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.