Taxing corporate book income: minimum tax vs. add-on tax

Vice President Biden has just proposed a 15% corporate minimum tax based on companies’ financial statement accounting income (aka, book income) above a large threshold. By contrast, Senator Warren is proposing a 7% add-on or additional tax on book income above the threshold. The difference is that the latter would be payable in all events, while the former would be payable only to the extent in excess of regular taxable income (albeit, with multi-year smoothing provisions).

Leaving aside perhaps the biggest issue here, which pertains to taxing book income or not, the contrast between them raises the classic old issue of minimum taxes versus separate add-on taxes. I have begin writing about this issue more generally (including in my analysis the US experience with the individual and corporate AMTS, as well as global minimum taxes such as GILTI and the OECD Pillar Two Globe proposal. But it also goes way back for me. The first article I published after entering academe in 1987 was entitled something like “Perception, Reality, and Strategy: The New Alternative Minimum Tax.” I published it in Taxes Magazine so I could get it out fast, although in style and substance it was more like a Tax Law Review article.

I am not, however, writing the new article within a time frame that’s aimed at participating in the current Democratic campaign debate. I’m more interested in getting a general analysis out there that I think is presently lacking, although lots of experts have a decent grasp on some of the main points.

Final NYU Tax Policy Colloquium session for fall 2019

Yesterday at the colloquium, after marking the completion of my 25th year co-running the thing, we discussed Josh Blank’s and Ari Glogower’s Progressive Tax Procedure. This is still an early draft of an ambitious project, hence plenty of opportunities to discuss the way forward. (Not presented when we discuss, as sometimes happens, recently published papers.)
Each of the three words in the title could be interrogated a bit. However, the basic idea is that procedural rules in the federal income tax – for example, concerning statutes of limitation, penalty rules, and standards of care in taking reporting positions – might vary with the income or wealth of the taxpayer. Audit rates are also in the ballpark, although to what extent within scope remains unclear. The clearest contrast, although here I seem to have begun interrogating the third word in the title, lies between procedural and “substantive “ rules – establishing, for example the tax rate and base.

“Progressive” raises numerous definitional issues, but the broader category might be called “means-based.” Suppose you want average or effective or statutory or marginal rates to rise with the taxpayer’s income. Then you favor income tax progressivity as defined or measured one way or another, but the broader point is that you favor a positive relationship between the rate of particular interest to you and the taxpayer’s overall income (which is a measure of the taxpayer’s means).

In that example, we also know how to define a regressive tax system. The rate of chosen interest goes south rather than north, with a perfectly flat tax standing in between them as the benchmark of a means-neutral system so far as these aspects are defined. (Of course, in a flat rate tax system, those with higher income still pay more overall tax, but the rate that one is focusing on, is distinct from overall liability, doesn’t vary with the measure of means.)

“Progressive tax procedure” therefore implies that item one is looking at grow less favorable in some way as the overall measure of the taxpayer’s means increases. Illustrative examples that the paper is at least willing to contemplate might involve, for example, having penalty rates go up as a percentage of the underpaid tax liability, statutes of limitation increase, or standards of taxpayer care to avoid penalties grow more demanding, as the taxpayer’s income (or, say, wealth, if a measure of that was available) increases. 

Having audit rates rise with income would be within the paper’s scope if that qualifies as “procedure,” which remains to be determined by the authors. This helps raise the point that once is talking about means-based tax procedure, without specifying as yet that it might be progressive, one might be motivated, not just by distributional preferences, but also the question of what information is relevant to tax administration. For example, supposed that the IRS’s information audits found that the amount of one’s income (at the start of the audit, or at the end) was informative regarding the likely revenue yield from a given audit. We know, of course, that the IRS must be looking at such things as whether, say, cash businesses or those in particular industries offer greater audit yields, or perhaps returns with large vs. small charitable contributions of a given type. If they find that something relating to the taxpayer’s overall means is also relevant to expected audit yield, one could ask (among other questions) whether using or ignoring this information would be, not only the better approach all things considered, but even the more “neutral” one, if one was attempting to define and apply such a benchmark. But while I suspect that a consistently applied audit yield metric would result in a significant upward shift, along the income scale, in who is audited, it wouldn’t necessarily be “progressive” all the time. E.g., suppose EITC claimants tend to yield greater audit yield than those earning above the phase-out. Or suppose there is more audit yield from the merely rich in the 99.0 to 99.5% percentile, than from those at the very top. Then one’s audit yield strategy wouldn’t be “progressive” at all margins, even when it was means-based.

