Monday, November 13, 2017

110th Annual NTA Conference on Taxation

From Thursday through Saturday, I spent an enjoyable if hectic stretch of time at the National Tax Association's 110th Annual Conference on Taxation, which this year took place in Philadelphia. I stayed overnight even though NYC is close by, hence I guess cue the W.C. Fields jokes ("Last night I spent a weekend in Philadelphia").

I always enjoy going to the conference, both intellectually and socially. One gets to hear about a smattering of current research (I focused on international tax and tax "reform" panels), and to meet old friends or (less commonly at this point) make new ones who are in the "biz" whether as economists, lawyers, government folk, or practitioners.

My own direct involvement, apart from moderating a panel, consisted of presenting a shortened (by more than 50%) but also modestly updated version of my slides discussing the destination-based cash flow tax. In deference to events since I gave the earlier version of this talk, I call the new version "A Requiem for the Destination-Based Cash Flow Tax."

The earlier version remains available here.

I wasn't exactly a winner in the scheduling for this talk. It ended up in a far-off room that one pretty much needed a compass plus trail mix to find. Plus, the other two papers on the same panel were quite different from mine. One discussed the incidence effects of sales tax holidays, while the other discussed tax-favored tobacco sales by Indian tribes. Both were quite interesting and good, but the common ground with my talk wasn't enormous.

This is not, in the slightest, meant as a complaint! I know how hard it is to schedule all the panels and talks, as Tracy Gordon and I shared this same job a few years ago. I am certain that we inadvertently did the same or worse to lots of people,* because this is simply inevitable when you are scheduling dozens of panels. Not all of the papers will fit together into unified panels, and not all of the panels can get the best locations. In consequence, as a presenter, you win some and you lose some.
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*Indeed, I also remember - and here the fault was definitely mine, not Tracy's - inadvertently rejecting all three papers by a given author, even though they were interesting and good, due to a screw-up in the course of deciding which one of the three to accept. I was able to correct this error when I discovered it in the course of looking for commentators on other papers.

The Tax Arbitrage Act of 2018?

Tax arbitrage, as the term is used in the literature, involves having offsetting long and short positions that are taxed asymmetrically.

In a "pure tax arbitrage," as Eugene Steuerle first (to my knowledge) dubbed it in 1985, the taxpayer has perfectly offsetting economic positions that may pair, say, deductibility of the payout with excludability (or at least deferral) for the receipt. A classic example is the Knetsch case, decided by the Supreme Court in 1960. Here the taxpayer purported to borrow and lend the same $4 million from the same insurance company counter-party. But he "borrowed" at 3.5% and "invested" at 2.5%, leading to $140,000 of accrued interest expense and only $100,000 of accrued annuity appreciation per year. So he'd write the company a $40,000 check for the difference and deduct $140,000 of interest. (Black letter law at the time unambiguously supported both the deduction and the exclusion, leaving aside economic substance doctrine).

In a regular tax arbitrage, the positions aren't perfect offsets. Hence, they may not be arbitrages in the way that finance people use the term, but they are still tax arbitrages. For example, if you borrow to hold non-dividend-paying stock, deducting the interest while deferring the offsetting appreciation, this would give you a tax arbitrage, even though you have a net position (e.g., bad news for you if the stock market plunges). However, the tax juice from this little game is addressed by the investment interest limitation, which generally limits deductions for investment interest to net investment income.

There would be no tax arbitrages under a pure Haig-Simons income tax that was consistently applied. But when there is a hodge-podge of different rules for different types of items, some of it becomes inevitable. A whole host of special rules in the Internal Revenue Code try to limit it in one setting or another. These rules add complexity if one defines it simply as the number of pages of tax law, but they may actually reduce complexity in practice if they sufficiently discourage taxpayers from going to great (or any) lengths to arrange tax arbitrages that would siphon money out of the Treasury to no socially or economically valuable end.

Asymmetric substantive rules are one way get to the creation of tax arbitrages that serve no good purpose. Having at least some of this is inevitable once you have a realization-based income tax. But the creation of pointless tax arbitrages becomes even easier for taxpayers, if one allows them to pick and choose between alternative marginal rates for the income and/or loss from the same activities.

