Reform 2.0 – Some Passing Thoughts on S.B. 2687

Senator Ted Cruz has introduced S.B. 2687, described as a bill “to make permanent the individual tax rates in effect for taxable years 2018 through 2025.” Speculation about the success of the effort has run the gamut (see here and here), but after last year’s holiday surprise, the new bill, which would lock in rate gains across the board, merits a quick read-through. It is possible that Congress would pass this bill or a similar one. With the legislature having made corporate rate cuts permanent and individual rate cuts temporary, individual members may be motivated to respond to constituents’ distributive justice-based criticisms.

Notably, S.B. 2687 would make the increased estate tax exemption—previously $5 million, now $10 million—permanent. Given that this Congressional love letter to the wealthy is paid for by permanently eliminating deductions for things like health care expenses, it might be a wish-list item for Republicans to use as a bargaining chip. It affects a vanishingly small number of constituents, and allowing Democrats to win on this front might be face-saving enough to swing a vote or two.

Most of the proposed legislation is business as usual though. The bill would, as advertised, make the new personal income tax rate cuts permanent. It would permanently repeal the personal exemption and miscellaneous itemized deductions, and it would continue to limit the home mortgage interest deduction and the deduction for state and local taxes. As I previously have written, repeal of the personal exemption might adversely affect large and non-traditional families, a possibility that the original reform and Senator Cruz’s subsequent effort would mitigate (but not eliminate) by doubling the child tax credit. For more on that, see Shannon Weeks McCormack’s article here.

A couple of miscellaneous provisions in the bill are worth mentioning (and here, I am not claiming to be comprehensive). The first would permanently restrict deduction of moving expenses under IRC § 217 to members of the armed forces who relocate in connection with active duty. As long as we are re-upping this provision for Congressional consideration, why not add Americorp and Teach for America to it? Moving allowances for these programs may not cover all of the participant’s cost, but like members of the armed forces, participants move on assignment in service to their country. Adding Americorp and Teach for America to section 217 likely will not cost much—these young people don’t have high incomes, so their deductions are proportionately smaller— and their inclusion in section 217 signals the importance of their public service. Our laws embody our values, and allowing the moving expense deduction for Americorps and Teach for America participants would more broadly express the government’s vision of personal sacrifice for the public good.

A second interesting provision of S.B. 2687 is permanent repeal of IRC § 132(f)’s exclusion for qualified bicycle commuting expense reimbursements. Is it just me, or is this narrow repeal sort of peculiar? From a nudge perspective, the exemption seems like a net good. Biking is expensive, and people on the margins otherwise might choose to drive, causing pollution and diseases associated with a sedentary lifestyle. On the other hand, we all know that in most cities, only the truly committed bike to work. It’s dangerous; it requires a lot of gear and a funny hat; and at the other end, despite what people may tell you, you need a shower. Cyclists don’t need a tax incentive; they are impervious to people who swear at them from the passing lane, and they will bike whether we pay them to or not. In fact, the market appears to be so inelastic that Oregon taxes bicycles. Maybe the fringe benefit for cyclists is not warranted on behavioral grounds. But even if the section 132 allowance doesn’t change anyone’s behavior, allow me to park a final question in this spot. Why single out this one small piece of the Code for elimination when, perhaps, all of section 132 is due for a tune-up?

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Diplomacy, or the Art of the Tax Deal 2.0?

The Republican-led passage of the Tax Cuts and Jobs Act may have evoked a Marx Brothers movie for some, but when it comes to international competition for the capital investment of foreign multinational enterprises (MNEs), the reform seems to fall squarely into President Trump’s 2016 campaign promise, “America First.”

After a decades-long rise of free trade agreements and the automation of manufacturing jobs, United States political sentiment seems to be shifting away from international cooperation. (Hence the barrage of tariffs?) The new law, rather than seeking to harmonize international taxation (which could decrease the outsized role of tax in decision-making), instead casts the United States as Rocky making a comeback in the global fight for capital investment. In other words, from an America First perspective, efficiently allocating capital investment to create the most value for the global economy is less important than bringing that investment into the United States, even though it might be less productive here. The reform’s tax competitive stance is likely to be politically palatable because most voters neither understand nor care that the Trump administration’s fight for a larger United States share of the worldwide economy might result in a smaller worldwide economy overall.

