Dirty business afoot in the Ways and Means Committee?

There was an interesting snippet in today's Ways and Means hearing on the tax legislation. The Youtube footage is here, and the action that I have in mind starts at exactly 3:38:28. It's a colloquy between Democratic Congressman Blumenauer and Republican Committee Chair Brady.

Blumenauer reveals that he has been trying to get an answer for 3 days to the question of whether pass-through business owners - Donald Trump, law firm partners, etcetera - get to deduct state and local income taxes as trade or business (or investment) expenses that are allowable as itemized deductions, even though employees cannot do so, and whether the Joint Committee on Taxation revenue estimate was based on the correct and intended view of this.

He notes that JCT chief of staff Tom Barthold told him one thing - which, as I've pointed out in earlier blog posts, was in at least one respect (and probably more than that) unambiguously mistaken - while the Ways and Means majority staff was simultaneously suggesting something very different (namely that yes, Trump and the law firm partner CAN deduct all of their state and local income taxes under the bill, whereas their employees can't).

Despite the old-style Congressional politesse that both Blumenauer and Brady resolutely stick to, there appears to be some anger under the surface about this. Brady won't let Blumenauer ask Barthold a simple question, and promises only to provide some sort of answer to something or other in writing at some unspecified time or other (and while the clock is running out on committee consideration).

Here is what I strongly suspect is happening:

(1) While the Committee leadership knows that the answer is yes - the likes of Trump and the law firm partner can deduct their state and local income taxes under the bill, whereas employees can't - it does not want this to be generally understood at present.  So they are trying to stonewall.

And very possibly also:

(2) The Committee leadership knows that the JCT revenue estimate is wrong because it didn't account properly for the widespread "business owner" deductibility of state and local taxes. This could either have been an honest blunder amid the high-speed train wreck of the rapid-fire drafting, or it could have reflected diffidence about fully explaining things to the JCT - it doesn't matter now. But if they know that the revenue estimate is wrong, and that it would be higher if done right, and that this is at risk of coming out, then they may feel they are trapped and have to push aggressively forward, in the hope of completing this stage of the process before their actions are exposed.

Again, I don't know that #2 is so,  but stonewalling has a way of broadening one's suspicions. It would also help to explain why they appear to be so set on stonewalling, when the bill's substantive effect is bound to come out well before enactment anyway.

I'm also quite confident that the bill as it stands, is best interpreted as allowing state and local income tax deductions to business owners, including those who don't qualify for the 25% plutocrat rate. This is the clearly expressed intent of the committee report. It is also the best (and, as things stand, only convincing) reading of the bill's statutory language. But it could very easily be changed if they wanted to change it - except, I gather that they don't want to change it.

Something should be out on this tomorrow morning, possibly with my name among the co-authors but not on this blog (although I'll link to it when I get the chance - busy day as I'll be traveling to Philadelphia for the National Tax Association's Annual Meeting). But now, for the tax geeks in the audience (all others can skip the next three paragraphs), I'll just say:

Take a look at section 164(a) of present law, including the first sentence of the flush language at the end of it. See what is removed from the scope of that flush language ("not described in the preceding sentence") by section 164(a)(3). Then look at section 1303 of the bill, which would amend section 164(b)(5) of present law. The new section 164(b)(5) would make changes to how section 164(a)(3) would now read with respect to individuals. Finally, ask yourself how that change to section 164(a)(3) for individuals affects the scope of the first sentence of the flush language at the end of section 164(a).

I think the answer you will come up with, if you are practiced at reading tax statutes, is that the flush language now newly authorizes the likes of Donald Trump and the law firm partner to take state and local income taxes as an itemized deduction because they were "paid or accrued ... in carrying on a trade or business" and are no longer removed from the scope of the flush language by reason of section 164(a)(3).

This would retain the deduction for employees too (since they are in a trade or business as such), except that elsewhere the bill denies employees all itemized deductions with respect to this trade or business. So it's just for the business owners and passive investors, not for the employees.

It's been elegantly done, and all the more so if they managed to keep it out of the revenue estimate (or did so accidentally but now don't want to fess up). But are we only judging style here, or morality too?

Talk on the EU State Aid Cases at Fordham Law School

Yesterday afternoon at Fordham Law School, I participated in a session discussing the EU state aid cases. After Amedeo Arena of  the University of Naples "Federico II" School of Law offered a European perspective, I offered a U.S. perspective, the slides for which are available here.

Has the House bill received an accurate revenue estimate?

I've posted recently on the question of how the House bill treats state and local income taxes paid by "business owners" - a term that includes Trump, hedge fund managers, and, for that matter, law firm partners who generally wouldn't get the special 25% plutocrat rate because they are in a service business. [Side note: calling it the "plutocrat rate," while perhaps a bit aggressive, is more accurate than calling it the "small business rate." I'll stop if they do.]

As David Kamin lucidly explains here, it appears that the state and local income tax deduction has NOT been repealed for these individuals. The longstanding itemized deduction for these taxes is gone under the bill, but the business owners would get to deduct the taxes as a business expense, whereas employees would be denied the same deduction (even though it would technically qualify as a business expense for them, too) because they're in the trade or business of being an employee, and employee business expenses are disallowed under the bill.

Kamin's eye-opening follow-up, available here, is strongly recommended reading. Without putting words in his mouth that he didn't say, it raises questions about the accuracy, and perhaps even the integrity, of the revenue estimating process for this bill.

As Kamin explains:

(1) the House Ways and Means Republicans, whose bill this is, "intend to write a loophole into the limitation on the state and local income tax deduction - or have us believe they are. They've said so. Repeatedly. Over time. And the statutory language, though ambiguous, could get them there."

(2) Thomas Barthold, Chief of Staff for the Joint Committee on Taxation, believes otherwise. When asked in a Way and Means mark-up hearing on the legislation, "he said the loophole doesn't exist and that owners and investors wouldn't be able to take the deduction for state and local income taxes, though he conveyed this in a confusing fashion."

Barthold also made a clearly erroneous suggestion to the effect that, among business owners, those engaged in service businesses certainly wouldn't get the deduction. But while service businesses don't get the special 25% plutocrat rate, there is no ambiguity in the legislation about the lack of any tie between this issue and that of state and local income tax deductibility by business owners.

You can check it out for yourself here (footage of the relevant moment in the mark-up hearing).

Now, I don't mean in any way to criticize Tom Barthold for this. Even leaving aside the ridiculously abbreviated process that has got to be over-taxing (so to speak) the entire JCT staff, he is a person of great integrity, in keeping with a proud tradition of JCT integrity that goes back to long before my own days there (I was on the JCT staff from 1984 to 1987). It would be amazing if the JCT chief got everything right in a markup under these circumstances.

But if I understand how a JCT chief prepares for hearings like this, he works closely with his staff. What he says about a particular issue is highly likely to reflect what those among his staffers who are working on the issue believe to be the case. There are JCT staffers on point of two relevant kinds: (1) the lawyers, who are working on structuring, drafting, and explaining the legislation (possibly with an economist or two), and (2) the revenue estimators, who determine the revenue "score." And of course these groups (1) and (2) are talking to each other as well.

So I consider what Barthold said to be plausible prima facie evidence of what JCT believes about the legislation, and assumed for purposes of its revenue estimate.

This brings us back to the House Republicans whose bill this is believing something else about state and local income tax deductibility - or at least, as Kamin says, wanting to "have us believe" they are creating the loophole. (For "us," perhaps one might substitute "the lobbyists who are also pushing for the 25% plutocrat rate.")

Have the House Republicans tried to communicate their true understanding (assuming it's true) to the JCT? Have they tried to avoid communicating it? Has it simply been a huge oversight? If so, has anyone been eager to correct it, and thus fix the revenue estimate if necessary, before the House votes on the bill? Are the lobbyists, not the JCT, the ones who are being fooled? (But in that case, why wouldn't the loophole prevail, given the evidence supporting its being intended?)

These questions ought to be answered, and the sooner the better.

Broader thoughts on the House Republican bill's international provisions

I realize that my posts on the proposed pass-through legislation have been quite harsh. I really don't like sounding that way - it literally makes me heartsick, but I find those provisions to be so bad, indefensible, and redolent of bad faith that I'm pretty much driven to it. I feel it's necessary to sound the alarm.

The international provisions in the House Republican bill are different. So it's with considerable relief that I can address them, albeit still just preliminarily here, in an entirely different tone.

