Yearly Archives: 2016
Nov 28, 2016 Leigh Osofsky
Emily Satterthwaite,
Tax Elections as Screens,
Queen’s L. J. (forthcoming 2016), available at
SSRN.
The concept of “screening” taxpayers is theoretically appealing. According to optimal tax theory, our tax system should impose tax liability based on ability, which is a characteristic that reflects relative well-being. However, since ability cannot be directly observed, the tax system has to rely largely on income, a presumed surrogate of ability, as a tax base. The problem is that income is easily manipulable, making the tax system an inefficient tax on ability. Screening is a potential, partial solution to this problem. Screening involves relying on other characteristics that are more revelatory of ability. For instance, as it turns out, height is surprisingly strongly correlated with earning ability. However, as theoretically appealing as screening may be, the discussion of it is generally politically unrealistic enough, or sufficiently divorced from the realities of the actual tax system, to make it a largely academic exercise.
In Tax Elections as Screens, Emily Satterthwaite gets beyond the theoretical possibilities of screening taxpayers. She does so by examining how an existing tax election—the election to itemize deductions—can serve as a screening mechanism. By examining how screening may work in our actual tax system, Satterthwaite offers an important contribution that has few companions in what is a largely theoretical field.
Satterthwaite begins by offering a simple model of the potential value of tax elections. She then goes on to illustrate what practical information the election to itemize may offer the government. She marshals evidence from an empirical study that, for taxpayers with income below $58,000, a taxpayer’s cost of itemizing cannot be inferred from observable characteristics on the taxpayer’s return (such as gross income). As a result, Satterthwaite posits that the election to itemize may reveal otherwise unobservable information about this income group.
Specifically, Satterthwaite posits that the election to itemize can reveal information about earning ability, how responsive a taxpayer is to taxation, and a taxpayer’s compliance posture. She then makes suggestions about how each of these various possibilities might shape tax policy. First, a taxpayer who is more conscientious is likely to have higher earning ability, and is also likely to face lower costs to engage in all of the tasks required to itemize (such as collecting, saving, and using deduction records). Satterthwaite suggests that the government may use this information to target various forms of assistance to non-itemizers, who are more likely to need it. Alternatively, a taxpayer may be more likely to itemize because the taxpayer is more responsive to incentives that reduce taxation, a quality that means the taxpayer is correspondingly likely to be more tax-elastic on other dimensions (for example, being more likely to change labor, savings, and other behavior in order to reduce tax liability). Satterthwaite suggests the government may therefore want to target higher marginal tax rates to non-itemizers, based on their low elasticity. As a final possibility, taxpayers who are more likely to itemize may also be more likely to take other steps (including aggressive tax reporting positions) to reduce tax liability. The government may therefore want to target more enforcement and auditing resources toward itemizers.
However, as Satterthwaite acknowledges, the analysis of exactly what the government should do in response to a taxpayer’s decision to itemize is quite complex. A taxpayer may be itemizing for any or all of the three reasons she posits (i.e., because the taxpayer is more conscientious, has lower tax-elasticity, or has a more aggressive compliance posture). What the government should do depends on the taxpayer’s dominant motive. For instance, if the taxpayer is itemizing because the taxpayer is more conscientious, the government would theoretically want to impose a higher rate of taxation (or the equivalent through higher auditing or the like) in response to the taxpayer’s higher ability. However, if the taxpayer is itemizing because the taxpayer is more tax elastic, this would be the exact wrong result. Ferretting out why the taxpayer is itemizing, all else being equal, would be difficult. Indeed, knowing whether a taxpayer is itemizing because the taxpayer has lower costs from itemizing, or just has more deductions, would itself be a difficult task. As Satterthwaite also acknowledges, determining whether it makes sense to introduce itemizing as a screen also presents other estimating difficulties, such as estimating the compliance costs of the election.
