David M. Schizer

Fiscal Policy in an Era of Austerity

We face a time of stagnant economic growth, severe unemployment, massive budget deficits, and an increasingly competitive global economy. Monetary policy is tapped out, and there is a great deal of uncertainty about the effectiveness of a traditional Keynesian stimulus – and, not surprisingly, a heated debate among economists. One thing we do know is that a stimulus is quite difficult to execute effectively. For example, it is a challenge to identify “shovel ready” projects that contribute to long-term economic growth, particularly on short notice. There is no uncertainty, though, about the need to address a broad range of specific problems contributing to our economic woes. As an illustrative example, this Article emphasizes the perils of having the highest corporate tax rate in the Organisation for Economic Co-operation and Development (“OECD”) in a competitive global economy. Cutting our corporate tax rate will encourage businesses to invest and hire more employees, while also reducing incentives to engage in wasteful tax planning and to shift taxable income and jobs overseas. In addition to these problems with our substantive law, we also face problems of process that are undercutting our government’s effectiveness. An important (and familiar) one is that politicians are consistently tempted to accommodate organized interest groups, especially if the costs of these favors can be quietly passed on to the general public. This is all the more true if special interest deals can be financed with deficit spending, so that the bill will not come due until long after our current political leaders have retired. Various measures can constrain this familiar political dynamic, and this Article sketches three strategies as illustrative examples. First, we should make the costs of special interest deals more visible through better budgetary accounting. Second, we should enlist specific institutions within our government to target waste and pork. For example, we should empower special House and Senate committees to cut particular budget items or, alternatively, to sever them from the rest of the budget and subject them to a separate public vote. Third, we should create stronger institutional barriers to deficit spending. Scarcity focuses the mind, so that our leaders will have greater incentive to reject initiatives that are not cost-justified.

Scrubbing the Wash Sale Rules

Loss limitations are an ugly but inevitable feature of any realization-based income tax. In essence, because the system mismeasures gains, it also has to mismeasure losses. Otherwise, the timing option inherent in the realization rule would allow taxpayers to defer gains (thereby reducing the taxs present value) while accelerating losses (thereby preserving the deductions present value). The wash sale regime of Section 1091 is one of our systems most important brakes on the timing option. Yet it is only a slight exaggeration to say that compliance with the regime is voluntary for very wealthy taxpayers - or, at least, for those who are willing to take aggressive positions. In response, this Article flags seven glitches in the regime that, at least arguably, permit perfect end runs. As used here, this phrase refers to strategies in which taxpayers can deduct losses while effecting virtually no change in their economic position. The essential point is that, if we are going to have a wash sale regime, these end runs should not be allowed. This Article also takes a more controversial position: Losses should still be deferred - even when taxpayers make meaningful changes in their economic position - as long as they keep material elements of their old return. The policy goal here is to ensure that, on average, taxpayers expect losses to be deferred as long as gains. This Article proposes concrete modifications in the regime to implement this goal, while also offering a caveat: The case for a strong wash sale regime is less strong if the regime can never be tough enough to stop loss harvesting. If so, other constraints on the timing option may be preferable, including accelerated timing for gains or a broader capital loss regime.

Border Adjustments and the Conservation of Tax Planning

This article is based on Schizer’s keynote address at the 17th annual NYU-KPMG Tax Symposium on March 10. In this article, Schizer argues that U.S. corporate and shareholder taxes need to be reformed, and the corporate rate should be much lower. In reforming this dysfunctional regime, according to Schizer, Congress should keep both of these taxes as a form of built-in redundancy; if one tax is avoided, the other can still be collected. More generally, Congress should be wary of Utopian solutions. Tax reform is more likely to change tax planning than to eliminate it entirely, Schizer concludes. For instance, although border adjustments would foreclose some strategies, they would encourage others.

