value in excess of that amount. The former might be viewed as reducing the expected cost of the consumption, which often is used as a proxy for its subjective value.

NFTs' closest substitutes presumably are various real-world art and trading card items of various kinds. These generally are taxed on a realization basis. This would tend to reduce the efficiency costs of taxing NFTs the same way, rather than on an accrual basis.

From an equity standpoint, the main issue is inequality. I would say that there are generally 3 types of reasons for caring about inequality: (a) because it can affect the marginal utility of $$ that might be taxed, (b) because it can affect the social consequences of inequality that people in the society actually subjectively experience, and (c) because it can affect the application of the observer's / policymaker's own inequality aversion, if any.

So, when people accumulate value of some kind in the Metaverse, does it affect any of these three things? The marginal utility of one's $$s is presumably greatly affected by convertibility into $$. As for the other two, it very much depends on one's framework. By analogy, consider two individuals who are identical in their circumstances and utility functions, except that A is in a happy and fulfilling relationship, while B wants to be but isn't. Clearly A is better-off than B. But does A therefore have lower marginal utility of $$? Not necessarily (although the answer would more clearly be Yes if one could somehow "buy" a fulfilling relationship for $$). Does this type of inequality in circumstances create social distress from inequality that could be mitigated by transferring $$ from A to B? Again not necessarily. (Consider the distinction that Robert Frank and others draw between positional and nonpositional goods.) And do you, if you are the observer, intuitively feel that this sort of inequality is wrong and needs mitigating via $$ transfers? Again not necessarily.

This is not to end the above conversation or reach any particular answer, but just to outline the inquiries that might need to be made.

2) Taxing sooner: I generally share the paper's inclination towards taxing accrued income "sooner" when this is sufficiently feasible. But one is reminded of the debates about currently taxing, say, publicly traded stock on an accrual basis when non-publicly traded, but otherwise similar, assets are not being taxed before realization. This makes the issues more complicated than they would otherwise be.

In discussing the paper with students in the class that we held the week before the public session, I noted the difficulties that arise when one wants to allow tax payments to be deferred, without deferral's reducing their present value, under an income tax. Under a perpetual, fixed-rate consumption tax, deferral does not benefit the taxpayer. E.g., suppose that the tax rate is 40% and the interest rate is 10%. Then, if you earn $100 and can either pay consumption tax of $40 this year or $44 in a year, deferral does not reduce the tax's present value. But under an income tax the effective tax rate, as to the whole, must rise with each year's  saving and reinvestment, if one is to avoid making deferral tax-beneficial. This creates complications that a huge scholarly literature has examined. 

The paper proposes adapting the so-called "ULTRA" method that David Gamage, Brian Galle, and Darien Shanske laid out in a recent paper. This method provides a mechanism that can be used either in a wealth tax or (with modest adaptations) to impose deferred income taxation that is present-value equivalent to current income taxation. But the paper suggests (and I have not had the chance to verify this) that applying it to Metaverse items would require knowing the path of fair market value, which might be feasible for some such items but again raises issues akin to those raised by the divide between publicly traded and non-publicly traded assets.

For Metaverse value that is convertible into $$, one current taxation method would be to pay the tax on a current basis in Lindens or "gold" or whatever, that the government would then immediately sell for $$. But this leads us directly to the next question, concerning tax jurisdiction.

3) Tax jurisdiction: Suppose that Individual A, who resides in Country X, earns income that we agree arose in Country Y. This, from X's standpoint it is foreign source income of a resident, and Y would tax it on a source basis. This brings us into the realm of international taxation and international tax policy, such as the decades-long debate regarding residence-based taxation versus source-based taxation.

A's Metaverse income potentially raises issues in this domain. One might think of it as arising "nowhere," or in virtual rather than physical space. Or one could try to give it a geographical source based on such considerations as where A was physically situated while earning it, or alternatively where the servers or the underlying metaverse-providing company is deemed to have been located.

Because we are dealing here with the taxation of an individual who (let us assume) is located in the space where he or she resides, I am inclined to see residence-based taxation as standing on strong ground. The physical location of corporations and other business entities is much more challenging to tax on a residence basis than that of particular individuals acting as such - both because the former might not literally "reside" anywhere, and because the normative links between a "person" and any given country may be far weaker where the "person" isn't an actual individual.

