Ronald Coase tribute

As I am a former University of Chicago Law School professor, who overlapped with Ronald Coase during my eight-year stay there, I was asked a couple of years ago if I would like to join a group of people who would be writing short tributes to Coase, for a volume to be published by the U of C Law School, via the Coase-Sandor Institute for Law and Economics.  Now that the volume has come out, here is my little snippet.

The Coase Theorem and the Two Fundamental Theorems of Welfare Economics

                                                                                                Daniel Shaviro*

Both the Coase Theorem and the two Fundamental Theorems of Welfare Economics are well-known.  Less widely recognized, however, is their close intellectual relationship, which helps us to understand the nature of one of Ronald Coase’s main contributions.

The First Fundamental Theorem of Welfare Economics holds that a competitive equilibrium, where supply equals demand, maximizes social efficiency.[1]  The Second Fundamental Theorem of Welfare Economics holds that society can attain any efficient outcome by suitably redistributing resources among individuals and allowing them to freely trade.[2]

Two different ways of stating the Coase Theorem help to make clear its relationship to each of these propositions.  First, suppose we state it as follows: “When there are well-defined property rights and costless bargaining, the negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity.”[3]  This is basically the First Fundamental Theorem, supplemented by the point that all a market requires is well-defined property rights that can cheaply be transferred.

Now suppose we state it as follows: “The efficient solution to an externality does not depend on which party is assigned the property rights, so long as someone is assigned those rights.”[4]  This is basically the Second Fundamental Theorem, again with the added point that distributable “resources” can include property rights with respect to the creation of externalities.

The two Fundamental Theorems of Welfare Economics predate the Coase Theorem by many decades,[5] and surely were well-known to the “room full of skeptical Chicago economists – including future Nobel laureates Milton Friedman and George Stigler”[6] who debated it with Coase on that famous evening when he first presented his reasoning.  What, then, was actually novel about the Coase Theorem?

The answer, I believe, lies in its extending the Welfare Theorems’ range of application.  Rather than applying just to readily observable markets for consumer goods in the field of organized economic production, they can apply wherever their basic underlying assumptions hold.[7]  Coase understood that the right either to engage in or to block polluting activity could be just like ownership of a widget.  And a “market” could be understood as any setting where people have well-defined property rights that they can transfer through low-cost transactions.[8]

Coase was thus a prominent early mover in one of the major developments of the last fifty-odd years in law and related social sciences: the steady expansion of the realm of neoclassical economic reasoning. To be sure, even before Coase, pollution was well-understood to involve “economic activity” that called for an “economic analysis” of government policy responses.  Later decades would see economists ranging considerably further out of their ancestral realm of studying organized economic production.  Consider, for example, Gary Becker’s Treatise on the Family,[9] applying neoclassical economic reasoning to study of the household, or Richard Posner’s The Economics of Justice,[10] taking “an economic approach to issues – including the meaning of justice, the origin of the state, primitive law, retribution, the right of privacy, defamation, racial discrimination, and affirmative action – that are not generally considered economic.”[11]  But Coase was an early mover, important not just for how he advanced the economic analysis of externalities, but also as a pioneer and harbinger of economic reasoning’s broader future.

---

* Wayne Perry Professor of Taxation, NYU Law School.

[1] See, e.g., Jonathan Gruber, Public Finance and Public Policy 50 (4^th ed. 2013).

[2] Id. at 53.

[3] Id. at 130.

[4] Id. at 131.

[5] They were first set forth by Pareto in 1894.  See John S. Chipman, The Fundamental Theorems of Welfare Economics (2002), available on-line at http://www.econ.umn.edu/~jchipman/econ4960/ftwe2_all.pdf .

[6] Sarah Galer, Ronald Coase Still Stirs Debate at 101 (2012), available on-line at http://www.uchicago.edu/features/20120423_coase/.

[7] For example, “[t]o establish the First Theorem, we need to sketch a general equilibrium model of an economy.  Assume all individuals are price takers: none is big enough, or motivated enough, to act like a monopolist.  Assume each individual chooses his consumption bundle to maximize his utility, subject to his budget constraint.  Assume each firm chooses its production vector, or input-output vector, to maximize its profits subject to some production constraint.  Note the presumption of [rationally pursued] self-interest.  An individual cares only about his own utility, which depends on his own consumption.  A firm cares only about its profits.”  Allan M. Feldman, Welfare Economics, in John Eatwell, Murray Milgate, and Peter Newman (eds.), The New Palgrave Dictionary of Economics, 4: 889 (1987).

[8] Coase’s notion of transaction cost can be viewed as underlying the existence of a well-functioning market.

[9] Gary S. Becker, A Treatise on the Family (1981).

[10] Richard A. Posner, The Economics of Justice (1981).

[11] Id. at 1.

NYU Tax Policy Colloquium - another cancellation due to winter weather!

Tomorrow's Tax Policy Colloquium sessions, featuring my colleague David Kamin's paper "In Good Times and Bad: Designing Legislation That Responds to Fiscal Uncertainty," has been cancelled due to the blizzard that is already hitting NYC and thereabouts.

We also had a session cancelled last year due to a winter storm, and a second session was hampered because the author understandably wanted to head back to the airport early - in the middle of the 4 pm session - before yet another another storm might have trapped her in NYC for up to 48 hours.  And we also had a cancellation due to the weather a couple of years before that.

In the first 15-plus years of the NYU Tax Policy Colloquium, we not only never had a weather-based cancellation, but it was never even close.  There may have been about two storms during that whole period that would have been a problem had they hit on the wrong day of the week.

Then there are the two hurricanes we had in NYC in recent years, one of which knocked out electrical power in downtown Manhattan for 6 whole days.  The other one might have done similar damage, except that luckily it peaked at low tide, rather than high tide.

Anecdotal though this may be, I certainly get the impression that climate change is starting to have a personal impact here.

