Monday, April 27, 2015

New article draft on international tax policy, perhaps to be available soon

I have just now - and I literally mean, within the last hour - completed a draft of a shortish-by-legal-standards international tax article (just over 16,000 words), tentatively entitled "The Crossroads Versus the Seesaw: Getting a 'Fix' on Recent International Tax Policy Developments."

The basic idea is to establish a kind of cross-interrogation or dialogue between two things.  The first is the main analytical points that I made in my February 2014 book, Fixing U.S. International Taxation.  The second is four prominent developments in international tax policy since the manuscript went final. These are the new wave of U.S. inversions, the progress made since then in the OECD's BEPS project, the U.K.'s recently implemented diverted profits tax (aka "Google tax"), and the introduction of recent U.S. international tax reform proposals that could be viewed as offering suggestions regarding how to implement some of my ideas.

I find that the cross-interrogation or dialogue goes both ways.  I believe that the analysis in the book helps one to understand those developments, but also that those developments have helped me, at least, to think more clearly about some of the issues that I discuss in the book.

My immediate impetus for writing the article was to present it at the ninth annual academic symposium of the Oxford University Center for Business Taxation (at Oxford's Said Business School), which will be taking place this June 22-25.  I also hope or plan to present it at this year's National Tax Association Annual Meeting, which will be taking place in Boston on November 19-21.  And I will presumably aim eventually to publish it somewhere as well.

Forthcoming on SSRN, I suppose, but for now I will sit on it while I turn to other urgent triage items on my short-term to-do list.

Wednesday, April 22, 2015

NYU Tax Policy Colloquium, week 12: David Albouy's Should We Be Taxed Out of Our Homes?: The Optimal Taxation of Housing Consumption

Yesterday at the colloquium, David Albouy presented the above article, applying optimal tax theory to the question of how consumption via home occupancy should be taxed.  This was welcome diversification of the balance in our overall portfolio of articles for the semester.

I also got an update that I shouldn’t have needed (i.e., I ought already to have been up-to-date) regarding how Albouy has, in prior work (The Unequal Geographic Burden of Federal Taxation), modified or corrected the view taken by Louis Kaplow (in Regional Cost of Living Adjustments in Tax/Transfer Schemes, Tax Law Review, 1995) and Michael Knoll with Thomas Griffith (in Taxing Sunny Days: Adjusting Taxes for Regional Cost of Living Adjustments, Harvard Law Review, 2003) who concluded that generally the income tax system ought not to take into account regional cost of living differences.

By taking a fuller view of how a national labor market with regional wage and price differences operates, in the presence of a tax system that hits wages but not amenities that are accepted in lieu of wages, Albouy finds that “workers in cities offering above-average wages— cities with high productivity, low quality of life, or inefficient housing sectors—pay 27 percent more in federal taxes than otherwise identical workers in cities offering below-average wages. According to simulation results, taxes lower long-run employment levels in high-wage areas by 13 percent and land and housing prices by 21 and 5 percent, causing locational inefficiencies costing 0.23 percent of income, or $28 billion in 2008. Employment is shifted from north to south and from urban to rural areas. Tax deductions [that take account of regional cost-of-living differences] index taxes partially to local cost of living, improving locational efficiency.”

Thus, without impugning the logic employed by Kaplow, Knoll, and Griffith under their assumptions, it may be that one should adopt an opposite conclusion regarding the bottom line question of whether the tax system ought to address regional wage and price differences.  Arguably, the better view is that it should so adjust, due to the distortion that results from taxing wages while not taxing the imputed income (in a broad sense) that a low-wage region may offer at equilibrium in lieu of cash.

 Anyway, on to the current article, which is closely related to the earlier one in focusing on the regional distortions that result from taxing cash wages but not their in-kind substitutes such as good weather.  Here is an expanded version of my own thoughts about the article.  It addresses 3 topics: (1) housing and the work-leisure choice, (2) other inputs to how we should tax housing, and (3) political economy and fiscal federalism considerations.

