Wednesday, July 24, 2013

What the banks’ three-year war on Dodd-Frank looks like

A fascinating account from the Sunlight Foundation of the gutting of a regulatory initiative by the kind of methodical persistence that can only be sustained by special interest groups with much to be gained from weak regulation:
In the three years since President Barack Obama signed the Dodd–Frank Wall Street Reform and Consumer Protection Act, federal regulators charged with implementing it have opened their doors to the biggest banks over and over again – 14 times as frequently as they have to representatives of consumer and pro-financial reform groups, a new Sunlight Foundation analysis finds. 
By most accounts, the banks’ besiege-the-regulators strategy has yielded rich rewards in sapping, slowing, and stymieing regulations intended to prevent another massive financial crisis. The emerging consensus is that Dodd-Frank implementation is limping, while the big banks are poised to return to being the most profitable industry in the U.S.
The website feature an interactive showing the number of meetings by sector over the three years; you can mouse over the dots to see their identities. Is it any surprise that the Giant Vampire Squid is at the top with a whopping 222 meetings, followed closely by JP Morgan with 207? Each of these giants independently dwarfs the entire "pro-reform" group, that tiny cluster of dots on the other end of the graph.

Here's a chart depicting meetings by sector over time:

From the discussion:
In the 152 weeks our data cover, we find 59 weeks in which regulators met with financial sector representatives at least once every single day (Monday through Friday), and 47 weeks in which they met with financial sector representatives at least four times. 
... By contrast, active pro-reform groups appeared in only 153 meetings logs – only about one meeting for every 14 regulators held with financial institutions and associations. Moreover, 24.2 percent of pro-reform group meetings took place on a single issue: the Consumer Financial Protection Bureau. 
...Law and lobbying firms, largely working in service of financial institutions, appeared in 707 meetings. Other, non-financial corporate interests, largely energy and agricultural companies, participated in 381 meetings. These companies are major purchasers of derivative contracts, which they use to hedge against price risk.
Imagine you're a regulator. 3,000 meetings with finance industry lobbyists, lawyers, and other corporate interests over three years, each one doing their best to explain why you should undermine the law as written in some tiny way. Would you not want to tear your hair out? Quit in despair? Or just give in to the soothing balm of lobbyist favor? What could possibly be left of the law after this barrage? Meanwhile the anti-regulation crowd has worked very diligently to kill Dodd-Frank's provisions in other ways, such as the lawsuit against the corporate tax transparency provisions sponsored by the American Petroleum Institute.

Sunlight catalogues the delays and dismantling of Dodd Frank that has been accomplished by all this lobbying and litigating and concludes:
...Collectively, the data offer a powerful testament to the oldest and still perhaps most effective technique in the lobbyist’s playbook: sheer persistence. As the Dodd-Frank law passes its third anniversary, lagging on deadlines, and increasingly defanged, the meetings log data offer a compelling reason why: the banks have overwhelmed the regulators. 
Lobbying pays, and it pays whether it is done before, during, or after legislation has been passed. This represents a major governance crisis with no redress anywhere to be found.

Taxcast on unilateral and multilateral approaches to the problem of base erosion

I contributed to this month's Tackle Tax Haven's podcast, together with the very interesting Krishen Mehta, formerly of PWC and now of Asia Initiatives where he works on tax policy issues. This month's topics included the OECD's report on the base erosion project and what countries can do unilaterally while they are waiting (potentially for a very long time) for multilateral change. Have a listen.

Thursday, July 18, 2013

Quebec's governance crisis continues: mayor who resigned under fraud charge gets $267K severance

There is something seriously broken in a governance system that produces this result, as reported by  the CBC:
The City of Montreal has confirmed that former mayor Michael Applebaum has received more than $267,000 in severance pay. 
Applebaum resigned from office after being arrested in June on 14 charges including fraud and conspiracy.
City spokesman Gonzalo Nunez said the law governing severance payouts does not take into account the reason for the end of time in office, except in the case of death.
Mr. Applebaum and Mr. Tremblay should both disgorge their severance pay of course, and while they are at it, why not all the pay they have ever received from the taxpayers of Quebec, in restitution for abuse of office. But that's not what the law requires. More evidence that we are experiencing a serious governance crisis in Quebec.

