California's budget crisis and the upcoming federal budget crisis

California is teetering on the budgetary cliff these days, issuing IOUs in lieu of meeting its obligations because it can't adopt a plan to close the budget gap even though it is wealthy enough to do so without serious difficulty.

The IOUs remind me of the line in Duck Soup, where Groucho asks Ambassador Trentino for a personal loan until payday and offers a 30-day note. "If it isn't paid in 30 days, you can keep the note."

Living across the country from California, and thus not myself directly facing the main consequences as this plays out, the question that occurs to me is whether this is a harbinger of future U.S. budgetary problems. I am inclined to think that it is.

Obviously, the federal and California situations are easy to distinguish. The U.S. government presides over an even bigger economy, from which exit by tax base factors is costlier. The U.S. borrows in its own currency, and thus has a one-time option to default implicitly through inflation, although this is a bit of a nuclear option given the likely macroeconomic consequences. And the federal government doesn't have Proposition 13 or the other various fiscal hamstrings adopted in California via the statewide ballot process.

But the key point in common is that California's crisis is an entirely self-inflicted wound, reflecting the political system's inability to respond adequately, even when everyone knows (in broad outline) what it has to do, since it's consumed with ideological posturing and chicken games. That is already a problem on the federal level as well, and there is no particular reason to believe that it will ease.

Shadow, 1991(?)-2009

Today, with a bit of heart-wrenching assistance on the home front, Shadow met his end. At age 18, his body was breaking down on several fronts, with multiple severe conditions that required a very high level of active daily care - seemingly inadequate, however, so far as we could tell, to give him a decent quality of life. At the end he had diabetes, a thyroid problem, bladder problems, kidney disease, was unsteady, and may have had bad arthritis. He would still eat, but slept and rested the remainder of the time, meowing plaintively in an uncharacteristic way and sometimes seemingly trying to keep himself awake, which I've never seen from a cat before.

He was one of the nicest and kindest creatures of any species that I have ever known. I'm not sure our species entirely deserves his extremely positive view of us - although I suppose his experiences with us were pretty uniformly good.

I first met him in a men's clothing store that was having a closing sale. We made friends right away, which I must say wasn't hard to do, and he actually was following me around the store on a short acquaintance. He made us all very happy for eight years, and I just wish we could have known him longer.

Extremely mellow and easygoing at all times, except that he sometimes felt strongly about our food. Here you can see him in happier times, ingeniously using his front paw to extract milk that had been left for a minute in a glass on the table.

Finally, a reason to live in Washington!

... So as NOT to subscribe to the Washington Post, now that it has fired its only good print or on-line political columnist, Dan Froomkin, for political incorrectness as defined from a neoconservative perspective.

I already don't and wouldn't subscribe to the Post, but living in Washington would make it more pointed.

All things considered, probably not a good enough reason to live in Washington.

Recent diversions

Mark Maxwell's novel Nixoncarver; Lily Allen (both albums but especially It's Not Me, It's You). The first is mainly for hardcore Nixon (and to a lesser extent Carver) fans; the latter should be (and is) for lots of people.

Not sure I like my new green background on the top, but it's for Iranian solidarity.

Battle of the revenue estimates

As noted in several news articles with links at the TaxProf blog, the Joint Committee on Taxation estimates that President Obama's international tax proposals will bring in about $50 billion less than the Administration had estimated, over the period from 2011 (when the proposals would take effect) through 2019.

I thought it might be helpful to show the line by line comparisons of the estimates for the main proposals applying to U.S. multinationals:

1) Defer deductions for (other than research & experimentation) that current law apportions or allocates to foreign source income that is deferred: $60.1 billion according to the Administration, versus $51.5 billion according to the JCT. I guess we could say this one is not entirely un-close.

2) Deny foreign tax credit where the associated income isn't recognized and require pooling approach for determining which foreign tax credits are made available by repatriation: $43 billion according to the Administration, versus $55.7 billion (the sum of two amounts estimated separately) according to the JCT. The JCT is higher here, and higher for changes 1 & 2 combined. I wonder if a difference in "stacking" convention is operating here (e.g., when either of two proposals, standing alone, would raise a given dollar, to which of them do you credit it?).

3) Prevent use of "disregarded entities" in overseas tax planning: $86.5 billion according to the Administration, versus $31 billion according to the JCT.

This last one seems to be the source of the big difference. Everything else, including proposals for individuals, adds up roughly the same as between the two sets of estimates over all. So evidently the big disagreement concerns item # 3 above, which would eliminate a device that multinationals use to shift income abroad from high-tax to low-tax jurisdictions without thereby (as would happen if they did it more straightforwardly) incurring a deemed dividend to the U.S. parent under subpart F in the U.S. international rules.

I must say, even without analyzing any data, I thought the Administration's estimate of the disregarded entities change seemed a bit high. I would assume that, as between the two estimates, the one by the JCT (a) treats taxpayers as much more able to find alternative routes to the same tax planning ends, and/or (b) assumes that taxpayers give up on their overseas tax planning maneuvers, since subpart F would now eliminate the benefit, and therefore they end up paying higher taxes to the source jurisdictions, rather than to the U.S. Treasury.

The Obama international tax proposals were probably DOA (in the short run at least) anyway, given the combination of (a) bipartisan opposition, (b) the existence of higher-priority legislative issues, and (c) the lack of top staff on hand in Treasury (especially given the sad recent news that Beth Garrett has withdrawn her candidacy for the Assistant Secretary of the Treasury for Tax Policy position).

A couple of quick points about the disregarded entities proposal:

(a) It merely corrects a mistake that the Treasury made in 1997 when it changed the rules for classifying ambiguous legal entities as C corporations or not for purposes of the U.S. federal income tax. The Treasury surely has the power to act unilaterally on this by fixing the regulations, only (a) under federal budget rules, the Administration then wouldn't get credit for the extra revenue (though obviously the budget deficit would reflect whatever revenue came in, and (b) Congressional leaders, hearing angry complaints from U.S. multinationals, might regard it as a breach of comity. But this doesn't mean the Administration's proposal is good - the past mistake is water under the bridge, and the question of interest today is whether the proposed legislative change would on balance be good or bad policy.

(b)The proposal clearly makes sense IF one favors the use of subpart F to prevent companies from shifting business income abroad from the true source jurisdictions to tax havens. Note that the source jurisdictions could do this themselves (and get the revenue) if they wanted, such as through tougher rules for transfer pricing and the use of debt to strip away local earnings. Perhaps they don't want to because they see it as a targeted tax break for mobile capital investment. I myself am on the taxpayers' rather than the Obama Administration's side in this debate, on the view that the proposal would result in revenue-raising for other countries not the U.S., or else simply lead to reallocation of who does foreign business investment from U.S.-incorporated to non-U.S. incorporated companies.

Clearly it's in the U.S. national interest, all else equal, for companies owned by U.S. individuals to pay lower taxes abroad (since the money goes to someone else, not to us). To take an opposite and pro-Administration view of this issue, one might have to either (a) believe that we still come out ahead from reciprocal anti-tax avoidance efforts, which strikes me as unlikely, or (b) view the lower tax rates abroad as likely to reduce investment and revenues in the U.S., which the empirical evidence (with good logical underpinnings) tends to rebut.

Remiss?

Not many blog entries lately, because in summer my engagements reduce sufficiently that I'm not distracted and running from one thing to another. Instead, I can focus at work on my writing, and my energy goes into that. I'm nearly done with chapter 2 (not counting a short intro chapter) of a book on U.S. international taxation that I'm fairly enthused about, in that I feel it will contain new insights and advance the debate. Not that anyone will accept them or anything, but still. A few will possibly see the merits.

My most recent book, Decoding the U.S. Corporate Tax, didn't center on bringing new insight to the practical issues in the field because they haven't engaged me as deeply. Instead, its prime strength is in explaining how and why the rich but under-appreciated economic literature in the area is important, and why none of it really fits (which is the lawyers' fault, not the economists). I do feel this makes the book valuable, as well as often fun to read. But in international tax the practical policy questions engage me more and I feel the theoretical literature has to a greater extent fallen short.

Anyhow, some other random notes. Tonight I attended (most of) an Elvis Costello concert on his country & bluegrass tour. Enjoyable, professional, nice band and sound, seems at this stage an amiable raconteur. I'd never seen him before, but I'll swear by his first 4 albums (plus Spike to a lesser extent). These days, a bit literalist and lacking in poetry as a writer. And almost the only songs I recognized were Blame It On Cain and the Velvet Underground's Femme Fatale. Still, nice to have seen him.

On a completely different subject, I'd meant to post a link to Greg Mankiw's recent co-authored paper that offers a nice little summary of the optimal income tax literature. So here it is. Next time I'm teaching a basic tax policy class I may well assign it, and people who want an intro to the field may find it useful. I had been waiting to have the chance to post a corrected link to an old paper of mine that discusses some related ideas, and that more or less started a micro-genre in the legal tax policy literature on endowment taxation. So here that is. I found to my surprise that this link has a problem - the paper as posted is lacking two charts that may help in understanding the discussion, as well as the bibliography. I'm trying to post a corrected version but it's not up yet. Better the posted one than nothing, I suppose.