NYU Tax Policy Colloquium, week 1: paper by Brigitte Madrian

Yesterday we had the first session of the 2015 NYU Tax Policy Colloquium.  This is the 20^th time (in 20 straight spring semesters) that I have done the colloquium.  This year, I am happy to be co-leading it with Alan Viard.  (The full roster of people I’ve co-led it with in the past, ranked by how many weeks or years they’ve done it, except that the last two are tied, is David Bradford, Alan Auerbach, Mihir Desai, Bill Gale, Rosanne Altshuler, and Kevin Hassett.)

One sign of institutional health, I suppose, is that we can’t accommodate all of the students who want to enroll.  Luckily from an overall institutional standpoint, the law school ties my hands so that I can’t act in accordance with what would otherwise be my revealed preference of just letting everyone in.  (The problem is that the feel of the class changes for the worse if the class size grows too great.)

Although lots of other tax policy colloquia around the country have followed in our wake – maybe 20 or more, although they may not all be operating at present or in a given year – we still have a unique format, in which the author doesn’t present the paper, but rather a lead commentator focuses the conversation on a couple of main topics, one at a time.  We consult with each other first, then with the author, and then we run the show at 4 pm.

Not having the author present is admittedly a tradeoff.  I personally find the conventional twenty minute presentation upfront to be boring – including, and indeed especially, when I am the author and presenter at someone else’s session – if I have already read the paper carefully (or wrote it).  And not having the presentation induces the audience either to (1) invest more in reading it in advance or (2) not to come.  The key, for it to be a positive strategy, is that there must be enough people out there who choose option (1) rather than option (2).

For me, the tiebreaker against the author presentation is that, if you do that and then follow it up with your own commentary, the audience is just going to be sitting around forever before it gets to participate.  I don’t find that to be either fun or interesting, whether I’m in the audience or at the front.  So in my view, not shared by everyone who runs a tax policy colloquium, skipping the author presentation verges on being a necessary cost of leading and initially directing the discussion, rather than just asking for audience questions.

Anyway, on to yesterday’s session.  The author was Brigitte Madrian, presenting “Does Front-Loading Taxation Increase Savings?  Evidence from Roth 401(k) Introductions.”

While I thought it was a really good session, I don’t comment here about the content of a given session, because that would be inconsistent with our policy that they are off the record.  So here are some thoughts about the paper and the issues it raises, mainly based on expanding my notes for the session (I was in the lead this week).

The paper reports on the findings of a study of 11 firms that initially had just “pre-tax” retirement saving plans under Internal Revenue Code section 401(k), but then added Roth options.

To illustrate how these two types of section 401(k) plans work, suppose that my marginal tax rate is 35 percent at all times.  Suppose I contribute $100 to a pre-tax plan, and withdraw it after retirement once the money has doubled to $200.  I get to deduct the $100 contribution, generating a $35 reduction in my current year tax liability.  Thus, the cost to me is only $65.  Then, when I withdraw the money, it is taxable at 35%, so I end up with $130.

Under Roth, my contributions are not deductible, but the withdrawals are not taxable.  Thus, it turns out to be exactly identical – again, assuming my marginal tax rate is the same at all times, and ignoring various statutory differences between the two types of plan – so long as my nominal contribution – matching my “true” after-tax cost under the pre-tax option - is $65.  Once again, I have $65 less in my pocket up front, but end up with $130 in retirement once the money has doubled.

Suppose that, under a switch to Roth, I still nominally contributed $100, and thus ended up with $200.  I would then have changed the amount of consumption that I am actually from the present to the future.  Absent more to the story, it would violate consistent rational choice for me to contribute the same nominal $100 under pre-tax as under Roth, given that, in the rational choice model, I am aiming for a particular consumption flow, and wouldn’t change this merely due to form if my true opportunity set was the same in both cases.

Anyway, the paper finds evidence that people didn’t reduce their nominal contributions by reason of the firms’ adding Roth to pre-tax employer retirement plans.  The apparent violation of consistent rational choice (unless otherwise explainable) might come as a surprise if not for twenty years of excellent empirical research into retirement savings behavior, much of it by Madrian herself, that finds even greater violations of consistent rational choice regarding even simpler decisions, such as whether or not to save for retirement.  (I discuss this evidence and its broader implications in a recent paper that you can find here.)

I proffered two discussion topics: the paper’s empirical analysis, and the broader policy implications.

1) Empirics.

The paper is based on studies of 11 firms that added a Roth option between 2006 and 2010.  As one would expect given the skill of the researchers, it is normalized for age, salary level, and gender.  It compares people who were hired just before the Roth option was added, to those who were hired 12 months later (and thus at the same time of year) when the Roth option was available.

Suppose marginal tax rates are entirely fixed, even for the future, will be the same for each individual all times, and that there are no relevant differences between the actually available pre-tax and Roth style 401(k) plans.  Then any individual who contributes $X under pre-tax should contribute $X(1 – t) under Roth, where t is that individual’s marginal tax rate.

To know how much employee contributions should drop when a Roth option is made available, we have to know how much they utilize it.  E.g., suppose everyone’s marginal tax rate is 35%, and that given everyone’s hypothesized complete indifference they are simply told which type of plan they were in.  Then contributions should drop by 35% if everyone is put in Roth, 17.5% if it’s half-Roth and half-pretax, and zero if no one uses Roth.

The paper shows that only about 15% of the money that employees were contributing ended up in Roth plans after the option was introduced.  Hence, if we posit that everyone has a marginal tax rate at all times of 33.3%, the expected drop in pretax contributions would only be 5%.

This alone might be small enough for one to worry about losing it amid the statistical noise.  (The authors had only limited data, and published to get the ball rolling in terms of academic study of the issue – they not only acknowledge the need for further research, but very likely will be doing some of that further research themselves.)

