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Chris Sanchirico

Chris Sanchirico, Samuel A. Blank Professor of Law, Business, and Public Policy at the University of Pennsylvania. Chris has a law degree and a Ph.D. in economics, both from Yale University. In graduate school, his fields of study were mathematical economics and public finance. At Penn Law School, he teaches Federal Income Tax, Taxation of Business Entities, International Taxation, and Tax Policy. Before moving to Penn, Chris taught in the economics department at Columbia University and the University of Virginia School of Law. Chris’s research focuses on a variety of issues in tax policy using a diverse array of methodologies.

As American as Apple Inc.

March 18th, 2014

Are large U.S. multinationals largely U.S. owned? To hear some of the arguments for retaining or enhancing the tax benefits that these companies enjoy, you’d think this was a given. Think again.

Quirks in the tax laws essentially provide large U.S. multinationals like Apple, Google, and Cisco with a kind of turbo-charged Individual Retirement Account (IRA).

The companies bottle up profitable aspects of their businesses in foreign subsidiaries located in no or low-tax jurisdictions. They pay little or no tax on the profits as earned, or on the build-up from reinvesting those profits within the subsidiary. Tax is imposed only when the subsidiary returns the built-up earnings to the U.S. parent in the form of a dividend. This much is just like an IRA: no tax as earned, no tax on build-up, tax upon withdrawal.

Better than an IRA is that the tax “upon withdrawal” has in the past been, and may again be, significantly reduced. In 2005, Congress granted a “repatriation tax holiday” on dividends from foreign subsidiaries and lowered the tax from 35% to 5¼% . Several tax reform plans floating around Washington today would provide yet another holiday on these repatriated earnings.

Whether providing tax benefits of this kind is good policy is a complicated issue—perhaps more complicated than it seems. Any serious consideration of the issue quickly gets bogged down in long-running debates regarding the “double taxation” of corporation income, the propriety of specially encouraging business investment, and the proper taxation of foreign source income.

But this much can be said: Some of the most common arguments for retaining or enhancing these tax benefits stand on very shaky ground. They rest, at least in part, on the premise that the multinational companies that enjoy these benefit are largely U.S. owned.

In fact, we have very little idea who owns these companies. I explain why in a new paper “As American as Apple Inc: International Tax and Ownership Nationality”.

Consider the claim that the tax benefits enjoyed by large U.S. multinationals are crucial for “U.S. competitiveness”. If the idea is that we should sacrifice precious revenue to help someone “win”, it seems worth knowing who that someone is.

To be sure, proponents of the competitiveness argument generally focus on helping U.S. workers—and that is certainly part of the story. But on the other hand, there is little doubt that some of the benefit of reduced taxation of corporate profits goes to those who own those profits, namely shareholders. Based on a careful review of the literature, the Tax Policy Center itself allocates a substantial portion of corporate tax incidence to corporate shareholders, as opposed to workers, consumers, and owners of other forms of capital. Who then are these shareholders?

U.S. multinationals and their supporters also make the claim that a second “repatriation tax holiday” would induce them to “bring the money home” and create jobs. We know that the 2005 repatriation holiday caused these companies to pass at least some portion of the dividends to their own shareholders. This doesn’t rule out job creation. But it raises the question of whether and to what extent these shareholders would plow the funds back into the U.S. economy. To answer this we’d also want to know who these shareholders are and where they live.

As I discuss in the paper, a well-known economics literature identifies and attempts to explain the phenomenon of “home country bias” in stock portfolios. This research points toward the largely U.S. ownership of U.S. companies in general. Yet it has little to say about the special case of large U.S. multinationals.

The data analysis in the home bias literature doesn’t distinguish large multinationals from other kinds of U.S. companies. Moreover, commonly-accepted explanations for home bias—information asymmetries and cognitive biases based on “familiarity”—suggest that large U.S. multinationals are exceptional. After all, if a French citizen wanted to learn about home country bias, she might well Google it on her iPhone. Multinational companies are, well, multinational.

The next step then is go back to the original data to try to zoom in on these companies. But that turns out to be largely fruitless exercise.