Fool me once, shame on you ...

... but needless to say, fool me twice and it's shame on me. By these lights, our cat Buddy (a.k.a. the Wascally Wabbit) succeeded in shaming us the other day.

Perhaps 3 years ago, we had a period when we would occasionally let him go out into our small, fence-surrounded backyard. For a while, he just patrolled, sniffed things, and so forth, but one day, while someone's back was turned, he hopped over the fence and we didn't see him for five whole days. Since he didn't have a collar, this was a pretty big problem. We papered the neighborhood with photos and so forth. Finally one day I spotted him on someone else's second-floor terrace. He meowed at me though it was several houses down, and we were able to retrieve him.

He looked pretty good - well-fed and well-groomed, rather than in the least bit bedraggled. We were curious how he had lived those 5 days - and, for that matter, how he had gotten onto a terrace that was seemingly inaccessible, even to a cat, from the ground (nor had the neighbors seen him in their house). But he wasn't talking. I am confident that he will take those secrets to the grave (though not for many years yet - he is only about 4 and we also have a 19-year old cat).

This led to a policy of not letting him out, ever. But the years pass and one's policies loosen up. He's been so desperately eager to get outside that, over the last few days, we let him out a few times, albeit while very closely watched. Since cats are usually deliberate in their movements in territories they don't know well, we figured we would be able to grab him if he got ideas, as no doubt he eventually would. We also blocked the easiest escape routes.

Then two days ago, he was calmly sitting in the middle of the yard looking around, when suddenly he saw another cat on one of the fences between the different yards. In a quarter of a second if not less (it seemed), he (a) shot across the yard, (b) jumped to the top of a fence that's about 6 feet high (scrabbling along the side on the way up, as cats do when the jump is too high to do all at once), and (c) raced along the top of the connected fences (a functional catwalk) at least thirty feet down, and well out of our yard, in pursuit of the other cat.

You had to see it to believe it, though it was so fast that I barely did. Truly the peewee version of the Hound of the Baskervilles racing down the moor in pursuit of fresh game.

By five seconds later, we couldn't tell where he was - there were perhaps 20 possible backyards, many of them in small apartment buildings. And we didn't entirely (or perhaps at all) trust him to return. Our relations are very cordial but less intense than with our other two cats (he is very sweet but, if he were a person, we'd say he's in his own head). The saying "You can never really own a cat," is true of him, though not of all cats. Also, we don't feed him enough, by his lights, because if we did (as we used to) he'd be extremely overweight.

But the story has a happy ending. A neighbor on the other side, not previously known to us, heard us calling his name and asked if everything was okay. A fellow cat-owner, she volunteered to call her cat-owning neighbors to see if Buddy had shown up in any of their yards. He had, and I went to fetch him. When I got to the yard in question, Buddy had left, apparently startled by the stranger who had gone out to check on him.

But good old bribery did the trick. I had shown up with "greenies," a small cat treat that, in our house, he likes to chase and bat around before gobbling down. I called out to him and he looked at me, but that alone didn't seem to count for much. But when I started rattling the greenie container and actually took one out, he calmly walked over and let me grab him.

Fool me three times and ... well, we don't plan ever to let him out again, but we're also ordering a collar with contact information.

Latest publication

A short article of mine, "Internationalization of Income Measures and the U.S. Book–Tax Relationship," just came out in the National Tax Journal. Not available on-line (other than the abstract), and I don't seem to have posted it on SSRN, but the cite is 62 N.T.J. 155-67 (March 2009).

The abstract is as follows:

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

Doug Holtz-Eakin talks up new conservative think tank

I admit to having been hard occasionally on Doug Holtz-Eakin during the 2008 presidential campaign. I had three reasons for this: (1) at times he deserved it, (2) I expected better from him, and (3) he risked harming his entire profession's public reputation through egregious flacking that should have been left to others in the McCain campaign. The strangest thing about his flacking was its inconsistency - one day he'd spout a silly talking point that was beneath his station (so to speak), and the next day he'd make a responsible comment about the long-term fiscal situation (which of course neither candidate wanted to highlight).

Anyway, Doug has now resurfaced via his statement that he's developing a proposal for a new think tank that he calls a “Center for American Progress for the right.”

This in turn prompts Paul Krugman and Matt Yglesias to note the already large supply of conservative think-tanks (such as AEI and Heritage) with exceptionally deep funding. They posit that, since the Republican Party and the conservative movement have gone stark raving mad, institutions that align with them, in Yglesias' words, must "not [be] prepared to accept anything other than 'tax cuts' as a solution to anything. Consequently, they’re not really even prepared to accept the premise that other problems exist. Tax cuts can’t solve climate change, so there must be no such thing! Tax cuts can’t curb inequality, so there must not be a problem with growing inequality."

This is a bit unfair. AEI, for example, is a mixed bag. On the one hand, it was the venue the other day for the Cheney speech, about which the less said the better. But it also still features intelligent and responsible commentary, such as (just to give one example without prejudice to others) this.

The problem is that, when an institution gets too deep in bed with really bad apples (or demanding funders), the good people doing good work there suffer a labeling or guilt by association problem. Or they may need to watch what they say and avoid pursuing some ideas too far. Thus, Holtz-Eakin could accomplish something by creating an institution that stuck to the high road. But the tricky part is getting the funding and prominence needed to pick off the good people from compromised institutions. Making this all the harder, those institutions have good reason to treat a few high-minded people very well. The labeling confusion goes both ways - the institutions gain luster from good and honest work done there, just as the people doing that work risk losing a bit of their own luster.

In discussing his initiative, Holtz-Eakin talks a bit too much for my taste in terms of reviving the Republican Party. It's certainly extremely important for our national welfare - as numerous people on the left have noted - that the Republicans return to planet Earth and to our country's traditions (not to mention those of the Enlightenment). It's also true that hypothetical Republicans who had returned to sanity and decency would be the natural constituency for a policy shop lying on the side of the spectrum that is more pro-market and less focused on inequality. But I would say that the smarter and safer way of getting to that end state would be to utterly ignore the Republicans for now, and wait for them to come calling in 2014 or so. As I would have hoped Holtz-Eakin had already learned, engaging with them now is a recipe for debasing oneself without improving them.

Possible early hire, if Doug is serious: Bruce Bartlett.

Summer's here and ...

So far I've written a 1,000 word piece on tax reform ideas for a U.S. publication, another of 5,000 words on the Administration's international tax proposals for a U.K. publication (the U.K. is preparing international tax changes in the opposite direction), and better nailed down my plans for an as yet untitled but perhaps 15% written book on U.S. international tax policy.

Cheney

I've been following the man's antics with amazement. He's obviously a very disturbed individual. I've heard privately from people who worked in national security in the Bush Administration that he had a fascination with torture and would keep after it even when begged by his associates to give it a rest. Obviously it serves deep psychological needs for him. His daughter is right - torture truly is his cause, in the same sense that global warming is Al Gore's.

Of course, I don't wish to discount Cheney's rational motive, from his perspective, to fabricate evidence in support of invading Iraq.

Charming show

Yesterday, to celebrate Mother's Day plus certain household members' birthdays, a close fambly group of us went to see Coraline at the Lucille Lortel Theater - this being the stage musical version, with songs by Magnetic Fields / 69 Love Songs genius (if I may say so) Stephin Merritt, rather than the movie that I have thus far avoided (based on my perhaps unjustly suspecting it of being Disneyesquely cloying). The show was delightful and the music extremely inventive, one person being enough orchestra here to outdo the typical Broadway theater pit.

UPDATE: A few days later, as part of an end-of-year school event, we saw the Broadway adaptation of Schiller's Mary Stuart. Very different genre. The acting was good, but MY GOD what a flurry of over-long bombast.

Radio appearance off the usual circuit for me

Today I discussed the Obama Administration's international tax plan on a Jamaican radio show, Evening Edition Newstalk 93 FM. I assume the interest over there lies in concern that Jamaica is one of the tax-friendly locations being targeted by the plan. My fellow commentator was someone from the Tax Foundation, who I assume was more anti-plan than I was (though you can guess my largely skeptical content from my prior post), but through my phone connection I could not hear more than one word out of every 10 that he spoke. Luckily he didn't try to cross-talk me (or if he did, I never realized) as it's hard to respond when you don't know what they're saying.

Silliest moment came when the host asked me if the Administration's tax plan was socialistic. After half-snorting, half-laughing (you had to be there), I noted that JFK's international tax plan went a lot further than Obama's (repealing deferral altogether) and also involved a higher rate than 35%, but no one seemed to think that was socialistic.

I suggested that the part of the plan aimed at U.S. companies, if not quite DOA, is likely at a minimum to be cut back substantially by Congress, but that the part aimed at tax-evading individuals seems feasible both politically and administratively.

The Obama Administration's new international tax proposals

I'm still trying to get a preliminary handle on the Obama Administration's international tax proposals. The fullest description I've yet been able to find, from a White House fact sheet, is available here.

