Of particular interest to many of us may be (1) Part LL, starting at page 47, establishing a Charitable Gifts Trust Fund, and (2) Part MM, starting at page 56, which establishes an Employer Compensation Expense Program.

The Charitable Gifts Trust Fund creates two distinct accounts, one called the “health charitable account” and the other called the “elementary and secondary education charitable account.” The moneys contributed to each (or otherwise accruing to it) are held separately from each other and everything else under the state’s purview, under the joint custody  of the state comptroller and the commissioner of taxation and finance. These moneys generally are required to be expended only for specified services that relate to the purposes indicated by the accounts’ names.

Starting in 2019, by making a timely contribution to one of these accounts, one can qualify to receive an 85 percent tax credit against New York State income tax liability with respect to the amount contributed.

I haven’t yet had a chance to do any serious analysis of this provision – pertaining either to how it works, or to its effects on federal income tax liability. But suppose one makes a $100 contribution to one of the funds, thereby reducing one’s New York State income tax liability by $85. Assuming a favorable federal income tax analysis, this yields the contributor a federal charitable deduction in the amount of $100. Depending on the relevant marginal rate, this could potentially reduce one’s federal income tax liability by more than the $15 difference between $100 and $115.

For this result to follow, the federal income tax measure of the charitable contribution would have to be $100, not $15. But there are both administrative and case law precedents in support of this result. (And note that, when a charitable contribution is deductible under New York State law, one generally does not have to reduce the federal value of the contribution by the state tax saving.) The use of the funds would also need to have economic substance, compared to simply paying state income taxes. But if you read the new law carefully, you will see the aspects of such substance that a contribution to either of the funds has – in particular, given the degree of pre-commitment of the funds. Indeed the NY State legislature might receive useful information from contributions to the two programs regarding donors’ substantive policy preferences.

Under Part MM, the Employer Compensation Expense Program, employers that are required to withhold income taxes from their employees’ wages can elect to pay a special payroll tax that equals a specified percentage of the payroll amounts paid to covered employees. The percentage is 1.5% in 2019, 3% in 2021, and 5% starting in 2021. Covered employees get state tax credits for their shares of the special payroll tax thus paid by the employer.

With the caution that my understanding of the provision remains very preliminary, the effect may be as follows. Suppose that I am a covered employee of an electing employer that is taxed at the 21 percent federal corporate rate, and that in 2019 the employer paid me $1,000 of wages, on which it paid a $15 special payroll tax. My New York State income tax liability declines by $15.

Deducting the $15 payroll tax as a business expense would reduce the employer’s federal income tax liability by $3.15 (at the 21% rate). Meanwhile, my reduced state income tax liability has no adverse federal income tax consequences for me, assuming that the transaction is respected for federal income tax purposes, if the extra $15 would havbe been nondeductible anyway. Also, the employer’s current year tax flows would not be adversely affected by keeping current on the new payroll tax, insofar as it comparably reduced state income tax withholding on its employees’ behalf, to reflect the expected reduction in their ultimate state income tax liabilities.

Let’s assume that the federal income tax results here are indeed as stated. Why would the employer make the election, given that it’s still worse-off after tax under the stated facts? The main point here is that, as a general matter, employees may be willing to accept less pretax compensation when they are paid in a more tax-favorable, rather than a less tax-favorable manner. For example, suppose that my employer offered me a choice between (a) a higher salary but no employer-provided health insurance, and (b) a lower salary but with federally excludable health insurance benefits. It would be unsurprising if I agreed to (b) in lieu of (a), in part or even wholly by reason of the federal income tax savings. This is par for the course.

More broadly, it’s long-accepted Tax Planning 101 that parties engaged in arm’s length transactions with each other will often have the flexibility to determine which of them will bear particular tax consequences, either favorable or unfavorable. Thus, in my Tax I class, I have long emphasized what I call “collective tax minimization” – the fact that, so long as the transaction parties can duly adjust multiple transaction terms, they may mutually benefit from their structuring their agreements in such a way as to keep their collective tax liability as low as possible.

Thus, consider employee stock options. As a practical matter, they often can be structured to be either (1) currently deductible by the employer and includable by the employee, or (2) currently neither deductible nor includable.  (To simplify, let’s ignore here questions of future deductibility and includability, and of the possible effect on future employee capital gains realizations.) All else equal, (1) is better for the employer, and (2) is better for the employee. But if they can adjust the gross (i.e., pretax) value of the option grant to reflect whether they are choosing (1) or (2), then their interests may align.