Indeed, foreign-based MNEs are likely to benefit from increased capital investment in the United States going forward. At an event hosted on March 5 in Vienna by IFA Austria, one panelist noted that at least three large foreign manufacturers—Daimler, BMW, and Siemens—expect to see initial benefits in the hundreds of millions of Euros. In fact, the United States reform has prompted the EU to request an OECD investigation of whether the new law violates international standards on harmful tax practices.

The United States’ forward-leaning stance is somewhat (or some might say almost entirely) unhinged from typically applicable diplomatic constraints, both formal and informal. In particular, Congress seems to have disregarded potentially applicable WTO prohibitions on export subsidies. (For more on this point, read my OSU colleague Ari Glogower and others here and here.) Given the United States’ long history of these types of violations (you may recall the DISC, the foreign sales corporation, and the extraterritorial income system), this new WTO fence-jump cannot easily be viewed as accidental. Already several EU finance ministers have already lodged complaints about it with members of Congress and the U. S. Treasury.

It is difficult, then, not to think that the new law was written in part to provoke a worldwide competitive response. Particularly in light of the president’s move toward tariffs, the new tax law reads like a catch-us-if-you-can grab for capital. Christian Kaeser, global head of tax for Siemens, described it as a “showcase of protectionism.” German newspaper, Die Welt, ran an editorial headline that translates, “Europe Dreams of a Tax Fortress- Trump Acts.” Ralf Kronberger, Head of the Department of Financial, Fiscal and Trade Policy at the Federal Austrian Economic Chamber, said of the EU, “We have to be in the game and create an attractive environment, and tax policy must contribute its share.” He added that while countries like Austria may be forced to compete with the United States for capital investment, “tax and trade war are not beneficial for anyone.” (Would someone please tell that to the president?)

So how will Europe react? Corporate tax policy in the European Union generally assumes that coordination within Europe and cooperation under BEPS will be sufficient to protect the tax base. Coordination, though, may not be compatible with competition, which the new United States law seems deliberately designed to provoke. Casually, tax folks here in Europe have been wondering aloud whether increased pressure to compete will further strain the effectiveness of the European Union’s effort to curb base erosion or whether it may put pressure on the alliance itself. If nothing else, economists and political scientists should be having a moment. The new law sets up a credible natural experiment for the observation of tax as a factor in capital mobility. And if viewed as a tool to encourage renegotiation of trade deals and bilateral tax treaties, it is an exciting (frightening?) opportunity to see what happens when a world power brings a business approach to statecraft at a time when states cannot be as facile as businesses in their response.

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Are Forty Percent of Tax Compliance Employees About to Get the Boot?

By Stephanie Hoffer, @prof.hoffer

New technology has the potential to completely change the face of tax law and accounting: that was the take-away from a recent installment of a tax and tech series organized by Professor Jeffrey Owens and Julia de Jong of Vienna University’s Digital Economy Taxation Network. The roundtable on Governance Implications of Disruptive Technology assembled experts from Microsoft, PWC, think tanks, and the academy.

The session began with a staggering prediction that large companies will sack up to 40% of their tax compliance employees in coming years. Why? Experts anticipate that technological progress in data collection and algorithmic reporting will allow audit functions to be built directly into data collection and management. This integration will allow governments to coordinate seamlessly with taxpayers by assuming the role of tax preparers whose reliance on algorithms largely eliminates the need for auditors. Similarly, data technology will eventually obsolete VAT returns, an administrative headache for most of the globe and a major source of work for the accounting industry. Eelco van der Enden, a partner with PWC Netherlands, went so far as to predict the breakup of Big Four accounting within ten years as technology grabs the tax prep reins and renders auditing obsolete.