The fact sheet opens by stating that the White House's key concern is about jobs fleeing the U.S. However, recent empirical literature about U.S. international taxation on balance supports skepticism that jobs really "flee" the U.S., on a net basis, when U.S. companies invest abroad due in part to the lower tax rates available there. The two main reasons for doubt are (a) at the firm level, complementarity rather than substitution as between home and overseas investments; (b) what I call the "musical chairs" point. If there are good slots for business investment in the US (e.g., available workers, nearby resources & consumer markets, etc.), then one prospective user's deciding against using a particular slot may induce someone else to go there.

I thus think of it as more of an efficiency and revenue issue. Raising taxes on outbound investment to be closer to those on domestic investment has the potential - subject to the problems discussed below - to be more attractive on efficiency grounds than alternative means of raising the same revenue.

The efficiency gains from equalizing domestic and foreign tax rates faced by U.S. taxpayers might verge on being a slam dunk argument for the Administration's general position if not for one further problem. When we impose business taxes on legal entities such as corporations, rather than directly on individuals, we can only impose the U.S. tax rate, for investment abroad, on companies that are classified as U.S. residents. Unfortunately, corporate residence is an extremely weak reed for the imposition of U.S.-level rather than tax haven-level taxes. For new investments (as distinct from those already out there, which are hard to shift without paying a tax price), it is quite easy for investors to use non-U.S. entities.

Anyway, onto the Administration's proposals after one last bit of background. The Administration is proposing to use legislation even for changes that it could accomplish purely by revising Treasury regulations. This, in turn, may be an artifact of budget rules that only permit it to claim credit for extra revenues when achieved through legislative changes. That's really too bad insofar as changes that one deems desirable end up being blocked by the vociferous opposition that clearly will emerge in the legislative process.

And fight the opponents will. Herewith a quote from a newly posted article by Ryan Donmoyer at Bloomberg:

“'This is bad stuff,'” Kenneth Kies, a tax lobbyist at the Washington firm Federal Policy Group, said of Obama’s plans. “'This is going to be the biggest fight for the corporate community in the next two years.'” Kies represents General Electric Co., Anheuser-Busch Cos. and Microsoft Corp., among others."

But don't worry about Ken, who I'm sure will find the fight lucrative as well as stimulating. Think of all the other corporate lobbyists in different areas who wish they could say with a straight face that THEIR issues are the biggest ones.

Anyway, back to the White House press release, which opens with the following fun facts:

--In 2004, U.S. multinationals paid $16 billion of tax on $700 billion of foreign active earnings, an effective U.S. tax rate of 2.3%. Comment: Given foreign tax credits, this would be true even without the benefits of deferral and their enhancement by tax planning, if foreign rates were close enough to U.S. ones. It would be interesting to see the pre-credit "gross" tax liability, although that requires a grain or two of salt as well given foreign tax credit planning games. Note, however, that if we can't do much better than this (and I'll suggest below that perhaps we can't even with aggressive anti-tax planning rules), one wonders if the game is worth the candle. Lots of tax planning, compliance, and administrative costs relative to the revenue that's being raised.

--83 of the 100 largest U.S. corporations have subsidiaries in tax havens. Comment: What could possibly be holding back the other 17? Are their operations purely domestic?

--One address in the Cayman Islands hosts 18,857 corporations. Comment: I've always wanted to visit that building, especially if there are nice beaches nearby.

--Nearly one-third of all foreign profits reported by U.S. corporations in 2003 came from Bermuda, the Netherlands, and Ireland. Comment: One dismaying fact one learns from this is that, of the two pillars of international taxation, residence and source, BOTH lack fundamental economic meaning and thus invite extensive game-playing. This helps explain why there are no really good answers in U.S. international taxation. Disposing of the corporate residence concept and taxing income based purely on source (e.g., via an exemption system) would be far more clearly correct if source were a less slippery and manipulable concept.

Anyway, on to the Administration's proposals with very brief comments based on what I understand so far:

1) DENY DEDUCTIONS ASSOCIATED WITH UNTAXED OVERSEAS INVESTMENT UNTIL THE INCOME IS REPATRIATED TO THE U.S. - This amounts to a partial repeal of deferral, just as denying home mortgage interest deductions would amount to a partial repeal of the imputed rent exclusion. Note also that allowing the deductions (as under present law) arguably goes beyond putting U.S. and foreign companies on a level playing field. Suppose a U.S. company deducts domestic expenses at 35 percent so it can earn abroad at 10 percent. This is a better outcome than a company that was purely in the source jurisdiction would get from both deducting and earning at 10 percent.

Deferral creates massive distortions in tax planning by U.S. companies. A burden-neutral repeal of deferral (as proposed by Rosanne Altshuler and Harry Grubert) therefore strikes me as all to the good. They propose to get there by lowering the rate to offset the effective base-broadening. But non-burden-neutral, revenue-raising repeals of deferral run into the problem that companies may simply respond by reallocating their investments so that companies classified as U.S. residents aren't the ones doing these things. Over the long run, certainly, it's not going to be very sustainable to impose a worldwide tax on U.S. companies that exceeds the taxes owed if the same owners invest through non-U.S. companies.

Since it's really a transition issue, involving revenues from taxing existing profits that we might be able to get while companies are in the process of shifting around to beat the rules, my preferred proposal, which I realize is politically unrealistic, is to impose a one-time transition tax on the unrepatriated earnings of U.S. multinationals, accompanied by a change in regime to show that we don't plan to do it again. If credible, this would avoid affecting incentives regarding whether new investments starting tomorrow should be made through U.S. companies or foreign ones.

2) CLOSING FOREIGN TAX CREDIT LOOPHOLES - According to the White House fact sheet, "current rules and tax planning strategies make it possible to claim foreign tax credits for taxes paid on foreign income that is not subject to current U.S. tax." Agreed that this is not supposed to happen under the current rules, though I'm not surprised to hear that it does. Offhand, I'm not up on exactly what sort of tax planning strategies they have in mind. The Administration proposes to respond by changing the rules so as to determine allowable FTCs based on the ratio of total foreign tax to total foreign earnings. If I understand this correctly, it's a pretty big shift from basing FTCs purely on the income brought home this year and the foreign taxes associated therewith. This one is pretty interesting, and, like proposal (1), sounds like it's potentially a big structural improvement, only, subject to the same concern that, in the long run, the optimal U.S. tax burden on outbound investment by our multinationals is greatly lowered by the ease of investing through non-U.S. entities. Hence, same comment about preferring a transition tax to increasing the tax burden on outbound investments that might be made tomorrow.

FTCs are a really lousy instrument design, and I'd support extending Altshuler-Grubert to include burden-neutral repeal of FTCs as well as deferral. This idea couldn't be done the Altshuler-Grubert way, however, since they propose lowering the domestic corporate tax rate to match their burden-neutral reduced foreign rate. Doing this for FTCs would lower the burden-neutral rate too much for it to apply domestically as well as on outbound.

3) USE THE REVENUES RAISED ABOVE TO MAKE THE RESEARCH & EXPERIMENTATION CREDIT PERMANENT - Companies are going to laugh at this one, since they expect to have the credit extended anyway. (It's always ticketed for phase-out in a couple of years but is always extended again.) That said, extending the credit arguably gets some support from R&E's positive externalities - though I suspect that, in practice, the credit also covers a lot of junk. Making it permanent has additional virtues in that it adds certainty and reduces the need for ongoing lobbying expenses by the companies that want it, and financing the extension is a step in the right direction given the U.S. fiscal gap.

4) PREVENT U.S. COMPANIES FROM USING THE "CHECK-THE-BOX" REGULATIONS TO SHIFT INCOME TO TAX HAVENS WITHOUT BEING SUBJECT TO U.S. TAXATION UNDER SUBPART F - This recoups a blunder that the Treasury made during the Clinton Administration when it adopted "check the box" without thinking through the international ramifications. I'd think they could do this through regulations alone, apart from the budgetary scoring problem I noted above (though companies might complain and try to get Congress involved). Main problem is simply that the subpart F rules that companies evade by using check-the-box are subject to the same concern that I keep repeating here, i.e., limited ability to keep on imposing higher taxes based on U.S. corporate residence.

The remaining Administration proposals in the press release mainly pertain to individuals and compliance problems using tax havens. In general, I'm strongly in favor - these often involve fraud, and taxing resident individuals on outbound investment lacks the fundamental conceptual problem of doing so for legal entities such as corporations, since it's actually economically meaningful (and hence less tax-elastic) to live in the U.S. and/or be a citizen.

The New York Mets

I'm a Mets fan, not by choice, but because I have no choice. The affliction first struck me before my 7th birthday, and there's really nothing I can do about it now.

Queue here the Macbeth quote:

MACBETH: Canst thou not minister to a mind diseas'd;
Pluck from the memory a rooted sorrow;
Raze out the written troubles of the brain;
And with some sweet oblivious antidote,
Cleanse the stuff'd bosom of that perilous stuff
Which weighs upon the heart?

DOCTOR: Therein the patient
Must minister to himself.