It's amazing to me to what extent the House and Senate versions of tax "reform" pointlessly create huge tax arbitrages of this kind. The proposed special rate for pass-throughs, a key feature of both bills, has the potential to become the single greatest inducement to tax arbitrage ever enacted by a single Congress.

And of course I have been noting here how the Senate Finance Committee's idea of expanding expensing immediately while delaying the corporate rate increase by a year, creates a massive tax arbitrage loophole. As per my prior post, it is economically equivalent to providing 175% expensing - i.e., allowing deductions of $1.75 for every $1 the taxpayer spends - for 2018 only. Spending a dollar to earn a dollar, but getting to deduct $1.75 while only including $1, is a classic tax arbitrage example.

If I were willing to lengthen this post still more, I could explain in detail a further tax arbitrage that is possibly more important than the ones I have been emphasizing. The bills combine allowing expensing for new investment with partially retaining interest deductibility, and the literature has shown that this allows the creation of tax arbitrages that can drive the effective tax rate for new investment below 0 percent (i.e., to amount to a net payout from the government even if the investment offers a pretax return of zero).

Given these egregious problems in the bills, I am thinking that the Republicans should relabel what they are doing the Tax Arbitrage Act of 2018.

They may not have fully realized this, but it's an inevitable byproduct of trying to craft multiple rates that can apply to the same taxpayer and (with requisite planning) to the same offsetting outlays and receipts.

Sunday, November 12, 2017

Trying to rationalize the Senate Finance Committee's mistake

There's a story about a man who goes hunting and accidentally shoots his own thumb off. "Why''d you do that?," he's asked.

"Oh, I don't know, but it seemed like a good idea at the time."

Give him an extra day, however, and perhaps he'd do better at rationalizing what happened. If sufficiently averse to admitting the blunder, he might be able to fake out an explanation of why it not only seemed like, but actually was, a good idea, and not only at the time but even now.

Maybe: "I never liked that thumb. It always got dry in the winter and the skin would crack."  Or, "I figured it was easier to do that than buy mittens."

I am reminded of this story by desperate, recently emerging efforts by supporters of the Senate Finance Committee chairman's mark to explain why it was actually the height of wisdom, rather than a blunder, to delay the low corporate rate for a year while expanding expensing immediately.

As I've explained in earlier posts, here and here, this combination of timing approaches strongly encourages taxpayers to make negative-value (on a pretax basis) investments, such as expensing $100 in 2018 when the rate is 35%, in order to earn $90 in 2019 when the tax rate is 20%, thereby converting a $10 pretax loss into a $7 after-tax gain.

But now the pushback has started. Given that they've already, with high publicity, included this blunder in the chairman's mark, and are still counting on tax savings from delaying the low rate by a year (even if over-estimated by the Joint Committee on Taxation, if it didn't think sufficiently about the revenue hole that I have been discussing), the new line that I gather someone has been trying out on reporters is that it was actually a brilliant plan to promote growth. Companies will invest more in 2018 because it pays off specially!

Let's explain a bit more straightforwardly the claim that they are trying to make here. It is effectively a call for one year of 175% expensing in 2018 - an approach under which each dollar spent triggers a $1.75 deduction - since that would yield the same after-tax economics, in my example, as if the tax rate were indeed 20% both years.

Does anyone on the Senate Finance Committee, or among their supporters and apologists, wish to call for a year of 175% expensing? If so, I'd like to hear it.

Why wouldn't we want to have a year of 175% expensing? Well, for one thing, we're not currently in recession. For another, it encourages negative-value investments, including (as I've discussed in the prior posts) those that verge on being shams, featuring the use of circular cash flows (or transactions as close to that as the economic substance doctrine will permit).

But it's also true that what the Senate Finance Committee is actually proposing is less stimulative than that silly plan would be. After all, by postponing the 20% rate for a year, while they are encouraging 2018 investment outlays under the high rate, they are discouraging 2018 gain realizations - from consumer sales, for example. Postponing the rate cut incentivizes companies to postpone 2018 income into 2019, whenever and wherever they can. So what they are actually doing is significantly worse, from a stimulative standpoint, than offering a year of 175% expensing.

If you've made a mistake, as the Senate Finance Committee has, why not just admit it? Attempting silly rationalizations isn't likely to help.

