Tax Advice for the Second Obama Administration

Taxprof posted news today about a conference at Pepperdine scheduled for January in which I'll be participating with comments on U.S. international tax policy.  Lineup:

Introduction and Welcome

• Deanell Tacha (Dean, Pepperdine)
• Chris Bergin (President, Tax Analysts)

Keynote Address:  Michael Graetz (Columbia)

Occupy the Tax Code:  The Buffett Rule, the 1%, and the Fairness/Growth Divide

Moderator:       David Brunori (Tax Analysts)

Papers:            Dorothy Brown (Emory), Francine Lipman (UNLV), Kirk Stark (UCLA) (with Eric Zolt (UCLA))

Commentary:  David Miller (Cadwalader, New York), Bruce Bartlett (New York Times) 

Estate and Gift Tax

Moderator:       Paul Caron (Pepperdine)

Papers:            Ed McCaffery (USC), Grayson McCouch (San Diego), Jim Repetti (BC) (with Paul Caron (Pepperdine))

Commentary:  Joe Thorndike (Tax Analysts)

Luncheon Address:   David Cay Johnston (author/journalist)

Business/International Tax #1

Moderator:       Tom Bost (Pepperdine)

Papers:            Steve Bank (UCLA), Karen Burke (San Diego), Martin Sullivan (Tax Analysts)

Commentary:  Michael Schler (Cravath, New York)

Business/International Tax #2

Moderator:       Khrista McCarden (Pepperdine)

Papers:            Reuven Avi-Yonah (Michigan), Allison Christians (McGill), Susan Morse (UC-Hastings)

Commentary:  Robert Goulder (Tax Analysts)

Closing Remarks:  What Have We Learned Today?:   David Cay Johnston (author/journalist)

The Tax Dodger Ledger, Updated

Here is the Guardian with a "roll call of corporate rogues who are milking" the UK, naming (I've re-ordered alphabetically, and added links):

Amazon--"paid just £30m in tax over the past four years despite generating more than £3.1bn in sales"
Apple--"avoided over £550m in tax on more than £2bn worth of underlying profits in Britain"
Asda--"payments it has made to US parent Walmart has cut its UK tax bill by £250m"
eBay--"channels payments through Luxembourg and Switzerland to avoid paying nearly £50m in tax in Britain"
Facebook--"paid just £30m in tax over the past four years despite generating more than £3.1bn in sales"
Google--"paid just £30m in tax over the past four years despite generating more than £3.1bn in sales"
Ikea--"siphoning off profits abroad in the form of royalty payments to a sister company"
Starbucks--"no corporation tax in Britain for the last three years"
Vodafone--paid no tax in the UK last year, and proud of it.

As I've said before, this is all part of the global system--a feature, not a bug.  It's not a coincidence that these same countries would be listed on a US-based ledger (well, not Asda).  So if a person wanted to avoid supporting tax avoiders with their post-tax wages, they would have to work very hard to do that.  

Canada negotiating on FATCA

Possible advancement on the FATCA front?  From Davies Ward:

The Canadian Department of Finance announced on November 8th that negotiations are being held between Canada and the United States on an agreement to improve cross-border tax compliance through enhanced information exchange under the Canada-United States Tax Convention. The changes would support the provisions of the United States Foreign Account Tax Compliance Act (FATCA). 

The announcement is welcome news to Canadian financial institutions and investment funds. They have been waiting to see whether they will be required to enter into individual agreements with the U.S. Internal Revenue Service to avoid becoming subject to the onerous new withholding taxes FATCA will impose on non-participating financial institutions. ...

The announcement does not include any details ... The talks appear to be in their early stages, as is evident from the fact that Canada is not mentioned at all in a separate announcement released by the U.S. Treasury Department on the same date. 

No details, early stages, who knows what will happen.  I am not sure why we are still in early stages when we apparently had the same news six months ago and nothing seems to have moved since then; then again, I can't find the Nov 8th 'announcement' of which DWVP speaks, so I am working in the dark here.  Here, however, is the US Treasury's press release.  It says:

The U.S. Department of the Treasury today announced that it is engaged with more than 50 countries and jurisdictions around the world to improve international tax compliance and implement the information reporting and withholding tax provisions commonly known as the Foreign Account Tax Compliance Act (FATCA). 

