NYU Tax Policy Colloquium, week 8: Leigh Osofsky's The Case for Categorical Nonenforcement

Yesterday we continued our theme this semester of branching from tax towards other law, rather than towards public economics, by discussing the above paper.  "Categorical non-enforcement" is a label that one might, subject to dispute, extend to the Obama Administration's currently contested immigration plan, but there are also various tax applications of the concept.  More on this momentarily.

Despite the paper's title suggesting that it is "for" the allowability of categorical non-enforcement, it's probably better viewed as anti-anti-categorical non-enforcement, in the sense of questioning standard arguments against it from con law, which it argues rest on drawing exaggerated or unpersuasive distinctions.

As an initial aside, however, one of the things we happened to look at in the course of the day was excerpts from the Obama Administration's Office of Legal Counsel (OLC) memo explaining why the immigration plan is within the President's power to faithfully execute" the laws.  I was a bit disappointed by the OLC's reasoning, finding it a bit thinner than I would have liked, given that as a matter of policy I am highly sympathetic to what the Administration is trying to do.  For example, it relies on the claim that the "categorical" policy of suspending deportation within certain categories is actually case-by-case, since they could actually override it for unstated reasons in any particular instance, which they don't appear actually to be planning to do.  This is arguably a bit formalistic, rather than substantive.  And it relies on the fact that Congressional legislation deliberately extended other benefits to the groups that get favorable treatment here, ostensibly showing consistency with Congressional intent.  But that might be a bit like saying that, if the bank gives me a toaster when I open a new savings account, the underlying intent supports also separately giving me a clock radio.

None of which is to say that a 5-4 Supreme Court vote striking down the immigration plan would merit much of a presumption that it had been reached through good-faith legal reasoning, rather than on political grounds.  Too much water under the bridge at this point (even before we get to see what they do in King v. Burwell).

But anyway - back to the paper.  It does a nice job of showing that it's hard to draw lines between permissible and impermissible exercises of executive discretion regarding how to enforce the tax laws in the face of limited resources and diverse underlying objectives on the part of Executive Branch officials.  Here are a few examples, all raised in the paper, but arguably very different from each other.

1) President Romney in 2013, or present Bush-Walker-Whomever in 2017, announces categorical non-enforcement of the estate tax.  "I will not allow a single IRS auditor to review any Death Tax issue whatsoever.  It's time for us to drive a stake through this heart of this unfair, job-destroying, family-farm-endangering monstrosity."  The OLC memo in support notes that Congress repealed the estate tax for 2010, then raised the exemption amount, and left substantial scope for avoiding it through tax planning even though the "loopholes" were well-known.  It also claims that estate tax audits may be considered after all on a case-by-case basis, under criteria that it declines to explain and in seeming tension with the President's sweeping statement.

Whether or not this hypothetical executive quasi-repeal of the estate tax would be justiciable, I would call it clearly illegitimate.  But I would agree that the Romney, Bush, Walker, or Whomever Administration could shift some audit resources from the estate tax to other areas that it cared more about (e.g., EITC enforcement).  I would probably disagree with this shift as a matter of policy, but presumably up to a point this is what elections are about.  After all, it seems unlikely that the Executive Branch is required to set audit rates purely on the basis of an objective of maximizing correctly-determined tax revenue, even though that objective should presumably be an important input to the allocation of auditing and other such resources.

2) Frequent flyer miles appear clearly to be taxable under section 61 of the Internal Revenue Code, in cases where one accumulates through business use (deductible or reimbursed) and then uses them for personal travel.  True, there are some valuation and timing issues, but there basic taxability seems clear.  Nonetheless, the IRS has announced that it will not assert income tax deficiencies by reason of people's using such frequent flyer miles.  In other words, it's effectively acting as if there were an unenacted exclusion for the value of such items.

This is certainly categorical non-enforcement of a kind.  But note the likely motivation for it: Any attempt to enforce would lead to a huge outcry, almost certainly followed by the prompt bipartisan enactment of legislation blocking enforcement or expressly excluding at least standard-case frequent flyer miles.  So the IRS commissioner who directed a shift to enforcement would merely get the Congress mad at him or her without actually accomplishing anything.

Arguably there is a kind of "rule of law" violation here.  If Congress wants frequent flyer miles excluded, they should say so through legislation.  But the IRS is not really to blame here, e.g., in the sense of showing a proclivity to over-reach.  It is just declining to fall on its sword and get another black eye with Congressional leaders in exchange for no benefit (other than to the rule of law in general).  I certainly can't blame the IRS for not being so noble as to want to take a bullet for abstract reasons here.

3) It has recently come out that the IRS audit rate for large and complex partnerships is about 0.8 percent, despite the fact that there appears to be a lot of suspect or outright bogus tax planning going on this sector.  (More on this on May 5, when Gregg Polsky will be presenting a paper on this topic at the colloquium.)  The reason the audit rate is so low, even though the IRS is thereby leaving a whole lot of lawful tax revenue on the table, is that it simply lacks the staffing and expertise, especially in light of extremely complicated audit requirements that Congress imposed with respect to large and complex partnerships in the 1980s.  It therefore is fair to say that the low audit rate here represents a shocking and costly misallocation of auditing resources, albeit one reflecting constraints that the IRS faces rather than its own preference for any such misallocation.

The paper argues: Why not go to full-out non-enforcement here, so that what's going on even at 0.8% will be more transparent?  Might this help induce Congress to address the problem?  (It's presumably not unaware of the problem today, but, even apart from political gridlock and Republican hostility to high-end enforcement, there is the fact that high-income partners who are benefiting from the aggressive tax planning have friends in both parties.)

I'm not entirely sympathetic with this argument.  In effect, the IRS commissioner, Secretary of the Treasury, or some other such individual should start shouting, jumping up and down, waving his or her hands in the air, etc.  But going all the way to zero enforcement isn't quite the point (and might further backfire if it effectively invited others to join the party).

4) The paper discusses a well-known partnership tax case called Diamond v. Commissioner, in which the IRS succeeded in requiring a taxpayer to treat the receipt of a profits interest in exchange for services as a taxable event.  The IRS quickly, it appears, came to agree with commentators who viewed the decision in Diamond as anomalous.  The holding not only departed from standard practice, but raised valuation issues, and arguably was in tension with generally taxing labor income on a realization basis.  The IRS decided not to follow up, or use Diamond in audit disputes, but for a long time failed to explain its position publicly, presumably in part because it was still figuring things out.

Was this categorical non-enforcement of Diamond?  I would view it instead as IRS determination of what it thought the law actually was in this area.  At worst, the IRS might have been a bit slow to announce (as it eventually did) how it actually viewed and would be proceeding in this area, but it wasn't declining to enforce Diamond if it didn't agree that this decision (in just one circuit) offered a reliable general guide to how the receipt of profits interests in exchange for services generally should be taxed.

Deep thought for the day

People like cats for reciprocating their feelings but just a bit less; people like dogs for reciprocating their feelings but just a bit more.

Since I haven't had any cat posts for a while ...

Yogurt-drinker deploys highly sophisticated lapping technology.  Arguably more impressive than the first-generation iWatch.  Then again, cats and their forerunners have been working on it for millions of years.

NYU Tax Policy Colloquium, week 7: George Yin's Protecting Taxpayers from Congressional Lawbreaking

Last year at the Tax Policy Colloquium, I thought that the balance had perhaps tipped a bit too far towards economics rather than tax law, from the standpoint of best serving our students and much of our audience.  This year, partly due to deliberate adjustment but also due to the papers we happen to have drawn, it's been more "legal," and often less focused on tax law in particular than, say, constitutional and administrative law, than ever previously in the 20 years I've been doing this.  I wonder if there is any broader trend here at work, regarding shifting interests in tax academic scholarship, or if it is just idiosyncratic.

A couple of weeks ago, we had Linda Sugin's paper on standing in tax cases.  On March 24 (which is  our next session, as March 17 falls during our spring break), Leigh Osofsky will have a paper on "categorical non-enforcement" -  the scenario where an agency announces it will not be doing anything to enforce Rule X.  That is basically an administrative law question with a strong constitutional overlay, although the paper's inquiry is situated in tax.  And yesterday, George Yin's paper had us thinking about statutory interpretation and the Speech and Debate Clause of the U.S. Constitution (which protects federal legislators from being "questioned in any other place" regarding certain legislative acts).

"Protecting Taxpayers from Congressional Lawbreaking" is mainly an intensive case study.  In 2014, the House Ways and Means Committee, during Dave Camp's chairmanship, publicly released confidential tax return information that pertained to 51 taxpayers in the tax-exempt sector.  This related to publication of a referral letter to the Department of Justice regarding claims of criminal misconduct by Lois Lerner regarding audits of organizations, including in particular Tea Party entities, that were seeking tax-exempt status under Code section 501(c)(4), but would not qualify if, among other relevant aspects, they exceeded limits on permissible political activity.