Saturday, November 11, 2017

Yet another problem with the House's (and Senate's?) special tax rate for passthroughs

Things are happening too fast in Washington tax "reform" for one to keep full track of all the snafus and scandals that are likely to be hidden in all the weeds. But here's one more that a friend brought to my attention.

There's nothing better than getting to make "heads I win, tails you lose" bets. So here's one, when you get a special 25% tax rate for certain income from pass-throughs, as under the House bill. What about losses?

The ideal, from the taxpayer's standpoint but not anyone else's, would be to include profits from the favored activities at 25%, while still getting to deduct losses at 39.6%, if one is rich enough to reach the top bracket. So what does the House bill do to prevent that?

(Similar question, what does the Senate bill do to prevent this in their version of the passthrough tax break? Answer, at this stage nothing so far as we know, but we haven't seen the statutory language yet.)

I'm currently on an Amtrak with relatively limited access to the things one could look up in one's office. But, as I recall, what it does is require a limited species of recapture, that fails to reach all cases.

Suppose you are in an activity that would generate profits at 25%. In Year One, it instead generates losses, and indeed you get to deduct them at 39.6 percent. What the bill appears to try to do is require "recapture" of this income at the full rate. So in Year 2, you wouldn't get the special rate until you had reversed out the prior loss deduction.

(What if the activity changes status under the rules from year to year? Let's not even go there yet. It may turn on what the passive loss rules have to say about "former passive activities" - at least, leaving aside the case where one only gets the special rate for 30% of the income.)

Suppose that provision works properly within its four corners, although I haven't as yet had the chance to look it over carefully. (I am posting now, rather than waiting, because speed is of the essence given their timetable.)

It still isn't good enough to do the job. Case 1, risky activity that now ex ante faces a 25% rate on the income if it comes out heads, and a 39.6% reimbursement rate via deductions if it's tails. So heads I win, tails you (the Treasury and other taxpayers) lose.

Case 2, income first and deductions/losses later. Normally, due to the time value of money, taxpayers want to accelerate deductions and defer income. But here, if doing it the other way around creates a huge tax rate disparity, there are strong incentives, and no doubt when well-advised means, of flipping it around. So you pay tax at 25%, and then the next time you deduct the losses at 39.6%. I don't believe there's a carryback for losses into prior tax years - which would of course complicate things still more.

True, it might be somewhat of a one-time gain given that the recapture might get you again further down the line, but still potentially well worth doing if the payoff is large enough.

Same question as in my last post about the problems with the deferred corporate rate cut in the Senate bill: Is this issue properly reflected in the Joint Committee of Taxation revenue estimate? I bet not, as their process has been so rushed and you need time to think in order to start locating all these things

And I'm only focusing on a couple of the areas that I happen to know something about. There are plenty of other portions of the House and Senate bills that might raise similar or analogous issues

Huge problems with the Senate Finance Committee's delayed effective date for the corporate rate cut?

In my last blog post I offered a simple illustration of the problems that may result from the Senate Finance Committee's planning to enact expanded expensing immediately, while delaying the corporate rate cut for a year. Again, it said: expense $100 in December 2018, collect $35 in tax savings from the expensing, earn $90 in January 2019, pay $18 of tax at the new 20% rate. Result: a $10 pre-tax loss is converted into a $7 after-tax gain, by reason of one's extracting $17 net from the U.S. Treasury.

This is just a toy example, but the more I think about it, the more it becomes clear to me that this is potentially a huge problem - in terms both of revenue and ridiculous tax planning games.

Whenever the tax rate on a given actor is declining with a delay, it has an incentive to accelerate deductions and defer realizing positive income. We already knew that. But here the spread is really large - 15 percent - and the period of pre-announcement is really long - more than a year. Has there ever before, in U.S. tax history, been so large a rate cut that (if the Senate approach becomes law) was pre-announced so far in advance? Willing to stand corrected, but I think not.

Plus, the problem is hugely worsened by the presence of expensing. In the 1986 tax reform process, when the corporate rate did indeed decline by 12 points, not only was there offsetting base-broadening, but there was movement towards economic depreciation, rather than towards expensing. Now, as a matter of steady-state tax policy, you may prefer one, or you may prefer the other. But one thing that's indisputable is that expensing creates a much greater gulf between the time when the deduction arises, and that when the income arises. So it is much more problematic and gameable when the specific issue is one of tax rate changes between years.

