2008-1

 Kyle D. Logue and Joel Slemrod, “Genes as Tags:
The Tax Implications of Widely Available Genetic
Information

Advances in genetic research promise to loosen the tradeoff between progressivity and efficiency by allowing tax liability (or transfer eligibility) to be based in part on immutable characteristics of individuals (“tags”) that are correlated with their expected lot in life. Use of genetic tags would reduce reliance on tax bases (such as income) that are subject to individual choices and therefore subject to inefficient distortion to those choices. Taking advantage of this information will allow policy outcomes that dominate the outcome menu available without using genes as tags: the same distributional outcome can be attained with less cost to the economy. As genetic information spreads to private employers and insurers (and assuming the law did not effectively prevent them from using such information), the case for adopting a genetic endowment tax becomes more compelling, as genetic inequalities would be exacerbated by market forces. If society desires to reduce or eliminate such inequalities, to maximize overall utility by shifting resources from the genetic rich to the genetic poor, at least two potential policy instruments are available: a direct genetic endowment tax-and-transfer regime, or a regulatory regime that forbids genetic discrimination and forces genetic cross-subsidization.



 

2007-5

 Austan Goolsbee, Michael Lovenheim, and Joel
Slemrod, “Playing with Fire: Cigarettes, Taxes,
and Competition from the Internet”.

 This paper documents the rise of the Internet as a source of cigarette tax competition for states in the United States. Using data on cigarette tax rates, taxable cigarette sales and individual smoking rates by state from 1980 to 2005 merged with data on Internet penetration, the paper documents that there has been a substantial increase in the sensitivity of taxable cigarette sales that is correlated with the rise of Internet usage within states. The estimates imply that the increased sensitivity from cigarette smuggling over the Internet has lessened the revenue generating potential of recent cigarette tax increases substantially. Given the continuing growth of the Internet and of Internet cigarette merchants, the results imply serious problems for state revenue authorities.
 

2007-4

 James R. Hines Jr., “Taxation of Foreign Income”

 Taxation of foreign income entails the taxation by one country of income that its residents earn in another country. While most countries exempt active foreign business income from taxation, several large capital exporters subject foreign income to taxation but permit taxpayers to claim credits for taxes paid to foreign governments. There is extensive empirical evidence that the taxation of foreign income influences the magnitude of foreign investment, and the tax avoidance activities of investors. Neutral taxation of foreign income entails considerations not only of the volume and location of investment, but also the effects of taxation on capital ownership.

 

2007-3

 James R. Hines Jr., “Tax Havens”

 Tax havens are low-tax jurisdictions that offer businesses and individuals opportunities for tax avoidance. The 45 major tax haven countries in the world today are small, affluent, and generally well governed. They attract disproportionate shares of world foreign direct investment, and, largely as a consequence, their economies have grown much more rapidly than the world as a whole over the past 25 years. The effect of tax havens on economic welfare in high tax countries is unclear, though the availability of tax havens appears to stimulate economic activity in nearby high-tax countries
 
 

2007-2

 James R. Hines Jr., “Excise Taxes”

 Excise taxes are selective taxes on the sale or use of specific goods and services, such as alcohol and gasoline. Over time, governments have relied less on excise taxes, though excise taxes still contribute 12 percent of total government revenues in OECD countries. In addition to generating needed revenue, excise taxes can be designed to control externalities and to impose tax burdens on those who benefit from government spending. Rather more controversially, excise taxes also can be used to discourage consumption of potentially harmful substances (such as tobacco and alcohol) that individuals might overconsume in the absence of taxation
 

2007-1

 James R. Hines Jr., “Excess Burden of Taxation”

 The excess burden of taxation is the efficiency cost, or deadweight loss, associated with taxation. Excess burden is commonly measured by the area of the associated Harberger triangle, though accurate measurement requires the use of compensated demand and supply schedules. The generation of empirical excess burden studies that followed Arnold Harberger’s pioneering work in the 1960s measured the costs of tax distortions to labor supply, saving, capital allocation, and other economic decisions. More recent work estimates excess burdens based on the effects of taxation on more comprehensive measures of taxable income, reporting sizable excess burdens of existing taxes.
 

2006-5

 Keith J. Crocker and Joel Slemrod, “The Economics of Earnings Manipulation and Managerial Compensation

 This paper examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm. When realized, these earnings constitute hidden information that is privately observed by the manager, who may expend resources to generate an inflated earnings report. We characterize the optimal managerial compensation contract in this setting, and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits, and to report those profits honestly. As a result, some degree of earnings management must be tolerated as a necessary part of an efficient agreement.
 

