Campaign spin wars

I'll admit it; I quite enjoyed Marco Rubio's epic (whether or not electorally consequential) meltdown yesterday, in which he responded to Chris Christie's accusation that he was just parroting pre-memorized talking points by re-parroting the very same pre-memorized talking points.  "Show it, don't say it" is the advice that writers always get, and Christie was able to do this, by reason of Rubio's unwitting connivance.

While I have nothing unique to add about this little drama, I was interested by some of the follow-up today, which I think actually relates in an odd way to the topic of my last blogpost here (how the "paradox of voting" affects voters' belief formation).

Rubio today naturally tried to spin his constantly repeating the same thing about Obama ("He knows exactly what he's doing") as reflecting that he Cares So Deeply about the argument he was making. The point being, professing deep conviction sounds less pathetic than fessing up to a panicky meltdown.  He even said that this deep belief is why he is running for president (I guess, long-held ambition had nothing to do with it).  But there actually is a reason he was saying it - well, not four times - and whoever's idea this was (perhaps, just that of his handlers), it's an interesting example of being too clever by half, rather than just not clever enough.

The underlying argument that Rubio apparently was making aimed to rebut an argument against him.  Christie was saying: Obama was a bad president (in the Republican view) because he was so inexperienced.  Rubio is also inexperienced.  Hence, let's not make the same mistake again, by picking Rubio.

Note that there's a bit of an ambiguity here.  Christie needn't choose between saying (a) he's an inexperienced candidate so he'll lose the general election, versus (b) he's inexperienced so he'll be a bad president.  On its face, the argument is mainly (b), but inevitably, in an election campaign where the two parties' voters hate each other so much, those on either side are going to care a lot about the potential truth of (a), not just (b).

Yet obviously, no matter what one thinks of Obama as to (b), it's clearly he did pretty well in 2008 and 2012 as to (a).  So Republicans who only believed (b) would face a dilemma, if they rejected (a) and still thought Rubio the strongest November candidate.  This might reduce the overall force of the offered syllogism.  But the Rubio camp evidently wanted to respond anyway.

Someone, and I honestly don't know whether or not Rubio has the wit to think of this (or even understand it) himself, but in any case someone in the Rubio campaign evidently thought: Suppose we say Obama was a good president, not a bad one, by his own ideological lights.  Then seemingly Christie's syllogism is rebutted.  If Obama was good for his side despite being inexperienced, then what the precedent suggests is that Rubio will likewise be good for our side despite being inexperienced.

This is actually terrible political reasoning.  It's an example of what Jeeves in the Wooster books, called being "too elaborate," when he questioned the scheming of the "brilliant but unsound" Catsmeat Potter-Pirbright.  In effect, Rubio is arguing: Obama and I indeed ARE alike in a particular way - but that's good, not bad, in terms of its predictive value, because Obama is actually a good president from his ideological perspective.

Problem #1 - if one side hates a political leader, those on the other side should probably avoid arguing that they're like him in any way.  Embracing the analogy, even just implicitly and to turn it around, is probably not the way to go.

Problem #2 - it mistakes the nature of emotional partisan belief.  From a Republican perspective, one could imagine a debate: is Obama inept, or merely serving goals we detest?  Logic suggests that it can't really be both.  If he likes where we are, then he didn't blunder by getting there.  But when emotionally involved partisans  on one side hate someone on the other side, they have no reason to value being logically consistent in the criticisms they applaud.  They are expressing their feelings.  For whatever broader reasons, which I won't try to explain here, they hate Obama and think he has done terrible things.  So it's emotionally satisfying to hear him being insulted, be it as feckless or as deliberately, effectually "evil."

In the nature of the enterprise - by which I mean, having political beliefs and being invested emotionally (but from the sidelines) in the great game - there's absolutely no reason to choose.  "Gee, he's doing it on purpose, so maybe he's actually smart."  Or, "Gee, he's incompetent, so perhaps he actually means well."  No - recall the voting paradox again.  Audience members who get involved emotionally in politics are not engaged in staking real resources that will affect their personal wellbeing on correctly understanding an individual who is on the other side.  They're not being irrational or stupid - rather, they're acting like sports fans, which is often a good analogy for political belief, when they decline to subject their angry disdain for someone on the other side to rigorous logical parsing.

By contrast, Republicans in Congress who are deciding how to interact strategically with the Administration, or the people in the McCain campaign in 2008 and the Romney campaign in 2012, DO need to evaluate Obama accurately and dispassionately.  They are actually playing against him, in a game that they want to win, and it's useful to understand your foe.  But voters are just spectators.

So the thought, by whomever in the Rubio camp, that praising Obama's skill was a smart political tactic, via the logical impact on the implied analogy between Obama and Rubio, appears not to have as good an understanding of real world politics and voter psychology as I might have expected of someone in the biz.

Again, who's to say whether or not any of this will actually matter politically in the end.  But it's still amusing as an apparent micro-illustration of political actors outsmarting themselves.

Tax policy colloquium, week 3: Lucy Martin’s “The Structure of American Income Tax Policy Preferences” (co-authored with Cameron Ballard-Rosa and Kenneth Scheve)

Yesterday, Lucy Martin of the UNC Political Science Department presented the above paper, discussing survey evidence regarding how Americans think about tax progressivity.  The paper addresses an apparent puzzle: the fact that rising high-end inequality, plus stagnant real income growth for everyone outside the top 0.1 percent, has not yielded greater high-end tax progressivity.

Is this lack of an offsetting tax policy response to rising high-end inequality actually surprising? I’m not all that surprised by it, but it clearly is surprising if one’s baseline assumptions reflect (1) the median voter hypothesis, which holds that the median voter’s policy preferences tend to be enacted, plus (2) a view of voting as being based on narrowly defined economic self-interest.  Under such a view, the median voter should want higher tax rates at the top under these circumstances, and should be expected to succeed in getting it – wholly independently of the question of whether or not this would be a good policy choice – unless she is sufficiently concerned about the efficiency costs on her of the high-end rate increase (or believes that it wouldn’t actually raise revenue).

The two main explanations for the “puzzle” that political scientists have offered are (1) the rich have too much political power for the sentiments of the median voter to carry the day, and/or (2) voters actually aren’t strongly supportive of increasing high-end redistribution – perhaps because they don’t just focus on narrowly defined economic self-interest.

The paper mainly comes out in favor of explanation #2.  It concludes from survey evidence (gathered on yougov, with sampling to replicate characteristics of the general voting population) that, while there is widespread support for mildly progressive tax rates, these sentiments are relatively tepid, and support a progressive rate structure rather like the one that we currently have – rather than one with much higher marginal rates at the top.

However, explanation #1 is not refuted, except insofar as one interprets it as involving affirmative elite override of strongly held popular sentiments.  The fact that the public does not care intensely can plausibly be viewed as leaving the elite free to decide.  The evidence in the paper might come closer to supporting a strong version of explanation #1 if the 2016 election were to lead to the election of a Republican president, along with continued Republican Congressional control in both houses, and this in turn led to the enactment of a flatter rate structure – promised by all leading Republican candidates – that actually would be at variance with the paper’s findings regarding voter sentiment, including that among Republican voters.

Among the paper’s features that I particularly like are its (1) disaggregating between high-end and low-end inequality issues, (2) disaggregating between the issues under study and those of views on government spending and/or the “size of government,” and (3) offering a gauge on voter sentiments’ intensity and elasticity (defined as the rate of change, for one’s preferences regarding tax rates, as the income level that is under consideration changes).

In preparing for the session, I divided my thoughts into two main topics: (1) political science issues, focusing on survey design and one’s theory of voting, and (2) the tax policy takeaways one might glean from the evidence in the article.

1.         VOTING & VOTER PREFERENCES

A) Research design – Here I see four main issues:

(i) Tax base – Marginal tax rates don’t mean much until we know to what they apply. Given the limitations on how much one can lay on the plate of survey respondents, we don’t know what (if anything) they had in mind if they liked, say, a 35% or 40% top rate. How might this relate to – and what would they think about – say, the use of tax shelters, the capital gains rate, or the general non-taxability of unrealized appreciation. These are techie issues, but surely they might have some actual or potential state of mind regarding the relevance (and high likelihood) of significant divergence between taxpayers’ taxable income and their economic income.

For that matter, what about average rate versus marginal rate?  For a top bracket of, say, 35%, were they assuming that this was also the average rate that taxpayers with income in that bracket actually faced as to their taxable income as a whole?

