Tag Archives: Tax

Border Adjustment Tax

On VoxEU, Mary Amiti, Emmanuel Farhi, Gita Gopinath, and Oleg Itskhoki discuss a border adjustment tax and its consequences.

… a border adjustment tax … would make export sales deductible from the corporate tax base, while expenditure on imported goods would not be deductible … Therefore, if the border adjustment extends to all imports and exports, it is akin to a combination of a uniform import tariff and an export subsidy on all international trade …

… it would limit the incentives for profit shifting across countries by means of transfer pricing towards lower tax jurisdictions … the border adjustment tax is a destination-based tax, linking the tax jurisdiction to the location of consumption, rather than the location of production.

Under certain circumstances … the border adjustment tax has no effects on economic outcomes … Lerner (1936) symmetry [implies] … that a uniform tariff on all imports is equivalent to a uniform tax of the same magnitude on all exports. As a corollary … a combination of a uniform import tariff and an export subsidy of the same magnitude … [has] no effect on imports, exports and other economic outcomes … results in an increase in the home relative wage and domestic cost of production by the amount of the tariff. … the relative cost of domestic production increases proportionally with the cost of imports, as well as with the subsidy to exports, leaving no relative price affected, nor the real wage. … As a result, tax policies that feature a border adjustment, such as the value added tax (VAT), do not have to systematically promote or demote trade.

Amiti, Farhi, Gopinath, and Itskhoki discuss several conditions for neutrality:

  • Flexible wages. If wages are sticky, a nominal exchange rate appreciation may partly substitute.
  • Uniformity of the border adjustment tax. This condition would likely not be met. Exchange rate fluctuations thus would affect some sectors more than others. And imports by non-incorporated businesses would be favored.
  • Foreign currency denomination of gross foreign assets and liabilities. (Not met, see below.)
  • Unexpected, permanent policy change, to prevent anticipation effects and currency appreciation before the fact.
  • Unchanged monetary policy stance, also in other countries, in spite of the exchange rate shock. This condition would likely not be met.

If the conditions for neutrality are met the border adjustment tax generates no international transfer. The fiscal implications depend on the sign of the trade balance. A home country exchange rate appreciation (that keeps relative trade prices and flows unchanged) generates a lump-sum transfer from households to the public sector when households hold net external assets which they use to pay for imports. When households have net external debt and thus, export on net, then the fiscal implications are reversed.

Since the US has currently a negative net foreign asset position, the US must run a cumulative trade surplus in the future. … the overall transfer would be away from the government budget and towards the private sector …

When some gross positions are denominated in domestic currency an appreciation transfers wealth internationally.

Since for the United States, the foreign assets are mostly in foreign currency, while foreign liabilities are almost entirely in dollars, this would generate a massive transfer to the rest of the world and a capital loss for the US of the order of magnitude of 10% of the US annual GDP or more.

US imports and exports are predominantly invoiced in dollars. With sticky pricing a border adjustment tax would raise the relative cost of imported inputs and consumer prices.

US exports … will likely fall together with US imports in the short run, with no clear effect on the trade balance. As trade prices adjust over time, both imports and exports will recover, resulting in a neutral long-run effect of the border adjustment tax on trade.

Tax Evasion and Wealth Inequality

The Economist reports about a study by Annette Alstadsæter, Niels Johannesen and Gabriel Zucman who matched leaked information from Swiss banks and Panamanian shell companies with Scandinavian wealth records. Their findings:

  • Tax evasion is progressive. The average / top 1% / top 0.01% Scandinavian household paid 3% / 10% / 30% fewer taxes than it should.
  • Accordingly, estimates of wealth inequality (based on tax data) likely underestimate the degree of inequality.

Mankiw on the Congressional Tax Plan

In the New York Times, Greg Mankiw applauds the tax reform plan discussed in Congress. He emphasizes four points:

  • The reform would move the US tax system toward international norms, from worldwide to territorial taxation.
  • It would move the system from income towards less distorting consumption taxation, by allowing businesses to deduct investment spending immediately.
  • The reform would change the origin-based into a destination-based system (taxing imports and exempting exports, a.k.a. “border adjustment”), with similarities to a value-added tax, making it harder to game the system. “[T]he immediate impact of the change would be to discourage imports and encourage exports. … the dollar would appreciate … The movement in the exchange rate would offset the initial impact on imports and exports.”
  • The reform would abolish tax deductions for interest payments to bondholders, eliminating incentives for corporate leverage. “A business’s taxes would be based on its cash flow: revenue minus wage payments and investment spending. How this cash flow is then paid out to equity and debt holders would be irrelevant.”