I've already briefly addressed, in that less heated vein, section 4301 of the House bill, which requires current incluson by U.S.-headed multinationals of foreign high returns. Herewith a bit of expansion in scope.

I would group the international tax provisions in the House bill into three categories.

First, tax cuts that are mainly from exemption, plus making permanent a rule in the current Code that facilitates foreign-to-foreign tax planning by U.S. companies, would lose $212B during the period. (Note, however, that exemption here just means dividend exemption - subpart F, which denies deferral to certain foreign earnings, would remain in place with specified changes, and would now have the effect of denying exemption, rather than denying deferral.)

Second, anti-base erosion provisions would raise $265B during the period. So we are already, at this point, plus $53B in projected revenue.

Third, the deemed repatriation provision for pre-enactment unrepatriated foreign earnings would raise $212B.

Should #3 be added together with ##1 and 2? If so, then the net revenue increase rises to $265B. The answer to this is Yes or No, depending on your purpose. It is additional tax liability from US multinationals. On the other hand, it's from past stuff that doesn't have the same relevance for incentives and tax burdens going forward. The US companies would certainly have voluntarily paid something to wipe clean the deferred liability. But I doubt that the amount they'd be happy to pay is anywhere as high as $212B. I imagine that they anticipated getting off cheaper (and probably still do).

To return to the cynical tone for a moment, what seems to have happened here is that the House Republicans pulled a Willy Loman on the US multinationals. In short, those companies are liked, but not well-liked, by the House Republicans, and hence have been sacrificed to the cause of directing more of the kitty to the pass-throughs, for whom even "well-liked" is probably too milquetoast a term (try "loved").

I don't know as yet how U.S. multinationals are reacting to this. They can't be ecstatic, although it's true they get the general U.S. rate reduction. They may even, for all I know at this early point, be strongly opposed. One  thing that's got to displease them in particular is that, even if none of this passes, the anti-base erosion provisions are now on The List. The fact that a generally business-friendly House Republican leadership proposed them may offer a kind of free pass for others to re-propose them in the future, and to have a strong talking point to the effect of: This can't be crazy harsh - look at who proposed it!

I mentioned in my earlier blog post that the provision (sec. 4301) requiring current year inclusion by US shareholders of certain foreign high returns (projected to raise $77B in ten years) has the virtues of (a) taxing the income that is subject to it at a rate between 0 and the full domestic rate, and (b) making foreign taxes only partly creditable, hence having a marginal reimbursement rate (MRR) that is between the marginal tax rate and 100%. Both of these very general ranges are the ones that I have argued for, which obviously leaves a whole lot of room for debate about too high vs. too low. This provision appears to be aimed above all at rents, such as from intellectual property, that typically ends up in a tax haven at the expense of US as well as foreign tax bases.

The next of the three anti-base erosion rules addresses interest-stripping - in other words, the use of intra-group interest deductions and strategic placement in the US of third-party bank borrowing - that companies would use to reduce US source taxable income. Notably, it applies to foreign-headed as well as US-headed multinational groups. The key term of art, making one potentially subject to the rule, is membership in an "international financial reporting group." I don't as yet know how problematic (or not) that will be to apply, but I do like the aim of moving towards residence-neutrality in anti-base erosion rules (i.e., not just applying such rules to US companies). Here the 10-year revenue estimate is $34B.

The third anti-base erosion rule is the biggest, with a 10-year revenue estimate of $154.5B. It definitely raises some issues, but certainly has the advantage of being interesting.

It slaps a 20% excise tax on payments from domestic companies to related foreign companies if the payment is either deductible in the US or added to the basis of something. One exception to the application of this rule is for certain commodities transactions. But the big exception is for payments at cost (i.e., with no markup). Once again, it's residence-neutral, with respect to US vs. foreign multinational, via application to international financial reporting groups.

Here is a possible illustration (if I am understanding this correctly). US company buys good or services from a foreign affiliate for $1M.  If the foreign company has sold it to the US company at cost (i.e., its cost  was $1M), no effect. But if there is any markup (its cost was <$1M) then bingo, 20% excise tax, or $200K.

Let's elide for now the issue of determining the foreign company's cost, which the statute does indeed address (it appears, under pro rata type principles for expenses of doing lots of different things). The result would be over-harsh, and subject to a severe cliff effect since the whole thing becomes taxable as soon as there's any markup, if one imagined it actually applying. But the excise tax appears to be intended as a hammer that taxpayers will opt out of, rather than as something that's actually meant to apply frequently.

One way to avoid it is by electing, as the provision permits, to have the payments to the foreign affiliate treated as effectively connected US business income. In other words, one avoids the 20% excise tax on the gross amount by electing to pay a 20% income tax on the net profit. This eliminates the transfer pricing benefit to having the US affiliate pay a high price to the foreign affiliate. Plus, it applies this 20% tax to the profit that the foreign affiliate would have treated as foreign source even with reasonable and defensible transfer pricing.

The other way to avoid it is by doing a true arm's length sale with a third party. That presumably is meant to assure that the arm's length price will truly be a market price. I would think that one has to look at what happens next, on the other side of the transaction, to address strategic use of third party companies as well-compensated intermediaries, and the statute contains an authorization for the Treasury to issue regulations addressing conduit transactions. This could end up being drafted either narrowly, for pure conduits that just get a fee for spending 5 minutes in the middle, to more broadly, if both sides of the transaction (US company to third party, third party to foreign affiliate of US company) are sufficiently closely scrutinized.

This may be quite significant. After all, it seems eminently worthwhile to pay an accommodation party something just to get out of all the rest. But if the high revenue estimate is correct then it must not be (in the estimators' judgment) quite as trivial as all that.

Hard to tell at this point how this provision would work out in practice - e.g., too harsh? too avoidable? too complicated and uncertain? It also may raise treaty issues.  I would expect US companies to aim a lot of fire at this provision if it goes far enough for this to be worth their while, and if they agree as a ballpark matter with the revenue estimate,.  What they have to say may be illuminating, even if (to mix the metaphors) one has to discount it with a grain of salt. But it does look like the House Republicans have taken a urprisingly big swing at transfer pricing games by both US and foreign multinationals.

One further political aspect here is that a lot of the pain (such as it is) is being imposed on foreign multinationals, rather than US multinationals. The latter may be fine with this!

While I think a whole lot more work and information will be needed to evaluate the anti-base erosion rules, it does look like they should be taken seriously, and at a minimum added to the list of proposals in this genre to consider no matter what happens (or doesn't) to the rest of the U.S. international tax regime.

Again, it feels much better, on my part, to be able to take such a tone rather than the sharply hostile one that I felt was unavoidable with respect to the pass-through proposals.

Message to US multinationals: the House Republicans don't like you as much as you thought they did. True, they'd undoubtedly be happy to give you everything you want if the political cost to them was low enough. But they evidently like you a whole lot less than they like their friends in the pass-through sector. This is something you should keep in mind even if, with changing circumstances, they choose to re-align with you.

Amazing audacity

As David Kamin explains here, the House Republicans appear to have attempted a very sneaky move that they may have been hoping people wouldn't catch until it was too late.  The committee report makes it clear that they are trying to make state and local income taxes still deductible for "business owners" and passive investors - but not for anyone else.

As a technical matter, they arguably screwed this up and failed to get the result they have stated they want. But the legislative language may well be, at a minimum, ambiguous enough to permit its being interpreted the way that they evidently want it to be.

For a full technical dive, read Kamin's just-posted column, including the full walk through at the end. But the basics are as follows:

The bill repeals the itemized deduction for state and local income taxes.  Thus, no more state and local income tax deduction of any sort, UNLESS - and this is a big "unless" - it's a business expense or an expense of earning income.

So let's take 3 people: (1) Donald Trump (pass-through owner who gets the special 25% plutocrat's discount rate for business owners),

(2) Law Firm Partner, who doesn't get the 25% plutocrat's rate because he or she is in a service business (leaving aside the inevitable real estate partnership that owns the building and will be used to drain off profits from the service partnership, as Victor Fleischer has explained), and

(3) Regular Employee - in the law firm context, including associates, paralegals, and secretaries, but also generally all employees everywhere.

All three are in a trade or business. And the proposed legislation expressly says that state and local income taxes, though no longer allowable as an itemized deduction, can be treated as a business expense or expense of earning income. (See Kamin, in particular the appendix at the end, in re. why and how this may have changed from present law, under which state and local income taxes generally are forced into the itemized deduction rubric for individual returns, and otherwise can't be deducted by the individuals who incur them.)

