Michael S. Knoll

Uncertainty, Efficiency, and the Brokerage Industry

T HE purpose of this article is to examine the socially efficient class of brokerage-fee rules. It is a commonly observed phenomenon that real estate brokers charge a fee of about 6 percent of the sale price on private homes.1 The tendency for the brokerage fee to increase with the price of the item sold has been observed in other markets as well.2 There is, however, no reason to expect that a 6 percent rule, or any other class of rules where the brokerage fee is not fixed independently of the price of the property, is efficient; for it costs no more to sell a relatively expensive piece of property than to sell a relatively inexpensive one.3 There has also been considerable speculation that the traditional brokerage-fee arrangement is anticompetitive. The argument, which is that brokers are engaging in price discrimination by charging the owners of expensive houses more

Taxing Sunny Days: Adjusting Taxes for Regional Living Costs and Amenities

Taxpayers pay tax on their nominal income without regard to their regional cost of living or the value of their regional amenities. Although commentators have argued that the income taxs failure to account for such differences is unfair - because residents of high-cost and low-amenity regions pay higher taxes than residents of low-cost and high-amenity regions - that argument is unpersuasive because migration tends to eliminate regional differences in living standards. The tax systems failure to adjust for regional differences is, however, likely to misallocate resources across regions in two ways. First, it is likely to discourage taxpayers from settling in high-cost regions where the high cost of living is matched by high salaries. Second, it is likely to discourage taxpayers from settling in low-amenity regions where the lower value of amenities is reflected in higher salaries. Both misallocations can be eliminated by multiplying each taxpayers earned income (but not her unearned income) by the reciprocal of the regions relative salary level. Such a relative salary multiplier imposes the same nominal tax on each resident without regard to her location, thereby eliminating the tax-driven incentive for individuals to settle in low-tax regions.

Samuel Zell, the Chicago Tribune, and the Emergence of the S ESOP: Understanding the Tax Advantages and Disadvantages of S ESOPs

Samuel Zells acquisition of the Chicago Tribune Company (the Tribune) in December 2007 using a little-known type of Employee Stock Ownership Plan (ESOP) made headlines. In a complicated transaction, which took nearly a year to complete, the Tribune converted from a subchapter C corporation to a subchapter S corporation, established an ESOP that purchased 100 percent of the companys equity, and sold Zell a call option giving him the right to purchase 40 percent of the companys equity. Press reports claim that Zells novel structure enabled Zell to outbid other suitors. And financial commentators predict that many acquirers will employ that same structure as soon as acquisition activity picks up. Zells Tribune transaction also caught the eye of legislators, including Congressman Charles Rangel, who introduced a bill that would increase the tax on indirect claims - such as the one owned by Zell - on the equity of an S corporation held by an ESOP (synthetic equity).Although ESOPs are more than 30 years old, until 1998, an S corporation could not sponsor an ESOP. Over the last ten years, so-called S ESOPs have grown rapidly, but largely outside of public view. The Tribune transaction has focused a bright light on S ESOPs and there are some who believe that their current tax treatment is too favorable. Yet, there has been little in-depth analysis of the tax treatment of S ESOPs. Accordingly, this paper attempts to fill that gap by presenting a systematic economic evaluation of the tax consequences of using an S ESOP. It seeks to describe both qualitatively and quantitatively the tax advantages and disadvantages of using an S ESOP (with or without synthetic equity) relative to alternative available structures. This paper also estimates by how much the S ESOP structure likely allowed Zell to increase his bid for the Tribune.

Taxes and Competitiveness

Around the world, the tax laws are shaped by concerns with competitiveness. This paper provides a general theory of how taxes impact competitiveness. As part of that theory, this paper also introduces the concept of tax-based competitiveness neutrality. A tax system is competitively neutral when taxes do not cause competitors to change their relative valuations of any investments. This paper then uses that theory to evaluate tax policy in two high profile and important areas. The paper begins by describing two models of competitiveness, called the conduit or new money model and the investor or old money model. The central difference between the models is whether the competition is between conduit entities that must compete for funds or is between the ultimate investors themselves. When the competition is between conduits that raise the funds to invest, competitiveness neutrality requires that the tax cost of the investment be the same across entities. In contrast, when the competition is between investors who invest their own money, then neutrality does not require that the tax cost be equal across the investors. Instead, when investors are investing their own money, competitiveness neutrality requires only that tax incentives have the same dollar value for all competitors. This paper then uses the theory of competitiveness neutrality to analyze two sets of laws that were heavily influenced by concerns with competitiveness. They are the unrelated business income tax (UBIT) and the tax treatment of cross-border transactions. In both areas, the failure to recognize the nature of the competition has caused policymakers and scholars to rely on the incorrect model in designing and evaluating tax policy.

The Section 83(B) Election for Restricted Stock: A Joint Tax Perspective

In the wake of the Financial Accounting Standard Boards decision to require firms that grant employee stock options (ESOs) to treat such options as an expense, many large and sophisticated firms are switching from ESOs to restricted stock. Restricted stock - stock granted to an employee as part of her compensation and subject to the condition that if she leaves the firm within a period of time (often 3 years) she forfeits the stock - appears to be on its way to becoming the dominant form of equity-based pay in the United States. Yet, in spite of its prominence, little attention has been paid to how employers should design their restricted stock programs in light of tax considerations. The tax consequences to both the employee and the employer of a grant of restricted stock are deferred until the restriction lapses and the stock vests. There is however an exception to that general rule: If, within 30 days of receiving the stock, the employee makes what is called the Section 83(b) election, then both the employer and the employee are taxed at the time of grant.Employing a joint tax perspective that looks at the tax consequences to both the employer and the employee, this paper attempts to answer several compensation design issues raised by the use of restricted stock. Specifically, I address the question under what circumstances should the employer charge the employee explicitly for her restricted shares and when should the employer charge implicitly for the restricted stock through a lower salary. I also look at the desirability to the employee, the employer, and the employee and employer together of the employee making the Section 83(b) election. Finally, I look at the value to the employee and cost to the employer of the employees option to wait 30 days until making the Section 83(b) election.

