Time for more cat pandering

In response to popular demand (i.e., a recent conversation), I’ve decided that it’s time for more cat pix. So here goes, with quiz question:

I wonder if one can tell just from these two pictures who is the calmer, and who the crazier, of these two brothers (whom I would presume are genetically just half-siblings). Whether or not the pictures give it away, it’s not a close call.

Here’s Gary:

And here’s Sylvester:

So, whaddaya think?

NYU Tax Policy Colloquium, week 2: Rebecca Kysar’s Unraveling the Tax Treaty

Yesterday at the Tax Policy Colloquium, Rebecca Kysar of Fordham Law School presented Unravelingthe Tax Treaty. Here are some of my thoughts regarding this very interesting paper and the issues it raises.

Bilateral tax treaties are the subject of a flourishing sub-literature that has often, and perhaps increasingly, criticized their impact on developing countries in particular.  The paper explores extending this critique to the United States, e.g., because, as a net capital importer these days, we may tend to lose current tax revenue from treaties’ standard practice of having the two treaty partners mutually surrender source taxing jurisdiction with respect to the other’s residents.
For purposes of thinking about the issues that the paper raises, I find the following outline of main treaty provisions helpful. Bilateral tax treaties frequently include the main six types of provisions, among others:

1) Residency/LOB rules – Treaty benefits are accorded to residents of the two treaty partners. However, reflecting corporate residence’s inherently limited meaningfulness as a concept, there may be “limitation on benefit” (LOB) rules that aim to defeat “treaty-shopping” by denying treaty benefits to, say, entities that are residents of one of the jurisdictions but that are functioning as mere conduits.

2) Permanent establishment (PE) rules– Treaty partners generally agree not to tax each others’ residents’ business profits on a source basis in the absence of a “permanent establishment” (PE) in the source jurisdiction – e.g., an office with dependent agents working there.

3) Withholding taxes – Countries frequently tax domestic source dividend, interest, and/or royalty income that is paid to nonresidents. Given the collection and enforcement problems that might otherwise arise, this is done via withholding taxes that have a fixed rate and are gross basis (i.e., no deductions are allowed).  For example, the U.S. by statute has a 30% withholding tax.  In treaties, however, countries may reciprocally agree to a charge a lower withholding tax rate (e.g., 15%, 5%, or even 0%) to each other’s residents.

4) Anti-“double taxation” rules– I’m putting “double taxation” in scare quotes here for a reason. As I discuss below, the concept at issue here is perhaps better described other than as one of double taxation.  But there can be good reason for one not to like the result whereby cross-border investment is tax-discouraged, such as by reason of its being fully taxed in both the residence jurisdiction from whence it came, and the source jurisdiction to which it went. Treaties may address this problem by requiring that each treaty partner, with respect to its residents, either exempt foreign source income (FSI) earned in the other jurisdiction, or grant foreign tax credits with respect to the taxes imposed by the source country. The tax treaties also typically provide mechanisms for achieving consistent treatment if otherwise each country would treat the same income as earned within its own borders.

5)  Nondiscrimination– Treaty partners may agree not to have tax rules discriminating against each others’ residents for tax purposes (although the provisions tend to be quite narrowly drawn).

6) Information exchange, etc. – Treaties also contain lots more types of provisions, which I will here cavalierly funnel into a catch-all, albeit noting in particular information exchange between the two sovereigns as it’s an important aspect that treaty critics often praise.

A number of further common treaty provisions might merit separate coverage due to their potential importance. For example, treaties may indicate that one should apply an arm’s length standard to transactions between commonly owned affiliates, supporting the use of transfer pricing. But these provisions are not as extensively discussed in the Kysar paper as those listed above.

The paper’s main arguments are to the effect that (a) 2 and 3 are bad, (b) 4 and 5 are poorly defined and/or not needed, and (6) can be done separately.  For reasons of time and space, I’ll just discuss (a) here.

WHY CEDE SOURCE-BASED TAX JURISDICTION RE. NON-PE BUSINESS INCOME AND PASSIVE INCOME?

Features 2 and 3 above cede source-based tax jurisdiction with respect to non-PE business income and passive income. This leads to the question: Why would one ever reduce optionality / future flexibility by ceding something in advance? There are 3 main answers that one could offer in this context, pertaining in turn to pre-commitment, reciprocity, and coordination.

