Tax policy colloquium, week 11: empirical paper on Belgian IP box rules

Yesterday at the colloquium, Stacie LaPlante presented The Effect of Intellectual Property Boxes on Innovative Activity and Effective Tax Rates (coauthored by Tobias Bornemann and Benjamin Osswald, both former students of mine as I teach a mini-course every 3 years at Vienna University's DIBT program, from whence they both recently graduated).

This paper looks at the patent box that Belgium enacted, effective 2008, which presented a nice research opportunity due to its design. It was for patents only, not other IP, making empirical measurement easier, Plus, it required new patents, and gestured in the direction of requiring activity in Belgium, although as we'll see this may not have been much more than a gesture.

It also was exceptionally generous. Belgium had a 34% corporate income tax rate (okay, strictly speaking, 33.99%, but for a corporate income tax "99 pricing" strikes me as a bit idiotic and pointless). The patent box retained the full tax rate on the deduction side, and provided an 80% exclusion for gross income (generally) from patents.

Thus, suppose one spends €100 developing a patent that ends up earning €70. The former can presumably be expensed as R&D, leaving €66  after-tax given the 34% rate. The latter is taxed at 6.8% (20% of 34%), leaving €66.17 after-tax. So the 30 percent pre-tax loss becomes an after-tax gain, under the Belgian patent box. That is not exactly ungenerous.

As background before discussing the paper's empirical findings, why would one have a patent box? It's one mechanism among many for increasing "innovation" that is thought to have positive spillovers. These might be of two main kinds: (1) the global benefit from increasing knowledge that leads to further knowledge expansion, practical applications that benefit people, etc.; (2) local spillovers from having the activities take place in one's own jurisdiction. Here the idea is that everyone wants their own Silicon Valley, on the view that it enriches and otherwise benefits the jurisdiction and its residents.

Alternative ways of increasing valuable innovation include (to name just two among many) (1) patent law and other associated legal protections, and (2) up-front tax benefits, such as R&D expensing or credits, perhaps made refundable so that innovators can benefit even if they don't have current net income.

For real world patent boxes, the particular motivations might include (1) nobly and disinterestedly wanting to benefit everyone in the world by at least slightly and incrementally increasing global innovation activity, (2) more selfishly (and via tax competition) aiming to become the host of a new Silicon Valley, (3) revenue piracy - which I don't mean to condemn via the label - meaning that one gets patenters to assign legal and tax claims to one's jurisdiction so that both they and oneself will benefit - less global taxes for them, more revenue for oneself than if it hadn't offered accommodation services, and (4) simple Ramsey pricing, whereby one lowers the tax rate (for efficiency reasons) on activity that is relatively mobile and thus elastic.

As we'll see, the paper's findings reinforced my view that, while in principle countries can benefit from offering patent or broader innovation boxes, on one or more of grounds 2 through 4, in practice this never seems actually to be the case. This in turn leaves a question that I'll address at the end: Why, then, do patent boxes seem to be so popular with national policymakers. But first, let's look more closely at the paper.

The paper has 6 main empirical findings, each of which I'll accompany here with my own commentary.

1) Effect on patent applications and grants - Using a difference-in-difference research design and with multiple controls, fixed effects, alternative specifications, entropy balancing, etc., the paper finds that the Belgian patent box increased patent applications by 0.4 to 1.8%, and patent grants by 0.4 to 5.1%. This is consistent with concluding that the patent box increased innovation activity in Belgium, although this could of course involve shifting from other countries, rather than new activity.

There's a vast IP literature, making the point that it's tricky to go straight from more patents to more spillover benefits from innovation, for a number of reasons. For example, strategic patents and greater activity by patent trolls often are not good things. But, in a study like this, increased patent applications and grants is verging on necessary, even if not sufficient, to suggest a strong case that there might be increased innovation, at least as to that which is being (perhaps formalistically) assigned to the country with the patent box.

The paper aims to offer only a lower bound on the response. For example, its panels exclude firms that weren't around for all of the years under study, thereby omitting the creation of new firms in response. But even granting that, the positive response, while unsurprising given the very substantial benefits Belgium was offering to patents that ended up earning gross income, seems rather small.

2) Effect on patent quality - Combining several standard measures of this that are used in the IP literature, the paper found a decline in patent quality by reason of the patent box (although the effect's magnitude is hard to quantify, given the squishiness of the metric). This is hardly surprising under a design that allows investments earning a 30% pretax loss to be profitable after-tax. Of course, if profitability rather than spillovers were the sine qua non for the patenting activity that one wants to encourage, there'd be no need to do more than, say, address liquidity problems. Still, the provision's allowing a tax arbitrage between deductions at 34% and gross income taxed at 6.8% seems unlikely to be a strong positive inducement to "quality" of any kind.

3) Intra-Belgian shift in firms' use of employees with college degrees - The paper found a quite substantial increase - in contrast to its generally otherwise modest results - in the extent to which Belgian firms that could make practical use of the patent box, as distinct from those that couldn't, increased their relative levels of employment of individuals with a college education. The paper uses this just as an indicator that something is happening in these firms.  If they were just mailing patent applications to a Belgian rather than non-Belgian address, there might be no need for greater relative use of college grads. But the data don't permit analyzing whether these were, say, engineers or tax planners.

From a nationally self-interested standpoint, it might be great for Belgium if its enacting a patent box induced a good number of educated, high-value employees to move to Belgium from, say, neighboring EU countries. The tax revenues alone might be significant in such a case (although they wouldn't be scored under Belgium's corporate income tax). But data limitations made it impossible to test for this intriguing possibility. But that said, if I were trying to attract high-skilled workers from neighboring countries, I rather doubt that a patent box is where I'd start out.

4) Rate of increase in patent activity vs. other EU countries - The paper compared Belgian patent trends to those in 3 peer countries in the EU: Germany, France, and Sweden. Germany and France are of course both neighbors, and neither changed their rules with respect to patent boxes during the period under study. Germany never had a patent box during the period, while France always did. Sweden is included because of similarities to Belgium in terms of overall size and that of its IP sector.

The paper finds that Belgium's highest rate of relative increase in patent activity pertained to Germany, as opposed to France or Sweden. While the cause and significance of this can't be nailed down definitively, I view it as consistent with (and perhaps mildly supportive of) a switching story. Germany was the one country of the three that combined being adjoining with not having its own patent box regime.

5) Relative effective tax rate (ETR) effects - Overall, the paper found that firms taking advantage of the patent box saw their ETRs drop by 2.2 to 2.4% absolutely, or 7.2 to 7.9% relative to their prior ETRs. However, the degree of average benefit varied by the type of firm. It was highest for multinational companies (MNCs) that had limited profit-shifting opportunities out of Belgium, intermediate for MNCs that had profit-shifting opportunities (and that thus had already been shielded from actually paying an ETR in the ballpark of Belgium's 34% statutory rate), and lowest for firms that were Belgian only.