(ii) Taxes only, without direct regard to the use of the funds – In principle, one should always think about tax changes in a long-term balanced budget sense. However, since money is fungible and there are many different possible uses of say, increased high-end revenue, the survey design did not offer any indication regarding how marginal revenues might be used (or ceased to be used).  Instead, to avoid encouraging complete disregard of budgetary considerations, the survey informed respondents when particular choices would affect or greatly affect net revenue levels.

This probably was a better survey design than proposing particular uses of the funds – especially since, if one used too many alternatives, one would both be degrading the results’ statistical significance and requiring respondents to slog through more.  But it did mean that respondents weren’t offered the possibility of taxing the rich more in order to fund something they might like.  Obviously, a savvy politician might make earmarking claims of this kind (like NYC Mayor Di Blasio campaigning for higher taxes on the rich that he said could fund universal pre-K).  It also may have caused revenue-raising higher tax rates at the top to look as if they merely would have imposed burdens on one group without conveying benefits to any other group.

(iii) $375,000 of income and above as the top group – In order to keep the rate brackets similar to those under actual U.S. income tax law at the time that the survey was being designed – which had advantages in terms of figuring out net revenue effects – the study’s top group was people with income of $375,000 or more.  Insofar as actual voter concern today focuses on plutocracy and/or the super-rich – say, the top 0.1%, as opposed to just the top 1% - this meant that one did not learn what the respondents thought about tax rates for people earning at least, say, $1 million or $10 million a year.

(iv) Anchoring – What should we make about the fact that the tax rate structure getting the most support looked rather like what we actually have right now?  Does this mean public sentiment is being honored?  Alternatively, might the causal arrow run the other way, with people taking cues from what is actually on the books?  What would happen if we could run the same test with U.S. voters 60-odd years ago, when the top rate was over 90%?  And if we found that people liked that top rate then, once again we’d have to ponder the direction of the causal arrow, i.e., do the rates reflect preferences or anchor them?  More feasible, of course, would be doing a similar survey in, say, an EU country with higher marginal rates for individuals at the top of the distribution.

B) Theory of what drives voter preferences

The paper identifies three main explanations for voters’ tax policy (and other) preferences: (mainly economic) self-interest, fairness norms, and partisan identity.  Herewith some thoughts on each:

(i) Economic self-interest – Assertions that voters should be expected to vote in their self-interest, generally defined economically, have long struck me as hard to reconcile with the voting paradox.  Here I mean not the range of Condorcet, etc., phenomena, but rather the fact that voting itself is not an economically way of promoting narrowly self-interested outcomes.

Everyone knows the basic issue here.  I once heard (perhaps apocryphally) about a prior-generation professor who apparently told his students that he never voted, even though he cared about political outcomes, because the chance that his vote would alter the outcome was effectively zero.  Therefore, the benefit certainly wasn’t worth the cost, defined in terms of the time he would have to spend on voting.  “What if everyone thought that way?” he was asked.  “Well, then I’d certainly vote,” he replied.

While awareness of the voting paradox surely does reduce turnout, obviously millions of people vote anyway.  But the paradox is still, to my mind, of primary importance in understanding and explaining voter behavior.  Since voting is so irrational, if defined as seeking to realize the dollar value one places on a desired election outcome, divided by the likelihood that it will actually change the outcome, obviously something else is going on.  Consumption? Self-expression? Sense of obligation?  Cooperating rather than defecting with regard to like-minded voters, who face a prisoner’s dilemma insofar as each would rather not bother to vote but they’ll only win if enough of them vote?

Once one is voting based on any of those motives, it is no longer irrational not to vote based on economic self-interest, even if one otherwise acts pursuant to it.  Suppose you just like voting for the candidate with whom you’d hypothetically rather have a beer.  It’s not personally irrational to vote for this person, even if he or she would be bad for one’s economic interests, if this feeling sufficiently flavors one’s enjoyment of the voting act.

More important still, it is now affirmatively irrational – and people damn well know it – to invest significant effort in figuring out which candidate would best serve one’s interests, unless one happens to enjoy the investigative process.  How much time would you spend figuring out what car you ought to buy, if the decision wasn’t up to you but instead would be made by a multi-million person electorate?

Given this point, it verges on being paradoxical that people pay as much heed as they do to the question of which candidates would favor their interests and those of people like them.  I would presume that this reflects feelings of affinity that in turn reflect our having evolved to internalize sincere belief in arguments in favor of our own interests.

But one still doesn’t get a strong prediction that the median voter will respond to high-end inequality in the manner presumed by standard political science models.

Fairness norms – The paper notes that people who favor higher tax rates at the top tend to believe that the most economically successful were mainly lucky, while those who oppose such rates tend to believe that merit and hard work play larger roles.  Likewise – though the issues are somewhat independent – those who favor high tax rates tend to have a lower valuation of the likely efficiency costs than those who oppose such rates.

While this does not contradict the paper, which looks at correlations without proposing specific causal theories, I tend to wonder which way the causal arrow runs.  I would suspect that there is a widespread tendency to take the “progressive” view on both issues as a consequence of one’s (for other reasons) favoring higher rates, and the “conservative” view on both issues as a consequence of one’s (for other reasons) opposing such rates.  In other words, I think people often start with biases and then develop the needed rationalizations, although certainly one ought to aspire to the reverse.

Perhaps more intriguing is the paper’s finding that those who favor high rates at the top tend to lean towards being “reciprocators,” as tested separately within the survey, while those on the anti side tend to lean more towards being “free riders.”  But given this point , along with the voting paradox, it is interesting that conservatives, whom the survey suggests lean towards being on the “free rider” side, have nonetheless done a better job of countering their own internal group prisoner’s dilemma, by maintaining higher voter turnout levels even in non-presidential election years.

Partisan identification – Not surprisingly, this proves to have the strongest predictive value, arguably supporting the observation that following politics is a lot like picking sports teams to root for.

2.         TAX POLICY IMPLICATIONS

Given the structure of the U.S. political system – in particular multiple branches, status quo bias, and partisan entrenchment, frequently yielding gridlock – it’s no surprise that the system hasn’t grown significantly more progressive at the top.  This would require (a) Republicans to lose their veto power at all levels, plus (b) Democrats to support as a bloc enacting a more progressive rate structure.  (The 2013 budget deal did a bit of this, but only by restoring the Clinton-era top rate.)

So it’s not clear what extent we need to look to voter preferences to explain the “puzzle” of limited change to high-end rates.  But nonetheless, because Knowledge is Good (in the words of Emil Faber, but I actually mean it), one does not need policy or outcome relevance in order to find the paper’s analysis interesting.

In any event, however, I see the following three main takeaways for people who favor greater high-end progressivity:

(a) Suppose one favors raising tax rates at the top – even if not to 1960s levels, then at least to something approaching Diamond-Saez-advocated levels on the order of 70%.  The information provided is not encouraging, and suggests that the indicated change would most likely have to reflect intra-elite opinion movements, rather than the empowerment of widespread public sentiment.  While it’s not clear why the elite should be expected to favor higher tax rates, to some extent on itself, note that the conservative movement, unlike its counterpart on the left, has spent the last 4 decades building a powerful policy advocacy infrastructure in Washington.

(b) Efforts to increase high-end progressivity can try to take advantage of earmarking the net revenues for widely supported functions, although the public is far from being wholly naïve regarding the relevance of earmarking given that money is fungible.

(c) Otherwise, efforts to increase high-end progressivity should focus on the tax base and/or the choice of tax instrument.  For example, advocacy of taxing appreciated assets at death and strengthening the taxation of gratuitous transfers might be more fruitful than focusing on the top rate – although clearly these ideas as well could not be expected to benefit from mass movements in their support.

They're sometimes there when you need them, they're sometimes there when you call them

To get through the slog of elliptical machine sessions at the health club, I periodically rediscover old musical favorites that I can use for a few days, until I once again need something fresh. Most recently it's been early Talking Heads, and especially my favorite of their albums, Fear of Music. I consider this a great comedy album, except that it's also lifted into something stranger and more unnerving by its weird intensity.

Great disquisitions, for example, on:

--Air ("Air can hurt you too / Some people say not to worry about the air / Some people haven't had experience with air")

--Cities ("London ... dark in the daytime / People sleep in the daytime / If they want to")

--Heaven ("Heaven is a place where nothing ever happens / There is a party, everyone is there / Everyone leaves at exactly the same time")

--And of course, animals ("Animals are laughing at us / Don't even know what a joke is / They're never there when you need them / They're never there when you call them / They think they know what's best / They're making a fool of us / They ought to be more careful / They're setting a bad example").

David Byrne is the only rock lyricist in history who would worry about someone needing to be more careful or setting a bad example.