Pre-commitment – Retaining discretion for future policy choices is a bad thing if one is sufficiently likely to misuse it. (This of course is the “tie Odysseus to the mast” line of argument.) Governments may benefit, for example, from committing in advance against ex post expropriation of inbound investment. In the realm of free trade, if we posit that tariffs are generally a bad idea, but are too often produced by protectionist forces even when one doesn’t have a malignant clown at the helm, free trade treaties serve to pre-commit countries to do what they would benefit from doing anyway.

The best argument for applying that line of reasoning here is that small open economies may fail to benefit from taxing inbound capital. Absent market power, local rents, etc., the tax is likely to be borne by locals even if it is nominally paid by the foreigners, and may impose greater deadweight loss than the alternative tax instruments that might have been used instead. But the optics of literal tax payment by the outsiders may be unduly enticing.

This line of argument seems more likely to apply to withholding taxes on passive income, than to non-PE business income. For example, foreign multinationals with valuable IP or trade names may be in a position to earn local rents, so one might want to tax them without regard to whether they have been able to avoid crossing the PE threshold.

Reciprocity – A tax treaty’s two parties reciprocally recede. So one’s loss of source-based taxing jurisdiction is offset by the other side’s so receding with respect to one’s own residents.

In a pure symmetry case where investment flows, income earned, tax rates, etc., are completely the same, the revenues foregone equal those that the other side foregoes with respect to one’s own residents. The paper notes that, if net capital importers tend to lose in revenue terms (at least on a current basis) from the asymmetry between the value at stake on the two sides to the deal, that is an issue not just for developing countries, but also for developed net capital importers like the U.S. Agreed that this is relevant to the analysis.

Coordination – If countries attach positive value to coordinating their tax systems with each others’, and thereby avoiding peculiar interactions or combined effects, then tax treaties may offer a valuable coordination device. There has increasingly been concern that countries’ go-it-alone responses to profit-shifting concerns (e.g., digital services tax, UK diverted profits tax, the BEAT, etc.) may interact with each other in undesired ways. But admittedly existing tax treaties may not help all that much in coordinating responses.

How much difference does it make?– To the extent that the U.S. is losing tax base by reason of treaty concessions with respect to non-PE businesses and withholding taxation, it’s worth noting that the treaties’ marginal effect is seemingly reduced by relevant aspects of domestic U.S. tax law. For example, we don’t tax inbound business income on a source basis unless there is a “U.S. trade or business.” The legal concept here overlaps considerably with that of finding a “permanent: establishment.” Likewise, even if we presume that 30% is the truly “intended” withholding tax rate (rather than serving in part merely to give us something to negotiate away on behalf of U.S. taxpayers), the extent to which it can be avoided by, say, using derivative financial instruments (such as notional principal contracts) instead of directly realizing income that is subject to withholding tax – and the extent to which (despite recent regulatory tightening) this might be intended and reasonably so given the “small open economy” issue – is worth keeping in mind.

NYU Tax Policy Colloquium, week 1: Stefanie Stancheva’s Taxation and Innovation in the 20th Century

Yesterday we kicked off the 24th NYU Tax Policy Colloquium, with Stefanie Stantcheva of the Harvard Economics Department presenting Taxation and Innovation in the 20th Century. Here are some of the main points that occurred to me about the paper. (I don’t comment here about the discussions, in order to preserve their off-the-record status – not that this often matters, but so that no one in attendance will ever need to worry about this question.)
1) Strong empirical results – This paper is a major success (for Stantcheva and her co-authors: Ufuk Agcigit, John Grigsby, and Tom Nicholas) because it generates strong and robust empirical findings, using new datasets that permit them to examine how state and local personal and corporate income taxes since 1920 may have affected innovation, as defined by patent quantity and “quality” (measured by citations).  They find very significant tax elasticities for innovation quantity and quality, as thus measured, that are robust across a range of different specifications.  And while a lot of what they find appears to be “business-stealing” – i.e., mere shifting of activity from one tax jurisdiction to another – they conclude that this is not the entire story; there appear also to be (lesser) effects on overall activity levels.

While the paper is science not advocacy, it strikes me as potentially important for a broader set of tax policy debates. A whole lot more would be needed to support some of the implications that I discuss below, and the authors make no claim that such support is likely to be found, but it’s nonetheless worth spelling out here why I think this line of research is of broader interest.