I would think it's reasonable to presume that the MNCs were predominantly owned by non-Belgians. After all, they're presumably on at least EU-wide or even global capital markets, and Belgium is too small for one to think that its residents would typically own a high percentage. By contrast, I'd presume that the Belgian firms were mainly owned by locals. So the tax benefit was going far more to companies whose shareholders were non-Belgians, than to those whose shareholders were Belgians.

6) Revenue effect - The paper estimates that the Belgian patent box resulted in a revenue loss of €68 million per year, representing 0.63% of Belgian corporate income tax revenue.

This is a very bad result, from the standpoint of the provision's merits from a Belgian national welfare standpoint. It means that, far from representing successful revenue piracy - or, to put it more charitably, hitting the peak of the Laffer curve, the provision is actually losing money. So rather than making money out of being an accommodation party, Belgium is paying.

One needn't generally demand of tax breaks that they better than pay for themselves. But here it's very plausible that they should. Again, this money is coming mainly from non-Belgians, as to whom it's plausible that Belgium benefits from revenue-maximizing, subject to modification by reason of positive externalities created by luring patent activity inward. It's plausible that the incidence of the tax cut actually lay with the MNCs' predominantly non-Belgian shareholders, given the recent prevalence of extra returns (presumably reflecting market power) to MNCs generally, and those involved in IP activity particularly. For Belgian residents, by contrast, one would have Ramsey tax motives of trading off revenue against deadweight loss, and thus of adopting more efficient tax levels even if one thereby loses revenue. But deadweight loss incurred by non-residents is normatively irrelevant under a selfish national social welfare function.

This pushes pretty far towards one concluding that Belgium hurt rather than helped itself by adopting the patent box. Again, global positive spillovers might not do much for Belgium in particular even if one did not suspect that there's more switching than fresh innovation activity in response to the provision.

But what about the local spillovers? I suspect that this would require a lot more substance than the Belgian patent box appears to demand. To qualify, the taxpayer must have a Belgian "qualified research center" (QRC). But this need only be Belgian-owned, which can be close to meaningless given the flexibility of corporate residence. And even if the QRC is actually in Belgium, it need only be sufficiently capable, staffed, etc., to "supervise" the research that's going on. Maybe this calls for renting an office that's staffed by a few college grads who look over the docs, but I seriously doubt that it calls for anything close to even requiring the first faltering steps towards the true establishment of a Belgian Silicon Valley.

So Belgium appears to have been losing tax revenues, giving the money to foreigners, subsidizing projects that might even have had significant expected pre-tax losses, and failing to encourage any significant local positive spillovers (apart, perhaps, from encouraging the firms to hire a few college grads who might instead have been toiling in some other office in Brussels or wherever).

This appears to be a very typical story regarding patent boxes. So why they are so popular? I'm not cynical enough, at least in this particular case, to attribute it mainly to lobbying and interest group influence. Rather, the thing sounds trendy and new ("wow - a patent box - where do they keep the darned thing?"). So it might mainly be self-branding by policymakers who want to associate with something that sounds hard-headedly cool, even if it actually isn't. 

Law school naming gift?

Listening to Daft Punk and Diana Ross's Inside Out on an elliptical machine at the health club this morning, it occurred to me that, if I had a few billion dollars lying around, I'd need to consider a naming gift to establish the Nile Rodgers School of Law.

P.G. Wodehouse and Neil Young: decades apart, but geographically almost together

P.G. Wodehouse was living in what is now the Washington Square Hotel, two short blocks away from NYU Law School, when he invented the character of Reggie Pepper, the prototype for Bertie Wooster.

When you add to this the famous Neil Young album cover photo for After the Gold Rush, showing him striding along the fence on the west side of the main law school building, it becomes clear that at least two major, albeit admittedly heterogeneous, cornerstones of my personal aesthetic have historical roots here.

Revised version of my source / digital service taxes paper

I have posted on SSRN a revised version of my paper, "Digital Service Taxes and the Broader Shift From Determining the Source of Income to Taxing Location-Specific Rents." In a broad sense, it's basically the same as the earlier draft. At the same time, however, due to numerous helpful comments that I have received (as credited in my acknowledgement up front), I also feel it's significantly improved.

You can find it here.

Illustrating stylized normative views of tax policy

The Fleurbaey paper that we discussed in yesterday's NYU Tax Policy Colloquium describes 4 normative views that it proposes to embody in social welfare functions. Since these views each have some following or potential plausibility, it might be useful (or at least interesting) to set out how these views might apply to a toy hypothetical involving an 8-person society. Hence the following:

DESCRIPTION	WAGE RATE EX ANTE	WAGE RATE EX POST*	HOURS WORKED	INCOME
A Talented, lucky, hard-working	100	150	40	6,000
B Talented, unlucky, hard-working	100	50	40	2,000
C Talented, lucky, lazy	100	150	4	600
D Talented, unlucky, lazy	100	50	4	200
E Low-talent, lucky, hard-working	10	15	40	600
F Low-talent, unlucky, hard-working	10	5	40	200
G Low-talent, lucky, lazy	10	15	4	60
H Low-talent, unlucky, lazy	10	5	4	20

*Wage rates ex post differ from ex ante because each individual makes an irreversible occupational choice. This either pays off and yields a 50% increase in the wage rate, or backfires and results in a 50% reduction. The ex ante wage rate is an expected value prior to one’s making this choice.

Utilitarian: Absent incentive effects, equalize everyone. But may need to consider incentive effects on both wage rates ex post (if dependent on choice under uncertainty but some information) and hours worked.

Resource egalitarian (Dworkin version): Wage rate ex ante is brute luck. Suppose we agree that wage rate ex post and hours worked are option luck. In that case, only want to address ex ante differences.

John Roemer 1996 (from Theories of Distributive Justice): Same as resource egalitarian except treat option luck the same as brute luck when not effort-related. OR, same as utilitarian except for effort level. Want to equalize for ex ante AND ex post differences, but not hours worked (= effort level). Note: This is Roemer 1996 as viewed through the filter of Fleurbaey & Maniquet 2018; no guarantees that the actual John Roemer would agree with it.

Libertarian: Don’t want to equalize anything. So no transfers & also no tax, except to fund public goods, based on benefit that might (???) have something to do with income levels.

FIRST-BEST DISTRIBUTIONAL OUTCOMES, IGNORING “SLAVERY OF THE TALENTED” ISSUE

Suppose no public goods to fund, no incentive issues, labor supply is fixed (e.g., the state can’t command people to increase their hours), and full information regarding not just income but wage rates ex ante and ex post, and hours worked. Then:

Utilitarian: Equalize everyone by dividing up the $9,680 of total income so each individual gets $1,210.

Resource egalitarian: Equalize between people with different ex ante wage rates but the same ex post luck and effort levels. So A and E should split their $6,600 ($3,300 each). B and F should split their $2,200 ($1,100 each). C and G should split their $660 ($330 each). D and H should split their $220 ($110 each).

Roemer 1996: Equalize between people with the same effort level. So hard-working A, B, E, and F split their $8,800 ($2,200 each). Lazy C, D, G, and H split their $880 ($220 each).

Libertarian: Leave everything as is.