 ...The Treasury Department has already concluded a bilateral agreement with the United Kingdom.  Additional jurisdictions with which Treasury is in the process of finalizing an intergovernmental agreement and with which Treasury hopes to conclude negotiations by year end include: France, Germany, Italy, Spain, Japan, Switzerland, Canada, Denmark, Finland, Guernsey, Ireland, Isle of Man, Jersey, Mexico, the Netherlands, and Norway.

So either DWVP missed the mention of Canada or the US added it in later.  If the latter, that's also very interesting.  Davies Ward has this cute little picture to denote what negotiating with the US on FATCA looks like, but somehow I feel like this might not  capture the mood, quite, so I added a caption to help it along:

Its possible the lady on the right plans to turn that finger-bang on
her smiley-faced compatriot if things don't go well here.

Recall that the Finance Minister has been very vocal in his opposition to FATCA.  About a year ago, KPMG reported:

... Jim Flaherty has sent a letter to several major U.S. newspapers expressing Canada's concerns about the far-reaching implications of the extraterritorial U.S. Foreign Account Tax Compliance Act (FATCA) and the "nerve-wracking" effect that the Foreign Bank Account Report (FBAR) reporting rules has on Canadians. The letter, dated September 16, 2011, criticizes the broadness of the U.S. rules that would essentially cause Canadian banks to become "extensions" of the Internal Revenue Service (IRS). Flaherty also notes that the rules raise privacy concerns for Canadians who may not be aware that they needed to file U.S. tax returns. 

It is unclear what effect this Canadian political pressure may have on the U.S. administration of the reporting requirements and penalty regime that apply to Canadian residents. ...

Not much effect, I think-- it looks like the US will plow ahead and if you want an agreement you'll have to go knocking and then likely have to give something up to get it.  As I have said before, in the case of Canada, which already shares tax information on an automatic basis with the US, I am not sure what sorts of concessions the US means to extract here.  It is possible that the concessions could be unrelated to tax--it could be anything, really, bringing FATCA agreements fully into the category of the age-old practice of using unilateral regulation as little more than a means for diplomatic strong-arming.  

What if marijuana survives gross basis taxation? Will there be pie?

Taxprof has this today:

Forbes: Voters Say Yes to Marijuana, IRS Says No, by Robert Wood

A total of 18 states and the District of Columbia have legalized medical marijuana. Massachusetts just came on line after the November 6, 2012 vote. Colorado and Washington just went further to legalize recreational use too. 

But can a legal dispensary operate like a “legitimate” business? Amazingly, they can’t and are still labeled as drug traffickers. ... no matter how “legal” the states make it the IRS is federal and that means trouble. American businesses pay tax on their net not their gross income and business expenses are as American as apple pie. But Section 280E of the tax code denies deductions for any business trafficking in controlled substances. This black letter rule to stop drug dealer tax deductions also covers medical marijuana since federal law still classifies it as a controlled substance.

So the obvious question is, if it comes to pass that marijuana businesses can survive and even thrive under gross-basis taxation what will we then say about the taxation of business income more generally?

I'll even put it in multiple choice format for you.

(a) it turns out deductions for business expenses are not, after all, as American as apple pie.
(b) business deductions are still as American as apple pie, but not as American as ganja consumption.
(c) business deductions are as American as apple pie, but not necessary to the continued production of optimal amounts of apple pie once Americans get their hands on the dino koosh
(d) what does any of this have to do with pie?  I thought we were supposed to eat Cheetos.
(e) all of the above

Tremblay: I fought the corruption but the corruption won

As expected, the mayor of Montreal has resigned under the pressure of the ongoing investigation into widespread corruption through all levels of Quebec's government.  The transcript of his resignation speech is here.  He continues to deny any personal wrongdoing, and claims he is the victim of "unbearable injustice."   That's an all-too familiar refrain, I am sorry to say, and shouldn't elicit much sympathy at this stage.  There is an awful lot of self-pity in this transcript.  Excerpts:

Was I sceptical? Yes. Did I ask questions? Yes. Was I vigilant? Yes. But unfortunately, it was only after the facts that I was given documents, files and internal memos, dating from 2004, 2006 and 2009. 