Other empirical results in the paper that are of interest include (a) its comparison of the effects of corporate versus personal income tax rates, and (b) its finding that agglomeration effects, such as the concentration of IP researchers in Silicon Valley, reduce the tax elasticity of the measured behaviors.

2) Contra Diamond and Saez, Ocasio-Cortez, et al? – Our era of rising high-end inequality has helped to shift the Overton window for academic debate, and perhaps even public political debate, regarding how high marginal rates at the top should be.

Optimal income taxation (OIT), a literature to which Stantcheva has (elsewhere) made significant contributions, was long thought to suggest having relatively flattish rates, for what is essentially a technical or logical reason.  OIT aims to maximize a measure of social welfare, typically based on utilitarian or other summations of individuals’ welfare, by trading off redistributive benefits (from declining marginal utility or a pro-egalitarian aggregation rule) against efficiency costs. However, the fact that rate brackets at the very top of the income distribution are inframarginal (because one is guaranteed to be above them) for so small a proportion of the people subject to them, as compared to rate brackets lower down the distribution, pushes against steep rate graduation. E.g., if I know that I will be earning $1 million or more, and the choices that I am considering relate only to the question of how much more, then rate brackets for the first $1 million of my income have no distortionary effects (i.e., only income effects) on what I decide to do.

An influential paper from several years back, by Peter Diamond and Emmanuel Saez, nonetheless used an OIT methodology to support top marginal rates as high as 70%. Their conclusion relied heavily on (1) empirical evidence of low short-term labor supply elasticity, which suggested that the deadweight loss from so high a rate at the top might not be so great, and (2) a view that any lost utility to people at the very top from the high rates would be subjectively, and/or as a matter of social welfare function weighting, indistinguishable from zero. Under the Diamond-Saez paper’s model, one therefore might choose the revenue-maximizing rate for people at the top of the income distribution. One still, however, wouldn’t want a more than revenue-maximizing rate.

An admitted problem with this conclusion was our lack of good knowledge about long-term labor supply elasticities. However, one may derive additional support for very high rates, and indeed for more than revenue-maximizing rates at the top, if one believes (as I do) that extreme high-end wealth concentration can have negative externalities, e.g., by reason of its (in the words of an NYT op-ed today by Saez and Gabriel Zucman) undermining “democracy against oligarchy” and creating “corro[sion of] the social contract.”  Under that view, extremely high wealth and income concentration at the top can be like pollution, which a Pigovian tax would price at marginal cost rather than aiming at revenue maximization.
As Paul Krugman and Matthew Yglesias, among others, have noted, this academic research underlies Alexandra Ocasio-Cortez’s recent call for a 70 percent top marginal rate, which I view as desirably expanding the Overton window for public policy debate, although I wouldn’t go all the way there myself for reasons that it would be too digressive to address here.

So, how is the Stantcheva paper on innovation’s tax sensitivity relevant to all this? The answer is that it could point the way towards a new line of argument against very high marginal rates, in particular at the top where one might expect successful IP entrepreneurs to find themselves.  The point here is not just that innovation, as measured by the paper, appears to be highly tax-responsive, but also that there are arguments for its having great social value.
3) Is “innovation” special? – In my days (back in the mid-1980s) as a Legislation Attorney at the Joint Committee on Taxation, I had a colleague whose area of responsibility included the R&D credit. He personally hated the credit (not that he could do anything about this preference), despite the fact that our economists loved it, at least in principle, because they viewed R&D activity as having positive externalities. He liked to say, in support of his view, that too much of the activity that would end up qualifying for the credit was of the character of, say, McDonald’s or Burger King working on their sesame seed buns.

But even leaving aside knowledge spillovers from businesses’ research that may be more consequential than improving the sesame seed bun, we know there is some patentable innovation that appears to have strong positive externalities. Consider iPhones, or else advances in medical treatment that prolong people’s lives and wellbeing. There is “innovation” out there that (a) creates new consumer surplus, in that the subjective value to people of a newly available item exceeds its market price, and/or (b) increases workers’ productivity, thereby permitting to reach higher levels of market consumption plus leisure than were previously available to them.