So again, we can take it just for starters that there will be huge incentives to accelerate deductions and defer income realization. But beyond that, there will be huge incentives to arrange economically senseless (or meaningless) transactions in order to extract huge boatloads of money from the Treasury.

Example: in December 2018, a U.S. corporation pays $100 million to a tax-indifferent counter-party that generates an immediate expensing deduction. In January 2019, the corporation sells it for $90 million, in the simplest case to the very same counter-party. Bingo, everybody wins except for the American people via the effect on the U.S. Treasury.

Who are tax-indifferent counter-parties? We can start with tax-exempts, foreigners under appropriate circumstances, etcetera. But the counter-party doesn't have to be literally tax-indifferent. It just has to be tax-indifferent as between 2018 and 2019. So everyone outside the corporate sector who has the same tax rate in 2018 and 2019 is a potential counter-party.

Okay, as described here that's a sham transaction that would lose under the economic substance rules. But not to worry, build in some economic reality - there's plenty of juice to make sure it will still be worth everybody's while. Companies are starting at huge tax savings from circular cash flows, and there's plenty of room to accommodate tax-indifferent counter-parties, when this is even necessary, and also to tolerate real economic effects (sufficient to defeat the economic substance doctrine) that they'd just as soon do without.

Did the Joint Committee on Taxation include this, and at a proper level, in their revenue estimates? Sorry to be skeptical regarding my old employer, and I know they're doing their best under trying circumstances and at hyper-speed, but I would bet not.

Friday, November 10, 2017

Perverse transitional incentive under the Senate tax bill

The Senate tax bill provides increased expensing immediately (i.e., for 2018), but delays the corporate rate cut for a year (until 2019). This has interesting transition effects, and I don't mean "interesting" as a compliment.

Suppose a company has the opportunity to spend $100 in 2018, in order to earn $90 in 2019. So it faces a $10 loss before tax. But if it can expense the outlay at a 35 percent rate, and include the receipt at a 20 percent rate, then after-tax it's out only $65 in 2018, and retains $72 in 2019. Voila, profitable after-tax investment.

This is a standard problem about tax rate changes with expensing, accelerated depreciation, etc. (And it's why David Bradford came to favor a consumption tax with income tax accounting and interest on basis.) But it's accentuated here by enacting a corporate rate cut more than a year in advance, while providing increased expensing immediately. Not a great idea, I would say.

This time around, I'm sure the villain is inadvertence, not malevolence, but it is an example of how ill-advised it can be to rush out massive tax reform bills with inadequate feedback and vetting, and with ad hoc decisions being made on the fly to finesse revenue targets.

Thursday, November 09, 2017

Pass-throughs remain a train wreck in the Senate Finance Committee chairman's mark

For reasons I have discussed in earlier posts, I continue to be baffled (other than on cynical grounds) by the Congressional Republicans' interest in creating lower tax rates for pass-through income. So it's a disappointment, though not a surprise, to find this bad idea being perpetuated in the Senate Finance Committee chairman's mark.

Basically, the chairman's mark provides a 17.4 percent (just over one-sixth) deduction for business income from partnerships, S corporations, and sole proprietorships, although generally not for service businesses (defined similarly to in the House bill).

While the tax rate cut is smaller at the top than in the House bill, in some ways the guardrails are even weaker.  Nothing about material participation as in the House bill. On the other hand, other than for sole proprietors the deduction is limited to 50% of the amount of related W-2 wages. So an S corp sole owner whose business earned, say $800,000, and who paid herself $200,000 of salary would only be able to deduct $100,000 (which is just under 17.4%) of the remaining $600,000 of business income,.  She thus might end up reducing her marginal tax rate by only 1/8, under these facts, rather than 1/6. And if, say, a law firm wanted to take advantage by having a separate capital partnership that owned the building and the goodwill and then used transfer pricing to siphon off a share of the profits, it would also have to contrive an excuse for salary payments from the capital partnership (not just the service partnership) to the partners, in order for them to get the deduction.

The provision remains unmotivated  industrial policy that sacrifices efficiency, simplicity, revenue, and progressivity in exchange for I can't see what (apart from pleasing donors and employing tax planners). Admittedly, in several respects it is not quite so laser-focused on people at the very top as the House bill. But still there's no tradeoff here - it's just bad tax policy.