When I finally received the information, I asked the public servants and the councillors why I had not been informed about this, especially when the individuals in charge had done nothing. 

The trust I had on some, was inevitably betrayed; I assume the full responsibility. 

However, every time, as soon as I was informed of irregularities, collusion and corruption, I took action. The information was immediately given to the appropriate authorities. I shall produce the proofs at the right time and the right place. 

...I fervently hope that one day there will be recognition about the fact that I fought - often alone - this system of collusion and corruption as the Charbonneau Commission is revealing it had existed since at least 1988. 

...As for the allegations of collusion and corruption, I would have expected a more attentive and more urgent hearing from the government, especially when dealing with the obligation to award contracts to the lowest bidders. 

In politics, it seems that perception matters more than the truth. Especially when this perception is manipulated by multiple factors, not to say agendas, and when we're not given a chance to reveal the truth or, when it is stated, no one believes it. 

...I now must suffer an unbearable injustice. I never thought my life could be subjected to such a fury in a society of Law and Justice. But, one day, justice will prevail. Under these circumstances, I cannot help any more. The success of our city is much more important than my personal interest. 

...To those who relied and trusted me all these years, I want you to know that I have never betrayed you.

The sheer number of "I"s in the transcript is just too telling--I tried, I was duped, I was deceived, I am shocked, shocked at the allegations and the shoddy investigations and the lack of a chance to defend myself.  Certainly this story is not over.

The cost to Canadians of pension splitting

We had a lively discussion over Lisa Philipp's paper today, during which a question arose regarding the cost of pension splitting to the budget, i.e., how much does pension splitting cost as a matter of tax expenditure analysis?  Note for non-Canadian readers, the pension splitting issue is as follows: Canada has individual filing only, no joint filing.  But for various reasons, in 2007 Canada introduced what amounts to joint filing with respect to private pension income, i.e., one spouse can deduct and the other include up to half of an annual pension income stream (some restrictions apply)--this is not for a federal pension income but strictly for income generated from private retirement savings.  A ready answer to the TEA question was not immediately found, but I've since had a look at the Tax Expenditures and Evaluations 2011 Report, found the data and made this handy chart:

So we can see that pension income splitting created a $840 million hole in the budget in 2007 and it has increased since then to about $925 million.   In class someone pointed out that pension splitting rule incidentally increased the value of a related tax benefit, namely the pension income credit, i.e., the amount of pension income a taxpayer is allowed tax-free (currently $2,000).  Sure enough the TEA report explains in fn 39: "The introduction of pension income splitting in 2007 increases the number of individuals claiming the Pension Income Credit and thus increases the value of this tax expenditure (i.e. spouses who previously did not have pension income)".  Putting the two pension benefits together yields this:

So we can see the cost of the credit increased by about $110 million in 2007, dropped a bit in 2009 and by 2011 was again about $100 million higher than it was in 2006.  It therefore seems plausible to attribute about $100 million of the credit's cost to the pension splitting rule, bringing the total TEA cost of the latter to about a billion per year.

That is about 0.4% of the total annual budget (which is currently about $245 billion) or about 4% of the annual budgetary deficit (currently about $26 billion).  Not huge perhaps, but not to be dismissed as nothing, either, especially when we know there is scant policy here: this is a straight up tax giveaway for Canadians with private pensions, i.e., higher income retirees.  Political pandering?  A quick scan of the TEA list shows it is in the league, TEA cost-wise, of the working income tax benefit and the medical expense tax benefit.  I am now very curious how many Canadians share the pension splitting benefit, both alone and in comparison to other tax expenditures.  I don't know how to find that though, so will leave the discussion right here.

OECD enters multinationals’ tax debate

That is the headline from the FT for a tiny little piece that says very little other than that the OECD "is tightening the rules on intellectual property to make it harder for multinationals to site their intellectual property, brands, trademarks and know-how in tax havens where there is no genuine business."  But it's a fascinating headline, isn't it, conveying the idea that this is new territory for the OECD.   No mention that it was the OECD that in effect created and continues to shape the whole international tax system as we know and love it today, tax havens and all.

Sub-primal scream therapy

Let's get the week started off right.

"See, if you blame your parents, you see it's not your default."

"I just want this to end, I just want some, some..." "Foreclosure?"  "Augh!"