Insofar as high taxes reduce the amount of such socially valuable innovation, we have positive externalities from low rates to think about, not just the negative externalities that Saez and Zucman invoke. Thus, a finding that socially valuable innovation is reduced – not just shifted around between jurisdictions – by higher tax rates would complicate the OIT analysis and push back against the Diamond-Saez-Zucman / Ocasio-Cortez approach.

This is very far from being established by the Stantcheva paper (as Stantcheva herself would be the first to agree). But it helps to show why further research, along the lines that this paper significantly (albeit still preliminarily) advances, is of very broad interest.

One should also note the possibility of negative externalities that might be associated with innovation – e.g., if it increases high-end inequality, creates welfare losses from Schumpeterian “creative destruction,” and/or involves strategic and defensive patenting, patent trolling, etc. But in any event the paper helps to point out the need to think more about possible spillovers from “innovation,” as well as about long-term labor supply elasticities, when debating top marginal rates.

4) The paper’s quantity and quality measures of innovation – In keeping with much other IP literature, the paper uses patents as a measure of innovation quantity, and patent citations as a measure of innovation quality. This is inevitably open to challenge and imperfect, as a rich vein of IP literature has been exploring.

5) Policy implications if high tax rates reduce socially valuable innovation – Even if the paper’s possible and still speculative broader policy implications are confirmed, there is a whole lot of instrument choice to think about. E.g., lower rates vs. exempting the normal return to innovation vs. targeted subsidies for innovation vs. stronger IP protections. Each tool might have its own set of tradeoffs.

6) Fiscal federalism issues – Some of the positive spillovers that innovation might yield may operate at the global level. E.g., insofar as iPhones improve people’s lives, such improvement is not conditioned on the iPhone’s having been invented within one’s own taxing jurisdiction. So just as any one country, if it is acting purely selfishly and unilaterally, lacks the incentive to impose carbon taxes that are priced at global marginal cost, so it might be expected to disregard or at least undervalue innovation’s positive spillover effects on outsiders.

On the other hand, “business-stealing” may be locally beneficial even if not globally so. Thus, local incentives to encourage innovation might end up being either too high or too low in the aggregate, but seem likely to be misdirected from a global social welfare standpoint.

I’ve commented here mainly on some of the broader implications, albeit as still unknown, that cause “Taxation and Innovation in the 20th Century” to be of especial broader interest. But I should also note one more time its yielding strong and robust empirical findings, of a sort that researchers more commonly wish for than achieve.

2019 NYU Tax Policy Colloquium

As it’s now less than two weeks to showtime, here is an update on our speaker schedule for the 2019 NYU Tax Policy Colloquium, now including most paper titles:

SCHEDULE FOR 2019 NYU TAX POLICY COLLOQUIUM

(All sessions meet from 4:00-5:50 pm in Vanderbilt 208, NYU Law School)

1.      Tuesday, January 22 – Stefanie Stantcheva, Harvard Economics Department. “Taxation and Innovation in the 20thCentury.”

2.      Tuesday, January 29 – Rebecca Kysar, Fordham Law School. “Unraveling the Tax Treaty.”

3.      Tuesday, February 5 – David Kamin, NYU Law School.  TBD.

4.      Tuesday, February 12– John Roemer, Yale University Economics and Political Science Departments. “A Theory of Cooperation in Games With an Application to Market Socialism.”

5.      Tuesday, February 19 – Susan Morse, University of Texas at Austin Law School. “Government-to-Robot Enforcement.”

6.      Tuesday, February 26 – Li Liu, International Monetary Fund.  “At a Cost: The Real Effects of Transfer Pricing Regulations.”

7.      Tuesday, March 5 – Richard Reinhold, Willkie, Farr, and Gallagher LLP.  [The parsonage allowance and the establishment clause.]

8.      Tuesday, March 12 – Tatiana Homonoff, NYU Wagner School. “Encouraging Free Tax Preparation Among Paper Filers: Evidence from a Field Experiment.”

9.      Tuesday, March 26– Michelle Hanlon, MIT Sloan School of Management.  TBD.

10.  Tuesday, April 2– Omri Marian, University of California at Irvine School of Law. “The Making of International Tax Law: Empirical Evidence from Natural Language Processing.”

11.  Tuesday, April 9– Steven Bank, UCLA Law School. “Manufacturing Tax Populism.”

12.  Tuesday, April 16– Dayanand Manoli, University of Texas at Austin Department of Economics. “Tax Enforcement and Tax Policy: Evidence on Taxpayer Responses to EITC Correspondence Audits.”