But the bill also disallows ALL itemized deductions by employees in relation  to their trade or business of being an employee. (This is probably intended in part as a sneak attack on deducting union dues, but it also reaches plenty of other meritorious items, along perhaps with some dubious ones, that under present law would generally be deductible below-the-line at least to the extent in excess of 2 percent of adjusted gross income.)

So here's where we end up, assuming that the above analysis is correct:

First, Trump still gets to deduct all of his state and local income taxes, other than those that relate to being an employee (which presumably will just be for his salary as president). Note that he also no longer has to worry about state and local income taxes being disallowed as an itemized deduction under the alternative minimum tax (AMT), since that is being repealed. So, his president's salary aside, he is actually getting an expanded state and local income tax deduction compared to present law, albeit that its value is reduced by the bill's slashing his marginal rate for most of his income to 25%.

Second, the law firm partner, although denied the 25% plutocrat's rate because he is in a service business, gets to deduct his state and local income tax because he incurs them as a business owner.

Third, all of the employees, at the law firm and elsewhere, are denied state and local income tax deductions because they are under the wholly disallowed employee business expense rubric.

Kamin asks in his blog whether the revenue estimators at JCT understood this when they prepared their estimates. I would presume that the answer is Yes, because (a) they're smart folks, would have spotted the issue, and would have needed to know how to estimate it, plus (b) the intent by the drafters appears to be quite clear. But in truth who knows at this point. If it fell between the cracks - or was successfully concealed from them - and they thus didn't know, then the revenue estimate for repealing the state and local income deduction is going to decline significantly. This is probably big enough to have nontrivial implications for the overall bottom line revenue estimate relative to the budget ceiling with which they were working.

If the proponents didn't mean to allow state and local income tax deductions for plutocrats and other business owners, while denying the deductions for everyone else, then they'd best say so ASAP.

I'm not easily shocked, but, unless an innocent explanation unexpectedly emerges, I consider this a truly disgusting episode. Trying to sneak in continued state and local income tax deductions for what are generally high-income people and no one else, and doing it in a way that meant significant legwork was needed to figure it out, is both substantively indefensible and a slap in the face of honest and open lawmaking.

Two gigs next week

I'll be participating in panels twice next week. For each, I've prepared slides that I'll post in due course.

First, on Tuesday at 5 pm at Fordham Law School, I'll be commenting on the EU State Aid cases, in the aftermath of comments by Professor Amedeo Arena of the University of Naples School of Law. Details about the event are available here.

Then on Thursday, I'll be in Philadelphia at the National Tax Association's Annual Meeting. In addition to chairing a panel, I'll be giving a shortened and altered version of my talk from early June 2017, entitled The Rise and Fall of the Destination-Based Cash Flow Tax: What Was That All About? This time, my slides are entitled "A Requiem for the Destination-Based Cash Flow Tax."

Meanwhile, back at the ranch ...

While I've felt impelled to think a bit about the House Republican tax bill, and to write a few blog posts about it, my main scholarly efforts and interests at present are actually in a very different area.

As some regular readers may know, I've been working for some time on a book about high-end inequality as it has figured in various (mostly great) works of literature over the last 200+ years. The description of the project here is by now quite out of date, but it shows where I was at an earlier stage. Where I am now is having two separate books, for reasons of length plus natural divisibility. Book 1, of which I'm in the later stages now, takes the story from the Age of Revolution to the Gilded Age & run-up to World War I.

As of a  couple of months ago, I thought the only books I'd discuss at length in Book 1 (although I have a shorter section on Horatio Alger) would be the following:

Part 1, Age of Revolution
Chapter 2 (after introduction) - Austen, Pride and Prejudice.
Chapter 3 - Stendhal, Le Rouge et Le Noir
Chapter 4 - Balzac, Le Pere Goriot and La Maison Nucingen

Part 2, England Mid-Nineteenth Century Through the Onset of World War I
Chapter 5 - Dickens, A Christmas Carol
Chapter 6 - Trollope, The Way We Live Now
Chapter 7 - Forster, Howards End.

Part 3, American in the Gilded Age
Chapter 8 - Twain and Warner, The Gilded Age
Chapter 9 - Dreiser, The Financier and The Titan

I have completed drafts of all these chapters and am reasonably happy (despite self-critical tendencies) with most or perhaps even all of them.

Okay, quiz question. How does Part 3 look different from Parts 1 and 2? Snap answer, it only covers two books, not three. I had persuaded myself, partly for reasons of length, that this made sense, but I've now come to realize that it doesn't. I need a third book not just for symmetry, but to broaden the inquiry and get to where I see it all going.

I've now picked my book, which will be new Chapter 9 (ahead of Dreiser). It's an obvious choice, I guess - Edith Wharton's The House of Mirth. I'm in the later stages of researching the chapter and have begun to lay out, albeit still tentatively, the chapter's structure and trajectory.

Quick shout-out: I absolutely love this book. Although I'm biased at the point when I am actually writing about a particular book (which causes me to engage with it emotionally), I would probably rate it in the top 3 out of the 9 that I am discussing (along with Austen and Stendhal).

It's an amazingly angry and bitter book. None of the others on my list comes close (well, Stendhal perhaps closest). It's also exceptionally timely and prescient, in the age of Trump and Weinstein, on gender issues as well as status battles at the top. Indeed, a lot of its anger is about gender issues, as distinct from class, although the two are intertwined and my project is directed at the latter.

Reflecting sexism, Wharton has always tended to be dismissed as a junior varsity Henry James. (Indeed, James was among those taking this view.) But here's a snippet for you. The House of Mirth has a scene in which the heroine, Lily Bart, is sexually assaulted by a rich and powerful man who she thought was helping her. (Using the standard powerful man's playbook, he tricks her into going to his house when he's alone there, in this case by making her think his wife invited her.)

Lily escapes the assault. But it leaves her feeling shamed, embarrassed, disgraced, and as if it were HER fault. She doesn't need others to blame the victim - she's doing it herself.

But not to worry, others are happy to blame her, too.  These include the man who she thinks is her friend and defender, Lawrence Selden, but who, seeing her leave the assaulter's house in dishevelment, immediately assumes it's her fault, and that she's unworthy, and so, without any further inquiry, abandons her.

There isn't too much of that sort of thing in Henry James novels. Or indeed in anything by male novelists writing > 100 years ago.

Time to dust off the shingle?

An old friend who's a tax lawyer called to ask me if I am celebrating the Republican House bill. He had a particular (if partly tongue-in-cheek) reason why he thought I should be.  A bit of background will supply the reason.

As I've noted, the special 25 percent percent rate for business owners in industries that the House Republicans like relies heavily on the passive loss rules in order to determine who gets the 25 percent rate as to all of their income from a given business, not just 30% of it.

I was in drafting sessions during my days as a legislative staffer, and I can totally understand why the drafters, if it was their call, decided to do this. It solves a drafting problem for them, related to higher vs. lower labor income component from a given business, without requiring them to draft anything new. The passive loss rules have been there for 30+ years, and apparently have worked okay for the most part. So why not borrow them for this purpose? Drafters do this sort of thing all the time, and indeed, given the constraints they face, they must.

But as I pointed out in an earlier post, the passive loss rules are highly unlikely to be able to function adequately in this new area. They most commonly induce taxpayers to try to claim they HAVE materially participated, not that they haven't. This question has strong factual inputs that the taxpayer can take care to document - e.g., hours spent on a given activity. And in any case the passive loss rules, by helping to shut down the late-1980s tax shelter industry, meant that a lot of the intended targets simply gave up, rather than trying to establish material participation.

Now, if the passthrough provision passes, we will have enormous tax stakes for people at extremely high income levels who have multiple "activities" for purposes of the passive loss rules, and who will want to DENY, not establish, that they have materially participated. This leaves the IRS in the uncomfortable position of having to prove that they have actually spent more time than they say on each item, or that others haven't spent more time, etc.

This strikes me as a huge problem. The passive loss rules were mainly able to handle the material participation issue that they created, but I don't think they can handle this problem adequately. It is going to be a mess.

But back to my friend's telling me I should celebrate. Here's the thing. I'm actually an expert on the passive loss rules. (A bit out of date at the moment as I haven't been involved with them for a while, but it would be easy to catch up.) I was present at the creation, as I was part of the team that designed and drafted them.  Subsequently, I wrote a leading practitioner guide on the rules that I for a while was updating regularly. I've done consulting on the rules' proper application, and I've even been co-counsel, with a taxpayer's own representative, for purposes of discussing particular passive loss issues with IRS appellate conferees.