Monday: Lisa Philipps on Income Splitting at McGill

Professor Lisa Philipps will be at McGill this Monday, where she will present a paper as part of our Tax Policy Colloquium Series.  Her paper, entitled Income Splitting and Gender Equality: The Case for Incentivizing Intra-household Wealth Transfers, is a chapter in Challenging Gender Inequality in Tax Policy Making: Comparative Perspectives (Kim Brooks, Asa Gunnarsson, Lisa Philipps, Maria Wersig, eds., Oxford: Hart Publishing Inc, 2011).

It opens as follows:

In this chapter, I examine the problem of income splitting under an individual tax unit and Canadian legal developments that have expanded the scope for such tax planning by spouses. Income splitting poses a dilemma for tax policy analysts concerned with gender equality because, left unchecked, it opens a back door to joint taxation, with its troubling impact on labour-market incentives for secondary earners, who are mainly women. Yet ignoring intra-familial transfers in order to prevent income splitting may disrespect women's individual agency over property to which they hold legal title, and it may close off a potential source of economic power for those who do the bulk of the unpaid work in a household. This tax policy dilemma engages fundamental, normative debates about the meaning of gender equality and whether it is possible to enhance women's access to markets while also valuing and compensating their unpaid contributions. 

The Colloquium is open to all.  If you will be in Montreal tomorrow, I invite you to join us at 11:35 am at the McGill Law Faculty, Chancellor Day Hall Room 202, 3644 Peel Street.

Montreal budget standoff: what a governance crisis looks like

Mayors of montreal's island suburbs are refusing to endorse Montreal Mayor Gérald Tremblay's 2013 municipal budget and the budget-approval process, due to " the deteriorating climate at Montreal city hall" according to the Gazette.

Radio Canada yesterday seemed to frame this pushback as a response to the increasing public mistrust of government in the midst of the Charbonneau commission that is finding corruption rampant all the way up the feeding chain of Quebec political office. It was in French so I may not have perfectly understood the report, but I would think that yes, when you're finding out daily just how high the cost of corruption is and that apparently all of your elected officials are interested in having their cut, when those same officials come round asking for tax dollars you don't feel so keen.

Charity vs taxes and the destruction of the state

From the FT this week, a story on John Paulson's $100 million donation to the Central Park Conservancy.  The article focuses on the idea that charitable organizations can step in for government to provide public goods, and why that idea is pernicious:

[America]’s philanthropy is unique. Its two key institutions are the tax deduction for charitable gifts and the tax-exempt foundation. Noting the role of the Ford Foundation in Lyndon Johnson’s “war on poverty” in the 1960s, Daniel Patrick Moynihan, the late senator, called foundations a “new level of American government”. 

Americans pat themselves on the back for their generosity, not always with good reason. Olivier Zunz, a historian of philanthropy at the University of Virginia, calls American charity a “capitalist venture in social betterment, not an act of kindness as understood in Christianity”. 

Giving to a foundation can be self-interested – a way for a rich person to launder economic power that he does not need into political power that he does. Foundations inevitably get politicised, not because donors are corrupt or insincere but because they are rational. Lobbying for a piece of a government budget is a more efficient way of serving most causes than simply spending donations.

Note that this story comes on the heels of the recent news about how presidential candidate Mitt Romney has used donations to the Mormon church to secure huge tax breaks for himself, even while he campaigns to dismantle agencies like FEMA.  True to form, the Heritage Foundation has suggested that the right answer to Sandy and other natural disasters is for the private sector to support charities like the Red Cross.  It is ironic that Heritage begins its discussion by lauding the fact that "Americans are already coming together to help family, friends, and neighbors."  Isn't that, after all, the whole point of our democratic society: people come together and decide how to govern themselves, including how and when to help each other when disaster strikes someone you don't know personally but who is part of your larger community?

We need only look a little closer at the Red Cross to see the utter silliness of the Heritage foundation's response.  From the Red Cross website:

We have the legal status of “a federal instrumentality,” due to our charter requirements to carry out responsibilities delegated to us by the federal government. Among these responsibilities are:

• to fulfill the provisions of the Geneva Conventions, to which the United States is a signatory, assigned to national societies for the protection of victims of conflict,
• to provide family communications and other forms of support to the U.S. military, and
• to maintain a system of domestic and international disaster relief, including mandated responsibilities under the National Response Framework coordinated by the Federal Emergency Management Agency (FEMA).