“SLAVERY OF THE TALENTED” ISSUE

The above took labor supply as given. Suppose we continue to ignore incentive issues, but allow for the possibility that the state could command individuals to work more hours. Then there’s a possible implication that the utilitarian, at least, would consider commanding people with high ex post wage rates to work longer hours, so as to fund greater transfers to everyone. These, too, would be split evenly, unless working longer hours (via command) affected the marginal utility of a dollar for those subject to the command. This possibility might make one uneasy. Ronald Dworkin dubbed it the “slavery of the talented” problem.

Within the utilitarian framework, the only way to rule out the problem (if one is not willing simply to embrace it) is to posit that the utility losses from being thus commanded would exceed the utility gains. In a very simple framework, however, the only utility loss would be from reduced leisure, as distinct from the indignity, etc., of being thus commanded to work longer.

Because the other frameworks are less committed in advance to a determinate framework, they can – for better or worse – accommodate an ad hoc (which is not to say necessarily unreasonable) presumption or side-constraint to the effect that we rule out doing this. This, of course, leaves the question of what underlying meta-framework one is using to determine the set of desirable side-constraints. Arguably, the desirability (if one agrees to it) of this side constraint does not necessarily dictate adopting the other normative frameworks’ approaches to other issues, such as what we think of option luck and/or low effort levels. Note that a utilitarian might also more readily accommodate than the others the view that “low effort” is merely an anodyne example of commodity choice, i.e., preferring leisure to work and market consumption, just as one might have a preference between ice cream flavors.

SECOND-BEST DISTRIBUTIONAL OUTCOMES

Suppose that we can only observe income (and perhaps the overall statistical distribution of types), as opposed to the distinct breakdown items above (ex ante and ex post wage rates, along with hours worked). Suppose, moreover, that we add in incentive issues, as well as public goods that even the libertarian agrees require tax funding. Then the utilitarian approach is to a degree specified, at least within the contours of a simplified model, although it requires other inputs, such as concerning labor supply elasticity and the slope of declining marginal utility. It’s not clear (at least to me) how this might be made equally to hold for the other approaches.

NYU Tax Policy Colloquium - paper by Marc Fleurbaey on optimal tax theory

Yesterday at the colloquium, Marc Fleurbaey presented his recent JEL paper, Optimal Income Taxation Theory and Principles of Fairness (co-authored by Francois Maniquet). The paper is more mathematical and abstract than our usual fare at the colloquium, but it aims to illuminate an aspect of the philosophical debate around tax policy that is certainly of interest.

A central premise is that optimal tax theory (OTT), as founded by Mirrlees' famous 1970s work, has made major strides in deploying social welfare functions (SWFs) to support conclusions about, not just optimal, but second-best tax systems. An example is the long-standard recommendation that the tax system use demogrants at the bottom with relatively flat rates, possibly even declining (in theory to zero) at the very top. Diamond and Saez have recently expanded the Overton window by arguing that OTT might instead support a tax rate as high as 70 percent top. A key move that they make in this regard is to argue that the marginal utility of a dollar for the very richest people should be valued at (effectively even if not quite literally) zero - whether as their own presumed subjective measure, or as a social assignment of value in the SWF. With a welfarist SWF,  only people's welfare counts to the bottom line evaluation of a set of outcomes, and it can only count positively, but differential weighting of people's utilities is permissible unless one adopts a utilitarian approach, which requires valuing everyone's utility equally.

The paper notes that utilitarianism (and other welfarism) have not won universal, unchallenged acclaim. Hence, if one considers the exercise of using SWFs intellectually (or otherwise) valuable, one should be in favor of modifying them, so that they can accommodate alternative viewpoints, such as those which value "fairness" defined in one way or another. The idea is that, say, libertarianism or resource egalitarianism (or systems resembling / parallel to them) ought to be expressible in SWF terms, permitting one as well to be, say, partly one or another or both.

The concept of "money market utility," dating back (at least) to a 1974 paper by Paul Samuelson, plays an important role in the analysis, but explaining all that here would be rather complex and take a long post of probably less than general interest. The basic idea behind money-market utility is to surmount interpersonal utility comparison problems by employing complete specifications of people's preferences, stated in dollar terms, in comparing states of affairs. E.g., rather than asking how my utility differs in inferior State 1 as compared to superior State B, we ask how many dollars I would have to be given, in State 1 as compared to State 2, in order to deem them equivalent. The concept's usefulness is undermined by problems such as preference knowledge and preference revelation. But it may help if one considers its existence in principle (assuming that people have consistent and well-ordered preferences) to be important.

But the following two quick points may help to show very generally what the paper has in mind:

1) Technically speaking, most efforts to incorporate non-utilitarian (albeit generally not non-welfarist) values into the SWF have involved differential weighting of people's utilities - for example, to give priority to the wellbeing of the worst-off, at the extreme through the quasi-Rawlsian maximin, in which the welfare of the worst-off individual completely outweighs that of everyone else. Under the maximin, reducing everyone else's welfare by 20 trillion utiles (granting for argument's sake the existence of such a thing) in order to raise that of the (still) worst-off individual by one utile would be scored as a social welfare gain. This might support the tax policy conclusion that everyone above the worst-off individual should be taxed at the revenue-maximizing rate, with the proceeds being used to raise the bottom as much as possible. But the paper argues that differential weighting of utilities generally doesn't get one to the right place, so far as the various fairness theories it explores are concerned. Instead, one has to go the individual inputs (people's utility as determined for purposes of the SWF) and modify them as needed.

2) To illustrate that point, consider what I just called the quasi-Rawlsian maximin. I called it quasi-Rawlsian because, as many have noted, it's not really what Rawls supports even though he advocated absolute priority for the relevant concerns of the worst-off individual. The difference arose in his not being a welfarist. E.g., he spoke of primary goods rather than welfare generally. Suppose, therefore, that one modified the SWF so that the relevant "arguments" (i.e., people's utilities) were based on a Rawlsian primary goods conception, rather than on the notion of utility. Or to put the same point differently, suppose that one defined "utility" for purposes of the Rawlsian SWF in terms of primary goods - on the view that it is simply a marker for what the social welfare evaluator cares about, rather than purporting to represent an objective fact about people's welfare. I suspect that the SWF one thus computed still wouldn't be precisely what Rawls, or various of his followers, might say they want to do, but it would certainly come closer to systematizing, OTT-style, the normative concerns that motivate them.

I'll have a follow-up post to this in which I discuss a road not followed in our discussion yesterday, so that it doesn't go to waste (as it may, I hope, be interesting & useful). It involves a little illustration I prepared, but then elected not to use in the discussion as it proved not to be sufficiently germane, that sketches out how some different philosophical positions discussed in the paper (utilitarianism, resource egalitarianism, an approach taken by John Roemer, and libertarianism) might apply to a particular stylized fact pattern.

Progress on literature book

I've just sent the publisher final revisions to my submitted manuscript on literature and high-end inequality. The book's projected publication date is April 1, 2020, or just over 5 months from now.

The current working title, which could change again, is Literature and Inequality: Nine Perspectives from the Age of Napoleon Through the First Gilded Age.

