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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Debt versus equity ruminations

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

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

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

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

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

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

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

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

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

Radio chat

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

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

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

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

UPDATE: Here is the audio link for the interview.

New York Times article on carried interest

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

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

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

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

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

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

Fun science reading

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

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

George W. Bush, I feel your pain

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Battle of the downloads

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

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

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

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

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

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

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

I.    INTRODUCTION

            The ancient Greek philosopher Heraclitus famously remarked that you cannot step into the same river twice, to which a disciple supposedly replied that you cannot do so even once. Both remarks may shed light on the problem of specifying how legislation should apply over a period of years, in relation to the aim of keeping what I will call “current policy” constant as time moves forward.  Heraclitus reminds us of the difficulty of truly being in the same place at different times, if everything is continually changing around oneself.  The disciple could be viewed as casting doubt on the notion that there is such a thing as a well-defined place, even the first time around.

            Despite these warnings from the ancient world, two simple ideas about policy across time may initially seem uncontroversial.  The first is that, if (and insofar as) two different years are relevantly the same, the policies that apply to them should be the same.  The second is that, in order for the policies applying in different years to be the same, their nominal terms may need to differ. The classic, and seemingly no-brainer, illustration of both ideas is indexing the dollar amounts in particular statutes for inflation.  Annual inflation indexing has been in place since 1981 for the marginal rate brackets in the U.S. federal income tax, and since 1972 for U.S. Social Security benefits.  Obviously, or at least apparently obviously, it results in keeping income tax and Social Security policy substantively the same across time.  Absent inflation indexing, Congress would frequently have to amend the law – changing nominal dollar amounts in the statutes – in order to keep the actual policy the same.

            We will see, however, that keeping current policy the same is more complicated and perplexing than it may initially seem.  Indeed, a closer look even just at inflation indexing in the income tax and Social Security reveals broader issues, pertaining to both motivation and implementation. The dissonance only widens when one turns to other actual or possible types of automatic indexing in the income tax and Social Security.

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

Two new articles (both short) posted on SSRN

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

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

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

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

Arnold Harberger's famous 1962 article on corporate tax incidence

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

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

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

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

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

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

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

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

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

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

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

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

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

                                                                                                                              August 31, 2015

Financial Accounting Standards Board

Norwalk, Connecticut

Dear FASB Members,

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

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

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

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

1.       As the “Quad B” dissenters to APB 23’s adoption warned in 1972,[3]  the suppression of DTLs under APB 23 may misinform investors looking at book income by mixing restricted earnings (i.e., income for which IRE designations are made) with unrestricted earnings.

  

2.       APB 23 requires management to assert the unknowable in order to achieve the book income advantage of suppressing a DTL.[4]  Companies cannot reliably assert, whether as a probability or a possibility, that certain income will not be repatriated in the next 20 or 30 years (which is how “indefinitely” needs to be defined for accounting consistency).[5]  Changes in management, business circumstances, and shareholder needs make such assertions impractical (as demonstrated by recent big and small reversals of IRE designations by companies including Avon, eBay, Pfizer, and General Electric). Prudent accounting requires use of the DTL, which is ideal for accommodating long-term book/tax differences, to remind investors of the inevitable cost of repatriation. 

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

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

Sincerely,

Patrick Driessen

Revenue Estimator, Federal Government (retired)

J. Clifton Fleming, Jr.

Ernest L. Wilkinson Professor of Law

J. Reuben Clark School of Law

Brigham Young University

Jeffery M. Kadet

CPA (retired) and Adjunct Lecturer

University of Washington School of Law

Edward D. Kleinbard

Johnson Professor of Law and Business

University of Southern California Gould School of Law

David L. Koontz

CPA (retired)

Robert J. Peroni

Fondren Foundation Centennial Chair for Faculty Excellence and Professor of Law

University of Texas School of Law

Daniel N. Shaviro

Wayne Perry Professor of Taxation

New York University School of Law

Stephen E. Shay

Senior Lecturer

Harvard Law School

---

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

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

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

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

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

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

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

NYU Tax Policy Colloquium - spring 2016

The schedule for the 2016 NYU Tax Policy Colloquium, which I will be co-teaching with Chris Sanchirico of U Penn Law School, is now set (as to speakers, though not as yet paper titles).  We'll be meeting on Tuesdays, from 4 to 5:50 pm, at NYU Law School, 40 Washington Square South (i.e. Vanderbilt Hall), room 208.  The speaker list is as follows.