Anyway, this got me to thinking about cats, as they are certainly among the main species as to which his  charges might ring true more broadly (although they certainly don't live on nuts and berries).

People less crazy than Byrne's character in Fear of Music might say that cats don't care about their "owners" (or should I say caretakers), but this is not true, certainly as to friendly and socialized cats. They can be very affectionate, want attention, and find what you are doing very interesting.

What they almost always don't have, in the slightest, is a desire to please you, or any concept of doing something because you want them to do it.  And it's not that they don't understand intention.  They can learn all too well, for example, that you don't want them on the counter, or grabbing items of your food that they like. So they won't do it if you are nearby, and will jump down if you approach.

This gap in their social schema, relative to that of humans and dogs, can be frustrating if you actually need them to do something in particular.  (The Coen brothers apparently vowed, after Inside Llewyn Davis, never to use cats again, even though they had three with distinct temperaments available to play the one role.)  But perhaps this makes it seem all the more an honor when they show affection - you know that it's sincere, perhaps I should even say disinterested, in the sense that they aren't trying to get you to reciprocate so as to boost their own self-regard (a potential motivation that I'd attribute to dogs as well as people).

Mitchell Kane's "A Defense of Source Rules in International Taxation"

My colleague Mitchell Kane has recently published a quite interesting article on source rules in international taxation, taking a view that differs more from mine on the surface than I think it does in underlying substance.

A commonly quoted line about determining the source of income, from Hugh Ault's and David Bradford's piece on the subject more than 25 years ago, says that the notion of "source" lacks coherent economic content. I recall Bradford frequently noting that, while there is an intellectually coherent Haig-Simons income concept, there is no such benchmark for source. I've frequently quoted this line, as it's seemed both (a) clearly right and (b) related to the difficulties that source-based taxation presents in practice.  But I've also been aware that (a) it's easy to determine source in some cases, and (b) in other cases it depends on how you define it - e.g., origin basis vs. destination basis (more on this shortly).

Kane agrees at least arguendo that there may be no coherent economic definition of source, but then says: Why would the definition have to be an economic one?  "Household" or "family," for example, can't be satisfyingly defined for tax or other transfer system purposes unless one informs it with ideas taken from somewhere else that express one's underlying purposes.  For source, he sees the purposes as relating to how countries try to divvy up income tax bases between themselves.  He approaches this as a multilateral cooperative process, whereas - just as a matter of taste or interest; either approach can be fine - I tend to think about it more in terms of unilateral processes that may be conducted in the shadow of particular strategic interactions.

Then comes an important point that I've been thinking of writing about, although at the moment I'm engaged in my literature book - origin-based vs. destination-based income concepts. Say I sit at my desk in New York and write a book in Bengali that I will sell for large profits to people on the Indian subcontinent. Under the origin concept, the income is U.S.-source because that's where I did the work.  Under the destination concept, the income is sourced in India and Bangladesh because that's where the sales occurred.

In the context of, say, a retail sales tax or value-added tax, we often hear about the point that they can use either the destination basis (which is the universal norm) or the origin basis (as under some progressive consumption tax models that would use a VAT as part of their structure).  It's a familiar point that, in the consumption tax environment, one can use either, and in the long run it doesn't matter which one uses, leaving aside some extremely important issues pertaining to transition and administrability.

Income is commonly called an origin concept, and I've written about the difficulty of trying to run an income tax off the destination basis.  Absent some very fancy footwork, the equivalence from the consumption tax context is undermined by the fact that how long one saves before consuming (e.g., the time between exports to earn $$ and imports to spend it) affects income tax liability, whereas it hypothetically doesn't affect the present value of consumption tax liability using constant rates across time.

But in fact there are plenty of destination-based source concepts in existing income taxes.  For example, the U.S. income tax sources labor income based on where the work occurs, but it sources royalties based on where the property is used. So what if you use labor to create royalties? Then formalism determines the source of income.

The mix between origin and destination concepts in the income tax creates various tax planning opportunities, but that's not to say, at least right off, that a given country isn't better off using both in different places rather than just one.

Now let's consider source in the taxation of multinational enterprises.  Using transfer pricing between affiliated entities is apparently an origin based concept, but doesn't work too well.  Shifting to one-factor formulary apportionment that was based solely on sales would make it a destination concept.  But as Jerry Seinfeld and George Constanza would say, not that there's (necessarily) anything wrong with that.  When Reuven Avi-Yonah, Kim Clausing, and Michael Durst propose replacing transfer pricing with formulary apportionment, they are surely not "wrong' by reason of urging the use of a destination concept in a mainly origin-based system. After all, suppose the switch has predominantly good effects, whether adopted just by the U.S. or more generally. And the assessment of that depends on all sorts of wholly separate things (e.g., how manipulable would the sales factor be) that are quite distinct from the theoretical choice between income and consumption taxation.

Anyway, back to Kane's article.  The fact that one can use either origin or destination concepts to define the source of income has figured in my thinking as evidence for the prosecution in calling the source concept incoherent. Kane instead views it as evidence for the defense, showing that there are two ways one can actually do the thing, and it is simply a question of deciding which is better.  He mainly comes out pro-origin, because of the points that make it a better fit with the income concept.

Is the choice "really" evidence for the prosecution, as I have thought, or for the defense, as he argues? Once again this is really a matter of perspective - it's not a case where reasoning logically from required premises leads to one conclusion or the other.

Kane has one other main point in defending the coherence (whether it's economic or not) of the source concept.  He notes the problem of, say, deciding where interest should be deducted, when a multinational has both interest expense and gross income that presumably was produced by using the borrowed funds.  (But of course we don't really know what income this "really" is, given that the fungibility of money makes it quite meaningless where the particular loan proceeds were directly sent.)  But he notes that this is simply a broader difficulty of applying the income concept which applies even in the context of one-country taxation where there is no source issue.

Let me broaden that a bit.  Consider the "synergy" problem in transfer pricing. Standard example: U.S. and French company, if separately owned, would have earned $1M each. But they're co-owned by a multinational enterprise, leading to synergies that increase their combined net income to $2.5M. Where did the extra $500,000 of synergy income actually arise? I see it as in principle a bilateral monopoly bargaining problem - one could imagine the U.S. and French entities negotiating over it, if we posit that neither could realize it separately.  But since we can't really say anything about bilateral monopoly bargaining outcomes in the abstract, there's seemingly no good answer here.

So source might be viewed as an economically (and otherwise?) incoherent concept with respect to the $500,000 - though not as to the underlying $1 million that "should" be the minimum reported in each jurisdiction.

Once again, however, Kane's argument, to the effect that this is not a "source" problem as such, can be made here.  Suppose you have related entities in the U.S. that are taxed at different rates - e.g., because we have a special tax rate for the finance industry as compared to the electrical generating industry, and a given conglomerate entity or set of entities does both.  Now it matters which entity has how much income, but there is comparably no coherent answer to the bilateral monopoly bargaining issue that's raised by the synergy income.  So the transfer pricing problem isn't so much a source problem as a related-parties problem.

How much does all this matter in the end?  The issues of ultimate importance really turn on the consequences of alternative rule designs, as judged based on some underlying set of metrics.  So I'm not substantially more (or for that matter less) sanguine on the question of how well or poorly one can use source concepts in practice than I was before reading the Kane article.  But it provides very useful clarification regarding a set of conceptual issues that interest me, and on which I may still write a bit (in light of this article) at some point down the road.

Tax policy colloquium, week 2: Michael Simkovic's The Knowledge Tax

Yesterday, we discussed the above paper, which builds on Mike's co-authored empirical work on the economic value of a law degree, along with other empirical work that Mike and others have done suggesting that higher education degrees (college and up) offer highly favorable pre-tax (and to a lesser degree, after-tax) rates of return, even taking into account of opportunity costs (foregone earnings while one is in school).

The underlying research reaches two main conclusions.  The first is that lifetime earnings are sufficiently higher for those who get higher education degrees (despite the time away from being more than part-time in the workforce) to offer an above-market rate of return on tuition, etcetera.  The  comparison here is to investment returns on different forms of capital other than human capital.  The second is that a causal arrow runs from higher education to higher earnings - in other words, that it's not just selection bias, as in the case where those motivation and abilities will tend to produce higher earnings in any event also happen to pursue higher education.

Both of these conclusions, perhaps the second in particular, are controversial in the literature. Based admittedly on just superficial inquiry, Simkovic's work on these issues strikes me as plausible and well-reasoned, but I admittedly don't know enough to form a definite opinion.