If this thing passes, I suppose I could hang out my shingle and do quite well, even keeping in mind that I'd want to keep the hours low due to (a) my greater enjoyment of doing academic work and (b) my internal normative compass.

So there's that, I guess.

Regressive, distortionary pseudo-consumption taxation

A lot of tax policy folks across the political spectrum see great potential advantages in consumption taxation.  By excluding the normal risk-free return to saving (which is all that gets distinctively excluded, compared to an income tax, in theoretical textbook models), it can achieve greater efficiency and economic growth. Plus, it is more readily made neutral between assets, because expensing for everything is easier to figure out than correct economic cost recovery for everything. Plus, it needn't have a realization problem (although one does have the problem of rate changes that can destroy inter-temporal neutrality if anticipated).

But many people think that a flat rate consumption tax would be too regressive. This is not just people like me. Hall and Rabushka weren't exactly raging leftists, and they devised a progressive flat tax, made progressive despite the name due to its zero bracket.

Lots of work since then on progressive consumption taxation has established that it has intriguing possibilities. E.g., this could be a consumed income tax in which traditional IRA treatment extends to all saving and dissaving. Or it could be the X-tax, which (depending on the exact model) can be thought of as Hall and Rabushka plus a more progressive rate structure.

I myself feel that rising wealth inequality at the top means that something else has to be done too. This might involve sufficiently effective inheritance taxation. But all that is a topic for another day.

This brings me to the House Republican bill. This would move the tax system closer to a consumption model. It also still has progressive rates. Yet in some ways it is best thought of as regressive, distortionary, fake consumption taxation with huge gouged-out holes in the base that mainly accrue to the super-rich, in effect permitting them to exempt a lot of their consumption from ever being taxed, at least at the top rate.

For example, there's a move towards expensing, but also enough retention of interest deductibility to mix-and-match consumption and income tax models in a wholly inappropriate way that can result in net subsidies for debt-financed investment.

And then there's the ludicrous 25% rate for business owners who happen to be in industries that the House Republicans like, which will cost an estimated $448 billion over ten years - nearly one-third of the entire net revenue loss. That is clearly a very highly motivated provision, but not by any plausible tax policy rationale.

Even less defensible is the movement towards eliminating the estate and gift tax without addressing the tax-free step-up in basis at death. Despite what remains of entity-level corporate taxation, this means that a huge proportion of the consumption enjoyed by the self-made super-rich (such as by borrowing against appreciated assets) will be permanently exempted from taxation of any kind. This would NOT happen under any well-designed and genuine consumption tax.

So we get enhanced inter-asset distortions and inefficiency (such as from inducing massive tax planning) in various respects, plus potentially a steeply falling lifetime net tax rate as one moves from the bottom to the top of the top 1 percent.

Unexpectedly interesting international idea in the House bill?

I just don't have the time today to come fully to grips with what the House bill does to U.S. companies' foreign source income (FSI), as it's complicated and requires studying 100 pages of statutory language that's full of newly defined terms and cross-references.

But, if I am reading it correctly, while generally creating an exemption system, it appears to address base erosion by taxing 50% of certain "foreign high returns." This involves (1) computing a rate of return, based on relevant capital invested, following complicated rules for the treatment of interest flows, etc., (2) comparing that rate of return to the 3-month Treasury rate, and (3) taxing 50% of the excess over a Treasury return plus 7%. It appears that commensurately scaled down foreign tax credits will apply to the taxable piece.

This looks like a version of the approach that I have proposed with regard to taxing FSI. In short, "foreign high returns" face a U.S. marginal tax rate (MTR) that is in between zero and the full U.S. rate, and get a marginal reimbursement rate (MRR) for foreign taxes that is less than 100%, given the foreign tax credit scaledown for the excluded portion. So one gets intermediate rates, as I have been advocating, for both the MTR and the MRR. (By intermediate, I mean an MTR between zero and the full domestic rate, and an MRR between the MTR and 100%.)

Suppose, where this rule applies, that a US company earns 15% (reflecting rents) and the US Treasury bond rate is 2%. Then the excess return is 6% [i.e., 15 - (2+7)], and half of this is taxed at 20% (the bill's corporate rate), which is equivalent to saying that the entire 6% extra return is taxed at a 10% rate. Given that 3/5 is exempted (under my numbers) and the rest is taxed at half the domestic rate, the overall tax rate for the FSI here is 1/5 of the domestic rate (4%). And if the foreign tax credit aspect works as I would presume it is meant to work, there would be, in effect, a 1/5 foreign tax credit and 4/5 at least implicit (whether or not literal) foreign tax deduction under these facts.

Exempting something that is based on the normal rate of return, defined in terms of bond rates, raises concerns about workability, but otherwise has good arguments in its favor.

It's dangerous to comment on this without understanding it more fully than I do at this point. But insofar as the "foreign high return" rule is a key operating feature at the end of the day, and is not overly gamable, they certainly could have done a whole lot worse.

Note also that, while they exempt the Treasury return plus 7%, there are U.S. companies with giant rents that might actually face non-trivial liability under this, again depending on how well the rate of return computation can be done in practice.

I'll also admit that I'm pleased to see ideas that I've advocated, and that I think make some sense, appearing to have some actual policy traction on Capital Hill.

NOTE: I've edited this entry to reflect my initially getting the provision a bit wrong on a quick read. Thanks to a Twitter reader (whom I thanked on Twitter) for setting me straight.

All hail the NPIP!

NPIP stands for "New Plutocratic Industrial Policy."  It's the label that occurs to me with regard to the 25% maximum tax rate for business income that the House Republican drafters have decided they like.

While they have been claiming it's for "small business," there is absolutely nothing that so limits it. Indeed, it's been very carefully drafted to make sure that people in the 39.6 percent get the full rate reduction. Under the bill, these are people with taxable income of at least $1 million. So we can be reasonably confident that its $4448 billion 10-year revenue estimate is mainly about big non-corporate businesses and their very rich owners. (Since I first posted this, it's been pointed out to me that reportedly 86% of small business pays at a rate of 25% or less anyway, meaning they'd get nothing from giving them a 25% maximum rate.)

So what must you do, or whom must you be, to get the 25% rate? First, you get it for 100% of your net business income from passive activities, which generally are business activities in which you personally do not materially participate. (They take this definition directly from the passive loss rules, which I helped to draft back in 1986.) This typically applies to people who invest money in all kinds of partnerships, S corporation activities, etcetera  that engage in pretty much any type of business - subject to the carve-out that I'll mention below. But they are passive investors, giving $$ but not sufficiently working in the business to meet the passive loss rules' material participation standards.

Second, you get the low business rate for 30% (in the simplest case) of net business income from all such activities in which you DO materially participate. This percentage can change under complicated, and at least partly elective (by the taxpayer) tests that seem aimed at raising it for more capital-intensive activities.

Suppose, then, that I have a business activity on which I work full time, earning $1 million and having no expenses. So far as I can tell at an initial read - subject to the limitation that I discuss next - 30% of the $1 million gets the 25% rate. But this income does count to pushing me into higher tax brackets for the rest of my taxable income.

Okay, so what exactly limits this? Under the passive activity rules cross-reference, a business activity is any activity which involves the conduct of a trade or business. I note that being an employee is a trade or business activity. So the one big thing limiting it is an exclusion from the special rate for "specified service activities," defined in a preexisting Internal Revenue Code section that the provision cross-reference as follows:

"ANY TRADE OR BUSINESS INVOLVING THE PERFORMANCE OF SERVICES IN THE FIELDS OF HEALTH, LAW, ENGINEERING, ARCHITECTURE, ACCOUNTING, ACTUARIAL SCIENCE, PERFORMING ARTS, CONSULTING, ATHLETICS, FINANCIAL SERVICES, BROKERAGE SERVICES, OR ANY TRADE OR BUSINESS WHERE THE PRINCIPAL ASSET OF SUCH TRADE OR BUSINESS IS THE REPUTATION OR SKILL OF 1 OR MORE OF ITS EMPLOYEES."

There are also a couple of items added for particular functions in the financial services industry.

What does this mean? If you're in the professional service industries, the arts, sports, financial services, consulting, etc., you lose. If you're in the trade or business of being an employee, you lose. But if you're a business owner (including via passive investment) in, say, the real estate, oil and gas, manufacturing, or retail sectors, it sure looks like you win. Although you win more (from 100% vs. 30%) if you aren't actually doing the work.