13.  Tuesday, April 23– Sara Sternberg Greene, Duke Law School.  A Theory of Poverty: Legal Immobility.”

14.  Tuesday, April 30– Wei Cui, University of British Columbia Law School. “The Digital Services Tax: A Conceptual Defense.”

AALS Tax Section panel

This past Saturday (January 5), at the American Association of Law School’s Annual Meeting (in New Orleans), I was among the four panelists at an AALS Tax Section panel. The panel was organized and moderated by Shu-Yi Oei, the other panelists were Karen Burke, Ajay Mehrotra, and Leigh Osofsky, and the topic was “The 2017 Tax Changes: One Year Later.” For more general background information about the panel, see here (from the Tax Prof blog).

We divided up in advance the particular topics to be discussed by each of us, and here is a very rough effort to reproduce in miniature my comments:

1) What have we learned in the past year about the economic impact of the 2017 tax act?
This morning, the Sun rose. Did we thereby learn something new  about the Solar System? No, because that is exactly what we expected. By contrast, we most definitely would have learned something new (assuming we were still around to reflect about it) if, for some extraordinary reason, the Sun HADN’T risen in the morning today.

For exactly that reason, we haven’t learned all that much, in the past year, about the economic impact of the 2017 tax act. For example, there was absolutely no dispute, among serious, responsible, and knowledgeable people, that the act was going to lose a lot of revenue. And so it has – perhaps slightly on the high side, relative to “dynamic” expectations, but that is what I expected for various reasons.

We also “learned” that it did not stimulate a flood of new U.S. investment and other economic activity. But the only thing that was seriously in dispute in this dimension remains so – what might be the effects on U.S. investment over a much longer time horizon – given, e.g., that the relationship between statutory and effective tax rates for multinationals is not perfectly understood (and may have changed in multiple ways by reason of the 2017 act), and that the long-term effect of rising debt overhang will need more time to be observed.

There also seems to have been, unsurprisingly, a bit of mild Keynesian stimulus at the wrong time, i.e., when it was not really much needed. The rising debt overhang may make it harder in the future to use Keynesian stimulus through budget deficits at times when it might be far more needed.

Whether or not the flood of stock buybacks by U.S. companies was expected, it should have been. What else to do with the money that one is no longer constrained from “repatriating” as an accounting matter? And big U.S. companies with overseas profits were not generally cash-constrained with regard to U.S. investment.

The buybacks gave a great talking point to critics of the 2017 act, because their occurrence seemed so contradictory to the ridiculous talking points that were being made by the act’s proponents. But were the buybacks as such bad? Not really. They presumably shifted funds from companies that had no particular current use for the $$ to shareholders who now might find it transactionally cheaper to direct as they liked the value that was paid out. This can be a good thing. And if the funds transfer was merely being delayed under prior law by international deferral, that wasn’t really doing anyone any particular good (including the U.S. tax authorities).

2) International changes
I’ve discussed the 2017 U.S. international tax changes in greater detail on other occasions. But 3 points I made are as follows:

(a) In the aftermath of GILTI and the BEAT, it’s clearer than ever that we’re in a “post-territorial” world, i.e., one in which the old “worldwide versus territorial” debate has been shown to be orthogonal to the issues of main interest to policymakers.

(b) Many U.S. tax lawyers with whom I have spoken have an aesthetic dislike for the shift in U.S. international tax law, and not just because it wiped out much of their knowledge and allowed their junior associates to be on a more even knowledge footing with them, going forward. GILTI, the BEAT, and FDII (to the extent that anyone actually cares about it) have devalued legal advice based on judgment, relative to clients’ running lots of scenarios to guide tax planning.

E.g., suppose the client is wondering about whether it will face the BEAT this year, rather than escaping it under the so-called 3 percent rule (under which the BEAT doesn’t apply if less than 3% of one’s deductions are “base erosion tax benefits”). Even if one can set the numerator for this computation with certainty – which may not be the case – one is highly unlikely to know the denominator with anything close to certainty, as it may depend on the uncertain course of various business outcomes. So rather than just ask the lawyers what the BEAT means, firms may base key planning choices on running lots of probabilistic scenarios. Whether or not this is any worse than the prior state of the play ifor American or global welfare, it’s definitely much less fun for the tax lawyers.

