Tax policy colloquium, week 8: Lisa De Simone on the aftermath of the 2004 repatriation tax holiday

Yesterday at the Tax Policy Colloquium, Lisa De Simone of the Stanford Business School presented Repatriation Taxes and Foreign Cash Holdings: The Impact of Anticipated Tax Reform.

The paper examines how, in the aftermath of the 2004 repatriation tax holiday, U.S. multinationals (MNCs) responded to the possibility that there would be a second such holiday in relatively short order. Although the supposed rationale for the holiday was “just this once, and never again,” there were many people who believed that there’d be another one soon. Indeed, I was among said people. And it might indeed have happened but for three intervening developments:

–A big part of the rationale for the repatriation holiday had been that it would lead to increased U.S. investment and jobs. Academic studies suggesting that the impact had been more in the direction of increasing share repurchases and/or M&A activity (shades of 2018!) had an adverse effect on lobbyists’ talking points in favor of a new holiday.

–The Joint Committee on Taxation turned out to have under-estimated the immediate response to the holiday. Hence, the first-year revenue gain was higher than expected. This is one reason I expected a repeat. What could possibly be better, from Congress’s standpoint, than raising revenue within the budget window while very likely losing revenue long-term, and making the companies that are paying the added short-term tax revenues happy because they have longer time horizons than the budget rules? BUT – evidence rapidly emerged to the effect that the hope for a second holiday was leading to increased profit-shifting – a subject of study in the paper we discussed yestereday – causing the JCT to conclude that a second holiday would lose revenue even WITHIN the budget window.

–Once Congressional Republicans were focusing on enacting a new set of international tax rules that included dividend exemption, they viewed a holiday as counter-productive in terms of the prospects for doing that, as it would both reduce the pressure in support and possibly undermine revenues to be gained from a transition tax on pre-enactment foreign earnings.

Among other things, the paper focuses on the distinction between the incentives created by (a) a repatriation tax holiday, as distinct from (b) enacting dividend exemption as a “permanent” item, with possibility of an accompanying  transition tax (as was actually enacted in 2017). BTW, for what it’s worth, other countries that shifted to dividend exemption had no transition tax, and I believe I was the first in the US to call for it (in this 2010 paper), although full credit for the idea, in the conceptually similar context of domestic corporate integration, goes to the likes of David Bradford and William Andrews.

Anyway, the De Simone paper is based on comparing two types of US MNCs: those that were MORE likely to want to repatriate CFC profits soon, and those that were LESS likely to have this inclination. We can call the former group the “treatment”firms – those potentially responding more to the prospect of a second repatriation holiday – and the “control” firms that were less likely to respond to that in particular. Treatment firms were distinguished from control firms in part by examining  the characteristics of MNCs that actually had repatriated during the 2004 holiday. The paper also makes use of events that may have made the perceived prospect of an imminent new repatriation holiday seem either more likely or less so (such as, for the former, the introduction of a new repatriation holiday bill in 2008).

In the paper’s analysis, treatment firms, as compared to control firms, generally were larger and more profitable but with lower recent total and foreign growth in pofitability, had higher market-to-book ratios, more working capital, more cash, and less debt, had indicia of greater cash needs, and had larger deferre foreign tax liabilities. So these were in general pretty strong firms, albeit possibly more cash-hungry than the norm. Cash-hunger would of course help motivate wanting to repatriate, as also might low recent growth in foreign profitability, but they do not stand out as firms that would have been unusually distressed, despite the crazy things that were happening in the world economy, in 2008 or thereabouts.

In the data, when a second repatriation holiday seemingly was in the cards, treatment firms, as compared to control firms, (1) had more growth in “excess cash” (although this could not be directly tied to excess cash in the hands of CFCs), (2) reduced share repurchases but not dividends more, (3) did more profit-shifting, (4) had more of a rise in “permanently reinvested earnings” (PRE) that they declared for accounting purposes, (5) had positive stock price effects, (6) did more lobbying for a new holiday, and (7) had more growth in “excess cash” even if they didn’t so lobby. But these differences generally vanished after 2011, when arguably a holiday was no longer much in the cards, but the enactment of “permanent” dividend exemption arguably was.