Now let’s add the fact that pretax and Roth plans are not entirely identical in practice.  For example, Roth is better if you expect your tax rate at retirement to be higher than it is at the time of contribution.  Optionality – pretax versus Roth – inherently makes retirement saving through the employer plans more attractive (although admittedly this might lead not just to increased true saving via substitution effects, but also reduced true saving via income effects).

Anyway, the bottom line is that one can’t be sure the “rational adjustment” effect would actually show up here in the data.  So while I believe the result, this reflects my priors, as much or more than what we learn from the study.

One bit in support of independently crediting the paper’s finding was that pretax contribution rates did not discernibly differ as between firms which had different levels of Roth utilization.  I would guess the authors’ reason for not highlighting this potentially very helpful point more (although they do mention it) was that the amount of data involved was admittedly limited.

They did apparently find, although not reported in this paper, that peculiar behavior around 2008, when the financial crisis hit and (obviously) may have strongly affected people’s thinking, does not appear to have a measurable effect.

2) Policy implications

(a) Zero long-term budgetary cost – or zero “unintended” long-term budgetary cost? – The paper concludes: “These results raise the possibility that governments may be able to increase after-tax private savings while holding the present value of taxes collected roughly constant by making savings non-deductible up front but tax exempt in retirement, rather than vice versa.”

Just as a quibble, if people make (in real terms) more use of Roth than pre-tax 401(k) plans, because their fixed nominal contributions are equivalent to making what are actually greater tax-adjusted contributions, implies that there might be a positive long-term budgetary cost.  To be sure, this is an “intended” budgetary effect if we think of policymakers as wanting to encourage greater utilization of the retirement savings provisions.

(b) Pre-tax vs. Roth if Congress uses time-limited budget windows. – Because Congress tends to use short-term, rather than infinite horizon, budget windows, Roth saving “looks” cheaper than pre-tax in budgetary terms even if the true  long-term cost is the same.  Both Congress and particular legislators, making supposedly budget-neutral proposals, have not been shy about exploiting this point to engage in bogus “deficit reduction” or “budget neutrality.”  So it is plausible that, even if using Roth in lieu of pretax increased private saving, it might induce increased government dissaving.

(c) Other pre-tax versus Roth issues – The tax benefits for retirement saving under Roth are less truly pre-committed than those under pre-tax.  We can be confident that in, say, 2030, Congress won’t increase particular individuals’ taxes because they got deductions in 2015 from using pre-tax retirement savings plans.  But Roth exemption would effectively remain on the table in 2015 even if Congress didn’t explicitly and directly renege.  An example would be partly or fully replacing the income tax with a VAT or an X-tax (i.e., an individual-level progressive consumption tax that effectively combines a VAT with low-wage subsidies).

This difference could be either good or bad from the standpoint of evaluating Roth.  It makes the tax benefit less credible, but leaves Congress with more discretion.  (Those are basically two different ways, with seemingly opposite normative implications, of saying the same thing.)

One thing I don’t like about Roth style exemption is that it can result in effectively exempting extraordinary returns that people have a limited opportunity to generate.  E.g., Mark Zuckerberg would have done a whole lot better with Roth than pre-tax treatment for his initial investment in Facebook.  This is a real issue when you recall the evidence suggesting that, say, Romney (along with lots of other financial sector insiders) appears to have played games with the IRA contribution limits by grossly undervaluing initially contributed assets.  The answer, when using Roth-style savings rules, is to require that only true arm’s length asset purchases and contributions be permitted.

.

(d) Construing the choice set more broadly – It makes perfect sense for this paper to research pre-tax versus Roth, and then in its conclusion to spell out the main direct implication of its empirical finding.  But obviously policymakers should be thinking in broader terms than just pre-tax versus Roth.  The big items on the agenda today are Social Security, the use of “nudges” such as automatic enrollment in employer plans, and whether to continue using income tax “incentives” to encourage / increase retirement savings.

But note that income tax “incentives,” such as pretax and Roth, actually result in tax-neutral treatment of retirement saving – not in tax-favoring it – if one’s marginal tax rate is the same at all relevant times.  Thus, despite my general admiration for Raj Chetty’s work (with coauthors such as John Friedman) in this area, it makes my teeth ache a bit they describe the income tax rules (for example, here)  as providing “subsidies” for retirement saving.  This is only so (a) relative to an income tax baseline that discourages saving, or (b) when one uses a pre-tax plan and one’s marginal tax rate is lower at retirement than in the year of the contribution (which is, admittedly, likely to be a common scenario).

(e) Income tax vs. consumption tax – As discussed in my article on behavioral economics and retirement saving  a lot of evidence suggests that people have a great deal difficulty with intertemporal choice.  This has important implications for the income tax versus consumption tax policy debate that have not as yet been widely recognized.

Taxing capital gains at death

I'm pleased by the headline item in the tax proposals issued by the White House in connection with tomorrow's State of the Union address: the proposal to tax capital gains at death.

Current law, with its stepped-up basis at death, is  rightly called, by the write-up "perhaps the single largest loophole in the entire individual income tax code."  It means that asset appreciation that accrued during one's life will never be taxed.  (The possible, but today relatively limited, application of the estate tax, is quite different - it applies to value without respect to appreciation.)

Here is a simple hypothetical illustration of why this matters.  Despite my personal fondness for Apple products, I will take the late Steve Jobs as my example.  Suppose - no doubt exaggerating the actual facts, but probably in close relationship to them of Jobs, and even if not for him than for others - that he paid $1 for his initial stake of Apple stock when it was founded, and that the value of this stock appreciated to $1 billion by his death.  The income tax will never reach this enormous gain under stepped-up basis.