As an aside, I feel justified in using scare quotes when referring to the IRS "scandal" in this matter.  BTW, if the Tax Prof Blog keeps on counting off the days, Day 1,000 of the "scandal" is less than a year away now, and Day 10,000 - if I have counted correctly - will fall on August 16, 2040.

Why the scare quotes?  There's a real issue here, which a Republican Congressional majority has wholly legitimate reasons to pursue in the face of a Democratic executive branch.  Suppose, as would not surprise me at all, that there are plenty of 501(c)(4)s on both sides of the political divide that are violating, or at least closely skirting, the provision's limits on political campaign activity.  Then this is a logical subject for administrative enforcement, subject to discretionary determinations about competing priorities in the face of limited resources.  But it would be illegitimate, and potentially criminal, to target the groups on one side of the political divide more than those on the other side - or, for that matter, to target more "extreme" relative to more "mainstream" groups, in the eyes of the IRS beholder, even if left and right get equivalent treatment,

The problem, as in the endless Benghazi investigations, is that the desire to find some sort of a scandal vastly exceeds what has actually been found, and that the investigation arguably is not being conducted entirely in good faith.  The Yin paper notes that, in the 1970s when the Ways and Means Committee investigated charges of political bias by the Nixonized IRS, it specifically looked for departures from neutral treatment of differing groups overall.  This time around, there appear not to have been similar efforts to test for this in a fair and reasonable way, as opposed to hunting for hunks of red meat to toss to the base. (And often red meat out of context, so to speak.)

I suspect, by the way, that from the standpoint of Chairman Camp, engaging in tendentious grandstanding on this issue was a service worth rendering to the Congressional leadership, helping to preserve his discretion to pursue tax reform proposals that have won widespread admiration (if zero political traction, but that isn't his fault) without having the party leadership on his throat.  This is the sort of tradeoff that people in real political situations often have to make.  Camp may actually have made the right call, from the standpoint of what he could do that would have the greatest overall net public value.  You have to pick your spots.  And the need for such tradeoffs is a good example of why I personally would never want to be in politics, even as an appointee to the type of position that tax law academics sometimes can get.

But I digress.  Returning to the topic of the Yin paper, the referral letter to the Department of Justice concerned supposed perjury by Lois Lerner.  Before the time when she had admitted in testimony to being aware of Tea Party groups, she had been involved in email correspondence identifying some such groups, along with other groups (e.g., the World Wildlife Foundation, Miss America Foundation, and an organization that was directed aid to victims of the Boston Marathon bombing) that might merit auditing.  But the Committee chose to make public, not just the referral letter, but confidential tax return information from the associated attachments, despite having the issue clearly raised.  Indeed, the Committee met and, on a party line vote, agreed to let the whole shebang be published, including confidential information pertaining to all these taxpayers.

Seemingly none of these needed to be published in terms of the political aims being served, other than perhaps confidential info pertaining to the Karl Rove-affiliated Crossroads GPS, as to which the Committee probably could have gotten the group's consent.  So why did they publish the whole thing, when it was urged that they shouldn't?  Importantly from my standpoint, there doesn't seem to have been any particular malice towards the groups whose privacy rights at least formally suffered. A reasonable guess, as per the paper, might hold that the committee simply wanted to avoid any appearance of doctoring or limiting the public record, working closely with Crossroads GPS, etc.

The Yin paper agrees that no significant harm was done to anyone, and that probably no one even particularly cared (among the groups whose confidential info went public).  But it takes the view that the precedent is potentially very dangerous, since the next time around a tax committee on the Hill could decide to publish other people's or entities' tax information out of pure malice or at least indifference.  So it discusses at the end possible measures to discourage this, e.g., by giving the Joint Committee on Taxation a measure of gatekeeper discretion to try to keep the Members away from stuff that they don't need to see.

Much of the paper, however, focuses on legal analysis of whether the committee's release of the information was a felony under federal criminal law (more specifically, Internal Revenue Code section 6103).  It concludes that the action WAS a felony, although not punishable in court due to the legal immunity that is provided by the Speech and Debate Clause.

Given the conclusion, which I agree with, that the Speech and Debate Clause would prevent prosecution of the dissemination even if it was a felony, the inquiry is a bit academic, so to speak.  My go-to literary reference for such issues ("Would this be a crime if we could prosecute it, which we can't?") is the argument in Catch-22, between two atheists, regarding what God would be like - benign or malicious - if He actually existed, which they both agree He doesn't.  But it would matter at least in a hortatory sense - one presumably shouldn't commit felonies, even if one can't be prosecuted, and if one does then one faces criticism on that ground.  So let's take a look.

Code section 6103 criminalizes the release of confidential tax return information.  But section 6103(f)(1) affords the tax committees access to such information, and section 6103(f)(4)(A) provides that such information "may be submitted by the committee to the Senate or the House of Representatives, or both."  This in turn led, and was expected to lead, to general publication of the tax return information at issue in this case. 

Suppose we accept that "may be submitted" means "may be released to the general public," although perhaps one could poke away at the distinction.  The Yin paper argues that there is an inherent or implicit limiting clause here - the submission / release must be something akin to "reasonable," although the threshold might be lower than that (e.g., not entirely unrelated to the committee's performance of its legislative functions."

How could the release here fail to meet the unstated threshold limiting the power to cause the release of tax return information without commission of a felony?  The paper's argument is that the referral had purely to do with a claim that Lerner had been committing perjury, and the other confidential info was 100% unrelated and irrelevant to that.

I tend to question this analysis.  Again, the Ways & Means Committee was conducting a political war against the Obama Administration (but that's how our political system works), and the criminal referral on the narrow perjury claim was related to its broader argument of unfair and possibly criminal political bias by the Administration or at least the IRS.  I believe that the committee fell very far short of establishing that, and acted in an irresponsible way that did not appear to reflect a spirit of good faith inquiry.  But again, that is how our political system generally operates, and it's not only probably best, but surely the current state of U.S. constitutional and statutory law, that we give this sort of activity a very broad zone of non-criminality.  The proper sanction for what the Committee did in the IRS "scandal" generally is that, in the court of public opinion, they should be viewed as having failed to make their case, and also as having acted tendentiously and irresponsibly.  Or at least, that's my judgment.  Others may disagree, and that's what political debate is all about.  But action by the Committee that was pursuant to its side of the political war (here, presumably wanting to avoid any appearance of doctoring the public record, working hand-in-glove with a Rove group, etc.) is something that I'd be very reluctant to criminalize, even absent the Speech and Debate Clause.

What might I criminalize here, based on reading an implicit limitation of some kind into the provisions statement that tax return information "may be released."  Basically, I'd look to stuff that was malicious and not related to lawful purposes such as investigating and debating claimed executive malfeasance.  An example would be releasing confidential tax return information of people or entities that the Committee disliked, in order to embarrass or otherwise hurt them.  But again, no hint of this in the case at hand.

One more statutory interpretation issue may further, in my view though not that of the paper, undermine the argument that the Committee's action was felonious albeit protected.  For 50 years (though ending in 1976), the committee was empowered to submit "any relevant or useful information" to the Senate or House.  But the words "relevant or useful" were stricken from the statute in a 1976 technical corrections bill.

This clearly seems to lay out the legal contours, pre-1976, of what would then have made a release of tax return information by a tax committee non-felonious.  The information would have had to be "relevant or useful."  In the paper's view, that threshold was not met in the present case, because the information was completely irrelevant to the perjury claim.  (But on the other hand one could argue that it was relevant to the broader political war concerning bias.)  But again, the most obvious way to interpret deletion of the words "relevant and useful" is as indicating that the limitation no longer applies.  Post-1976, under this view, relevance and usefulness no longer need be shown.

The paper rejects this interpretation by arguing that there is no evidence that Congress meant to loosen the requirements for releasing tax return information, when they didn't indicate so anywhere, e.g., not in the legislative history, floor debate, or anything else, and when in general what the 1976 revisions did was tighten the rules governing transmission and release of tax return information, in response to the Nixon Administration scandals.  Hence, it is more inclined to view "relevant and useful" as evidencing the prior scope of limitations that remained in place or if anything were meant to be tightened.  E.g., suppose the reason for removing the words was that they unduly weakened the implicit limitation that follows from the context.

But it is hard to rule out the possibility that someone on the tax committees, during the legislative process in 1976, decided deliberately to strike those words in order to free the committees' hands a bit more, even though no mention was made of this and everyone else was getting the rules tightened.  So I might view the prior existence and 1976 removal of these words as leaning against the paper's argument that the Camp committee's release of the tax return information was a (non-prosecutable) felony.