I found the paper’s empirics generally persuasive – reflecting, of course, that it’s the result I would have expected – although matters of timing for the relevant expectations are inevitably hard to pin down. The main thing I might question or at least supplement, in terms of the paper’s conclusions, is the mechanism suggested for relative rise in declared PRE among treatment firms. The mechanism that the paper suggests is that firms might view increased PRE as likely to increase the amount that they were allowed to dividend home at a reduced tax rate in the event of a new holiday.

In support of this interpretation, (1) the 2004 holiday capped tax-reduced dividends at the higher of one’s PRE or $500 million, and (2) the 2008 “REAP Act” proposal that would have provided for a second holiday repeated this exact mechanism. But, on the other hand, (1) given the $500M number, I don’t know to what extent treatment firms would have anticipated needing more PRE in the event of a second holiday, and (2) it’s amazing to think that Congress might have been stupid enough to encourage PRE by making it the prerequisite for a tax benefit not just once, which is remarkable already, but twice.

My alternative suggestions re. the reasons for a relative growth in PRE among treatment firms, as distinct from control firms, might include such possibilities as (1) declaring PRE and then bringing it home anyway is made less costly, for accounting as well as cash purposes, by a repatriation holiday, and (2) endogeneity: treatment firms might also have for other reasons been more inclined than control firms to value getting accounting benefits from aggressive profit-shifting.

Anyway, here are three of the paper’s takeaways with my comments on them, plus two takeways that I would add:

Paper’s first takeaway: The expectation of a second dividend holiday was a major reason for the run-up in firms’ “excess cash” during the post-2004 period.

This is very plausible, and accords with findings elsewhere in the literature.

Paper’s second takeaway: Expectations about future tax law changes can affect current corporate behavior, and can induce behavior that would have a negative impact on net present value in the absence of the anticipated changes. Here, the point being made is that (when repatriations are taxable) firms reduce their internal liquidity, and force themselves to play costly Twister games with their internal finances, when they shift profits to their CFCs for tax planning reasons.

This, too, makes sense. But, if one is refining broader models of how companies respond to prospective but uncertain tax changes, it’s worth noting that here is truly a quintessential place where one would expect that. Two points about repatriating CFC earnings through an inter-company dividend: the potential tax law change matters a lot, and the independent economic consequences of the action being studied, and its timing, may be relatively slight.

As the so-called “new view” (although by now it dates back to a 1985 article by David Hartman) shows, a repatriation tax has zero incentive effects on the timing of taxable repatriations so long as (1) the after-tax rate of return is the same with or without a repatriation, and (2) the repatriation tax rate is permanently fixed and ultimately can’t be avoided. So anticipated changes in the repatriation tax rate are absolutely at central stage in creating lockout, i.e., reluctance to repatriate today. When the repatriation tax rate can change, a sooner repatriation throws away the option value of waiting for a lower rate in the future. And when it’s systematically likely to decline rather than go up – whether due to a holiday, a cut in the general corporate tax rate, or the enactment of dividend exemption with a lower-rate or no transition tax – then lock-out becomes especially strong.

That helps show the centrality of future vs. present repatriaton tax rates in deciding whether to repatriate today. But it also matters that this is simply a matter of shifting $$ from one pocket to another within the same firm. While this may matter more than zero – given the internal liquidity issues and potential costs of resulting Twister games – it might often be rather different than, say, (1) paying dividends outside the entity to the ultimate owners, or (2) deciding whether to sell one’s appreciated asset (where present and expected future capital gains rates are key, but the sale might significantly affect one’s diversification and risk exposure).

Paper’s third takeaway: Temporary tax rules can have important subsequent planning effects that linger.

Agreed, and this is why the repatriation tax holiday was such a horrendously bad idea. Like non-credible, supposedly “once-only” tax or other amnesties, it made things a lot worse afterwards given the inevitable expectation that it might be repeated soon. The fact that something else ultimately happened instead did not prevent much of the harm from being realized.