Too soon for a victory lap

Today Ways and Means Chair Brady sent a letter to Congressman Blumenauer that seemingly - but not actually - puts the question of state and local tax deductibility by pass-through owners to bed.

Distastefully and inaccurately, but unsurprisingly, he blames the entire thing on the Joint Committee of Taxation. First he notes, in accordance with what we already pretty much knew, that the revenue estimate was prepared under the assumption that state and local income taxes incurred by the owners of pass-through businesses would not be allowable as itemized deductions.

As an aside, I suspect that some combination of that and the adverse political effects of public exposure may possibly have played a role in the decision to "clarify" that no itemized deductions would be allowed to pass-through business owners for state and local income taxes. Ways and Means majority staff has done too much communicating of the contrary answer for one to be confident that what he says now was really the intent, before today.

Anyway, back to the letter. He quotes a JCT publication as saying - the added italics are his - "State and local income ... taxes paid or accrued, other than those paid or accrued in carrying on a trade or business or an [investment] activity ... are no longer allowed as an itemized deduction."

Then he says: "We have discussed the italicized language with the JCT staff, and they have confirmed that this language was an error. We intend to correct this mistake in the Committee Report."

Comment 1: While it's inaccurate and unfair for him to blame the JCT, taking unfair blame is part of their job and they know it. You have to be a grown-up to work for that staff, and preferably not too thin-skinned.

Comment 2: I don't think saying something in the Committee Report is sufficient. They need to address the text of the statute, so that it's clear that pass-through owners can't deduct state and local income taxes despite arguably favorable statutory language that a court could decide to interpret differently than the Committee Report.

Comment 3: What about income taxes that a state or local government formally places on the business itself, not the business owner? A case in point is New York City's unincorporated business tax, which I gather many people believe is deductible as a business expense under present law. There may well be wholesale changes in the formal structure of state and local income taxes, to maximize deductibility for resident business owners, if that works. So this too needs to be "clarified," preferably in the statute as well as the Committee Report.

House bill international tax provisions update

Since I posted on the House bill's international tax provisions, they have amended the rather aggressive excise tax provision that I discussed, limiting its reach to high-return foreign subsidiaries, apparently reducing its revenue estimate by 95 percent.

A fuller analysis of the state and local income tax deductibility issue

Here is joint analysis, penned by David Kamin, regarding the state of the play re. state and local income tax deductions for Trump and law firm partners, but not for you.

Because I'm a gentle and charitable soul, I am open to the theory that the mistakenly low revenue estimate - albeit, apparently reflecting a deliberate choice to retain likely state and local income tax deductibility for business owners and passive investors but no one else - arose innocently. But a lot of foot-dragging seems to have been going on towards the end of preventing its being addressed or corrected. And at this point, even if they do correct it, I for one will be inclined to attribute it to their having decided the game was up. A mere misunderstanding could easily have been fixed as early as Tuesday, three days ago, and it wasn't.

Some people not familiar in detail with the substantive analysis have been skeptical of our conclusion - likely continued state and local income tax deductibility for the favored ones - for a couple of reasons. One has been that, under current law, they are rightly skeptical that the favored ones can deduct state and local income taxes other than as itemized deductions on grounds that are independent of the business/ investment aspect (and that are being repealed). But: this view overlooks (a) the subtle backdoor change to flush language at the end of section 164(a) that supports the result, and (b) the distinguishability of existing case law that arises under a different provision altogether (as discussed in the Kamin post. So their assumption that the only deductions at issue are those from a narrow category of existing state and local taxes, such as NYC's "unincorporated business tax" (UBT) is probably incorrect even as things stand. Plus, as Kamin points out, even under that interpretation states could do a whole lot of self-help to make much of their income taxes effectively deductible at the federal level without significant substantive change to their laws. (And it would be a freebie to their own high-flyers that would come purely at the expense of the federal government, not at the expense of less privileged fellow citizens within their own states.)

Second, they may be relying on language in existing section 164(a) that admittedly is not 100% slam dunk certain to provide the result that we have been arguing is probable. The relevant language refers to taxes "paid or accrued within the taxable year in carrying on a trade or business or an activity described in section 212." One could argue, against our view, that this means the tax has to be imposed directly on the trade or business, etc., in its capacity as such - whence NYC's UBT but not regular income taxes.