Unfortunately, accomplishing that is a bit above my pay grade. But at least a Mets site that I saw today (while struggling with the start-up to a new section of my U.S. international tax book-in-progress) offered two appropriate photos, one capturing my sense of the Mets front office and the other of the team itself.

Virtually participating

As I noted in my last post, today I was supposed to be in Milan, Italy, participating in a panel at a conference entitled "Tax Policy and the Financial Crisis," held by Econpubblica, the Center for Research on the Economics of the Public Sector at Milan's Universita Bocconi. Lots of excellent people, mainly European economists, officials, and businesspeople, were also there, and I was looking forward to meeting many of them for the first time, as much as to seeing The Last Supper and sampling the local cuisine. Severe though transient back pain forced me to cancel, but this morning I was able to participate from my desk, courtesy of the remote video conferencing wizardry of Skype, along with the help of kind people on both ends.

My talk was entitled "The 2008-09 Financial Crisis: Implications for Tax Reform." It's briefly described here. You can also, if interested, access a pdf version of my PowerPoint slides for the talk, either at the previous link or here.

Ouch

The semester is now over, and I was supposed to be (at this very hour) headed to JFK Airport to fly to Milan, where I'm scheduled to appear on Thursday, April 30 at an Econpubblica, Universita Bocconi conference entitled "Tax Policy and the Financial Crisis." Good food, a viewing of Leonardo's The Last Supper, and getting to meet a number of leading European tax policy economists and lawyers, were also part of my plans for my expected 48+ hours in Milan.

Severe though (I hope) transient back pain forced me to cancel, and I'll instead be attempting remote video participation via Skype. Have PowerPoint slides, will travel, even if only virtually.

Final NYU Tax Policy Colloquium of 2009

Yesterday we had our final session, featuring Tom Brennan's Certainty and Uncertainty in the Taxation of Risky Returns.

Tom's article, still in early draft form, is a contribution to the extensive Domar-Musgrave literature on the treatment of risk in an income or consumption tax. It's well-established in that literature that, with a uniform tax rate (including loss refundability) and complete financial markets, neither an income tax nor a consumption tax affects the after-tax return available to taxpayers on their investment portfolios, except that the income tax hits the entire portfolio at the tax rate times the risk-free rate. That rendering may sound esoteric, but the key point is that taxpayers can undo the tax system's mandatory insurance by suitably adjusting their pre-tax portfolios, again assuming that financial markets are complete.

While the Domar-Musgrave reasoning notoriously requires all sorts of strong assumptions, these help to focus (as I put it at the session) on the "income-ness" of the tax base. In other words, there's no claim that the actual tax system has no effect on risk; rather, its being an income tax has no effect that wouldn't generally be the same (e.g., due to incomplete markets) if it were instead a consumption tax.

One feature of the actual tax system actually having a huge effect on risk-bearing is the lack of full proportionate rates. Rates on positive income are graduated (though for large corporations this is relatively insignificant), and net losses are non-refundable except insofar as one has net income in other years permitting the use of net operating losses (NOLs).

Tom Brennan, who has a math PhD, aims in his paper to give us a new way of looking at the tax rate effect on risk. Taking the simple case of an investment that will either gain $X (taxable at the statutory rate) or lose $Y (assumed to be non-recoverable despite the possibility of other taxable income in the same or a different year), he models nonrefundability as equivalent to a government call option on the value of the asset, based on the statutory rate.

His analysis used investments changing value over time, but I thought it could be made simpler through an example involving an instantaneous coin toss bet. E.g., suppose if it's heads you win $100, tails you lose $100, and the tax rate is 50%.

The standard Domar-Musgrave point (leaving out time and thus income taxation) could be illustrated by noting that, if there's a 50% tax with full loss offsets, all you have to do is double the bet to $200 pre-tax to end up in exactly the same place as if there were no tax.

Tom proposes to look at the case where the gain is still taxable at 50% but the loss is disallowed. Now, to restore after-tax the $200 dispersion in outcomes that you had in the non-tax world (since you'd either gain or lose $100), the amount bet has to be jumped up to $133.33. This will leave you, after-tax, either plus $66.67 or minus $133.33. Only, this is not very satisfying despite restoration of the prior level of dispersion, since the expected after-tax return is now minus 25%. So in fact you'd refuse to bet if you demand at least the 0 expected return that you could have gotten by doing nothing.

Tom notes that one could look at the government's tax claim as akin to its having gotten a free call option permitting it to claim half of the betting outcome. Win and the government takes half of your risky outcome for the strike price of zero; lose and the government lets the option expire as it's out of the money (a negative return being worth less than zero). Under these facts, the government's option was worth ex ante 25% of the amount bet.

Final step in restoring Domar-Musgrave style equivalence, if you happen to have an aesthetic taste for going there, is that, if the government compensated the TP for the value of the option, we'd end up (as in the standard Domar-Musgrave scenario). Specifically, the TP would bet $133.33, the government would hand him $33.33 in cash to make up for the option that it's taken, and the taxpayer would end up after resolution of this bet with either $66.67 or minus $133.33, in either case plus the cash that the government handed him.

The point not being that this is either a policy recommendation or a prediction of any kind; it just closes the circle so we can square our accounts (so to speak). Or, a bit more pertinently, if the government doesn't compensate the TP for the value of the option (and why would it, if it evidently wants to impose the asymmetric tax), the value of the option that's been taken tells us something about the burden being imposed through the asymmetric rates.

All this may sound a bit esoteric, but it was a good last PM session, as we were able to help clarify what the paper says (it's math-heavy and tough reading for lawyers). Question to be answered down the road is how much the model helps us in advancing our understanding of the real world impact of asymmetric rates. While this particular way of parsing them is new, experts have certainly long understood that loss nonrefundability is potentially important to risk-taking, as are graduated marginal rates.

More on this from me in a few days and in a different setting. I will be in Milan, Italy for a couple of days next week, to speak on April 30 at a conference entitled "Tax Policy and the Financial Crisis," to be held at Econpubblica, Universita Bocconi. I'll be on a panel addressing the financial crisis's long-term implications for tax reform, and one of the topics I plan to address is the interplay between loss nonrefundability and excessive risk-taking, AIG-style.

Torture revelations

I've been staying away from the Bush Administration torture controversy as it really isn't anywhere near my area of expertise, but I must say, the new revelations that one motivation for torture may have been to generate "evidence" of al Qaeda-Saddam ties truly takes it to a new level.

It's Curry Time!!

My basketball-playing, basketball-fan son and I had been watching some Knicks games during the season, are now watching the NBA playoffs, and have developed a new phrase: "It's Curry Time!"™

(Based on the overweight, unmotivated, perpetually injured and indifferent Knicks player, Eddie Curry, who has about an $18 million annual salary but who played only about 5 minutes this year, during which time the Knicks were badly outscored.)

He's a big center, only he can't or won't run, jump, pass, catch a pass, rebound, or play defense. He can shoot from 5 feet away when he's healthy, but getting him the ball there is another question unless he's being defended by Ferdinand the Bull (as distinct from, say, Joakim Noah the Bull).

Curry Time!™ used to be the moment when a game was enough of a blowout that you would voluntarily put Curry in if you were the Knicks coach, just to showcase him (as if that could help) and rest someone else. Meaning, garbage time to the nth degree.

It's been redefined to mean the point in a game when the team with the lead could put in Curry if they had him, keep him in for the rest of the game, and still win.

At the end of the third quarter tonight, the Cavaliers were beating the Pistons by 27 points. I asked my son: "Is it Curry Time!™ yet?"

He thought it was still a bit too soon. Even with a 27 point lead, even with LeBron, the Cavs might not be able to hold this lead against a mediocre 8th seed with Curry in the game.

Turned out he was right. Even without Curry, though also without LeBron (whose presence would be a wash at best for Curry's), it's down to 11 points with 8 minutes to play.

Chicken game

Considering the shape that Chrysler is in, it would be amusing, if it weren't so contemptible, that the company opted for expensive private financing in lieu of cheaper bailout financing, in order to avoid limits on executive compensation.

I read some speculation that this was to make it easier for Chrysler to conclude the Fiat deal - although Fiat presumably doesn't care about current Chrysler executives' compensation levels (so the argument would have to be about people it brings in). But I would guess the Chrysler execs are simply gambling that the more they keep over-paying themselves, even if they needlessly increase the company's financial burdens (which are not their problem any more), the more they will end up taking home in the end given U.S. government reluctance to pull the plug and let them go. They are playing a chicken game with the federal government, and I would guess they're winning.

Moral hazard indeed.

This is the most "it figures, business as usual" story I've seen since FASB, responding to Congressional bullying, eased the mark-to-market rules for financial institutions in a manner that invites abuse of discretion, evidently reasoning that the markets have simply been plagued by too much transparency lately. (Yes, I know the argument for the change, but don't like either the short-term effects on rightfully skittish investors' confidence or the long-term effects on financial statements' reliability.)

Interesting new development

According to the Daily Tax Report (subscribers only, so this link may not work for all users):

"Edward Kleinbard is leaving the Joint Committee on Taxation after nearly 20 months as its chief of staff, lobbyists and congressional staffers said April 21.