Despite these difficulties, Satterthwaite’s insights are important. First, whether optimal or not, the tax code does provide an election to itemize deductions. As a result, Satterthwaite does not need to prove that introducing itemizing as a screen is welfare enhancing. Rather, she merely needs to show that, given that the election is already in place, the election can provide the government valuable information. And she succeeds in this task. Perhaps the most useful insight is Satterthwaite’s suggestion that the government may use the failure to itemize (and the likely higher cost of itemizing) to target other assistance to the taxpayer, such as help preparing a tax return or enhanced information about government benefits that are provided through the tax code, such as the earned income tax credit. This suggestion is particularly helpful because, even without being able to determine definitively why a taxpayer failed to itemize, the government can reasonably imagine that a non-itemizing taxpayer is likely to be less well-informed or sophisticated in preparing government forms than a taxpayer who itemizes. Targeting greater assistance to the former than the latter may create welfare improvements at a low cost. Moreover, the suggestion harnesses information that can be gleaned from tax filing behavior to help improve the administration of unrelated welfare benefits that, whether rightly or wrongly, are already being provided through the tax code. This sensible, incremental improvement arises out of Satterthwaite’s real-world tax policy approach. This approach, which has much to commend it, merits more scholarly attention.
Oct 27, 2016 Charlotte Crane
Edward Kleinbard,
The Trojan Horse of Corporate Integration, 152
Tax Notes 957 (Aug. 15, 2016), available at
SSRN.
Edward Kleinbard’s The Trojan Horse of Corporate Integration critiques the U.S. Senate Finance Committee’s current proposal for corporate integration. This is an important read for those who have not yet come to grips with the forces at play in contemporary tax policy. Kleinbard refers to these forces as the “political economy agenda” behind the proposal. That agenda has as much to do with appearances relating to tax liabilities as it does with any cash actually being paid.
Most tax policy analysis has historically assumed that it is the amount of tax that is actually paid that matters most. Taxes paid are resources that are no longer available to the private sector; taxes not paid are not available to the public sector. At bottom, the tax policy challenge has usually been seen as balancing the deadweight losses that are inevitable with resources taken away from the private sector with the market failures associated with leaving deployment of all resources in private hands. This view of the impact of taxes is all well and good for economists to theorize about, but does not capture very much of the political decisions taking place in the real world about the type of taxation that should be adopted.
As Kleinbard points out, a significant portion of the “political economy agenda” behind the Senate Finance Committee proposal is simply to allow corporations to report paying lower taxes for financial accounting purposes, without lowering the overall taxes paid on corporate investment. The Senate Finance Committee proposal would do this by allowing a corporation to deduct from its tax base dividends paid from corporate income. But even as it allows the corporation this “dividends paid deduction” (DPD), the proposal would require the corporation to withhold tax from the dividends actually distributed to the shareholder. This withholding tax would not be treated as a liability of the corporation, and therefore would not be included in the corporation’s financial accounting reports reflecting the taxes it pays. Thus, the taxes imposed at the corporate level would be reduced, even though the total taxes on corporate earnings (taking into account both the tax on corporate income and the withholding tax) may not be.
The equivalence between the collection of taxes paid by a corporation on its own behalf and the taxes paid by the corporation as unrefunded withholding taxes remains uncertain. It will depend on many features relating to the design of the tax (including the preservation of tax exemption for certain domestic taxpayers and any mechanism available for credits for foreign taxpayers).
As Kleinbard also points out, the DPD often produces a similar result as the imputation credit approach to corporate integration, since in both approaches a payment made by the corporation is credited against the shareholder’s tax liability. In fact, the DPD approach may often produce greater tax liabilities if the withholding scheme does a poorer job than the credit imputation scheme of taking into account the particular characteristics of shareholders, including tax exempt or foreign status. (Incidentally, Kleinbard’s piece is a good place for those having lost track of the complexities of integration design to get back up to speed.)
But the DPD, unlike the imputation credit approach, would also have the salutary effect, from a political economy point of view, of making the burden of taxes on investments in US corporations appear to be less because the withholding tax would not be treated as a corporate tax for financial accounting purposes. Kleinbard intimates that no one should consider this as an actually accomplishing anything different. After all, he asks, “how stupid are we?”