Disruptive technologies that leverage data also have the potential to revolutionize how we address the tax gap. As van der Enden noted, “[d]ays are gone when you could create a bunch of bullshit” in a tax return to force regulators into a negotiation. The ready availability of data from sources as disparate as taxpayer reporting, social media accounts, and even satellite pictures of the planet are poised to revolutionize business and tax transparency. In addition, advances like quantum computing, when combined with what has been called a tsunami of data, will allow tax systems to handle an exponentially increasing amount of complexity. Transfer pricing, for instance, will be a whole new ballgame with the advent of close-to-omniscient tech. When (not if, but when) complexity no longer results in a loss of efficiency on the human side, tax administrations could see large gains from re-regulation in some cases.

As Harald Leitenmuller of Microsoft concluded about tax experts going forward, “[t]he future of your profession is to be a good data scientist who can leverage the knowledge hidden in the existing data.” Congress and IRS, take note.

(Written with thanks to Fulbright Austria for supporting my work.)

How Will Trump’s Tax Plan Affect Middle-Income Families?

By Stephanie Hoffer, @profhoffer

The President’s one-page tax plan, released on Wednesday, claims that it will “[p]rovide relief to American families – especially middle income families.” Whether tax reform eventually lives up to the President’s claim, though, will depend on how he and the Congress choose to address not only tax rates and the standard deduction, but also the personal exemption and credits related to children and dependents.

Like the Republican blueprint for tax reform, the President’s plan would double the standard deduction while trimming itemized deductions. It also would expand the credit for child and dependent care, although the plan doesn’t specify how.

Notably, the Republican proposal would eliminate personal exemptions provided by § 151, which allow a deduction of $4,050 per dependent in 2017. Dependents include a taxpayer’s spouse, children, and other members of the household who rely family support. Although the repeal of § 151 was not specifically mentioned in the President’s proposal, the President and Congress must reach consensus on how to reduce the cost of tax reform. Eliminating personal exemptions in favor of an expanded standard deduction may be an approach on which both could agree, but it may not be good policy. Continue reading “How Will Trump’s Tax Plan Affect Middle-Income Families?” →

Hemel and Maynard Push Boundaries of Equity in Recent Workshops

As part of its summer workshop series, Ohio State’s Moritz College of Law invites junior scholars to present works-in-progress. This summer, we had the pleasure of hosting both Daniel Hemel, an assistant professor at the University of Chicago Law School and Goldburn Maynard, an assistant professor at the University of Louisville Brandeis School of Law. Both junior tax scholars are challenging the ways in which tax policy makers think about equity in the context of distributive justice.

Maynard, whose work-in-progress finds its intellectual genesis in Murphy & Nagel’s The Myth of Ownership and Reuven Avi-Yonah’s “The Three Goals of Taxation,” focused on the prominence of everyday libertarianism in tax litigation and policy making. Tax’s redistributive function, he asserted, should be tethered to equality rather than to economic liberty or to efficiency. While acknowledging that “equality,” could mean different things to different people, Maynard concentrated on equality of income or wealth, rather than on more difficult-to-quantify forms, such as equality of opportunity. Although he did not explicitly raise it, Maynard seems also to be contemplating an eventual challenge to the sufficiency of vertical equity as a measuring stick in tax policy. At this point, though, his goal is primarily to widen the discussion.

Hemel, too, is thinking of distributive justice in broader terms. Using the home mortgage interest deduction as a case study, Hemel and Kyle Rozema, a postdoctoral fellow at the Northwestern-Pritzker School of Law, argue that labeling a tax provision as “progressive” or “regressive” should not be done in isolation. Instead, scholars and policy makers should look both at the operation of a provision within the context of the Code and at the reallocation of revenue generated by a provision’s amendment or repeal.

For example, households in the top 1% of the income distribution tend to benefit more from the mortgage interest deduction than households in the bottom 99%. On the other hand, the presence of the deduction in the Code counter-intuitively causes the top 1% to bear a larger share of the total tax burden than they otherwise would. In other words, Hemel and Rozema assert that while the deduction looks regressive when viewed in isolation, it actually increases progressivity overall in the Code. (This, of course, is a function of what percentage of a taxpayer’s income is devoted to mortgage interest in a skewed income distribution, so the result might be different if Hemel and Rozema dug deeper into the distribution rather than focusing on the top.) Regardless, Hemel and Rozema seem to be proving Maynard’s implicit point that traditionally “equitable” policies do not necessarily promote equality of income or wealth.