For example, suppose that the employer faces the corporate rate of 21%, while the employee faces the top individual rate of 37%. Then option (2) is collectively better for the two parties combined than option (1). But, for each $100 of stock options granted, (2) is $21 worse than (1) for the employer (all else equal), albeit $37 better for the employee.

Not to worry, however – both are better off under (2) than they would have been under (1) so long as the option grant is between $21 and $37 smaller (per $100 of options that would otherwise have been granted) under (2) than it would have been had they chosen (1).

Obviously further legal analysis is required before one can definitively set forth the federal income tax consequences of employers’ electing to participate in the Employer Compensation Expense Program. And participation in the Program may not be the easiest thing in the world to establish and explain adequately to employees. But this provision, like that pertaining to the Charitable Gifts Trust Fund, has the potential to mitigate the adverse consequences to New York State residents of the 2017 tax act’s largely repealing state and local income tax deductions. And it does so within the 2017 act’s deliberate contours, which were based on the view that employer business expenses, like individuals’ charitable contributions, should generally be treated more favorably than individuals’ payments of state income tax liability. So both provisions can reasonably be viewed as wholly consistent with the intent behind the 2017 tax act.

“Is it hard to make arrangements for yourself / When you’re old enough to repay, but young enough to sell?”

So asked Neil Young at age 25. But by the time you’re 59-1/2, while one hopes you’ve repaid and built up some equity (if you’re a homeowner), are you still young enough to sell? It can be a transitional age, as I know from recent personal experience – rather late to start a new business or career or start living in a new place (except for a few relatively privileged and successful people), rather early to be thinking about retirement, and – at least for significantly older age cohorts than my own, when people tended to marry and start raising families (if that was their path) by their early to mid twenties – a bit late to be putting one’s kids through school.

It’s thus always seemed a bit odd to me that individual retirement account (IRA) early withdrawal penalties – discouraging withdrawals that undo the IRA provisions’ aim of encouraging retirement saving – cease to bite when one reaches the particular age of 59-1/2.  That’s awfully early from a retirement standpoint, yet a bit late for some possible uses of the funds – e.g., handling major life cycle expenses or charting a new course in life.

I gather that the use of this age dates from 1974 ERISA legislation, which included an IRA provision although prior to the full-fledged IRA boom. This was a time when “normal” Social Security retirement started at age 65, with “early” starting at age 62. I’m told that someone or other who was guiding the ERISA legislation, possibly at the staff level, apparently figured that age 60 was about right for permitting people to withdraw retirement savings without penalty, perhaps on the ground that voluntary retirement savings had to be more leniently structured than the mandatory kind that Social Security offers, or else people wouldn’t opt in sufficiently.  The reason for then picking 59-1/2, rather than 60, was to make it seem more appealing still to the prospective participants, just as retail stores offer 99-cent pricing.

Anyway, IRAs to this day have early withdrawal penalties. For traditional IRAs, you’re taxed on the withdrawal (in effect, under normal income tax rules), but with the addition of a tax penalty equaling 10% of the amount withdrawn. There is a hardship exception to owing the penalty, but it’s fairly narrow – covering, for example, death or disability, unreimbursed medical expenses, and health insurance premiums while unemployed.

Evaluating the withdrawal penalty requires a deep dive into theories of lifecycle optimization – how would people generally be expected to optimize the allocation between periods of their lifetime resources?  And secondarily, why would the government seek to influence what people do? Here the main rationale is behavioral – e.g., if we think that people are prone to irrationally under-saving for retirement – but there are also aspects of possible market failure (e.g., difficulty in life-annuitizing sufficiently given adverse selection, or on the other side difficulty of borrowing against future earnings) and moral hazard (e.g., expectation of being supported at retirement if one under-saves).

It’s often said (as a convenient, if over-simplified, shorthand) that the goal is to increase consumption-smoothing, which at the limit would mean equal consumption in all periods, if all periods are otherwise the same and one has period-specific declining marginal utility of consumption. But of course there can be rational reasons, unrelated to market failure or moral hazard, for favoring higher or lower spending in different periods. These might range, for example, from one’s taste for consumption when young versus old, or alternatively for a particular pattern such as rising consumption or for periodic “binge” years. One also might have periods with especially high needs (e.g., to launch one’s children or pay uninsured medical costs).