2006-4

 Dhammika Dharmapala and James R. Hines Jr.
“Which Countries Become Tax Havens?”
December 2006

 This paper analyzes the factors influencing whether countries become tax havens. Roughly 15 percent of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Using a variety of empirical approaches, and controlling for other relevant factors, governance quality has a statistically significant and quantitatively large impact on the probability of being a tax haven. For a typical country with a population under one million, the likelihood of a becoming a tax haven rises from 24 percent to 63 percent as governance quality improves from the level of Brazil to that of Portugal. The effect of governance on tax haven status persists when the origin of a country’s legal system is used as an instrument for its quality of its governance. Low tax rates offer much more powerful inducements to foreign investment in well-governed countries than elsewhere, which may explain why poorly governed countries do not generally attempt to become tax havens – and suggests that the range of sensible tax policy options is constrained by the quality of governance.
 
 

2006-3

 James R. Hines Jr., “Taxing Consumption and
Other Sins,” November 2006

Throughout American history, the U.S. federal and state governments have imposed excise taxes on commodities such as alcohol and tobacco (and more recently, gasoline and firearms). Rates of such “sin” taxation, and consumption taxation broadly (including sales taxes and value-added taxes), are currently much lower in the United States than they are in Europe, Japan, and other affluent parts of the world. In part, this reflects relative government sizes, but that is not the whole story, since even controlling for total tax collections, levels of national income, government decentralization, and openness to international trade, the United States imposes unusually low excise and consumption taxes. As a result, the United States relies to a much greater degree than other countries on personal and corporate income taxes, thereby affording fewer opportunities to use the tax system to protect individuals and the environment by discouraging the consumption of “sinful” commodities, and instead simply discouraging saving and investment
 

2006-2

Mihir A. Desai, C. Fritz Foley, and James R. Hines
Jr., “Capital Structure with Risky Foreign
Investment,” May 2006. 

American multinational firms respond to politically risky environments by adjusting their capital structures abroad and at home. Foreign subsidiaries located in politically risky countries have significantly more debt than do other foreign affiliates of the same parent companies. American firms further limit their equity exposures in politically risky countries by sharing ownership with local partners and by serving foreign markets with exports rather than local production. The residual political risk borne by parent companies leads them to use less domestic leverage, resulting in lower firm-wide leverage. Multinational firms with above-average exposures to politically risky countries have 8.4 percent less domestic leverage than do other firms. These findings illustrate the impact of risk exposures on capital structure.
 

2006-1

 Joel Slemrod, “Taxation and Big Brother: Information, Personalization, and Privacy in 21^st Century Tax Policy, October 2005.

 The transmission and processing of information is at the core of taxation, and one of the great ongoing technological resolutions has been in information technology. Looking forward ten, twenty, or thirty years, what are the implications of technological advancements for tax policy? How will, and how should, tax policy be different twenty years from now than it is today? This paper argues that, although the new technology greatly facilitates the use of taxpayer information to create a personalized tax system, there are forces pushing the tax system in the opposite direction, toward a radically depersonalized tax system, partly out of concern over the infringement on privacy of the information.
 

2005-13

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Foreign Direct Investment and Domestic Economic Activity,” October 2005.

 How does rising foreign investment influence domestic economic activity? Firms whose foreign operations grow rapidly exhibit coincident rapid growth of domestic operations, but this pattern alone is inconclusive, as foreign and domestic business activities are jointly determined. This study uses foreign GDP growth rates, interacted with lagged firm-specific geographic distributions of foreign investment, to predict changes in foreign investment by a large panel of American firms. Estimates produced using this instrument for changes in foreign activity indicate that 10 percent greater foreign capital investment is associated with 2.2 percent greater domestic investment, and that 10 percent greater foreign employee compensation is associated with 4.0 percent greater domestic employee compensation. Changes in foreign and domestic sales, assets, and numbers of employees are likewise positively associated; the evidence also indicates that greater foreign investment is associated with additional domestic exports and R&D spending. The data do not support the popular notion that greater foreign activity crowds out domestic activity by the same firms, instead suggesting the reverse.
 

2005-12

Joel Slemrod, “My Beautiful Tax Reform,” March 2005.

 Many experts equate the best tax system with the simplest, and the best tax reform with the one that most simplifies the system. However, the simplest, most elegant policy need not be the best because tax policy involves a tradeoff among objectives, including equity and efficiency objectives, and often, achieving equity and efficiency requires some complexity. Because one’s favored tax system depends both on economic assumptions and value judgments, which not everyone shares, this paper discusses both what tax system I favor and what has led me to my viewpoint, so the reader can get a sense of how his own economics or values would lead to a different policy prescription. Under my beautiful tax reform, most Americans would not have to file tax returns. The tax system would no longer be the primary source of goodies passed out by the government and a major determinant of how resources are allocated—what goodies and subsidies that remain would be consolidated. Progressivity would be retained with a system under which most, but not all, American taxpayers would be subject to a low, basic rate, the same rate at which all tax credits can be redeemed. Taxation of business income would be rationalized with the objective of taxing all business income at the appropriate tax rate of the income earner, sharply reducing tax sheltering, and making corporation tax payments more transparent.
 