My first additional takeaway: the accounting rule for PRE was really terrible. While it’s now moot given that the repatriation tax has been repealed, this may have broader implications regarding accounting rules that create the opportunity for gameplaying based on corporate management’s assertions and representations to the accountants.

Think about it: What the paper suggests is that companies that actually were MORE likely to repatriate their foreign earnings disproportionately got their accountants to agree to the opposite – i.e., that particular profits were going to be kept abroad indefinitely. This is akin to having a self-reported net worth contest in which the poorest systematically claim to be the richest.

My second additional takeaway: The core problem with deferral – i.e., with taxing US companies’ foreign source income specifically when it was repatriated, rather than either immediately or not at all – was not that the repatriation tax rate was positive, but that it was not credibly fixed at a durable rate. The great thing about dividend exemption, all else equal, is that the zero percent rate is credibly fixed at zero, rather than that it is low or high. Again, given the new view, any fixed and ultimately inevitable repatriation tax rate avoids affecting the timing of repatriations (after-tax rates of return may matter too, but their effects on planning are multidimensional), but for positive rates this is presumably much harder to accomplish.

Just to make the point clearer conceptually, suppose it were plausible that Congress, in the future, might possibly enact a repatriation subsidy. (E.g., repatriate a $100X dividend from your CFC, and the Treasury will pay you $100X multiplied by the subsidy rate.) In that admittedly improbable scenario, merely exempting repatriations would lead to lock-in, since companies would want to wait for the possible future subsidy.

Given the difficulty of credibly fixing the repatriation rate, other than at zero, I’d argue that it makes sense to have any taxes on resident companies’ foreign source income be levied immediately, i.e., in the year when they accrue for tax purposes. This is what countries’ CFC rules generally do, including our own subpart F rules and now GILTI.

As I’ll be explaining in my forthcoming international tax article on GILTI, the BEAT, and FDII, dividend exemption does not mean one has a “territorial” system, and indeed it’s been widely recognized that the new US system is not a “territorial” one given the significant taxes it can impose on resident companies with foreign source income.

Raking in the bucks?

I just got a $5.39 royalty check – the latest rich winnings from my satirical law firm novel, Getting It.

Since Getting It is just $3.99 on Kindle., I guess I could use this latest killing to buy it in that format – at present, I only have hard copies plus the doc/pdf files – and still have a cool $1.40 left over. (Enough for a beer out of a Trader Joe’s sixpack.)

Another new publication!

I’ve now published my second article of the day. (I wrote both in December / January, each being only about 10,000 words total.)

This one is entitled “Evaluating the New U.S. Pass-Through Rules.” It was officially published / posted today in Issue 1 of the 2018 British Tax Review, pages 49-67.

The abstract goes like this:

“The pass-through rules that the U.S. Congress enacted in 2017 – permitting the owners of unincorporated businesses in favored industries to escape tax on 20 per cent of their income – achieved a rare and unenviable trifecta, by making the tax system less efficient, less fair, and more complicated. It lacked any coherent (or even clearly articulated) underlying principle, was shoddily executed, and ought to be promptly repealed. Given the broader surrounding circumstances, the mere fact of its enactment sends out a disturbing message about disregard among high-ranking US policymakers for basic principles of competence, transparency, and fair governance.”

With the permission of the publishers, it’s available for download here.

As you can perhaps tell from the abstract, this article is a bit on the candid and unvarnished side – even though it’s been toned down significantly from earlier drafts. But I think the tone is justified given the passthrough rules’ egregiousness – at least leaving aside the old maxim that, if you can’t say something nice, you shouldn’t say anything at all. (That maxim would tend to hold down the quantity of writing about the passthrough rules.)

It also addresses the 2017 act’s negligence or worse (it appears to have been deliberate) in cutting the corporate rate without addressing the use of C corporations as tax shelters that can be used to lower the rate on labor income. Read the article and you’ll find a few well-chosen (I’d like to think) words about that.

New publication

My paper “Goodbye to All That? A Requiem for the Destination-Based Cash Flow Tax” has now officially been published online, in the Bulletin for International Taxation, Volume 72, no. 4/5 (2018). You can find it here, or for that matter also here.