So, while we have gone pretty far in the international tax realm away from considering residence-based taxation a very good approach for taxing corporations and other business entities, for individuals we are still (I think) pretty much still there, despite the issues presented by migration, the rise of "tax nomads," etcetera.

Still, it is common for the Country Y's of the world to want to tax the income that they reasonably deem to have been earned there by individuals who reside in Country Y. (And of course every country is X in some instances, and Y in other instances.) And, to paraphrase Seinfeld, it's not as if there's anything wrong with that. If I'm an American but I am earning income by selling something to Britishers, there is no compelling normative argument against letting the UK tax that income if the UK likes. (It is not as if some wholly unrelated third country, say Belgium, is inviting international tax chaos by trying to tax this income despite, let us posit, any particular relationship between it and either the income or me.) But once this happens we do have a bit of a problem as between US and UK taxes, if we don't want to tax-penalize cross-border activity.

Still, the motivation to tax such "foreign source income" is probably strongest if the source jurisdiction has some sort of market power that can cause the incidence of the tax to fall, at least in some degree, on the nonresident individual. This might not be the case either if the server happens to be there, or perhaps even if the Metaverse business happens to be there. (We are discussing here taxing the Metaverse user, not the business itself.)

Much of the time, therefore, there may be little reason to take seriously the prospect of source-based, as distinct from residence-based, taxation of people's Metaverse income. But then again, this conclusion will not always follow. E.g., suppose that my business model as a WoW savant is to sell gold and shields to Britishers in particular. The issues raised might not be entirely dissimilar to those posed by, say, Facebook's (I'm sorry, Meta's) earning income in the UK, and thus facing digital services taxes that might conceivably be replaced someday (but I'm not betting on it) by taxes under Pillar 1. Or, at least further analysis would be needed to establish whether these two cases are relevantly different. (But I won't further lengthen this post by including such analysis here - but see, e.g., papers on digital service taxes and the like by Wei Cui, by Bankman-Kane-Sykes, and by myself, among others.) Accordingly, I suppose one can't categorically say that it seems wisest for taxes on individuals' Metaverse income to be taxed exclusively on a residence basis, even subject to such caveats as the ascertainability of a given user's actual residence.

Monday, August 07, 2023

Susswein et al on tax expenditures

 In an article in today's Tax Notes (here, but it's behind a paywall), DC tax lawyers Donald Susswein, Kyle Brown, and J. Anthony Coughlan report their "surprising finding that there are billions in deferred corporate and individual capital gains taxes missing from the official tax expenditure budgets."

What they have in mind is realized but not recognized capital gains from tax-free corporate mergers and acquisitions, in cases where the transactions aren't mere changes in legal form (like reincorporating an existing corporation with all the same owners for some sort of minor technical reason). Rather:

"We are talking about exchanges that substantially change the parties’ economic holdings before and after the deal. Examples would include the tax-free merger of companies like Exxon and Mobil into Exxon Mobil Corp. or the tax-free transfer of $1.65 billion in Google stock to the founders of a 2-year-old startup like YouTube, deferring individual and corporate capital gains taxes on as much as $1.65 billion of realized capital gains in a single deal. These and thousands of similar arm’s-length exchanges clearly meet the official definition of a tax expenditure (there would be no feasibility problem with taxing the Exxon or Google deals if they failed to satisfy all of the technical requirements for tax-free treatment). But they are seemingly invisible to the tax expenditure budgets."

Their point is not that the underlying recognition rule is bad policy (reflecting that classifying something as a tax expenditure does not necessarily mean that it is bad policy). Rather, it's that these are clearly "income" under the "normal" income tax rules - which only count realized, not unrealized capital gains - on which the tax expenditure budget has long relied.

The article takes a bit of a wrong turn in relating all this to purported ambiguities in the Haig-Simons income definition. What makes that a wrong turn is the fact that the conventional tax expenditure budget expressly does not rely on the Haig-Simons concept, which again would apply even to unrealized gains.