2005-11

Mihir A. Desai, Dhammika Dharmapala, and Winnie Fung, "Taxation and the Evolution of Aggregate Corporate Ownership Concentration," June 2005

 The concentration of corporate ownership is a critical element of a corporate governance environment and reflects the degree to which different income groups participate in the stock market. Legal rules, politics and behavioral factors have all been emphasized as explanatory factors in analyses of corporate ownership concentration and the degree to which different income groups hold equities. An extension of standard tax cliente arguments demonstrates that changes in the progressivity of taxes can also significantly influence corporate ownership concentration. A novel index of the concentration of corporate ownership over the twentieth century in the United States provides the opportunity to quantitatively test for the role of taxes in shaping ownership concentration. The index of ownership concentration is characterized by considerable time series variation, with significant diffusion of ownership in the post-WWII era and reconcentration in the late 1990s. Analysis of this index indicates that the progressivity of taxation significantly influences corporate ownership concentration and equity market participation as predicted by the model. This evidence supports the intuition of Berle and Means (1932) that taxation can significantly influence patterns of equity ownership.
 

2005-10

Edward L. Maydew and Douglas A. Shackelford, “The Changing Role of Auditors in Corporate Tax Planning,” June 2005.

 This paper examines changes in the role that auditors play in corporate tax planning following recent events, including the well-known accounting scandals, passage of the Sarbanes-Oxley Act, and regulatory actions by the SEC and PCAOB. On the whole, these events have increased the scrutiny of auditor independence. We examine the effects of these events on the market for tax planning, in particular the longstanding link between audit and tax services. While the effects are recent, they are already being seen in the data. Specifically, there has already been a dramatic shift in the market for tax planning away from obtaining tax planning services from the same firm that does one’s audit. We estimate that the average ratio of tax fees to audit fees paid by firms in the S&P 500 to the firms doing their audits declined from approximately one in 2001 to one-fourth in 2004. At the same time, we find no evidence of a general decline in spending for tax services. The total revenue of the tax practices of the largest accounting firms has held steady over this period. In sum, the evidence indicates a decoupling of the longstanding link between audit and tax services, such that firms are shifting their purchase of tax services away from their auditor and towards other providers. We close with conjectures about the implications of these changes for corporate tax collections, financial accounting for income taxes, and the structure of the accounting industry.
 

2005-9

James R. Hines Jr., “Corporate Taxation and International Competition,” July 2005.

 Countries around the world continue to tax corporate income at significant rates despite downward pressures from international competition. Average statutory corporate income tax rates fell from 46 percent in 1982 to 33 percent in 1999, though tax bases simultaneously broadened, as a result of which average corporate tax collections actually rose from 2.1 percent of GDP in 1982 to 2.4 percent of GDP in 1999. Two pieces of evidence point to the possibility that mobile capital has received favorable tax treatment in recent years as a result of tax competition. The first is the experience of American multinational firms, whose average effective foreign tax rates fell from 43 percent in 1982 to 26 percent in 1999. The second is the cross-sectional pattern of tax rate-setting: small countries, facing elastic supplies of world capital, taxed corporate income at significantly lower rates than did larger countries in 1982. Corporate tax rates in 1999 did not substantially differ between small and large countries, implying that large countries set their tax rates in response to the same competitive pressures that small countries have always faced.
 

2005-8

Donald Bruce, John Deskins, and William F. Fox, “On the Extent,Growth, and Efficiency Consequences of State Business Tax Planning,” June 2005

 Our focus in this essay is on the extent to which tax planning in response to variations in state tax policy has affected state corporate income tax bases and revenues. Tax planning is defined as a broad set of actions undertaken by firms to reduce their tax liability. Financial or accounting tax planning is contrasted with what we refer to as locational distortions, in which firms move physical operations to avoid higher tax liabilities. Results from a fixed effects instrumental variables regression model using a 1985-2001 panel of state-level data provide highly suggestive evidence that tax planning activity significantly diminishes taxable corporate profits in high tax states. Specifically, we find that state corporate income tax bases decline by nearly 7 percent following a one-percentage-point increase in the top marginal corporate income tax rate, controlling for locational distortions. We also find that throwback rules are usually ineffective in restoring corporate income tax bases while combined reporting requirements are often effective. Further analysis indicates that tax planning has not diminished the locational distortions of tax policy.
 