Yes, the federal government and the several states contract (pay) the Red Cross to fulfill government functions, even on occasion appropriating funds for the direct support of this organization.  It is not an independent charity that sinks or swims on the altruism or lack thereof of the giving class.  It is a public/private hybrid that relies on donors and the government, and--more importantly--that follows direction from the government in responding to matters involving the common good.  It is not, in other words, subject solely to the whims of its donors in deciding what public goods to provide.


The dismissal of FEMA that characterizes organizations like Heritage and sympathetic politicians like Romney and Ryan even while they laud charitable organizations like the Red Cross betrays the utter emptiness of their fundamental mistrust of "government" as well as that of their trust in the private sector to furnish necessary public goods.

The central problem with relying on purely private charities to provide public goods like disaster relief is not that the donors are self-serving (they are) but that in promoting a mythical idea of a private sector that solves public goods problems without any coordination from government, you have to believe that such a sector exists and further that is can and will accurately assess public needs and mete out coherent responses.  That involves a lot of faith in individuals and organizations that are subject to any number of cognitive biases and mistakes even while they are not subject to the same level of scrutiny to which we can subject government.  The FT says, "most charity does some good for someone, at the price of a certain corruption."  True enough, but what are we to do about public goods problems that rich donors don't find compelling or interesting enough to support?  Moreover, where is the accountability if no private charity steps up to meet a given demand or that in responding to a real and serious demand, bungles the job?

That is why the Red Cross' mandate from the federal government to respond to FEMA reveals the bankrupt idea of anti-government sentiment when it comes to disaster management in particular and government vs charity more broadly.  We should be very skeptical of any attempt to wrest the mandate to provide public goods out of the hands of government and into the hands of the private sector alone.

The FT concludes:

[Mr. Paulson's gift raises] no worries that well-heeled experts are bypassing or steering democratic processes. It simply puts a large fortune at the disposal of a beloved and perennially underfunded institution. There is no better use for a billionaire’s money, short of taxing it.

That's the right answer.  Taxes are what we pay for a civilized society: one in which public goods problems are identified, assessed, and responded to in a way that can be in turn assessed, evaluated, and yes criticised when necessary (cf: Katrina).  That accountability loop exists in government, even if imperfectly.  It is not the same for individual donors or purely private charities.  Churchill's famous quote about democracy holds true for taxing and spending.  It's the worst way to fix public goods problems except for everything else.

Capital Flight and Tax Competition

Allison posted an extremely interesting article discussing capital flight from Africa (there were two studies, one for North Africa and one for Sub-Saharan Africa).  While there are clearly development and finance issues implicated by this, I am most interested in the tax consequences.

Capital flight from poor countries confounds traditional tax analysis.  Neo-classical economics provides that capital should flow from rich countries to poor countries; since poor countries need it more, they will have higher demand and thus pay more for it.  The problem is that this has rarely been observed in real life.  Nobel laureate Robert Lucas first identified this in the context of Colonial India, where significantly less capital flowed from England than would be expected under neo-classical models.  This was so contradictory to accepted wisdom it was dubbed the "Lucas Paradox."  Yet the empirical research, including the articles cited by Allison, keeps finding this result, over time and among countries.

The Lucas Paradox has received a fair amount of attention in economics literature, but far less in tax literature.  Instead, the driving policy behind international tax has been "neutrality" - that is, minimize tax distortions to capital flows around the world.  The theory provides that neutral tax laws would increase efficiency as they would permit capital to go where it is needed most.  But what if capital doesn't flow to high demand countries even when the tax laws are neutral?  In that case, I argue, certain countries may have no choice but to engage in tax competition just to attract some minimal amounts of capital.

If neutral tax laws are in fact creating or exacerbating incentives for certain poorer countries to engage in tax competition, presumably that should be taken into account when structuring US tax laws.  In other words, if the same model that predicted capital flows to poorer countries also recommends neutrality as the primary policy goal of international tax, why shouldn't we question that policy as well?