(c) It’s been interesting to observe that a number of other countries appear to be intrigued by the idea of adopting their own versions of GILTI and the BEAT. While not a huge surprise, I didn’t regard this in advance as entirely certain..

3) Partial repeal of state and local tax (SALT) deductions
On this front, it’s been fun (if that’s the word for it)  to observe the fault lines in academic debate between people who might typically agree more with each other than they do on this issue.

In the broader policymaking world, I’ve been at least mildly surprised by:

(a) the extent to which blue states have stepped forward to devise what might be called workarounds (I think this reflects the legislation’s nasty red state vs. blue state optics).

(b) the extent to which the Treasury, in response, has seemingly been willing to back away from past limited giveaways to what were mostly red state (albeit more limited) workaround schemes. I had wondered if the Treasury might either (i) feel more constrained by past rulings that favored, e.g., the use of state law tax credit tricks to make private school tuition effectively deductible, or (ii) be willing to respond with baldfaced inconsistency as between past red state and post-2017 blue state planning responses.

4) Where might we be headed next?
This remains unclear, given both the long-term fiscal gap and pervasive U.S. political uncertainty. But future action may need to focus more on new revenue sources (such as from VATs, including disguised versions such as the BAT/DBCFT, and/or from carbon taxes and the like), and less on “tax reform.”

Indeed, I think the term “tax reform” is now dead, other than as a synonym for “changes that I, the speaker, happen to like.” And good riddance, as it had outlived its usefulness.

From at least the 1950s through the 1970s, “tax reform” mainly meant broadening the base so that high-end effective rates would tend to come closer to matching the era’s steeply graduated statutory rates.

Then in the 1980s, “tax reform” came to mean broadening the base and lowering the rates, in a manner that was meant to be net revenue-neutral and distribution-neutral. It might also involve switching from the current income tax to a far more comprehensive version of the consumption tax, although that definition didn’t really get very far off the ground until more recent decades, when it continued to lack political traction.

After the so-called 2017 “tax reform” that lost immense revenue, was extremely regressive, and in many respects narrowed the tax base (e.g., via the egregious passthrough rules), I think we can forget about the term’s being used in public policymaking without evoking derisive laughter. Whether or not 1986 tax reform was tragedy (I don’t think it was), 2017 was definitely farce, and this implies no third act for the concept.

Close to publication

If I do say so myself, I’ve always (well, since I wrote it in 3 days, a couple of summers ago) rather liked this paper of mine, which mainly takes the form of a dialogue between two friends who disagree about the ethics of “legally defensible” tax planning by the super-rich and large corporations that might have the effects of helping to super-charge plutocracy and monopoly. It’s no Socratic dialogue – the contestants are evenly matched, reflecting that I myself partially agree with each.

The article is now close to being published, as a chapter in the forthcoming Oxford University Press volume, Tax, Inequality, and Human Rights.

Tax issue re. Donald Trump, Michael Cohen, and Stormy Daniels

A reporter on the national beat recently asked me whether Trump might be guilty of tax fraud if he deducted the payments of $35,000 per month that he was making, for some period, to reimburse Michael Cohen, for paying $130,000 in hush money to Stormy Daniels. The payments reportedly included a gross-up for the income tax consequences to Cohen, under the assumption that he would include them without deducting the hush money payment.

This would have been a great question for my Federal Income Tax exam, if only (1) I had heard it in time, and (2) it weren’t too politically sensitive to be a proper exam question. (E.g., one doesn’t want students’ answers to be influenced by their own political views, or their perceptions as to mine.)

Anyway, here’s a lightly edited & expanded version of my response:

That’s an interesting question. The key tax issue is, what would have been Trump’s legitimate business reason for deducting the payments to Cohen?  Clearly there would be tension between Trump’s (1) saying it was just personal, hence not a campaign finance violation, and yet also (2) treating it as deductible (if he did).

But here’s an odd aspect of it. Suppose we posit that Trump is a long-time criminal who sought the presidency for multiple reasons, but in part as a money-making scheme that would give him opportunities to defraud the U.S. government and the American people by – just to give a partial list – violating the emoluments clause, putting foreign policy up for sale, having the U.S. government pay fees to his businesses, serving the interests of foreign governments that were giving him a lot of money, and so forth. To the extent that he was seeking to maximize the profits from his preexisting business by becoming president, illegal payoffs to Michael Cohen to help him win the election might be viewed as an expense of this business.