In reading The Knowledge Tax for our session, I thought it reasonable to accept the empirical conclusions for argument's sake (which again, is not to suggest skepticism about them), because the main issue presented by the paper concerns their further implications. The paper argues that part, though not all, of the higher pre-tax return associated with higher education reflects that human capital investment is treated less favorably by the U.S. fiscal system (and in particular, though not exclusively, the U.S. federal income tax) than other investment. It thus argues that more favorable treatment of higher education would increase tax neutrality, economic efficiency, and long-term growth, due not only to the standard efficiency arguments for tax neutrality between particular alternatives, but also positive externalities.

There is of course a difference between devising "neutral" rules, at some particular margin, and those that are aimed at inducing particular behavioral responses, but if the rules are currently biased against something with positive externalities, then up to a point the two modes of analysis may have some tendency to travel together.

I thought the paper made a good case that we should mainly think of higher education expenses as investment, rather than as consumption (an old debate, of course).  But it's harder to draw firm conclusions about the current degrees of relative bias.  Obviously, the question of how favorably the U.S. federal income tax system actually treats non-human capital investment of varying kinds is quite complicated.  And one tax benefit of pursuing higher education, in lieu of working currently, is that the opportunity cost isn't taxable.

E.g., say I could have earned $50,000 this year, but instead I earn zero and rely on loans, savings, or family resources to spend an additional $50,000 going to law school.  I get implicit expensing of the $50,000 foregone earnings, even though the law degree may have future value that goes forward for decades.  This is highly favorable treatment from an economic standpoint.  On the other hand, I never get cost recovery for the $50,000 of tuition, even though it may reasonably be viewed as a cost of generating earnings.  There is of course no general answer to the question of how alternative investment choices would have been treated by the tax system, given the crazy quilt of possibilities.  So figuring out what's treated better or worse than what is quite tricky.

It's also fair game to ask how we think people who are considering higher education actually decide, and to what extent they are focusing on the long run, and sophisticated aspects of it such as the tax treatment of alternative types of future income.  As I discuss in my recent paper on behavioral economics and retirement saving, people often act as if they are myopic, even if that is not exactly the internal mental process. Now, when one decides to pursue higher education, evidently there is some sort of departure from the blinkered, short-term focus of the classic myope.  But still, even if people are taking account (or act as if they are taking account) of long-term earnings potential, it is possible that some aspects of the myopic or as-if-myopic frameworks will continue to influence them.  And this is potentially relevant to how they respond to reasonably expected after-tax earnings under alternative choices, and to tax rules that would change the overall treatment (especially down the road).

There are also important institutional issues to think about, e.g., does the education sector respond to demand (e.g., given that much of it is nonprofit), and how do relevant labor markets function - e.g., those for lawyers and doctors.

So it's a rich topic, to which the paper makes an interesting (if inevitably inconclusive) contribution.

Behavioral economics and retirement saving

My recently published Connecticut Law Review article, "Multiple Myopias, Multiple Selves, and the Under-Saving Problem," is now available on-line here.  It joins the fray regarding the reasons for apparent under-saving for retirement, with particular reference to the "nudges" debate, the well-known Chetty et al Denmark study, and the sometimes under-appreciated links between income tax "incentives" for retirement saving, fundamental tax reform, and Social Security reform.

Tax Policy Colloquium, week 1: Eric Talley's "Corporate Inversions and the Unbundling of Regulatory Competition"

Yesterday we began Year 21 of the NYU Tax Policy Colloquium. It occurred to me that I have been doing the Colloquium for more than half of the adult portion of my life, whether we date if from my first being eligible to drive (other than on a learner's permit), to vote, or to drink. At least we haven't yet reached the point where the age of the colloquium exceeds that of any student in the class (given that we don't have undergraduates). But that is not so many years off.

My co-convenor this year is Chris Sanchirico, and the speaker for Week 1 yesterday was Eric Talley, We discussed his recently published U Va Law Review piece on corporate inversions.

Because the sessions are off the record (although it is not as if a lot of Page Six-worthy stuff happens at them), my procedure here is to focus just on the paper and my reactions to it, as opposed to discussing what happened at the session.

Talley's paper takes advantage of his expertise in corporate governance and securities law to offer an insight that was not, so far as I know, familiar to tax people who have been thinking, talking, and writing about corporate inversions. Certainly it was new to me. He notes that recent moves towards the effective federalization of U.S. corporate governance law have potential implications for taxpayers' interest in engaging in corporate inversions that cause a given multinational to have a non-U.S., rather than a U.S., parent.

Federalization in this context refers particularly to the enactment of Dodd-Frank and Sarbanes-Oxley. Whether these laws are good, bad, mixed, or indifferent, one effect they have is to move legal provisions that are relevant to corporate governance, managerial discretion, etcetera, from the state level (such as Delaware corporate law) to the federal level.

The reason this matters to inversions is as follows. Suppose the relevant choosers (be they the managers who direct corporate planning, or the shareholders and other investors, if their preferences constrain or influence management) like Delaware corporate law. An inversion that makes, say, Dutch, Swiss, U.K., or Irish corporate law the relevant body will have the disadvantage, to the choosers, of supplanting Delaware law.

But so long as the company's stock is still traded on U.S. markets post-inversion, the federal regimes, such as Dodd-Frank and Sarbanes-Oxley, continue to apply.  So one doesn't opt out of them by inverting, even though one does effectively opt out of Delaware.

To get Delaware corporate law, you have to be incorporated in Delaware, with the inevitable consequence that the company is a U.S. tax resident. But if you want Dodd-Frank and Sarbanes-Oxley (which is not to say whether companies DO generally want them), you don't have to be U.S.-incorporated.  In short, in the paper's lingo, we have unbundled them from the requirement that one be treated as a resident U.S. company.

It is possible that this change, by allowing U.S. companies to invert without as fully exiting U.S. corporate governance law, has made inversions more attractive to some companies than they would otherwise have been. Of course, the magnitude of this effect is unclear. But I'm less sold on the paper's analysis of bundling corporate governance services with makng one accept resident taxpayer status. Under the paper's basic model, this functions as the means of (a) funding the costly provision of corporate governance services and (b) permitting corporate tax revenues to be collected, up to the value that choosers place on those services.

Some particular points I might make, in questioning the bundling model, include the following:

1) How costly is it to provide governance services? Of course they don't cost zero, but are they significant enough to make a model that emphasizes them especially useful?

2) Even if governance services are costly and funded by choosers, why fund it this way? The residence-based aspect of corporate income taxation presents a rather odd funding model for corporate governance services.  Note that companies that act in the U.S. are taxable here on a source basis anyway. So what I mean by the "residence-based aspect of corporate income taxation" is (a) the issues around deferral for profits stashed abroad and (b) the greater difficulty in some respects of profit-shifting out of the U.S., if one is a resident U.S. company.

3) Note that corporate governance services are not currently funded by choosers in the manner that the model envisions. Extra corporate income tax revenues to the federal government don't pay for Delaware's corporate law regime, and (as the paper notes) U.S.-listed companies don't distinctively pay for Sarbanes-Oxley and Dodd-Frank.

4) Suppose you have a public goods argument for the federalized corporate governance rules, e.g., based on systemic risk to the economy or the general benefits of having well-functioning and transparent corporate securities markets. These aspects can't be funded via value provided to the choosers, given the public goods aspect. So they can only be funded through general revenues or some other dedicated source that relies in some different way on the governance jurisdiction's market power.

BTW, what would I do about inversions, at a more general level than simply tightening the inversion rules? I think the key elements are (1) addressing the $2.3 trillion buildup in public companies' "permanently reinvested earnings" abroad, such as via mandatory deemed repatriations of some kind, (2) changing the U.S. rules' current relative over-reliance, in combating profit-shifting by multinationals, on (a) CFC rules that only apply to resident companies relative to (b) rules that apply comparably to all multinationals (e.g., thin capitalization rules), and (3) perhaps broadening the grounds on which a given company will be deemed a U.S. company (e.g., headquarters location in addition to place of incorporation).

But the paper makes a nice contribution by raising the issue of governance-federalization's effects. It also argues that the inversion wave is likely to exhaust itself faster than many have been assuming, due to the relative scarcity of suitable foreign "dance partners" for U.S. companies.  This, in turn, reflects both (1) the substantive requirements for tax-effective inversions that have been put in place since the last corporate inversions wave, and (2) companies' apparent preference, at least so far, in confining inversions to those that are at least arguably strategic (i.e., involving companies in the same industry - such as Burger King and Tim Horton's, or Pfizer and Allergan.