This distinction can be an important one – looking at “means” because it has relevant informational content wholly apart from one’s distributional policy preferences, vs. because it is itself a topic of interest under one’s distributional preferences.

A further distinction to have in mind here lies between formal and substantive means-based variation in tax procedural rules. You know the old gag: “The law, in its majesty, forbids the rich and poor alike to sleep under bridges.” An opposite version of the same thing is FATCA, requiring information reporting about US taxpayers’ foreign bank accounts. As between full-time U.S. residents, this has progressive impact, at least to a degree, because you have to be at a certain level of wealth and/or income before one starts availing oneself of foreign bank accounts. (But perhaps it tapers down at some point towards the top? And of course for U.S. taxpayers who spend enough time abroad to need local banking outside the country, FATCA looms even if their resources are decidedly modest.) Likewise, if one applies particular penalties above a flat dollar amount of overall tax liability shortfall, or if one disfavors the use of tax advisor opinions as penalty shields, the rule even if formally neutral will have upwards-tilting effects.

In thinking about the various approaches that the paper puts in play, both the Kaplow-Shavell work on restricting distribution policy to the “tax system” and the Kaplow work on the social value of determining income (or whatever) accurately offer important orienting devices. Rules that might be described as implementing progressive tax procedure are contrary to the Kaplow-Shavell approach if they are used to increase the overall progressivity of the tax system – except insofar as by, say, reducing tax avoidance opportunities they affect optimal rates. But if they are using means-based information that is relevant to efficient implementation, the case is different. The point here isn’t to insist on Kaplow-Shavell conformity, as that’s a live issue under debate, but it’s useful for situating and understanding the claims.

And here’s where “accuracy” as discussed by Kaplow and others may enter the analysis. Suppose we used means-based, whether or not progressive, tax procedural rules to change the taxation of rich people in the following way. E.g., suppose that initially half were paying tax at a 40% effective rate and others at a 20% rate, due to tax avoidance opportunities available disproportionately to the latter. Then we used tax procedural rules, such as cutting back on the use of penalty shield tax opinions, or more broadly (whether or not within the term’s scope) by increasing audits of high-income taxpayers. One might think of the shift as being distributionally neutral, in an aggregate group sense, if now all the rich paid 30%, but for multiple reasons this might now be a better system (leaving aside the costs of getting there). Whereas, if we got all of them up to 40%, the system would now apparently be more accurate, but it would also be more progressive – which might be fine, but muddies the waters a bit regarding why we might favor (if we did) the tax procedural changes that brought about this new state of affairs. In Kaplow terms, a key question in the now-all-30% scenario would be measuring the benefit vs. the cost (if positive) of the greater accuracy – we obviously wouldn’t be willing to spend infinite resources in order to measure everyone’s income accurately and assure the uniformly “correct” application of statutory tax rates.

My point here is simply that this helps to demarcate the different issues raised by means-based tax procedure that the paper will be exploring as it develops. 

NYU Tax Policy Colloquium: 25 years in the bank!

Today was the final session of my 25th Tax Policy Colloquium at NYU. The occasion was honored by kind people with a poster, card, cake, and short speech (actually, that was impromptu & by me). This photo shows me reenacting the candle blow-out (2 + 5 = 7 in one blow, just like the Little Tailor from Grimm’s Fairy Tales). Room was fairly full of people, but they backed off for the photo op.

Modestly revised paper draft

I have revised, although this time fairly modestly, the SSRN-posted version of my article on multinational rents or quasi-rents, the source and value creation concepts, and digital service taxes as an exemplar of where international tax policy may more generally be heading.

You can find the revised version here.

For now I’ve kept “Digital Services Taxes” as the first 3 words in the title, though this risks over-stating the extent to which the paper is actually about them as such. They remain a relevant piece of the paper’s analysis, and (at least so far) I couldn’t come up with a good title that didn’t start by referencing them.