Not impossible, but it puts an awful lot of weight on a very particular reading of "in." Note how incredibly easy it would have been to signal, either in the statute or the legislative history, that this meant distinguishing between the individual on the one hand and the business on the other hand (even in the case of a sole proprietorship), such that the tax had to be imposed on the business qua business in order to be deductible. But rather than signaling any such view, either in the statute or the legislative history, we have repeated statements that there will be deductions for state and local taxes, including income taxes, incurred in the trade or business and investment settings.

Wednesday, November 08, 2017

Dirty business afoot in the Ways and Means Committee?

There was an interesting snippet in today's Ways and Means hearing on the tax legislation. The Youtube footage is here, and the action that I have in mind starts at exactly 3:38:28. It's a colloquy between Democratic Congressman Blumenauer and Republican Committee Chair Brady.

Blumenauer reveals that he has been trying to get an answer for 3 days to the question of whether pass-through business owners - Donald Trump, law firm partners, etcetera - get to deduct state and local income taxes as trade or business (or investment) expenses that are allowable as itemized deductions, even though employees cannot do so, and whether the Joint Committee on Taxation revenue estimate was based on the correct and intended view of this.

He notes that JCT chief of staff Tom Barthold told him one thing - which, as I've pointed out in earlier blog posts, was in at least one respect (and probably more than that) unambiguously mistaken - while the Ways and Means majority staff was simultaneously suggesting something very different (namely that yes, Trump and the law firm partner CAN deduct all of their state and local income taxes under the bill, whereas their employees can't).

Despite the old-style Congressional politesse that both Blumenauer and Brady resolutely stick to, there appears to be some anger under the surface about this. Brady won't let Blumenauer ask Barthold a simple question, and promises only to provide some sort of answer to something or other in writing at some unspecified time or other (and while the clock is running out on committee consideration).

Here is what I strongly suspect is happening:

(1) While the Committee leadership knows that the answer is yes - the likes of Trump and the law firm partner can deduct their state and local income taxes under the bill, whereas employees can't - it does not want this to be generally understood at present.  So they are trying to stonewall.

And very possibly also:

(2) The Committee leadership knows that the JCT revenue estimate is wrong because it didn't account properly for the widespread "business owner" deductibility of state and local taxes. This could either have been an honest blunder amid the high-speed train wreck of the rapid-fire drafting, or it could have reflected diffidence about fully explaining things to the JCT - it doesn't matter now. But if they know that the revenue estimate is wrong, and that it would be higher if done right, and that this is at risk of coming out, then they may feel they are trapped and have to push aggressively forward, in the hope of completing this stage of the process before their actions are exposed.

Again, I don't know that #2 is so,  but stonewalling has a way of broadening one's suspicions. It would also help to explain why they appear to be so set on stonewalling, when the bill's substantive effect is bound to come out well before enactment anyway.

I'm also quite confident that the bill as it stands, is best interpreted as allowing state and local income tax deductions to business owners, including those who don't qualify for the 25% plutocrat rate. This is the clearly expressed intent of the committee report. It is also the best (and, as things stand, only convincing) reading of the bill's statutory language. But it could very easily be changed if they wanted to change it - except, I gather that they don't want to change it.

Something should be out on this tomorrow morning, possibly with my name among the co-authors but not on this blog (although I'll link to it when I get the chance - busy day as I'll be traveling to Philadelphia for the National Tax Association's Annual Meeting). But now, for the tax geeks in the audience (all others can skip the next three paragraphs), I'll just say:

Take a look at section 164(a) of present law, including the first sentence of the flush language at the end of it. See what is removed from the scope of that flush language ("not described in the preceding sentence") by section 164(a)(3). Then look at section 1303 of the bill, which would amend section 164(b)(5) of present law. The new section 164(b)(5) would make changes to how section 164(a)(3) would now read with respect to individuals. Finally, ask yourself how that change to section 164(a)(3) for individuals affects the scope of the first sentence of the flush language at the end of section 164(a).

I think the answer you will come up with, if you are practiced at reading tax statutes, is that the flush language now newly authorizes the likes of Donald Trump and the law firm partner to take state and local income taxes as an itemized deduction because they were "paid or accrued ... in carrying on a trade or business" and are no longer removed from the scope of the flush language by reason of section 164(a)(3).