2005-7

Michelle Hanlon, Lillian Mills, and Joel Slemrod, “An Empirical Examination of Corporate Tax Noncompliance,” June 2005.

 This paper offers some exploratory analysis of an extraordinarily rich data set of audit and appeals records, matched with tax returns and financial statements, of several thousand corporations. We find that corporate tax noncompliance, at least as measured by deficiencies proposed upon examination, amounts to approximately 13 percent of “true” tax liability. Second, noncompliance is a progressive phenomenon, meaning that noncompliance as a fraction of a scale measure increases with the size of the company. Other things equal, noncompliance is related to two measures of the presence of intangibles and with being a private company. We find some evidence that incentivized executive compensation schemes are associated with more tax noncompliance, but only with respect to bonuses and not for stock options and other equity-related incentive pay. We uncover no relation between a commonly-studied measure of the quality of corporate governance and the extent of proposed (scaled) tax deficiency. Finally, we find that there is no consistent simple or partial negative association between our measure of tax noncompliance and measures of the effective tax rate calculated from financial statements. These conclusions are preliminary because our central measure of tax noncompliance is the result of an imperfect and perhaps systematically detailed audit of a tax return declaration that may itself be the opening bid in what is expected, often correctly, to be an intense negotiation and formal appeals process. Second, the causal links among tax aggressiveness, executive compensation, and corporate governance are potentially complex, and the analysis presented here at best establishes statistical associations, but certainly does not establish causal relations.
 

2005-6

Jonathan Gruber and Joshua Rauh, “How Elastic Is the Corporate Income Tax Base?” June 2005.

 We estimate the impact of the corporate tax rate on the level of corporate taxable income for publicly traded firms from 1960-2003. In the spirit of Gruber and Saez (2002) who consider the elasticity of household taxable income, we overcome the endogeneity of corporate tax rates to taxable income by modeling the effective tax rates faced by firms in one period, and the effective tax rate that would be faced by firms with the same characteristics in the next period. Using industry level aggregates, we find strong evidence that the corporate tax base is elastic with respect to the marginal effective tax rate, though the magnitude is smaller than typical estimates of household taxable income elasticities. .
 

2005-5

Alan J. Auerbach and Kevin A. Hassett, “The 2003 Dividend Tax Cuts and the Value of the Firm: An Event Study,” June 2005.

 The “Jobs and Growth Tax Relief Act of 2003” (JGTRA03) contained a number of significant tax provisions, but the most noteworthy may have been the reduction in dividend tax rates. The political debate over the dividend tax reductions of 2003 took a number of surprising twists and turns. Accordingly, it is likely that the views of market participants concerning the probability of significant dividend tax reduction fluctuated significantly during 2003. In this paper, we use this fact to estimate the effects of dividend tax policy on firm value. We find that firms with higher dividend yields benefited more than other dividend paying firms, a result that, in itself, is consistent with both new and traditional views of dividend taxation. But further evidence points toward the new view and away from the traditional view. We also find that non-dividend-paying firms experienced larger abnormal returns than other firms as the result of the dividend tax cut, and that a similar bonus accrued to firms likely to issue new shares, two results that may appear surprising at first but are consistent with the theory developed in the paper.
 

2005-4

Stephen R. Bond, Michael P. Devereux, and Alexander Klemm, “Dissecting Dividend Decisions: Some Clues About the Effects of Dividend Taxation from Recent UK Reforms,” June 2005.

 We present empirical evidence which suggests that a big increase in dividend taxation for UK pension funds in July 1997 affected the form in which some UK companies chose to make dividend payments, but otherwise had limited effects on both the level of dividend payments and the level of investment. These findings are consistent with a version of the 'new view' of dividend taxation. We also identify a group of firms whose dividend choices are difficult to reconcile with (stock market) value maximization.
 

2005-3

Raj Chetty, Joseph Rosenberg, and Emmanuel Saez, “The Effects of Taxes on Market Responses to Dividend Announcements and Payments: What Can We Learn from the 2003 Dividend Tax Cut?” June 2005.

 This paper investigates the effects of capital gains and dividend taxes on excess returns around announcements of dividend increases and ex-dividend days for U.S. corporations. Consistent with standard no-arbitrage conditions, we find that the ex-dividend day premium increased from 2002 to 2004 when the dividend tax rate was cut. Consistent with the signaling theory of dividends, we also find that the excess return for dividend increase announcements went down from 2002 to 2004. However, these findings are very sensitive to the years chosen for the pre-reform control period. Semi-parametric graphical analysis using data since 1962 shows that the relationship between tax rates and ex-day and announcement day premia is very fragile and sensitive to sample period choices. Strong year-to-year fluctuations in the ex-day and announcement day premia greatly reduce statistical power, making it impossible to credibly detect responses even around large tax reforms. The important non-tax factors affecting these premia must therefore be understood before progress can be made in evaluating the role of taxation in market responses.
 