1.  January 19 – Eric Talley, Columbia Law School.

2.  January 26 – Michael Simkovic, Seton Hall Law School.

3.  February 2 – Lucy Martin, University of North Carolina at Chapel Hill, Department of Political Science.

4.  February 9 – Donald Marron, Urban Institute.

5.  February 23 – Reuven Avi-Yonah, University of Michigan Law School.

6.  March 1 – Kevin Markle, University of Iowa Business School.

7.  March 8 – Theodore Seto, Loyola Law School, Los Angeles.

8.  March 22 – James Kwak, University of Connecticut School of Law.

9.  March 29 – Miranda Stewart, Australian National University.

10.  April 5 – Richard Prisinzano, U.S. Treasury Department, and Danny Yagan, University of California at Berkeley Economics Department.

11.  April 12 – Lily Kahng, Seattle University School of Law.

12.  April 19 – James Alm, Tulane Economics Department.

13.  April 26 – Jane Gravelle, Congressional Research Service.

14.  May 3 – Anne Alstott, Yale Law School.

Belated comment on Hillary Clinton's capital gains proposal

I was away on vacation when Hillary Clinton released her capital gains proposal, but figured better late than never, so here are a few words on it now.

Under present law, the top individual tax rate is 39.6%, and this is also the tax rate for short-term capital gains, or items held for less than a year.  Any capital asset that is held longer is taxed at the long-term capital gains rate, which for people in the top bracket is 20%.

The Clinton proposal is pretty simple: require that one hold the asset for six years to get the 20% rate.  In the interim, the applicable rate slowly drops to 36% for (2-3 years), 32% (3-4 years), 28% (4-5 years), and 24% (5-6 years).

The stated aim is to combat "short-termism" by the managers of publicly traded companies (which Clinton calls "the tyranny of today's earnings report").  The idea is to make corporate executives less avid than they presently are (it is argued) to boost the current stock price at the expense of long-term profitability.  Ostensibly, if investors switch to long-termism by reason of the incentive that the rate structure offers for longer-term holding, managers will change, too, so they can remain in step with investors' preferences.

I agree with Victor Fleischer that the proposal "misses the mark" if it aims to change managerial behavior.  Fleischer emphasizes the virtues, in some cases, of more rapid trading if it results in reallocating capital, and more particularly the continuing incentives that arise from managerial compensation design.

I would further emphasize a couple of additional points.  Current law already combats "short-termism," insofar as deferral reduces the present value of the expected capital gains tax and the step-up in basis at death can lead to its complete elimination.  But I don't know anyone who thinks this has a significant (or perhaps any) positive effect on managerial behavior.

Addressing the misalignment of managerial incentives, insofar as it is feasible via tax and regulatory instruments, really requires going inside the company, not just aiming at the investors.  In general this is probably best done through corporate governance rules, although it is not impossible that tax rules could play a positive role.  (E.g., the $1 million ceiling on deductible non-incentive compensation of top executives in publicly traded company has surely hurt things, although how much is a matter of debate, given that "incentive" compensation can be so misaligned from the standpoint of actual long-term investor returns or national economic welfare.)

There are other problems lurking in the area, and at first I was inclined to think that the Clinton proposal might have some relevance to them, but on balance I think pretty much not.  I refer here to the set of issues, sometimes raised in favor of enacting a financial transactions tax (which I have discussed here), pertaining to whether (a) high-speed trading has negative externalities, and/or (b) what Keynes called the "beauty contest" aspects of stock market trading are socially wasteful or even actively destructive.  But here the focus is not on managerial short-termism, but rather on the mis-allocation of societal resources towards rent-seeking activity, along with possible volatility effects on asset markets and real economies.  These are issues that might merit a serious proposal from a leading Democratic candidate - and that might similarly signal that she is proclaiming her independence from Wall Street - but that would look quite different from this one.

Is the Clinton proposal actively harmful?  I don't think so, although it is true that in some cases people would pointlessly hold stocks just a bit longer so that they could lower the applicable tax rate.  And if one wanted to raise the capital gains rate, doing it this way might be better than not doing it at all, even if the time sequence is otherwise pointless.

The change to capital gains taxation that I would urge Clinton to advocate - although I can't speak to its political virtues or demerits - is automatic capital gains realization at death (or when one makes a gift of appreciated property), perhaps only reaching net gain above a dollar ceiling, even though this would reduce the current system's discouragement of short-termism.