Dean Baker on "A Progressive Way to End Corporate Taxes"

In today's New York Times, Dean Baker floats a corporate tax reform proposal that, as he notes, is well-known in the biz and yet has gotten little attention in recent years:

"Suppose that, instead of taxing corporate profits, we required companies to turn over an amount of stock, in the form of nonvoting shares, to the government.  We can fight over the percentage later ....

"The shares would be nontransferable, except in the case of mergers and buyouts, but they otherwise would be treated just like any other shares.  If the company paid a dividend to its other shareholders, then it would pay the same per share dividend to the government. If it bought back 10 percent of its shares, then it would buy back 10 percent of the government's shares at the same price. In the event of a takeover, the buyer would have to pay the same per-share price to the government as it did to the holders."

Suppose the government's non-voting share percentage is 25%.  If $75 million in dividends are paid to the regular shareholders, the government gets $25 million.  Obviously, this has a lot in common with the case where the government taxes dividends to the shareholders at a 25% rate, in lieu of owning nonvoting shares. In that scenario, the company pays out the same total of $100 million, all to the shareholders, but they pay $25 million over to the government.  Or, you can think in terms of the case where, with an entity-level corporate income tax of 25%, the company earns $100 million, pays $25 million in taxes to the government, and then can pay out the remaining $75 million to the shareholders.

Obviously, this is an integrated corporate tax if we don't otherwise tax dividends.  But if we still do, then it's analogous to the existing two-level corporate income tax. To make life simpler, one could imagine eliminating the shareholder-level tax when the proposal is hypothetically adopted, and simply taking that elimination into account when one decides what share ownership percentage to give the federal government.

The rationale for the proposal is that the corporation can no longer use tax planning to avoid its liability. The government stands in the same boat as shareholders.  Now, this clearly does leave some other games on the table.  As Herwig Schlunk notes, in his article "The Cashless Corporate Tax" that I believe we discussed at the NYU Tax Policy Colloquium around 15 years ago, the games companies might be expected to play include "the use of [financial] instruments that can avoid the designation of equity. This is not a new problem. Under the current corporate tax, the tax base (taxable income) is avoided through the use of debt." These problems might get worse under the new regime, albeit subject to influence by the question of how dividends versus interest are treated at the holder level, but presumably there'd still be less overall scope for tax planning than under present law.

To my mind, one of the biggest problems with the approach, which I haven't seen addressed at length although there might be something out there that I simply don't recall offhand or haven't seen, lies in the international realm. If we apply the proposal to domestically incorporated companies without regard to their mix between domestic source and foreign source income, then we have in effect adopted the equivalent of a worldwide residence-based corporate income tax (with no deferral, and foreign taxes merely being deductible).  If we try to avoid that result for U.S.-incorporated companies, then we are at a minimum bringing back some of the problems that the proposal presumably is meant to avoid.

What about foreign-incorporated companies that have U.S. source income?  Baker says in the op-ed that "we would presumably ... require that foreign companies making a substantial portion of their profit in the United States grant shares."

Without meaning to be too dismissive up-front, I am inclined to say "Ah, there's the rub."  Presumably, we'd have to look at the U.S. source versus foreign source income of foreign companies. That's bad enough to start with, but it's not even clear how income shares for a given year would translate to ownership percentages over a longer period.

The proposal is a non-starter unless something that's good enough can be devised to handle international issues.  I'm pessimistic about this, but admittedly have not studied the question, or read about it recently.

More on David Bowie

When not working on my Tax Policy Colloquium (which starts next week) or my book on literature and high-end inequality (I'm currently having fun with Stendhal's The Red and the Black), I've found myself mulling over David Bowie's career and death, and what he meant and means to me - at this point, more than any surviving Rock God from days of yore, apart from Dylan, who is obviously very different.

Herewith a few random reflections:

1) "A whole new school of pretension" - Bowie in 1973 or so famously said that he had already authored a whole new school of pretension. I didn't hear about this quote until some time later, but it was part of his image from the start.

I didn't naturally have a huge interest in the theatricality and the characters, but what I did find striking from early on was the commentary on / contrast with the rock 'n' roll ideal from the 1960s of being totally "authentic." This was a credo I thought I believed in. But someone like Springsteen, who carried it forward in the 1970s so resolutely and reverently, I found less interesting and provocative than someone like Bowie, who audaciously challenged it.

One could think of the Beatles as having pioneered the idea of pop music staying fresh, and changing from album to album, by reason of the writers' organic evolution.  Bowie, in a sense, made a mockery of this, by instead making disjunctive stylistic jumps from one album to another.  But again, despite my liking the prior model, I also liked its being transformed or subverted in this way.  Of course, it helped that Bowie did so many of his new styles so well.

2) "To be played at maximum volume" - Those words appeared prominently on the back of Ziggy Stardust, and were no small part of this album's eventual appeal to me.

Again, as a Beatles-Stones mid-1960s classicist (although I was  young for this role), I had thought things got less interesting with the rise, say, of groups such as Creedence Clearwater Revival (although I liked them OK) and CSNY.  I also was left cold by the prog rockers such as Jethro Tull and Yes.  (I remember a debate with a prog rock-loving friend of mine regarding whether the best new song on the Beatles' Yellow Submarine album was "It's All Too Much," his choice, or "Hey Bulldog," which I liked much better.)

Bowie may have toyed with intellectual pretension (albeit to his artistic benefit, overall), but he was much less prone to windy musical pretension.  His early-70s music often matched the urgency and directness of great 1960s forebears, and thus (like the punk and new wave music that started coming out later in the decade) was very easy for one with my musical foundations to embrace.

Obviously, another huge part of Bowie's image in those days was the exploration of different sexual roles and gender identities.  I was too straight-laced, as was my milieu insofar as I knew, for this to matter to me as directly as it did to all those people, and I know now that there were many of them, who felt personally validated and empowered by it.  But again, it meant to me that he was interesting and creative and different.

It also importantly saved Bowie from a particular niche that I probably would have disliked even then. A big part of the appeal of an album such as Ziggy Stardust was that it spoke to teenage, and to a considerable extent teenage boy, angst. I thought of it from early on as the type of thing kids who feel alienated from school or the parents or the culture play "at maximum volume" in their rooms, with the door closed.  But loud music for teenage boys can be too bro / jock / frat boy to hit the dissident gene unless there is something there that feels outrageous or transgressive, which Bowie of course had.  Again, I think of Springsteen, decent joe though he always was, as the contrast that I found less interesting despite his classicism, authenticity, compassion, etcetera.

3) Catch-22 and beyond - In those days, unless radio stations or roommates' / neighbors' / friends' record collections came to the rescue, I had a Catch-22 issue with buying new records by artists I wasn't familiar with.  I didn't want to buy new records unless I'd like them, but I couldn't know if I'd like them unless I bought them.  (I think this was a combination of limited budget, not wanting to make a "mistake," and figuring there was just too much out there to know which things to try first.)  So I'd heard about Bowie, but I didn't take the plunge until 1976 when his first greatest hits collection, Changesonebowie, came out.

This I did partly because Tom Carson, a writer on pop culture who was always in the college newspaper, a couple of years older than me and clearly a hipster in waiting, kept writing these raves about Bowie.  (I knew who Carson was, as he was a prominent campus figure, but I didn't know him personally.) It got to be funny.  Not only did he rave about Bowie when he was writing about Bowie, but it seemed like he would write, in effect, "What a beautiful sunny day. It reminds me of how great all of Bowie's albums are."  (Only so much snark is intended here, however - I did regard Carson as someone to take notes from.)

I finally figured: OK, fine, I'll give up and actually buy a Bowie album, especially now that I can cream-skim via the greatest hits.

I liked Changesonebowie right away (although soon, of course, I transitioned to buying the actual albums), and for a while was continually playing it in rotation with another record that I got at the same time, Eno's Taking Tiger Mountain By Strategy.  These, you might say, are the two records that really got me ready for the punk / new wave movement when it hit the next year (via Television, the Talking Heads, Blondie (first album), the Ramones, the Sex Pistols, the Clash, Elvis Costello - to name the ones I liked best at that time).  So thanks in part to Bowie for all that.

BTW, I couldn't resist checking online what Tom Carson might have to say now about Bowie's death.  (I figured he'd have some expressive vehicle at hand, and it turns out he's on Twitter.)  Sure enough, he had tweeted the following: "I only have one request for the gods today: let David Johansen outlive me. Bowie I can (barely) handle, but never David Jo."

Watch it there, Tom - this wish could be fulfilled in multiple ways, some of them better for you than others.

Death of David Bowie

I haven't really followed his work since the Berlin trilogy plus the one after it (Scary Monsters), but still very sad to hear of David Bowie's death.