2005-2

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Do Tax Havens Divert Economic Activity,” April 2005

 When multinational firms expand their operations in tax havens, do they divert activity from non-havens? Much of the debate on tax competition presumes that the answer to this question is yes. This paper offers a model for examining the relationship between activity in havens and non-havens, and discusses the implications of recent evidence in light of that model. Properly interpreted, the evidence suggests that tax haven activity enhances activity in nearby non-havens.
 

2005-1

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Foreign Direct Investment and the Domestic Capital Stock,” January 2005.

 This paper evaluates evidence of the impact of outbound foreign direct investment (FDI) on domestic investment rates. OECD countries with high rates of outbound FDI in the 1980s and 1990s exhibited lower domestic investment than other countries, which suggests that FDI and domestic investment are substitutes. U.S. time series data tell a very different story, however: years in which American multinational firms have greater foreign capital expenditures coincide with greater domestic capital spending by the same firms. One dollar of additional foreign capital spending is associated with 3.5 dollars of additional domestic capital spending in the time series, implying that foreign and domestic capital are complements in production by multinational firms. This effect is consistent with cross sectional evidence that firms whose foreign operations expand simultaneously expand their domestic operations, and suggests that interpretation of the OECD cross sectional evidence may be confounded by omitted variables.
 

2004-11

James R. Hines Jr., “Do Tax Havens Flourish?” October 2004.

 Tax haven countries offer foreign investors low tax rates and other tax features designed to attract investment and thereby stimulate economic activity. Major tax havens have less than one percent of the world’s population (outside the United States), and 2.3 percent of world GDP, but host 5.7 percent of the foreign employment and 8.4 percent of foreign property, plant and equipment of American firms. Per capita real GDP in tax haven countries grew at an average annual rate of 3.3 percent between 1982 and 1999, which compares favorably to the world average of 1.4 percent. Tax haven governments appear to be adequately funded, with an average 25 percent ratio of government to GDP that exceeds the 20 percent ratio for the world as a whole, though the small populations and relative affluence of these countries would normally be associated with even larger governments. Whether the economic prosperity of tax haven countries comes at the expense of higher tax countries is unclear, though recent research suggests that tax haven activity stimulates investment in nearby high-tax countries.
 

2004-10

Mihir A. Desai and James R. Hines Jr., “Old Rules and New Realities: Corporate Tax Policy in a Global Setting,” October 2004.

 This paper reassesses the burden of the current U.S. international tax regime and reconsiders well-known welfare benchmarks used to guide international tax reform. Reinventing corporate tax policy requires that international considerations be placed front and center in the debate on how to tax corporate income. A simple framework for assessing current rules suggests a U.S. tax burden on foreign income in the neighborhood of $50 billion a year. This sizeable U.S. taxation of foreign investment income is inconsistent with promoting efficient ownership of capital assets, either from a national or a global perspective. Consequently, there are large potential welfare gains available from reducing the U.S. taxation of foreign income, a direction of reform that requires abandoning the comfortable, if misleading, logic of using similar systems to tax foreign and domestic income.
 

2004-9

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Economic Effects of Regional Tax Havens,” October 2004.

 How does the opportunity to use tax havens influence economic activity in nearby non-haven countries? Analysis of affiliate-level data indicates that American multinational firms use tax haven affiliates to reallocate taxable income away from high-tax jurisdictions and to defer home country taxes on foreign income. Ownership of tax haven affiliates is associated with reduced tax payments by nearby non-haven affiliates, the size of the effect being equivalent to a 20.8 percent tax rate reduction. The evidence also indicates that use of tax havens indirectly stimulates the growth of operations in non-haven countries in the same region. A one percent greater likelihood of establishing a tax haven affiliate is associated with 0.5 to 0.7 percent greater sales and investment growth by non-haven affiliates, implying a complementary relationship between haven and non-haven activity. The ability to avoid taxes by using tax haven affiliates therefore appears to facilitate economic activity in non-haven countries within regions.
 

2004-8

Joel Slemrod, “The Economics of Corporate Tax Selfishness,” September
2004.