Although I thus tend to disagree with the paper's legal conclusion, I should note how refreshingly in good faith the argument is - not always something one can take for granted when people are discussing hot-button political topics, such as this one.  Yin not only was appointed by Republicans, rather than Democrats, both times that he served on Capital Hill, but is well-known as having no political ax to grind.  In addition, Tax Notes publicly quoted him in 2014, when the issue first came up but before he had researched it, as saying he couldn't comment on the merits without knowing more about them.  Plenty of commentators on the political wars in Washington would have followed the Red Queen's lead, in Alice in Wonderland, when she says "sentence first, verdict afterwards."

A change in the weather is known to be extreme / I'm glad we're finally changing horses in midstream

It would be difficult to overstate my relief at the change in the weather that has finally hit the New York area. I certainly hope that those in New England and the upper Midwest are out of the horrors as well.  It happened at a specific moment.  This past Sunday, the brutal, horrible, and unrelenting winter that we have been suffering through for months (and yes, I realize that Boston and Detroit, to name just two places, had it much worse than us) suddenly disappeared and apparently (knock on wood) won't return before the next winter season at the end of 2015.

I am reminded of the old joke about the guy who loves going to the dentist, and having cavities filled without any anesthesia, just because it just feels so darned good when it's over.  The end of the winter is a bit like that, except that I would much sooner have skipped the whole thing.  (I only go to the dentist for pragmatic reasons.)

Death of Jerome Kurtz

Another sad passing from among the tax professoriate.  Jerry Kurtz, a former colleague of mine at NYU who is most famous for his time as IRS Commissioner, died last Friday.

Kurtz took over at the IRS not long after its low ebb during the Nixon era, involving what definitely were actual scandals involving White House malfeasance.  He both helped to restore the actual and perceived integrity of the IRS, and had strong tax policy views involving the desirability of income tax base-broadening that commissioners have not always pushed as strongly as he did.  He was a disciple of Stanley Surrey, and while I did not agree 100% either with Jerry or with Stanley (whom I never met, as he died the year before I entered academia), they were forces for good.

Kurtz also participated in the transformation of NYU Law School and our tax program into what they are today.  At an earlier stage, only the tax program, not the law school, had enjoyed an eminent national reputation.  As the law school rose, and as both legal academia and law practice were transformed, the tax program had to change in some ways, just to keep its high place.  Jerry Kurtz and the late Paul McDaniel (also a great man) were then-dean John Sexton's first two wartime consiglieres (as I jokingly called them) towards this purpose, at least starting the count from when I got here.

Jerry was a great person in all senses, and I will miss him.

Tax Policy Colloquium, week 6: Ruth Mason's "Citizenship Taxation"

Yesterday at the colloquium, Ruth Mason discussed her paper, Citizenship Taxation.  I enjoyed reading it enough to conclude that I may want to write about this topic as well.  (I generally agree with the paper, but it’s a rich topic and perhaps a fruitful area for me to deploy some of my interests and approaches.)

Here are some of the points from my notes that I thought worth discussing.

(1) The U.S. as outlier (again!).

Here we go again.  To paraphrase Ray Davies in a 1960s Kinks song, “we’re not like anybody else.”  The U.S. is the only country to impose (at least in theory) worldwide taxation on all non-resident citizens.  Other countries may tax some non-residents on a worldwide basis, via the use of standards other than just current year physical presence to determine who is really still a member of the domestic community, but no one else does it flat out based on citizenship.

Other examples: we don’t have a VAT, our statutory rate for corporations is unusually high, and in the international realm we employ deferral / foreign tax credits far more extensively than anyone else.

Now, everybody else could be wrong and we could be right.  Or our circumstances could be distinctive.  But it is natural to wonder, given, for example, the “wisdom of crowds” line of argument.

(2) Benefit tax rationales.

The literature discussing citizenship-based taxation often employs a benefit tax rationale.  On the one hand, U.S. citizens living abroad aren’t using the roads, etc.  They also generally can’t get U.S. public assistance, or use healthcare subsidies that apply within the U.S., etc.  On the other hand, in theory the U.S. Army is protecting them, plus they have the valuable option to return, which lots of other people might pay good money for if it were on sale.

All this might call perhaps for an intermediate U.S. tax burden on U.S. citizens living abroad - which we actually have, given section 911(b), which permits excluding about $100,000 of earned income, and the allowance of foreign tax credits.  But benefit tax rationales are not widely accepted these days, as compared to ability to pay, which of course raises the core question here: Whose ability to pay?

Suppose that, by reason of my living abroad, the U.S. government saved a marginal $10,000 that it would otherwise have spent giving me services.  Even without any normative attachment to benefit taxation, it might make sense to reduce the U.S. tax bill I would otherwise have incurred by $10,000, as this properly aligns my incentive regarding where to live, from the fiscal standpoint and assuming that there are no other relevant considerations.  But not much of what the U.S. government does on my behalf invites this sort of marginal cost analysis.

 (3) Defining “us” versus “them.”

Here is the nub of the issue.  From a utilitarian standpoint, everyone in the world matters equally.  Numerous other philosophical approaches agree that everyone counts the same in the relevant sense, although they have other ways of implementing the idea that everyone matters equally.

But just as individuals, rather than being perfect altruists, generally act for their own benefit and that of loved ones, so it is generally accepted that countries can care primarily just about “us” (the members of the national community), as opposed to “them” (everyone else).  Indeed, just like a buyer and seller in a market negotiation, it is widely considered fine if everyone would like to extract as much money from each other as possible, albeit subject to rules of honesty and fair dealing, not doing bad things, and acting altruistically in extreme cases (e.g., rescue when you see someone drowning, seeking to prevent genocide abroad).

Let’s just take it as given that this personal, family, or community-based selfishness can be justified philosophically.   Many regard it as a prudentially required exception to universal morality (we don’t have to be saints, especially when everyone else isn’t being a saint).  I gather that Ronald Dworkin tried to fit it into his philosophical system more holistically, but I don’t generally find myself in agreement with his full approach.

But even taking all this as given, it is difficult to find firm normative footing for the determination of who fits into our community.  Personally, I care about the people I care about (and for close family members or other associates, there’d be an argument that I ought to care even if I didn’t).  But, in the impersonal setting of a national mass community, it is hard to establish definite guideposts re. what we are trying to do.

If I am a citizen who goes abroad for a month, I’m surely a full U.S. person for the year (not just 11/12).  Arguably the same, whether or not we choose to impose full citizenship taxation, if I go abroad for three years but always plan to return.

If I am here illegally, I definitely should count normatively, at least to a degree.  (Not to dive into the murky, for me, waters of immigration law and policy.)  This is why most of us would insist on allowing illegals to get treated in the ER when they face dire medical problems.  And we shouldn’t be happy about having a two-class society here, the Americans here and the others, whether the latter are lawful guest workers or illegals.  But I digress.  The point here is simply that residence inevitably counts – we care more about people who are right in our faces than about others – but it is not all that counts given that I can be away from what continues to be my community.

What we mean by the “us” whom we agree to care about, once we have accepted an approach that mainly limits altruism to the members of one’s own community, is most likely going to be multi-dimensional, rather than turning on a single metric such as citizenship.  Specifying a legal rule to define the members of our community (who may be subject to at least some elements of worldwide taxation, even when they are abroad) may involve the usual tradeoff between complexity and accuracy.  But as I discuss below, there may also be efficiency benefits to a multi-factor approach.

(4) What about “them”?

 For those in the “them” category, in principle we might want to revenue-maximize – that is, get as much money from them (in real economic incidence terms) as we can.  This is not diabolical; it’s just how transactional counterparties commonly deal with each other. 

This of course leads to the Monty Python Principle: “Tax all foreigners living abroad.”  So why don’t we try to do that?  Well, obviously, it would not be a great idea to try, at least without more of a hook.  We don’t have jurisdiction, we don’t have information, it would violate comity and get them really angry, they would retaliate in various ways that we wouldn’t like, etcetera.  And more generally, cooperation for mutual gain is always a good idea when it can be done.  But, when we turn to the treatment of “us,” it’s worth keeping in mind that there is a hypothetical perspective from which we might like to tax all foreigners living abroad.

(5) The basic paradox: if you’re “us” and we care about you, you lose.

Once we accept that we can’t, and generally won’t even try, to “tax all foreigners living abroad,” something that is at least facially paradoxical arises when we consider taxing at least some nonresident citizens on their foreign source income.  This tax burdens the individual who has to pay it.  So we are effectively saying: “If we care about you, we’re going to burden you.  If we don’t care about you, because we have decided not to classify you as a member of our community, then we’re not going to burden you.