Tax policy colloquium, week 13: “Helen of Troy” anti-inversion regulations

Yesterday at the colloquium, Deborah Paul presented “Has Helen’s Ship Sailed? A Re-Examination of the ‘Helen of Troy’ Regulations.” This paper, which is closer to the ground-level institutional details of federal income tax practice than most of our fare this semester, addresses a kind of coelacanth of the federal regulatory process, although the time frame for this “living fossil” is 25 years rather than 400 million.

The “Helen of Troy” regulations are so known because they were issued in response to an inversion transaction involving a company of that name. They came out in 1994, or a decade before an ensuing wave of inversion transactions gave rise to the enactment of IRC code section 7874, responding to the phenomenon both legislatively, and far more broadly and systematically.

A corporate inversion, as presumably is known to most readers who were interested enough to read this far, involves a U.S. multinational company with foreign subsidiaries seeking, through tax-free reorganization transactions, to substitute a foreign corporate parent (often located in a tax haven) on top of the prior U.S. parent, and also to change the corporate structure so that the foreign subsidiaries are under the new parent, rather than the U.S. company, which remains on hand just to engage in the broader group’s U.S. operations.

Pre-2017, the main tax planning aims served by inversions were (1) to allow dividends to be paid up from the foreign subsidiaries to the company on top of the chain without triggering the U.S. repatriation tax, and (2) to facilitate earnings-stripping out of the U.S. tax base. If this is done by having a U.S. parent pay interest to foreign subsidiaries (which might have made the “loan” by simply round-tripping equity previously inserted by the parent), it ends up being foiled because the U.S. interest deduction is offset by subpart F income taxable to the U.S. parent by reason of the subs’ interest income from the loan. But this doesn’t happen if the interest is paid to foreign group members that have a sibling or parent, rather than subsidiary, relationship to the U.S. company in the corporate ownership chain.

The 2017 act eliminated the repatriation tax that used to motivate inversions, and created some additional barriers around interest-stripping. But its enactment of GILTI (a quasi-minimum tax on U.S. companies on their foreign subsidiaries’ profits) it created a new reason for wanting to invert.

Anyway, back in the day (1994) the Treasury wanted to clamp down on inversions, but didn’t have all the tools it has now. I don’t know why there was no legislative push – this was before the November 1994 elections swept Gingrich et al into power – but conceivably the politics had something to do with it. What they decided to do was issue regulations under section 367(a).

Let’s pull back the camera now for some broader background. In general under the U.S. federal income tax (and most others), gain from asset appreciation (or loss from its declining in market value) is not taken into account for tax purposes until there is a realization event, such as sale. This rule leads to numerous distortions and tax planning opportunities – the late William Andrews called it the “Achilles heel of the income tax” – but it has generally been though necessary in response to problems of asset value measurement and taxpayer liquidity. (There are now proposals around to apply mark-to-market taxation, or retrospective systems that aim for equivalence thereto, but that’s another topic.)

 But once realization events were made taxable, it was thought desirable to create exceptions, by allowing nonrecognition for certain transactions, such as incorporating one’s business, turning one corporation into two or two into one, etcetera. The rationale was that these transactions not only might be doing little to address measurement and liquidity issues, but also were not convenient occasions for levying the tax on appreciation – for example, because they were merely reshuffling how one’s assets were held, and would tend not to happen (rather than yielding taxable gain) if they were taxed.

But then the next step was the tax authorities’ learning the hard way that taxpayers could exploit nonrecognition transactions to achieve tax planning aims beyond business-motivated reshuffling. A classic example is the Gregory case from the late 1930s, which established modern economic substance & business purpose doctrine. A simplified version of that case might go as follows. My company has two types of assets: boring stuff and cash. I want to get the cash out into my own pocket, but dividends were subject to high tax rates at the time. So step 1, I do a tax-free spin-off so there are now 2 companies, one holding the boring stuff and the other holding the cash (both wholly owned by me). Step 2, I liquidate the company holding the cash. Now I’m taxed at the capital gains rate rather than the dividend rate (today they’re the same, but at the time CG rates were much lower), plus I get some basis recovery with respect to the cash company’s stock. If this had been allowed to work, there would never have been a taxable dividend transaction again – everyone would have done these two-steps instead. So tax-free reorg treatment was denied.