What about Jobs' salary from Apple?  With his famous dollar-a-year salary, this wouldn't have done anything either.  But even if Apple had paid him an arm's length salary, rather than effectively compensating him via stock and option appreciation, each dollar of salary it paid him would be includable by him yet deductible by it, leading to zero net tax revenue if their tax rates were the same (as during the long period when the top marginal rate was 35 percent for both individuals and corporations).

What about taxing Apple at the entity level?  In principle, taxing Apple at the corporate level could be a proxy for taxing Jobs as an individual, subject only to the question of whether its marginal tax rate was as high as the rate that one might have wanted to apply to him.  But Apple famously has minimized its tax liabilities through clever international tax planning.

In sum, Jobs' income may never be taxed to any significant degree absent a tax on capital gains at death.  And note that, in this instance, we are talking about labor income that any sensible tax base - including, for example, a well-designed consumption tax - would have reached at some point.  It is not just a question of taxing "capital income."

The tax on capital gains at death really is directed at the top 0.1 percent, especially with the bells and whistles that the White House proposal adds to address political concerns about "small business" and the like.  Note also that, in at least one respect, it actually increases the efficiency of the tax system.  Lock-in, or tax-induced reluctance to sell appreciated assets even if one would otherwise like to do so, is greatly worsened by the tax-free step-up in asset basis at death.  With step-up, selling one's appreciated assets while alive means that one is not merely accelerating a tax that will be due at some point in any event, but incurring a tax liability that would simply go away if one waited.  Hence, it encourages the simple tax planning trick that Ed McCaffery has labeled "buy, borrow, die."  Without step-up, capital gains taxes can achieve a decent tradeoff between revenue raised and distortionary costs from lock-in at a higher rate than is possible today.

The White House fact sheet calls tax-free step-up the "trust fund loophole," which is fair enough although we will see whether or not it catches on.  Obviously, there is not a snowbill on the Sun-facing side of Mercury's chance that the repeal of tax-free step-up will be enacted any time soon, but, if it enters the conversation as a serious reform proposal, this could matter down the road.  And note that sincere progressive consumption tax advocates should recognize that present law's step-up undermines their vision, not just the achievement of more comprehensive income taxation.

Someone has attacked my work!

It was unprovoked, and not on the merits.  Here is the evidence.

The attacker was sharp-clawed Sylvester, the individual on the lower step in this picture.  

From this picture alone, it should be obvious that serene Gary, unlike the crazed Sylvester, would never do such a thing.

Stanford talk on behavioral economics and retirement saving

This past Tuesday, I flew to Stanford Law School for a one-day visit, and presented my paper "Multiple Myopias, Multiple Selves, and the Under-Saving Problem" at Joe Bankman's and Dan Kessler's tax policy colloquium.

My slides, revised from when I presented the paper at the National Tax Association annual meeting last November, are available in pdf form here.

Although I struggled a bit writing this paper, some have told me that it makes a couple of reasonably new contributions to the literature on behavioral economics and retirement saving.  One is to connect the issue about retirement savings "incentives" in the income tax to the fundamental tax reform debate.  For example, I note that if we take the Chetty et al point that "subsidies don't work" in increasing retirement saving, the underlying claim is highly relevant to the relative merits of income and consumption taxation.  The case for income taxation is potentially strengthened if people are relatively oblivious to the deferred taxation of saving.

Second, I talk about the labor supply issues raised by, say, reducing under-savers' take-home pay via "nudges" that cause them to enroll in employer retirement savings plans.  These are at least conceptually important, as they are part of understanding how people make decisions, even if short-term labor supply responsiveness is generally low for the relevant population.

I'm aware of no empirical work on this issue.  As the paper notes, under some of the explanations for under-saving one would expect to have offsetting substitution and income effects, making the research problem more complicated than it would otherwise be (though surely not impossible to address).

I also haven't seen anything discussing the labor supply issues from a theoretical standpoint, with the exception of this article by Louis Kaplow, which helped to inform my own thinking.

The article will be appearing in the Connecticut Law Review sometime this year, as the focus of a symposium issue that will also have three or more papers commenting on it.

One of the questions I was asked at the Stanford session was: What sort of responses have you gotten to the article?  I answered: I've gotten some nice feedback from commenters, and from a few other people to whom I sent it.  But other than that, it was exactly the same as what almost always happens when you post or publish something.  Out it goes, you don't hear much back, and you just go on to your next project, whatever it might be.

2015 NYU Tax Policy Colloquium

We start up in less than two weeks, on January 20 at 4 pm.

Our first two papers, by Brigitte Madrian of the Harvard Kennedy School and David Kamin of NYU are now available through our website. Madrian's paper, "Does Front-Loading Taxation Increase Savings?  Evidence from Roth 401(k) Introductions," is available here.  Kamin's paper, In Good Times and Bad: Designing Legislation That Responds to Fiscal Uncertainty, is available here.

Both should be good sessions and, as we like to do from one week to the next in the colloquium, on wholly different topics.

Both will be followed small-group dinners.  Interested attendees can sign up in advance, and can also get on the regular weekly mailing list for the papers, by contacting me off-line.

New article in Tax Notes

I have an article in today's Tax Notes, entitled "Evaluating the Case for 1986-Style Tax Reform."  You can download it here.

This is the piece, expressing skepticism about the degree of policy gain that would result from lowering the corporate tax rate plus broadening the business tax base, that I presented at the Boston College-Tax Analysts Conference on Reforming Entity Taxation on October 10, 2014.  As per earlier blog posts, you can find slides for the talk here, and an account of the day's proceedings (from a Tax Notes article by Amy Elliott) here.

Spring 2015 Tax Policy Colloquium

The time is now drawing near - January 20, or just under 7 weeks away - when I'll be co-leading my/the twentieth (!) NYU Tax Policy Colloquium.  I've previously posted the speaker schedule, and noted that my co-convenor will be Alan Viard of the American Enterprise Institute, but the following is a first-time-posted full schedule with tentative paper titles (many of them placeholders and/or subject to change):

SCHEDULE FOR 2015 NYU TAX POLICY COLLOQUIUM

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

1.  January 20 – Brigitte Madrian, Harvard Kennedy School.  “Does Front-Loading Taxation Increase Savings? Evidence from Roth 401(k) Introductions.”

