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Thursday, July 17, 2003
Mitchell will be blogging with us, at least from time-to-time. His UVa profile page is on the left. Welcome!
Mitchell Kane on the Finance Committee and International Tax
Mitchell Kane, a new taxprof at the University of Virginia, writes:
Yesterday the Senate Finance Committee held a hearing on U.S. international tax policy and the competitiveness of U.S.-owned foreign operations. Last week the committee held a similar hearing on the competitiveness of U.S. firms conducting domestic operations. The testimony presented at these hearings evidences a fascinating clash among various interests, all of whom want a piece of the $50 billion that would be on the table following a repeal of FSC/ETI.
It is possible to distinguish among three broad interest groups. First, non-exporting firms with predominantly or exclusively domestic operations are advocating some program of general corporate tax relief (e.g., across the board rate reduction). These firms were not historic beneficiaries of FSC/ETI. They appear, however, to be using FSC/ETI repeal as a way to advance the position that across the board corporate tax relief will maintain competitiveness (and jobs) of U.S. firms in a manner that is WTO-compliant.
Second, U.S.-based firms with substantial export activity (i.e., the parties who stand to lose the most from FSC/ETI repeal) are attempting to keep the revenue gains from FSC/ETI repeal in the export sector to the extent possible but in a way that is WTO-compliant. For example, U.S.-based manufacturing firms have suggested that the proceeds from FSC/ETI repeal be used to fund tax breaks limited to manufacturing and processing companies. As compared to across the board corporate tax relief, such an approach would reduce the amount of revenue shared with parties that did not historically benefit from FSC/ETI.
Third, firms with substantial foreign operations are hoping to use the event of FSC/ETI repeal to fund a grab bag of items on their wish list of international tax reform. Possibilities include repeal of the subpart F base company rules, amendment of the foreign tax credit limitation interest allocation rules to provide for worldwide allocation of interest expense, a temporary rate reduction on repatriations from CFCs, increase of the cutoff for the subpart F de minimis rule, decrease in the number of foreign tax credit limitation baskets, provision of overall domestic loss rules that parallel the overall foreign loss rules, and many others. Most of these items have nothing to do with the historic rationale for DISC/FSC/ETI. Interested parties are taking the position that FSC/ETI repeal will aggravate the competitive disadvantage generally imposed by the U.S. tax system in the international setting and this is accordingly an appropriate time to undertake reform measures to address concerns about competitiveness.
David Rosenbloom and Stephen Shay should be commended for offering testimony rising above the fray of interest group politics. Mr. Rosenbloom offered a moving (for me anyway) and seldom-voiced assessment of what is right about the U.S. tax system:
[I]t touches the lives of more than 150 million people year in and year out, and does so with virtually no corruption, surprisingly little error, and remarkable efficiency, given the scope of the system and the complexity of our national economic life. Both the system as a whole and the agency that administers it are national treasures – the envy of just about every other country that has devoted serious though to these subjects.
I take Mr. Rosenbloom’s point to be that this is indeed an ideal time for fresh, and perhaps radical, thinking about fundamental reform of the U.S. international tax rules. In going down that road, though, we should be careful about embracing wholesale criticism of the system as dysfunctional and anti-competitive. Such sentiments are more likely to be voiced by parties that have a short-term interest in tax reduction, through whatever means possible, than by parties with an interest in establishing long-term and conceptually sound tax reform. Mr. Shay likewise counsels that we ought to be taking a broad view of the tax system. In Mr. Shay’s opinion it would be wrong to conclude, without further analysis, that the proceeds of FSC/ETI repeal should necessarily be earmarked for international tax reform. The determinative criterion should be how the proceeds can be used best to improve the lot of U.S. citizens and residents. That goal may or may not involve revision of the international tax rules.
The submission of the U.S. Treasury, by contrast, was singularly disappointing. The Treasury continues to advocate reform, in part, on the grounds that the current U.S. approach of worldwide taxation is anti-competitive as compared to territorial systems (and other worldwide systems with less stringent CFC rules).