An earlier draft was 110,000 words. It's now down to less than 92,000 words. I think a key reason that it was previously longer was that my writing in what was a new area for me caused me initially to be a bit too prolix, just as early-career academics can sometimes be. I feel that I've been able to add discipline and focus. And there are certainly, at a minimum, some well-written bits, if I do say so myself.

I really had to teach myself a new genre in doing this, without much in the way of role models. And at some point I'll have to ask myself the question: Do I now do this again by writing Part 2? (1920s through the present.) It's hard to imagine now feeling sufficiently motivated, as it wouldn't be an easy project to plan, research, and write. But never say never.

My current next project, other than finalizing my recently posted draft on digital services taxes et al, is to write a short (50,000 to 60,000 word) sequel to my earlier book on international tax policy. I think there's room for and a point to writing such a book, and it's also way easier than writing a literature book sequel. It would also probably have a higher floor, albeit a lower ceiling, on public success than writing a literature book sequel.

Sufficient public success of the literature book would certainly push me towards greater likelihood of writing its sequel. But I know from this biz (and from books by friends that have fallen short commercially of meeting their perhaps too-high hopes and expectations) that breaking through isn't easy.

NYU Tax Policy Colloquium, week 9 - paper by John Friedman on colleges and intergenerational mobility

Yesterday at the colloquium, John Friedman presented work in progress from his big-data project with Raj Chetty, Emmanuel Saez, Nicholas Turner, and Danny Yagan. This is a very important and interesting project,. However, because it's work-in-progress involving IRS tax data, I won't comment on or link to the draft(s) we saw or heard about yesterday. And as the sessions are off the record, what I'll discuss here, rather than either the work presented or the PM discussions, is issues raised by the research.

Friedman et al have access to data (not to put it passively - they've done a great deal of work to create usable data) that permits them to link (1) college admissions, (2) the applicants' parental / household income, (3) the applicants' test scores, (4) where they ended up going to college, and (5) their labor income (for people born in 1980-82) thirty to thirty-two years out.

The U.S. is a big country, so there's a lot of information here that can be analyzed in various ways. For example, they can look at such questions as how people with different parental incomes and the same test scores differentially attended colleges in particular tiers, how people with the same parental incomes and test scores but who went to colleges in different tiers ended up doing in the labor market at age 30 to 32, etc.

A lot of interesting information can come out of this. For example, what sort of "value add" if any do top tier schools appear to have, in terms of subsequent labor income? Are colleges differentially picking more high income, middle income, or low income students with the same test scores? Do kids from lower income households but with good test scores end up doing better or worse in the labor market than peers from higher income households, if they go to the same schools or to different tier schools? Etcetera; you can add your own questions to this as you like.

Without reporting here on any preliminary results, let me say this. If high-tier colleges have significant value-add, as defined above, and this value-add applies to both lower-income and higher-income applicants, then they have the power to increase intergenerational mobility by tilting towards the lower income in admissions, or to reduce it by tilting towards the higher income. From a structural standpoint, they may have a lot of incentives to do the latter - that is, to offer what is in effect affirmative action for the rich, not limited to "legacies" (children of alums) or to athletes in the specialized types of sports that tend to require rich parents. That would be very unfortunate, as it would mean they were both reducing intergenerational mobility relative to the case where they were neutrally meritocratic (defining meritocracy as rewarding high test scores), and also increasing income segregation at high-tier colleges relative to what would happen if they neutrally applied such a benchmark. We will have to wait and see what the data shows, when final versions of the papers are released.

Suppose top tier colleges have a significant value-add but fewer slots than there are qualified applicants who could take advantage of it. Then there would be an analogy between top tier college admission and allocating scarce kidneys or livers to sick people in acute care wards. In each case:

1) There are more people who could derive full benefit from the scarce resource (restored health, or higher career earnings) than there are available resources. The winners will therefore discontinuously be better-off than the losers, as between people who could have made comparably productive use of the scarce resource.

2) We may be reluctant to allow use of the price mechanism to allocate the scarce resource. We don't put kidneys and livers up to auction so the richest people will get them all. In college admissions, there is obviously more opportunity for the price mechanism to operate, but we may tend not to like the idea of allowing rich kids to buy more slots by having their parents pay more.

To the extent that use of the price mechanism to allocate the scarce resources is restricted, other metrics are going to have to be used. In the case of college admissions, a strong argument could be made for favoring lower-income over higher-income applicants with close or similar test scores, especially if it's shown that the former can at least comparably benefit from the value-add. Specifically, there are two positive externalities to keep in mind. The first is reducing income segregation in top schools, so that richer, middle, and poorer kids mingle more than they would under a caste-like system. The second is increasing intergenerational income mobility, which may have broader social benefits, again in reducing the extent to which we have a hereditary caste system in our society.

If richer kids with the same test scores were disfavored, they could make arguments based on meritocratic desert to the effect that they were being treated unfairly. But this might be at least partly rebutted by noting the advantages they may have had, such as greater tutoring, in getting the same test scores.

If intergenerational mobility is low enough, we also know that it's unlikely to be as truly meritocratic as it appears to be. Income-earning "ability" seems unlikely to be sufficiently inheritable that there wouldn't be more movement up and down, in a legitimately meritocratic process, than we appear to be observing lately.

But of course, while mobility sounds good as an aim (and is good, if we dislike hereditary castes), it does mean people are moving down as well as up. Those who move down, or see their kids moving down, are not going to be made happy by it. And if they're powerful, they may be likely to resist.

I suspect that very wealthy people are more determined to ensure that their kids be the most successful ones in the next generation, whether meritocratically or not, than they are to avoid, say, paying wealth taxes. So the political playout of college admissions over time could end up being interesting and fraught.

Strange musical dream last night

Close to morning, I found myself either leading or watching a small rock group in a studio, rehearsing a new song, presumably to record it when the arrangement was set. Lucky us, we had John Lennon and Paul McCartney there to help with back-up vocals. Set to come in on the second verse, McCartney came up with a back-up answering vocal for the lead, under which he and John would keep singing "Baby, can you run?" Lennon changed it so it would go "Baby, can you run? Baby, can you run now?" (He messed it up and came in wrong initially, but they immediately realized this was an improvement.)

I know the notes, but would need a piano to identify them. I don't remember the lead melody, if indeed there was one. And again it was fluid whether I was watching or participating. But anyway then the alarm went off.

Certainly better than dreaming about current U.S. politics.

NYU Tax Policy Colloquium, week 8 - paper by Oei and Ring

Yesterday at the colloquium, Diane Ring presented her paper (coauthored with Shu-Yi Oei), Falling Short in the Data Age. This is not a tax paper as such, although it touches on tax topics, but grows out of the authors' interest in the rise of ubiquitous data that governments or firms can increasingly access and analyze, possibly in relation to their work, for example, on "leak-driven law" and on recent workplace shifts that are epitomized by the rise of Uber et al.