But the standard conclusion, which I certainly accept, is that the main aim calling for policy intervention with regard to saving – leaving aside the question of borrowing against future anticipated resources – is to push people towards greater retirement saving. Only, one should think about the possibility that they will want to take back some of the savings sooner than anticipated. Now, just to make voluntary retirement saving more attractive than it would otherwise be, one might want to allow some of this. If the saving is voluntary, rather than mandatory like Social Security (assuming effective barriers to borrowing against expected future Social Security benefits), then one reason for allowing early withdrawal – even where it might undo the policy to a degree – is to reduce people’s reluctance to participate. But in addition, unanticipated shocks may contribute to early withdrawal’s being apparently optimal in some cases, and not just “leakage” that reflects the reasons for expecting too-low retirement saving.

The Jones et al paper makes an ingenious use of IRS data to examine the effect of the 10% early withdrawal penalty on behavior around traditional IRAs. It examines withdrawals during a 5-year window for people, around the year in which they turned 59-1/2. As it happens, given the period covered, these were people born between 1941 and 1951. The data includes people’s birthdays, how much they withdrew in a given taxable year, and what they paid in penalties. Since the actual withdrawal dates aren’t known (other than whether they led to a penalty), the key distinction is that between people who turned 59-1/2 early versus late in the middle year. If this date was early in the year, then (a) any penalty paid could have been avoided by waiting not all that long, and (b) there was more time in which withdrawals could be made after the penalty had ceased to apply (a distinction that one could imagine not mattering all that much, but in the data appears to have mattered).

A central finding was that people very much did respond to the early withdrawal penalty. In other words, it discouraged prior withdrawals, as it was meant to. This would have been an obvious result if we could assume that people are well-informed and acting rationally, but given questions about that it was worth establishing empirically. One imagines that the prominence of this date, perhaps including in brokers’ solicitations and the like, would help to fix it in people’s minds, along with the strong evidence from behavioral literature that people hate “penalties.”

But a secondary finding in the paper is that a distressingly high percentage of individuals, many of them low-income, incur the early withdrawal penalty when it seems relatively irrational to have done so – e.g., when one’s turning age 59-1/2 must have been relatively close, rather than being far enough in the future (such as December) that even a 10% penalty might have been preferable to, say, multiple months of high interest rate credit card debt.

Especially as applied to lower-income individuals, the reason for the penalty is so that it won’t be incurred and people will retain their retirement saving. But it uses a cliff, and if it’s being incurred too frequently that might indicate a need to rethink the discouragement design.

A related issue concerns the main reasons for favoring both greater retirement saving and an ability to access funds pre-retirement (and also potentially to borrow) in response to great needs. Just as we want people to have adequate retirement saving, so we want them to be able to meet major medical needs, smooth consumption when they lose their jobs, handle disability expenses, etcetera. And both choice failures and market failures (along with having low lifetime income) may undermine their doing this adequately.

When one is thinking about these various needs, whether incurred later or sooner, there are two complementary perspectives that one could have in mind. The first is optimization. Is one making the best use of one’s lifetime income, treating that as fixed? In principle, improving someone’s lifetime optimization, such as by adjusting for choice failures or solving market failures that the government is better equipped than private firms to address, can make her better-off at zero cost to everyone else. (If this sounds paternalistic, it is – but if one wholly rejects it then one should question the existence of anything like Social Security. A key mitigating idea is that, much of the time, one will only be forcing people to do things that they wanted to do anyway. E.g. I personally am not being forced by Social Security to over-save for my retirement. It’s in effect just a floor on my retirement saving.)

The second approach I’ll call adequacy, for want of a better word. We may want to make sure that people can meet basic needs of retirement, sickness, disability, etcetera.

The optimization perspective arguably supports having Social Security as a forced retirement saving program that could in principle be actuarially fair as to everyone (although of course in practice it transfers resources between age cohorts, different types of households, etc.). The adequacy perspective might call for, say, paying demogrants to retirees, and then separately deciding on the financing for this benefit as just one more input to one’s overall distribution policy. Likewise, it might call for a general safety net approach to earlier needs arising from unemployment, accident, sickness, etcetera.

While we employ aspects of both approaches in the U.S. fiscal system, a more generous social safety net and approach to adequacy might ease (although not eliminating) our concerns about optimization, by mitigating both the worst failures of optimization and our conviction that there are failures (given the connection between consumer choice and reasonably presumed utility). Thus, for example, returning to IRAs and early withdrawal penalties, the case for allowing hardship withdrawals without penalty would be eased if the needs that most obviously might trigger this approach were better approached by our fiscal system from the adequacy perspective.

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.

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.”

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.