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Category: Tax

Industrial Policy for Big Data

If you are childless, shop for clothing online, spend a lot on cable TV, and drive a minivan, data brokers are probably going to assume you’re heavier than average. We know that drug companies may use that data to recruit research subjects.  Marketers could utilize the data to target ads for diet aids, or for types of food that research reveals to be particularly favored by people who are childless, shop for clothing online, spend a lot on cable TV, and drive a minivan.

We may also reasonably assume that the data can be put to darker purposes: for example, to offer credit on worse terms to the obese (stereotype-driven assessment of looks and abilities reigns from Silicon Valley to experimental labs).  And perhaps some day it will be put to higher purposes: for example, identifying “obesity clusters” that might be linked to overexposure to some contaminant

To summarize: let’s roughly rank these biosurveillance goals as: 

1) Curing illness or precursors to illness (identifying the obesity cluster; clinical trial recruitment)

2) Helping match those offering products to those wanting them (food marketing)

3) Promoting the classification and de facto punishment of certain groups (identifying a certain class as worse credit risks)

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Andrew Blair-Stanek on “IP as a New Front in the Tax Avoidance Battle”

My colleague and guest blogger Andrew Blair-Stanek is working on a fascinating new piece entitled “IP as a New Front in the Tax Avoidance Battle.” As the piece exposes, multinationals’ IP-based tax avoidance is a serious problem that IP law, scholars, and practitioners have largely ignored. The abstract and corresponding cool diagram can be found here. I will blog more about it after the piece goes up on SSRN.

Tax Havens on the Electronic Silk Road

UKTaxHavensElephantInRoomAnupam Chander could not have picked a better topic in modern political economy than the digitization of flows of commerce. The Electronic Silk Road is packed with fascinating narratives about the legal conflicts that digitization generates.

As more value becomes digitally mobile, we may be on the cusp of unprecedented regulatory arbitrage (predicated on dubiously relevant doctrines, free trade commitments, and contracts.) To his great credit, Chander offers a fair assessment of digital commerce, balancing enthusiasm for its inclusive effects with caution about the need to curb the worst abuses of multinational corporations. My question is: will there be funding available to governments who take such a regulatory agenda seriously? For example, if Amazon’s Mechanical Turk decomposes digital labor among workers on different continents, how are we to fund the (sure to be sizeable) regulatory apparatus needed to assure that basic labor, safety, and other legal obligations are honored?

Consider, for instance, the aggressive tax planning of Apple. The company uses transfer pricing and Irish subsidiaries to manipulate its tax obligations. Apple’s IP (ranging from the Apple trademark, to the copyright-protected software, to patents on the phone’s innards, to design patents that give Apple an exclusive right to use the particular “look and feel” of its phones) may, in turn, be “owned” by an Apple subsidiary in, say, Bermuda, or the Cayman Islands. When people try to criticize Apple’s suppliers’ sharp labor practices, their work is often banned from the company’s app store. Apple ensures its own iGovernance mechanisms are unitary, swift in judgment, and a near-absolute authority on many aspects of the smartphone experience of tens of millions of netizens, while taking advantage of weak and fragmented jurisdictions for tax planning purposes.
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Grassroots Campaigns to Untax the One Percent

RPMThis book, recently published by Oxford, ought to draw some comment this Fall. From its description:

Isaac Martin shows how protesters on behalf of the rich appropriated the tactics used by the Left-from the Populists and Progressives of the early twentieth century to the feminists and anti-war activists of the 1950s and 1960s. He explores why the wealthy sometimes cut secret back-room deals and at other times protest in the public square. He also explains why people who are not rich have so often rallied to their cause.

For anyone wanting to understand the anti-tax activists of today, including notable defenders of wealth inequality like the Koch brothers, the historical account in Rich People’s Movements is an essential guide.

As Ezra Klein notes, for many, “opposition to taxes has nothing to do with policy. It has nothing to do with the economy. It’s religion. It’s dogma. It’s identity.” Martin’s scholarly work may help explain this development.

Two Views of Charities

The Tampa Bay Tribune has put out a list of “America’s Worst Charities,” based on payments to solicitors. Dan Pallotta offers some reservations regarding that approach:

[T]he overhead question has a number of flaws. A few of the easy ones to talk about and describe are, first, it operates on a mistaken theory of waste. So, a [soup kitchen] tells you $.90 of your donation goes to the cause and you think: Well, that’s great, now I know that they don’t waste any money. But you don’t know that at all. How do you know they are not wasting the $.90 that’s being spent on the cause? That’s where all the money goes; that’s where the largest opportunity for waste is. Related to that, it tells you nothing about the quality of services. So, that soup kitchen can tell you $.90 of every donation goes to the cause and you’ll never learn that the soup is rancid. . . .