The particular angle they explore here is that technological shifts may reduce the "fall-short spaces" that people have long had as a practical matter. Here's an example that I find convenient for purposes of thinking about what they have in mind, although it isn't actually mentioned in the paper. In New York, jaywalking, while illegal, is the norm. This isn't rulelessness - there is a rule, although not everyone always follows it. The rule is that a red light is a yield sign. (I would say check-and-yield, but given how bicyclists operate in NYC you must always check in all directions even if the light is in your favor, and indeed even if you're crossing a one-way street in which no one is coming from the mandated direction.)

This is more than just a fall-short space, in the sense that New Yorkers jaywalk right in front of police who don't enforce the rule. But suppose that - at least in places where jaywalking violates norms as well as laws - there were facial recognition cameras at every corner, so that if you jaywalked you'd get a ticket, levying a fine, by mail (just as can happen when you go through a toll plaza without EZ Pass, & they photograph your license plate).

The issue that would arise then isn't (mainly) that people would be getting fined all the time. Rather, they would stop jaywalking, which would be somewhat good and somewhat bad. (The NYC norm for jaywalking is superior to the blind-obedience norm when properly executed by everyone, but it also invites greater, and potentially costly, errors in applying it.) Plus, we would have the other issues around cameras everywhere telling whomever had access to the footage where one was going all the time.

One could enrich this little example's capacity to stand in for the broader set of problems that the paper discusses by adding in discriminatory enforcement. E.g., suppose Attorney General Barr gets to decide who does and doesn't get a jaywalking ticket.

The paper has laudably broad ambitions, which combine devising a general compendium of issues and categories, with offering a couple of broad takeaways, e.g., (1) space to "fall short" of honoring all of the legal commands one faces is shrinking and this isn't all good, (2) more sophisticated and well-financed players will be especially well-equipped to take advantage of new high-data environments (although that's also likely to be true in other environments). I look forward to seeing the final version.

Most wanted

Someone in our house keeps knocking over garbage cans, looking for small items that are usable as toys.

Based on character and propensity evidence that might not be admissible in a court of law, here is our chief suspect: Gary, aka the Silly Bandit.

I'd say: Butter wouldn't melt in his mouth, except I'm fairly confident that it would.

Talk at University of Toronto Law School on my new international tax paper

Yesterday at the University of Toronto Law School's Tax Law and Policy Workshop, I gave a talk concerning my new paper, "Digital Service Taxes and the Broader Shift From Determining the Source of Income to Taxing Location Specific Rents."

The slides are available here. I'll soon be posting a revised version of the paper on SSRN; the currently posted version is a bit out of date.

It was very nice seeing the folks there. But if you do enough travel, you have to take the rough with the smooth occasionally. Yesterday's fun was having a flight delay of nearly 2 hours when I had only 90 or so minutes of margin built in (due to the previous day's tax policy colloquium at NYU). By running through the airport etc. I managed to get there only 10 to 15 minutes late.

Today was almost even more fun, as the person at the hotel front desk simply forgot to make the wake-up call that they had in their book. Since it was at 4:45 am, the omission could have been rather consequential, had I not also set my phone.

Tax policy colloquium, week 7: Zach Liscow, part 2

My prior blogpost offered some background regarding Zach Liscow’s “Democratic Law and Economics.”  Liscow has been in the forefront among those questioning the merits of following the “double distortion” line of argument to conclude that “legal rules” or other regulatory policy should respond purely to efficiency concerns, leaving distribution to be handled by the “tax system.”

While earlier work by Liscow and others (such as Sanchirico) has challenged the accuracy and completeness of the assumptions that underlie the admonition that distributional issues be ignored outside the “tax” realm, here he accepts the analysis, at least arguendo, but says: What if following it leads to too little redistribution because voters, while not otherwise averse to it, really dislike cash transfers? (This is the demogrant side of the Mirrlees tax model.) While the paper’s formal model defines this as a universal aversion among voters to cash transfers (held even by poor people who would receive the transfers), its textual discussion invokes beliefs about entitlement to pre-tax market income. So we might think of it informally as concerning the higher tax rates that are needed to fund demogrants, rather than about the demogrants themselves.

The paper further posits that this is not generalized anti-redistributive sentiment, but merely reflects “policy mental accounts.” This draws on the behavioral economics insight that how an individual chooses to spend a given dollar may reflect which pot of money or transaction he assigns it to – leading to departures from consistent rational choice, although perhaps understandable as a heuristic or rough rule of thumb to guide choice.

This in turn implies that voters (presumed to influence policy outcomes) who oppose high tax rates to fund large demogrants might be perfectly happy with redistribution accomplished by different means. Perhaps one might think of this as involving the endowment effect on the tax side (i.e., coding precluded market returns differently than those that were first earned then taxed), plus greater tolerance of in-kind than cash benefits on the benefit side.

The paper therefore posits that inefficient redistribution through legal rules might be an overall policy improvement if there is space for it, but not for the first-best of doing it the Kaplow-Shavell way.

Here is a very simple example that I think can be used to help illustrate the paper’s analysis. It’s taken from one of the central cases discussed in the paper, but here I spell it out a bit more.

Suppose the Department of Transportation (DOT) is deciding whether to spend $$ saving a rich person an hour of travel time (via airport upgrades), or a poor person the same hour (via mass transit upgrades). Suppose further that, based on willingness to pay, the rich person values the hour saved at $63, and the poor person at only $25. (The paper derives this from actual data noted in the paper.

OPTION 1, spending the money on mass transit, benefits the poor person by $25 and the rich person by zero.

OPTION 2, spending the money on airports, benefits the poor person by zero and the rich person by $63.

Cost-benefit analysis, as done at the DOT and elsewhere, commonly uses willingness to pay to discern value. So the “efficient” choice is Option 2, spending the money to help rich people because they place greater value on their time. Instead choosing Option 1, e.g., based on valuing people’s time equally and then using benefit to the poor as a tiebreaker, is inconsistent with the view that only the tax system should consider distributional issues.

Let’s now further strengthen the case for Option 2. Using it in lieu of Option 1, but with the addition of a cash transfer from the rich taxpayer to the poor taxpayer, can create a Pareto improvement relative to choosing Option 1.

Again, under Option 1 the parties gain 25 (poor) and 0 (rich).

Under Option 2, they gain 0 (poor) and 63 (rich).

Suppose we adopt Option 2 but the rich person pays the poor person anywhere between $26 and $62 in cash.

Under Option 3a (Option 2 plus a $26 side payment,) they gain 26 (poor) and 37 (rich).

Under Option 3b (Option 2 plus a $62 side payment), they gain $62 (poor) and $1 rich).

Both of these options are Pareto-superior vs. Option 1. So, while this is not exactly the double distortion argument in action, it supports the same conclusion: Do the most efficient thing possible outside the tax system (using willingness to pay as people’s own measure of utility effects on them), and then, with the economic pie having been made as large as possible, use tax-funded cash grants to create a Pareto improvement relative to the case where we used inefficient legal rules to address distributional concerns.

This is a highly stylized and simplified example. But it’s useful to illustrate the line of argument in the Liscow paper. In effect, he accepts the entire thing at least for argument’s sake, but adds a political economy constraint: Suppose that in practice Option 3a or b would happen, in a mass society as opposed to one with just one rich and poor person negotiating, only via higher labor income taxes to fund larger demogrants. And suppose that aversion to high taxes or cash grants means that 3a and b simply won’t happen. So our only choices are Option 1 or Option 2.