 The corporation income tax occupies a tenuous place in the economics of taxation. The purpose of this paper is to offer an economics perspective on the issue of corporate tax reporting behavior, and to focus on what economics can contribute to the policy debate about corporate tax noncompliance. The policy and practice of corporate tax avoidance and evasion are ahead of economic theory and empirical analysis. Our empirical understanding of corporate behavior depends mostly on two sources of data, (publicly-available) financial statements and (confidential, but characterized in aggregated form) tax returns. There is a set of empirical questions on which we can make progress, such as the interaction between sheltering and real decisions, the cross-sectional determinants of corporate evasion and the use of abusive tax shelters, and how accounting rules and enforcement affect tax reporting and real decisions. There are subtle policy questions, such as the impact of public disclosure of corporate tax return information, linking tax liability to financial statement income, and the impact of penalties on corporate directors and abusive tax shelter promoters, to which clear thinking about the demand and supply of tax evasion and abusive avoidance can contribute.

 

2004-7

Keith J. Crocker and Joel Slemrod, “Corporate Tax Evasion with Agency Costs,” July 2004.

 This paper examines corporate tax evasion in the context of the contractual relationship between the shareholders of a firm and a tax manager who possesses private information regarding the extent of legally permissible reductions in taxable income, and who may also undertake illegal tax evasion. Using a costly state falsification framework, we characterize formally the optimal incentive compensation contract for the tax manager and, in particular, how the form of that contract changes in response to alternative enforcement policies imposed by the taxing authority. The optimal contract may adjust to offset, at least partially, the effect of sanctions against illegal evasion, and we find a new and policy-relevant non-equivalence result: penalties imposed on the tax manager are more effective in reducing evasion than are those imposed on shareholders.

2004-6

Jon Bakija and Joel Slemrod, “Do the Rich Flee from High State Taxes? Evidence from Federal Estate Tax Returns

 This paper examines how changes in state tax policy affect the number of federal estate tax returns filed in each state, utilizing data on federal estate tax return filings by state and wealth class for 18 years between 1965 and 1998. Controlling for state- and wealth-class specific fixed effects, we find that high state inheritance and estate taxes and sales taxes have statistically significant, but modest, negative impacts on the number of federal estate tax returns filed in a state. High personal income and property tax burdens are also found to have negative effects, but these results are somewhat sensitive to alternative specifications. This evidence is consistent with the notion that wealthy elderly people change their real (or reported) state of residence to avoid high state taxes, although it could partly reflect other modes of tax avoidance as well. We discuss the implications for the debate over whether individual states should “decouple” their estate taxes from federal law, which would retain the state tax even as the federal credit for such taxes is eliminated. Our results suggest that migration and other observationally equivalent avoidance activities in response to such a tax would cause revenue losses and deadweight losses, but that these would not be large relative to the revenue raised by the tax.

2004-5

Roger Gordon, Laura Kalambokidis, Jeffrey Rohaly, and Joel Slemrod, “Toward a Consumption Tax, and Beyond,” June 2004.
 

 In this paper we investigate the extent to which the U.S. income tax system of 2004 collects tax on capital income, and the implications of extending tax-preferred savings accounts. We do so by applying a methodology that estimates how much tax is collected on capital income by calculating how much tax revenue would change if the tax system were modified to exempt income from capital in present value—specifically by adopting what the Meade Committee (1978) called an “R-base tax”—while leaving the tax rate structure and tax incentives otherwise unchanged. The difference between actual revenue and revenue under this alternative tax system is a measure of how much tax on capital income is collected under current law. We find that, as of 2004, the U.S. tax system has returned to the situation of the mid-1980s wherein our income tax system raises little revenue from taxing capital income. If extensive tax-free savings accounts were to be introduced, the system would raise almost no revenue from capital income and possibly subsidize, rather than tax, capital income. The main culprit in this state of affairs is the retention of interest deductibility. Although the revenue from taxing capital income is small, the gains that would result from a clean consumption tax have not been attained, as there remain distortions to both saving and investment decisions, and distortions across capital assets, portfolios, corporate financing, and choice of organizational form under the patchwork of provisions that have been adopted.

2004-4

Joel Slemrod and Varsha Venkatesh, “The Income Tax Compliance Cost of Large and Mid-Size Businesses,” April 2004.
 

 This reports presents evidence on the compliance costs of medium-sized businesses based on a survey conducted by the Office of Tax Policy Research. The survey attempts to measure the size and composition of compliance costs and to identify firm characteristics that affect these costs. Our analysis of the responses of taxpayers and tax professionals confirms the regressivity of business compliance costs and suggests that, as a proportion of taxes paid, they are significantly higher than for the largest U.S. businesses and for individual taxpayers. Comparisons to revenue must be done carefully, however, because the majority of medium-sized businesses are in fact not taxpaying entities, but are rather pass-through entities.