Among the relevant tax law doctrines here is the one holding that one can’t deduct as business expenses the costs of seeking to enter a new line of business. So, just as law students can’t deduct law school tuition (but an established lawyer may be able to deduct expenses of paying for continuing legal education), Trump in 2015-2016 couldn’t properly deduct the costs, such as paying off Cohen, of seeking the presidency, if we consider his seeking public office to involve entry into a new business.

But insofar as he was merely seeking to advance his preexisting criminal career by running for president, the case for the business deduction is strengthened.

In short, I think a strong argument against viewing deduction of the amounts paid by Trump to Cohen for silencing Stormy Daniels as improper (whether or not as meeting the mens rea requirement for tax fraud) relates to the view that Trump incurred these costs as part of an ongoing course of criminal activity, of which his political career is merely a continuing part.  Kind of like Michael Corleone moving the family business to Las Vegas.

So far as the mens rea required for tax fraud is concerned, Trump may also have reasonably believed that this line of argument made the payments to Cohen a proper deduction, since surely we know that he was lying when he said publicly that it was merely a personal and private matter.
A further issue pertains to Internal Revenue Code section 162(c)(2), which denies deductions for “an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty or the loss of license or privilege to engage in a trade or business.”

The payoffs to Daniels via Cohen do not appear to have been an illegal bribe or kickback under relevant U.S. law – except, of course, for the campaign finance angle, which led to Cohen’s guilty plea.  Does this make it a nondeductible illegal payment (to Daniels via Cohen) by Trump?  Does it matter if we accept the apparent DOJ position that a president can’t be indicted while in office?  Does it further matter that the statute of limitations will apparently run while he is still in office if he serves for at least five years?
I suppose we could also ask whether the expense could be deducted or instead was required to be capitalized, as an input to creating goodwill. (Or was it merely about preserving existing goodwill? Cf. the pompous, confused, Delphic, and ultimately verging on useless analysis that Justice Cardozo offered in Welch v. Helvering.)

Sounds like a great topic for further legal research by someone (although I don’t think it will be me).

Reilly on Shaviro on the pass-through rules

In his newly posted piece on Forbes.com, “Law Professor Argues New Pass-Through Rules (199A) Are Horrible,” Peter J. Reilly in Forbes reads my article on the pass-through rules, supplemented by a phone interview. He notes that I published the piece in the British Tax Journal, rather than in the U.S., because (however justifiably) its tone was less temperate than is usual for me.

He notes that I credit section 199A with having “achieved a rare and unenviable trifecta, by making the tax system less efficient, less fair, and more complicated,” and that I compare the 2017  proceedings to Gilded Age politics.

It’s a fun response by Reilly, and insofar as he disagrees with me it’s because my noting that the provision will require business people to “pay large sums to tax lawyers and accountants to figure out how best to structure their arrangements with an eye to minimizing federal tax liability” is good news for accountants such as him.  “So a small portion of those large sums is coming my way.”

Reilly also quotes my noting, in the article, that the motivation for the pass-through rules appears to be sociological – aimed at rewarding members of the business elite while excluding member of the more educated professional and academic elites, simply because these are self-consciously distinct groups and the former were driving the bus in 2017.

He responds that this mistakenly classifies accountants as part of the educated classes and the intellectual elite. That may well be right, if one looks just as accountants from a sociological standpoint. But in the 199A list of professions banned from getting the 20% tax cut (other than below income phase-out), accountants were unlucky enough to get grouped, based on prior statutory precedents, with the likes of lawyers, doctors, and artists.

BTW, on a related note, I recently heard through the grapevine an explanation of why, at the last moment in the 2017 enactment process, architects and engineers were taken out of the professional classes’ exclusion from full pass-through benefits. The word is that Bechtel told their Congressional patrons (or servants?) to take out engineers, and architects got pulled too because the two groups were listed right next to each other, and a second deletion was thought useful in obscuring the political deal.

Gives you a nice sense of the sheer thoughtfulness behind contemporary Congressional Republican industrial policy.