Now, one thing we clearly do care about, when taxing members of our community whether they are currently residents or not, is deadweight loss that we impose on them through our rules.  We don’t necessarily care directly about deadweight loss that is imposed on non-members, since we are at least mainly excluding all “thems” from our social welfare function, but for “us” it matters.  And this is pretty much the proof that the current U.S. regime for taxing nonresident citizens is defective and needs to be revised.  It appears to impose a lot of deadweight loss, from compliance burdens and the like, relative to the revenue that is actually raised.  This results, for example, from tax filing requirements who owe little or no U.S. tax (e.g., due to the earned income exclusion plus foreign tax credits).  Now, we may gain valuable information from the filing (or, rather, we would if people actually filed), but this is still a serious concern.

A question meriting further thought: Why don’t we extend more transfers or other social welfare, safety-net style benefits to non-resident citizens?  Perhaps there are good reasons for not doing so, but at the least it requires further thought.  Presumably if we had greater tax-transfer integration, such as via a Mirrleesean demogrant / income tax system, we would at least consider giving the demogrant to non –resident “us.”  Or perhaps not, if there are particular incentive issues to keep in mind here.  But worth some thought in any event.

Circling back to “us” versus “them”: Suppose we can tax U.S. citizens living abroad, but we classify these individuals as “them” rather than “us.”  Only, suppose that, because they are arguably “us,” we can get away with it – other countries won’t start to scream, retaliate, etcetera.  Then we would have a “them”-based reason for imposing the tax (and also for withholding welfare benefits and not caring so much about deadweight loss).  In short, it could be the one case of “Tax all foreigners living abroad” that we could actually pull off.  And this would imply not caring so much about deadweight loss that we impose on nonresident citizens.  But it does strike me as a bit harsh.

(6) Two-stage analysis for immigrants: before & after they become “us”

Let’s leave aside all the issues about illegal residents, as that’s a very different topic and neither raised by Ruth’s paper nor an area of personal expertise on my part.  Instead, let’s consider people who might like to immigrate to the U.S., at least conditionally on comparing it to other places where they might choose to live, and whom we are considering admitting to our community voluntarily.  They are not here yet, and suppose they will only come here if we let them.

I bring up these people because Ruth’s paper rightly expands the scope of the inquiry to them, by noting that, when we are considering the taxation of nonresident U.S. citizens (as well as green cardholders) on their worldwide income, prospective immigrants are among those whom we should have in mind.  Suppose, for example, that immigrants whom we would like to attract would take note of the U.S. worldwide tax system for citizens and green cardholders, when they are deciding where to go.

Since prospective immigrants are not “us” yet, we might want to maximize the sum of (1) the present value of the money we could get by admitting them, plus (2) the positive externalities that their presence would generate for us.

In terms of (1), you can be crude about it, if you like, and charge an upfront fee for a passport.  Malta and Cyprus do this, and can charge extra-high fees because they can offer EU passports.  Several Caribbean countries also sell passports, albeit for less as they can’t offer an EU passport.  The closest the U.S. comes to charging an upfront fee is via our EB-5 immigrant investor program.

For the most part, however, we are a bit more decorous about exchanging money for admission to our community, in that we allow immigrants – once admitted – to pay under the installment plan, rather than up-front.  That is, immigrants generally can be expected to generate positive tax revenues for the U.S. by reason of paying income and other taxes once here.

We probably should admit more of these people than we do, especially if positive externalities are significant too (as I suspect they are).  But from the standpoint of efficient pricing, telling prospective green cardholders in particular that at some point they would be getting taxed on their worldwide income even if they weren’t living in the U.S. might not be an optimal way to structure the “fee.”  We’re telling them, “It’s going to cost you even if and when you don’t find yourself living in the U.S., which might be the scenario in which they would value it the least.  I have heard it said that well-heeled foreigners who are thinking of spending significant time in the U.S., and who have access to temporary admission under various of our categories, often are advised against seeking a green card.

(7) Relevance of multiple margins (citizenship & residence)

As David Gamage notes in a paper that he presented at our colloquium last year, it is often preferable to have many small distortions, rather than a few large ones.  Citizenship-based taxation may induce people to renounce U.S. citizenship.  Residence-based taxation can encourage them to make sure they are out of the country for at least the requisite time each year.  A rule based on domicile may discourage having one here.  And so forth.  But a standard that relies on several different factors may end up, with proper design, inducing less tax-motivated distortion overall.  Obviously, the fiend or goblin (to avoid saying “devil,” as that’s become such a cliché) is in the details.

(8) Foreign taxes

I’ve written extensively (such as here, here, and here) against the desirability of providing full and immediate foreign tax credits in the setting of business taxation.  My main argument is that foreign taxes are a cost from the unilateral domestic standpoint, hence we should want domestic taxpayers to be foreign tax cost-conscious.  Indeed, straightforward deductibility for foreign taxes (so they will be treated as equivalent to other outlays or forgone inflows)  is the way to go, from a unilateral national welfare standpoint, unless there is more to think about here.  As it happens, I agree that there actually is more to think about in the setting of corporate income taxation, e.g., because if profits show up in a tax haven that may be a “tag” for discerning profit-shifting away from home, whence my conclusion that, for U.S. companies, we might favor a better-than-deductibility, worse-than-creditability bottom line effect.  Well-designed anti-tax haven rules can have this effect.

Exemption is an implicit deductibility system.  Of course, if you limit exemption for the foreign source income of resident companies via anti-tax haven rules, you may get back into that intermediate range (or even beyond, if the rules are poorly designed)

How do these arguments apply to taxing nonresident individuals on their foreign source earned income?  While the topic may require further thought, my initial thought is that a similar basic analysis does indeed apply.  Suppose, for example, that an American is deciding whether to work abroad in lower-tax Singapore or the higher-tax UK.  It may be desirable, from a U.S. standpoint, if he or she bases the analysis on after-foreign tax income, rather than before-foreign tax income.  After all, from our standpoint those taxes are just a cost, as we don’t get the tax revenues.

While it might be the case that the use of tax havens at the expense of the domestic tax base is not as much a problem for individuals’ earned income as it is for companies’ reported profits, that would only push harder towards the deductibility, as opposed to creditability, side of the spectrum.  And even if we treated foreign taxes on U.S. individuals’ foreign earned income as effectively deductible, rather than creditable, then (assuming a treaty-compliant design, which might not be impossible) we might decide to apply a significantly lower tax rate to foreign than domestic earned income, e.g., for the reasons I will discuss next.

The exclusion under Code section 911(b) for about $100,000 of qualifying foreign earned income has the desirable effect of pushing away from effective creditability.  You can’t claim foreign tax credits with respect to foreign earned income that we don’t tax.  But that doesn’t tell us whether zero is the right rate (perhaps even without being so capped), or is too low a rate.  That depends on other considerations.

(9) Foreign earned income

Even leaving aside the treatment of foreign taxes, should we tax U.S. individuals’ foreign earned income at the full domestic rate?  An “ability to pay” perspective would suggest that the answer is yes.  But there may be an efficiency argument (from a national welfare perspective) in favor of a lower rate.  This argument is borrowed from Mihir Desai’s and Jim Hines’ analysis of “national ownership neutrality” (“NON”).

Suppose the following, as Desai and Hines do in the NON context: Each “outbound” dollar is replaced by an “inbound” dollar from a foreigner who earns income that is taxable in the U.S. by reason of the outflow.  Translating it from their context to mine, let’s take a simple case, grossly overstated by me just so one can grasp the argument.  Suppose that, if I leave NYU for a year to teach at a foreign university (which will pay me in lieu of NYU’s doing so), NYU will hire a foreigner to teach in the U.S. in my place, and pay U.S. tax on the substitute salary.  At a rough approximation, even if the U.S. gave me an incentive to visit abroad by not taxing my foreign earnings (and again, the U.S. may have no direct reason to view payments to the foreign tax authority as equivalent to paying U.S. tax), it would not have lost any domestic tax base.  U.S. salaries would be the same, and the IRS would be taxing that foreigner, who would otherwise have escaped its clutches.

Suppose we take this hypothetical to be appropriate – as Desai and Hines do in the setting of cross-border business investment.  (They of course do not make any such claim, or at least they haven’t yet, with regard my hypothetical, which they might join other readers in finding fanciful.)  They then argue that the optimal U.S. tax rate on the foreign source income is zero, so that there will be no distortion at the margin of U.S. companies deciding how much to invest abroad rather than at home.  (Again, the claim is that the lost domestic investment is actually zero, net of the inbound flows it induces that would not otherwise have occurred.)

I think this argument is wrong, because we are trying to balance distortions at multiple margins, not reduce them to zero at some arbitrarily chosen margins while they remain high at other margins.  But I will go so far as to agree with Desai and Hines that it may support a lower U.S. tax rate on resident companies’ foreign source income than that on all companies’ U.S. source income.