This is industrial policy - picking favored industries that should win while the rest lose.  Businesses using capital and not just selling services are good, services businesses are bad. Perhaps the regulations will pick winners and losers in an even more fine-grained manner, especially if you can lobby the White House, not just the Treasury and IRS.

And it's a weapon to enhance plutocracy - offering the biggest rate cut to millionaires, allowing plutocrats who work to get the low rate for 30% of their income, and those who are in effect rentiers to get the low rate for 100%.

And here's a tax planning trick that occurs to me right off. I'm a plutocrat and so are you. If we just got the $$ from our own businesses, in which we're working actively, we'd only get the low rate for 30% of our net business income. But if we invest in each other's business, 100% since we're passive as to the other person's business.

So why don't I invest in your business and you invest in mine? And I get some of the returns from your business, while you get some of the returns from mine? But since we don't really want to invest in each other's businesses, rather than our own, what can we do to ensure indirectly that, at the end, of the day, our takes from each other will be somehow adjusted so that we are really getting ultimate net payouts based on our own stuff, not each other's?

Let the drafting, of contracts followed by tax opinions, begin.

But that's not the worst of it, purely as a matter of tax administration. Consider also this. Under the passive activity rules, people most commonly want to AVOID being classified as passive, and to show that they are materially participating. This often depends on things such as how many hours they spent working on the activity. They are as a practical matter encouraged, although not required, to keep records establishing their hours spent. There has actually been Tax Court litigation about what sorts of hours count.

But now it's reversed. To get the 25% rate for ALL of your business income, not just 30% of it, you have to AVOID materially participating. So it's up to the IRS to prove how you actually spent your time (!!). How exactly are they supposed to do that, for business people with ownership interests who go around doing this & that?

So you have a horrendously bad statute administratively, devoted solely, it seems, to enforcing an incoherent industrial policy and enhancing plutocracy. If there's ever been a worse federal income tax enactment, I'd like to know what it could possibly be.

Renaissance Technologies and "basket options"

Earlier this week, I was on MSNBC discussing (with Stephanie Ruhle) Robert Mercer / Renaissance Technologies in re. the "basket options" tax avoidance scheme that they are reported to have used to the tune of $6.8 billion or so. I'm told that the feature may air again later this week, but you needn't wait if you click here. It's about a 4-minute clip, and I first appear at about 2:30. It also features Steve Rosenthal.

The interview was taped a couple of weeks back. So I hadn't known exactly when it would air. But then I heard about it from excited fans (so to speak).

I think there's a possible journalistic backstory to this that doesn't appear in the piece, but that may have helped to motivate general press interest. Mercer's political activism has increased since the IRS started questioning his reported $6.8 billion of claimed tax benefits from the basket options, and I gather that his involvement has extended to the conservative campaign against the IRS Commissioner. One might deem this a bit tactless and tasteless, although Mercer certainly appears to have far bigger (and, I would say, more rancid) fish to fry than "just" a possible $6.8B tax liability.

Another question that I suspect has prompted journalistic interest in the story pertains to whether the Trump Administration would interfere with the IRS to Mercer's benefit. When I've been asked about this, I've said that for decades we have had clear norms that generally prevent any such thing from happening. These norms and institutional barriers date back to Nixon, who tried to weaponize the IRS against his political foes, and thereby provoked a whole lot of pushback.

But we do of course live in an era when norms of fair and honest governance seem to be increasingly under threat. So, while this would not have been a major concern at any time in the last 40+ years, who knows what one should expect today.

Taking a (more) charitable ad hominem view of CEA wage claims about corporate tax reform

Kevin Hassett, in his new perch at CEA, has dismayed me by claiming - I would say (and I'm not alone in this) absurdly - that cutting the corporate rate from 35% to 20% would in short order raise wages by at least $4,000 per household. Indeed, I have considered this claim dubious enough to cause me to speculate that he has consciously decided that academic and think tank economists, among whom he has certainly hurt his credibility by making this claim, are not the audience that he believes will matter to him personally or professionally when his CEA stint is done.

But to put it more charitably, perhaps he is subject to sincere (if ill-founded) over-exuberance - akin to Dr. Malcolm's "deplorable excess of personality" in the Jurassic Park I movie - that can lead him astray without evidencing bad faith. As evidence for continued sincerity and good faith, he  today reiterated, in a Politico interview, a previously expressed view that is anathema to right-wing Trumpite opinion leaders, and hence that presumably reflects sincere conviction while not otherwise serving his or the Administration's interests.

He says, in particular: "We've not done a good job as a society at thinking about how do we take people who have become discouraged [from participating in the workforce] and reconnect them. And it's such an urgent problem that government programs that directly hire people might be part of the solution."

As the Politico column describing the interview notes, "[t]hat's a New Deal-style idea more closely associated with highly progressive Democrats." It has already begun to attract the inevitable brickbats, and I see no reason to think that there's anything more behind it than his believing that it's actually true. It doesn't look, from here at least, like a  deliberate sop or pitch to the Bannon wing.

The interview does, however, rewrite history a bit concerning a prior instance of ill-founded over-exuberance:

"Hassett, an affable economist with friends on both sides of the partisan aisle, also spoke about his often-lampooned 1999 book with James Glassman, Dow 36,000, that predicted stocks would hit that mark by 2004. Instead, the dot-com bubble burst and stocks tanked.

"Hassett described the title of the book as a bit of a 'youthful indiscretion' that was also somewhat unfairly maligned. 'The point was that people who buy and hold stocks tend to do well, but that stocks go up and down a lot and it's scary.'"

With all due respect, while that may reflect how he thinks about the stock market now, it's not quite the same as what the book said. Again, Dow 36,000 offered a specific prediction with an equally specific analysis behind it. This framework went well beyond "buy and hold," to assert that historical evidence supported viewing stocks as grossly undervalued based on their expected future payouts, even allowing for a reasonable degree of risk aversion.

I actually recall speaking to Kevin, at an AEI event, before Dow 36,000 came out or had been widely publicized. He explained the book's basic undervaluation claim to me, and added that, because he was so convinced it was true, he had placed all his savings in the stock market, none in bonds.

I asked him (obviously paraphrasing here): "If you're so bullish about stocks, why stop at 100% of your net equity, instead of also borrowing a lot of money and putting that in the stock market, too?"  But someone else came up to chat just then, so I never got an answer to this question.  From today's perspective, I'd note that even going 100% of net equity, without also borrowing so that one can push past that line, seems a bit aggressive (even allowing for the fact that Kevin, like me, was younger at the time) if "stocks go up and down a lot and it's scary."

In fairness, he was not alone in 1999 in thinking that the stock market was undervalued, even duly adjusting for risk (e.g., based on evidence of comparative asset riskiness and how people adjusted for it elsewhere). Finance folk were writing a lot more in those days than they seem to be doing today about the "equity premium puzzle," i.e., the view that, all things considered, stock prices seemed to be over-discounting for risk.

At a general conceptual level, the main things that Dow 36,000 added to merely relying on the equity premium puzzle were (1) a particular set of claims about what stock values "should" be if the premium, assumed to be mysterious and irrational, were to disappear, and (2) as assertion of confidence that it would indeed disappear in fairly short order.  (This too I recall, perhaps from the same conversation, as resting on the idea, not exactly uncommon among economists, that surely rationality will soon prevail.)

Even back then, however, a mutual friend with unimpeachable academic credentials, who was highly skeptical of the book's thesis even at the time, told me that he had advised Kevin to have stickers ready for all the book's copies to cover the last zero if necessary. This would have allowed rapidly changing the title to Dow 3600.

In sum, one could think of Dow 36,000 as supporting a relatively charitable explanation for what we are hearing from Kevin these days about how a corporate rate cut would rapidly boost wages. Both in a personal sense and given his possible influence while at CEA, that's good to know. But I believe that at least the general basics of his Dow 36,000 claim were closer to the mainstream, and to apparent contemporary plausibility, than what he is saying about corporate tax rates and wages now.

The best summary of "tax reform" that I have yet seen

From Jonathan Chait:

"Republicans have promised their donors $5 trillion worth of tax cuts. But their budget only allows for revenue loss of $1.5 trillion. What they call “tax reform” is a process of trying to stuff the $5 trillion tax cuts into a $1.5 trillion bag."

But on a cheerier note ...

Gary's tired, but it's only because he's been working so hard.

Worst proposal in the history of the U.S. federal income tax?