Section 367(a), the provision under which the Helen of Troy regs were issued, responded to another type of taxpayer planning trick. Say I own an appreciated asset of any kind – be it a painting, Facebook shares that I got back in the day, etc. – and want to move towards converting it to cash. As per the legislative history of the provision’s 1932 enactment, I might contribute it to a new foreign corporation (FC) in exchange for all its stock, have the FC sell the asset outside of the U.S. (generating no U.S. tax), and I now have 100% control of an entity that’s sitting on the cash (although it remains in corporate solution, and paying myself a dividend would be taxable. Congress viewed this as undue avoidance, so it passed a provision stating that otherwise tax-free reorganizations in which one ended up with foreign stock would be taxable, subject to the Treasury’s creating exceptions.

The statutory language was quite broad. In current form, section 367(a) says that FC stock won’t count as stock received for purposes of determining gain recognition, subject to the Treasury saying otherwise. So it went well beyond the specific situation that Congress had most directly in mind.

Section 367(a) imposes a shareholder-level sanction – gain recognition – and is widely thought of as responding to shareholder-level, not entity-level, tax planning fun and games. But in 1994, when the Treasury announced and then adopted the Helen of Troy regs, they aimed it at inversions, which are an instance of entity-level tax planning. This led some to argue that the regs were beyond the provision’s statutory purpose (since Congress in 1932 presumably had no idea that inversions would become a problem 60+ years later), and also that it was in tension with principles of sound system design. E.g., it might be good drafting to have the provisions aimed at entity-level planning issues over here, and those aimed at the shareholder level over there. As an example of the mismatch, the Helen of Troy regs leave inversion transactions unscathed if the shareholders are tax-exempt, because in that case they aren’t going to face taxable gain recognition anyway.

The regs apparently are a bit of a mess – reflecting, for example, that the state of the art so far as drafting provisions applying to the issues presented has improved since then – as is reflected in section 7874 and its regs. So the Deborah Paul paper that we discussed yesterday goes through a lot of the problems, and urges that the Helen of Troy regs be addressed. For example, they might be eliminated, or alternatively they might be updated, improved, conformed more to section 7874.

I don’t know enough about conditions on the ground to evaluate the cost-benefit analysis that would be involved in deciding whether this distinctly tertiary means of discouraging inversions should be streamlined or eliminated. The first tool at hand is section 7874, while the second, which I gather has been quite effective, is the 2016 regulations, issued during the Obama Administration, under the guise of section 385 (addressing debt vs. equity). The fate of the latter remains uncertain, although so far the current administration has merely tinkered around the edges, rather than more substantially scaling them back. Perhaps they’re worried about the headlines if they throw out the 2016 regs and more inversions ensue.

Another piece of this whole story is the increasing difficulty, given the current state of U.S. politics, of using legislation to respond to new developments in tax practice that seem to undermine the existing system (as a wave of inversions can do). Regulators increasingly will and (given the totality of circumstances) should address urgent problems that might better have been left to Congress, as a matter of design flexibility and also inter-branch comity, if things weren’t the way they are. One wild card left behind by doing more through regulations, and less through legislation, is that there may be a rise of back-and-forth seesaws when the presidency changes hands. A second is that the courts may increasingly be following their own ideological (and even partisan) preferences in deciding when to rein in regulation, and when to approach it deferentially. These of course are bigger problems than just Helen of Troy, even if it was the transaction that launched a thousand regs.

Paper formerly known as my digital service taxes paper

This past Thursday through Saturday, I had a very enjoyable time seeing lots of old friends, along with interesting papers and discussions, at the National Tax Association’s 112th Annual Meeting, which was held this year in Tampa.

On a Saturday morning panel, I presented what I am still more or less calling my digital service taxes paper, although I am moving towards better memorializing in the title that it is not really, except fairly secondarily, about DSTs. I also spent some of my time in Tampa, both through conversation and reading (aka finally doing my homework while still amid a busy semester), better catching up with the OECD’s recently issued Pillar One and Pillar Two pronouncements, which need to be (and will be) addressed in my paper’s next draft, and which show the OECD somewhat moving on from the “value creation” focus that I discuss a bit in the paper.

My slides for the talk, which show the transition in progress, can be viewed here.

Tax policy colloquium, week 12: Intuit, Ready Return, and Free File

Yesterday at the colloquium, our pen-penultimate session (if the word is permissible) featured Joe Bankman’s “Mr. Smith Gets an Education: Why It is So Hard to Get Easy Tax Filing.”