2004-3

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “Capital Controls,
Liberalizations, and Foreign Direct Investment,” February 2004

Affiliate-level evidence indicates that American multinational firms circumvent capital controls by adjusting their reported intrafirm trade, affiliate profitability, and dividend repatriations. As a result, the reported profit impact of local capital controls is comparable to the effect of 24 percent higher corporate tax rates, and affiliates located in countries imposing capital controls are 9.8 percent more likely than other affiliates to remit dividends to parent companies. Multinational affiliates located in countries with capital controls face 5.4 percent higher interest rates on local borrowing than do affiliates of the same parent borrowing locally in countries without capital controls. Together, the costliness of avoidance and higher interest rates raise the cost of capital, significantly reducing the level of foreign direct investment. American affiliates are 13-16 percent smaller in countries with capital controls than they are in comparable countries without capital controls. These effects are reversed when countries liberalize their capital account restrictions.

2004-2

Mihir A. Desai and James R. Hines Jr., “Market Reactions to Export
Subsidies,” January 2004.

This paper analyzes the economic impact of export subsidies by investigating stock price reactions to a critical event in 1997. On November 18, 1997, the European Union announced its intention to file a complaint before the World Trade Organization (WTO), arguing that the United States provided American exporters illegal subsidies by permitting them to use Foreign Sales Corporations to exempt a fraction of export profits from taxation. Share prices of American exporters fell sharply on this news, and its implication that the WTO might force the United States to eliminate the subsidy. The share price declines were largest for exporters whose tax situations made the threatened export subsidy particularly valuable. Share prices of exporters with high profit margins also declined markedly on November 18, 1997, suggesting that the export subsidies were most valuable to firms earning market rents. This last evidence is consistent with strategic trade models in which export subsidies improve the competitive positions of firms in imperfectly competitive markets.

2003-7

Naomi E. Feldman and James R. Hines Jr., "Tax Credits and Charitable Contributions in Michigan," October 2003.

This paper analyzes the impact of tax credits on charitable giving in Michigan and around the United States.  The evidence indicates that the availability of tax benefits, in the form of federal and state tax deductions and state credits, significantly encourages charitable giving.  The state of Michigan permits taxpayers to claim tax credits for contributions to public institutions, community foundations, and homeless shelters and food banks.  While only a small fraction of the Michigan population claims these credits, their aggregate value exceeds $40 million a year.  Contributors claiming credits in Michigan are disproportionately drawn from the high-income part of the population, though the ratio of tax credit benefits to total tax obligations is approximately equal for all income groups.  The estimates imply that the availability of tax credits in Michigan increases annual credit-eligible contributions by more than $40 million, possibly at the expense of contributions to other nonprofit recipients.

2003-6

Matthew D. Shapiro and Joel Slemrod, “Did the 2001 Tax Rebate Stimulate Spending? Evidence from Taxpayer Surveys,” July 2003.

In 2001, many households received rebate checks as advanced payments of the benefit of the new, 10 percent federal income tax bracket.  A survey conducted at the time the rebates were mailed finds that few households said that the rebate led them mostly to increase spending.  A follow-up survey in 2002, as well as a similar survey conducted after the attacks of 9/11, also indicates low spending rates.  This paper investigates the robustness of these survey responses and evaluates whether such surveys are useful for policy evaluation.  It also draws lessons from the surveys for macroeconomic analysis of the tax rebate.

2003-5

Mihir A. Desai and James R. Hines Jr., “Evaluating International Tax Reform,” June 2003.

This paper introduces “capital ownership neutrality” (CON) and “national ownership neutrality” (NON) as benchmarks for evaluating the desirability of international tax reforms, and applies them to analyze recent U.S. tax reform proposals.  Tax systems satisfy CON if they do not distort the ownership of capital assets, which promotes global efficiency whenever the productivity of an investment differs based on its ownership.  A regime in which all countries exempt foreign income from taxation satisfies CON, as does a regime in which all countries tax foreign income while providing foreign tax credits.  Tax systems satisfy NON if they promote the profitability of domestic firms, and therefore home country welfare, by exempting foreign income from taxation.  Standard normative benchmarks of capital export neutrality, national neutrality, and capital import neutrality carry very different implications, since they fail to account for the productivity effects of tax-induced changes in capital ownership.  Proposed U.S. tax reforms that reduce the taxation of foreign income, thereby bringing the U.S. tax system more in line with the systems of other countries, have the potential to advance both American interests and global welfare.

2003-4

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., “A Multinational Perspective on Capital Structure Choice and Internal Capital Markets," May 2003.