Talks in Tel Aviv

This Thursday night, on the day after my last class of the semester, I’m heading to Tel Aviv, where I’ll be participating in two events next week at the Bar Ilan Law School. First, on Tuesday, December 12, I’ll discuss my recent article on international tax policy after the 2017 U.S. tax act (see part 1 here and part 2 here). This may be the last time I discuss this piece at a seminar, but as I’m in effect expanding it (plus other stuff) into a short book, it remains reasonably fresh to me.

Second, on Thursday, December 14, I’ll be among those discussing Tsilly Dagan’s excellent recent book, International Tax Policy: Between Competition and Cooperation. We international tax policy book authors need to stick together. Her book is complementary to mine, as I’m mainly interested in the unilateral angle (what a given country might want to do absent strategic interactions between countries) and she is more interested in the strategic aspect. In the time allotted to me, I’ll discuss underlying dilemmas in the field, the book’s main contributions, and follow-up qustions or issues.

Comments at NTA plenary session on fiscal policy after the 2017 act and the 2018 midterm elections

Today at 10:15 am, the National Tax Association’s 111th annual meeting had a “plenary session” on the topic of Fiscal Policy After the Midterm Elections. The law prof on the panel was originally scheduled to be Michael Graetz, but he got trapped in NYC by the freak November snowstorm, so yesterday afternoon they decided to call for the left-hander, and asked me if I would be able to sub in as a panelist. I said yes, and here is approximately what I said in my 5-minute opening statement on the panel:

I have 5 points to make today about fiscal policy in the aftermath of the 2017 tax act and last week’s midterm elections: 

1) I don’t call what happened last year “tax reform.” Not because it was bad legislation – although I think that in the main it was, despite some good features – but because the term has become completely empty, and now just means “legislation that the proponents like.”

The 1986 Act was called “tax reform” because it related to a particular conceptual model that had captured the term’s then-agreed meaning, and that involved cutting rates and broadening the base while being at least short-term revenue and distribution neutral.

The 2017 act was unfunded, seems fiscally unsustainable, and in some ways narrowed the base, even from a consumption tax perspective (which I consider an entirely valid one for assessing “base-broadening”). For example, a broad-based consumption tax wouldn’t have industrial policy in it like that from the pass through rules.

2) The 2017 act’s proponents undermined its long-term prospects by allowing it to look unprincipled – For example, it doesn’t look like good faith to cut the corporate rate to 21% without either funding it or attempting to limit the use of corporations as tax shelters by high-earning owner employees. The passthrough rule look like sociological discrimination in favor of business types over professional types and employees, for no discernible reason other than the pass-throughs telling Congress “the C corporations got theirs, so we want ours.” Meanwhile, employees not only pay higher rates than non-employees who are doing the same jobs, but lose all business expense deductions.  This is not a defensible policy, even though it’s true that, in practice, actual employee business expense deduction claims may tend to include a lot of junk. 

The new restrictions on state and local income tax deductibility might have been viewed less hostilely in the blue states if the overall bill hadn’t looked to so many people as something that was politically targeted and designed in bad faith.

3) It’s hard to see a sustainable budgetary path forward – Democrats are unlikely to play the fools a third time with regard to addressing the fiscal gap, after Clinton was followed by Bush II and Obama was followed by this tax bill. This is dangerous for our country, and reflects a broader breakdown of cooperative political norms that are really vital to our national welfare.

4) The broader destruction of American social capital in recent years has further bad implications for the tax system – If no one believes in a fair, cooperative policy process any more, and the IRS has next to no auditing capacity and an inadequate budget, could we be risking a serious tax compliance breakdown, from changed behavioral norms?  It’s not impossible.

5) On a brighter note, thank goodness the unhelpful “worldwide vs. territorial” distinction in international tax policy discussion has been put to bed. By repealing deferral, we replaced “now or maybe later” taxation of foreign source income with “now or never” taxation, but the “now” has been significantly expanded. The new international provisions have serious flaws, but could in principle be cleaned up a lot if we still had a functioning bipartisan legislative process. And they do mostly focus on issues of genuine concern that tend to lack clear answers from a policy standpoint.

It’s also interesting to note that other countries are starting to copy aspects of the BEAT and GILTI. This might be good or bad for the U.S. and for the world, and doesn’t prove that the provisions are good ones, but it is an interesting trend to keep in mind.

It could conceivably betoken a future era of greater global cooperation than we observe right now. And why don’t I close now on that relatively optimistic note.

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