(1) Housing and the work-leisure choice

Since income (and other related) taxes hit work but not leisure, it’s theoretically agreed that, while we should generally tax all commodities equally, this is subject to the proviso that we should tax those that are leisure complements at a higher rate, and those that are work complements at a lower rate, in cases where we can identify such commodities.  This has the efficiency benefit of somewhat offsetting the tax system’s underlying discouragement of work relative to leisure.

Less well-settled is the question of whether there is much to gain practically by looking for leisure complements and work complements.  But housing is a very important element of overall consumption that clearly might have systematic relationships to this question.  So not looking there would be foolish, yet little has been done on this question in previous work.

As background to this inquiry, the current federal income tax system heavily favors home ownership.  But, on the other hand, state and local real property taxes tend to burden home consumption relative to other consumption.  The net balance is probably pro-home consumption, but one should keep both pieces in mind.

The article identifies several dimensions to locational choices that might affect how we might like to tax home consumption, in view of its interaction with the work-leisure relationship.

(a) “Hawaii versus Manhattan” – To typify this distinction simplistically for clarity’s sake, Hawaii offers nice weather and beach access, which are nontaxable amenities albeit built into housing prices.  Manhattan instead offers two distinct kinds of taxable amenities that are also built into housing prices.  The first (earning amenities) is that you may be able earn a lot more if you live in Manhattan than in Hawaii.  The second (consumer spending amenities) is that you may be better situated to buy nice things for daily consumption if you live in Manhattan than in Hawaii.  For example, consider all our restaurants.

(b) “Westchester versus Manhattan” – Second, even if you work in a high-wage area with low nontaxable amenities, you can either live near work, or else some distance from which you commute.  As I’ll discuss in section (2), there are several reasons outside the simple optimal tax model why we might take an interest in commuting.  But even just within the basic model, the paper offers evidence suggesting that long commutes tend to crowd out marginal work, more than marginal leisure.

The basic argument is to tax Hawaii housing because its nontaxable amenities are a leisure complement and a work substitute, along (perhaps more contingently) with Westchester housing because the commuting also operates at the margin as a work substitute, while subsidizing Manhattan housing because its two types of amenities are work complements / leisure substitutes.  You earn more instead of choosing nice weather and the beach due to the earning amenities, and you use restaurants instead of cooking due to the consumer spending amenities.

This argument makes good sense to me – perhaps no surprise, given that I am a Manhattanite – and of course it dovetails nicely with Albouy’s earlier work concerning the unequal geographic burden of federal taxation.  One point I might add, however, is that Manhattan may differ from Hawaii and Westchester with respect to the marginal effect on work versus leisure of increasing one’s house size, given that one lives in a given location.  In Manhattan, all you need is a roof over your head to have a shot at realizing the earning amenities.  But once you actually have a kitchen, along with enough space to restrain the urge to go out all the time, you may start substituting away from the consumer spending amenities.  So possibly the basic optimal subsidy for the Manhattan housing location should be supplemented by a larger marginal rate of tax on increasing house size in Manhattan than in the other two locations.

(2) Other inputs to how we should tax housing

The paper notes 4 main inputs to how we might want to tax housing, other than those involving the work versus leisure choice.

(a) Positive externalities to urban agglomeration – These might also support a Manhattan subsidy.

(b) Henry George case for a land tax on site value – The famous Henry George argument for taxing site value (as distinct from improvements), because land is relatively fixed and yet taxing it tends to be progressive, is one of those things that is potentially important, generally accepted theoretically, and yet generally ignored.  It’s more important than ever in a Piketty era – especially when it’s been argued that a lot of Piketty’s finding reflect real estate value hikes, rather than a generalized r > g.  Even taxing site value plus the value of improvements (i.e., housing) may retain some of the lump sum tax elements of the pure Henry George land tax, despite its discouraging the improvements.

(c Other commuting issues – One may also want tax housing that is associated with commuting if commuting imposes other social costs that for some reason cannot be taxed more directly.  For example, if we fail to adopt proper Pigovian taxes on the pollution associated with car travel, and also don’t adopt proper congestion pricing for rush hour traffic, taxing the housing in communities associated with such travel may be better than nothing.

In this regard, it’s worth noting that the U.S. income tax system actually does discourage commuting a bit.  We don’t allow commuting costs for going to one’s primary place of work, whereas some other countries (e.g, Germany do).  Purely from the standpoint of measuring income, neither approach is fully correct.