Shortened abstract: “In this article, the author addresses the destination-based cash flow tax, which was recently proposed as a tax reform option in the United States, compares it to its forebears, the flat tax and the X-tax, and concludes that, although its substance has potential merit, it does not warrant further consideration in tax policy debate.”

Cat update

A reader recently asked me: Why no cat updates lately? I suppose the point is well-taken, given that the Internet’s chief virtue, limiting oneself to those that are purely benign, appears to pertain to cat photos and videos.

Having just gotten back from a few days away, our current three are letting us know they missed us.  They had food and regular visits in our absence, but I guess it just wasn’t the same.

Seymour, of course, is mellowest about it. He doesn’t stir much from this chair except to eat, but he’s purring more when petted.

Then there are The Kittens, so to be known forever because we adopted them when they were 6-8 weeks old, at which time I could hold them both in one hand, although by now they are over 5-1/2 years old. (Similarly, my father had a set of female cousins, all born before 1920, who were known collectively as The Girls even when they were in their eighties.) They were pretty frantic on our return because, even though they are cats, we evidently loom large in their universe.

Gary has been meowing loudly and bringing us small mouse toys in his mouth. It was hard to sleep last night because he kept scratching at the covers so he’d have warm hands to sleep on. It was almost enough to make one doubt the common view that he’s perfect. A gently probing paw on the face at night is okay most of the time, but best if he’s calm enough to have retracted the claws fully.

Last but certainly not least – he wouldn’t like that – there is Sylvester, whose frantic mental world I’ve always wished I could imaginatively inhabit for just 5 seconds, so long as I could have a good long rest to recover right afterwards. (We like to say, it’s a shame his mom seems to have dropped him on his head early on.)

He has been meowing loudly for food, even when he isn’t hungry. When he lets me pick him up (an element of surprise helps), he gives a sudden screech, but then, so long as I begin petting his head very vigorously, the way he likes it, he just hangs there like a rag doll, all four paws extended outwards and down, for as long as I am willing to keep it up.

It’s nice to be back, fellas.

Tax policy colloquium, week 7: Lisa Philipps’ Gendering the Analysis of Tax Expenditures: Bridging Two Solititudes in Canadian Tax Policy

This past Tuesday, Lisa Philipps presented the above-titledpaper, happily the day before (rather than that of) our hideous Nor’easter. I was unable to post the next day, as I usually do, due to the crush of other obligations, but now, from a sunnier realm than NYC, here are some thoughts about the paper and topic.

The impetus for the paper (co-authored with Isabella Bakker) is as follows.  Canada’s executive branch, which one might say (without reckless exaggeration) is at present somewhat differently directed than our own, has begun disseminating gender-based analysis of budget measures.  But tax expenditure (TE) analysis and information reporting have not similarly changed.  So the paper’s main impetus is to argue that gender-based analysis of the impact of Canadian TEs would offer a worthwhile expansion of publicly available information and knowledge.

The paper then offers preliminary analysis of various TEs as officially listed and measured. What makes this technically feasible is that Canada has separate filing by married couples. So access to the data permits one to say, for a particular TE, X amount has been claimed by men, and Y amount by women.

Among the pertinent items on the list are childcare and dependent benefits, a child care expenses deduction, and narrowly tailored tax credits or deductions for volunteer firefighters, clergy, police, and members of the military. Also, alimony deductions (and presumably exclusions, as under U.S. income tax law for pre-2019 divorce agreements). And also, pension-splitting.  Under this one, half of one’s pension payments can be reported in taxable income by one’s spouse, rather than by oneself, if both sign an agreement to that effect, without regard to whether said spouse has a legal claim to said half. This is commonly called income-splitting for pensions, in the same sense that, under the U.S. rules, having a joint return in which all relevant dollar amounts (such as tax brackets) are double their levels under individual returns may be arithmetically equivalent to separate returns with income splitting. (The key point here, of course, is the effect of progressive rates.)