Does this argument apply to foreign earned income of U.S. individuals?  I suspect that the extent to which it applies is greater than zero, albeit less than 100 percent.  Americans who work abroad may indeed often leave slots that get filled by someone else, including a foreigner.  (There may also be a positive spillover if the result is to increase other Americans’ domestic earnings by reason of the slot I left open for the year.)  So there may be an argument for taxing foreign earned income of U.S. individuals at a lower rate than their U.S. earned income, even wholly leaving aside the issue of how to treat foreign taxes.

There may also be positive externalities when U.S. individuals work abroad.  One hopes that they are effective ambassadors, spreading goodwill abroad towards those of our ilk, rather than being the stereotypical “ugly Americans.”  Plus, if they learn about life abroad and then return here, the things they learn may enrich life for other Americans.  One of the absolutely greatest things about our country is the extent to which we’ve been a global melting pot, not only because people come here from abroad and are accepted, but also because it makes us (at least on the coasts) more cosmopolitan and international, to our great hedonic benefit.  Or at least that’s how I view it.

(10) Exit tax

Code section 877A generally requires tax expatriates to pay tax on a deemed sale of their assets for fair market value.  The tax only applies to net gain in excess of $600,000.  This exit tax makes up for the fact that, once you’re gone, the built-in gain from the period when you were still a U.S. citizen is unlikely ever to be taxed here.  So one could view it as anti-windfall gain, rather than as aiming to be punitive.

That characterization of the provision would be more solid and beyond dispute if we taxed net asset appreciation at death, rather than allowing a tax-free step-up in basis at that time.  But, for what it’s worth, the provision can indeed reduce lock-in on the part of individuals who are considering expatriating.

Here is a further issue that might be worth thinking about.  Suppose someone who might owe estate tax liability at death expatriates before that point.  Proponents of the estate tax might support treating expatriation as a triggering event for levying the tax.  Not just because "You're dead to us now," but to avoid creating the incentive to expatriate for that reason.

Aftermath of the Columbia / Davis Polk panel on corporate inversions

Just back from the above panel, which was held under the Chatham House Rule, which provides that "participants are free to use the information received, but neither the identity nor the affiliation of the speaker(s), nor that of any other participant, may be revealed."

So I'd better not say whether I actually delivered the remarks in my prior post, or whether, if I did, I spoke fast enough (or the chair was lenient enough) for me to deliver the whole thing in five minutes.

But I will mention what I considered the most interesting thing I heard at the session.  It was suggested in some quarters that, even though the U.S. has what we label as a "worldwide" system, while Germany has what we label as a "territorial" system, it is not entirely clear which system bears more rigorously on its multinationals.  Germany, for example, has much tougher earnings-stripping rules than we do, perhaps even making it harder, in some circumstances for German than U.S. companies to strip earnings out of the domestic tax base.

The response offered to this was as follows: If the U.S. isn't much tougher on its multinationals than Germany, why is it that tax inversions are a U.S. phenomenon, not a German phenomenon?

Sounds convincing, right?  Actually, not so much.  The response offered to that was, at least my view, a game, set, and match refutation of the claim that inversions prove the U.S. tax regime to be more onerous.

The point is as follows.  Companies don't look to invert because their current tax rate is high - it's not based on the absolute pre-inversion level.  Rather, they consider inverting based on an assessment of before versus after.  The U.S. rules differ from Germany's in that they make the before vs. after analysis of an inversion potentially far more appealing for U.S. than German companies.

This, in turn, happens for two reasons.  First, given how much tougher the German than the U.S. earnings-stripping rules are, there's much less payoff to a German inversion.  You can't do as much great stuff afterwards, such as through intra-group loans.  Plus, in the U.S. setting, since we use our controlled foreign corporation (subpart F) rules to discourage the use of intra-group debt to reduce U.S. tax liability, you really give yourself a new tool here by inverting.

Second, because we have deferral, you get out from under the burden of having to play costly tax planning games to access the overseas earnings without incurring U.S. repatriation tax.  That reflects a stupid design element of our system, but again, it's about the before versus after, and doesn't prove anything about the overall relative levels.

My remarks in the previous blog post emphasized the importance, if we eliminate deferral, of imposing a transition tax on the pre-change foreign earnings that would now permanently escape the repatriation tax.  I would also consider applying such a tax to U.S. companies that invert, i.e., treat the transaction (even if very substantive) as a constructive repatriation of prior foreign earnings of the U.S. group.  Indeed, this cash-out of the deferred tax liability could apply even though the foreign earnings typically remain in the hands of subsidiaries of U.S. companies in the ownership chain, since having a foreign parent on top of the whole group generally makes it easier to avoid repatriation indefinitely than it would have been before.

Columbia Law School / Davis Polk panel on corporate inversions

Today, in just over an hour, I will be participating in a panel discussion regarding corporate inversions that is sponsored by Columbia Law School along with the law firm of Davis Polk.  My co-panelists will be Rosanne Altshuler, Richard D'Avino, Mihir Desai, and David Schizer.

We'll each be talking for 5 minutes near the start on assigned topics, before getting to general discussion.  My assigned topic is deferral.  Since I talk fast, I am hoping to use my 5 minutes to say something rather like this:

If there’s one U.S. international tax rule that everyone hates, with good reason, it’s deferral.  Proponents of a strong worldwide tax want to replace it with full accrual.  Proponents of a more territorial system want to replace it with exemption of foreign source income.

The reason they can’t agree to get rid of it is that each side hates the other side’s proposed system even more.  So deferral is the boundary line of an enforced political ceasefire in place between armed camps, like the trench lines between the German and Allied forces in World War I.

Deferral originally arose for purely formalistic reasons, via realization doctrine.  If you own GE stock and GE has profits, you don’t personally have taxable income until you get dividends or sell the stock.  But applying this concept to a company and its wholly-owned foreign subsidiaries is just silly.

So in 1962, when the Kennedy Administration proposed repealing deferral, U.S. companies did NOT primarily respond by making formalistic arguments, such as saying the income hasn’t been realized yet.  Instead, they talked policy, saying that the U.S. tax burden on their foreign operations would be too high if we adopted a worldwide system with full accrual.

OK, what’s wrong with deferral?  It’s not that it prevents U.S. companies from getting their hands on cash that they want to invest at home.  I wouldn’t gratuitously insult these companies’ tax directors by falsely suggesting that they are too lame or dense to figure out how to get around the rules.  But once a lot of money is nominally abroad – often, due to profit-shifting games – the tax planning games start getting costly, as Rosanne showed in a recent paper.

In practice, companies may pay less attention to the tax rule as such than to the associated accounting rule, under which all deferred U.S. taxes are a current expense unless you declare that the earnings have been permanently reinvested, in which case the deferred tax expense goes to zero.

You don’t have to know anything about accounting to see what a stupid rule this is – it’s just too discontinuous.  Once companies get the PRE designation, that alone deters taxable repatriations, both to avoid an earnings hit and so the accountants won’t start questioning other claimed PRE.

While simply bad considered in itself, deferral also has important effects at two completely distinct margins.  First, in practice it effectively lowers the U.S. tax burden on U.S. companies’ foreign earnings.  This could be good or bad, depending on how the actual effective rate that U.S. companies face compares to the optimal effective rate, all things considered.  That is an issue on which serious people disagree. 

Second, deferral makes the allowance of foreign tax credits domestically tolerable, rather than intolerable.  Under a worldwide / foreign tax credit system without deferral, each dollar of foreign tax liability costs domestic companies precisely zero, until the foreign tax credit limit is reached.  But with deferral, U.S. companies generally are foreign tax cost-conscious – which is good, from a U.S. standpoint.

Suppose we adopted a worldwide minimum tax for U.S. companies with full foreign tax credits – unlike the recent Administration proposal, which limited them to 85%.  Even if the rest of the current system remained in place, that would be like partly repealing deferral.  A company that was currently paying zero worldwide would say: Hey, we might as well pay 19% to other countries and still pay zero to the U.S.  Why keep on bothering with all the extra overseas tax planning if it makes no bottom line difference anyway?

At that point, you’d have to ask exactly what the U.S. had accomplished by enacting the minimum tax.  Why should we be glad that other countries are getting more tax revenues from companies with U.S. shareholders?

In sum, it’s a great idea to get rid of deferral – everyone agrees.  But if we do it, we have to think about 3 things.  First, what should be the tax rate on foreign source income?  Definitely not zero, at least not for all foreign source income.  All of the major so-called territorial countries, such as Germany, the U.K. and Japan, agree.  They all have anti-tax haven rules of some kind, which can cause certain foreign source income of resident companies to face a domestic tax.

Second, without deferral and without full territoriality, it’s a big mistake to offer full foreign tax credits, which would eliminate the companies’ zero foreign tax cost-consciousness in certain ranges.  Now, there are ways of taxing foreign source income at a low though positive rate, and not granting full foreign tax credits, that might avoid formally violating any treaties with rules against “double taxation.”