With apologies for the hyperbole, I do think it's possible that the special 25% passthrough rate that the Republicans are eager to enact might be the single worst proposal ever prominently made, in the history of the U.S. federal income tax. Certainly I can think of none close to being as bad in the last 30+ years when I have been an observer.

It combines inequity with inefficiency in a manner that is really hard to top.  Let's start with the inequity. It ensures (and this is evidently its central purpose) that people like Trump and the Koch brothers will pay taxes at a lower marginal rate than you and me.  This is both horizontally and vertically unfair. Lower rates for the super-rich than the upper middle class. Express regressivity. This is why I've in the past compared it to the gabelle - the hated salt tax in pre-Revolutionary France from which the nobles were exempt. Here, the equivalent to the gabelle is the excess over 25% that only employees and those in service businesses, as distinct from super-rich business owners who are able to blend their labor income with capital income, are required to pay.

Making this inequity worse, it's precisely targeted, almost like a laser, in order to make rising high-end inequality as much worse as possible.  Consider this article, Capitalists in the 21st Century (by Smith, Yagan, Zidar, and Zwick), which as it happens I will get to see being presented at Columbia Law School next week. Here is the paper's abstract:

"Have passive rentiers replaced the working rich at the top of the U.S. income distribution? Using administrative data linking 10 million firms to their owners, this paper shows that private business owners who actively manage their firms are key for top income inequality. Private business income accounts for most of the rise of top incomes since 2000 and the majority of top earners receive private business income—most of which accrues to active owner-managers of mid-market firms in relatively skill-intensive and unconcentrated industries. Profit falls substantially after premature owner deaths. Top-owned firms are twice as profitable per worker as other firms despite similar risk, and rising profitability without rising scale explains most of their profit growth. Together, these facts indicate that the working rich remain central to rising top incomes in the twenty-first century."

These are exactly the people who would get the 25% passthrough rate. Hence my view that this proposal is laser-targeted to increase high-end inequality as much as possible, by offering a special low tax rate to the exact people whose rise is causing it.

What about efficiency? I would call the proposal social engineering or targeted micromanaging of the economy, attempting to override the signals of the free market regarding pretax returns, except that would be giving it too much credit. Aiding the coal industry would be an example of that, but here I see no ghost of a rationale apart from cliches about "entrepreneurship" (which can be countered by noting that, when people are earning rents, that should make them less tax-sensitive).

Here are a couple of simplified examples showing how this provision inefficiently tampers with market outcomes, and leads to the diversion of effort and investment out of the most productive channels.

Example 1: Suppose I could earn $1 million as an employee, and pay tax at 35%, or $900,000 as a self-employed passthrough owner, and pay tax at 25%. If markets set prices properly, the former is more socially valuable than the latter. But as an employee I'll end up with $650,000 after tax, whereas as a self-employed passthrough owner I'll end up with $675,000. So the special tax break steers me into the less productive activity.

Example 2: Suppose that the passthrough rules prevent people like me from just using S corporations and the like to convert our labor income into passthrough income that qualifies for the low rate. These rules might require that capital is being sufficiently used in the business.

Now suppose that I have the following choice.  I can: (a) earn $1 million in a service business, and separately invest $1 million in capital that I possess so that it earns 5% ($50,000) before tax - say, as interest income. So I end up with $1,050,000 before tax.

Or I can (b) mix up the capital with my services, even though this puts me in a worse business that earns less money - say, $925,000. In effect, the capital has a negative rate of return. Given its effect on the bottom line, one could think of it as having been invested at a negative 7.5% rate of return, rather than positive 5%. But it served to allow me to bring my labor income into the low-rate passthrough regime.

Under option (a), at a 35% tax rate I end up with $682,500.

Under option (b), at the 25% passthrough rate, I end up with $693,750.

But at least I will be making America (and high-end inequality) great again.

The proposal amounts to fining people for being employees and working in service businesses. This is mindless and senseless at best, combining inequity and inefficiency in a perfect storm of disingenuousness by the self-interested proponents.

UPDATE: It's true that lowering the corporate rate to 20% would incline one to think about the relative taxation of alternative business organizational forms. But:

(1) There is a second level of corporate tax.  And if we are talking here about people who will organize businesses, to which they supply their own labor, either as passthroughs or via a C corporation, then we are not talking about all the corporate shareholders who, as discussed in recent work by Austin and Rosenthal, are tax-free with respect to dividends.

(2) The proper solution to that problem is to address misuse of the lower corporate rate to benefit owner-employees who cause the entities to underpay their own salaries because they benefit from stock appreciation anyway. There are ways of doing this (e.g., Kleinbard on the dual income tax aspect of his dual BEIT proposal).

Warning: conceptual hipsters are on the loose in my neighborhood

Here is the evidence:

in case the photo doesn't make it clear, this actually is a mattress, which someone left propped upright on a street corner.

Back in the U.S.A.

Last Friday, I returned to NYC after almost a month abroad.

Most of my time away was spent in Berlin, where I was a Research Fellow for 3 weeks at NYU Berlin. My professional activity there consisted mainly of working on a new article draft on international tax policy.  Then I spent a week in Vienna, where I taught a mini-course on International Tax Policy for graduate students in Vienna University's doctoral program in international business taxation (DIBT).  Side trips to Amsterdam (for a public speaking event) and Ljubljana (for enjoyment).

Although I enjoyed the trip, it's nice to be back in NYC, which remains my favorite city apart from its winters.

Ninth Circuit oral argument on Altera

I have been reliably informed (and then was able to confirm for myself online) that the Ninth Circuit oral argument in the appeal of the Tax Court's misguided Altera decision is taking place this Wednesday.  I gather that Susan Morse and Steve Shay will be blogging about this, and I'll duly post links thereto.

I previously discussed the Altera decision here and here. Stripped to its substantive (as opposed to administrative law) essentials, it's a case in which the Tax Court ruled that an indisputably correct Treasury regulation, to the effect that the bulk of compensation costs in a cost-sharing deal between related parties should be included in the formula even if they're structured as incentive compensation, was arbitrary and capricious, hence an abuse of discretion. In effect, it's an abuse of discretion to say that 1 + 1 = 2, unless one spends pages of regulatory preamble explaining why taxpayers were incorrect when they filed briefs at the notice and comment stage arguing that 1 + 1 = 1.

The Tax Court relied upon aspects of true arm's length deals that had zero pertinence or relevance to related party paper-shuffling agreements, and accepted expert testimony to the effect that incentive compensation that in fact is worth millions of dollars should be viewed as having a cost of zero.  Here's hoping that the Ninth Circuit straightens things out.

UPDATE: Here is the link for the Morse-Shay posting, further explaining why the Tax Court so clearly erred in striking down the regulation at issue in Altera.

Leandra Lederman adds her comments here.

Busy weekend in Ljubljana

Taking time off from my Berlin stay to enjoy a vacation weekend in Ljubljana (pronounced Loobleeyana), I kept busy by testing my new superpowers.

I also got to practice my famous John the Baptist impression.

Unfortunately, neither special talent seems to have survived my return to places further west.

The international part of the "Framework"

The bit on international in the "framework" is worth quoting in full:

"TERRITORIAL TAXATION OF GLOBAL AMERICAN COMPANIES

"The framework transforms our existing 'offshoring' model to an American model. It ends the perverse incentive to keep foreign profits offshore by exempting them when they are repatriated to the United States. It will replace the existing, outdated worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).

To transition to this new system, the framework treats foreign earnings that have accumulated overseas under the old system as repatriated. Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years.

"STOPPING CORPORATIONS FROM SHIPPING JOBS AND CAPITAL OVERSEAS

"To prevent companies from shifting profits to tax havens, the framework includes rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations. The committees will incorporate rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies."

Let me see if I can make any sense of this. They say it's a territorial system. But they also say that they will be "taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations." This can formally be reconciled, in the sense that what they literally say up top is that they will offer dividend exemption.  Of course, a full worldwide system in which deferral (for the foreign profits of foreign subsidiaries) was repealed would also have dividend exemption. Bringing the foreign profits home would have no tax consequences, since those profits would already have been taxed.


Is that what they are saying, albeit with a reduced rate for foreign source income? Seemingly yes, but then how is it a "territorial" system? And if they are taxing U.S. companies' foreign source income, how do they propose to "level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies"?

The repatriation tax is of course a welcome feature of switching to territorial, but the rate imposed is all important here.  I'm guessing it will end up being very low.  The dual feature, as between cash equivalents and illiquid assets, has a rationale but is likely to be messy at best in practice.