To illustrate, suppose Person A has a job and is choosing between two places to live, one of them downtown with higher rent and lower commuting costs, and the other in the suburbs with lower rent and higher commuting costs.  In this scenario, the U.S. income tax system properly disallows commuting costs as, in effect, rent substitutes.

But suppose Person B has a fixed home and is choosing between two jobs, one near home with a lower wager and lower commuting costs, and the other some distance away with a higher wage and higher commuting costs.  In this scenario, the German system, rather than the U.S. one, rightly frames the taxpayer’s presumed marginal choice.

While I suspect that the U.S. approach is empirically better on balance from an income measurement perspective, the fact that the Person B scenario sometimes exists suggests that we are “inefficiently” (all else equal) disfavoring commuting a bit, as compared to getting it right all the time.  But this may be a good feature, rather than a bug, if we also independently have grounds for tax-disfavoring commuting.

(d) Housing consumption by the poor – There is probably little or no good reason for generally favoring home consumption relative to other consumption. But if homelessness has negative externalities (in addition to being very bad for those who face it), we may want to subsidize housing consumption by the poor, in lieu of just giving them enough aid to fend off homelessness.

(3) Political economy / fiscal federalism

The issues that the paper presents regarding how to tax housing in Manhattan versus Hawaii versus Westchester are singularly those of interest to a national-level decision-maker – not one who is setting tax policy (even optimally from the standpoint of residents) for any of those localities.  This is of especial interest given that the relevant tax instruments include real property taxes that are set at the state and local levels.  Obviously, these issues belong in a wholly different paper, but given the Albouy paper they are worth noting.

Sunday, April 19, 2015

Sign of the times

Last year my wife and I went to the Tribeca Film Festival for the first time, saw an absolutely stunning, wrenchingly sad, film called Gabriel, plus a documentary that was just OK.

This year, we're headed back for 4 bites at the apple, no pun intended.  The first two, Bleeding Heart and The Wannabe, were both pretty good - much more interesting than most commercial films, and of the two Bleeding Heart felt more authentic and less genre, but Wannabe was arguably better-done / more professional.  We split 50-50 on which we preferred.

One thing that's getting tiresome is the half-hour sitting in the theater before the show starts (you have to get there early), watching all the sponsors flit by on-screen.  The ads for a Lincoln car, which we've now seen multiple times at both of the pre-shows, truly overload on the 21-tens wannabe billionaire lifestyle cliches.

Let's see: "meticulously curated," "incredibly personal," crafted for "impact plus subtlety," you not only get a personal interview to buy the car but a "dedicated" personal interview.

If they left anything out, I can't think what.

Friday, April 17, 2015

Someone thinks we're stupid

The House of Representatives just voted to repeal the estate tax, while also preserving the tax-free step-up in basis at death for appreciated assets.

As others have said, one couldn't ask for a clearer illustration of House Republican priorities than this unfunded $269 billion tax cut (over the next ten years) for the richest 0.2 percent of households.

But do they also have to insult everyone's intelligence?  Paul Ryan explains that he is trying to help "family farmers ... [and] small and minority business owners."  He claims that, the estate tax is "absolutely devastating" to family farms - even though there has literally never been a single substantiated case where this folk tale (selling the family farm to pay the estate tax) actually took place.

He also claims that repeal would remove "an additional layer of taxation" from assets that have already been taxed.  This despite preserving the tax-free step-up in basis at death for appreciated assets.

Ryan can do what he likes, but it's a shame that he feels free to say things that so clearly are untrue.

Thursday, April 16, 2015

Why don't people respond much to marriage penalties and bonuses (insofar as they don't)?

Just a couple of more thoughts about marriage penalties and bonuses in the U.S. federal income tax law, prompted by discussing the issues that were raised by this week's colloquium regarding Larry Zelenak's paper.

First, insofar as marriage rates are observed not to respond much to marriage penalties and bonuses, even in an age when unmarried cohabitation has become far more socially permissible than it used to be, what would be the reason? 