"Kleinbard is expected to leave his post May 15. It is not clear who will serve as acting chief of staff. Last time there was a vacancy, Deputy Chief of Staff Thomas Barthold served as acting chief of staff for nearly two years.

"Prior to coming to Washington, Kleinbard was a partner with Cleary Gottlieb Steen & Hamilton LLP in Manhattan. Sources said Kleinbard will join the faculty of the University of Southern California Gould School of Law."

I personally wouldn't be surprised if Barthold becomes the permanent Chief, and that would certainly be a good outcome. I doubt that many outsiders of Kleinbard's or his predecessor George Yin's stature, be they leading practitioners or academics, would want the job at this point.

Some readers may know that I am a big fan of Kleinbard's scholarship and work, as well as a friend. At the JCT, he did a great job of advancing the ball on tax expenditures and in generally making the JCT issue pamphlets more serious intellectual contributions that merited broad reading.

Obviously the current political environment, even post-2006 and indeed post-2008, makes it hard for the JCT to play the substantive political role that it had decades ago, before the committee and member staffs got to their current size. Even the institutional independence that, say, the CBO chief but not the JCT chief currently has would be welcome from a policy standpoint, but it's hard to see why Congress would ever choose to grant it.

I anticipate that Kleinbard will be an outstanding academic success - smart move by USC Law School in signing him up.

NYU Tax Policy Colloquium on Mitchell Kane's Taxation and Global Cap and Trade

Neither I personally nor the colloquium have focused as much in the past as we are likely to in the future on the carbon taxes/cap and trade set of issues. (I've never written about these issues because I don't as yet see the angle or intellectual arbitrage opportunities using my skill set.) But yesterday Mitch Kane's paper provided a welcome step in the direction of focusing on them more.

Mitch's paper takes as given that we'd be doing cap and trade not a carbon tax, this being his assigned topic for a forthcoming NYU conference in Abu Dhabi. (Not to mention that current political noises center on cap and trade.) But every time one reads the papers or thinks about the issues it becomes clearer that, even though in principle the two approaches (with suitable ongoing adjustment to each) are interchangeable, in practice it's insane to go the Rube Goldbergesque cap and trade rather than carbon tax route.

My preferred way of thinking about the interchangeability is as follows. Under a carbon tax polluters pay as they go. With cap and trade, they prepay the tax before engaging in the polluting activities, and then use it up by doing the now-permitted carbon-emitting activity. Only, they can sell the taxes-paid voucher to someone else, and, if they want to pay more to emit more, they can't unless the government is willing to sell more prepaid tax vouchers. (Whereas in the carbon tax model you automatically can pay more to pollute more.)

There's a theoretical literature suggesting that the relative merits depend on whether one is more uncertain about the social cost of emissions (which the carbon tax ideally would reflect) or about supply and demand responses (which get reined in by cap and trade if the government keeps the permit supply fixed). But if you keep adjusting the carbon tax to control output levels, or the number of outstanding permits to keep their prices relatively constant, they start to look like each other. In terms of the political frictions if there are adjustment lags, I'd tend to think it makes more sense to take a stab at the social costs and set a carbon tax than to posit something about desired emission levels when the inputs, such as cost of abatement, have such a big effect (which one may not understand) on the optimal reduction in emissions for a given period.

The political reason for cap and trade, of course, is that it isn't called a tax. Only, everyone knows it's a tax (which obviously is what you need to make polluters internalize the social costs of their activities), so one doesn't really gain very much. Plus you get the insane and apparently irresistible political incentive to shower money on polluters by giving them permits for free rather than through auction. This reflects a failure to recognize that we are giving them prepaid tax vouchers without requiring them actually to pay the taxes first. The optics of carbon taxes would be unlikely to yield this result. And, as Alan Auerbach noted at the session, their profits are likely to go up in the post-permits because the reduced output enables them to raise prices. It's as if we organized them into a cartel by charging a tax to reduce output and letting them keep all the revenue. Only mingled corruption and confusion could produce such a result, but evidently they are not in short supply.

Mitch's paper discusses several of the tax issues in handling a cap and trade system. He argues that there is an essentially arbitrary choice between "pre-regulatory" and "post-regulatory" baselines in determining tax basis for permits that were granted for free, but we argued that this is better conceived of as a standard transition issue. (For handy reading on transitions, I suppose one could take a look at this.)

Mitch also focuses on the question of how to minimize inefficiency in the choice between permits and abatement, and offers two alternative approaches that he dubs "no clienteles" and "harmonious clienteles." Alan Auerbach argued, to my view entirely persuasively, that essentially what one needs is income tax neutrality (i.e., permits and alternative abatement methods all are taxed the same for each taxpayer), with marginal rate differences between taxpayers not distorting anything other than via the general work and savings effects of an income tax. This was related to but more demanding than the requirements for satisfying Mitch's "harmonious clienteles" scenario.

Tomorrow may rain so, I'll follow the sun

As you can perhaps see, Shadow (left) and Ursula (center) are doing a lot better these days, though Shadow remains a bit creaky. He's been scoring Passover gefilte fish lately. Buddy (right) spends his days proving that there's nothing like high spirits (and limited calories, despite his best efforts) to keep the mind clear and the body healthy.

Tax Policy Colloquium on Desai & Dharmapala, Investor Taxation in Open Economies

This past Thursday we discussed the above paper proposing "global portfolio neutrality," or GPN, as a new entry in the alphabet soup of proposed international tax norms (joining CEN, CIN, CON, NN, and NON). GPN holds that national as well as worldwide efficiency is maximized by causing individuals to face the same tax rate on their portfolio holdings no matter where they invest. It would be satisfied by purely residence-based taxation of individuals on their portfolio holdings. Given source-based taxation of passive income, such as withholding taxes on dividends, the authors argue for granting unlimited foreign tax credits (FTCs), including refundable FTCs for tax-exempts. They also apply GPN to inbound investment, and suggest, therefore, that we not tax sovereign wealth funds (SWFs) that are not otherwise taxable outside the U.S. on their worldwide holdings.

The paper is partly a response to an earlier paper by Michael Graetz and Itai Grinberg, which - at least as interpreted by Desai and Dharmapala, although Graetz, attending the session, did not entirely accept this interpretation - argues that the US should merely allow deductions for withholding taxes paid abroad. The Graetz-Grinberg argument, at least as reported, was as follows. As per the Desai-Hines norm of capital ownership neutrality (CON), who owns a given business actually may matter a lot, in the sense of affecting profitability, in the case of conducting an active business. But for portfolio holdings there presumably is no effect, since the holder is assumed to be passive and to play no operating role in the business. Hence, while merely allowing a deduction rather than an FTC for foreign withholding taxes would distort ownership decisions - discouraging the holding of foreign stock - this doesn't matter since ownership is irrelevant here.

Desai and Dharmapala respond that ownership does so matter, for reasons of optimal diversification. People in a given country who are already "long" the national macro-economy because their human capital is tied up in it should be eager to diversify via exposure to foreign macro-economy risks (which are somewhat but not perfectly correlated with our own) by holding foreign stock. (BTW, the "home bias" that we continue to observe in stock ownership patterns, though it is declining, arguably shows irrational under-diversification although there also are some rational proposed explanations for it.)

So far, so good. But the trickier part, for me, is their argument that GPN establishes, as a matter of unilateral national self-interest, providing FTCs for foreign withholding taxes so long as our withholding tax rate is about the same as those applying abroad.

They have a logical and internally consistent argument for this, which would take too long to explain here but can be found at pages 23-24 of their paper (available here under April 9). But I was skeptical on the grounds that:

(a) It isn't actually unilateral if withholding tax rates have to be about the same.

(b) FTCs create bad incentives, from the U.S. standpoint, both for our taxpayers (who need not seek to economize on foreign taxes in deciding where to invest if we'll offer a credit anyway) and for foreign governments (who can think of the tax cost as passed on to the U.S. Treasury).

(c) The reason D&D require that withholding taxes be about the same is that foreign inbound investment will replace the outbound (e.g., if Americans sell U.S. stocks to hold foreign stocks, then someone else has to buy the U.S. stocks). Hence, we automatically pick up withholding tax revenues to replace the lost revenues from offering FTCs. But Alan Auerbach and I argued that this amounted to assuming that capital flows must be symmetric by asset class, which isn't necessary even if symmetry holds overall.

A further issue I raised is that investors care about true diversification as to underlying economic characteristics. But the determination of source for dividends received is essentially formal - under U.S. law, depending almost purely on where the issuer is incorporated. Does selling GE stock to hold Siemens stock have anything to do with diversification if both companies are active in the same places to the same degree? Diversification by source, as determined by the tax system with respect to passive income, could at the limit be no more meaningful than making sure you hold both stocks that are printed on red paper and those that are printed on blue paper.

A final criticism I offered on these issues (although actually, at the session, I stated it first) is that GPN, like all of the alphabet soup norms, addresses only one margin (portfolio diversification) whereas there are many. For example, can one really discuss the tax treatment of passive income held by U.S. taxpayers without considering U.S. corporations, the outbound passive investment of which is taxable without deferral under subpart F.