The relevant research is still in progress, but at least some of it suggests that many groups of suppliers of capital may actually be that stupid, at least in the sense that the way that taxes are reported for financial purposes is important independently of the amounts ultimately paid. This may be true if the focus is on management incentives and perhaps even if the focus is on investor behavior. Kleinbard’s explication of this phenomenon is a good first step in helping the rest of us see the implications.
Kleinbard is especially dismayed at the possibility that the DPD would allow, more cleanly than other forms of integration, repatriation and distribution of the foreign income of US multinationals that has only been lightly taxed, if taxed at all, in any foreign jurisdiction without any additional corporate tax. This possibility is the not-so-very-well-hidden secret in the DPD approach to integration. Kleinbard does seem to acknowledge that this change could break the log jam that has previously blocked progress in corporation tax reform. But he decries the breaking of the log jam as wasting a chance to do something more significant.
We probably are not so stupid as to not see the political economy behind the DPD. But the best part of the Kleinbard contribution is its capacity for pointing out that we could really be that stupid when it comes to more generally neglecting the importance of the appearance of tax burdens rather than the burdens themselves. There is a real possibility that analysts and the investors they serve may respond favorably to the reporting of lower corporate taxes, even though investors’ overall burdens will not be reduced. Although Kleinbard takes no view on whether and when such responses dominate over actual tax payments, he reminds us well that we cannot ignore such possibilities when implementing corporate tax reform.
Sep 30, 2016 Neil H. Buchanan
Lisa Philipps,
Registered Savings Plans and the Making of Middle Class Canada: Toward a Performative Theory of Tax Policy, 84
Fordham L. Rev. (forthcoming 2016), available at
SSRN.
Analyses of tax policy are typically based on a familiar cost-benefit framework. There are important debates about which costs and benefits should be included (and which are measurable), but the standard formula is simple: (1) Describe the policy goal; (2) Present the costs and benefits of a policy that is meant to achieve that goal; and (3) Conclude that the policy is good or bad, depending on whether benefits exceed costs or vice versa.
In her important new article, Professor Lisa Philipps uses a Canadian tax policy debate to show that this approach is fundamentally misleading. Standard cost-benefit analysis—even if it is focused on inequality or other social outcomes— ignores the effect that adopting policies has on, as Philipps puts it, “the range of policy options considered thinkable.” (P. 102.) Tax policies can become embedded in the social system in a way that cannot be explained by standard cost-benefit analysis, and the resulting changes in social expectations can lead to self-defeating policy inertia.
Philipps’s article, which is part of a symposium in the Fordham Law Review entitled “We Are What We Tax,” adapts Judith Butler’s important work in feminist theory to analyze a seemingly technocratic question about tax incentives for saving. To some readers, this might seem a jarring combination, but the intersection of feminist theory and tax policy has become a growing and vibrant area of scholarly inquiry over the past few decades. This line of research is providing important theoretical and practical insights into tax policy debates that helpfully move the conversation past the usual neoliberal framework.
As noted, Philipps focuses on the social impact of tax incentives for saving in Canada. Philipps looks at changes in Canada’s tax policies over recent decades, showing how the government has increasingly relied on the tax system to encourage people to save for their retirements, through what are called “registered savings plans.” This approach is, however, only one possible response to the broader policy question, which is how a society can allow people to spend the latter years of their lives living a dignified retirement rather than either working themselves to death or being reduced to poverty when they can no longer work.
Another possible answer to that question is known in the United States as the Social Security system. Although that system is often understood as a system in which people pay taxes while working and then “get their money back” when they retire, Social Security is in fact financed on a pay-as-you-go basis, and there are no “accounts” into which payroll taxes are deposited. Although it is beyond the scope of this essay to discuss the issue in detail here, the fact is that pay-as-you-go systems and systems of personal deposit accounts are analytically identical in the aggregate. In one way or another, workers at any given time are reducing their consumption in order to allow former workers to stay alive, and in turn those current workers will be allowed to live without working at some point in the future. The means by which that system is financed cannot change that fundamental tradeoff.