Subsidies and Nonprofit Governance: Comparing the Charitable Deduction with the Exemption for Endowment Income

Charitable subsidies are supposed to encourage positive externalities from charity. In principle, the government can pursue this goal by evaluating specific charitable initiatives and deciding how much each should receive. But this Article focuses on two income tax rules that leave the government very little discretion about which charities to fund: the deduction for donations to charity (“the deduction”) and the exemption of a charity’s investment income (“the exemption”). Under each rule, as long as charities satisfy very general criteria, federal dollars flow automatically. While both of these sibling subsidies delegate key decisions to private individuals, they create very different incentives and effects. This Article breaks new ground by showing their different effects on the governance of nonprofits. Specifically, the deduction has three advantages over the exemption. First, the deduction uses a more reliable test for determining whether a charity should receive government funding: a charity has to attract donations, which means donors believe in the charity. For the exemption, by contrast, the charity has to run a surplus, which is less dependable evidence of social value. Second, the deduction empowers donors to monitor nonprofit managers, while the exemption sometimes undercuts this monitoring. Since the exemption offers tax-free returns only to charities, and not to donors, it encourages donors to turn over assets to charities (“endowment gifts”), instead of keeping these assets and making annual gifts of the investment return (“spendable gifts”). If a donor gives an endowment to an operating charity, such as a university or a museum, she cannot redirect this money to another charity, even if she later develops doubts about the charity’s mission or management. Alternatively, if a donor gives the endowment to a grant-making charity that she can influence, such as a private foundation or a donor advised fund, she avoids committing to a particular operating charity, but she is likely to incur other costs, such as taxes, managerial fees, and agency costs (e.g., when managers disregard donor preferences in making grants). Third, in favoring endowments, the exemption exacerbates another familiar governance problem: cumbersome or stale limits on endowments. These governance issues are an important, but largely overlooked, reason to favor the deduction over the exemption. Yet although scaling back the exemption solves one set of problems, it creates another: charities would begin making tax-motivated saving and investment decisions. In deciding how much of the subsidy for charities should be delivered through the exemption, as opposed to the deduction, Congress needs to manage this tradeoff. This Article explores various ways to do so.

Between Scylla and Charybdis: Taxing Corporations or Shareholders (or Both)

The US taxes both corporations and shareholders on corporate profits. In principle, the U.S. could rely on only one of these taxes, as many commentators have suggested. Although choosing to tax the corporation or its owners may seem like taking money from one pocket or the other, this Essay emphasizes a key difference: corporate and shareholder taxes prompt different tax planning. Relying on one or the other mitigates some distortions and leaks, while exacerbating others. As a result, choosing which tax to impose is like navigating between Scylla and Charybdis.In response to these dualing distortions, this Essay recommends using both taxes. Some tax should be collected from corporations, and some from investors. The two rates should be coordinated, so they aggregate to the combined rate Congress wants, which ideally would be the rate for pass-through businesses. The main goal of this Essay is to defend the use of both taxes, and to analyze what the balance should be between them. Using both taxes has three advantages. First, if one of these partially overlapping instruments is avoided, the other still raises some revenue. Second, if the goal is to deter a planning strategy, cutting the rate to zero is an overreaction. If the rate is low enough, paying a tax is cheaper than avoiding it, since tax planning is not free. Third, if one tax is cut instead of repealed, the other can be correspondingly lower, and thus induces less planning.Even so, using two taxes poses challenges as well. First, although the taxes are supposed to backstop each other, they cannot do so when a planning strategy avoids both. Second, using two taxes is likely to increase administrative costs. Third, coordinating the two taxes to produce the right combined rate – ideally the rate for noncorporate businesses – is not easy.Once Congress chooses the combined rate on corporate profits, how should this burden be allocated between corporate and shareholder taxes? Since the corporate tax probably is more distortive, it should be cut significantly. The shareholder tax should be increased to make up the difference (or at least some of it).This Essay also cavasses reforms to shore up corporate and shareholder taxes, so the combined rate that actually is collected comes closer to the one on the books. While the focus is on incremental reform, this Essay’s central recommendation extends to more ambitious reforms as well. They also benefit from using two taxes, instead of one.