Despite these criticisms, this was one of the best papers and sessions of the semester. Among its virtues was addressing the significance of tax rate differences among investors within a jurisdiction. But here, although I largely sympathized with the analytical bottom line, I of course found a way to carp and cavil all the same.

With respect to refundable FTCs for tax-exempts, my main critique was that, since FTCs create incentive problems from the national welfare standpoint, it's logical to limit them. The way we actually do so, by offering a 100% marginal reimbursement rate (MRR) until one hits the credit limit and then 0% thereafter, seems a bit arbitrary and unlikely to be optimal. But it's hard to say if, overall, we are too generous or not generous enough. Hence, in any given case (such as the tax-exempts) in which one proposes to scrap the limit and permit more FTCs to be claimed, it is hard to be sure whether we are going in the right direction or not.

Finally, with respect to sovereign wealth funds (SWFs), I agreed that it is likely to be in the U.S. national self-interest not to tax them on inbound investment IF we are effectively a small open economy without the market power to impose some of the burden of the tax on them. They're distinctive in that, for various other inbound investors, the withholding taxes we impose might (a) not exceed the tax rate they would face anyway, and/or (b) be creditable by their home governments. But SWFs can't take advantage of FTCs because, effectively, they ARE the home governments that would be providing the credit.

But it seemed odd to me to call this GPN, given that (a) from a national welfare standpoint we don't care about affording them better diversification, and (b) we'd be quite happy to tax them and distort their portfolio choices insofar as we have enough market power to stick them with some of the economic incidence of the tax.

Dismaying encounter

Earlier this week I had coffee with a former colleague, now eminent outside the legal academy, who was in town for a few days. He's very much to the right of me politically, but someone I've always respected as intelligent, thoughtful, and intellectually honest. Not a law and economics person, by the way.

The financial crisis came up and, while it's not his area of expertise, I must admit to being startled by what I heard. First off, he noted that the whole thing resulted from a regulatory failure. I agreed, but then it turned out that what each of us meant was rather different. He believes the entire thing was caused by the Community Reinvestment Act (apparently burrowing underground since 1976 until it finally exploded to deadly effect), with an assist from Fannie and Freddie.

He in turn was startled by my suggestion that failures in corporate governance, particularly in the financial sector, reflecting managerial opportunism and lack of transparency, could reasonably be thought by anyone to have had anything to do with the crisis. The only problem he could see in the financial and general corporate sectors that markets weren't completely able to handle was the "too big to fail" problem of government rescue.

He also believes that it is logically impossible for Keynesian stimulus to have any effect whatsoever, since what you spend here doesn't get spent there, and that there is absolutely no need to worry about the banks. If they all fail and money can be made by lending, then of course businesses will spring up right away and start doing it.

I have to confess that this exchange diminished my enjoyment of the meeting, but it was also more broadly dismaying. Level one is realizing the degree to which even intelligent people on the right can be completely divorced from reality on these matters. They go to trusted information sources, which have been making absurd and easily falsifiable claims about the current situation and the underlying issues. Level two is realizing how everyone does this to a degree. Because we all get our information from sources we have pre-coded as trustworthy and simpatico, we all may have a difficult time seeing what's right in front of our eyes.

One more reason to despair about public policy, even leaving aside all of the incentive and interest group problems that even by themselves are so crippling.

2010 NYU Tax Policy Colloquium - great news

I'm pleased to be able to announce that my co-teacher for the 2010 Tax Policy Colloquium will be Mihir Desai.

Sessions at U Va and NYU

I'll often blog about my talks or conference appearances and such, but have lately been too busy and backed up at work to spare the time. But at a certain point it gets so bad that it really doesn't matter any more at the margin if you ignore your main responsibilities for a bit. It can't get any worse, and is very far from getting noticeably better. So here goes.

Last Friday, I traveled to Charlottesville, VA to discuss Decoding the Corporate Tax at a Virginia Tax Study Group panel, kindly arranged by Michael Doran (who is leaving Virginia for Georgetown). My co-panelists were Ethan Yale (who is leaving Georgetown for Virginia) and Michael Schler. Nice discussion, and to my shock I actually succeeded in personally selling 11 of the books afterwards to people who I hope are now satisfied customers.

Ethan presented his own paper, describing a corporate tax reform proposal to tax corporate dividends like share repurchases (i.e., with basis recovery). I find this an interesting proposal to add to the existing menu, and think its merits depend in part on the significance of the corporate governance issues that might make the dividend vs. repurchase choice important. Then I described my book (overview plus brief description of policy proposals at the end) and Mike S. commented on both of our proposals.

I do like the policy proposals in my book, which are (1) lowering the corporate tax rate but with offsetting adjustments, (2) ceasefire-in-place international tax simplification, and (3) addressing corporate governance problems via the gap between taxable and financial accounting income. But I agree with the other two discussants that the book's main contribution over a long-term perspective is expositional, relating to the rich yet inconclusive economics literature and how to think about the subject, rather than to the proposals themselves.

So there we are, a nice and reasonably productive day in Charlottesville, VA; it's Friday at 4 pm, and I've just arrived at the airport to fly back to NYC. I need to fly back promptly as I have no overnight bag, no place to stay, and a commitment to appear the next morning, back in NYC, at an NYU Alumni Reunions panel with a couple of hundred scheduled attendees. The panelists are supposed to discuss tax policy in the Obama Administration, and as an added complication we have been too busy to finalize what we're actually doing.

In the Charlottesville airport at 4 pm, I learn that my flight to NYC has been cancelled, a victim of the East Coast storms last Friday, and indeed that the Charlottesville Airport (a very small one) is done for the day apart from (1) a couple of flights headed to points further south, plus just maybe (2) a flight to Philadelphia that was supposed to leave at 3:30 but is now tentatively scheduled for 7:15.

Lots of options at this point. Drive to NYC? Drive to Washington (2 hours) and take a shuttle in the morning? Airport hotel? Ask my hosts to find lodging? (They were very willing to help.) I chose Door Number 5, the flight to Philadelphia, and hoped for the best. Good call, as it transpired - it left earlier than expected and via 3 separate trains I made it the rest of the way back home only 3 hours late overall.

This left time the next morning to plan and then execute the panel on Tax Policy in the Obama Administration. Greg Jenner, whom I've known since we both worked on the Tax Reform Act of 1986, was my main co-discussant on the topics for our half of the panel. We ran through most of the Obama budget proposals, other than business & international (which went to our co-panelists), and although Greg is at least technically a Republican (albeit the honest and intellectually responsible kind that's all too rare these days) we agreed about a lot. Both of us either need more meds, or are rightly reading the long-term fiscal situation as extremely threatening.

Act now while supplies last

My new book, Decoding the Corporate Tax, is now available directly from both Amazon and Barnes & Noble (albeit with the wrong title).

Tax policy colloquium on Lily Batchelder's Savings Incentives with Insurance Objectives: A Bankrupt Approach?

Last Thursday we discussed Lily Batchelder's new draft paper (still a work in progress), which argues that savings incentives in the tax code are poorly designed to advance insurance objectives for poorer individuals. She notes low responsiveness to the rules in present law, and their generally providing larger incentives to higher-income individuals who arguably are saving enough already. Thus, she proposes either (a) changing defaults so people automaticallty save for retirement through their employment, but with opt-out and no tax benefit for saving, or (b) a refundable saver's credit that's phased out based on income. Absent opt-out, the savings accounts would automatically convert shortly before retirement to fixed real life annuities.

Alan Auerbach and I were more inclined than Lily to think of saving enough and having enough insurance of various kinds as very different things. Suppose you know with certainty (a) your entire future earnings profile, (b) your exact life expectancy, and (c) anything you need to know about consumer prices, your consumption preferences, and rates of return on saving until the day you die. In this scenario there's no uncertainty about any of these inputs, hence no need whatsoever for insurance so far as any of them are concerned. Yet it would still be vital to save enough to smooth your lifetime consumption path optimally, and people who were myopic or had self-control problems would fall short of optimizing. Hence, we might want to require or induce more saving in order to increase their welfare (and also to save us from having to "rescue" them later on if they depart too far from the optimal path).

Likewise, consider in these terms Social Security. In large part it is simply a device to force a minimum level of retirement saving given one's lifetime income (net of taxes and transfers, including its own). Indeed, though it is always called social insurance for purely formal reasons (e.g., its purporting to have dedicated financing, which in fact aren't much like insurance premiums), its sole insurance feature (redistribution in the program aside) is the fixed real life annuity.

Suppose that we knew everyone's exact lifespan. We'd still need Social Security, but we'd be able to substitute term annuities, equal in length for each retiree to her remaining lifespan, for the life annuities. Now it wouldn't be insurance at all, yet it would still be pretty similar to what we now have. So insurance is not really a huge part of Social Security, despite the semantic convention that supposes it to be a core case.

If we limited the "social insurance" label to programs that actually are economically insurance, and furnished by the government due either to adverse selection problems or people's under-appreciating the value of being insured, the preeminent case would be the income tax plus welfare system, which provide insurance against income risk. But these of course are the programs that no one calls insurance and that indeed were the very ones the inventors of the "social insurance" label were trying to distinguish from their favored programs. (See my Social Security book for a fuller discussion.)