Back from Spain

After an enjoyable close-to-two-weeks in Spain (Barcelona, Seville, Madrid, Toledo), I am back in NYC, more or less for the duration.  Among the best things I saw out there were the Gaudi buildings and Sagrada Familia church in Barcelona, and the astoundingly rich collections of Spanish and other European art in the Prado and Thyssen museums in Madrid. It actually got painful trying to see as much as one could, in a day each, of those two collections.  For example, lots of great El Greco (supplemented in Toledo), Velazquez, and Goya. And the Picasso Museum in Barcelona was quite interesting for its early works, pre-fame and fortune and thus predating the emergence of all those trademark mannerisms.

Things I should have known

I was pro-EU for many years, reflecting my dislike of parochial nationalisms, and my analogizing from my belief that, in the U.S., the optimal balance as between the national government and the state governments should be tilted much more towards the national side of the scale than it would be we if we were like Europe.

But U.S. federal government policy is run by a nationally elected president plus a national legislature where all states are represented, not to mention that we're all in the same boat economically even when we don't realize it.  E.g., I was reading the other day about how the S&L crisis was essentially a rich coastal states' bailout of Texas, only no one even thought of it that way, as it just happened automatically.

When you lack both democratically elected (and adequately empowered) federal-level political institutions and a federal-level economic union that operates automatically, one thing you can end up with (as anyone versed in American history can tell you) is the Articles of Confederation. But a very different thing that you can end up with - the EU today - is in its own way just as bad.

Herewith Ben Bernanke, not generally known as a fire-breathing lefty:

"In late 2009 and early 2010 unemployment rates in Europe and the United States were roughly equal, at about 10 percent of the labor force. Today the unemployment rate in the United States is 5.3 percent, while the unemployment rate in the euro zone is more than 11 percent. Not incidentally, a very large share of euro area unemployment consists of younger workers; the inability of these workers to gain skills and work experience will adversely affect Europe's longer-term growth potential....
"Currently, the unemployment rate in the euro zone ex Germany exceeds 13 percent, compared to less than 5 percent in Germany. Other economic data show similar discrepancies within the euro zone between the "north" (including Germany) and the "south." ....
"Germany has effectively chosen to rely on foreign rather than domestic demand to ensure full employment at home, as shown in its extraordinarily large and persistent trade surplus, currently almost 7.5 percent of the country's GDP. Within a fixed-exchange-rate system like the euro currency area, such persistent imbalances are unhealthy, reducing demand and growth in trading partners and generating potentially destabilizing financial flows....
"Germany could help restore balance within the euro zone and raise the currency area's overall pace of growth by increasing spending at home, through measures like increasing investment in infrastructure, pushing for wage increases for German workers (to raise domestic consumption), and engaging in structural reforms to encourage more domestic demand."

But of course they won't.  It's easier just to let everyone else suffer, while also feeling very noble and put-upon.

Bernanke doesn't address the political institutional side, but you can bet that things would be different if an EU-level prime minister and legislature were setting policy, and if the EU was automatically funding social welfare programs in Greece and southern Italy, like the US national government does in Mississippi and South Carolina.

Many U.S. tax people (not just me) have tended to be pro-EU, in part from the U.S. analogy in which we think that limiting internal tax competition to the relatively small state and local tax systems, which themselves face federal judicial review under the dormant commerce clause, gets it more or less right, all things considered. But we have often not been huge fans of the jurisprudence emanating from the European Court of Justice, which at times creates the worst of both worlds by handcuffing national governments' reasonable responses to aggressive tax planning, while lacking the power to impose federal-level uniformity. I don't blame this on the people at the ECJ - it's structural and inherent to the institutional set-up, rather than being particularly their fault.

What I hadn't understood until recently is the similarity between the structural flaws that tax people have seen all too clearly for years in the ECJ model and what we've seen at the macro level between Germany and the European "south" (not just Greece). Without federal-level democratic institutions, legitimacy, or true economic and political integration, you combine the evils of centralized decison-making that ignores reasonable local needs, with the evils of not being centralized enough to advance the common good in an integrated way.  One would have thought you could only one get set of evils at a time, but the EU has advanced our intellectual understanding of federalism by showing that, with a sufficiently perverse institutional design and ruling ideology, you can simultaneously get both.

Obviously, the ECJ looks great compared to these other jokers.