The federal government has several overlapping reporting regimes regarding equity ownership in U.S. companies. These include the Treasury International Capital system used to compile the balance of payments, IRS data on the withholding tax on dividends paid to foreign shareholders, and three separate regimes administered by the SEC: reporting by “institutional investment managers” on Form 13F, by mutual funds on Forms N-Q and N-CSR, and by “registered investment advisers” on Forms ADV and PF.

Several of these reporting regimes are ingeniously designed. Some require surprisingly detailed responses. But none were designed to reveal the foreign ownership share of large U.S. multinationals. And none of them supply this information serendipitously.

Nothing should prevent large U.S. multinationals from making the “what’s good for us is good for America” argument. There’s a lot to be said for that approach. But in weighing such arguments, we should lend a critical eye to any claim–however implicit, however rhetorical–that the “us” are themselves U.S. Certainly, the fact that a firm files its corporate documents in Delaware rather than Düsseldorf shouldn’t matter. And if we’ve been thinking of these companies as U.S. firms based on the presumption that their owners are largely U.S. persons, we will need to reevaluate.


“Stateless Income” Versus “Statefully Taxless Income”

November 4th, 2013

Ireland is playing the world like a Celtic harp, and perhaps the world deserves it.

The US and other European nations have been complaining for some time about Ireland’s impish behavior in international tax. Ireland, it is said, has specifically designed its tax system to help facilitate tax avoidance by massive multinational enterprises (MNEs) such as Apple, Google, and Cisco.

But Ireland’s critics have been imprecise about their gripe. They accuse Ireland of enabling “stateless income”, income that escapes taxation because each nation with a claim to tax it ascribes it to another country—like two gentlemen who each refuse to be the first to enter a closing elevator. Stateless income is a catchy phrase with resonating negative connotations and has become a rallying cry for reform. A quick and dirty Google search pulls up 25,000 hits in the last year alone.

Statelessness, however, was never the issue. (USC law professor Ed Kleinbard, who is credited with coining the term has always been clear on this.) Plenty of states are perfectly willing to count income as their own without taxing it. We call them “tax havens.” Consequently, it is as easy to be statefully taxless as it is to be stateless. The circumstance is different. The result, however, is the same.

Now Ireland is gaming this imprecision. Last week its Department of Finance responded to the literal demands of critics while leaving Ireland’s tax system effectively untouched. It thus threw the world the meatless bone it has been demanding.

To help understand what the Irish government proposed, let’s take a quick tour of the existing laws in Ireland and the U.S.

Consider, for example, Apple Inc., whose tax strategy does utilize stateless income.

Apple’s first tier subsidiary is chartered as a corporation under Irish law, but is managed and controlled in the United States. The U.S. taxes the foreign sales of a company only when it regards that firm as a “resident” of the U.S. for tax purposes. But the U.S. bases tax residency on where a company is chartered. It pays no attention to where it is managed and controlled.

Because Apple’s first tier subsidiary is chartered in Ireland, it is not taxed by the U.S. on its foreign sales income, despite the fact that it is managed and controlled in the U.S.

For its part, Ireland also taxes only those companies that it regards as resident for tax purposes. But Ireland defines a corporation as a tax resident if it is managed and controlled in Ireland regardless of where it is chartered. Because Apple’s first tier Irish subsidiary is managed and controlled in the U.S., it is not taxed in Ireland, despite the fact that it is chartered there.

Consequently, Apple’s first-tier Irish subsidiary is a tax resident of neither the U.S. nor Ireland. Of course, these aren’t the only two countries in the world. But Apple’s first-tier subsidiary has also declined to establish tax residency in any other nation. The subsidiary’s income—which, thanks to careful tax planning, is a substantial portion of Apple’s profits—is thereby “stateless” and, in turn, taxless.

But so what? Apple’s top tier subsidiary—free of U.S. or Irish tax residency by virtue of the mismatch between these nations’ laws—might just as well have established tax residency in Bermuda or the Cayman Islands. If it had done so, its income wouldn’t be stateless any more. But it would still be taxless since these island nations impose essentially no tax.