Bush versus Trump tax plans

Now that the Tax Policy Center has added an analysis of Donald Trump's tax plan to its earlier analysis of Jeb Bush's plan, Kevin Drum offers the following snark:

"[Trump's plan is] bigger, more energetic, and altogether more taxerrific than Jeb Bush's weak-tea excuse for a tax plan. Bush would increase the national debt by 28 percentage points over the next decade. Trump kills it with a 39 point increase in red ink. Bush raises the federal deficit by $1 trillion in 2026. Trump goes big and increases it by $1.6 trillion. Bush's plan costs $6.8 trillion over ten years. Trump's plan clocks in at a budget-busting $9.5 trillion. And Bush reduces the tax rate of the super-rich by a meager 7.6 percent. Trump buries him by slashing tax rates for the Wall Street set by 12.5 percent."

I realize this is a "glass half-full versus half-empty" type of a thing, but I see an angle to this that's opposite to the one Drum emphasizes.  He notes: "Once again, Bush has brought a knife to a gun fight, and Trump has slapped him silly" - fair enough as campaign commentary, leaving aside the point that these tax plans are mainly for the donors and D.C. conservative leadership types, not the Republican voters, and that those target groups are nonetheless still anti-Trump.

I see the opposite point, which is that all of the Republican candidates are very similar to Trump - it's just a matter of degree.  E.g., in all the above measures, Trump has merely taken insane features of the Bush tax plan and given them a roughly 50 percent boost. This still leaves Bush's substantive tax proposals about 2/3 as insane as Trump's.

I say "insane" because the plans are so fiscally reckless.  They're not going to get the budget cuts or growth boosts that would cause them merely to express a different fiscal philosophy than the one I happen to prefer.  The effects on the super-rich admittedly require a separate and longer conversation.

In sum, to recompute the metaphor above in light of the actual numerical ratios from the TPC studies, Bush's glass of tax crazy is either 2/3 full or 1/3 empty, if we use Trump as the benchmark for a full "glass."  It's not just half-full versus half-empty.

I'm disappointed that "responsible" people on the seemingly adult right, like Martin Feldstein and Glenn Hubbard, either actually want to do the sorts of things Bush advocates, or feel bound to act as if they do. Under present circumstances, and if the Republicans win the White House in 2016, it really doesn't matter which.

American Enterprise session on OECD-BEPS

This morning I was in Washington, where I participated in an AEI panel discussion entitled "The OECD Base Erosion and Profit-Shifting Report: Should the United States Be Worried?"

You can see a video of the two-hour event here.  I come on at about minute 52 (I started a minute earlier than that, but initially my mike was off.)  And my slides, which pretty well tracked my talk (though of course I didn't just read them) are available here.

It mainly went as follows.  Grace Perez-Navarro and Thomas Neubig presented the report on behalf of the OECD. Apart from providing the backstory, details, etcetera, they say that, at least outside the U.S., there is widespread movement in favor of actually adopting the report's recommendations, reflecting multiple levels of support (e.g., from both political leaders and technical staff) in many countries.

David Ernick of Price Waterhouse then offered some U.S. practitioner or taxpayer-based skepticism - arguing, for example, that, as long as our corporate marginal tax rate is higher than the global norm elsewhere, we may not want to join the crowd (even if we would otherwise).

I said - well, my slides are short, so you can have a look for yourself - that it seems unlikely to me that U.S. policy will in fact be significantly swayed by anything about this process. This is typical of U.S. policymaking, but in addition there's been a perception here that the process is anti-U.S. multinationals.  Plus, if it did start making headway, there'd be an awful lot of money deployed to stop it (and this may be happening anyway).  So we are just going to do whatever we do, and if that involves getting tougher on U.S. or foreign multinationals, it will be for our own reasons.

I also said that, if one is proceeding unilaterally, the really tough issue is to decide how one should respond to foreign-to-foreign tax planning.  This is the issue at the heart of battles over our subpart F rules, and other countries' CFC rules, over the decades.  The problem is that, from both a residence country and a source country standpoint, there are rationales both for letting such tax planning go forward, and for trying to impede it.  Read the slides to see how I would explain this.

Martin Sullivan then addressed how to model economic substance - the issue raised by the OECD's focus on "artificial" profit-shifting, and had some interesting points that, like my discussion of foreign-to-foreign tax shifting, reached the normative bottom line, perhaps less generally useful than either of us might have liked, that "it depends" and "it's hard to say."  (But at least we both try to say something about the "it" that "it depends on").  He then expressed skepticism about patent boxes, as a tax preference design, even if one wants to tax-favor domestic R&D activity.

One audience member suggested that some of the presentations, presumably including mine, were a bit too negative and pessimistic with regard to how well OECD-BEPS is actually doing. I agreed that this might be so - I'm best informed on U.S. developments, not those occurring elsewhere, and this tends to make me a pessimist.

Holiday gift ideas

With apologies for the crude solicitation, this is (a) just 61,000 words long, (b) an easy airplane read or tired evening read (or beach read if you are going somewhere warm during the holidays), (c) fun, I hope, and if I do say so myself, and (d) not wholly unreasonably priced.

More on the international tax extenders

According to the Committee for a Responsible Federal Budget, the 10-year revenue cost of making the "active financing" exception permanent is $78 billion, whereas 5-year extension of section 954(c)(6) costs "only" $8 billion.

Obviously, the low-hanging fruit here (especially given the overall ten-year revenue cost of $680 billion on the tax side, or $830 billion for tax plus spending changes) is its showing that almost no one in Washington, and certainly not the Congressional Republicans whose majority status put them in the lead in bipartisan negotiations, actually cares in the slightest about budget deficits and public debt.  Whatever the real merits of deficit and long-term debt concerns, on which reasonable minds differ, it's clear that, in the political sector, yelling about it is purely a partisan sham to harry the other side and discourage the enactment of particular tax or spending proposals that one dislikes on other grounds.  But again, this has been too blindingly obvious for too long to count as much of a revelation.

Turning back to the international tax provisions, it's interesting to note that, even if section 954(c)(6) ends up being extended through the full 10-year period, and even assuming rising annual revenue costs, it would still presumably be less than 25% as costly as the active financing rule. I would assume that this reflects section 954(c)(6)'s redundancy, in many cases, given the general availability of tax planning that uses "hybrid entities" or "hybrid financial instruments."

I would expect a significantly higher marginal revenue cost of extending section 954(c)(6) if the Treasury addressed hybrids, including those created by its 1997 check-the-box regulations.  By the same token, the revenue effect of addressing check-the-box would be much higher absent section 954(c)(6).  But admittedly, even if both were addressed, there's a basic conceptual challenge that revenue estimators face in this area. Since both hybrids and section 954(c)(6) empower foreign-to-foreign tax planning, aiding the elimination of foreign taxes once multinationals have characterized their global profits as foreign source for U.S. tax purposes, it's tricky to determine just how much the companies' foreign taxes, as opposed to their U.S. taxes, would eventually go up in the new equilibrium.  And while I know that revenue estimators do their best with this, and may have useful data that they can draw on (especially for short-term estimating purposes), I do think there's potentially a big uncertainty here, especially once the companies have fully adjusted.

Tax extenders news for international tax buffs

The House version of the tax extenders bill (the "Protecting Americans From Tax Hikes Act of 2015") has now been posted online.

Of note to international tax buffs, the "active financing" exception to applying subpart F to financial income earned abroad by U.S. companies' foreign subsidiaries is made permanent by section 128 of the still-just-proposed Act.

Also, section 954(c)(6), the so-called "look-through" rule that often permits U.S. companies to avoid subpart F on foreign-to-foreign tax planning, without requiring the tedium of using hybrid entities, is extended through the end of 2019, by Act section 144.

The active financing rule's initial enactment and frequent extension have been popularly attributed to GE, at least as a key organizing player. GE presumably doesn't care about this rule any more, given their recent restructuring, but evidently it still has friends.

Extending section 954(c)(6) could certainly be viewed as in tension with the spirit of the OECD BEPS project, but it's not as if this makes it a surprise.

Three analyses of corporate inversions

Martin Sullivan has a good article in this week's Tax Notes, called "A Middle Path for Stopping Inversions.  Here is the link, but it may not work for non-subscribers.

Sullivan notes that the main issue posed by inversions such as that by Pfizer and Allergan "involves a loss of revenue, not employment .... Pfizer's operational headquarters will remain in Manhattan - just as the operational headquarters of Allergan, legally resident in Ireland, has remained in Parsippany, New Jersey."