What would a non-neutral tax law look like?  Perhaps it would subsidize investment in poorer countries.  Perhaps it would basket income from poor countries differently than wealthy countries, or allow blending of losses across certain countries, or permit different structuring rules in such countries. This might come across as heresy to some, but in fact this used to be US tax policy , before it was repealed in the 1970s in the name of neutrality.

The real lesson may be that there are no "first best" solutions to international tax.  Neutral tax laws may work best for wealthy countries but could lead to intensified tax competition from poorer countries, while non-neutral laws could distort economic decision-making in, at best, a second-best manner.  This may not be a deeply satisfying answer, but simply pretending the empirical results don't exist doesn't seem any better.

Missing billions: capital flight from Africa

TJN reports on a paper by Léonce Ndikumana and James K. Boyce, Capital Flight from Sub-Saharan African Countries: Updated Estimates, 1970 - 2010

Here is the abstract:

"The performance of Sub-Saharan African economies over the past decade has inspired optimism on the region's prospects. But the region still faces major development challenges, and it is now clear that the majority of its countries will not achieve key millennium development goals.

A key constraint to SSA's growth and development is the shortage of financing. At the same time, the sub-region is a source of large-scale capital flight, which escalated during last decade even as the region experienced growth acceleration. The group of 33 SSA countries covered by this report has lost a total of $814 billion dollars from 1970 to 2010. Boyce and Ndikumana compare this to the level of development aid and foreign direct investment received by these countries. Assuming that flight capital could have earned the modest interest rate measured by the short-term U.S. Treasury Bill rate, they find that the accumulated stock of capital flight far exceeds the external liabilities of this group of countries, making the region a "net creditor" to the rest of the world.

This report provides updated estimates of capital flight for 33 SSA countries from 1970 to 2010. It describes the methodology used to estimate capital flight and highlights important methodological differences with other existing studies. The report presents key results on capital flight both in absolute terms and in comparison to other capital flows, especially debt, aid, and foreign direct investment, as well as in relation to the size of the economy (as percentage of GDP and in per capita terms). The report stresses the urgency of efforts to stem capital flight and repatriate stolen assets as a part of the broader goals of scaling up development financing, combating corruption, and improving transparency in the global financial system."

Add Starbucks, eBay and IKEA to the tax dodger ledger

When the list gets too long to count, will we finally come to see that tax dodging is in the fabric of the income tax as practiced by most countries today?  It is structured, systemic, and by design, not a loophole, not a bug.  It is the dominant culture.  Probably it is destroying the income tax for all intents and purposes.

Gender pay gap begins one year out of college

From Salon:

A report from the American Association of University Women (AAUW) flagged by Raw Story found that a gender earning gap usually occurs just one year after graduates leave college, with men making an average of $42,918 one year after graduation while women make an average of $35,296. The report, “Graduating to a pay gap” notes: 

“Graduating to a pay gap” finds that women working full time already earn less than their male counterparts do just one year after college graduation. Taking a closer look at the data, we find that women’s choices—college major, occupation, hours at work—do account for part of the pay gap. But about one-third of the gap remains unexplained, suggesting that bias and discrimination are still problems in the workplace.

More at the link.

Is Romney proposing a new AMT?

Believe it or not, for a tax professor I actually have not been following the tax plans of the two candidates for president very closely ... mostly because they are both frustratingly vague.  But as of late one particular item has caught my eye: Romney's proposal to cap itemized deductions at a fixed dollar amount (not a percentage) combined with a large cut in the marginal tax rate.  The idea, I think, is that marginal tax rate reductions lower the substitution effect on labor while capping deductions offsets the revenue on a less elastic base, thus increasing growth with no revenue cost.  There is some theoretical support for a proposal like this, and some theoretical critiques as well.  But I would like to focus on a different issue.

Romney likes to say that this is a return to the Reagan tax policy.  But it seems to me this more closely matches another aspect of tax law - the AMT.  Under the AMT, taxpayers recalculate their tax liability by getting rid of a number of deductions and applying a lower marginal rate.  Sounds familiar.  Of course, Romney also proposes repealing the current AMT.  But the combined effect of repealing the existing AMT with the other proposals seems quite similar (at least to me) to repealing the entire income tax and leaving the AMT.