A broader lesson is that, even if greater EU centralization would potentially be good, it does not follow that decentralizing wouldn't also be good, relative to where they are now.  In my view, greatly decentralizing (e.g., dismantling the Euro and reducing ECJ oversight) would be a sizable improvement over the current state of play, even if it would be better still to centralize more, and in the end truly to become a single nation (subject, of course, to people actually wanting to do that).

Jury duty

For the last three days, I've spent most of my time at a New York State criminal courthouse, where I was called for jury duty. Lots of sitting around, but, while sent to a courtroom where they were picking jurors, I never got selected even for voir dire, much less actual jury service.

I was actually selected once for a civil jury - despite my law prof background and my having (long, long ago) taught Evidence and written a couple of articles about statistical probability issues.  But that civil trial settled before the opening statements. Just as well, as I was merely an alternate, so I probably wouldn't have gotten to participate in the jury deliberations.

It's actually quite interesting to see the process from the quasi-inside.  One clear point that I've noticed on more than one occasion is how earnest, or at least apparently earnest (it's hard to know) people are about expressing their views and feelings accurately during the voir dire.  But at the same time a part of the process is designed to overawe them into doing as they are told, in terms of following the law and the judge's instructions.

It would definitely be interesting to serve on a jury sometime, but I was glad not to be chosen this time, for personal reasons relating to set-in-stone vacation plans.

Another article draft that I may post soon

I've recently completed another article draft, one more of the things that I've committed to do before getting back to work on my literature book.  This one was commissioned for an edited volume that is being put together by a friend at another leading law school, on issues related to timing and legislation. My book from 15 years ago, When Rules Change, is well within the topic range of the new volume, but as it happened I didn't want to return to the issues I discussed there.

While the editors have a book contract, I'm not 100% sure this is public information yet, so I will hold off on giving more details.

The piece I've written is a short one by legal standards - under 10,000 words, as indeed was specified by the invite.

Article title: "The More It Changes, The More It Stays the Same? Automatic Indexing and Current Policy."

Opening sentence: "The ancient Greek philosopher Heraclitus famously remarked that you cannot step into the same river twice, to which a disciple supposedly replied that you cannot do so even once."

My topic is automatic adjustment rules in the income tax and Social Security.  E.g., apart from inflation indexing in both, I discuss such automatic indexing possibilities (or actualities) as:

--In the income tax, indexing the rate brackets to prevent real bracket creep, or to respond to vertical distributional changes via the "Rising Tide Tax System," or to provide automatic tax smoothing when a measure of the fiscal imbalance changes.

--In Social Security, disputes over how to measure inflation for indexing purposes, wage indexing in actual Social Security, and proposals to index the normal retirement age for life expectancy changes.

The aim here is conceptual, rather than to endorse specific proposals.  E.g., I discuss indexing's general appropriateness (I consider it just fine if one happens to agree with the policy it advances), the difficulty of defining current policy if that is what one is trying to maintain, and the links between particular proposals that might be debated on seemingly technical grounds and separately conceived policy preferences that might lead one either to support or oppose them.

Aging rock nerds debate "want versus need"

Recently, at an informal academic seminar, a colleague quoted the famous Rolling Stones line to the effect that, while "you can't always get what you want, if you try sometimes you just might find you get what you need."

I couldn't resist responding after the session with Dylan's take on the Want Versus Need issue: "Your debutante knows what you need, but I know what you want."

He struck back with earlier Dylan: "Go 'way from my window, go at your own chosen speed, I'm not the one you want, babe, I'm not the one you need."  He called this classic regulatory command and control - apart from its leaving open the speed choice - since Dylan purports to know both what the other person wants and what she needs.

I responded that negative externalities and asymmetric information provide the classic rationales for regulation.  Here, not only does Dylan evidently find her presence at his window irksome, but he also claims to know more about himself than she does (hence "I'm not the one you want / need"). Both claims are plausible.

Nonetheless, my colleague replied that this is just the usual public interest rhetoric disguising private rent-seeking.  Perhaps he has a point, given that, while the Dylan of mid-60s love-hate songs is frequently compelling, he does not, thank goodness, come off as public-spirited like the earlier folksinger.  ("Ah, but I was so much older then, I'm younger than that now.")

Speaking metaphorically, of course

Here's my EU debt plan: reverse Germany's 1953 debt forgiveness on the ground that they violated the implicit terms by not "paying it forward," call it an equity interest that's deemed to have grown since 1953 at the rate of the German stock market, and then propose a summit meeting covering both the German and the Greek debt.