And that’s exactly the wedge Ireland exploited. Thursday before last, its Department of Finance proposed legislation that would tax Irish-chartered companies that take advantage of this legal arbitrage and furthermore have no tax residency.

Thus, firms that declare tax residency in jurisdictions that do not impose tax—that is, companies that have no-tax residency, rather than no tax residency—would be unaffected by the proposal.

In response to Ireland’s clever parry, reform advocates must now revise their message, explaining that, well, they never really meant “stateless” per se. Quite likely, the cause will suffer. It is no easy thing to backpedal without losing forward momentum.

Precision can be boring—tax experts relearn this every holiday season as relatives’ eyes take on a turkey-like glaze as we try to explain what it is we do. But international tax reformers might have been better off with a little more precision upfront. Arguably, the rhetorical cost they will pay for having to back away from their rallying cry mid-charge exceeds the rhetorical benefit of choosing catchy over correct.



“Common Sense” Aside, What Do We Really Know About Capital Income Taxes and Growth?

March 15th, 2013

If you’re discussing tax policy with someone who asserts that his or her point is “just common sense,” this could indicate one of two things: Either no deep thought is required—as the person would have you believe. Or no deep thought has been applied.

The “common sense” notion that capital income taxes hinder growth seems to be more a case of the latter.

Long term capital gains are taxed only when the asset is sold and at roughly half the rate on wages and salaries. Dare to suggest that the rate on investment profits could be raised a bit—so that perhaps the rate on labor income could lowered—and you’re liable to be reprimanded for failing to understand something as plain as the nose on your face: To tax capital income is to tax the reward for saving and thus to discourage saving. Less saving means less investment and less investment means slower growth, fewer jobs, and lower wages.

Everyone knows that.

Everyone, that is, except the people who study the issue.

Economic theory teaches that the impact of capital income taxes on savings is robustly ambiguous. Empirical research has yielded mixed results, but overall the data seem to indicate that reducing capital income taxes decreases rather than increases savings. In addition, lowering capital income taxes is likely to go hand in hand with raising labor income taxes or government borrowing, both of which are arguably at least as harmful to growth as capital income taxation.

I step through these points in a recent Wharton policy brief. Here’s a brief of the brief:

Notwithstanding the common sense story that taxing the reward for saving reduces it, the effect of capital income taxes on savings is theoretically indeterminate. There are several sources of indeterminacy. Here is one:

Suppose that you’re putting money away for retirement and Congress increases taxes on what you earn from that savings. There are two countervailing effects on how much you save. First, every future dollar of retirement consumption now requires additional savings—to pay the additional future tax. Second, you’ll probably plan to spend fewer future dollars on retirement consumption—because it’s become in effect more expensive. Whether, in the end, you save more or less depends on whether the first effect is greater or less than the second.

What then do the data say? Econometricians have taken several different approaches, and findings vary. On balance, however, the empirical literature seems to lend greater support to the view that capital income taxes increase rather than decrease savings.

Some of the best empirical research, for example, focuses on estimating a key parameter of individual choice called the “intertemporal elasticity of substitution”. Applied to the retirement savings story told above, the bulk of estimates for this parameter support the conclusion that the first effect dominates, and retirement savings increase in response to greater capital income taxation.

But even if one could support the claim that capital income taxes—considered in isolation—hinder growth, that would not be enough. Capital income taxes aren’t set in a vacuum. Lower capital income taxes mean higher labor income taxes or additional government borrowing. (Yes, capital income tax reductions could be offset with spending cuts. But that just begs the question of why such cuts aren’t instead being used to reduce labor income taxes or borrowing .) Thus, to make the case against capital income taxes, one has to argue not just that such taxes hinder growth, but that they hinder growth more than labor income taxes and government borrowing.

That’s not an easy task.

Government borrowing is generally thought to crowd out private investment. CBO, for example, posits that each dollar of government borrowing reduces domestic investment by anywhere from 10 to 50 cents.