Neither tax reform nor a plan

I often feel impelled to quote that famous line about how the Holy Roman Empire was neither holy, Roman, nor an empire. The supposed tax reform plan that the "Big Six" have just released gets two-thirds of the way there. It is about taxes, but it's not reform - just massive, unfunded tax cuts - and it's not a plan - just rough ideas, sketched in crayon, that a Tax I law student could have done (better) in 24 hours or less.

It's really an insult to have to focus on so sketchy and poorly conceived an issuance.  I have better things to do with my time, and there are more thoughtful people around, on the right as well as the left, with whom it would be more fruitful to interact intellectually.

Just two quick things, as I'm saving international for a follow-up post:

--Why raise the bottom rate from 10% to 12%? I can see no good reason for this apart from malicious class warfare.  It can't be about revenue, given everything else in the plan.

--The 25% rate for business income of pass-throughs may take the prize as the worst new tax policy idea of the past thirty years. They say they'll have rules to prevent conversion of "personal income" into business income - but that just states (a part of) the problem, rather than offering any suggestion that it could be handled with any success or without massive and idiotic complexity. And why should "business income" get a lower tax rate than "personal income" - such as wages - anyway? Do they hate employment, as opposed to being self-employed? If so, why not simply fine people who take jobs working for someone else? That is essentially what they are proposing to do.

Back from Amsterdam

Back in Berlin after 3 days in Amsterdam, where I participated in a KPMG conference meant to enlighten corporate tax directors and such on what to expect and prepare for. I played the role of American expert (as did Danielle Rolfes) and of house pessimist.   The two are strangely linked these days.

Back in Berlin, where I've been writing a new international tax article on the treatment of foreign taxes by the U.S. and other tax systems and how this might related to what I call unilateral and strategic tax policy approaches. This piece pushes forward on some ideas that I've covered more cursorily in the past, and is a nice change of pace for me before returning to my literature & high-end inequality book. Among other things, it's easier to write.

The view from my window at NYU Berlin

Nice to see this corvid right outside my window at NYU Berlin, where at the moment I am working on a new international tax article (as a brief change of pace from my literature book).  I am a fan, or more like a distant admirer, of corvids as a group.

Corvids, due to their strikingly high intelligence, have been called "flying monkeys" by knowledgeable bird experts.  I gather that they need the brains (which are definitely not "bird brains" in the colloquial sense) both for social reasons and to navigate a complex environment. E.g., given that they are willing and able to eat just about anything, they both need to make good choices, and may try to access things that require some work and cleverness.

But, alas, it doesn't seem practical (and might not be prudent) to try to make a new friend here.

I am confident that my cats, if they were on the scene, also wouldn't deem it prudent to seek a closer association, even if they could get through the closed window. This bird is too big for them.

Precise targeting to increase high-end inequality?

I haven't yet read this recently posted article, but I plan to, as it seems to be important (and is by good researchers). But here is the key finding from its abstract:

"Using administrative data linking 10 million firms to their owners, this paper shows that private business owners who actively manage their firms are key for top-income inequality. Private business income accounts for most of the rise of top incomes since 2000 and the majority of top-earners receive private business income - most of which accrues to active owner-managers of mid-market firms in relatively skill-intensive and unconcentrated industries."

This would appear to suggest that the proposed lower tax rates for business owners of pass-throughs are almost precisely targeted to increase high-end inequality as much as possible, in exchange for as little efficiency payoff as possible. These probably tend to be people with low labor supply elasticity and/or who are in effect reaping rents.

What could Trump / Mnuchin mean when they claim taxes won't decline for the wealthy?

Not just Trump but also Mnuchin have been claiming that taxes won't decline for the high-income in the supposedly soon-emerging tax "reform" plan. The fact that Mnuchin is saying it, too, makes one think that maybe it isn't just impulsive lying or oblivious salesmanship, but reflects a view about what they will be able to claim about the ultimate package. Yet this is a deal that they are working on with Paul Ryan, not with Ron Wyden or Chuck Schumer.

So what might they be thinking, if we make the assumption (not 100% certain to be correct) that they actually are thinking strategically about the next stage? The following four things occur to me:

1) The fact that a corporate rate cut is likely to be at centerstage in the package may help them. Their argument that this doesn't help rich people can be both formalistic (corporations are separate taxpayers) and substantive (claims about the incidence of the corporate tax). Two points they will have to ignore, however, are (1) the transition incidence of cutting the corporate rate, which benefits existing shareholders if it wasn't fully anticipated, e.g., due to political uncertainty, and (2) the tax planning opportunities that a low corporate rate may give to high-income owner-employees.

2) They will be trying desperately to ignore the effects on high-income taxpayers of lowering the tax rate on amounts that business owners earn through pass-through entities. This is where the really big distributional action will be, if they go ahead with their reported plans to require people whom the tax system classifies as employees to pay significantly higher tax rates than those whom the tax system classifies as business owners. They'll call this a "small business" tax cut, but the point will be made in response that this a misportrayal of where the bulk of the benefit actually goes.

3) They anticipate announcing a package that takes away state and local tax deductions, and perhaps that also does something to home mortgage interest deductions. But these provisions seem highly unlikely to get through the Senate even if they are in the package and pass the House. Indeed, it's possible that they're being over-optimistic about the prospects even for unified "Big Six" endorsement of this.

4) Might they be planning not to propose repealing what is left of estate and gift taxes? Leaving that out of the package would certainly make it easier to claim that taxes aren't declining for the wealthy. But if I had to guess, they'll just try to brazen through the awkward tension between proposing estate and gift tax repeal and dressing up the package as no tax cut for the rich.

Plus ça change, plus c'est la même chose

After last night's game, the New York Mets' team ERA climbed to 5.02.

In 1962, the Mets' team ERA was 5.04.

Very different eras, but just sayin'.

Tax "reform" update

According to this account in Politico, the so-called Big Six disagree fundamentally about what their tax "reform" legislation should look like.

Speaker Ryan wants to enact expensing, but "Senate Republicans believe it won't fly in their chamber."

Ryan also wants to eliminate (net?) corporate interest deductions, but "the break is important to many companies, and other negotiators [Senate? Administration?] want only to reduce it."

Ryan wants to repeal state and local tax deductions for individuals, "but some are concerned over what that means for upper-middle class people."

Meanwhile, Senator Hatch favors a corporate integration proposal that presumably is dividend deductibility, but "the idea has not gotten much traction with House Republicans."

These are some pretty fundamental disagreements. Indeed, other than cutting rates and exempting things, which as a standalone cannot plausibly be called "reform" and would of course raise budget issues, there's nothing of comparable importance left. (Home mortgage interest deductions are presumably even a bigger political lift than state and local tax deductions.)

Tough question?

Two weeks from today, I'll be speaking at a KPMG-run conference in Amsterdam entitled "EMA Tax Summit 2017: A Year of Disruption and Rapid Change."  It would be rather a long trip to undertake from the U.S., but as it happens I'll be by then in Berlin, amid a three-week stay at NYU Berlin, where I'll be doing some work on my literature book. (The work isn't site-specific, except insofar as I suppose that getting away can help one's focus.) So I thought it was reasonable to engage in the side-trip.

Since the conference deals with what tax planners should expect in both the US and the EU, I wouldn't be surprised if they asked me whether it's realistic to expect Congress to enact comprehensive tax reform - say, by the end of this year or so.

Hmmm, that's a tough one. I will have to think about it.

Why is Exile on Main Street so much better than Let It Bleed and Sticky Fingers?

More ruminations here from my resurrecting stuff via Spotify that I hadn't listened to for a while, to help get me through my elliptical machine sessions at the health club:

The canonical view of the Rolling Stones' career, for those in my approximate taste sector, goes something like this. In the 1960s, they were the best and most important white rock or pop musicians, with the exception of the Beatles and Dylan, plus in retrospect perhaps the Velvet Underground. But they were mainly just a great singles band (plus other outstanding tracks - e.g., Sitting on a Fence, What to Do, She Smiled Sweetly, and Ride On Baby, to name four that come right to mind), whose albums generally fell short of showing them consistently at their best. Then came the mistake of Satanic Majesties, after which they pulled themselves together by starting their mature period with Beggars Banquet, followed by the 3 classics - Let It Bleed, Sticky Fingers, and Exile on Main Street - after which they got bored and mostly dull for a few albums (albeit, still with a few great tracks). Then they woke up one last time for Some Girls, the fading echoes of which somewhat enlivened the next two albums (Emotional Rescue and Tattoo You). But after that, while perhaps there's a good track here or there, their recordings are generally best forgotten.