Perhaps more interesting is Hemel and Rozema’s argument that the progressivity or regressivity of an amendment to the Code cannot be determined without also considering Congress’s use of the resulting revenue. For example, if Congress were to repeal the mortgage interest deduction and write equal-sized checks to each household, the distributional consequences would be more progressive than if additional revenue were used to reduce all taxpayers’ liabilities proportionately. Here, Hemel and Rozema’s argument brings to mind earlier work by Lily Batchelder and others on the use of refundable credits versus non-refundable credits or deductions. And notably, like Maynard’s work in progress, Hemel and Rozema’s work is pushing policy makers to look deeper into equity, questioning stock assumptions and asking how the concept can be made meaningful in practice and not just on paper.

That the traditional tax policy cannon (if there is such a thing) would breed restiveness in junior scholars at a time of political and class unrest should come as no surprise. Maynard’s assertion that equality has separate meaning and import, and Hemel’s and Rozema’s argument that tax analysis is only half of the picture push tax policy scholarship in a direction that is more pragmatic, building a bridge of sorts between what students of tax policy learn and what is happening in government. It will be interesting to see what the future holds both for these young scholars and for the world of tax policy more generally.

@ProfHoffer

Ohio is First in Country to Make § 529A ABLE Accounts Available to Residents of All 50 States

2016-06-01 STABLE Account Launch 2 By: Stephanie Hoffer

The ABLE Act is finally a reality for residents with qualifying disabilities in all 50 states, who now may open tax-preferred savings accounts through Ohio’s Stable Account program. The ABLE law, which I’ve previously covered on this blog and for TaxProf, allows individuals with disabilities to save money in tax-preferred savings accounts without jeopardizing their eligibility for Medicaid and other programs that make life in the community possible. As I have previously written, with the ABLE account, Congress has provided not only a tax advantage that may offset some of the cost imposed by society on individuals with disabilities, it also has taken a first step toward treating them like adults whose dignity and autonomy matter. Congratulations to the State of Ohio and to Treasurer Josh Mandel’s team for making the law a reality.

SSA Guidance Changes the Impact of Section 529A

By: Stephanie Hoffer

Passed as part of the Stephen Beck, Jr. Achieving a Better Life Experience Act of 2014 (the “ABLE Act”), IRC § 529A permits the creation of savings accounts, similar to college savings accounts, for individuals with qualifying disabilities. Although ABLE accounts are tax-preferred, tax preference is not the star of the show. Rather, the key feature of ABLE is its requirement that when determining an account owner’s eligibility for federal benefits like Medicaid and Supplemental Security Income (SSI), “any amount (including earnings thereon) in the ABLE account . . . of the individual, any contributions to the ABLE account of the individual, and any distribution for qualified disability expenses (as defined in subsection (e)(5) of such section) shall be disregarded . . . .” Medicaid, in particular, is important for individuals with qualifying disabilities because it covers social services that enable individuals to remain in the community rather than in institutional settings. SSI is also important, and not just as a source of income. In many states, eligibility for Medicaid is pegged to eligibility for SSI, and income and asset limitations apply to both.

As I noted in my prior article about ABLE, one viable interpretation of the statute could be that income contributed to an ABLE account is not countable income when determining an account owner’s eligibility for SSI (which, again, in many states is the key to Medicaid eligibility). Such an interpretation would be in keeping with Congress’s goals for ABLE, one of which was to overcome perverse incentives against savings faced by individuals with disabilities. But the Social Security Administration, in recently released POMS guidance, took a different position. The POMS provides, “[t]he fact that a person uses his or her income to contribute to an ABLE account does not mean that his or her income is not countable for SSI purposes.” So it’s back to the drawing board for individuals like Sarah Wolff, a woman with Down Syndrome who testified before the Senate Finance Committee, “I currently work two part-time jobs, and my employers have been gracious enough to work with me so I do not earn more than seven-hundred dollars a month . . . .” ABLE could have (and I believe it was meant to) provide Sarah with a place to save her extra income so that she could cover her own disability-related expenses and rely less on the government. SSA chose the well-worn path to dependence instead.

@ProfHoffer