Wednesday, July 17, 2013

TJN on the rule of law and the forthcoming OECD report on base-erosion

The OECD is expected to release its plan to implement its anti-base-erosion project this Friday, and the Tax Justice Network has issued a pre-emptive strike as it were, predicting that the OECD will do very little by way of fundamental reform. Instead, TJN predicts a patchwork of half-hearted measures that will be delivered through the toothless mechanism of non-binding recommendations, instead of a full-throated commitment to real change, which the TJN says would require endorsement of combined reporting & formulary apportionment for multinational companies. I am still not convinced combined reporting is a panacea, but I understand TJN's perspective that arms' length reporting probably isn't capable of delivering the result they seek with respect to taxing the profits of multinationals on a global basis. You can read TJN's whole report here.

But I wanted to note something that particularly struck me in this report, an issue that I worked through at length not too long ago and that has been bothering me for quite a while, and that is the recognition that for the international tax law system to work, we desperately need more transparency regarding what lawmakers actually do when it comes to international tax compliance. Here is what I said on the subject in an article called How Nations Share:
In the case of international income, it is [tax] disputes and their resolutions, and not the law on the books, that constitute the international tax regime. Yet it is all but impossible for citizens to observe exactly how, or how well, their governments navigate this aspect of economic globalization. [Tax treaties] provide only a design for allocating international income among nation states. It is the application of these agreements that determines how revenues are allocated in practice. This application has taken place over the years through hundreds of thousands of interpretive decisions, the vast majority of which are not accessible to the public. Instead, international tax disputes are mostly delegated to institutions that resolve issues in informal, “non-law” ways with minimal public access to the decision-making process and its outcomes. As a result, international tax law in practice features little or no “law.”
In the article, I explained that when actual decisions about the taxation of multinationals are made through processes that lack judicial oversight and feature no public access whatsoever, this creates a huge knowledge gap between the law as written (in legislation and in treaties among other documents) and the law in action (after the competent authorities make their decisions).

The OECD has exploited this gap to its own institutional advantage, by making itself a norm aggregator and filtering mechanism. It thus deliberately creates a non-legal alternative to direct access to legal decision-making. This is a major, even if not well-understood, impediment to the development of law in taxation that has serious consequences precisely because it shields from public scrutiny just how much base erosion is actually going on. We (the public) simply cannot know how big the base erosion problem really is because we cannot access the competent authority decisions that in fact allocate income internationally. The OECD presumably knows the answer but suits its own political and institutional purposes by publishing a highly-processed version of events in the form of reports, guidance, etc.

Because I view this as a major problem for the rule of law which is made ever more serious by being ignored as an issue altogether, I was very gratified to see TJN pick up on the theme and call for publication of competent authority decision-making:
Currently, the MAP [competent authority dispute resolution process] is very secretive, and decisions often involving hundreds of millions or even billions of dollars are not published. The secrecy of both MAP processes and APAs greatly increases the power of frequent actors in these processes, i.e. the international tax and accounting firms – to the great detriment of the system as a whole. Publication of both would be a great step towards a system which could both provide and more importantly be seen to deliver a fair international allocation of tax.
TJN's worries about the repeat-player advantage gained by tax and accounting professionals are well-founded, but I think what is most clearly articulated here is that this is fundamentally a rule of law matter. Moreover, TJN puts this issue third in line in terms of reform priorities but I actually think it is much closer to being at the top of the heap in terms of structures that cause intractable problems for international taxation. I will be very interested to see how the continued pressure TJN has been able to place on OECD decision-making to date plays out on this particular issue.

Friday, July 12, 2013

FATCA delayed again, this time Treasury giving itself 6 months to get the house in order. Lesson: internationalizing a unilateral legal regime is really difficult.

Treasury issued a new Notice 2013-43 today, pushing the withholding deadline to July 1, 2014 (was January 1 2014), the portal opening to August 19, 2013 (was July 15), and the deadline to register as a FFI is now six months from when the portal opens, which I believe would be February 19, 2014 (was October 25, 2013) (but for some reason this date doesn't seem to be indicated in the Notice, instead it says "On or after January 1, 2014, each financial institution will be expected to finalize its registration information by logging into its account on the FATCA registration website, making any necessary additional changes, and submitting the information as final. Consistent with this 6-month extension, the IRS will not issue any GIINs in 2013. Instead it expects to begin issuing GIINs as registrations are finalized in 2014"). Accordingly, no GIINs will be issued in 2013, IRS "expects to begin issuing GIINs as registrations are finalized in 2014," with the first posting of the compliant FFI list by June 2, 2014.