This would retain the deduction for employees too (since they are in a trade or business as such), except that elsewhere the bill denies employees all itemized deductions with respect to this trade or business. So it's just for the business owners and passive investors, not for the employees.

It's been elegantly done, and all the more so if they managed to keep it out of the revenue estimate (or did so accidentally but now don't want to fess up). But are we only judging style here, or morality too?

Talk on the EU State Aid Cases at Fordham Law School

Yesterday afternoon at Fordham Law School, I participated in a session discussing the EU state aid cases. After Amedeo Arena of  the University of Naples "Federico II" School of Law offered a European perspective, I offered a U.S. perspective, the slides for which are available here.

Tuesday, November 07, 2017

Has the House bill received an accurate revenue estimate?

I've posted recently on the question of how the House bill treats state and local income taxes paid by "business owners" - a term that includes Trump, hedge fund managers, and, for that matter, law firm partners who generally wouldn't get the special 25% plutocrat rate because they are in a service business. [Side note: calling it the "plutocrat rate," while perhaps a bit aggressive, is more accurate than calling it the "small business rate." I'll stop if they do.]

As David Kamin lucidly explains here, it appears that the state and local income tax deduction has NOT been repealed for these individuals. The longstanding itemized deduction for these taxes is gone under the bill, but the business owners would get to deduct the taxes as a business expense, whereas employees would be denied the same deduction (even though it would technically qualify as a business expense for them, too) because they're in the trade or business of being an employee, and employee business expenses are disallowed under the bill.

Kamin's eye-opening follow-up, available here, is strongly recommended reading. Without putting words in his mouth that he didn't say, it raises questions about the accuracy, and perhaps even the integrity, of the revenue estimating process for this bill.

As Kamin explains:

(1) the House Ways and Means Republicans, whose bill this is, "intend to write a loophole into the limitation on the state and local income tax deduction - or have us believe they are. They've said so. Repeatedly. Over time. And the statutory language, though ambiguous, could get them there."

(2) Thomas Barthold, Chief of Staff for the Joint Committee on Taxation, believes otherwise. When asked in a Way and Means mark-up hearing on the legislation, "he said the loophole doesn't exist and that owners and investors wouldn't be able to take the deduction for state and local income taxes, though he conveyed this in a confusing fashion."

Barthold also made a clearly erroneous suggestion to the effect that, among business owners, those engaged in service businesses certainly wouldn't get the deduction. But while service businesses don't get the special 25% plutocrat rate, there is no ambiguity in the legislation about the lack of any tie between this issue and that of state and local income tax deductibility by business owners.

You can check it out for yourself here (footage of the relevant moment in the mark-up hearing).

Now, I don't mean in any way to criticize Tom Barthold for this. Even leaving aside the ridiculously abbreviated process that has got to be over-taxing (so to speak) the entire JCT staff, he is a person of great integrity, in keeping with a proud tradition of JCT integrity that goes back to long before my own days there (I was on the JCT staff from 1984 to 1987). It would be amazing if the JCT chief got everything right in a markup under these circumstances.

But if I understand how a JCT chief prepares for hearings like this, he works closely with his staff. What he says about a particular issue is highly likely to reflect what those among his staffers who are working on the issue believe to be the case. There are JCT staffers on point of two relevant kinds: (1) the lawyers, who are working on structuring, drafting, and explaining the legislation (possibly with an economist or two), and (2) the revenue estimators, who determine the revenue "score." And of course these groups (1) and (2) are talking to each other as well.

So I consider what Barthold said to be plausible prima facie evidence of what JCT believes about the legislation, and assumed for purposes of its revenue estimate.

This brings us back to the House Republicans whose bill this is believing something else about state and local income tax deductibility - or at least, as Kamin says, wanting to "have us believe" they are creating the loophole. (For "us," perhaps one might substitute "the lobbyists who are also pushing for the 25% plutocrat rate.")

Have the House Republicans tried to communicate their true understanding (assuming it's true) to the JCT? Have they tried to avoid communicating it? Has it simply been a huge oversight? If so, has anyone been eager to correct it, and thus fix the revenue estimate if necessary, before the House votes on the bill? Are the lobbyists, not the JCT, the ones who are being fooled? (But in that case, why wouldn't the loophole prevail, given the evidence supporting its being intended?)

These questions ought to be answered, and the sooner the better.