Maybe this sounds a bit too obvious.  It's a big personal life decision, etcetera.  Plus, people often don't know what the marital stakes are, although websites such as try to fill the gap by offering primers.  But a big piece of it may be the following.  Even the members of tightly-knit couples cannot be entirely unmindful of the statements that they may implicitly make towards each other through their words and actions.  Thus, for either prospective spouse to say “No, let’s not get married as it would cost us $4,000 a year,” may unavoidably risk signaling something about his or her personal level of commitment.  That makes it different from, say, mutually agreeing to live where rents are $4,000 a year lower.

Second, as a kind of pedagogical note, as this came up in discussions during the day, one shouldn't necessarily think that a low behavioral response at the marital margin to marriage penalties means that they are an efficient way of raising revenue.  There is still the question of taxable income elasticity given one's marital status.  Thus, even if secondary earners aren't deterred from marriage by marriage penalties, they may be deterred from working by the marginal effect that this has on them.

One also shouldn't be too swift to conclude that net marriage penalties or bonuses at a particular income level must be affecting vertical distribution.  Suppose "the rich" will pay the same overall taxes either way, and that marriage penalties and bonuses only affect the distribution of the burden among them (what I'd call a "horizontal" distribution question).  Then it's just an issue of how to tax the rich, and whom to define as how rich, rather than affecting things vertically overall.  But admittedly, even if this is true in the long run, the short run can be different, as in the recent case where marriage penalties were pretty much ignored in the course of restoring the 39.6% top bracket.

Marriage or joint filing penalty in student loan repayment plans

I heard about something interesting this week, from students in my Tax Policy Colloquium and brought to their minds by Larry Zelenak's paper on marriage penalties and bonuses.  It was news to me, but apparently is common and perhaps well-known in the demographic of near-graduates from college or professional school who have huge student loans to pay and are making use of the federal income-conditioned repayment program.

Under this program, of course, the more one earns after graduating, the more one may have to pay annually.  Obviously this functions like a marginal tax on earning more, but what I hadn't known about was the interaction with marriage and filing status.

Apparently, the program relies on adjusted gross income (AGI) from borrowers' tax returns to determine how much one needs to pay in a given year.  First point, don't get married and file a joint return, so far as the program's incentives are concerned, if, say, you are both going to be lawyers earning junior attorney salaries.  (Actually, the examples I heard about may have concerned a student borrower marrying someone else, as opposed to two student borrowers getting married.)

Second point, you can get married after all, so long as you use the "married filing separately" category.  Since the program looks at AGI, doing this keeps your spouse's earnings out of the AGI on your tax return.  And apparently the loan repayment benefits from doing this may significantly outweigh the general disadvantageousness, within the income tax, of married-filing-separately status.

But apparently that comes at a further tax cost, since I am told (though I have not independently checked this) that those who select the married-filing-separately status are barred from taking advantage of special income tax deductions, subject to an income phase-out, for student loan interest.  To beat that as well as the loan program, you have to not get married.

It's obviously preposterous to have the application of the student loan repayment program turn on whether married individuals select "married filing jointly" or "married filing separately."  But is the question of how the loan repayment program operates, with respect to household or marital status, any different from that regarding tax and transfer rules generally?

One difference might be that, depending on the numbers and also on responsiveness in the affected population, marriage penalties here may simply be "too large," even if one is not wholly averse to them in all circumstances given the broader issues raised by household status.

A second difference is that we might need to think more about the purposes being served by the income-conditioned loan repayment program.  Suppose that it is rationalized, not just as tailoring loan repayments to ability to pay (and thus generally offering income insurance to participants), but also as specifically addressing the payoff that the borrower has derived from the education that triggered all those student loans.  The idea might be: We're sharing the risk by making you pay more if the educational loans really pay off big-time (at least, ignoring the point that correlation needn't imply causation - I may not make it big BECAUSE what I learned or my degree helped me so much).

Insofar as that is the rationale, one might conclude that purely individual rather than household "taxation" should apply here.

Nice job, CEOs

Due to pigheadedness, at least 50 percent of it mine, we've had a scheduling conflict at NYU the last couple of years, with both the Tax Policy Colloquium and the Law and Economics Colloquium meeting on Tuesdays in the spring semester.  This unfortunately will continue next year, as no one has blinked.