Revised article posted

I have posted on SSRN a revised version of my article "The Crossroads Versus the Seesaw: Getting a 'Fix' on Recent International Tax Policy Developments."  It's available here.

The changes reflect helpful comments that I received late last month at the 9th annual symposium of the Oxford University Centre for Business Taxation.  In particular, the introduction may now be clearer, In addition, I briefly discuss recent U.S. "patent box" proposals (see pages 5-6, 40-42, and 50), and I have added some needed nuance to my "tagging" discussion of paying low foreign taxes (see page 21).  Otherwise, it's mostly the same.

The Greek referendum

While I have far more sympathy for the Greeks than the Germans in their current standoff, this Vox post helps make the point that it's quite hard to say which referendum outcome would lead to better state of affairs down the road.

If the EU's future will be just like its present, and if the Greeks would be able to manage an independent budget and currency, then exiting the Euro (which a No vote would make more likely) strikes me as the significantly better choice, even though the next few years would be gruesome.

But on the other hand, if the EU were to evolve into a true fiscal state in which Germany would help out Greece the next time around, in the same way that boom areas in the U.S. help out bust areas via automatic fiscal policy instruments, and if a fully autonomous Greek state would have serious governance problems, the merits could lie in the other direction.

I am skeptical that EU internal governance will evolve the right way to make staying with the Euro a good choice for Greece, instead of just a recipe for endless austerity and disregard of their interests relative to those of more powerful countries.  But who really knows on either front.

Vacation reading

While traveling in the UK last week, the books that I got to read included Knausgaard Book 1, and a biography of Lewis Carroll / social history of the Alice books by Robert Douglas Fairhurst.

I liked, and more than that respected, the Knausgaard, but it wasn't a super-easy go when one wants to relax, and I'm not in an immediate rush for Book 2.

I am one of those people whose love of the Alice books (and The Hunting of the Snark) goes extremely deep. They are foundational for me, as they are for many others whom I have known. We used to be an enormous tribe. Indeed, for a sense of the books' cultural valence 50 years ago, consider that John Lennon and Grace Slick both wrote canonical 1960s rock songs that were rooted in them. But for some reason our numbers seem to have shrunk comparatively in recent decades. And for once it isn't the movies' fault - the 2010 version, although its wrong-headedness appalled me, can no more diminish it than did the Disney version 60 years ago.  (Cf. the Colin Firth Darcy, which really has knocked Pride and Prejudice out of its prior cultural orbit.)

Where the Alice books "came from" has always been a hard question. They are in a sense so radical, and the level of imagination, daring, creativity, and wit that they display is so extraordinary, that their fit with a pious, shy, stodgy, and in many ways reactionary Oxford don, with a distinctly creepy (whether or not one deems it actually pedophilic) interest in young children, seems inexplicable, even if also inevitable in the sense that no other sort of person could possibly have written them.

Just one small point, they feature a realistically portrayed 7 and then 7-1/2 year old girl - very sweet, but quite conventional, not to mention naive, sheltered, and snobbish - who also functions simultaneously (and, on the author's part, seemingly effortlessly) as (a) one of the great quest heroes in literature, (b) the books' sole spokesman and undiscouragable champion for the values of sanity, proportion, and common sense, and (c) the badly needed "straight man" (so to speak) for one outrageous high-wire performer after another.

Fairhurst's book is a thorough and fair-minded exploration of what's known or can still be learned about the man (Dodgson / Carroll), the work, and for that matter the subsequent life of the historical Alice. One of the interesting things it depicts is how the "Carroll" side lost ground to the "Dodgson" side as he got older. A second pertains to the interest in children that today would be universally (whether rightly or wrongly) viewed as aberrant and criminal. The book shows how more widely shared tropes of that era help to explain where Dodgson was coming from, allowing him to rationalize and perhaps experience it as nonsexual, in a way that would be impossible today. Even during Dodgson's lifetime, however, views of childhood were changing rapidly in a modern direction. By the time of his death in 1898, in just his mid-sixties, the world had wholly passed him by. Darwin he took in stride, but Freud would have been too much for him. Not so for the Alice books, however, which if anything gained force over time.

As has the The Hunting of the Snark, which I regard as not just great fun, but startlingly prophetic in an oddly gnomic way.  E.g., the map that is "a perfect and absolute blank" - "what I tell you three times is true" - "They threatened its life with a railway share, they charmed it with smiles and soap."