India’s Fight Against Shady Cash Holdings

India follows suggestions to fight tax evasion by taking high denomination notes out of circulation … and introducing new ones. Until the end of the year, Indians may exchange the old banknotes against new ones, at banks or post offices, by identifying themselves. On his blog, J P Koning discusses earlier demonetization episodes in Iraq and Sweden.

India’s move does not exactly follow the well publicized suggestions currently debated. But it might work.

“Causes of the Transformation of the US Fiscal System in the 1930s,” VoxEU, 2016

VoxEU, October 11, 2016, with Martin Gonzalez-Eiras. HTML.

  • The US fiscal system underwent a radical transformation around the time of the Great Depression.
  • Perceived cost differences of revenue collection across levels of government, due to general equilibrium effects, can partly explain the rise of tax centralization and intergovernmental grants.
  • We develop a micro-founded general equilibrium model that blends politics and macroeconomics. (See the working paper.)

“Fiscal Federalism, Taxation and Grants,” CEPR, 2016

CEPR Discussion Paper 11482, August 2016, with Martin Gonzalez-Eiras. PDF. Also published as CESifo Working Paper 6062, Study Center Gerzensee Working Paper 16-05. PDFPDF.

We propose a theory of tax centralization and inter governmental grants in politico-economic equilibrium. The cost of taxation differs across levels of government because voters internalize general equilibrium effects at the central but not at the local level. This renders the degree of tax centralization and the tax burden determinate even if none of the traditional, expenditure-related motives for centralization considered in the fiscal federalism literature is present. If central and local spending are complements and the trade-off between the cost of taxation and the benefit of spending is perceived differently across levels of government, inter governmental grants become relevant. Calibrated to U.S. data, our model helps to explain the introduction of federal grants at the time of the New Deal, and their increase up to the turn of the twenty-first century. Grants are predicted to increase to approximately 5.5% of GDP by 2060.

India’s Tax System

In the FT, Amy Kuzmin reports that after debating for nearly a decade,

India’s parliament has approved a long-awaited overhaul of the country’s fragmented tax system … The bill … will amend the constitution to permit replacing the current patchwork of national, state and local levies with a single, unified value added tax system.

He expects the reform “to create a genuine single market” and hails it as “one of the most significant reforms to the Indian economy since liberalisation began 25 years ago.”

Financial Transactions Tax—Stalled

In the FT, Jim Brunsden reports that the European Commission’s 2013 proposal to install a financial transactions tax has not made much progress. At least nine countries have to sign up.

The report highlights that key differences remain on how to craft exemptions from the tax, including the problem of how to shield transactions in other non-participating EU countries such as Britain. Other splits concern how to protect market-making activities by banks, and also what carveouts should apply for derivatives that are used by traders to hedge risk when they buy sovereign debt.

Basic Income

In the FT, John Kay points out that basic income proposals have one major drawback: They are very—expensive.

Not everyone agrees. Switzerland will hold a national referendum on the introduction of an unconditional basic income on June 5th, 2016. The supporters of the proposal write:

A basic income already exists today. Everyone obtains one from somewhere; otherwise we would not be able to live. In our society today, no one can survive without an income. The level of a basic income is currently included in the existing incomes. The shift that is needed now is to make current incomes free of conditions up to the level of this basic economic security. In fact, the introduction of an unconditional basic income does not cost anything. To assure basic security by means of a social contract will bring about a new situation for income of all origins. It opens up the possibility for negotiations at all levels. Principally, the existing incomes could be decreased by the amount of the basic income.

Addendum: The Economist discusses the pros and cons of universal basic income proposals.

Taxing the Rich

In Taxing the Rich: A History of Fiscal Fairness in the United States and Europe, Kenneth Scheme and David Stasavage

explore the intellectual and political debates surrounding the taxation of the wealthy while also providing the most detailed examination to date of when taxes have been levied against the rich and when they haven’t. Fairness in debates about taxing the rich has depended on different views of what it means to treat people as equals and whether taxing the rich advances or undermines this norm. Scheve and Stasavage argue that governments don’t tax the rich just because inequality is high or rising—they do it when people believe that such taxes compensate for the state unfairly privileging the wealthy. Progressive taxation saw its heyday in the twentieth century, when compensatory arguments for taxing the rich focused on unequal sacrifice in mass warfare. Today, as technology gives rise to wars of more limited mobilization, such arguments are no longer persuasive. [Text from the Publisher’s website.]

Summary by Bryan Caplan:

Democracies have no inherent tendency to “soak the rich.”