Just as a matter of topic, not all of the L & E papers interest me, and the same of course is true in the other direction as well, but there are cases running both ways in which the organizers of one would have liked to attend the other.

Good example next Tuesday, when we will have a very interesting paper on the optimal taxation of housing consumption by David Albouy.  Meanwhile, the Law & Economics Colloquium will have a paper by Rob Daines (formerly NYU, now Stanford) on options and executive compensation.

Here's the abstract:

"In the wake of the backdating scandal, many firms began awarding options at scheduled times each year. Scheduling option grants eliminates backdating, but creates other agency problems. CEOs that know the dates of upcoming scheduled option grants have an incentive to temporarily depress stock prices before the grant dates to obtain options with lower strike prices. We provide evidence that in recent years some CEOs manipulate stock prices to increase option compensation. We document negative abnormal returns before scheduled option grants and positive abnormal returns after the grants. These returns are explained by measures of a CEO's incentive and ability to influence stock price. We document several mechanisms CEOs use to lower the strike price, including changing the substance and timing of the firm’s disclosures."

Nice stuff, huh?  I am glad these CEOs are working so hard; it's just too bad for whom they're working.

Wednesday, April 15, 2015

Vastly easier and less painful tax filing

Nice article in today's Times about Joe Bankman's longstanding advocacy of less painful tax filing.  The story of how Intuit has been "ferocious" (the Times reporter's word) in opposing this otherwise almost universally win-win reform, spending millions of dollars on lobbying to oppose it, is one more dark chapter among many in how interest group politics distorts public policy.  Intuit would evidently rather sell us things than have us get them far more cheaply and efficiently.

NYU Tax Policy Colloquium, week 11: Lawrence Zelenak's For Better and Worse: The Differing Income Tax Treatments of Marriage at Different Income Levels

Yesterday, Larry Zelenak to present the above paper, which reviews a familiar issue in light of the rise in recent decades of unmarried cohabitation.  In my view, the main significance for marriage tax issues that is raised by unmarried cohabitation is the following.  I view households, involving people (including couples) who in some way pool and internally allocate resources owned by different members, as an important category in distribution policy.  The rise of unmarried cohabitation reduces the tax system's ability to discern "true" couples based on looking at marriage.  This complicates using household information.

While the paper is basically consistent with this take (also addressed, for example, by Anne Alstott here), it places more relative emphasis than I might on the particular horizontal comparison between cohabiting couples that are basically the same, for purposes relevant to the fiscal system, except that some are married and others not.  That comparison matters, on both efficiency and equity grounds, but the broader couples versus non-couples comparisons are as important or even more so.

The following is adapted from an outline that I prepared for my part of the discussion at the session yesterday, fleshed out with some of my thoughts on the particular topics.

1.  The case for using household-based information
     (a) Couples status versus marital status - Same point as above; while one could certainly argue that one's being married or not is relevant to how one is treated by the fiscal system, the central point for me is that understanding people's household circumstances is important.
     (b) What are households and why do they matter? - In general, for people who are not in the same household, the control, use, or benefit from particular resources depends mainly on legal title.  If I win the lottery, then, even if I buy the gang a round of drinks (for some reason, I have here "It's Always Sunny in Philadelphia" in the back of my mind), basically the beneficiary is me, family members aside - not, say, mere roommates even if I were still in a stage of life where I had them. Even leaving aside children, parents, and other relations, there are certain relationships, typically including but not limited to married couples, in which legal title as between particular individuals may matter less than the household's norms and rules for using the collective resources.  Consider a couple with a joint bank account and/or general sharing of expenses in some way.  BTW, there does NOT have to be a claim here of equal sharing - just that legal title generally matters less than internal household processes for determining how the overall resources of members should be used.
     Grant this, and the fiscal system cannot meaningfully address my current economic circumstances, such as based on my income, without also considering (a) income of other household members, (b) consumption needs and productive capacities of other household members, including in non-market settings such as providing childcare, and (c) the intra-household incidence problem.  On this one, suppose we had separate individual filing and that this caused high-income spouses to pay more tax while their low-income partners paid less.  Would this redistribute within the household?  Not necessarily - it would depend on how the household actually "works" in allocating its after-tax resources.
     (c) What's the issue? - Not just separate versus joint returns, but using vs. not using, as well as different ways of using, household information.  For example, having joint returns in which the rate bracket dollar amounts are doubled, relative to those on separate individual returns, can be equivalent to having separate individual returns but with income-splitting (i.e., my spouse and I are each presumed to have earned half of our combined income).