Anyway, the main payoff of all this to Alan and myself was disagreeing about the extent to which savings incentives and insurance objectives should actually be considered a natural match.

The other main quibble we had pertained to the proposal for default saving with free opt-out. Lily wants the opt-out, rather than mandatory saving beyond that in Social Security, because otherwise we might be requiring someone to over-save relative to what was truly optimal for them. Our objection was that we don't really have good reason to tilt the default towards more saving unless one thinks people are otherwise likely to be saving too little. But if we think they mostly are, why allow the opt-out?

The reason for allowing it would be clear if we expected the "right" people to opt out while the ones we wanted to save more stayed at the default level. But what if it was the other way around? It's hard to know why the opt-out would be exercised primarily by those who actually would be saving too much otherwise, rather than by those who want to under-save relative to what's optimal.

The real problem with Twitter

To do it right takes too long. How can you be interesting, fun, & worth reading in only 140 characters without taking all day? (time’s up)

Tax policy colloquium on Emmanuel Saez's "Details Matter"

Last Thursday, we started our post-spring break Tax Policy Colloquium final stretch run with Emmanuel Saez's "Details Matter: The Impact of Presentation and Information on the Take-Up of Financial Incentives for Retirement Saving." The paper analyzes a large-scale real world field experiment with H&R Block in St. Louis several years back, in which randomly selected but generally lower-income customers were offered a cash incentive for establishing an IRA account with Block. Some got no incentive, a second group got a 50% match (e.g., put in $600 and Block would add $300 to the account), and a third group got a 33% credit (e.g., put in $900 and Block would send you a check for $300).

Take-up of the IRAs was generally low, even though the two incentive plans offered free money given that, despite early withdrawal penalties, one would come out ahead if one closed the account in a year. This point was not emphasized, however, and the low take-up even with incentives reinforced the difficulty of encouraging what we might think is optimal retirement saving by lower-income workers. (Either that, or else they perhaps rightly didn't like this particular savings vehicle, which had high annual fees relative to value for small accounts.)

The main finding of the study was that the match proved more popular than the credit, even though, as the above example shows, they are arithmetically equivalent IF putting down more cash now (typically out of one's refund) and waiting two weeks for a check that one then has to cash is assumed to be cost-free.

In part, people seem to have responded to the nominally larger size of a 50% match compared to a 33% credit, even though they're actually identical since the base for computing the percentages differs as between the two of them. But there's also some reason to think that people like the match structure better than the credit structure even when they're effectively identical. My proposed explanation was that the match looks like free money, while the credit looks simply like a price break, which still leaves the question of whether the price is good enough to justify a purchase. Or, hyperbolic discounting could be doing the work if people think of the match as immediately effective (though in fact it takes a couple of weeks, and one is saving the money in the account anyway) and the cash back as in the future. Neither of these is a rational explanation, of course.

I more generally wonder to what extent incentives (at least relative to applying the regular income tax treatment of saving) can generate the sort of retirement preparation that we believe is in most cases optimal. One is appealing to rational calculation in a setting where it's generally thought not to work so well. Beyond the use of defaults so people have to opt out of retirement saving, I think the better answer lies in a Social Security-style mandatory approach(government takes money from you now and gives it back with interest later, or else simply makes you wait for transfers later). This isn't perfect either (e.g., as Louis Kaplow notes, it can affect work incentives, given the preference for immediate consumption, even if one demonstrably gets fair value back). But I see it as more promising than the income-conditioned saver's credit or match approach that motivated the Saez experiment.

Fraud and cheating synergies

From an ABC News story on AIG renegade executive Joseph Cassano, the infamous head of their Financial Products Division:

"Cassano set up some dozens of separate companies, some off-shore, to handle the transactions, effectively keeping them off the books of AIG and out of sight of regulators in the U.S. and the United Kingdom.

"'This is the other very important issue underneath the AIG scandal,' said Blum. 'All of these contracts were moved offshore for the express purpose of getting out from under regulation and tax evasion.'"

This is pretty much the point Mihir Desai makes in his work on taxes and corporate governance. Once there is a planning excuse for complex structures, they can be used for multiple nefarious purposes, e.g., tax fraud, avoiding internal and market as well as formal regulatory oversight, looting the company, etcetera.

Complex structures kill transparency. At the limit, they make corporate governance impossible and genuinely profitable activity by publicly traded companies a pipe dream. To some extent, this is a problem of financial not "real" activity, as the latter is much easier to observe. E.g., Apple Computers and General Motors both are presumably well-judged by the market because to a considerable extent one can see how well or poorly they are doing. But even companies engaged in real productive activity often have such large finance wings (think GMAC historically, or GE's recent problems) that the virus of non-transparency extends well beyond the pure banking and finance sector.

Payback from China continues

The head of China's central bank is now calling for the dollar to be dethroned as the world's reserve currency and replaced by a new IMF-controlled benchmark.

I doubt anything will come of this right away, and if I were the Chinese I might not even want immediate adoption of this proposal (which could devalue their vast dollar holdings), but this may well be the way we are headed. The U.S. has simply been over-exploiting the economic value of being the reserve currency, and at some point the golden calf perishes, so to speak.

My guess is that the Chinese are trying to scare us into taking more responsible measures so as to head off this kind of scenario. It's a tricky game, since until they've lowered their dollar holdings they don't really want to scare the world's investors more than they scare us - it has to be the other way around for them to benefit. But the fact that they are doing this shows how concerned they understandably are. And I don't know how responsive political constraints will permit U.S. policymakers to be, though I don't doubt that high-up Obama Administration officials have heard and understood the message.

Reasons to visit Washington

My family went site-seeing in Washington D.C. while I was going to a conference at the Washington University in St. Louis. Conceptual togetherness even when apart? They returned with this lovely photo, which they rightly surmised that I would enjoy.

On the same theme, I got to talk while at WULS with a former senior economist in the Nixon and Reagan Administrations, a very nice and interesting man. At lunch one day, I couldn't resist asking him about Nixon. He said Nixon was exceptionally intelligent but a strange person with an overwhelming aversion against ever taking the simple, direct, straightforward route to any objective. For example, if there was a public document to release, Nixon would insist on leaking it somehow as a means of rewarding friends in the media or punishing foes. Reagan, he said, was very pleasant but clearly regarded everyone working for him in the government (even people as high up as Jim Baker) as hired hands - you could see the contrast when Jimmy Cagney and Patrick O'Brien came in for a White House film screening and were greeted very differently.

Washington University Law School budget conference

I am sitting in a hotel lounge (better-appointed than the available ones at the airport) waiting for the departure time of a flight out of St. Louis, where I just spent the last two days at a budget conference organized by Cheryl Block of WULS. Lots of interesting sessions, on topics ranging from automatic budgetary changes (such as entitlements cuts) to restore fiscal sustainability, to how the Presidential and legislative budget processes do and should function (e.g., use of budget resolutions or automatic sunset rules), to the practical political feasibility of "saving" Social Security surpluses, to the relevance of the tax expenditure debate, to issues of capital budgeting (amortizing items with long-term benefit) and how to measure the budgetary cost of bailouts.

I was there to present my current paper on the fiscal gap, its generational equity and efficiency consequences, etc. I'll probably get to rewrite this paper, using more recent CBO estimates and changing the emphasis a bit, as Cheryl is planning to create a conference volume, or perhaps something better than a conference volume in that it emphasizes organizing new knowledge without being limited to what people happened to present.

One thing that became clear to me in re. my paper is that the financial crisis has opposite implications for the apparent relevance of my paper than I realized when I started writing it. As I noted in a prior post about someone's colloquium paper, it can be kind of awkward or inconvenient when current events, such as the financial crisis, overtake one while one is writing a given paper (e.g., if one is lauding universal home ownership). When the financial crisis hit while I was in mid-draft, I had a bit of the feeling that it was rhetorically inconvenient because the short-term emphasis has to be on pulling the economy out of its nosedive, rather than immediately restoring long-term balance. So while I could rightly point out in my draft that the financial crisis makes the long-term problems worse, I had to acknowledge that the current mess has to be dealt with first.

But especially in lieu of the Chinese prime minister's recent remarks about U.S. solvency, it became clear to me (perhaps with a little help from my friends) that the positive links between the two issues are stronger than I had recognized. If you're going to be borrowing $2 trillion a year for the next few years, you had damn well better take steps to reassure prospective lenders that you are on a course to assure your own long-term solvency.

One way of putting it is that the Washington MSM conventional wisdom, as usual, is 180 degrees wrong. Obama isn't tackling too much - healthcare and energy policy/ cap and trade permits are actually even more urgent given the crisis than they would be otherwise. Rather, he is tackling too little, in that he hasn't done enough so far to show that the U.S. will be trying to tack back towards the path of solvency. Which is not to say that his or his advisors' political judgment was wrong if they concluded this would be unfeasible. But certainly in terms of the correct policies to follow, by failing to address long-term solvency sufficiently yet (apart from a couple of tantalizing hints), one could argue that he needs to put more on his plate, not less.