Being analytically equivalent, however, does not mean that the two systems are socially or politically interchangeable. As Philipps points out, Canada made the choice to have its workers build nest eggs for their retirement years, and Parliament has experimented with various methods by which to use tax incentives to encourage people to save sufficient funds to live in some comfort during retirement. In that sense, much of the political discussion followed the standard pattern: (1) We need to get people to save more money, (2) The policies that we are adopting have succeeded in various ways and failed in various ways, and therefore (3) The policies need to be tweaked, enhanced, abandoned, and so on.
The Canadian policy of relying on private decisions to save was justified by the neoliberal gloss of “promoting individual self-reliance and familial responsibility to address human welfare needs” (P. 109). Even when supplemented by various tax incentives, however, the Canadian system has had a (completely predictable) negative distributional impact. Philipps’s insight, however, is not merely that private savings accounts have exacerbated inequality. She argues that the policy conversation is not merely a matter of saying, “Well, our current set of policies is not serving Canadians well in their retirement, so let’s put all possible ideas on the table to see what would work better.” Instead, the justifications for the private-saving approach to retirement became self-reinforcing, such that even the Canadians who are harmed by the system are now psychologically committed to its perpetuation.
How could that be? The idea behind the Canadian retirement system was not just a matter of telling middle class people that they had a personal responsibility to save for their retirement, but also of making retirement saving part of the very essence of middle class identity. Philipps writes: “To be an adult without a registered savings plan now threatens to place one on the margins of the social order” (P. 121). In other words, anyone who wishes to think of herself as a middle-class Canadian now automatically thinks that part of middle-class life will involve building retirement savings through registered plans.
This constructed social identity, however, has a surprisingly important impact on the policy debate. Because people aspire to be part of the middle class, and middle class identity includes being a rugged individual who saves for oneself and one’s kin, middle class Canadians (and those who hope to achieve that status) are now highly unlikely to approve of any plan to move away from a savings-based system to a macroeconomically equivalent pay-as-you-go system that looks like a Social Security plan. That is, people have learned that “being middle class” means sinking or swimming on one’s own, and because of that deeply embedded social expectation, any move to more explicitly acknowledge through policy that everyone is mutually dependent now somehow feels wrong.
This phenomenon is hardly limited to retirement savings. For example, basic financial principles make clear that the difference between owning and renting one’s residence is ultimately a matter of form and not substance, because the legal category of property ownership can be replicated through contractual agreements. Nonetheless, in the U.S. and Canada part of “the dream” is to be a homeowner. It does not seem to matter that the particulars of home ownership can be devastating for people when their houses lose value (as in the housing bust of 2008-10), or that good financial management should discourage putting all of one’s proverbial eggs in a single basket, because such cost-benefit considerations end up being overwhelmed by people’s psychological commitment to home ownership. A politician who suggests that home ownership is not a meaningful or appropriate goal will discover quickly that citizens strongly disagree.
And so it is now in Canada with respect to individually oriented retirement savings. As Philipps concludes: “Registered savings plans will endure not because they actually deliver the benefits they promise to most people but rather because they have been assimilated into Canadian middle-class identity” (P. 122). What would be viewed as a flawed and counterproductive policy that harms middle-class Canadians thus stumbles onward, because people have been taught to believe that there is a “right” middle-class way to save for retirement. The existing policy regime becomes its own justification.
Aug 12, 2016 Theodore P. Seto
In his book Capital in the Twenty-First Century, Thomas Piketty did us the great service of bringing the problems of wealth and income inequality to the fore. In the process, however, he also may have performed a bit of a disservice – making those problems seem simple, a mere function of the inequality r > g, where r is the rate of return to capital and g is the rate of economic growth. The solution, he suggested, was equally simple: a tax on wealth.
Bariş Kaymak and Markus Poschke, in The Evolution of Wealth Inequality over Half a Century: The Role of Taxes, Transfers and Technology, offer a more complex picture. They construct a general equilibrium model of the U.S. economy over the past half-century, incorporating (1) reduced income taxes on top earners (from a 45% effective rate for the top 1% in 1960 to a 33% effective rate in 2004, and from a 71% effective rate for the top 0.1% in 1960 to a 34% effective rate in 2004), (2) expansion of government transfers from 4.1% to 11.9% of GDP over the same period, and (3) higher pre-tax wage inequalities, which they attribute to technological change. (For these purposes, effective rate is defined as income taxes paid as a percentage of taxable income.) The question they ask and attempt to answer is: To what extent were the observed increases in wealth and income inequality over that period attributable to each of these changes or trends?