2.  Limited relevance of Boris Bittker's famous "trilemma"
     a.  Overview - Bittker in 1977 famously set forth the "trilemma" - one can't simultaneously have progressive rates, equal taxation of same-income couples whether married or not, and marriage neutrality.
     Here's a simple illustration of the trilemma.  Say we have a zero rate on the first $50,000 of income, and a 50% rate above that.  Ann and Bob earn $50,000 each, whereas Carol and Dave's earnings are $100,000 / zero.  With separate returns and no other adjustments, Carol and Dave will pay $25,000 more in tax than Ann and Bob.  With joint returns, they'll pay the same amount - just how much depends on where the joint return zero bracket amount ends - but that necessarily means that there will either be a marriage penalty to Ann and Bob, a marriage bonus to Carol and Dave, or else some combination of each.
    I have great respect and admiration for Bittker, who showed his mettle once again by writing something in 1977 that people are still talking about.  But I wouldn't make it as central to the analysis today as it sometimes still is.
     b.  Is it really a trilemma? - True, you need progressive rates for the story to get off the ground.  But since we will probably decide separately whether to have progressive rates - including those, outside the income tax, that arise at the low end of the income spectrum from phasing out safety-net type benefits - it's really a dilemma, same taxation of same-income couples versus marriage neutrality, that's premised on having progressive rates. So let's consider the relevance of those two competing considerations.
     c.  Same taxation of same-income couples - Premised on household pooling and our difficulty both in observing the actual internal splits and in targeting tax incidence as between household members, this objective has some value, conditioned on one very important modification.  There is a huge difference between a one-earner couple and a two-earner couple - say, with children, to make it especially stark - that are earning the same overall income.  The one-earner couple has extra labor services available, outside the formal job market, from the one who doesn't have a market job.  That individual may have decided not to work in the labor market, as opposed to lacking opportunities.  Treating the two couples as the same both ignores the real difference in their resources and can lead to strongly discouraging secondary earner labor supply.  Hence the powerful case for, at a minimum, secondary earner deductions or credits, childcare expense deductions or credits, etc.
     d.  Marriage or couples neutrality - Even without moralizing, there can be positive externalities to these relationships, e.g., the insurance benefit if both have resources and one could thus help the other upon job loss, sickness, etc.  This may benefit them both, but is also a positive externality insofar as society would otherwise either have to give more $$ to the hard-luck member of the couple, or would regret that individual's bad luck.
     Another, perhaps more obvious, issue in the externalities realm goes to the effect on children.  While I gather the empirical literature suggests that having two parents is associated with the best outcomes for children, I don't happen to know to what extent this literature has dealt with, say, issues of correlation versus causation.  E.g., suppose the benefit wasn't from having two parents, so much as from having parents who succeeded in keeping their relationship going, reflecting their underlying "types."
    Note also that it is surely not true that all marriages, even with children, ought to be kept together.  There are some out there as to which it's best for all concerned if they end, and overly tax-discouraging this could be bad.
     e.  The missing issue: secondary earner labor supply - Discussed above, but this is a really central issue that one must keep in mind and that the trilemma or dilemma leaves out.  It's an issue of both efficiency and distribution, with lots of other important implications mixed in as well (e.g., concerning the broader evolution of gender roles and power relationships).

3.  The rise of cohabitation outside marriage raises accuracy concerns, more (in my view) than the particular fairness concerns that the paper emphasizes
    Again, a central argument of the paper is that the rise of unmarried cohabitation makes marriage penalties especially unfair, since married and unmarried cohabitants may in substance be so much alike.  I might instead view the greater avoidability of marriage penalties (since one can now more easily cohabit without incurring them) as reducing fairness concerns about marriage penalties.  This reflects my seeing the issue more in terms of the greater difficulty of correctly observing household status that I do indeed view as at least potentially normatively relevant.