And although existing research is not definitive, there are valid reasons to believe that labor income taxes are at least as likely to reduce savings as capital income taxes. Consider, for example, that in the retirement savings story, labor income taxes have only the second, savings-reducing effect. Like capital income taxes, they reduce planned future consumption by making it more expensive (in this case, in terms of “leisure”). Unlike capital income taxes, however, they do not increase the number of current dollars that must be saved per dollar of future consumption.

In short, trying to spur growth by keeping capital income taxes low seems—at best—like trying to fix one side of the roof with shingles from the other.


Camp’s Investment Tax Plan: Implications for Lower Rates on Capital Gains?

January 30th, 2013

House Ways and Means Committee Chairman Dave Camp (R-MI) has proposed requiring most derivatives investors to pay tax on their annual returns even if they don’t realize their gains by selling their securities. This proposal, which requires investors to mark-to-market the value of financial derivatives, has ramifications far beyond the heady world of high-tech finance. It implicitly challenges our most basic and firmly held beliefs about why we tax investment gains the way we do.

Camp’s plan raises two key questions: First, should mark-to-market be required for all investment assets, not just derivatives? Second, does his proposal fracture one of the main justifications for taxing long term capital gains at roughly half the rate on ordinary income?

Ask most tax experts why, in a nutshell, rates should be lower for capital gains, and you’re liable to get a mini-lesson on the “lock-in effect.” There’ll be other reasons too. But the lock-in effect is going to be pulling some serious weight.

What the lock-in effect is and how it relates to mark-to-market—and why Camp’s proposal calls it into serious question—is best explained by way of analogy.

Imagine you’re a law professor, and your student comes to you with a note from the Dean saying that he should be allowed to take as much time as he needs on your upcoming exam. You shake your head, but decide it’s not worth bothering the Dean. The next day the student returns to your office to argue that his exam should also be graded more leniently. After all, given that he has as long as he likes on the exam, he’ll be temped to work on it an inordinate amount of time to the detriment of his other classes—unless, that is, he knows that he’ll get a decent grade in any event.

You’re astounded by the student’s audacity. Think of it: arguing that one problematic advantage, dubiously secured, deserves another. Rather than agreeing to grade more leniently, you resolve to call the Dean to question why the student is getting extra time in the first place.  (And you make a note to hire the student should you ever need legal help.)

The “lock-in” argument has the same basic structure as the student’s argument for lenient grading.

Start with the fact that investors “get as much time as they need” to pay tax on their accrued gains. Investment gains are taxed, not as they accrue, but only when they are “realized”—by, for example, selling the asset. This is a tax advantage because the unpaid tax stays on the taxpayer’s balance sheet and continues to earn income.

The lock-in argument then comes back for more: given that gains aren’t taxed until realized, it says, realized gains should be taxed at lower rates. Because investors can delay the tax until they sell the asset, they’ll be tempted to delay selling for an inordinate amount of time. That’s inefficient because better investments might crop up in the meantime. Keeping rates low reduces this tax-borne inertia.

Might it not be time to “call the Dean” about taxing only upon realization? Camp’s proposal—though it applies only to derivatives—is a strong prod to pick up the phone.

Proponents of the lock-in argument offer two main reasons to take the realization advantage as given. Camp’s proposal implicitly challenges both.

First, they say it’s just too hard to determine the market value of investments at year-end. That argument has always been suspect when it comes to publicly-traded securities for which prices are readily available with the click of a mouse.

But Camp now calls for marking to market derivatives whose underlying asset values are neither widely published nor even publicly traded. A derivative is merely a financial instrument, like an option or forward contract, whose value is tied to some underlying asset. One has to wonder: If it’s feasible to value the derivative, how can it not be feasible to value the underlying asset to which the derivative’s price is linked?

Second, proponents of the lock-in argument raise the specter of inconsistent treatment across assets. Sure, they say, some assets, like publicly traded stock, are easily valued and can be precisely marked-to-market. But others, like uniquely situated land, cannot be. Won’t that distort investment decisions and open up tax arbitrage opportunities?