Suppose further that, due to other aspects of voter belief systems, they’d be fine with selecting Option 1 – for example, based on the belief that people’s time should count equally and that tiebreakers favoring the poor are okay. But if the regulators believe that only efficiency should drive non-tax decisions, we’ll get Option 2.

In effect, the paper argues that Option 1 might actually be better than Option 2, if we assume both (a) that there is too little redistribution overall due to mental accounting rule disparaging high tax rates and cash grants, and (b) that there will be no marginal redistributive effects to the choice of Option 2 over Option 1. (In effect, nothing will happen towards implementing Option 3 variants.) So the DOT should employ distributional analysis, rather than purely efficiency-driven cost-benefit analysis, in the course of deciding whether it’s better to implement Option 1 or Option 2.

Choosing Option 1 might be here viewed as a standard “leaky bucket” problem in redistribution. The rich lose $63 while the poor gain $25, causing the analysis to depend at least in part on the marginal utility of these values at the applicable income levels. And again, the fact that one might have been able to use a less leaky bucket, if the public didn’t object to the standard optimal tax model, is ruled out of bounds as politically unavailable.

 The if-then logic of the paper is unassailable. It’s a basic second-best thing, aka, the best shouldn’t be the enemy of the better-than-nothing. If there are two paths to addressing distributional concerns, and the better one is unavailable in circumstances where the worse one might be available, then of course one shouldn’t rule out the latter, but should duly consider it.

The harder and more interesting question concerns whether and to what extent it might have significant policy relevance. Here are some quick thoughts about that:

1) Assuming voter control, or positing a fixable asymmetry? The paper posits that voter influence over political outcomes makes it relevant that people have inconsistent views, such that they might dislike redistribution done via taxes and cash benefits, but be fine with it when done by means that a welfarist with an advanced economic understanding of policy instruments might deem clearly inferior. The posited set of viewpoints strikes me as clearly plausible. The assumption that voters actually influence political outcomes sufficiently strikes me as less so. There are well-known studies by the likes of Martin Gilens, Larry Bartels, Benjamin Page, etc., suggesting that the policy views of the 99% have startlingly little influence on actual policy choices in Washington.

However, there is a different reason why the paper’s line of argument might be politically efficacious. Tax policymaking in Washington occurs in a highly politically charged realm in which the players are only marginally subject to influence by what people in the academic and think tank realms are saying. (An example of such influence, however, might be recent academic work by the likes of Diamond, Saez, and Zucman pushing out the Overton window so that 70 percent top bracket income tax rates, along with the use of wealth taxes or similar instruments, are now considered more plausible than they were previously.)

But regulatory policy et al is potentially subject to area-specific influence by specialists and experts, who might even have some discretion despite any political overlords from the Executive Branch or Congress who have the power to rein them in. If they have been thinking that the regulatory process should look solely at efficiency, because that is the climate of intellectual thought under which they have been trained (whether or not they are actually familiar with Atkinson-Stiglitz or Kaplow-Shavell), then it’s not impossible that suasion to the effect that distributional considerations should count here too might affect their judgments.

In other words, one could claim in support of the efficacy of the Liscow paper’s project that it’s addressing an asymmetry, in which the tax realm doesn’t much follow optimal tax theory recommendations re. what it should do, but the regulatory realm does follow the prescription that one should leave all distributional issues to the tax system. Moving towards distribution-conscious cost-benefit analysis might conceivably make a difference here, subject to the “political general equilibrium” question of how this will actually play out in the end overall.

2) General equilibrium political playout: ‘political Coase theorem” versus the baseball game metaphor – As the Liscow paper concedes, the distribution-conscious approach that it urges for regulatory policymaking might not matter after all if what David Weisbach, among others, has dubbed the “political Coase theorem” might apply at the end of the day.

As background, the actual Coase Theorem that’s being invoked here holds that, if transaction costs are zero, it will make no allocative difference – although it might make a distributive difference – whether, say, (a) I have a right to pollute unless you pay me to stop, or (b) you have a right to stop me from polluting unless I pay you to let me do it. Either way, with zero transaction costs it “doesn’t matter” – in terms of allocative outcomes – which way one allocates the initial right. The idea is that the higher-valuing user will end up possessing the right. E.g., if I value polluting at $10 and you disvalue it at $12, then either (a) you’ll pay me between $10 and $12 to forbear if you have the initial entitlement, or (b) I’ll ascertain that I can’t buy the right to pollute from you at the max I’d be willing to pay ($10). So either way, the pollution doesn’t happen. (Of course, the Coase Theorem’s main message actually is that transaction costs are why it might matter who gets the right – not that it generally doesn’t matter.)

Here are two versions of what proponents have called the “political Coase theorem,” adapted to my earlier example with the choice between mass transit and airport expenditure to reduce either a poor or a rich person’s travel time.

Version 1: if the poor person has the power to get mass transit spending that she values at $25 agreed to, in lieu of airport spending that the rich person values at $63, the latter offers the former between $26 and $62 to agree to the latter. So the latter, rather than the former, ends up happening.

As adapted to more real world regulatory choices, Weisbach has noted the possibility that groups potentially subject to inefficient redistribution have an incentive to offer a Pareto deal in which the redistribution is instead done efficiently. This creates surplus that all can share, so one might ask: Why doesn’t this just happen? (In that case, the power to threaten inefficient regulation might matter, but one wouldn’t expect actually to observe it.)

The answer to the question “Why won’t that just happen?” seems pretty clear. As per the Coase Theorem in its standard application, what about transaction costs? Inertia, information costs, disaggregated political power so that different principals cover different policy areas and can’t readily trade with each other, etc., are important enough (I’d argue) that we shouldn’t simply presume that this trade is the ordinary course of things. Sure, it’s a relevant consideration, but if anything the presumption might often lie in the other direction (Why would it be able to happen?)

Version 2: If Congress has specific distributional goals that it pursues coherently and consistently, then in a sense it really won’t care what the regulators do. Or more precisely, even if it doesn’t directly rein them in, it will simply adjust its distributional bottom line so that distribution comes out in aggregate the same as if the regulators had pursued efficiency alone.

I think hardened law and economics types may be prone to finding this line of reasoning more persuasive than it actually is, because they are used to thinking about consistent rational choice by an individual with coherent preferences. But in politics you get all the issues of collective choice, along with pervasive agency costs that include political actors’ frequently greater interest in such things as personal credit-claiming, blame avoidance, and symbolic gesturing, than in substantive outcomes. Thus, even insofar as individuals fulfill the rational actor model of optimization under coherent and consistently followed preferences, collective choice institutions in a modern mass society should not be expected to do this.

Once again, while obviously one has to think about the possibility that Congress will undo (or directly rein in) distributionally minded agencies that are not adhering to pure efficiency (as well as those that ARE adhering to pure efficiency), there is really no reason here for a general presumption that it just won’t matter. That, rather, is the question to be asked.