Third, the word is deferral because taxes are just being deferred.  U.S. tax liabilities have been at least hypothetically accruing, and they are even effectively accruing interest as they naturally grow over time.  The most prominent Republican and Democratic international tax reform proposals that would repeal deferral both include a one-time transition tax on prior foreign earnings.  These wouldn’t be unfair retroactive taxes – they’d be fair, anti-windfall taxes.

Now, we can debate how high or low the transition tax should be.  But not imposing it would be a giveaway.  It also would be inefficient.  Companies that anticipated the giveaway would be even more anxious than under present law to avoid any taxable repatriations until the change in law occurred.  So it would be desirable if both parties committed today to enacting a transition tax when and if deferral is finally repealed.

NYU Tax Policy Colloquium, week 5: paper by Linda Sugin

We had a week off from the colloquium last week, as the usual Tuesday was a "legislative Monday" at NYU Law School.  But yesterday we were back in business, discussing Linda Sugin's article, Invisible Taxpayers.

The article discusses tax issues related to standing, and in particular to the difficulty of getting judicial review of IRS decisions that fall outside of the "traditional dyad," i.e., IRS versus taxpayer.

A taxpayer who pays "too much," due to an IRS decision that arguably misinterprets the law, or a legislative rule that arguably is unconstitutional, unmistakably has standing and thus can get it reviewed by the courts

But whenever a taxpayer pays "too little" for the same reasons, others may lack standing, and thus be unable to get it reviewed by the courts, potentially permitting legally incorrect or unconstitutional policies to keep right on going as there is no forum for raising the challenges.

The paper notes up front that we are all fiscally interconnected.  Given the intertemporal budget constraint for all US taxpayers considered together, anytime you pay a dollar less or get a dollar more that's bad for me in a certain sense, and vice versa.

This alone, of course, probably would not make it wise to grant universal standing to challenge others' tax outcomes (e,g., for me to sue the IRS on the ground that it gave GE an unduly favorable advance transfer pricing agreement), even if there were no constitutional restraints based on separation of powers, the need for a proper case or controversy within the ambit of the adversarial system, etc.

But in some instances, third parties may have a stronger claim than this for invoking the judicial process.  For example, consider the Sklar case, which the paper discusses.  Here what happened is the following.  First, the IRS won a favorable Supreme Court ruling (in a case called Hernandez) regarding the non-deductibility of supposedly charitable gifts by Scientologists to their church that arguably were quid pro quos for goods and services.  Second, the IRS decided to unilaterally concede the issue that it had won in the Supreme Court, arguably to call off aggressive harassment of IRS auditors who were attempting to enforce the Hernandez rule.  This meant that people practicing Scientology were arguably getting charitable deductions despite the quid pro quo.  Third, in Sklar itself, Orthodox Jews that their free exercise rights would be violated if the IRS enforced against them rules that it had expressly agreed not to enforce against Scientologists.  Here there literally was standing for the Sklars to contest their own tax liability, but the court arguably declined to give due heed to the issue of equal treatment

More generally, First Amendment rights to equal treatment of different religions are hard to vindicate when the members of one religion are treated unduly favorably, rather than unduly unfavorably (in which they will probably be able to bring a challenge).

In a more recent case, the lamentable ACS v. Winn, the Supreme Court held as follows  Even if it is unconstitutional for a state to fund people's private religious school tuition directly, the very same policy is beyond judicial review if the state instead provides a 100% tax credit for such tuition.  This rested on a childishly - though probably deliberately - naive view of clearcut tax expenditures as mere "inaction" from not taxing, whereas direct spending is reviewable stat "action."

One could say a lot more about why this is so wrongheaded a view.  Treating clearcut tax expenditures as equivalent to direct outlays does NOT rest on some notion that your money belongs to the government whether they tax it or not. I have addressed this canard, for example, here.  And you don't need to be a constitutional lawyer to realize that it is idiotic to permit constitutional requirements to be evaded through purely nominal changes in form.  (The question of whether direct outlays for religious school tuition should generally be unconstitutional is separate.  But if one views this as unconstitutional, it's unconscionable to let states dodge the rule by playing silly semantic games.)

It's easy to conclude that ACS v. Winn was wrongly decided, and that the Supreme Court should have treated that particular state program exactly as they would have treated a direct outlay.  Other issues involving tax expenditures might, admittedly, be more ambiguous, since the category doesn't have absolutely clear boundaries.  But that is certainly something that the courts could deal with.

With regard to "invisible' taxpayer issues more generally, I would say that one needs a theory of standing.  Why limit it, given that there may be social value to having ambiguous legal issues addressed publicly by the courts, and to correcting misinterpretations of the law and instances of unconstitutional decision-making.  Presumably, the values on the other side of the ledger include not just avoiding over-burdening of the courts, but also upholding the bona fide adversarial structure (if one thinks it is a good thing) and perhaps limiting the courts' ability to throw their weight around, even when they can at least claim to be merely performing their normal interpretive function.

Despite those concerns, it is plausible that current standing doctrine is far too narrow in some settings.  One could argue, for example, for more regularly granting standing based on equal treatment claims that have a specific constitutional basis (e.g., pertaining to religion or race).

Suppose Congress enacted a s"White People's Tax Credit," offering white people a tax credit that equaled $X outright, or say a 100% credit for food outlays up to $X.  Could this be challenged in court under current standing doctrine?  White taxpayers wouldn't have standing to challenge it since they are the direct fiscal beneficiaries, and other taxpayers would  face doctrinal and precedential impediments to their being allowed to challenge it.

I find it hard to believe that the provision wouldn't be somehow reviewable and struck down.  But apparently those who have read the relevant case law carefully (in particular, ACS v, Winn, along with various cases denying taxpayer standing) don't universally share my perhaps naive confidence on this point.

Current projects list

For some reason, the embarrassing weakness of the badly over-written yet under-baked The Godfather, Part III, (despite a great plot idea: ruthless American gangster finds that he's out of his league dealing with sharpies from the Vatican) has not prevented its most famous quote from being widely remembered: "Just when I thought I was out, they pull me back in."

My version of this quote would be: "Just when I think I'm starting to run out of ideas to write about, they give me new ones."  For me, of course, it's good rather than bad, and "they" refers to people who are holding conferences, compiling edited volumes, etc.

My main project these days is writing a book on the super-rich in selected works of literature (great and otherwise) from the last two centuries.  Tentative title: "Visions and the Versions of the Point-One Percent."  However, I don't think this title quite captures what the project is actually about, so I am probably going to feel compelled to change it.

This book, which I am quite enthusiastic about and finding fun to write when I can find the time, is a byproduct of the Piketty conference that we held at NYU last October, and of the paper for that conference that I co-authored with Joe Bankman.

Due to further conference and book invites, I'm probably also going to write short papers on:

(1) How the framework that I develop in my book on international tax policy suggests thinking about recent developments in the international tax field (e.g., OECD BEPS, the UK Google tax, and recent US international tax reform proposals).  Tentative title: "Getting a 'Fix' on Recent Developments in International Tax Policy."  Play on words here, since "Fixing" is the first word of my book title.

(2) The current US practice, which no other country follows, of imposing at least some degree of worldwide income taxation on nonresident citizens.

(3) For a book (without conference) that will consist of invited articles discussing timing and legislation from various perspectives, I have a piece in mind that's tentatively called "On Beyond Indexing."

(4) I may also take a chapter from my book-in-progress on the super-rich in literature, and use it aas a standalone piece (for a conference on tax & philosophy), entitled something like "The Social Sciences and Beyond in Evaluating High-End Wealth Inequality."  Inside the book, this chapter serves to explain the possible relevance of reading literature to how one might think about the issues raised by high-end wealth inequality.  But this makes it potentially suitable for separate use as a standalone piece on how to frame the relevant normative issues. E,g., what do conventional economic approaches leave out.

I suppose all this should keep me off the streets (and often on the road), for the rest of 2015 and probably well into 2016.

Lee Sheppard at NYU Law School

Today Lee Sheppard appeared at NYU Law School to give a talk on a paper that she is writing - evidently not intended to be a Tax Notes column - entitled "Beyond Tax Avoidance: Managing Multinationals' Tax and Contractual Relationships With Developing Countries."

The session had excellent comments from Rebecca Kysar and Michael Schler.  But as usual, I view the session as having been off-the-record, and hence I can't comment specifically here about any of the speakers' comments, as opposed to the issues that Lee addresses in the paper.