I think that their article nonetheless makes an interesting point that may advance one's thinking about the use of tax expenditures as a concept. If one were to disagree with it within the conventional definition of tax expenditures (relying on the "normal" income tax structure, one would say that this structure excludes, not only unrealized gains, but what one might call (for want of a better term), kind-of, almost, quasi-unrealized gains. They themselves say that "[n]o one could object to not listing [mere changes in legal form] as tax expenditures." So they aren't actually drawing the line, for "normal" structure purposes, at technical realization vs. no technical realization. Rather, they are drawing it at technical realization plus something of economic significance changes as a result of the transaction.

This is a perfectly respectable way to define the "normal income tax structure" for tax expenditure purposes. Only, raising it highlights the unclarity of the underlying question: Why are we using that concept to begin with? What normative arguments should govern the debate about that choice?

When I wrote about tax expenditures some years ago - indirectly inspiring, I gather, the Joint Committee of Taxation's short-lived efforts to revise the concept when Ed Kleinbard was the JCT Chief of Staff - I thought that a far more coherent and useful concept than normal versus not normal structure was the famous distinction in Richard Musgrave's public economics work between the government's distributional and allocative branches. E.g., the distributional branch might or might not want to allow deductions for medical expenses (a long-debated policy question).  But it definitely would not distinguish between municipal and corporate bonds, which both income and consumption tax advocates agree should be taxed the same (whether both are included or both excluded) if one is merely trying to measure distribution without regard to implicit taxes. And it also would not countenance a tax credit or deduction for solar heating panels, as only the allocative branch would consider that a possibly worthwhile rule. I argued that, in the ordinary case, what we call a "tax expenditure" is an allocative rule (whether good or bad) that has been placed in what we think of as a mainly distributional system.

I thought that an improved version of the concept would distinguish between (a) rules that were clearly just allocative (at least, when thought about in a principled way), (b) rules that were clearly within the distribution branch's (such as deducting losses and gains in order to calculate net income), and (c) those as to which the distribution branch's preferred treatment was legitimately debatable (such as medical deductions)

[Let me insert here a brief detour. I have completed writing and will soon be posting on SSRN an article about medical deductions et al, which discusses among other things the recently much debated issue of deductions for the cost of assisted reproductive technologies or ART.]

Okay, back to the main topic. I thought that there should also be a category in the revised tax expenditure budget for items that reflect (at least in part) the concerns of the distribution system but that respond to administrative concerns rather than the aim of directly & correctly measuring (say) Haig-Simons income. This is where I would have put unrealized gains. It would be good, if the TE budgets are at all relevantly informative, to include a category for unrealized gains even though they are not, at least exclusively or even primarily, an intervention by the allocation system for incentive or other such reasons.

So the Susswein et al point could be construed as holding that amounts realized but not recognized by reason of the nonrecognition rules for corporate transactions should be divided into 2 categories. Those that apply to mere changes in legal form would go into my category of rules reflecting the administrative et al concerns of the distribution system. Those for the likes of the Exxon-Mobil and Google-YouTube transactions would be classified as tax expenditures. Not an unreasonable idea at all, although one would need to come up with and apply a dividing line.

Then again, maybe all this (including my work as well as theirs) vastly exceeds the real policy gains, if any, to be derived from trying to rationalize the tax expenditure budget. But I think there is some intellectual value to trying to get the underlying concepts (more) straight, and the Susswein et al article is helpful in this regard.

But one last quibble: Susswein et al argue that clarifying these points, while "obviously relevant to the tax expenditure budgets ... may be even more important to the question of whether unrecognized gains should be included in the determination of average tax rates (and other tax policy questions)." Here I disagree. When we are thinking, say, about the overall distributional effects of the tax system, or the broader fiscal system - e.g., how favorably does it treat the super-rich relative to those below them - Haig-Simons income is one of the distributional measures that one might consider using. (As I discuss here, another possibility is lifetime income.) The "normal" income tax structure really has no role to play in, and associated questions of what set of underlying motivations particular income tax rules might address, has really no role to play in, and nothing to contribute to, that discussion.