Income: Their answer with respect to income inequality is unequivocal: After taking into account standard general equilibrium adjustments, cuts in top rates had almost no effect on after-tax income distribution. Instead, the authors find that during the period studied, after-tax income inequality increased almost entirely because pre-tax income inequality increased.
Wealth: Their answer with respect to wealth inequality might strike some as counterintuitive. They find that an increasingly robust safety net (principally Social Security and Medicare) appears to have reduced incentives to save for the bottom 90%, resulting in increased wealth concentration at the top. Taken together, changes in U.S. tax and transfer systems explained nearly half of the observed rise in wealth concentration over the past half-century; the remainder was explained by increases in pre-tax income inequality.
Interactions: In addition, the two inequalities interacted in complex ways, intermediated by interest rates and prices:
Accumulation of additional wealth in response to tax cuts leads to a decline in the interest rate and an increase in the wage rate. The fall in the equilibrium interest rate discourages savings by lower wealth groups and exacerbates the direct effect of tax cuts on wealth inequality. As for income, the lower interest rate mitigates the rise in top incomes, while a higher wage rate benefits lower income groups as they live mainly off labor income.
(P. 5.)
By email to this reviewer, Prof. Kaymak explains the relationship between wealth inequality and wage rate increases as follows:
[T]he link from capital accumulation to the wage rate is an equilibrium effect …. As new wealth is channeled to production through investment, it generates a demand for additional labor since labor and capital are complements in production. Higher demand for labor then raises both employment (job creation effect) and wages. Of course, tax cuts could also change the labor supply behavior …. But we find this [latter effect] to be much weaker ….
Bottom line: greater inequality in wealth reduced income inequality by reducing the return to capital and increasing wages.
Finally, because general equilibrium adjustments take time, the authors predict that two or three more decades of increasing wealth concentration will result from policy and economic changes that have already occurred, at which point the top 1% will own about half of all U.S. wealth, up ten percentage points from their current share.
What should we make of all this?
First, general equilibrium analysis, although absolutely essential, is notoriously difficult and sensitive to assumptions. The authors note that their conclusions are inconsistent with those reached by some (Atkinson (2011) and Mertens (2013)), but consistent with those reached by others (Saez (2012)). Nonpartisans may want to take all such conclusions with at least a small grain of salt.
The authors might have distinguished between taxes on income from labor and taxes on income from capital, although these are difficult to tease apart. A priori, at least, we would expect different kinds of taxes to have different effects on savings and interest rates. Optimal tax theory, for example, conventionally assumes that taxes on income from capital depress savings, but that taxes on income from labor do not.
One wonders also whether some aspects of the U.S. tax system might have offset the results the authors describe through depressed demand for lower-wage labor. Accelerated and bonus depreciation may have encouraged the automation of less skilled jobs, for instance, and/or a largely territorial multi-national corporate tax system may have encouraged the offshoring of those same jobs as tariffs and other trade barriers were lifted.
With respect to the effect of offshoring, Prof. Kaymak observes, again by email:
For wages to rise through the equilibrium effect…, investment has to stay at home. We had run some simulations allowing for capital flight in early versions of our paper. What that does essentially is to mute the effect of top tax cuts on wealth inequality (interest rate does not fall in this case, so the bottom wealth groups do not curb savings as much). Income inequality in turn increases somewhat, because part of additional investment goes abroad, hence no wage gains for labor.
In other words, capital flight reduces wealth inequality but increases income inequality.
In any event, the paper makes an important contribution; its thoughtful analysis should persuade the reader that problems of wealth and income inequality are more complex than Piketty claims. Increases in the safety net that reduce disparities in consumption may exacerbate disparities in wealth. Ed Kleinbard, in his book We Are Better Than This, has urged that we worry less about progressivity in taxation and more about progressivity in spending. Doing so, the current paper suggests, may actually result in further concentrations of wealth in the already wealthy.