This argument is specious. The claim is that when making FDI U.S. firms cannot compete against firms from territorial systems (which, unlike U.S. firms, pay no residual home country tax on FDI and thus pay tax on host country investment at the host country rate). The term “competitiveness” is vague but let’s assume that to say a foreign firm has a tax-induced competitive advantage means that an otherwise identical foreign firm can, because of tax considerations, either (i) outbid a rival U.S. firm on the acquisition of a host country investment or (ii) in the operation of competing host country investment projects drive the US firm out of the market through an aggressive pricing strategy. I would have thought that a multinational firm would make its decision about its best bid or its pricing strategy on an integrated basis. That is, the firm’s competitive advantage or disadvantage should be based on the firm’s overall cost of capital, taking into account how the decision to finance the project through debt, new equity issue, or retained earnings affects the overall cost of capital. By contrast, the firm would be unlikely to base its acquisition or pricing strategy for a marginal investment based solely on host country taxes (deriving, in effect, some type of hypothetical country specific cost of capital as opposed to firm-wide cost of capital), though of course host country taxes go into the mix for determining the cost of capital.
Consider the following thought example. Assume a world with three countries: country A has a corporate tax rate of 90%, country B has a corporate tax rate of 5%, and country C has a corporate tax rate of 0%. Initially the world is characterized by complete autarky. Upon commencement of international trade country A adopts a territorial system of taxation and country B adopts a worldwide system of taxation. Who has a competitive advantage on FDI in country C: a firm from Country A or Country B? Put another way, you can’t tell anything about relative competitiveness simply by comparing an isolated piece of one tax system with an isolated piece of another. (On this point, it is worth noting that the underlying rationale for FSC/ETI is itself specious. The fact that European exporters get a rebate of destination based VAT while U.S. firms do not cannot by itself tell you anything about who has the overall lower tax burden and thus superior competitive position on exports.) Of course tax reductions for U.S. firms make those firms more competitive. But so what? The real question is whether the existing rules embody a competitive disadvantage that requires a fix.
The only way to get a handle on competitiveness is to examine marginal effective tax rates and overall cost of capital. The Treasury should be engaging in this type of analysis but it is not. Instead we are being offered observations about how inversion activity evidences the competitive disadvantages of U.S. firms. As Reuven Avi Yonah suggested in Tax Notes last year, this is the reddest of red herrings. Inversion activity evidences the fact that when you couple ineffective section 367 rules with a formalistic determination of corporate residence the current rules make it too easy for U.S. corporations in certain cases to opt into the more forgiving tax regime applicable to foreign corporations. When you make it easy for U.S. firms to reduce their taxes they can be expected to do so. Of course, one would expect to observe identical behavior whether or not foreign firms are exerting excessive competitive pressures, or indeed, whether or not foreign competitors exist at all.
Juan Non-Volokh weighs in on Alcohol Taxes over at The Volokh Conspiracy.
Juan argues that alcohol taxes might be bad because they reduce the drinking of non-problem drinkers as well as problem drinkers, and small amounts of alcohol consumption can have positive health benefits. Interesting argument. Unlike, say, cigarettes, the optimal amount of alcohol consumption (from a health point of view) may be greater than zero, so the deterrence effect of the tax is not necessarily good.
I wonder, though, if the positive health benefits of small amounts of alcohol consumption are somewhat offset by other bad externalities, e.g. increased drinking and driving. It's also hard to know if alcohol taxes have a uniform deterrence effect, or if non-problem drinkers are less affected, in which case Juan's argument is a little thin. In other words, a stiff 50% tax might lead Don Drunk to consume 6 beers instead of 8 (since he only has $x in his pocket) but Healthy Harry has two glasses of red wine either way. Or, it could be the other way around. I'll leave this to the economists and scientists to sort out.
Wednesday, July 16, 2003
In my current research, I am looking for instances where the Treasury issued (or proposed) a regulation that is inconsistent (or arguably inconsistent) with then-existing judicial precedent. I have found the following instances: (1) check the box regulations and Morrissey; (2) proposed INDOPCO regulations and INDOPCO; (3) continuity of interest regulations and Heintz/McDonalds; and (4) anti-Bausch & Lomb regs and Bausch & Lomb. If anybody out there can think of any others, please e-mail me.
Monday, July 14, 2003
Legal Transitions, Rational Expectations, and Legal Progress
Kyle Logue has posted a paper on SSRN, Legal Transitions, Rational Expectations, and Legal Progress. I haven't read the paper yet, but I read an earlier draft last year.
When it comes to legal transitions, tax law is often at the forefront of the debate, and Logue's paper adds to that important debate. (Taxprofs Graetz, Shaviro and Kaplow, among others, have done important work on transitions.)