Instead, democracies adopt high, progressive taxation in the face of compelling “compensatory” arguments for redistribution.

Only major wars of mass mobilization make compensatory arguments compelling.

Modern military technology has made majors wars of mass mobilization obsolete.

Therefore, tax the rich policies are a thing of the past, at least for developed countries.  They won’t be coming back

Tax Treatment of Negative Interest Rates in Germany

The German Ministry of Finance has decided (p. 55, nr. 129a) that for tax purposes, negative interest rates are not to be treated as the opposite of positive interest rates. Instead they are considered fees. This treatment lowers taxable income to a lesser extent than would be the case under a symmetric treatment.

Tax Federalism

In the NZZMarius Brülhart and Kurt Schmidheiny discuss the Swiss experience with a federalist tax system. Cantonal and municipal taxes average roughly 40 percent of the total tax take in Switzerland, see the first figure.

grafik-1

The decentralized tax system, tax competition between cantons and communities as well as mobility of high income tax payers imply that the effective average income tax rate substantially falls short of the unweighted average tax rate on high incomes. In fact, the effective average tax rate is degressive for high incomes, see the second figure (which the authors reproduce from an article by Roller and Schmidheiny (2015)).

grafik-2

Cochrane for Growth

In a blog post, John Cochrane proposes step-by-step (politically unattractive) measures to increase growth:

  • Smarter (growth-oriented) regulation, in particular
  • Higher equity requirements and less short-term funding rather than complex financial regulation
  • Deregulation of health care supply
  • More cost-benefit analysis in environmental policy
  • Broad-based consumption rather than investment taxes
  • Clear separation of allocative and distributive fiscal policy
  • Focus on distortions in social programs
  • Deregulation of labor markets
  • Rational immigration rules distinguishing between permits to entry, reside, or work and citizenship
  • Less government intervention in the student loans market
  • Less protection, more free trade
  • More spending for the legal and criminal justice system
  • Etc.

Corporate Taxes: Difficult International Coordination

The Economist discusses proposals for improved consistency of international company taxation with the aim to counter firms’ “profit shifting.” Harmonization does not seem to constitute a Nash equilibrium. Tax rates on “patent boxes” typically are much lower than the headline rates.

“Politico-Economic Equivalence,” RED, 2015

Review of Economic Dynamics 18(4), October 2015, with Martín Gonzalez-Eiras. PDF.

Traditional “economic equivalence” results, like the Ricardian equivalence proposition, define equivalence classes over exogenous policies. We derive “politico-economic equivalence” conditions that apply in environments where policy is endogenous and chosen sequentially. A policy regime and a state are equivalent to another such pair if both pairs give rise to the same allocation in politico-economic equilibrium. The equivalence conditions help to identify factors that render institutional change non-neutral and to construct politico-economic equilibria in new policy regimes. We exemplify their use in the context of several applications, relating to social security reform, tax-smoothing policies and measures to correct externalities.

Scandinavia’s Success

In an online book published by the Institute of Economic Affairs, Nima Sanandaji argues not only that the Scandinavian success story predates the welfare state but also that the welfare state actually undermined the success story. From the book’s summary:

Many analyses of Scandinavian countries conflate correlation with causality. It is very clear that many of the desirable features of Scandinavian societies, such as low income inequality, low levels of poverty and high levels of economic growth, predated the development of the welfare state. It is equally clear that high levels of trust also predated the era of
high government spending and taxation. All these indicators began to deteriorate after the expansion of the Scandinavian welfare states and the increase in taxes necessary to fund it.

Swiss Withholding Tax Refunds Subject to Restrictions

Katharina Fontana reports in the NZZ about a decision by Switzerland’s highest court concerning the refund of withholding tax on dividends to foreign investors. According to the ruling such refunds may be denied if the investors are found to have engaged in financial engineering with the purpose to help clients circumvent the Swiss withholding tax.

Debt Supercycle rather than Secular Stagnation

In a Vox column, Ken Rogoff argues that the world economy experiences a “debt supercycle” rather than the onset of secular stagnation in the West.

Rogoff argues that macroeconomic developments since the financial crisis are in line with historical experience, as documented in his book “This Time is Different” (with Carmen Reinhart): A large fall in output followed by a sluggish recovery; deleveraging; protracted higher unemployment; and a strong rise of the government debt quota are typical after a boom and bust of house prices and credit.

According to Rogoff, policy makers should have implemented more heterodox policies including debt write-downs; bank restructurings coupled with recapitalisations; and temporarily higher inflation targets. Rogoff supports the (in his view, orthodox) fiscal policy responses that were adopted but criticizes that many countries tightened prematurely.