Next, the percentage of your donation that goes to the cause depends entirely on how the charity defines the cause. So, the more broadly they define the cause, the higher the percentage they can tell you is going to the cause. It actually operates on a false theory of transparency as well, because unless you know the underlying accounting and definitions of the cause, there is no transparency in that simple articulation of an overhead percentage. Worse, this demand the charities keep overhead below prevents them from spending money on the overhead things they have to spend on in order to grow. And that’s how we institutionalize the miniaturization of these organizations.

Pallotta offers many provocative thoughts on how success is measured in the nonprofit sector.

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Agencies in the Cathedral?

AgenciesAreas of law dominated by government agencies haven’t taken advantage of the rich literature on property rules and liability rules, which are “workhorse concepts that permeate every corner of the economic analysis of law.” In their 1972 article Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, Calabresi and Melamed observed that there are fundamentally two types of remedies: (1) property rules, such as injunctions or disgorgement, which aim to deter, and (2) liability rules, like compensatory damages, which aim to compensate. This framework has paid rich dividends in areas like torts, property, IP, contracts, and conlaw — but seems to have bypassed areas of law dominated by agencies.

Government agencies’ remedies can be classified as either property rules or liability rules. For example, if a business has a permit from the EPA but violates the permit’s conditions, the remedy could be either taking away the permit (a property rule), or requiring proportional compensation (a liability rule). Similarly, if a broker has a license from the SEC and violates securities law, the remedy could be either yanking the license (a property rule), or requiring compensation for the harmed parties (a liability rule).

I apply the property rule and liability rule framework to my favorite agency — the IRS — in a forthcoming Virginia Law Review article. When a taxpayer violates a tax-law requirement, the remedy can be either yanking the taxpayer’s favorable tax status (a property rule), or requiring compensatory additional tax (a liability rule). Counterintuitively, anecdotal evidence shows that property-rule remedies may be less effective at deterring violations, because the threat of political and media blowback may make the IRS unwilling to impose a draconian property-rule remedy. As a result, when Congress protects a requirement with the property-rule remedy of yanking a favorable tax status, politically-powerful or sympathetic taxpayers are rarely deterred from violating the requirement. The IRS doesn’t dare impose it. Surely similar problems plague enforcement by other agencies.

Anyone working in any agency-dominated area of law could consider how the property-rule/liability-rule framework fits into their area.

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Gently Nudging with Liability Rules?

No Smoking symbolWhy have sexual harassment and anti-smoking laws been so successful in changing entrenched social norms in the U.S. over the past few decades? In a 2000 U. Chicago Law Review article, Dan Kahan observed that combatting these ills took the approach of “gentle nudges,” imposing moderate remedies that were within the range of what decisionmakers (e.g. judges and juries) thought was reasonably proportional to the violation. Because these moderate remedies were enforced, norms shifted, and lawmakers could ratchet up the remedies. By contrast, Kahan observed that “hard shoves” imposing remedies substantially exceeding social norms fail to be enforced or to change norms. For example, France tackled sexual harassment by making it a criminal offense, which French society saw as vastly disproportionate. As a result, French sexual-harassment law went unenforced against conduct that would have easily incurred liability under U.S. law, and French norms barely shifted.

There is an underexplored connection between Kahan’s “gentle nudge” vs. “hard shove” dichotomy, and Calabresi & Melamed’s “property rule” vs. “liability rule” dichotomy. Calabresi & Melamed observed that remedies are either (1) liability rules, such as compensatory damages, or (2) property rules, such as injunctions or prison, which aim to deter. Liability rules generally overlap with “gentle nudges” in that they aim for proportional compensation. Property rules largely overlap with “hard shoves.”

The debate over the relative merits of property rules and liability rules has raged in academia and the courts. Bringing Kahan’s observations into the mix weighs in favor of liability rules, which are more likely to be enforced – and to shift norms.

I explore the relationship between these two dichotomies in sections II.C.3 and IV.C of a forthcoming article looking at IRS enforcement (or lack thereof). But their interrelationship is promising for anyone interested in either the property-rule/liability-rule debate or in altering social norms.

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Taxonomy of Innovation Incentives

SIP folks don’t talk enough with tax-law folks, and vice versa. This has some unfortunate results. IP has become a leading tax-avoidance vehicle, without drawing sufficient notice from IP scholars and practitioners. And R&D tax incentives are rarely evaluated alongside patents, prizes, and research grants as effective ways to foster innovation.