Canonical or not, this basically matches my view of their career, except that I would make one big revision that I know is not canonical. Of the "3 classics," I find Let It Bleed and Sticky Fingers overrated and at times boring, although of course they have a number of essential tracks. But Exile on Main Street truly is their pinnacle.

I would put Some Girls second and Between the Buttons, released in January 1967 as their version of Revolver, third. Each of my favorite 3 Stones albums has a distinctive internal creative dynamic. Exile on Main Street is basically a Richards album with Jagger just along for the ride. Some Girls is basically a Jagger album with Richards just along for the ride. And Between the Buttons gets a lot of its punch from Brian Jones' playing a different odd instrument to flavor the sound on almost every track. (It thus makes their much later work sound incredibly monochromatic and boring.)

Anyway, so what makes Exile on Main Street so much better (in my view at least) than Let It Bleed and Sticky Fingers? Again, the latter two have a number of incredible tracks. But there's a whole lot of not that interesting macho posturing going on, along with rock-blues stuff that sounds a bit generic although I realize of course that this is partly from its being imitated so much afterwards (but then again, they were imitating earlier black artists when they did it). Take Honky Tonk Women and Brown Sugar, even leaving to one side their racial and sexual political incorrectness, which were deliberate, pursuant to their outlaw image in a more retrograde era than ours today. Although these tracks are extremely catchy, dynamic, and fun, they can't be at or near the artistic and expressive pinnacle of popular music from the rock era, unless that pinnacle was considerably lower than some of us would like to believe.

But Exile on Main Street is not just rich, full, and beautiful in its sound (despite its famously murky mix) - it makes fantastic use of all the great extra musicians and singers they had on hand - but soulful, wistful, elegiac, and hurt.  (Just one great example among many is Torn and Frayed.) Macho preening isn't its thing; instead it's about staring into an abyss of one's own creation. A suitable mood, perhaps, for the United States these days.

Not wonky enough?

Matt Yglesias, in a generally excellent column about the sorts of federal income tax changes that the Administration and Republican Congressional leadership may seek in the next couple of months, rightly notes that tax reform, in common usage, means “reducing tax rates without massively reducing federal tax revenue because the losses from the rate cuts are offset by closing loopholes and eliminating or curbing deductions.”  He also rightly notes that the Republicans are unlikely actually to attempt this, since base-broadening sufficient to offset the revenue loss is no fun politically. He then asks why, on policy grounds, one might favor bona fide tax reform:

“What’s good about tax reform?

“The official wonky case for tax reform stems from a divergence in the way that a normal person thinks about taxes from the way that an economist [does] ....

“To a normal person, taxes are a necessary evil. The evil thing about them is that after you pay taxes you have less money than you had before. Most people like money, so they like the idea of getting a tax cut, and they don’t like the idea of getting a tax hike, primarily because they are focused on the impact of tax changes on their after-tax income. If Congress changed the law to cut my taxes by $500, I’d be pretty happy about that. And I wouldn’t care whether they did that by tweaking the individual exemption, tweaking the dependent exemption for my 2-year-old, making his preschool tuition tax-deductible, or cutting my marginal income tax rate. At the end of the day, the point would be to get the $500.

“But from a supply-side viewpoint, these are very different policies. Making the individual exemption a little bit bigger puts $500 in my pocket but it doesn’t give me any new incentives to work harder and earn more money. If anything, by making me a little more economically comfortable it reduces my incentive to work harder and earn more money. By contrast, cutting my marginal income tax rate doesn’t just put $500 in my pocket. It makes it more worth my while to try to go out and hustle up some paid speaking appearances or otherwise find ways to earn a bit more.

“Tax reform is good, on this view, because it’s a way to greatly improve incentives without costing the government much in the way of revenue. The 1986 tax reform bill, for example, eliminated enough loopholes to pay for a cut in the top marginal income tax rate from 50 percent all the way down to 33 percent — drastically increasing the incentive of rich people to go out and try to become even richer.”

In the above text, Yglesias offers a generally useful explanation. However, he may overstate (or, at least, slightly misstate) the main character of the economist’s case for tax reform.  To show this, let’s make two tweaks to his illustration.  First, let’s suppose that I’d get $500 via Congress’s newly making preschool tuition tax-deductible, rather than by its either (a) raising personal or dependent exemptions or (b) lowering marginal tax rates.  Second, let’s suppose that I would decide to work and earn more if I were sending my child to a costly preschool than if I were keeping the child at home.

Now, with the tax treatment of preschool tuition tax being an input to my labor supply choice, it lines up more the marginal tax rate change, and less with changing the individual and/or dependent exemption. So, if we already had preschool tuition tax-deductibility as a feature of current tax law, and we were thinking of repealing it to fund a lower marginal tax rate, the “tax reform” might end up, at a first approximation, not increasing my incentive to earn. E.g., suppose that, when I was thinking of working more so I could send my child to preschool, the combination of (a) an increased after-tax return from my work and (b) an increased after-tax cost to the preschool, left me in the same place as I was before.

To make this a more plausible revision of the hypothetical, suppose that both decisions are scalable. E.g., I can work just a little bit more or a lot more; I can send my child to a cheaper preschool or a more expensive one. The bottom line may still be a lot less change than might otherwise have been expected to my labor supply incentives. I work to earn money to spend on things I want, and the base-broadening makes it costlier than it was before to buy the things I happen to most want.

Why point this out? In the 1986 tax reform, at least some studies found afterwards that work incentives hadn’t really changed much, by reason of the base-broadening. E.g., suppose I previously hadn’t minded the 50% top rate because tax shelters would prevent me from actually having to pay it. Now the rate was lower but the tax shelters were gone, so I would actually have to pay the headline rate. This may have been a good policy change for other reasons that I’ll get to in a moment. But it could mean that my incentive to earn more $$ wouldn’t actually have increased.

Now let’s turn to contemporary thought experiments in which, say, state and local tax deductions, home mortgage interest deductions, and/or 401(k) deductions are repealed to fund lower rates.  (In the 401(k) example, even if the current deduction is replaced by a future exclusion that’s slated to apply when I withdraw the money, suppose that I’m either myopic or else don’t trust future Congresses to retain the exclusion.) If I’m paying about as much tax on balance as I was before, it’s plausible, depending on the details and on my level of understanding, that my view of my after-tax incentive to work will also remain about where it was before, given the changes to the tax treatment of some of my earnings’ possible uses.

With that in mind, let’s re-ask Yglesias’s question: “What’s good about tax reform?” The answer, if any, is that, even if we haven’t substantially changed my incentive to work and earn, we have done so with respect to how I spend my earnings.

In terms of the 1986 example, it’s presumably good that I’m no longer investing in tax shelters (assuming that their tax benefits were socially undesirable), since I will now seek opportunities that offer greater expected pretax profitability. But it’s my inter-asset choices that are now less tax-distorted than previously, rather than my incentive to work and earn.

Likewise, for the 2017 scenario, suppose we see no relevant social difference between my spending my $$ on (a) preschool tuition or (b) fancy vacations. Then eliminating the distortion to my choice that resulted from the hypothetical tuition deduction is a good thing here, albeit by express stipulation. But if we don’t think the deduction was bad, e.g., because we see positive externalities to people’s sending their kids to preschool instead of spending the $$ on own consumption, then so much the worse for the case for “tax reform” here.

I myself tend to like the inter-asset efficiency consequences of a revenue-neutral tax rate cut plus reduction to the home mortgage interest deduction. But that’s because I don’t like the deduction, or more precisely what I take to be its main effects. The state and local tax deduction example is potentially quite different. So is the 401(k) deduction repeal, although there we would need to specify a lot more about what people expect, how they make savings choices, how we should think about socially optimal savings choices, etcetera.

Returning to Yglesias’s main point about tax reform, we’ve now both (a) made the economist’s argument wonkier still – by relating it to distortions in asset or activity or consumption choice, rather than to labor supply as such, and (b) shown that it needs to be evaluated case-by-case, in terms of the arguments for a particular tax benefit that would be eliminated to pay for tax reform.

Of course, as I agreed with Yglesias at the start, the Republicans appear unlikely to attempt bona fide “tax reform” (with significant base-broadening) anyway. But just in case anyone should ever attempt it in the future, I hope it’s useful to clarify the nature of the main argument for it.