Anyway, here are some of my thoughts on the topics raised by the paper:

1) What is a tax expenditure? – The paper takes the government’s official listing of TEs for granted, which is perfectly fine given its purpose of expanding public knowledge regarding the gender impact of various tax rules. But this is a pet topic for me that I have written about elsewhere. In brief, I think the only way to make the term analytically useful or meaningful, in the context of income taxation, is as a way of distinguishing between purely allocative rules (the clear TEs) and those that are part of the distribution system’s doing its job. For example, it would be hard to argue reasonably that solar panel tax credits are an aspect of figuring out who is better off and who is worse off. Rather, such a feature of an income tax would have to reflect (as a matter of plausible rationales, and even if in fact it was passed to reward campaign contributors in the solar panels industry) an allocative aim of affecting people’s energy choices.

From this perspective, many of the items that the paper discusses – for example, the treatment of alimony or marriage or pension benefits within the household or children – really aren’t reasonably labeled as TEs. Even if also reflecting allocative effect and intent (as they well might), they are also a part of how the distribution system “decides” to distribute tax burdens between individuals based on household information about them.

But none of this in any way leans against the paper’s analysis, which takes the official TE list for granted. Indeed, the fact that none of the household-related items are TEs, if one accepts my view as to how thate term is best used, does not in the slightest detract from the importance of analyzing their gender impact.

2) Incidence issues with respect to tax expenditures– The paper takes advantage of the fact that, because Canada has separate filing by married couples (along with information regarding the filer’s claimed gender), one can actually figure out, by gender, who is claiming particular tax benefits. In the US, joint returns would make this impossible from an available data standpoint. But there are still (as the authors acknowledge) incidence questions regarding benefit. E.g., suppose a man in the 40 percent bracket makes deductible alimony payments to a woman in the 20 percent bracket.

Case 1, she is being conned (e.g., as he has better legal representation) and she gets the same amount they would have agreed to had they structured so that it wasn’t called alimony and was neither deductible nor includable. (This is feasible under U.S. income tax law for pre-2019 agreements; I don’t know whether Canadian law makes this any harder.) Here the economic incidence equals the nominal incidence – benefit to him, ost to her.

Case 2, this is mutually well-advised tax minimization. Given the tax bracket differences, her periodic receipt is adjusted upwards by between 20 and 40 percent, relative to the case where the payments would neither be deductible nor includable. In this scenario, both are better-off by reason of the tax treatment.

It’s an empirical question, and one that cannot be answered via tax return information, which of these two cases is more representative in practice, at a particular time and place.

3) Joint return vs. separate return – I increasingly feel that, for analytical purposes, it’s confusing rather than helpful to distinguish between the “joint return” and “separate return” approaches. (This is not to deny, of course, that, if one is making a concrete political proposal, using the terminology may be essential.)

Case in point, joint returns with double for all the dollar amounts can be the same as separate returns with income-splitting (i.e., half of the total income reported on each return).

Here’s what’s of greater interest: (a) the use of what I’d call “household information” (including income of other household members, the # of mouths to be fed, etc.) in determining taxes and/or transfers for any individuals in the household; (b) what for now I’ll just call “the rest” (administrative and filing aspects, legal liability with respect to claims made, etc.)

I tend to be less instinctively predisposed than the paper’s authors to put legal ownership to particular items at the center of how to think about what’s actually going on (for tax and transfer purposes) in a particular household. But agreed, that stuff can matter, and indeed a lot, depending on the household’s (hard to observe) internal rules and power relationships.

4) Secondary earners – Often in a couple, whether married or not and whether or not recognized by tax or transfer systems as a couple, there will be a “primary earner” and a “secondary earner.” This is not just a function of who is earning more this year, but of who is more definitely tied to engaging in taxable market work. When a given couple has a “secondary earner,” that individual tends to be much more tax-elastic with respect to labor supply than the primary earner. Among other things, this may reflect said individual’s capacity to perform valuable non-market and hence non-taxable services, including taking care of the couple’s children (if any) but also anything else that takes time and effort.

Secondary earners’ greater labor supply elasticity (where present) provides a standard efficiency reason for taxing them at lower rates. But of course in a U.S. joint return, if the primary earner will be working in any event and the question is whether the secondary earner will choose to do so, such individual’s first dollar of potential earnings may already face a high marginal tax rate, because the couple is taking for granted that the primary earner will be earning $X and thus running them at least partway up the marginal rate ladder.