A revenue issue arises for two reasons. Pfizer-Allergan will now find it easier to strip profits out of the United States through intra-group debt, and it will now have an easier time doing what it likes with the "trapped earnings" that it has given itself abroad, mainly through tax planning, without a taxable U.S. repatriation.

Sullivan, like me, believes that these issues are best addressed in a broader context than just anti-inversion rules.  Thus, he proposes improving our earnings-stripping rules - which, unlike our controlled foreign corporation (CFC) rules, need not be aimed disproportionately at U.S. as compared to non-U.S. companies - and enacting a one-time tax (in effect, a deemed repatriation) on the existing stock of unrepatriated earnings.

Less good, though not wholly devoid of merit, was Carl Icahn's op-ed in the New York Times yesterday. Icahn appears to have a couple of basic misunderstandings of how our international tax rules actually work.  For example, he claims that we impose "double taxation" upon U.S. companies' foreign earnings - apparently not understanding that we have a foreign tax credit. (Indeed, he expressly refers to the "foreign tax deduction.")  He also repeatedly says that the problem is our "uncompetitive" tax system, an annoying cliche that rests on assuming that U.S. multinationals face unusually high tax burdens by global standards. Researchers have tried to study this, and it is probably false. The motivation for inversions rests in their capacity to reduce the companies' tax burdens - which is distinct from the question of whether these burdens are high or low to begin with. 

Icahn does, however, note the importance of earnings-stripping. He also gives props to a bipartisan tax legislative proposal (Schumer-Portman) that would use deemed repatriation (at a reduced rate) to address trapped earnings, although he appears to misunderstand it as allowing voluntary repatriation.

I am perhaps least happy with a Business Insider op-ed by Glenn Hubbard. I don't really disagree with Hubbard's opening claim, which is that, if the deal benefits Pfizer's shareholders, there is good reason for management to want to do it. I am surprised, however, that Hubbard seems to think the main motivation for inversions is that the U.S. corporate tax rate is too high.

Now, it's true that a higher corporate rate raises the tax savings per dollar of earnings-stripping, as well as the tax charge associated with a taxable repatriation.  But for U.S. source activity that yields U.S. taxable income, the corporate tax rate, whatever it is, applies alike to U.S. and foreign multinationals. So it is not directly affected by inversions.

By all means, let's debate how low or high the U.S. corporate tax rate should be. But whether it's lowered significantly or not, let's also strengthen our earnings-stripping rules (so the rate will apply more uniformly to U.S. economic activity).  Also, Hubbard should know that it's not generally efficient to hand transitional windfalls to taxpayers, by wiping out deferred taxes that pertain to profits generated in the past.

And finally, calling the Pfizer deal (as Hubbard does) "self-help tax reform" is a bit gag-worthy.  Agreed that it's self-help, and that we should expect self-help. But preparing for greater earnings-stripping, and wiping out deferred taxes on profits that to a considerable extent may have been placed abroad, as an artificial accounting matter, through tax planning, falls somewhat short of what I would call "tax reform."

If I may deliberately (and egregiously) mix my metaphors, Hubbard's op-ed barks up the wrong tree regarding inversions because he has other fish to fry.  When you have a position, it's tempting to use everything out there as evidence in its favor, but inversions operate mainly at different margins than that posed by the choice of domestic U.S. corporate tax rate.

Upcoming DC appearance

This Friday (December 18), I'll be appearing in DC at a morning session at the American Enterprise Institute, entitled "The OECD Base Erosion and Profit-Shifting Report: Should the United States Be Worried?"

Others speaking at the session will include Alan Viard and Aparna Mathur of AEI, Thomas Neubig and Grace Perez-Navarro on behalf of the OECD, David Ernick from Pricewaterhouse Coopers, and Martin Sullivan from Tax Analysts.

I'll post my slides after the session (probably on Friday afternoon, assuming smooth travels back to NYC, or else next Monday).

Ear candy

Ultimate Painting often sounds like a mix between the Velvet Underground's ballads album and Paul McCartney's white album period, as played by the Feelies. But this one is perhaps a bit Hollies-ish, albeit in a good way.

Hillary Clinton's plan to address inversions

Hillary Clinton has released, through her campaign website, a plan to address corporate inversions, such as the Pfizer-Allergan deal.

In addition to limiting tax-effective inversions to deals in which the foreign "acquirer" is actually larger than the domestic "target" - thereby addressing "minnow swallows whale" deals that potentially can work (if not too extreme) under current law - the plan would also address the U.S. tax benefits that companies anticipate when they plan inversions, along lines similar to those that I have advocated, such as here.

First, the proposal would require companies that invert to pay an "exit tax" on their previously accumulated, but as yet untaxed, foreign earnings.  The logic here is that, in principle, these taxes have merely been deferred, pending the occurrence of a taxable U.S. repatriation of the funds. However, inversion can make it far easier to avoid ever engaging in a taxable repatriation. Thus, in a way it's like skipping town to avoid repaying one's loans from the local bank. The exit tax would take the form of a deemed repatriation, thus eliminating this pointless incentive to "skip town" just because one has tax-planned one's way into having very high reported foreign earnings.

Second, the proposal would address "earnings stripping," which typically becomes a lot easier when a U.S. company expatriates. The classic, most straightforward earnings-stripping device is to borrow money from, and thus pay deductible interest to, foreign affiliates within one's own global corporate group. But under the U.S. rules, if a U.S. company pays interest to a foreign subsidiary, the effect of the U.S. interest deduction is offset by the company's having to pay current U.S. tax on the subsidiary's receipt of the interest income. Inversion permits U.S. companies to borrow from foreign affiliates that are not their subsidiaries (e,g., their new corporate parents), and thus that are not subject to the offsetting inclusion. Addressing this tax planning device, as the plan would do (although I have not yet seen the details) could further reduce U.S. companies' tax incentives to invert.

Not that anyone cares any more about the Jeb Bush tax plan as such, but ...

According to an analysis by the Tax Policy Center, the Jeb Bush tax cut "plan" would yield a static revenue loss of $6.8 trillion over ten years. However, refining the estimate to include feedback effects and annual interest costs raises, rather than lowers, the projected effect on national debt - to $8.1 trillion over 10 years and $22 trillion over twenty years. This reflects that, absent very large spending cuts that have not been specified by the Bush campaign, there would both be huge interest costs from the higher annual deficits, and fiscal drag from the increased public debt overhang. This would apparently outweigh, in the estimate, the dynamic effects of lowering current-year tax burdens on work and saving.

Obviously, who cares about the Bush tax plan as such as this point. It's not as if the poor guy actually has any sort of a chance to win any elected office higher than dogcatcher.  But given that all other Republican candidates are essentially offering larger versions of the same thing, this is indirectly relevant. It suggests that, if a Republican wins the presidential 2016 election (and retains control of both the House and Senate, as one would expect), there will be a high likelihood of the U.S. budget's going down the path of Kansas, or perhaps even Greece.

2016 NYU Tax Policy Colloquium schedule, this time with titles

While I posted our speaker schedule the other day, I didn't have paper titles (which in some cases are tentative). So here goes again, showing the current state of the play:

SCHEDULE FOR 2016 NYU TAX POLICY COLLOQUIUM

(All sessions meet on Tuesdays from 4-5:50 pm in Vanderbilt 208, NYU Law School)

1.  January 19 – Eric Talley, Columbia Law School. “Corporate Inversions and the Unbundling of Regulatory Competition.”

2.  January 26 – Michael Simkovic, Seton Hall Law School. “The Knowledge Tax.”

3.  February 2 - Lucy Martin, University of North Carolina at Chapel Hill, Department of Political Science. "The Structure of American Income Tax Policy Preferences."

4.  February 9 – Donald Marron, Urban Institute. “Should Governments Tax Unhealthy Foods and Drinks?"

5.  February 23 – Reuven Avi-Yonah, University of Michigan Law School. “Evaluating BEPS.”

6.  March 1 – Kevin Markle, University of Iowa Business School.  “Income Shifting Incentives and Implicit Taxes.”

7.  March 8 – Theodore Seto, Loyola Law School, Los Angeles. “The Nonfalsifiability of Welfarism: Some Implications of Preference-Shifting for Optimal Tax Theory”

8.  March 22 – James Kwak, University of Connecticut School of Law. “Reducing Inequality With a Retrospective Tax on Capital.”

9.  March 29 – Miranda Stewart, Australian National University. “Transnational Tax Law: Reality or Fiction, Future or Now?"