This, in turn, raises fundamental normative questions: Do we really care about disparities in wealth? Why? Do we care more about disparities in income? Or is our ostensible concern about inequality really a concern about poverty? If Kaymak and Poschke are even partly right, it may not be enough to say: “Equality good. Inequality bad.” We may actually have to do some hard normative work.
Jul 18, 2016 Daniel Shaviro
The age of inequality has prompted an age of writing about inequality. Now writing about inequality has started to come of age. An important example is Branko Milanovic’s new book, Global Inequality: A New Approach for the Age of Globalization.
Milanovic, an economist and Senior Scholar at CUNY’s Luxembourg Income Study Center who has been studying global data regarding economic inequality for more than twenty years, discusses three main topics in this book: inequality within a given country, that between or among countries, and what might be the path of global inequality in the future. While the book’s contributions on all three topics contain numerous points of interest, the first has especial theoretical relevance. Milanovic suggests that inequality may decrease in the coming decades in some rich countries, but probably not in the United States.
In the 1950s, economist Simon Kuznets famously posited that, as an economy develops, market forces lead first to increasing and then to declining economic inequality. However, while this was the story seemingly told by the data available to him at the time, it has subsequently been contradicted by evidence of generally rising inequality in developed countries since the 1970s. Thomas Piketty, in his noted 2013 book, Capital in the Twenty-First Century, argued that rising inequality is the norm, and that the mid-twentieth century’s “Great Easing” from which Kuznets generalized was merely a blip, created mainly by the early-to-mid-century disasters of war, revolution, the Great Depression, and then more war. Piketty attributed the dominant trend that he discerned to “r > g” – a general tendency for returns to capital to exceed overall economic growth rates, causing wealth-holders’ share of the pie to keep on growing. This view did not, however, permit him to explain why, in U.S. data, rising wage inequality, rather than returns to capital, has played the largest role.
While Kuznets’ problem, in retrospect, was his projecting from just two main types of data points – Western countries during the Industrial Revolution and then during the mid-twentieth century – Piketty, for the most part, adds just one more: the same societies over the last several decades. Milanovic, by contrast, draws on data and studies from many more countries and over a far longer period. (He even has inequality estimates for the Roman Empire and its successor states, over the period from 14 to 700 A.D.) All this information permits him to develop a broader understanding of the multiple forces that historically have pushed towards either rising or falling inequality.
Against this background, Milanovic posits what he calls Kuznets cycles or waves – successive periods of rising, and then falling, inequality in a given country. He argues that these may tend (all else equal) to track periods in which the annual growth rate of the economy first rises and then falls, as new technological revolutions emerge and are then assimilated. However, he recognizes that one cannot overgeneralize, given that “[t]he future often likes to throw curve balls” (P. 117). In particular, various factors that are at least partly exogenous to technical change as such – pertaining, for example, to trends in a country’s politics, infrastructure, and educational system – may also affect inequality trends.
This could suggest a somewhat different view of Kuznets waves as being, in effect, an ex post observation that merely reflects how things happened to play out. By analogy, if you keep on tossing coins, you will periodically get several heads in a row at some points in the sequence, and tails at other points, leading to an observation of successive heads-dominated and tails-dominated cycles or waves.
Looking forward, Milanovic sees several ways in which “benign forces [i.e., not just disasters like those of the mid-twentieth century] could hypothetically push rich countries onto the downward portion of the second Kutznets wave” (P. 113). These include rising education, dissipation of the economic rents that have recently created so many high-tech mega-fortunes, income convergence between countries (especially if Asia’s recent rise extends to other continents), and a shift from high-skill-biased to low-skill-biased technological change (although it is not clear why this should be expected to happen).
For the United States, however, Milanovic sees the possibility for a “perfect storm” of rising inequality (P. 180), partly for internal political reasons. “Concentration of income will reinforce the political power of the rich and make pro-poor policy changes in taxation, funding for public education, and infrastructure spending even less likely than before.” (P. 181.) If he is right about this, as well as in his more optimistic forecast for other rich countries, then American exceptionalism may continually increase over the next few decades, but not in a good way.