The link above starts with Justin Elliott and Paul Kiel’s important ProPublica article, “Inside TurboTax’s 20-Year Fight to Stop Americans From Filing Their Taxes for Free,” an article that actually changed political outcomes on the ground. By exposing Intuit’s deceptive marketing practices, involving steering poor people who thought they were getting free filing to end up paying the company $$ that they might ill be able to afford, the article stopped in its tracks a disgraceful scheme to have Congress permanently take the IRS out of the business of itself making free filing available to people. Intuit had organized a so-called Free File Alliance that signed an agreement with the IRS, purporting to offer free filing if the IRS would stay out of the area, but then did its best to make it extremely inconvenient and difficult to use the service they were purporting to offer.

Bankman’s article, which is part of a larger, possible book project, details his experience in the 2006-2007 period attempting to help California state taxpayers by working on the development of Ready Return, a state-run online free file system (just for state income tax returns) that won rapturous customer reviews when it was rolled out as a pilot project, but then got crushed in the state political process by an unholy alliance between Intuit, which generously threw around both money and bogus arguments, and Grover Norquist, who wants to make people’s government interactions hateful so that they will hate government.

The story that the article tells is great fun to read, and eye-opening even for the already cynical regarding how lobbyists and money shape political outcomes in an inevitably low-information environment. It illustrates, for example, how legislative deliberation can be thoroughly corrupt and corrupted even if most of the individuals involved think of themselves as honorable, and indeed are following their incentives without getting anywhere close to legally defined corruption. And while the piece wasn’t published back then, Intuit’s rise back into political prominence, as its practices get exposed, makes it timely, while raising interesting issues about how best to relate the “then” story to the “now” story.

Here are just a few quick thoughts on selected aspects of the issues involved:

1) Rogue company? – Simply because the piece recounts what happened back in the day, albeit with a bemused rather than angry tone, one can’t easily read it without seeing Intuit as a villain. It causes one to wonder, perhaps naively, if there are distinctively rogue companies out there, based either on company cultures or their business models, or whether it is instead just Capitalism Plus Low-Information Democracy 101. For another example of what appears to be a rogue company, consider Facebook, which, even leaving aside their conning users and happily undermining American democratic institutions, lied to advertisers in a way that it seems should have landed people in jail. Or think of tobacco companies knowingly lying for decades about the medical implications for smoking. Or certain energy companies actively combating global efforts to address global warming.

Intuit is a for-profit business, and their business model involves selling tax filing and other related services to customers for money. So encouraging lots of people to use their platform for free is going to raise issues for them – although note that this is a role they volunteered to play in order to head off competition. But their tactics and behavior make me for one very glad that I don’t use their services any more.

2) Is Free File a feasible approach? – Why would the use of for-profit businesses be the right model for making sure that at least poor individuals can file for free? There’s an inherent conflict of interest here.

The conflict becomes less ineluctable insofar as for-profit businesses are seeking either good publicity (halo effects) or a marketing opportunity directed at the currently low-income who may in the future become good candidates to voluntarily buy paid services. But the sad story Pro Publica has uncovered suggests that the model is not feasible, at least given the current actors, unless there is a whole lot more sophisticated and assertive oversight by an IRS that would have to be less beaten down and underfunded than the current version.

3) Possible federal lessons of Ready Return – The California program involved people with very simple filing situations (e.g., no investment income) being able to access a pre-populated tax return, check it out, and then file it with the click of a button. Given all the anxiety and confusion that surround tax filing, it drew wildly enthusiastic responses from users. But a lot of the opposition to it has focused on having the government compute the bottom line tax liability, which raises concerns about trust.

The greater part of what the government could readily do (at least, once the IRS was brought up to speed, which I think an Administration that cared about governance would be able to do unilaterally) pertains to the information it has, not computations as such. For example, while I wouldn’t fit within typically discussed Free File boundaries, in a particular year nearly everything that needs to be inputted to my tax return, with the exception of charitable gifts, is memorialized by a W-2 or a 1099 that was sent to the IRS, as well as to me. Simply having pre-populated entries for all those things, which I could then review and supplement as needed, would save me a whole lot of effort, money, anxiety, and I’d greatly appreciate it. It makes me angry that people whose motivations I consider dishonorable (and I don’t just mean Intuit here) are keeping this huge benefit out of my reach.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Law school naming gift?

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

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

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

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