2.  January 27 – David Kamin, NYU Law School.  "In Good Times and Bad: Designing Legislation That Responds to Fiscal Uncertainty."  

3.  February 3 – Kimberly Blanchard, Weil, Gotshal & Manges.  "The Tax Significance of Legal Personality: A U.S. View."

4.  February 10 – Linda Sugin, Fordham Law School.  “Invisible Taxpayers.”

5.  February 24 – Eric Toder, Urban Institute.  “What the United States Can Learn From Other Countries’ Territorial Tax Systems.”

6.  March 3 – Ruth Mason, University of Virginia Law School.  “Citizenship Taxation.”

7.  March 10 – George Yin, University of Virginia Law School.  “Protecting Taxpayers from Congressional Lawbreaking.”

8.  March 24 – Leigh Osofsky, University of Miami School of Law, “Tax Law Non-Enforcement.”

9.  March 31 – Shu-Yi Oei, Tulane Law School.  “Human Equity? Regulating the New Income Share Agreements.”

10.  April 7 – Lillian Mills, University of Texas Business School.  “Topics [to be determined] in Financial Reporting and Corporate Tax Compliance.”

11.  April 14 – Lawrence Zelenak, Duke University School of Law.  “Up in the Air over the Taxation of Frequent Flyer Benefits: the American, Canadian, and Australian Experiences.”

12.  April 21 – David Albouy, University of Illinois Economics Department. “Should we be taxed out of our homes? Leisure and housing as complements and optimal taxation.”

13.  April 28 – David Schizer, Columbia Law School.  “Tax and Energy Policy.”

14.  May 5 – Gregg Polsky, University of North Carolina School of Law, "Private Equity Tax Games and Their Implications for Tax Practitioners, Enforcers, and Reformers."

You take what you can get

Harry Grubert has published a thoughtful review of my book, Fixing U.S. International Taxation, in the latest issue of the National Tax Journal.  It's a good read, not just for anything it says about my book, but perhaps even more so for its addressing some topics (such as formulary apportionment) that I mention in the book, but that have been been of especial long-term interest to him.

Although Harry is an economist and I'm a lawyer, he might actually have preferred a more "lawyer"-type book, whereas I wrote a conceptually more "economist"-type one.  Thus, take what I consider to be an important conceptual advance from the book and my related prior articles: distinguishing between (a) the tax burden on outbound investment and (b) the incentive to minimize foreign taxes.  To me, this is inherently important, in the sense that it relates to clear thinking.

Harry agrees that I have advanced the ball on thinking about U.S. companies' incentives with respect to foreign taxes, and that this may be "particularly useful" to keep in mind as the international tax reform process goes forward.  But he notes that there are also plenty of other important issues in international taxation relating to lots of margins.  Some might even have greater practical importance than this one.  (As I would agree.)

Harry's focus is thus, in a sense, more practically grounded than mine - as it should be, given how much he knows about the empirical interrelationships, across decades, of multiple moving pieces.  But there is certainly room for both types of approaches.  I very much look forward to our further exchanges on international tax topics.

I forgot to post this a couple of weeks ago

Posing with Lee Sheppard before a discussion of Ed Kleinbard's book, on Halloween at NYU Law School.

My own paper presentation at NTA

In addition to commenting on the Green-Phillips paper noted in the preceding blog entry, I also presented one of my recent papers, forthcoming in the Connecticut Law Review, entitled "Multiple Myopias, Multiple Selves, and the Under-Saving Problem."  Jason Seligman of Ohio State offered thoughtful and helpful comments.  This was my first, and perhaps last, presentation of this paper, which I finished early last summer, as consumer demand has generally been higher for my Piketty paper (as well as for a short piece on corporate tax reform that I will post on SSRN after it appears in Tax Notes next month).

A link of the slides for my talk is available here, and a link for the paper is available here.

Slide 5 contains a little table that ought to have been in my paper, and that will indeed be (with some expansion) in the final version.  Here is an initial expansion over what I had in the slide:

Table 1 - Summary of (Some) Possible Explanations for Low Retirement Saving

           

Cause for low                        Representative           Potential

retirement saving                 Figure                         Policy Response

Naïve myopia                          Grasshopper                Mandatory saving?

                                               

                                                                       

Sophisticated myopia              Odysseus (Sirens)       Opportunity to choose (and

                                                                                    lock in) saving pre-temptation?

Regret aversion re.                  Fantasy sports player   Good defaults, require active choice?

 "active" choice                      who won’t trade        
                                                           

                                                                                   

Procrastination                        Hamlet                        Good defaults, require active choice?

                                                                                                                             

Inattentiveness                        Voters                         Good defaults, require attention?

Multiple selves                        Sybil                            ???       

Comment I gave at the NTA Annual Meeting

At the recently-concluded NTA Annual Meeting, I was asked to offer a brief comment on a nice paper by Richard Green and Mark Phillips of USC, entitled "Demand for the 1%: Tax Incidence and Implications for Optimal Income Tax Rates."  I myself can access a link for the paper here, but I'm not sure the link will work for readers who didn't register for the NTA conference.

Anyway, here is an approximate reconstruction of my comments:

Assigning me to comment on this paper is a great example of the NTA at either its best or its worst.  That’s for all of you to judge, depending on how much value you think I add.

Reflecting the NTA’s interdisciplinary aspirations, we have here a lawyer – that would be me – commenting on an economics paper that is full of math, including numerous propositions and proofs.  In the words of Martin Short, playing a Hollywood agent in a movie called The Big Picture with respect to a stack of scripts that his client was naïvely hoping he had fully evaluated, “I read almost all of them almost all the way through.”  But perhaps I can try to add value in a different way.  In particular, I’d like to offer six quick comments in the 5 minutes that I have available today.