Rogoff acknowledges that secular forces shape the macroeconomy, in particular population ageing; the stabilization of the female labor force participation rate; the growth slowdown in Asia; and the slowdown or acceleration (?) of technological progress. But

[t]he debt supercycle model matches up with a couple of hundred years of experience of similar financial crises. The secular stagnation view does not capture the heart attack the global economy experienced; slow-moving demographics do not explain sharp housing price bubbles and collapses.

Rogoff doesn’t accept low interest rates as an argument in favor of the secular stagnation view. Rather than reflecting demand deficiencies, low interest rates (if measured correctly—Rogoff expects a utility based interest rate measure to be higher) could reflect regulation (favoring low-risk borrowers and “knocking out other potential borrowers who might have competed up rates”) and to some extent central bank policies.

Rogoff argues that the global stock market boom poses a problem for the secular stagnation view. He proposes changed perceptions about the likelihood and cost of extreme events (Barro, Weitzman) as factors to explain both low real interest rates and the stock market boom (after an initial asset price collapse during the crisis).

Regarding policy prescriptions to expand public investment in light of the low interest rates, Rogoff notes that

it is highly superficial and dangerous to argue that debt is basically free. To the extent that low interest rates result from fear of tail risks a la Barro-Weitzman, one has to assume that the government is not itself exposed to the kinds of risks the market is worried about, especially if overall economy-wide debt and pension obligations are near or at historic highs already. [Moreover] one has to worry whether higher government debt will perpetuate the political economy of policies that are helping the government finance debt, but making it more difficult for small businesses and the middle class to obtain credit.

Rogoff considers rising inequality to be problematic (and a possible factor for higher savings rates):

Tax policy should be used to address these secular trends, perhaps starting with higher taxes on urban land, which seems to lie at the root of inequality in wealth trends

He concludes that the case for a debt supercycle is stronger than for secular stagnation:

[T]he US appears to be near the tail end of its leverage cycle, Europe is still deleveraging, while China may be nearing the downside of a leverage cycle.

The Purple Plans

Laurence Kotlikoff appeals to “fellow economists and concerned citizens” to endorse plans for

Luxembourg’s Tax Agreements with International Companies

The International Consortium of Investigative Journalists reports about the tax agreements between Luxembourg and major international companies that helped these companies avoid taxes. The Consortium’s key findings:

Pepsi, IKEA, AIG, Coach, Deutsche Bank, Abbott Laboratories and nearly 340 other companies have secured secret deals from Luxembourg that allowed many of them to slash their global tax bills.

PricewaterhouseCoopers has helped multinational companies obtain at least 548 tax rulings in Luxembourg from 2002 to 2010. These legal secret deals feature complex financial structures designed to create drastic tax reductions. The rulings provide written assurance that companies’ tax-saving plans will be viewed favorably by Luxembourg authorities.

Companies have channeled hundreds of billions of dollars through Luxembourg and saved billions of dollars in taxes. Some firms have enjoyed effective tax rates of less than 1 percent on the profits they’ve shuffled into Luxembourg.

Many of the tax deals exploited international tax mismatches that allowed companies to avoid taxes both in Luxembourg and elsewhere through the use of so-called hybrid loans.

In many cases Luxembourg subsidiaries handling hundreds of millions of dollars in business maintain little presence and conduct little economic activity in Luxembourg. One popular address – 5, rue Guillaume Kroll – is home to more than 1,600 companies.

Hybrid loans combine the advantages of interest bearing debt and dividend paying stock. Profits are treated as interest payments (deductible for tax purposes) in Luxembourg and as profits (eligible for tax exemption) in the parent company’s country.

“The Future of Social Security,” JME, 2008

Journal of Monetary Economics 55(2), March 2008, with Martín Gonzalez-Eiras. PDF.

We analyze the effect of the projected demographic transition on the political support for social security, and equilibrium outcomes. Embedding a probabilistic-voting setup of electoral competition in the standard OLG model with capital accumulation, we find that intergenerational transfers arise in the absence of altruism, commitment, or trigger strategies. Closed-form solutions predict population ageing to lead to higher social security tax rates, a rising share of pensions in GDP, but eventually lower social security benefits per retiree. The response of equilibrium tax rates to demographic shocks reduces old-age consumption risk. Calibrated to match features of the U.S. economy, the model suggests that, in response to the projected demographic transition, social security tax rates will gradually increase to 16%. Other policies that distort labor supply will become less important; labor supply therefore will rise, in contrast with frequently voiced fears.