This paper examines the impact of local tax rates and capital market conditions on the level and composition of borrowing by foreign affiliates of American multinational corporations.  The evidence indicates that 10 percent higher local tax rates are associated with 2.8 percent higher debt/asset ratios of American-owned affiliates, and that borrowing from related parties is particularly sensitive to tax rates.  Borrowing by American affiliates responds to local inflation and political risks, and is more costly in countries with underdeveloped capital markets and those providing weak legal protections for creditors.  Affiliates in environments where external borrowing is costly borrow less from unrelated parties:  one percent higher interest rates are associated with 1.4 to 2.0 percent less external debt as a fraction of assets.  Instrumental variables analysis reveals that affiliates substitute loans from parent companies for between half and three quarters of the reduced borrowing from unrelated parties stemming from adverse local capital market conditions.  These patterns suggest that multinational firms are able to structure their finances in response to tax and capital market conditions, thereby creating opportunities not available to many of their local competitors.

2003-3

James R. Hines Jr., "Might Fundamental Tax Reform Increase Criminal Activity?" March 2003.

There is a widely held perception that fundamental tax reform would reduce the level of criminal and other “underground” economic activity.  The popular argument relies on the idea that replacing the income tax with a sales tax would implicitly tax the return to criminal activity, whereas the return to crime is effectively untaxed by an income tax.  This paper finds instead that the impact of tax reform on the underground sector of the economy depends on the relative labor intensity of production in the legitimate and illegitimate sectors of the economy.  In the likely event that illegal output is produced using more labor-intensive techniques than is legitimate output, then replacing an income tax with a sales tax reduces the cost of criminal and other underground activity, thereby increasing such activity.

2003-2

Claudio A. Agostini, "Tax Interdependence in American States," January 2003.

State governments finance their expenditures with multiple tax instruments, so when collections from one source decline, they are typically compensated by greater revenues from other sources. This paper addresses the important question of the extent to which personal and corporate income taxes are used to compensate for sales tax fluctuations within the U.S. states. The results show that one percent increase in the sales tax rate is associated with a half and a third percent decrease in the personal and corporate income tax rates respectively. In terms of tax revenues per capita, the results show that a one percent increase in the sales tax revenue per capita is associated with a 3 percent and a 0.9 percent decrease in the corporate and personal income tax revenue per capita respectively.

2003-1

James R. Hines Jr., "Michigan's Flirtation with the Single Business Tax," January 2003.

This paper evaluates Michigan's experience with the Single Business Tax (SBT). Michigan adopted the SBT in 1975; the SBT currently accounts for 10 percent of state tax revenue, but is being phased out and is slated for elimination in 2010. The SBT differs from standard corporate income taxes in two ways: first, it applies to all business entities, not only corporations, and second, it is a tax on value-added rather than income. In the original design of the SBT, taxpayers could deduct capital expenditures from the SBT base, but complications stemming from the taxation of multi-state businesses ultimately dictated a regime in which expenditures on capital located in Michigan cannot be deducted but are instead eligible for investment credits. Numerous other credits and exemptions are available for taxpayers subject to the SBT. The SBT is nevertheless imposed at a very high average rate; business income is taxed more heavily by Michigan's SBT than it is by the corporate income taxes of other states. The evidence indicates that the SBT has proven to be a very stable source of tax revenue, one that is much less prone to fluctuate with the business cycle than are the corporate income taxes used by other states. Revenue stability, together with the efficiency of the incentives created by its value-added structure, makes the SBT an attractive tax for Michigan, particularly compared to the leading alternatives.

2002-10

Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr., "Chains of Ownership, Regional Tax Competition, and Foreign Direct Investment," September 2002.

This paper considers the effect of taxation on the location of foreign direct investment (FDI) and taxable income reported by multinational firms with particular attention to the regional dynamics of tax competition and the role of chains of ownership. Confidential affiliate-level data are used to compare the investment and income-reporting behavior of American-owned foreign affiliates across ownership forms and regions. Ten percent higher tax rates are associated with 5.0 percent lower FDI, controlling for parent company and observable aspects of local economies, and 0.9 percent lower returns on assets, controlling for parent company and level of FDI. Tax effects are particularly strong within Europe, where ten percent higher tax rates are associated with 7.7 percent lower FDI and 1.7 percent lower returns on assets. Indirectly owned foreign affiliates also exhibit strong tax effects, ten percent higher tax rates being associated with 12.0 percent lower FDI and 1.4 percent lower returns on assets. American firms finance a growing fraction of their foreign operations indirectly through chains of ownership, which now account for more than 30 percent of aggregate foreign assets and sales. Ownership chains are particularly concentrated among European affiliates. Since multinational firms from countries other than the United States face tax environments similar to those faced by indirectly owned affiliates of American companies, these results suggest a greater sensitivity of FDI to taxes for non-American firms. The results also suggest that European economic integration may have the effect of intensifying tax competition between European jurisdictions.

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