Here is a model I prefer to the “political Coase theorem” for thinking about why, say, the left or the right might pursue particular distributional (or other) fights as zealously as they sometimes do. Each time you win a battle, you’re that one battle ahead, and it won’t necessarily be offset elsewhere even if outcomes aren’t entirely independent and uncorrelated.

Suppose a baseball team figures to win about half of its games. Bottom of the ninth with two outs, they’re down by one run but have the tying and winning runs in scoring position. So if the batter gets a hit they win, if he makes an out they lose.

Either way, they’re still a .500 team over the long run. But they’re one game ahead if he gets a game-winning hit, relative to the case where he makes the third out. And there’s no particular reason to think that this will be automatically offset. A win today doesn’t, at least inherently, make a loss tomorrow more likely than it would otherwise have been.

Tax policy colloquium week 7: Zach Liscow paper, part 1

Yesterday at the colloquium, Zach Liscow presented his paper “Democratic Law and Economics.” Before getting directly to the paper, I think it’s useful to put it in a broader context that will be familiar to some readers but perhaps not others.

The law and economics movement in law schools, which got going in earnest about 40 years ago, in its early stages made a lot of strides using an approach that some call “Econ 101ism.”  As per Noah Smith:  

“We all know basically what 101ism says. Markets are efficient. Firms are competitive. Partial-equilibrium supply and demand describes most things. Demand curves slope down and supply curves slope up. Only one curve shifts at a time. No curve is particularly inelastic or elastic; all are somewhere in the middle (straight lines with slopes of 1 and -1 on a blackboard). Etc.”

Econ 101ism was a step forward for legal scholarship, but not a step far enough. One had to understand what the logic of a standard neoclassical analysis implied, but the next step required recognizing that its assumptions might not always hold, and then asking what that would imply. It’s a great orienting tool, but its seductive power to purport to answer so many questions, from so parsimonious a starting point, can over-excite the incautious if they forget that they need to take that next step of testing the accuracy and sufficiency of its assumptions.

A more recent trend in what one might call tax or public finance law and economics involves using a very simple model that purports to answer lots of questions. The Atkinson-Stiglitz theorem holds (within the specified terms of its model): “Where the utility function is separable between labor and all commodities, no indirect taxes need be employed.”

Take the Mirrlees model, in which we want to base the tax on ability but can only measure earnings, so we impose a labor income tax that is equivalent to a uniform commodity tax. (Wages are used to buy commodities, and in a one-period model one spends it all currently.) Atkinson-Stiglitz asks whether one might get a better outcome by having non-uniform commodity taxes, e.g., taxing luxuries at a higher rate than the rest. It shows that, within its terms, the answer to this question is NO unless some commodities are leisure substitutes or complements. E.g., if I work more, I may substitute restaurant meals for buying groceries (leisure substitute). Or if I work less I might want to buy a telescope so I can spend hours stargazing (leisure complement). But absent any of that, the uniform commodity tax is best.

Suppose one thought that taxing yachts at a higher rate would have an admitted efficiency cost (discouraging yacht choice vs. other consumption), but also an efficiency gain (raising revenue that permits one to lower the labor income tax rate). So isn’t there a tradeoff, with even an implication that there might be a net efficiency gain, since multiple smaller distortions are often better than just one large one?

Answer: No. You still have to work to get the $$ to buy a yacht, and working is just a way of getting to buy things. So one is still, roughly speaking, discouraging labor supply as much as before, plus one is now also distorting commodity choice. Hence there is now “double distortion” without mitigation of the prior distortion.

Leading figures in tax or public finance law and economics (e.g., Kaplow and Shavell) have shown how broad Atkinson-Stiglitz’s implications might be. For example, one can think of an income tax as imposing higher commodity taxes on future consumption than current consumption, creating double distortion (discouragement of saving) without any mitigation of a consumption tax’s admitted discouragement of work and market consumption. Hence, case closed for the income tax? Yes unless there is more to the analysis, but the point (as with Econ 101ism) is that there might be. (And for what it’s worth, neither Atkinson nor Stiglitz agrees that based on their theorem one should prefer consumption taxation to income taxation.)

Likewise, case closed (within the analysis) with regard to using “legal rules” instead of the “tax system” to redistribute. Here the “tax system” means, not Title 26 of the Internal Revenue Code, but a labor income tax plus demogrant. “Legal rules” means pretty much anything else. E.g., income-conditioned speeding tickets, like they have in Finland. Product liability or tort rules that favor consumers or accident victims on the ground that they’re generally poorer. Mandatory contract clauses to protect tenants. Inducing corporate managers to optimize for “stakeholders,” not just shareholders, under a progressive redistributive rationale.

Under the view, using any of those types of vehicles to address distributional concerns about rich vs. poor merely yields double distortion. You’re still discouraging labor supply, insofar as becoming rich subjects you to expected unfavorable treatment under those rules. Plus, you’re departing from the efficient choice in those areas, which makes things worse overall than if one had just used the labor income tax to address distributional concerns.

The takeaway from this analysis was and is: All analysis of “legal rules” and government policies outside the labor income tax should be driven PURELY by considerations of efficiency. Leave redistribution purely to the “tax system.”

This view has been highly influential in legal scholarship, and also perhaps in regulatory policy as actually done. But it has inspired pushback, both on theoretical grounds (based on whether the underlying assumptions are sufficiently accurate and complete) and in light of concerns that, in practice, it leads to too little progressivity if policymakers adopt it in the realm of “legal rules,” but not when designing the tax system.

This, anyway, is vital background for discussing Liscow’s “Democratic Law and Economics,” to which I will turn directly in my next blogpost. 

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NYU Tax Policy Colloquium, week 6: Katherine Pratt's "The Curious State of Tax Deductions for Fertility Treatment Costs"

As we reached the 42.9 percent point (6 weeks out of 14 now in the books), it was nice to have an abrupt topic shift - one of the things I like best about the colloquium - in this case, from international tax the prior two weeks, to Katherine Pratt's The Curious State of Tax Deductions for Fertility Costs.

Narrowly speaking, this paper responds to a phenomenon we will surely be growing increasingly familiar with in coming years: a pompous, confused, biased, ignorant, and gratingly self-satisfied opinion by a Trump judge, although this individual may have higher than average judicial qualifications among the lot. The opinion at issue is Morrissey v. United States, in which an Eleventh Circuit judge purported to offer a "primer on the science of human reproduction," sharing with lucky readers such insights as: "It is a biological fact that, unlike some lower organisms ... human beings reproduce sexually .... Critically here, within the human reproductive process, the male and female bodies have different roles and purposes."

The judge's motive for so generously sharing these insights with us is that "the circumstances of the case - and the parties' competing contentions" made it seem necessary to him. More specifically, he viewed the plaintiff's contention that an unmarried gay man could claim medical deductions for assisted reproductive technology (ART) expenses (such as for egg donation and fertilized egg surrogacy) as contrary to nature, at least when backed up by (of course) statutory "plain meaning."