An insightful article forthcoming in the Texas Law Review, by Daniel Hemel and Lisa Larrimore Ouellette, takes a big step in bridging this gap. They observe that all innovation incentives can be broken down along three dimensions: (1) who decides (government vs. the market), (2) when paid (ex ante vs. ex post), and (3) who pays (government vs. users). For example, patents are market-driven, with money delivered ex post, from users of the patented technology. By contrast, R&D tax incentives are market-driven, with money delivered ex ante, from the government.

These three dimensions lead to a 2 x 2 x 2 matrix, suggesting a total of eight types of innovation incentives. But only five are currently used: patents, prizes, research grants, R&D tax incentives, and patent boxes (which provide favorable tax rates on patent income). As a result, Hemel and Ouellette’s taxonomy suggests three new mechanisms to encourage innovation. Their taxonomy also teases out some exciting new insights on the relative merits of existing innovation incentives, including some previously overlooked benefits of R&D tax incentives.

 

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Tall Latte with a Double Shot of Tax Avoidance

StarbucksLogoIntellectual property has become a major tax-avoidance vehicle for multinationals. Front-page articles in the New York Times and Wall Street Journal have detailed how IP-heavy companies like Apple, Google, and Big Pharma play games with their IP to avoid taxes on a massive scale. For example, Apple uses IP-based tax-avoidance strategies to reduce its effective tax rate to approximately 8%, well below the statutory 35% corporate tax rate (and well below most middle-class Americans’ tax rates).

Two characteristics of IP make it the ideal tax-avoidance vehicle. First, the uniqueness of every piece of IP makes its fair market value extremely hard to establish, allowing taxpayers to choose whatever valuations result in the least tax. Second, unlike workers or physical assets like factories or stores, IP can easily be moved to tax havens via mere paperwork.

But Starbucks is a bricks-and-mortar retailer dependent upon physical presence in high-tax countries. It wouldn’t seem to be in a position to use these IP-based tax tricks. Yet in an excellent, eye-opening paper, Edward Kleinbard (USC) delves into the strategies that Starbucks uses to substantially reduce its worldwide tax burden. Most interestingly, Starbucks puts IP like trademarks, proprietary roasting methods, operational expertise, and store trade dress into low-tax jurisdictions. Kleinbard cogently observes that the ability of a bricks-and-mortar retailer like Starbucks to play such games demonstrates how deep the flaws run in current U.S. and international tax policy.

 

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The IRS Scandal, Property Rules, and Liability Rules

IRS LogoRegardless of your take on the IRS targeting conservative groups applying for 501(c)(4) status, the episode demonstrates once again that Congress, the Administration, and the media have multiple avenues to pressure the IRS to act or to reconsider earlier actions. This susceptibility to political pressure has broad, counterintuitive implications for how to best deter violations of requirements throughout tax law.

In their path-breaking law & economics article, Calabresi & Melamed observed that every entitlement can be protected by either a property rule (e.g. injunctions, disgorgement of profits) or a liability rule (e.g. compensatory damages). The same is true in tax law. When a taxpayer violates a requirement for a favorable tax status, the tax code either imposes additional tax proportionate to the harm (a liability rule) or imposes the draconian penalty of taking away the tax status entirely (a property rule).

Which rule is most likely to deter a well-connected organization from violating a requirement imposed on it by tax law? At first glance, property rules (i.e. yanking the organization’s favorable tax status) appear to be the most effective deterrent. But the IRS routinely hesitates to take this draconian step, which would result in complaints to Congress, the Administration, the media, and other organizations. Even if the tax code, as written, imposes this property-rule remedy, the IRS can and often does decline to impose it in practice.

Examples of this problem abound throughout tax law. My favorite example is a real estate investment trust (or “REIT”) that had its IPO in 2007 and revealed in its SEC filing that it was in clear violation of one of the requirements (I.R.C. § 856(a)(2)) to qualify as a REIT for tax purposes. How brazen! But what was the IRS to do? The requirement is protected by a property rule: the only remedy available to the IRS was to take away the REIT’s favorable tax status entirely. This would have been draconian. All the REIT’s shareholders would have complained to their congresspersons, the financial press would have run stories, and the National Association of Real Estate Investment Trusts would have raised a ruckus. The IRS didn’t dare impose this property-rule remedy. The IRS did nothing, and the REIT suffered no consequences for the violation.

Would this REIT have been so brazen if the requirement had, instead, been protected by a liability rule, which would merely have imposed additional tax proportional to the violation? Almost certainly not. And that is the counterintuitive result: liability rules are often more effective in practice than draconian property rules in deterring taxpayers from violating tax-law requirements.

The relative merits of property rules and liability rules in tax law are explored in depth by this forthcoming Virginia Law Review article.