AIG bonus update

I now feel a bit more knowledgeable about the AIG bonus situation than the last time I posted about it, so here are some follow-up thoughts:

1) Words sure matter. If they hadn't called these things "bonuses," obviously no trouble. The underlying situation seems to have been as follows. These guys were getting what I'd call fake or misdirected incentive compensation. Fake in that, as we actually learned in the event, if the payoff from the incentive payments disappeared they would simply be compensated in some other way instead. So to a degree it was, as usual, "heads we win, tails you lose." Once there were no profits from their trading to share they simply got paid a flat fee instead. That said, I gather the salary cut they got was more than 50%, so there wasn't zero "incentive" element. But of course the incentive was misdirected even insofar as they actually faced variance, since the profits they shared in were akin to that from insuring 100% of New Orleans' hurricane risk before Katrina and hence taking home lots of money each year until it hit, whereupon the company got wiped out without actually being able to pay on its customers' insurance claims. Not a great incentive structure to induce people to pretend for a while the company is making money through these things.

2) Given the fixed pay they were receiving in lieu of "incentive" pay, there really was a retention element. Specifically, rather than getting paid more regularly they'd have to stay around for several months at a time in order to get their pay for the period only when it was over. So in that sense it wasn't really a bonus, so much as a plan to make them stay on instead of quitting sooner to get the salary they were otherwise earning (which wouldn't otherwise have been called a bonus, hence eliminating the entire political blowup).

3. Why pay these guys to stay? Who'd want them? What could be their opportunity cost of staying given (a) what they had done and (b) the down economy in financial services especially. I gather there actually is a decent answer to this question. While it's hard for me to judge how hard it would have been for someone else to unwind the AIG positions, these guys had economic value to other employers until the unwind was completed, for the simple reason that, having constructed the positions, they knew what the positions were. Someone who wanted to squeeze AIG (or rather the federal government) on the other side of the transactions could have made money off knowing just what the positions were. Or at least so I'm told. So by this light it was prudent to pay these guys something to stick around so they wouldn't quit and use their knowledge to help someone else cash in (along the lines of Long-Term Capital Management, which got hosed in the unwind some years back partly because counter-parties had figured out their positions and knew they had liquidity needs that would make them sell right away for whatever they could get in a thin market.

So there's underlying bad behavior at various levels here, but arguably the bonuses (a) weren't really that and (b) were worth paying from the government's position. Though I should stress that none of this interpretation is based on my own personal & direct knowledge - it comes rather from what I've read and heard, so in legal trial terms it's hearsay.

4. I gather that the blowup over the "bonuses" is already creating extreme reluctance by private parties to participate in ongoing and new government bailout programs that might subject them to similar firestorms in the future. Then again, given the extremely dim view that many have, for example, for Geithner's new bank bailout program (e.g., see Krugman here), maybe that's not as bad as it sounds. Suppose it forced the adoption of better-conceived bailout policies.

5. The 90% tax may conceivably face a serious constitutional challenge notwithstanding Larry Tribe's assurances to the contrary. Not a surprise, perhaps, as Tribe can be a bit political in his bottom line constitutional judgments. One source of possible trouble could be a NY state case from a few years back, Pataki v. Con Ed, in which a provision denying rate adjustments to the Con Ed shareholders for the blunders that had led to the Indian Point nuclear power plant problems was struck down as a bill of attainder. Obviously, the 90% tax is being drafted with an eye to avoiding the same fate, by causing it to apply more generally. But in the Con Ed case, the court cited legislative history showing that the legislators were specifically angry at Con Ed for its bad deeds and wanted to inflict punishment (hardly unreasonably, but that's not the point when the question of law is bill of attainder). Needless to say, the record of enactment for the 90% tax (if it goes through) is hardly lacking in evidence that the legislators were specifically interested in nailing AIG. Not to say that this is necessarily fatal, and it is presumably being drafted with a keen eye to the problem, but there's precedent for treating the clear intent as adverse evidence on the constitutionality question.

How did people understand the brain before computers?

On the tennis court recently, I had been playing very well, then I lost my strokes and floundered horribly for a couple of sessions, then I was able to find them again and played very well this week.

The analogy that seems utterly compelling to me is that of a computer file somewhere in your system that you need to locate and access quickly in order to run a particular program in real time. Maybe with the additional detail that it needs to be on your "Recent Applications" list in order for you to find it effectively. But one couldn't have conceptualized it this way until PCs came into common usage.

AIG bonus tax

I was angered by the AIG bonuses. Sure, it's a bit of a pop symbolism issue, but I found it odious that these Typhoid Marys of finance - who ought to be unemployable for life, other than asking if you want fries with that, after all that they've done to their shareholders and the world economy - should get all those million dollar bonuses out of federal money, supposedly so they won't leave, when some already have and the rest probably should. Plus my anger reflected my belief that over-the-top executive compensation, as it's developed in the last decade, has not just been wasteful and misguided, but a primary cause of the global economic disaster. Burning the money would have been better for the U.S. and world economy than letting the people in these sorts of positions "earn" it by pulling monkeyshines that involved phony income plus all too real downside economic risk.

But a 100% "tax" on a specific group of individuals with respect to items paid before enactment of the "tax" certainly makes me uneasy. (Scare quotes because - though I am no constitutional law expert - the narrowly targeted 100% rate seems to put it on the wrong side of the amorphous line between a tax and a Fifth Amendment taking.)

Frankly, it doesn't bother me in the slightest if the 100% tax applies just this one time to just these people. They would appear to deserve it many times over. But one can never be sure that one isn't creating a precedent with legs. Might the device someday be used against someone else who just happens to be unpopular?

I'd actually like to make an example of these guys - as the French would say, "pour encourager les autres," as well as for general public morale. But I'd prefer a better way of doing it, such as investigating them for looting and fraud, which might have been amply justified even without the bonuses.

This is how it starts

Alternative title: "Well, duh."

From the New York Times:

"The Chinese prime minister, Wen Jiabao, spoke in unusually blunt terms on Friday about the 'safety' of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to offer assurances that the securities would maintain their value.

"Speaking ahead of a meeting of finance ministers and bankers this weekend near London to lay the groundwork for next month’s Group of 20 summit meeting of the nations with the 20 largest economies, Mr. Wen said that he was 'worried' about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely....

"In January, Mr. Wen gave a speech criticizing what he called an 'unsustainable model of development characterized by prolonged low savings and high consumption.' There was little doubt that he was referring to the United States."

If I were Wen, I'd be worried too.

This is how a nation's credit reputation starts unraveling.

Tax policy colloquium on David Duff's "Tax Fairness and the Tax Mix"

Yesterday we had our ninth session of the year, and last before spring break, discussing the above article by David Duff, who has long been at the University of Toronto Law School but is moving to the University of British Columbia Law School, in Vancouver. (In weather terms, this is a bit like trading Boston for Seattle, which sounds pretty good to me after the 3-and-counting monstrously brutal winter months that we've had here in New York.)

The paper posits that different fairness norms apply to different elements in the tax structure. On reading the paper, this struck me as requiring one to deny or disregard the fungibility of money. But, as often happens at the colloquium lunches in advance of the sessions, we discerned that he actually meant something a bit different.

David classifies himself in philosophical terms as a liberal egalitarian, opposed to the welfarist and libertarian traditions, but he disclaims what at times can be the vindictive face of liberal egalitarianism - its suggestion, in some proponents' hands, that we should turn our backs on people who have made mistakes, rather than trying to help them out, because somehow this "respects" them more as moral agents. I personally am quite willing to suffer "disrespect" in the form of compassionate rescue if I ever need it. Another occasional implication of liberal egalitarianism that he disclaims is that equalizing opportunity downward is just as good as doing so upward. (This led to the retort at one conference I once attended that the best possible way of implementing equal opportunity is through global thermonuclear war - then we'd never have to worry again about some people having better opportunities than others.) What he does mean by liberal egalitarianism, however, was less clear - though this was partly our fault not his, because as usual we didn't get to the phantom "Topic 3" on our discussion list.

The paper perplexed me a bit by arguing that, wholly without regard to distributional issues, a VAT with an exemption amount would be the right way to pay for public goods. To me, it would seem that the only reason for having high earners pay more than low earners is distributional. David gets there by following Blum and Kalven to the effect that we should totally ignore benefit from public spending and pretend it was wasted, for purposes of deciding who should pay. He then argues for equalizing individuals' total sacrifice, as a loosely libertarian-style privileged baseline - from which (unlike the libertarians) he would then be willing to redistribute as well, but in his mind through a fundamentally different exercise.

I argued in response, inter alia, that "total sacrifice" is incoherent. E.g., just because we can't measure benefits going the other way doesn't mean that we should counter-factually pretend that they're zero. More generally, there simply is no meaningful baseline of "public goods without financing" - his revision to the libertarians' supposed state of nature - from which to measure total sacrifice. Nor would I find the exercise normatively motivated even if I thought it was coherently definable. But to each his own, and one need not always agree to have a civil and productive discussion.