All of this is going to require Treasury to amend the regulations and the model IGAs to adopt these rules, but taxpayers are advised they can rely on the Notice until that happens. Here is the explanation:
Comments have indicated that certain elements of the phased timeline for the implementation of FATCA present practical problems for both U.S. withholding agents and FFIs. In addition, while comments from FFIs overwhelmingly supported the development of IGAs as a solution to the legal conflicts that might otherwise impede compliance with FATCA and as a more effective and efficient way to implement cross-border tax information reporting, some comments noted that, in the short term, continued uncertainty about whether an IGA will be in effect in a particular jurisdiction hinders the ability of FFIs and withholding agents to complete due diligence and other implementation procedures. 
In consideration of these comments, and to allow for a more orderly implementation of FATCA, Treasury and the IRS intend to amend the final regulations to postpone by six months the start of FATCA withholding, and to make corresponding adjustments to various other time frames provided in the final regulations, as described in section III below.
There is also language about jurisdictions that have signed IGAs but have not yet ratified them according to their internal procedures for ratifying international agreements, in line with what the IRS agreed to in the Norway IGA, but notice that there are no hard deadlines here. Instead, FATCA partner jurisdictions get a "reasonable" period of time to get the IGAs through their respective legislative processes. I cannot see how a foreign jurisdiction would have any recourse to an unfavorable IRS determination that its internal ratification period is "unreasonable." I'd say that falls into a rather delicate area of diplomacy: I doubt the IRS will be eager to tell some other country its legislative procedures are too slow, sorry, you're off our whitelist. In any event:
A jurisdiction will be treated as having in effect an IGA if the jurisdiction is listed on the Treasury website as a jurisdiction that is treated as having an IGA in effect. In general, Treasury and the IRS intend to include on this list jurisdictions that have signed but have not yet brought into force an IGA. The list of jurisdictions that are treated as having an IGA in effect is available at the following address: 
A financial institution resident in a jurisdiction that is treated as having an IGA in effect will be permitted to register on the FATCA registration website as a registered deemed-compliant FFI (which would include all reporting Model 1 FFIs) or PFFI (which would include all reporting Model 2 FFIs), as applicable. In addition, a financial institution may designate a branch located in such jurisdiction as not a limited branch. 
A jurisdiction may be removed from the list of jurisdictions that are treated as having an IGA in effect if the jurisdiction fails to perform the steps necessary to bring the IGA into force within a reasonable period of time. If a jurisdiction is removed from the list, financial institutions that are residents of that jurisdiction, and branches that are located in that jurisdiction, will no longer be entitled to the status that would be provided under the IGA, and must update their status on the FATCA registration website accordingly. 
More details in the link to the Notice. I have some questions about the various exceptions and wheretofores, including a general sense of confusion about which of the various procedures and penalties starts when, but I'll save these thoughts for another day.

Moral of the story: it's really, really difficult to get an international tax regime going on a unilateral basis. There is a story in this about the difference in making a unilateral rule first, and then repeatedly changing it to fix all the problems that inevitably arise, versus sitting around in international networks trying to make sure the rule will work first, before trying to implement it internationally. Empirical project for international law buffs!

Tuesday, July 2, 2013

Licensed to Kill?

The ongoing congressional push for tax reform continues to focus on tax breaks.  In a new twist, Senators Baucus and Hatch have asked their colleagues to provide a "pardon list" identifying those tax benefits worth sparing.

Two breaks that will appear nowhere on any pardon list are tax-free corporate reorganizations and international tax treaties.  That may sound encouragingis it possible that members of Congress will turn a deaf ear to the pleas of big corporations and powerful multinationals?but the truth offers little reason for optimism.

Those preferences, unlike charitable deductions and the exclusion for employer-provided health insurance, simply don't need a pardon.  Why not?  In effect, they have a license to kill.

Although—or, a cynic might suggest, because—both of these longstanding features of the tax law provide vast, open-ended benefits to the well-connected and influential, no uncomfortable questions ever get asked about the large sums of cash they deliver to taxpayers.  Their special status has decades-old roots in the design of what is known as the tax expenditure budget.  Not as comprehensive as it purports to be, that mechanism counts the cost of some tax breaks, but not all.  Those tax breaks not included on the tax expenditure budget escape all scrutiny during the budget process. 

Like Keyser Söze, and the devil before him, these tax breaks have managed to convince the world that they don't exist.  When Congress trains its big guns on tax breaks that benefit the old (like the additional standard deduction for elderly taxpayers) and the infirm (like the exclusion for workers compensation), don't forget the generous preferences they never mention.