10.  April 5 – Richard Prisinzano, U.S. Treasury Department, and Danny Yagan, University of California at Berkeley Economics Department. "Partnerships in the United States: Who Owns Them and How Much Tax Do They Pay?"

11.  April 12 – Lily Kahng, Seattle University School of Law.  “Who Owns Human Capital?”

12.  April 19 – James Alm, Tulane Economics Department, and Jay Soled, Rutgers Business School.  “Whither the Tax Gap?”

13.  April 26 – Jane Gravelle, Congressional Research Service.  “Policy Options to Address Corporate Profit Shifting:  Carrots or Sticks?”

14.  May 3 – Monica Prasad, Northwestern University Department of Sociology. “The Popular Origins of Neoliberalism in the Reagan Tax Cut of 1981.”

Literary struggles

Now that I have taught my last classes of what has been a very taxing (so to speak) semester, in terms of demands on my time for both teaching prep and travel, I have finally, after months away from it, been able to return to working on my still tentative but definitely intended book-in-progress, "Enviers, Rentiers, and Arrivistes: What Literature Can Tell Us About High-End Inequality."

This project was originally inspired by the idea of wanting to do a better and more interesting job of looking at literature, in relation to evaluating high-end inequality, than Thomas Piketty does in Capital in the Twenty-First Century.

This is not meant as a shot at Piketty - it was clever of him to use illustrations from Austen and Balzac to illustrate his concerns about high-end inequality, and it helped him to attract attention that he deserved on other grounds. But just saying that those books illustrate the evils of a rentier society opened my eyes to the possibility of doing more with literature - especially since Balzac in particular is not just about a rentier society, but is centered on arrivistes who are trying to crash the heights of such a society, taking advantage of the fact that things are growing socially and economically more fluid.

Then I had the idea that Wodehouse, whose work I absolutely love, beautifully illustrates the "Great Easing" - the period when rentiers were at their low ebb, relatively speaking, hence making it plausible for Bertie Wooster, the aimless rentier par excellence, to be a mocked and comic, albeit not quite beleaguered, figure. (Unless the threat of being frowned at by your aunt and excluded from chef Anatole's splendid dinners meets the threshold for being beleaguered).

But here are two problems I encountered with this project. Well, three, if we count its being outside my usual comfort zone and having really no close models to draw on (while other people have of course done other interesting things with literature, none that I've seen is quite the same as what I want to do).  One is that I thought it would just be fun, both for me and hopefully for readers. But in a project of this scope, there has to more than that - there has to be clear purpose and direction, which I found myself needing to look for, and to keep on developing and revising, on the fly. It's turning out to have at least a 2 to 1 hard-to-fun ratio, at least in the still-early stages.

Second, I've been struggling with what I call the "Hegel problem." This refers to an I think famous quote about Hegel's work, to the effect that you can't understand the whole until you understand all of the parts, and you can't understand the parts until you understand the whole.

My version of this problem is that it's hard for me to figure out what I want to do with each literary work that I examine, until I know my general approach. But it's hard for me to figure out my general approach, until I've thought about particular literary works in close derail.

To change the metaphor, it's hard to get the chicken without the egg, and the egg without the chicken. But I think (or hope) that I'm getting closer.

Most recently I've been reading scholarly literature about Jane Austen, after initially thinking that I could write about Pride and Prejudice based just on my own reactions and resources. I'm finding this helpful, even though what I'm on about here is NOT to try to add to the body of Jane Austen literature (although this is a subject on which I have now developed some views). I had thought I could write the Jane Austen chapter straight up, then just one more (on Stendhal's The Red and the Black), and then I'd write a more general earlier chapter on just what I am aiming to get from the literary works that I examine. But I think now that I have to write that earlier chapter first, leaving it to be enriched and filled out as my work on later chapters causes me to understand it better.

In short, it seems like the right approach will have to be a back-and-forth mixture of incremental with iterative.  Feasible, I hope, but certainly not easy (and leading to fluctuating confidence levels about the project).

I'd also really like to test the market for getting this book published in a decent placement. This is a project with both upside and downside. It could come closer to mass market than my work usually does. Or it could be hard to publish because I can't pitch it as being wholly within my core expertise. I'm hoping literary critics will like it, but I'm certainly not expecting (or wanting) them to view it as being actually on their turf. And while the thing to do, at some point well before I'm finished, is to look for an agent or publisher, I think that is best put off until I have written not only the first 3 chapters, setting forth my aims and methods, etc., but also at least two chapters on particular literary works. Which requires greater progress on the incremental versus iterative front first.

The book I want to work on next, after this one, should be a lot easier so long as the publisher is interested. I want to update my book, Fixing U.S. International Taxation, to reflect subsequent developments plus how my own thinking has changed or at least clarified. But even if I didn't want to write the literature book first I would want to wait at least 2-3 years before undertaking this, given the continuing pace of international tax policy developments.

Foreign tax credits to the rescue?

Michael Graetz had an op-ed in Friday's Wall Street Journal decrying, on due process of law grounds,  recent European Commission challenges to tax planning by U.S. companies such as McDonald's, Starbucks, Amazon, and Apple.

The issue is the companies' cozy transfer pricing agreements with friendly and accommodating EU countries - Luxembourg, the Netherlands, and Ireland - that helped the companies greatly lower their overall EU tax bills. The European Commission views these agreements as involving illegal state aid, and is threatening the companies with large penalties that Graetz views as in tension with the rule of law, given the lack of prior notice that this might happen.

Graetz does not dispute that the EC is almost surely right in viewing the challenged transfer pricing agreements as substantively ridiculous, shifting reported profits to low-tax countries where there is neither significant economic activity nor value creation.  He expresses concern, shared by the U.S. Treasury, that the E.C. is particularly targeting U.S. companies, in keeping with European self-interest and political sentiment.

But here, as he notes, is the bright side, from the companies' standpoint:

"Ironically, if the EU labels these assessments as underpaid back income taxes, instead of fines, the companies' payments may be used to offset their U.S. income taxes dollar-for-dollar, and American taxpayers would ultimately pay the bill."

He is referring, of course, to foreign tax credits, which, when claimed immediately and in full, can make U.S. companies wholly indifferent to whether their foreign tax liabilities (up to the foreign tax credit limit) are low or high. The companies only cared about their EU tax liabilities because, given deferral, they did not anticipate claiming U.S. FTCs at any particular time.

So far as I can tell, structuring the assessments to qualify as foreign tax-creditable shouldn't be all that hard. After all, Luxembourg and Netherlands are being told: By failing to collect enough income taxes, you offered improper state aid. Rebating the state aid means that you collect those underpaid income taxes after all. So why wouldn't it be creditable, if structured intelligently?

Here's what I would guess might happen next. The companies will immediately use the foreign tax credits, by repatriating just enough foreign earnings to generate the requisite amount of pre-credit U.S. tax liability. So the U.S. Treasury gets no actual tax revenue.

Now, at this point the companies still aren't entirely happy. After all, they presumably would have preferred to pay no further EU taxes and keep the earnings abroad.  Then they wouldn't have incurred a pre-credit U.S. tax liability that needed to be offset by using the FTCs. But from their standpoint, at least the burden of paying those extra EU taxes has been partly offset by the benefit of tax-free repatriation.

Is Graetz entirely correct in saying that, in this scenario, "American taxpayers would ultimately pay the bill?" Formally, yes - but substantively, perhaps no.

Suppose we take as given the repatriations that I am hypothesizing.  Then, by claiming foreign tax credits for the EU penalties, the companies save an equal amount of U.S. taxes, thereby (it seems) shifting the cost from themselves to American taxpayers.

But again, suppose the repatriations only occurred due to the creation of the foreign tax credit claims. Then the U.S. taxes that the credits offset wouldn't otherwise have been imposed. So American taxpayers merely fail to gain revenue, rather than losing it.

Does this take too short-term a view?  After all, suppose that the occurrence of a taxable repatriation at some point was inevitable. Then the companies are getting to wipe out, in the year of the repatriation, U.S. tax liabilities that they otherwise would have incurred in the future.

But why should one think that future taxable repatriations are inevitable?  After all, Congress may at some point enact another tax holiday, or "permanently" lower the repatriation tax rate, or partly/wholly forgive the deferred liabilities in the course of shifting to a territorial system.

Here are the main conclusions I draw:

1) Substantively, the companies still lose despite getting the foreign tax credits (assuming that they do indeed get them). The loss equals the extra EU taxes paid minus the value to them of getting to repatriate without incurring further (U.S.) tax liabilities.

2) U.S. taxpayers lose insofar as the companies would otherwise have had greater taxable repatriations at some point in the future - but the extent to which this is so is quite unclear.