An Accretion Corporate Income Tax

This paper also describes how to implement the tax. In order for the tax to fall on income requires some adjustments. The basic rule for making these adjustments is to add nondeductible expenditures, such as dividends and federal income taxes, and to subtract nonincludable items, such as the proceeds of loans and equity offerings. The tax would also require the periodic valuation of nontraded securities, such as stock options issued to management, using option pricing techniques.

Resource extraction and anticipated demand shifts

Abstract Linking together two optimal control theory problems through Bellmans equation we derive closed form solutions for an extractive industry when a shift in the demand curve is perfectly foreseen. Monopoly and competition are compared.

International Competitiveness, Tax Incentives, and a New Argument for Tax Sparing: Preventing Double Taxation by Crediting Implicit Taxes

Tax sparing occurs when a country with a worldwide tax system grants its citizens foreign tax credits for the taxes that they would have paid on income earned abroad, but that escapes taxation by virtue of foreign tax incentives. The supporters of tax sparing argue that it is a form of foreign aid, an obligation owed to developing countries, and a legitimate means of improving the competitiveness of resident investors. Tax sparing, however, has long been opposed by the United States on the grounds that it is an expensive and problematic concession to developing countries, inconsistent with basic and fundamental tax principles, and an inappropriate mechanism for improving the competitiveness of resident investors. The U.S. position appears to be carrying the day as tax sparing has been on the wane.In contrast with the emerging consensus, I offer a new argument for tax sparing. Drawing on the literature on implicit taxes, I argue that tax incentives produce implicit taxes. From the perspective of the investor, implicit taxes are as real as traditional explicit taxes. Thus, tax sparing is best viewed as extending the foreign tax credit to include implicit taxes. Accordingly, I argue that tax sparing is consistent with the notion of a single level of taxation and the foreign tax credit. I also argue that tax sparing is necessary to prevent domestic investors from being disadvantaged by foreign tax incentives. In addition, I show that such arguments support a greatly expanded form of tax sparing. Finally, I demonstrate that the tax sparing credit, as currently calculated, will usually exceed the implicit tax paid and propose an alternative method of calculating the credit that will place investors residing in countries with worldwide tax systems on par with other investors.

Economic and Legal Arguments in PPL v. Commissioner

In late February 2013, the U.S. Supreme Court will hear oral argument in PPL Corp. v. Commissioner. The Court took that case, which involves a claim by a U.S. corporation for foreign tax credits for taxes paid in accordance with the 1997 U.K. Windfall Profit Tax Act, in order to resolve a conflict between the Third Circuit, which denied the credit in PPL, and the Fifth Circuit, which allowed the credit in Entergy Corp. v. Commissioner. Nominally, the U.K. Act imposed a tax on recently privatized regulated companies of 23 percent of the difference between their estimated market value and the price at which they were sold to the public. The Act calculated each company’s market value by multiplying average earnings over a period of up to four years by 9 (a multiplier described as a conservative estimate of the market capitalization rate for such companies). The Fifth Circuit allowed the credit on the grounds that the substance of the tax imposed by the Act is a tax on the four prior years’ earnings, albeit at an effective rate higher than the statutory rate. In contrast, the Third Circuit denied the credit on the ground that the Act imposed a tax on a difference in values, not on income, as required by the Code and the applicable Treasury Regulation for the foreign tax to be creditable. This essay examines the economic and legal arguments that have been raised in PPL.

Reconsidering International Tax Neutrality

For decades, U.S. international tax policy has shifted back and forth between territorial-source-exemption taxation and worldwide-residence-credit taxation. The former is generally associated with capital import neutrality (CIN) and the latter with capital export neutrality (CEN). One reason why national tax policy has shifted back and forth between those benchmarks is because it is widely accepted that a tax system cannot simultaneously satisfy both CEN and CIN unless tax rates on capital are harmonized across jurisdictions. In this essay, I argue that the international tax literature contains two different and conflicting definitions for CIN. Under one definition, which goes back at least to Peggy Musgrave’s early writings and which has been adopted by politicians, lawyers and lay readers, CIN is understood to refer to a tax system that was competitively neutral. That idea can be conceptualized as a tax system that does not distort the ownership of capital (ownership neutrality). In the economics literature, ownership neutrality is closely associated with the recent work of Mihir Desai and James Hines, who coined the phrase capital ownership neutrality (CON) to describe a tax system that does not distort the ownership of assets. Under the other definition, which goes back to Thomas Horst and which has been broadly adopted by professional economists, CIN is understood to refer to a tax system that does not distort the consumption - savings choice (savings neutrality). In this essay, I show that the widely accepted and often repeated proof that a tax system cannot simultaneously satisfy both CEN and CIN is based on the assumption that CIN refers to saving neutrality. In contrast, when CIN is interpreted as ownership neutrality, the global adoption of a worldwide tax system simultaneously satisfies both CEN and CIN. However, global adoption of a territorial tax system still cannot simultaneously achieve both CEN and CIN because a territorial tax system violates CEN. Not surprisingly, the use of the term CIN to denote two different types of neutrality - ownership neutrality and savings neutrality - has produced much confusion for those trying to understand, influence and set international tax policy. Accordingly, I recommend that commentators either stop talking about CEN and CIN and talk instead about locational, ownership, and savings neutrality or if they continue to talk about CIN that they clearly specify whether they mean CIN as ownership neutrality or as saving neutrality.