The underlying idea that Lee's paper expresses is that, while the developed countries have their own set of issues with multinationals (MNEs) that they are dealing with (or not) through the OECD BEPS initiative and the like, developing countries have their own set of problems.  But these aren't confined to tax.  For example, a country with mineral wealth that MNEs want to extract and sell on world markets really needn't care whether it's getting better royalties or more taxes paid to it out of the deal - leaving aside the fact that the taxes may qualify for home country foreign tax credits (a point that I of course have elsewhere emphasized from a developed country perspective).

Lee's paper urges developing countries to consider capital controls, cherry-pick good tax base protection ideas from the OECD, verify mineral extraction quantities that determine royalties due, and be smart / only sign good contracts to begin with.

It further argues that developing countries should not: sign OECD model tax treaties, sign US model bilateral trade agreements, sign treaties with tax havens, sign arbitration clauses (at least if the arbitrators are likely to be biased), borrow from the IMF, or listen to economists.  It suggests that economists not only are sometimes being paid by big companies, but are too anti-tax and too blind to the downsides of free trade ideology (recall, for example, the rise and fall of the 1990s "Washington consensus").

This critique of economists is similar to what Joe Stiglitz or Paul Krugman, themselves economists, might say.  Note also that the IMF, or at least its staff, has recently changed course on questions such as whether austerity makes any sense these days.  And while economists may often be anti-capital controls, consider that decades ago James Tobin wrote about the dangers small countries face from rapid, speculation-driven global capital flows, Jagdish Bhagwati has more recently been writing about this.

 The core issue, from the standpoint of developing countries that encounter MNEs that want to engage in inbound activity of some kind, is how much market power the countries have.  Despite global economic forces, the paper suggests that these countries - even when short of the scale of China, India, and Brazil, which stand up for their own economic interests quite effectively - often have more market power than they apparently realize or have exercised.  E.g., if you have a national sales market or workforce or natural resources that the companies want to tap, that is worth something.

Now, part of the question goes to such countries' ability to arrange cooperation among themselves, rather than competing to mutual detriment in a prisoner's dilemma scenario.  But the paper suggests that, to a considerable extent, ignorance, naivete, and misplaced trust in outside professionals or experts have led developing countries to demand less than they have the power to extract.  And you don't have to be a non-economist or anti-economist to agree that, if this critique is correct,then developing countries would benefit from addressing it.

The Monty Hall problem: bungling probability theory versus engaging in strategic thinking

When the Monty Hall problem was first brought to my attention a few years ago, I didn't get it right either.

But here's the thing: perhaps because I hadn't seen the show for decades, or else because I was taking the reference to Monty too literally, I was thinking about him as a strategic player who wants to trick you, because it's fun for the TV audience to laugh at you as they play that "wah-wah-wah-wah" music once you've switched from the new car to the smelly goat (or whatever).

So I figured, he is more likely to show you a door that is the wrong answer, and then to ask you if you want to switch to the third door, if the door you initially picked was the right one.  Hence I hadn't accepted the (often unstated) premise of the Monty Hall problem, which is that, no matter what, he will show you a door that is the wrong one.

Once you introduce the possibility of situation-specific strategic play by Monty, rather than his doing the same thing every time, there is no right answer to the puzzle until we know more about his decision function.

This causes me to think of the Monty Hall problem as demonstrating, not just our difficulties in thinking clearly about probability theory, but also our inclination for strategic thinking (and imputing it to others).  That surely is highly adaptive as a general matter, whereas tending to bungle probability theory is presumably more about heuristics and cognitive shortcuts.

Very sad news (re. Marvin Chirelstein)

I was greatly saddened to hear today of the death of Marvin Chirelstein.  Marvin was my tax (and Corporate Finance) professor at Yale Law School back in the day – I never took a course with Bittker, who was reputed to dislike having to deal with students’ vastly lesser state of intellectual attainment (both in tax and generally) than his own.

My intellectual inspiration in tax didn’t really come from Marvin – mainly through my own fault; at that stage I wasn’t very receptive to the Yale law professors’ intellectual interests.  Combination of burnout (I had gone straight through from nursery school to law school without a break) with disdain, at that callow stage in my personal development, for non-Ph.D. academic disciplines (I had planned until late junior year to go to history grad school).  But he had very few peers at the time in tax law scholarship.

Marvin was, however, by far my favorite professor at YLS.  I (along with all of my best friends among the students there) admired his humor, personality, and panache as a performer (if panache, rather than anti-panache, is the word for his brilliantly low-key comic style).  We all thought he was extremely cool - not an accolade that we extended, at the time, to many YLS faculty members, or, for that matter, to many people who were older than, say, John Lennon and Bob Dylan.

Word had it that he had been associated with the people in the Second City Theater Group in Chicago during the Nichols and May era, but didn’t formally join the troupe due to stage fright.  I honestly don’t know if that was true.  But he used to pace around nervously before class, sucking on a cigarette and narrowing his eyes, very much in his own head like a performer getting ready.  And, true or not, it was credible, because he was so hilarious in his distinctive style.  I thought of him, at the time, as a combination of Humphrey Bogart and Rodney Dangerfield.  I might now add, also with a touch of Stephen Wright.

Here is another story I heard about Marvin at the time, which I doubted was true but actually did later confirm.  Supposedly, when he was a student at the University of Chicago Law School, taking tax with my own subsequent mentor Walter Blum, two things became clear to Walter.  The first was that Marvin was intellectually gifted, and the other was that he was cutting a lot of classes, apparently because he detested the early morning meeting time.  Walter called Marvin into his office to discuss this, and Marvin made him the following offer: “How about you let me attend or not as I see fit, and if I get at least an A- on the exam you give me an A, but if I don’t, you fail me / lower my grade to a C” [I forget which].  I assumed that this story couldn’t actually be true, but when I asked Walter about it years later, he confirmed it.

Here are a few examples of Marvin’s comic style in class.  Disclaimer: You had to be there, it was a totally personal style that worked via his delivery and the character he played.

1) Marvin: “Feldman, this case says something about ‘old and cold.’  What’s the opposite of ‘old and cold’?

Student: “Uh, hot and fresh?”

Marvin.  “Hot and fresh … hot and fresh … I would have said young and warm.  Shame on you, Feldman.  You’re thinking about bagels.”

2) Student in the back: “Can you speak up?  We can’t hear you.”

Marvin: “Sometimes people don’t speak softly because they’re unaware.  Sometimes it’s because they’re so ashamed of what they’re saying.”

3) [To a student]: “Would you be able to defend this transaction?  … For a fee, of course.”

4) [Discussing a case that was decided in 1935.]  “Ah, 1935.  The best year of my life.  The Cubs won the pennant, and a boxer from my hometown became middleweight champion.”  He followed this with a toneless little laugh.  What made this funny, to Chirelstein aficionados such as myself, was the implicit suggestion that the point wasn’t that these things were so great, but rather that the rest of his life was so completely lacking in anything better.  But I should note that we didn’t think he was actually unhappy - rather, it was the character he played, like Jack Benny pretending to be cheap.  Indeed, if anything we figured he had to be confident and secure in his life, in order to be willing to pretend that he felt pathetic.

5) [Explaining why he wasn’t using Bittker’s casebook, in a year when Bittker was on leave and out of town.]  “He’ll never know.  He’s currently sailing down the Nile with a rose between his teeth.”

Whenever I saw Marvin in subsequent years, he would make a point of commenting on how awful my handwriting was on the exams I took in his classes.  He complained that it had permanently worsened his vision, and that surely I must have a physiological problem.  He also called me “young Shaviro,” well past the point when it was descriptively accurate.  And he would complain that I was publishing too much, pretending to demand that I stop so he wouldn’t look bad.

Early in my time at the University of Chicago Law School, I got a handwritten card from Marvin in which he suggested that I visit Columbia Law School.  He assured me that the head of the Appointments Committee, “Smiling Jack Coffee,” would be happy to extend a visiting offer.  Why not try New York, he wrote.  It has crime, dirt, and vermin – what more could you want? 

I’ll greatly miss Marvin Chirelstein, a brilliant and wonderful man whom I admired and wish I could see again.

NYC Tax Policy Colloquium, week 4: paper by Eric Toder et al

Yesterday, we had our Week 4 session at the Colloquium, featuring Eric Toder’s Lessons the United States Can Learn From Other Countries’Territorial Systems for Taxing Income of Multinational Corporations (co-authored by Rosanne Altshuler and Stephen Shay).  The following is an expanded version of a much shorter outline that I prepared to guide my portion of the discussion.

1.  International tax policy at a crossroads

(a) International tax policy is arguably at a crossroads.  It has been there for a while, and may stay there for a while.  But changes on the ground have important implications for current regime’s workability.  This comes from 2 related but distinct types of changes: rising actual global capital mobility, and advances in tax planning technology that create greater mobility for reported income, even if just from paper-shuffling.  The latter reflects not just ongoing innovation by tax planners, but also rule changes – e.g., U.S. adoption of check-the-box rules and these rules’ disregard of transparent single-owner entities (leading to the effective quasi-repeal of our CFC rules).  All this has fueled the newspaper headlines we see about Apple, Google, GE, corporate inversions, etc.  It also has influenced the U.K. & Japan to change their international tax systems in ways that have been described as replacing “worldwide” systems with “territorial” ones.