First, the paper is interesting and important because the question it examines – how optimal tax analysis might be affected if the incidence of a personal income tax may be shifted, such as through effects on pre-tax wage levels – clearly matters, yet has often been ignored.  But it’s a shame that the paper is interesting and important!  Life would certainly be easier if we could simply assume away any such effects.  The paper is convincing, however, when it argues that we cannot necessarily do this.

Two areas in which the literature has wrestled with income tax incidence are the taxation of saving, and corporate income taxation.  As to the first, if the overall level of saving doesn’t respond much to the taxation of saving – which some evidence, admittedly not entirely conclusive, suggests – then incidence-shifting would presumably be slight.  As to the latter, the reason we need to worry about the incidence of the corporate tax is not that it’s paid by a legal entity – pretty clearly, that makes it a tax on the shareholders who own the residual – but rather that its being shifted is highly plausible, especially when national-level corporate taxes are operating within an integrated global economy.

Second, in a sense that the paper nicely explains, incidence-shifting with respect to high-end wages makes the tax on them what I will call “as if lower.”  If pre-tax wages at the top of the income distribution rise in response to highly graduated rates, that partly reverses both the intended distributional effects and the tax’s dampening effect on labor supply.  So in some respects it is as if the tax rate were lower than if there were no incidence-shifting through wage effects.

This causes me to entertain the intuition that perhaps the optimal rate might turn out to be higher, rather than lower, in the presence of wage effects, so as to get back to approximately the same place.  But in the paper’s model it comes out the other way.  This presumably is due to how things work out with respect to the lower 99 percent of the wage distribution.  It would be nice for the paper to explain more fully what gives rise to its result, in which wage-shifting lowers, rather than raises, the optimal rate.

Third, a question of interest is how robust the paper’s finding would be to other inputs into the determination of optimal tax rates.  Suppose, for example, that optimal high-end rates reflect the policymaker’s belief that extreme high-end income or wealth inequality imposes negative distributional externalities on other in the society.  It seems plausible to me that the pattern of effect would be similar (lowering the optimal rate relative to the case of no wage-shifting).  But given my prior comment, I suppose I shouldn’t assume that my intuitions about how the model works are correct.

Fourth, the paper assumes competitive high-end wage markets, while noting that a desirable extension might be to test the consequences of changing this assumption.  Clearly, this could be important, given that there may in fact be non-competitive wage markets at the top of the distribution.  However, one challenge in incorporating this extension is that we don’t necessarily understand how noncompetitive wage markets actually operate.  Suppose initially that one is extracting the maximum available rent, and that changing the high-end tax rate won’t affect this.  That’s a pretty simple case to evaluate (the optimal rate presumably should be higher than otherwise if the pre-tax wage is fixed), but it is only one possibility.

But suppose instead that, say, CEO salaries set by sweetheart boards of directors are more responsive than this.  Might it conceivably go in either direction?  One scenario is that the board restores the CEO’s after-tax position by raising the pre-tax wage.  But for an opposite scenario, consider the claim (made, for example, by Thomas Piketty) that lowering high-end individual marginal tax rates led to higher pretax wages for CEOs, as it was now more worthwhile playing the entire over-compensation game.  Whether one agrees with that claim or not, it’s a real world claim about how CEO wages respond to marginal tax rates that might actually come out predicting that the pretax wage is lower, not higher, if the tax rate on the CEO goes up.  But my main point here is simply that we have to understand how particular noncompetitive wage markets work in order to be confident about how best to extend the paper’s analysis to such settings.

Fifth, the paper assumes away special sectoral taxes in response to noncompetitive wages in particular settings, noting that these would present both administrative and political economy challenges.  But at least as a political economy matter, it’s unclear if setting high wages in particular settings where the markets aren’t functioning well would be harder or easier than raising high rates generally.  For example, you might avoid needing to fight with the entire high-wage sector if only some of them are having their taxes raised.  My point here, however, is just to note that political economy effects can be complicated, hard to model, and can go in various directions.

Finally, a quick point about the earned income tax credit or EITC.  As the paper notes, if it bids down pretax wages at the bottom of the distribution, that would partly undo the intended distributional effects of the EITC.  Depending on one’s reasons for having the EITC, this might not be all bad.  For example, suppose that reduced pretax wages trigger expanded low-wage employment through their supply side effects, and that this would be desirable for other reasons (e.g., building the workforce affiliation, skills, and habits of low-wage potential workers, in ways those individuals have not anticipated).  This might further the EITC’s aim of increasing low-wage employment.  Then again, there might be lots of other ripple effects on wages in the low end of the distribution that one would want to think about.  (For example, suppose it also drove down other low-end wages.)

Again, my point here is simply that the paper’s unavoidable embrace of new areas of complication points the way to yet more complications that we may want to try to add to the analysis.

In sum, this is a good paper that should stimulate extensions and further thought.

A defense of cats (not that they need it)

For some reason, I have been annoyedly mulling over, for a couple of weeks now, an article that appeared in Ezra Klein's Vox blog concerning cats.  The case it sought to make, essentially, was "cats are bad."

Okay, I'll grant Vox the fact that cats kill a whole lot of birds.  But that obviously is only outdoor cats.  Our four have no chance of meeting wildlife other than creatures that we unabashedly classify as vermin if they cross the threshold into our house.  (I am far more benign towards these creatures when they remain outside.)

Then there was another point I suppose I have to grant, concerning the risk of getting diseases from your cat.  But lots of things that one may want to do have downside risk - and if that's dispositive, why ever leave your house or cross the street.