In the context of a tax code full of partway measures, this too has always been a dubious argument. But it is even more suspect in light of Camp’s proposal.

He’d mark-to-market most derivatives but none of the assets from which they are derived. If disparate tax treatment distorts investment decisions between land and stock, would it not distort investment decisions between derivatives and their underlying assets? If tax arbitrage is a danger between stock and land, surely it is a danger between a derivative and its underlying assets. The arbitrage seems readymade.

Camp’s proposal is more than food for thought regarding derivatives. It’s a four-course meal for fundamentally rethinking how we tax investment gains.


New Ways to Think About a Tax on Public Companies

December 30th, 2012

Suppose someone proposed a special tax on businesses that make their ownership shares publicly available in affordable, easy-to-sell units. Such an idea would probably generate a lot of push-back. Efficiency advocates might complain that it taxed the very attributes that make equity markets efficient. Progressivity advocates might object on the grounds that it taxed those who have no alternative to publicly available investment opportunities.

In fact we already have such a tax. We call it the corporate income tax.

In what sense is the corporate tax a special levy on being publicly traded? And what do we know about the policy implications of such a charge?

Corporate earnings are taxed twice: First at the corporate level, then again as dividends when they are distributed to shareholders or as capital gains when those investors sell their shares.

But not all businesses are double taxed in this manner. The earnings of certain businesses—commonly referred to as “pass-through entities”—are taxed only once, at the individual level.

At one time, businesses that wished to be taxed as pass-throughs had to give up certain legal benefits of the corporate form, including the concept of “limited liability” that bars creditors from going after the owner’s personal assets. Alternatively, they had to qualify as special “Subchapter S corporations,” which strictly limited their ownership structure.

Now, businesses have available to them alternative forms that replicate many of the legal benefits of the corporation, impose none of the requirements of Subchapter S, and yet avoid corporate tax. Limited liability companies and limited liability partnerships are two prominent examples. According to the Congressional Budget Office, the share of business receipts generated by these pass-through entities has more than doubled since 1980.

But there is still one circumstance in which a business cannot avoid the double tax. No matter its legal form, a firm is taxed as if it is a corporation if its ownership interests are publicly traded. (Entities whose earnings consist almost entirely of “passive type income” are exempt from this rule.) A firm meets Treasury’s definition of “publicly traded” if it is listed on an established exchange or otherwise makes its ownership rights publicly available in affordably small, readily salable units.

CBO reports that more than three-fifths of all business receipts are still earned by corporations. It is likely that many have not converted to pass-throughs because, wishing to remain publicly traded, there is no benefit to doing so.

Thus, the corporate tax is a tax on being publicly traded in the following sense: there is no real reason for a business to pay it unless that business is publicly traded.

Understood in this way, the corporate income tax would appear to have important implications for the progressivity and efficiency of the tax code. But those consequences are largely unstudied.

Consider, for instance, progressivity. One hypothesis worth considering is that the existing corporate tax is more regressive than a general tax on business investment because the corporate tax is borne more heavily by those who have no alternative to publicly available investment opportunities.

Unfortunately, existing research on who pays the corporate tax has little to say about hypotheses of this kind. That literature, which has been nicely summarized by my Tax Policy Center colleague Jim Nunns, has been primarily concerned with how the market shifts the corporate tax burden away from its original legal placement—for example, onto workers as lower wages.

But the literature makes counterfactual assumptions regarding the place from which the burden is shifted. The central economic model assumes that certain goods must be produced in corporate form, and that—for at least some consumers—such corporate-specific goods have no close substitutes. This is what gives the corporate tax its bite in the model.

But what really gives the corporate tax its bite is that it is effectively a fee on being publicly traded, and that—for at least some businesses and investors—publicly traded ownership has no close substitute.

While the original legal placement of a tax burden is not the whole story, it is part of what determines who bears the ultimate economic burden. In recent years, we have learned a great deal about how statutory burdens translate into economic burdens. The next big challenge for students of corporate tax incidence will be to apply those lessons to the actual statutory burden that is the modern corporate income tax.