(b) Many argue that the U.S. should do this too.  But there has also been pushback, as per calls in the U.S. for tougher rules and the OECD BEPS initiative.  Overall, our options could be classified as “retreat” versus “advance” versus “do something different entirely” (such as replacing the corporate income tax, and/or the entire U.S. tax system, with something very different – there are several alternatives that would eliminate the current dilemmas of international tax policy, which rest on the problems associated with entity-level income taxation).

(c) The paper’s main takeaways are twofold.  First, the “worldwide vs. territorial” framework is not a useful way of describing our choices.  Second, a simplistic narrative holding that the U.S. must become territorial because otherwise we will be “out-of-step” is wrong on two grounds: in some respects we aren’t actually that out-of-step, and neither Japan’s nor the U.K.’s reasons for adopting changes apply to us.

2.  What’s wrong with the “worldwide versus territorial” framework?

(a) As I discuss at length in my 2014 book, Fixing U.S. International Taxation, this is not a well-posed choice, because it conflates 2 distinct margins.  The first is what tax rate a given country applies to resident companies’ foreign source income (FSI).  The second is what marginal reimbursement rate (MRR) the country offers with respect to resident companies’ foreign income tax liabilities.

(b) Statutory tax rate on FSI: It’s often assumed that this must either be the same as the domestic rate (under “worldwide”) or else zero (under “territorial”).  Refreshingly widening the options, however, the Obama Administration recently proposed a 19% tax rate on resident companies’ FSI.

(c) MRR: In a worldwide system without foreign tax credit limits and without deferral (which I discuss below) the MRR is 100%, thus completely eliminating resident companies’ foreign tax cost-consciousness. A territorial or exemption system provides implicit deductibility of foreign taxes, in that the MRR equals the marginal tax rate or MTR, inducing resident companies to seek to maximize after-foreign-tax foreign income.

(d) In Fixing, I argue that, assuming our distortionary system for taxing business income will generally remain in place, an intermediate tax rate on FSI (i.e., between zero and the full domestic rate) is likely to be optimal if we have some market power over corporate residence.  The MRR should equal the MTR – the deductibility result – if (i) there is no reciprocity (e.g., we aren’t agreeing with other countries to credit each other’s taxes – and we aren’t if they are generally territorial AND (ii) there are no other issues to consider here.  As I discuss below, it’s plausible that there are other issues, supporting better-than-deductible (albeit worse-than-creditable) treatment for foreign taxes in the tax that the MRR should actually exceed the MTR, at least in certain settings.  But even so, the MRR shouldn’t be 100%.  When I wrote Fixing, I was concerned that this might require violating bilateral tax treaties (which address “double taxation”), albeit not actually to the disadvantage of other countries, relative to treaty-compliant things that we could do.  But since then, both the Baucus staff tax reform plan and the recent Obama Administration budget proposal have shown how one might be able to combine an intermediate rate for FSI with an intermediate MRR, without formally violating the anti-“double tax” requirement of our tax treaties.

(e) Toder et al Case Study, point 1: So-called “territorial” countries do indeed tax certain FSI of their corporate residents, in particular if it is passive income or associated with tax havens.  (These are effectively the same thing, as passive income tends to show up in tax havens.)   Such countries may also have tougher rules for the U.S. for defining domestic source income.  In practice, this can have very similar effects to taxing FSI that shows up in tax havens, especially if the tougher source rules apply distinctively to resident companies.

(f) Toder et al Case Study, point 2: Widespread anti-tax haven rules, yielding a positive tax rate on certain FSI of resident companies, effectively extend better-than-deductible treatment to foreign tax liability.  After all, a company that reduces its foreign tax liabilities by shifting income to tax havens ends up paying more domestic tax, effectively causing the extra foreign taxes that one pays by reason of not going to tax havens (and thus not incurring domestic tax liability) to be better-than-deductible at the margin.

3.  Deferral

(a) As is well known, deferral for FSI that is earned through one’s CFCs does not lower the present value of the deferred taxes under new view assumptions, which are twofold: (i) there is permanently fixed repatriation tax rate that will be paid at some point, (ii) convergence of all the after-tax rates of return one might earn, even with different source-based tax rates.  But the first of these assumptions clearly does not hold in practice, and the second may not either.

(b) Under new view assumptions plus a couple of extra ones (including the inapplicability of foreign tax credit limits), deferral does not reduce the 100% MRR that a “worldwide” system offers via foreign tax credits.  However, once we recognize that the new view assumptions do not generally hold in practice, deferral may and does lower effective MRRs, pushing towards (and possibly even all the way to) a deductibility result.

(c) For this reason, repealing or reducing deferral in favor of a more accrual-style worldwide system requires rethinking foreign tax credits.  The Obama Administration apparently recognized this.  Their 19 percent “minimum tax” proposal would have led U.S. companies to face zero after-tax cost from increasing their foreign tax liabilities, say, from 0 percent to 19 percent of FSI, if not for the fact that the proposal offers what are only, in effect, 85 percent foreign tax credits (i.e., a dollar of foreign tax liability effectively reduces one’s U.S. tax liability, within the range of potential application, by only 85 cents).

(c) Toder et al Case Study, point 1: Why did the U.K. & Japan even bother to go territorial?  After all, their deferral rules were so weak – since the domestic parent could borrow from CFCs without its being treated as a taxable repatriation – that it is unclear why the companies even cared.  I think an important part of the answer is that making the systems (more) territorial served as protection against possible tightening of the existing rules.

(d) Toder et al Case Study, point 2: As noted in the paper, the burden of avoiding the repatriation tax is much higher for U.S. firms than it was for U.K. and Japanese firms, recently estimated as akin to a 7% tax rate albeit taking the form of deadweight loss rather than U.S. revenue-raising.  This helps to explain U.S. inversions and support for territoriality?  Is this a helpful “friction” in any way?  The “yes” argument would hold that it deters U.S. companies from engaging in even more profit-shifting to the detriment of the U.S. domestic tax base. 

(e) The fact that U.S. companies have deferred tax on more than $2 trillion of foreign earnings provides strong grounds in favor of enacting a “transition tax” if the repatriation tax is eliminated, whether by a shift towards territoriality or an accrual-based worldwide system.  There is some bipartisan support for this.  For example, both the Camp plan and the Obama Administration’s budget proposals provide transition taxes, although the latter has a higher rate than the former.

4.  The paper’s response to claims that the U.S. is “out-of-step” unless it adopts a territorial system

(a) Despite our system’s distinctive (and often ill-chosen) features, we are not out-of-step if “territorial” countries are actually similar.  Apparently, one thing that German CFOs and company tax directors have in common with their American counterparts is that each group is convinced that its home country international tax system is the more rigorous of the two, thus placing their companies at a competitive disadvantage relative to the other country’s companies.

(b) Japan and the U.K. don’t offer us much in the way of relevant lessons.  Japan’s system appears to operate very differently than ours – for example, the companies are far less willing to engage in aggressive tax planning.  It’s very plausible that this has less to do with cultural differences (other than peer pressure that can support either equilibrium) than with Japanese firms’ having more reason to want to please government counter-parties, and also facing worse prospects if they try litigation.  Also, the Japanese government seems to have thought that formally eliminating the already trivial repatriation tax would help counter economic stagnation and recession.  This was not convincing as a matter of economic theory – especially given how easy it was to repatriate funds tax-free.  As for the U.K., its being a small island nation and one that was severely constrained by the European Court of Justice put it under pressures that the U.S. does not currently face to the same degree.

(c) Admittedly, one can’t do a case study of the future.  The paper agrees that competitive pressures on the ability of the U.S. to depart from international norms (insofar as it is even doing so) seem likely to increase over time.

5.  Conclusions

(a) Ought we to broaden the menu of choices? Australia’s full-imputation approach to shareholder-level taxation, the Toder-Viard plan to replace the corporate income tax with a shareholder-level mark-to-market tax, the Auerbach plan to replace the corporate income tax with a destination-based VAT-style approach, and progressive consumption tax models such as the X-tax, would eliminate certain of the dilemmas that one inevitably faces when engaged in entity-level corporate income taxation.

 (b) Assuming that we retain entity-level corporate income taxation , I would say that the approach I advocated in Fixing – involving an intermediate tax rate on FSI, an intermediate MRR, and the repeal of deferral – is looking pretty good, and has been gaining support, as reflected by the embrace of all three of these concepts in recent proposals by the Senate Finance Committee majority staff (under Senator Baucus) and the Obama Administration.