The point that really annoyed me in the Vox article was this section about how cats don't really love us.  Although in a sense, ahem, not entirely, completely, 100 percent untrue, my thought was: How pathetic and neurotic one would have to be to find oneself thinking, about one's cats:  "Do they love me? Are my feelings not fully requited? (whimper, sob)."

BTW, as I type this I have little Gary sitting on the tabletop next to the keyboard - he finds the cursor interesting and I have to save occasionally and keep him off the keyboard if I want to keep going.  But I digress.  Back to the "love" question.

If you are spending your life with a (human) significant other, the question of whether there is genuinely reciprocal love strikes me as rather important.  But suppose instead that we are talking about a pet.  Suppose that he* is beautiful, active, interesting, at times hilarious, playful, has strong feelings and distinctive personality traits, is definitely interested in you, often follows you around, sometimes likes to be petted and/or held (depending on individual feline taste), likes to rub against you sometimes (OK, granted that they also rub against the furniture), is extra friendly if he hasn't seen you for a while (this is true of ours, though not of all cats), puts you to some extent in the "mother" slot in his brain, purrs when you pet or hold him and he is in the mood, etcetera.  If, despite all this, you are going to start blubbering to yourself: "But does he love me as much as I love him?," then you are way too needy.  Enjoy the good things, and if that's not enough for you stick to dogs (or get yourself some helpful psychoactive medication) but recognize that it is your problem, not cats'.  (BTW, I have nothing bad to say about dogs - I agree that they're great, it's just that they're a whole lot of work, especially in an urban setting.)

If cats are simply not to your taste, then fine, no quarrel here, lots of us have different tastes in various respects and yet can have mutual respect, some of my best friends don't like cats, etcetera, although I'll admit to not counting it as a point in one's favor.

*I say "he" because all four of our cats are boys.

What can and will Paul Ryan do over the next two years as Ways and Means chair?

So far as enacting important substantive legislation is concerned, I think the answer is: virtually nothing.  This is no reflection on him; rather, it reflects the prevailing political and policy landscape.

So far as enacting legislation with the full expectation of its being vetoed is concerned, that is a matter of his choice and internal Republican legislative politics.  I personally see nothing wrong with the Republicans' enacting big bills that they would actually like, but that they know President Obama will veto without serious prospect of override.  That can be a legitimate way of framing the Republican side of the 2016 policy debate.  But I don't think the Republicans will be able to unite behind responsible tax reform legislation that is genuinely budget-neutral even over the next ten years.  This was well shown by the cool reception that Republicans offered Ways and Means Chair Camp's very serious set of business tax reform proposals.  While Congressman Ryan would presumably be better situated than Camp to sell such proposals to his own caucus, I doubt that even he could, and also that he would want to.

The really big question is whether Ryan and the Senate Republicans will decide to make major changes in revenue estimating, designed to score tax cut proposals as generally raising revenue, sharply reducing unemployment, etc., even when in fact there is no serious prospect of the proposals actually having the claimed effects.  Ryan has been talking this up publicly in aggressive terms.  I am willing to credit him with being completely sincere, in the sense of believing that the existing estimating process results in under-measuring the positive effects that he believes enactment of his policy preferences would have.  To him, it may therefore seem win-win to push for what is sometimes (on the whole inaccurately) described as more "dynamic" revenue forecasting.  Win-win, in the sense that the revenue estimates become both genuinely more accurate and more favorable to his policy views.

But - as the Republicans found in 1994 when they tried to move towards more "dynamic" forecasting - the results they want cannot in fact be yielded by an honest revenue estimating process.  And I suspect that leadership figures such as Congressman Ryan, even if they don't currently know this, are about to find out.  The conservative or Republican economists who have been named publicly as possible new heads of the Congressional Budget Office are all reputable and honorable people, and they know that an honest, even if "dynamic," revenue estimating process simply can't yield anything close to the numbers that the Republican leadership may not just want, but genuinely believe to be more accurate.

Accordingly, getting the desired numbers, as a regular product of a revised estimating process, would require crossing a Rubicon that at present remains somewhat in the distance.  Essentially, it would require dishonestly destroying valuable public institutions that produce information of value to everyone in the process.  I am very hopeful that the Republican leadership, once they realize that this is the choice, will recognize that it is neither good policy nor truly in their interest.  There is value to a legitimate process, both to provide oneself with better information and to maintain public credibility.  And note, of course, that the Democrats may well get back the Senate in 2016, so this really is a two-party game if you look more than two years out into the future.

Again, the Republican leadership in 1995, with Doug Holtz-Eakin playing an important and positive role at the Congressional Budget Office, swiftly came to realize that it made sense to do the right thing (i.e., preserve the legitimacy and honesty of the revenue estimating process).  Fingers crossed that it happens again.  And while I am not invariably inclined to lean sharply to the most optimistic side when making guesses about the future, I do think there are very good structural and institutional reasons to hope for a positive outcome here.

National Tax Association Annual meeting in Santa Fe, part two

Okay, more on the general sessions at this year’s National Tax Association Annual Meeting.  The Day 2 luncheon speaker was Mark Masur, Assistant Secretary of the Treasury for Tax Policy.  He mainly discussed the prospects for business tax reform in the next Congress.  I was struck by how measured and realistic he was concerning (a) the merits of the reform, which even if net-positive are not exactly a slam dunk, home run, or whatever sports metaphor denoting a huge triumph you happen to prefer, and (b) the prospects for enactment of the reform in the near term, which even a confirmed optimist might rate no higher than, say, 10 to 15 percent  He views the playout of the current issue in Congress regarding extension of expiring tax benefits as likely to provide instructive information regarding how the big players in Congress are likely to be interacting over the next two years.  Obviously, finding a mutually acceptable approach to the expiring tax benefits (including, for example, regarding whether and how they might be financed) ought to be a great deal easier politically than working out business tax reform (which I myself view as a non-starter anyway, unless Congress decides to accept significantly reduced tax revenues).  So if they can’t even do the easier task without a lot of sturm und drang, the significance will be easy to discern.