Romney says that his proposal will only effect the wealthy.  This was the same justification for the AMT in the first place.  In fact, I have no reason to believe this was not sincere.  Unfortunately, the experience with the AMT has not matched this expectation.

Take the Klaasen family.  According to the case, the Klaasen's faith required large families, and the Klaasens had ten children.  Under the regular income tax, the Klaasens owed very little tax due to the large number of exemptions and credits available for children, as well as other itemized deductions.  Under the AMT, however, the itemized deductions and tax benefits for children were taken away and a much lower rate applied.  Despite the lower rate, the Klaasens ended up owing significant AMT.  They sued, claiming this violated their First Amendment rights and that the AMT was not intended to reach poor families with large numbers of children.  The court disagreed, noting that the statute was clear in how it worked and was neutral as to religion on its face.

Similarly, the wealthiest rarely get hit by the AMT for one simple reason - the capital gains preference does not get taken away by the AMT.  Similarly, under Romney's plan as I understand it, the preference would not be affected (in fact, Romney proposes dropping it even further for taxpayers under some threshold).  Thus, taxpayers earning primarily capital gains (and presumably qualified dividends) won't be affected by the cap on itemized deductions.

The AMT also sneaks up on people with unexpectedly high, nonrecurring itemized deductions in any one given year, such as professors visiting at another school for less than one year.  Presumably a cap would do the same.

Perhaps the biggest problem with the AMT, however, is that the "AMT Exemption Amount" - basically the amount of income exempt from tax - is a fixed dollar amount not adjusted for inflation.  Thus, as salaries grew over time due to inflation, more and more people were thrown into the AMT.  Similarly, Romney has proposed a fixed dollar amount cap on itemized deductions.  Presumably, unless Romney proposes adjusting his itemized deduction amount for inflation, the same effect would occur under his plan.  As inflation increases salaries, more and more people would be hit by the cap.  This would increase revenue, but it would do so by taxing inflationary gains of middle class earners rather than real consumption or savings.  This was not an unexpected accident under the regular income tax, in fact CBO counted increased AMT collections without the so-called "AMT Patch" - which would offset inflation - in calculating revenue under the so-called "Bush tax cuts" in marginal tax rates.  It is also why the "AMT Patch" hits the budget every year, in increasing amounts.  (See here for a summary).


I do not know if this analysis is correct, mostly because of a lack of detail, but it seems plausible.  If true, both candidates propose raising revenue - one through higher marginal rates and one through taxing inflationary gains of earners on the margin of the deduction cap.  This really presents a true choice between theoretical tax bases, and thus is how I wish the choice was presented.  Perhaps the Wall Street Journal and New York Times editorial boards will read this?

What's A Derivative?

From NPR's Ask a Banker, here is a great primer on derivatives from Matt Levine.  Excerpt:

I will tell you what a derivative is, but I will take a while to get there, and since I won't use words like "put option" or "synthetic CDO" you may feel cheated. That is okay. If you want to understand derivatives, you must learn to live with uncertainty, and also with feeling cheated.
In your finance textbook, if you have one, which I hope you don't because I'm just making this up, a derivative is defined as a contract whose payoffs are determined by reference to the price of some underlying variable. Derivatives, which include options, futures, forwards and swaps, allow levered and/or nonlinear bets and ...
... and let's start somewhere else.
There is a world. That world will have a future, and that future is uncertain. There are different possible states of the world, and different things will happen to you in those different states. If it's cold this winter, you will be sad, or perhaps happy if that's what you're into. If it rains tomorrow, you will get wet. If you take an economics course, you will start to talk like this.
If you are a company or an investment fund, the outcomes that you care about can pretty much be reduced to money: if it's cold this winter, individual workers and managers might be happy or sad, but the company has no feelings. The company just has money. If it's cold this winter, the company might have more money, if it's an oil company, because people will buy more oil to heat their homes. Or it might have less money, if it's in the agriculture business, because its crops will freeze. Or it might have the same amount of money, if it's, like, Facebook or whatever.
One thing you can do is graph future states of the world versus the amount of money you will have in those states. So for instance here is the money that an oil company will make this year (y-axis), graphed against the temperature this winter (x-axis):

The world is not this simple.
This is a simple chart but you should see immediately that it's wrong, or at least not right.
Of course you can't predict how much money an oil company will make just by knowing the weather: there are many other things going on.