4.  The paper's case for equalizing marriage penalties and bonuses
    One of the paper's main arguments is that, assuming the system otherwise remains mainly as it is today, one should try to equalize the maximum marriage penalty and marriage bonus at a particular income level.  I think there's something to this, and I'd spell it out as follows: Suppose - a crucial prerequisite - that one normatively values marriage neutrality at a given income threshold.  And suppose that rising departures from it have efficiency and/or equity costs that rise at more than a linear rate.  E.g., just for a convenient illustration that's admittedly a bit artificial, suppose that doubling a marriage penalty or bonus makes it, in some sense, four times as bad.  Then if one of the marriage penalty or bonus was $X, and the other was $3X, shifting things around so both were $2X would reduce the combined social cost of the two errors.  But again, this presupposes both using marriage neutrality as one's baseline, and not having the conclusion disrupted by other considerations.

5.  Marriage penalties versus bonuses towards the lower end of the income distribution
    The paper shows how huge, relative to income, marriage penalties can be towards the lower end of the income distribution, by reason of the phaseout of the earned income tax credit.  Surely these marriage penalties are too big, all things considered, although my preferred solution wouldn't be to shrink the EITC.  The paper further argues that, given the evidence suggesting that children do better in two-parent families, we should have if anything marriage bonuses, not penalties, in this range.
    While this argument has some force, under its premises, there is also another side to it.  Suppose that children in two-parent households fare better than those in one-parent households.  If we respond (presumably for incentive reasons) by giving the former a bonus, we have an anti-insurance system in place.  That is, we reward those who are already better-off by reason of their being better-off.
    The EITC, of course, already has this character insofar as someone who gets a job gets more money out of it than someone who tries but fails to get a job (assuming the former remains short of the cutoff).  But while improving incentives is good, so is providing insurance rather than anti-insurance.  These objectives are in conflict, necessitating tradeoffs, if we provide marriage bonuses at the low end because we believe kids do better in two-parent households.

Wednesday, April 08, 2015

NYU Tax Policy Colloquium, week 10: Lillian Mills' Managerial Characteristics and Corporate Taxes

Yesterday at the colloquium, Lillian Mills presented the above article (coauthored with Kelvin Law), finding that among publicly traded companies, those whose CEOs have prior military experience engage in less aggressive tax planning – e.g., involving less use of tax havens and leading them to have smaller reserves for uncertain tax benefits (most likely due to differences in tax planning, not in willingness to reserve for uncertainty).  Due to this difference, companies with former-military CEOs pay higher effective tax rates than peer companies that otherwise are similar but don’t have former-military CEOs.

If correlation is causation running from the CEO’s background to the company, this would mean that the former-military CEOs are inducing over-payment of tax – relative to that what they could actually get away with, even if it reflects super-aggressive transactions – of an estimated $1M to $2M per year.  However, there appear to be offsetting benefits to the companies, relating to what may well be behaviorally-linked less aggressive behavior in other realms.  For example, the companies with former-military CEOs are less likely to face class action lawsuits, announce financial restatements, and backdate their stock options.

The paper’s current form invites one to speculate about military culture or personality types as causal factors.  For example, does military training make one more ethical about reporting matters?  More risk-averse?  Or are people with these attributes more likely to serve in the military, even going back to the era of the U.S. military draft?  Of note, the great majority of the former-military CEOs whose tenures contributed to the data set were not, say, lifers who retired as generals and then went to high-level private sector jobs (a la Alexander Haig ending up at United Technologies), but rather people who served for a few years in their 20s, including during wartime via the draft, and then started private-sector careers that culminated in their making CEO decades later.