Needless to say, the plain meaning is not so clear as our judge-lecturer thinks. Under Code section 213(d)(1), medical expenses include "amounts paid .. for the purpose of affecting any structure or function of the body." I would think it clearly affects a "function of the body" for the taxpayer's sperm to be successfully inseminated in a fertile egg that may may eventually grow into a child who is biologically his. Isn't it a "function" of the male body, in producing sperm, to make possible one's having biological children? That end result is certainly the evolutionarily selected function served by the male production of sperm (if we want to talk Nature).

This is not to say that "plain meaning" resolves the case in the taxpayer's favor. Rather, it shows that other interpretive methods are needed. For example, the fact that the taxpayer would not have needed to incur ART expenses in order to have a biological child, had he been heterosexual and with a fertile female partner - a point of central importance to the judge - clearly is relevant to the analysis. But now we are engaged in a more complex statutory interpretation exercise than he seems to realize is necessary, and one as to which his tediously trying-to-seem-bemused lectures about Nature are unilluminating. The judge's evident belief that section 213 shouldn't be available when people don't seek to produce children in what he thinks is the natural way - and, admittedly, thereby incur costs that could have been avoided had they used his preferred method - involves statutory interpretation via purposive analysis. That's fair enough, methodologically speaking, but it isn't "plain meaning."

Anyway, one reason Pratt wrote the article, in the aftermath of Morrissey, is that the 11th Circuit opinion carelessly (to put the best face on it) misstates actual IRS practice, insofar as one can glean it from limited evidence, with respect to different types of ART-related expenses incurred by differently situated taxpayers. So a bit of clean-up crew was needed in this area, on which she's been writing for a while, in addition to her wanting to address a set of very interesting issues around the tax and other treatment of ART expenses. With that said, let's turn to a few of those issues.

1) Infertility and dysfertility - Even after Morrissey, there are strong grounds supporting the conclusion that section 213 medical deductions are allowable for certain ART expenses, at least in the following scenario. Say that a heterosexual married couple establishes that one of them is infertile, and they therefore pay $$ for fertility treatments of the infertile party. That appears to be deductible. There is also an IRS letter ruling (admittedly, not constituting precedent) allowing various expenses incurred in connection with egg donation to be deducted under section 213 by a woman who was unable to conceive a child using her own eggs.

Morrissey does not contradict allowing ART deductions with respect to the taxpayer's own infertility (or that of "his spouse," as section 213 puts it). But the taxpayer's argument, which the court rejected, would add dysfertility to infertility as grounds for ART deductibility. As per Pratt's paper, dysfertility "refers to individuals who cannot bear children because they are single or in a same sex relationship."

Let's switch from statutory interpretation to policy - since, whether Morrissey is right or wrong as to the former, rejecting it as to the latter would call for legal change. I would argue that there is a compelling case for mandatory government-provided insurance coverage for ART for dysfertility, as well as infertility.

This obviously starts from mid-conversation, so far as government-provided health insurance coverage is concerned. I state it as generally as that to extend the sphere past income tax deductions for medical expenses to the realm of Medicare, Medicaid, single-payer, the mandated scope of universal health insurance coverage, etcetera.

I'd put the starting point for the argument as follows. From behind the veil regarding one's own particular identity within our society, one should recognize that it's very common to have a very strong desire for a biological child, or as close to it as possible, as a joint project with one's partner . One should further recognize that, again from behind the veil, one doesn't know whether one will be one of the people for whom this turns out to be relatively easy - i.e., a fertile heterosexual individual with a fertile heterosexual partner. From this perspective, both infertility and dysfertility are risks - partly converted by modern technology into financial risks, insofar as one can pay a lot of money for workarounds that did not always exist - against which it is rational to want to insure.

But why mandatory government insurance? This requires a market failure that the government can address better than private insurance firms. The most obviously relevant one here is adverse selection - widely recognized now as a key reason for favoring government provision in the healthcare arena, whether it be via the current ramshackle U.S. methods, single payer, or something else. It's very plausible that the government's superior ability to address adverse selection with respect to dysfertility - the risk of which gets affected by knowing one's own sexual orientation and partner preferences - creates a strong enough case to support the intervention.

The other classic issue in government vs. private insurance analyses is moral hazard. Here there is a difference as well. From the perspective of a private insurer, moral hazard is at work if people use ART coverage to do things that they wouldn't have done if forced to bear the full freight financially. But for the government this is not so clear. To a benign government, it's not just financial "waste" if motivated prospective parents get to have children with a particular desired relationship to themselves. (Yes, the fate of children in need of adoption is also part of the larger policy picture, but it's not clear that shutting off other routes to raising a child is part of the optimal response to that.)

2) Beyond dysfertility? - What about ART expenses incurred, say, by heterosexual couples that are neither infertile nor dysfertile? An administrative advantage of not requiring infertility or dysfertility is that one need not demand an inquiry into either when people incurred ART expenses. But this admittedly would come at a fiscal cost that would raise issues of moral hazard, insofar as one thinks these expenses might have been incurred out of a preference for neither going through pregnancy (even when feasible) nor adopting. But I'd be inclined to say the expenses should be covered even without either infertility or dysfertility. Going through pregnancy is a pretty huge thing, with significant potential health costs, impact on one's career and long-term earnings, etc. But I am leaving aside here questions of whether we are uneasy (e.g., for Handmaid's Tale-type reasons) about the extent to which surrogacy becomes a go-to. These are certainly beyond the scope of my expertise.

3) Why run ART expenses through section 213? - As a long literature discusses, income tax deductions for medical expenses are a bizarre way to increase overall government health insurance coverage, relative to what it would be if one simply repealed the provision without changing anything else in the legal and policy landscape. Medical deductions come with an adjusted gross-income related deductible, followed by a marginal tax rate-related co-pay, without its being obvious why this form of government insurance is being interacted with the income tax's general provision of ability insurance / under-diversified human capital insurance.

Even taking the use of section 213 as given, I suppose one might want to treat ART and adoption expenses in the same bucket, although to really do this right one might also want to throw in the marginal healthcare expenses that result from being pregnant, if these could be separately identified. And conceivably one would treat things in this bucket differently than other stuff, just as a well-designed health insurance schemes might vary the deductible, the co-pay, the cap if any on covered outlays, etc., based on the characteristics of particular areas.

4) The paper's proposed solution - Rather than discussing statutory changes that might directly address ART expenses, the paper proposes modifying section 213 in more general terms, so that it focuses on "inherently medical services" and on allowing taxpayers to "restore or approximate typical human functioning." This raises further interesting issues, although I won't explore them here, regarding, for example, the technology-driven rise of "inherently medical" procedures that might allow people to go way above the median (a la the use of human growth hormone by someone of average height who wants to become 6'5").

If only Descartes had met him

Sylvester, who nearly died this summer of a thymoma (along with a nearly disastrous general anesthesia episode that left him blind for 2 days) is now, many weeks post-surgery feeling well enough to meow plaintively, endlessly, and if I dare say so a tad annoyingly for food, to be followed by more food (perhaps more than his stomach will accept in so short a period).

He's so expressive of his often churning inner states that I'm sure Descartes would have realized how wrong he was to think animals are unfeeling automata, if only he had met the little fellow.