Next up, in terms of general sessions, was a colloquy concerning three different approaches to business tax reform / taxing capital income, each considerably more ambitious than just broadening the base (from an income tax perspective) and cutting the corporate rate.  Eric Toder, Alan Auerbach, and Ed Kleinbard each discussed their particular reform proposals, after which the audience succeeded in its aim of prodding them to say what they thought was wrong with each other’s proposals.

Toder, along with Alan Viard, has proposed repealing the entity-level corporate income tax, which would be replaced with an individual-level tax on the accrual of gain and loss (without regard to realization) on shares of publicly traded corporate stock.  In other words, shareholders of publicly traded companies would be taxed on a mark-to-market basis.

This proposal would clearly solve a lot of problems with the existing regime.  As I attempt to explain in some length in my books Decoding the U.S. Corporate Tax and Fixing U.S. International Taxation, once you are taxing corporate income at the entity level, rather than the owner level, you have guaranteed yourself a number of very serious problems, made worse in practice by “unforced errors” such as distinguishing as we do between debt and equity.

The big concern is about its non-application to non-publicly traded businesses.  Suppose, for example, that this regime had been in place before Facebook went public.  Would it still have done so?  And how effectively would we be taxing Mark Zuckerberg if it didn’t?  The pass-through regimes we have under existing law (partnership taxation and subpart S) have their own set of very serious problems that are not easily mitigated.

Auerbach would replace the existing corporate tax (and the current rules for taxing non-corporate businesses) with what is essentially a destination-based VAT, modified to (a) reach all cash flows, financial as well as real, and (b) allow wages to be deducted, as they are being taxed to workers.  This could easily be part of an overall X-tax regime, as advocated by David Bradford, and more recently by Robert Carroll and Alan Viard, in which, once again, we would pretty much solve most of the problems I analyze in my corporate and international tax books.  Concerns that might be raised about it include (a) relating it properly to the taxation of individuals, if not accompanied by the enactment of a broader X-tax, and (b) whether its treatment of financial flows, which are deductible / includable or not depending on whether or not they in effect cross the U.S. border, would invite abusive gaming that was hard rather than easy to address.

Kleinbard has proposed a business enterprise income tax (BEIT) in lieu of current rules for both corporate and non-corporate businesses.  Businesses would get interest on basis via a cost of capital allowance (COCA).  This resembles proposals (just for corporations) to address the distinction between debt and equity by providing an allowance for corporate equity (ACE) – in effect, an imputed interest deduction on equity to match the actual interest deduction for corporate debt – except that Kleinbard would use the COCA in lieu of actual interest deductions, an important distinction from ACE proposals given that financial instruments denominated debt can be used to pay out a lot more than just the normal risk-free rate of return.  The proposal would in effect make the entity-level tax a consumption tax, since interest on basis is present value equivalent to expensing, but rents and owner-employees’ undistributed labor income would face the entity level tax.  At the individual level, Kleinbard would impute a taxable return to holding debt, stock, etcetera, but the income being imputed here would exceed the COCA deductions being claimed at the entity level, if the basis of these financial assets exceeded the basis of business assets at the entity level.  This might often be the case, due, e.g., to owner-level sales of stock that had appreciated at faster than the normal rate of return, along with cost recovery deductions being taken at the entity level.

The BEIT as envisioned by Kleinbard would also involve worldwide taxation for all U.S. companies, at the full domestic rate and without the deferral that present law generally provides for amounts earned through foreign subsidiaries.  In other words, full global consolidation.  He would allow a foreign tax credit, which I of course don’t like (I’ve argued extensively elsewhere in favor of lowering the US tax rate on foreign source income in lieu of providing foreign tax credits).

One of the main challenges one could raise to Kleinbard’s proposal is that taxing U.S. companies on a current basis on their foreign extra-normal returns (i.e., those in excess of the COCA deduction), at the full domestic rate albeit with foreign tax credits, would be problematic in a world that has lots of countries with territorial systems for taxing multinationals (although it is true that some of these countries use residence-based rules to address income-shifting to tax havens).  He argues that meaningful corporate residence rules, based on such factors as where the managers are rather than just where the company at the top of the chain is incorporated, would make it extremely hard for existing U.S. companies to expatriate.  The current inversion problem reflects that our corporate residence rules are so formalistic and porous.  But even if existing U.S. companies can’t readily expatriate under a BEIT with much tougher corporate residence rules - which is very plausible - there are serious issues about the long-term sustainability and impact of a global regime for U.S. businesses if other countries are doing it very differently.

One point of general agreement was that all three proposals might offer enormous improvement over current law if they could actually be enacted without being wrecked by political considerations.  But none seems likely to be imminent, which of course is no argument against making sure that people hear about them.

The last general session at this year’s NTA Annual Meeting honored Jim Poterba, this year’s Holland Award winner for lifetime contributions to the field of public finance.  Even leaving aside Jim’s outstanding academic work over decades, which by itself amply supported the prize, the session permitted dozens of leading public finance economists around the country, to whom he has been a tremendous mentor and inspiration, to express their gratitude.  Jim proves the proposition that sometimes virtue and merit are duly rewarded.

Once I'm back in NYC, I will post here the slides for my talk on my behavioral economics / retirement saving paper, Multiple Myopias, Multiple Selves, and the Under-Saving Problem.  I will also probably post my comments on a very nice paper for which I was the discussant, presented there by USC economist Mark Philips.  I had planned to simply post here remarks that I had written out in advance.  But as I was thinking about my remarks at the actual session, which I had time to do as Mark went third, I decided I wasn't entirely happy with what I had in hand, and spoke extemporaneously instead.  If I get a chance to write that up briefly, I will do so and post it.