New series of papers on why government can and should bring financial services into the tax base

The Victoria University of Wellington (Australia) has a new SSRN issue of interest, featuring a series of papers by Sybrand van Schalkwyk and the ever-prolific John Prebble, all on the topic of consumption tax and financial services. The first of these is the big picture:

"Value Added Tax and Financial Services" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 363-370, 2004
Victoria University of Wellington Legal Research Paper No. 29/2013
Value added tax (VAT) is a relatively modern development. Designers of VAT recognized from the outset that the way in which financial institutions are remunerated creates significant difficulty when the tax is applied to their services. Administrative difficulties relate to imposing invoice-based VAT on service fees charged as part of the margin between buy and sell rates. Theoretical reasons relate to arguments that financial services should not be taxed under a consumption tax because, it is argued, financial services are not consumed in the way in which goods and services are consumed. Because of these difficulties, most jurisdictions have opted to exempt financial services from VAT. However, the commonly accepted reasons to exempt financial services from VAT are not compelling, since financial services are no different in relevant respects from other services. Moreover, there are methods by which financial services could be brought within the VAT base. Furthermore, although exemption is the simplest way for a VAT to treat financial services, it causes significant distortions in the economy. 
This paper is of special interest to me because it confirms my own view that societies are increasingly accepting tax systems that intentionally tax the "easy-to-tax" most vigorously, the "hard-to-tax" much less vigorously and more randomly, and the "impossible-to-tax" not at all, and that these categories have been intentionally constructed from regulatory decision-making that renders various activities to a given category in systematic and purposeful ways.

There are fundamental justice issues at stake in these regulatory outcomes. If Prebble and van Schalkwyk are correct that exempting financial services from VAT is a policy choice that has been made on the basis of an unexamined theory that these flows are hard or impossible to tax which in turn has been decided because of a failure to institute measures that would make them easy (or at minimum easier) to tax, then the failure to include financial services within existing VAT systems is a grave source of injustice within that tax policy choice (that is, in addition to and apart from the question about whether consumption taxation is itself a violation of justice in the exercise of taxation by states).

The papers that follow focus on various ways to increase the coherency of the taxation of financial flows--what I would suggest is an effort to show us that financial flows could in fact be easier to tax, if not "easy-to-tax," given various regulatory reforms:
"Defining Interest-Bearing Instruments for the Purposes of Value Added Taxation"  
Asia-Pacific Tax Bulletin, Vol. 10, pp. 418-426, 2004Victoria University of Wellington Legal Research Paper No. 30/2013 
This is the second of a series of four articles on the taxation of financial services under a value added tax. The first article considered whether, from a theoretical viewpoint, financial services should be included under a value added tax. It concluded that the arguments in favour of treating financial services in the same manner as any other service outweighed the arguments against doing so.

This second article considers the definition of interest bearing financial instruments in some detail. It also considers the kinds of activities that qualify as financial services in relation to the instruments. The definition of financial services is important where a different type of treatment is applied to financial services. If financial services were taxed like any other service, then no definition would be needed. However, where, as in New Zealand, supplies of financial services can be exempted, the definition of financial services becomes very important. Alternatively, if some financial services are to be zero rated or taxed but not others, then it is necessary to have a global definition of financial services followed by individual definitions of the particular kinds of service that are to be brought within the tax base one way or the other. This article begins by considering interest-bearing instruments. 
"Imposing Value Added Tax on Interest-Bearing Instruments and Life Insurance" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 471-468, 2004
Victoria University of Wellington Legal Research Paper No. 31/2013
Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, for instance tax cascading, which in turn causes price distortions. The application of VAT to interest-bearing financial instruments and life insurance is complicated by the way in which financial intermediaries charge for these services.

The first part of this article investigates how interest-bearing instruments can be taxed under VAT, and the second part how life insurance can be taxed under VAT. There are several options for the treatment of interest-bearing instruments. They can be exempted, zero-rated, or included in the tax base. In this last category, there are three possible methods of including interest-bearing instruments: the invoice, cash flow, and truncated tax flow systems. The last is recommended because policy makers have come to realize that the cash flow system cannot be applied without significant modification. 
"Imposing Value Added Tax on the Exchange of Currency" 
Asia-Pacific Tax Bulletin, Vol. 10, pp. 469-483, 2004
Victoria University of Wellington Legal Research Paper No. 32/2013

Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, such as tax cascading, which in turn causes price distortions. The application of VAT to services that bring about the exchange of currency is one instance where financial services could be included in the VAT base. Services bringing about the exchange of currency are a species of financial service, but are inherently different from other financial services since they are relatively simpler than other financial services. Reasons advanced for exempting financial services in general do not necessarily apply to services bringing about the exchange of currency.
Bravo to the authors--this represents a lot of work and adds much to the discussion of how economically-integrated yet politically independent nations can approach the subject of taxation from the perspective that justice matters in policy decisions.