Matt follows this intro with more great charts and graphs to explain hedging, prediction, and risk in the derivatives market, and concludes with "Next time, maybe: What I did in banking, or, derivatives for regulatory arbitrage, or, why everything above was false."  Levine also wrote "What Investment Bankers Do All Day," another snarky and fascinating piece ("The short answer: nothing. The long answer: They're "obsequious and needy" "middlemen" who find people looking to invest money).

Goldman pay pot hits $11bn as profits jump

From the Telegraph: "Goldman Sachs has joined in a much better-than-expected third quarter for Wall Street, raising the prospect its bankers will take home bigger bonuses this year."  It seems the backdoor bailout worked.  Can we have our money back now?

Pay or play under the ACA

A former UW law student of mine has published this brief explanation of the employer's responsibility under the Affordable Care Act.  In brief:

The Pay or Play Rule generally requires that "large" employers (i.e., those with 50 or more full-time or full-time equivalent employees) offer health plan coverage to full-time employees or potentially pay a penalty to the federal government. 

A persistent question for large employers has been how to define a "full-time" employee. The importance of "full-time" status cannot be overstated, because if an employer does not offer health plan coverage to just one full-time employee who then receives a federal subsidy to purchase health insurance at a Health Exchange, the employer could face a penalty of $2,000 per full-time employee per year. Also, if an employer offers health plan coverage to all full-time employees but the coverage does not offer "minimum value" or is not affordable for the employee, the employer could face a penalty of $3,000 per year for each full-time employee who receives a federal subsidy to purchase health insurance at a Health Exchange.

More at the link including compliance tips for employers.  Nice job Sarah!

What we know and can't know about MNCs and their taxes (a.k.a., why don't we know what Google actually pays?)

In Through a Glass Darkly: What Can We Learn About a U.S. Multinational Corporation's International Operations from Its Financial Statement Disclosures?, three accountancy profs explore what we can and can't discern from SEC disclosure about the taxes MNCs pay.  Here is the abstract:

We discuss the accounting rules that apply to reporting a U.S. company’s international operations. We use examples to illustrate diversity in accounting and offer caveats for policy makers, standard setters, analysts, and researchers regarding their interpretation and use of financial accounting information.

This is an important topic because it highlights a few of the many reasons why we might benefit from Dodd-Frank-style disclosure in the face of media stories about the low, low taxes paid on a global basis by companies like Google, Apple, and Microsoft.  The authors use case studies of SEC disclosures to highlight some of the book/tax differences that show why companies' reported tax rates are nowhere near their actual taxes paid.  For example, in the case of Google:

• Google’s “expected” provision at its federal statutory tax rate of 35 percent is a“hypothetical” federal income tax that Google would owe if all of its pretax book income was reported on its U.S. corporate income tax return.  
• In 2011, Google reported “income before income taxes” of $12.3 billion.  At a 35 percent tax rate, Google would owe $4.3 billion in taxes
• But Google reported an income tax provision (an amount it says it owes) of $2.5 billion, for an effective rate of 21%.  
• The difference between the headline 35% rate and the 21% effective rate is explained by book/tax reporting differences for various taxes and credits, some of which are permanent differences (will never be reconciled) and some of which could be reconciled in the future, but the big difference is explained by its "foreign rate differential," which is short form for what Google saved by reporting its income as earned outside of the US.

Much more in the paper.  The basic story is not new, but it's nice to see how the policy choices that go into corporate tax disclosure play out in practice and how they inform our understanding of how the tax system works.  The authors have a few suggestions for how non-accountants (including journalists) should understand and interpret what they find in SEC documents.  

I have been told that one of the reasons corporate managers resist greater tax disclosure in their SEC filings, such as is contemplated under Dodd-Frank and its impetus, the EITI regime (and country by country reporting more broadly) is the fear that people will misunderstand the information and therefore draw incorrect conclusions.  The authors acknowledge the validity of this fear and explore how companies make disclosure decisions with public perception in mind. Yet this paper itself provides an antidote to that fear.  It shows that tax data disclosure is capable of being correctly understood and interpreted.  We may need experts to help us do that in the face of flexible rules and ambiguous cases, but there is no shortage of experts.