Here are a few of the main thoughts that I had with respect to the paper:

1) While causal questions are important and interesting for their own sake, they don’t necessarily matter much to many of the main conclusions that one would draw from the study.  Thus, consider the choice between treatment and selection to explain former-military CEOs having different values, if these are viewed as explaining the finding.  In other words, did the military change them, or did certain types of people find the military?  (This could have happened even during the draft era, given that it wasn’t wholly unavoidable and that people who enlisted voluntarily as officers may have been the chief future-CEO pool.)  Likewise, suppose we are choosing between the scenario where the CEO is the true cause, and that where Board of Directors are more likely to choose former-military CEOs when they favor the strategy (merely to be implemented by the CEO) of being less aggressive across the spectrum.

While all this is worth knowing, if one can figure it out, it might not matter enormously either for the tax policy payoff, or for what it tells about the strategic setting in which companies (whether via the Board or the CEO) might be deciding about aggressiveness across the board.

2) Again, the paper finds that companies with former-military CEOs pay higher effective tax rates (ETRs), all else equal.  The ETR is a fraction.  The numerator is taxes paid worldwide (using two alternative measures: cash taxes and GAAP taxes).  The denominator is worldwide reported earnings.  Thus, companies with former-military CEOs would not need to pay more tax than other companies in order to have higher ETRs.  Having lower reported earnings due to lesser accounting aggressiveness, while doing the same tax planning, would have this effect as well.

The finding that these companies make less use of tax havens supports concluding that the numerator is at least part of the story.  I also agree that, in context, their having lower accounting reserves for aggressive tax positions probably reflects lesser tax aggressiveness, rather than greater accounting aggressiveness in determining what is a sufficiently uncertain position to require a reserve.  But the issue of the denominator might lower the estimated tax cost associated with former-military CEOs.

3) There is prior work finding both “technological” and “cultural” explanations for correlation between aggressive tax planning and other bad stuff, such as accounting treatment that blows up or looting of the company by rogue executives.  An example of a technological explanation is the view that, once you can use tax planning as the excuse for creating a byzantine corporate structure with multiple “special purpose entities” that no one but the insiders understands, looting becomes easier.  While the evidence in this paper for a cultural explanation does not rule out the simultaneous importance of technological factors, it adds to the case for concluding that those factors can’t do the job all by themselves.  A great example, from an earlier paper by other authors that this one mentions, is evidence that, in Russia, companies whose executives paid bribes to avoid traffic tickets suffered from greater looting by insiders than randomly selected Russian companies.

4) Presumably, an across-the-board cultural trait of lesser aggressiveness, and hence greater trustworthiness where CEO or company behavior cannot be perfectly observed, might have greater value in some types of industries than others.  One thing that seems clear, from anecdotal evidence that the paper mentions, that selling to consumers isn’t the key factor.  If it were, then companies like Apple might be a lot more reluctant than they actually are to be seen as engaged in aggressive tax planning.  Suppose that Apple’s international tax machinations caused people to think: “Wow, they’re so sneaky that I bet the iPhone 6 has undisclosed defects.”  But that evidently is not the case.

5) One obvious policy implication is that government regulatory agencies – and not just the IRS – should look more broadly for evidence of aggressive behavior in deciding whom to audit or monitor the most.  Perhaps a company that cheats on OSHA is more likely to need a tax audit, and one with aggressive tax shelters is more likely to cheat on OSHA.  I suppose the IRS might also incorporate former-military CEOs into its thinking about where to target its marginal auditing efforts, but subject (obviously) to the concern that companies would pick former-military CEOs for this reason when they were planning to get more aggressive.

The paper has no direct or first-order bearing on the question of what we should think about the social effects or the moral defensibility of more aggressive versus less aggressive tax planning.  The point, rather, is that aggressive tax planning may be associated in practice with other types of aggressiveness that may have downsides for the companies engaging in them, in particular by reason of agency costs.

But here is a small, second-order point.  Suppose a company is choosing at the margin between Strategy A (greater aggressiveness that reduces tax liability but imposes other costs) and Strategy B (lesser aggressiveness that results in tax “over-payment” relative to the maximally aggressive scenario, but that has collateral benefits).  Socially speaking, we may want to push companies towards Strategy B.  After all, taxes paid are socially a transfer between pockets, but other aggressiveness may involve broader social costs.  This might marginally induce one to favor more intensive auditing of aggressive companies than would have been optimal (given that auditing is costly) in the absence of collateral effects on other aggressiveness.