In response to this problem, from 1981(?) to 1986 the U.S. federal income tax system offered a secondary earner deduction. But this was repealed in 1986, on the rationale that it was both too costly and no longer necessary given flatter marginal rates. (But of course, if it hadn’t been necessary it wouldn’t have raised significant revenue – hence these two rationales were inconsistent with each other.)

Anyway, I think secondary earner deductions should be back on the table as an important possible change to current US federal income tax rules. Note, they needn’t require retaining joint returns if there is sufficient cross-reference between spouses’ “separate” returns.

Secondary earner deductions have the potential to be both efficient and horizontally equitable. Efficient because they respond to the possibility that the secondary earner, by working, is forgoing tax-free imputed income. Horizontally equitable, because two couples with the same net taxable incomes are not in fact similarly situated if one has two earners in the workforce and the other just one. The former evidently has both a lower current wage rate and less time available for tax-free yet valuable home production.

There are lots of design questions around reinstating the secondary earner deduction. But if it tends to offer greater benefits higher up the income scale than lower, other adjustments can be made to retain the vertical burden distribution that one wants. Note also that, while I’ve followed past practice in calling it a secondary earner “deduction,” it might also be structured as, say, a flat percentage credit.

5) Other U.S. fiscal system bias against two-earner couples – The fact that the secondary earner has taxable income upon working but not upon staying home is only one way in which the U.S. fiscal system both discourages secondary earners from working and disfavors two-earner households. Other important aspects (and there is a huge literature on this – I’m just referring here to issues that are very well-known in some circles) include the design of Social Security and Medicare, both of which discourage work by secondary earners and disfavor two-earner couples relative to one-earner couples.

6) Childcare expenses – One needs an integrated response to all this, but the question of how the tax system should treat actual or imputed childcare expenses is another huge topic that I don’t think the U.S. system currently handles very well. And this of course goes well beyond just the tax system or even the fiscal system, to include broader issues that might conceivably be better handled through “spending.”


I am currently rushing to complete a particular section of the article I’m in the middle of writing on the new international tax rules from the 2017 act, before heading out tomorrow (weather permitting) for an all too short vacation respite during part of our spring break.

If nothing else, the two particular rules that I’ve been writing about so far are cleverly named – BEAT (for “base  anti-erosion tax”) and GILTI (for “global intangible low-taxed income”).  Less so for the third that I’ll get to later this month, FDII (for “foreign-derived intangible income”).

Tax article writers have already been having much fun in their titles with both names.  E.g., “Get With the BEAT,” “More GILTI Than You Thought,” and “Guilty as Charged.”

By contrast, my current article title is “Does the United States Now Have a ‘Territorial’ Tax System?” I answer this question “NO” by the top of page 2, and then get on with the rest of it.

But I couldn’t help thinking of how GILTI might be renamed, without any loss of acroynmic punch. Suppose it were called “Foreign Intangible Low-taxed or Tax Haven Income.” This would support using the acronym FILTHI.

Hurrah for spring break

“I might take a boat, I might take a plane,
I might have to walk but I’m going just the same
To Negril, Jamaica – Negril, Jamaica, here I come
They’ve got some crazy good sunsets there,
And I’m going to see me some.”
Actually the airplane option – endangered by the storm, but hopefully things will have cleared up enough by tomorrow – would appear to be the only realistic one here. 
Before going, however, or perhaps just afterwards, I’ll plan to post regarding yesterday’s interesting Tax Policy Colloquium paper, by Lisa Philipps of Osgoode Law School in Canada.

NYU Law Forum on the 2017 tax act

Early last month, I participated (with my colleagues Lily Batchelder, David Kamin, and Mitchell Kane) in an NYU Law Forum were we discussed the 2017 tax act with a room full of law students. (The discussion was pitched to their generally not being tax experts.)  We had a pretty good time, and it even somehow seemed as if the audience largely enjoyed it, too.

An article on the NYU website discussing the session is available here.  And if you scroll down, you’ll find a video of the full event.