US Income Tax Research Articles

Tax In History: Acknowledging (Celebrating? Regretting?) Sixty Years of Subpart F

Deferral of home-country tax on the income of foreign subsidiary corporations produces the twin evils of business and investment location distortion and profit shifting. In 1961, the Kennedy administration proposed the almost complete elimination of this type of deferral from the US income tax system. Because of strong opposition lobbying, the result was a political compromise commonly known as Subpart F. This article explains why Subpart F was largely a failure, in spite of its being copied to various degrees by the controlled foreign corporation (CFC) regimes of many developed countries. The article also explores the extent to which the 2017 Tax Cuts and Jobs Act (TCJA) has, or has not, cured Subpart F’s failure to effectively address location distortion and profit shifting. Deferral, profit shifting, Subpart F, CFC regimes, US international income taxation, 2017 Tax Cuts and Jobs Act

Health Risk, Insurance, and Optimal Progressive Income Taxation

Abstract We study the optimal progressivity of personal income taxes in a general equilibrium overlapping generations model where individuals are exposed to idiosyncratic shocks to labor productivity and health status over the lifecycle. Our results—based on a calibration to the US economy—indicate that both, the presence of health risk and the available insurance institutions, have a strong effect on the optimal level of tax progressivity. Given the fragmented and non-universal health insurance system in the US, a welfare maximizing income tax system is substantially more progressive than the current US income tax. The higher progressivity provides additional redistribution and social insurance, especially for unhealthy low income individuals who have limited access to health insurance. When exposure to health risk is removed or reduced by introducing more comprehensive health insurance systems, we observe large decreases in the optimal level of income tax progressivity, and the optimal tax system resembles findings from the previous literature. These findings highlight the importance of accounting for the unique characteristics of health risk and the design of the health insurance system when characterizing optimal income taxes.

A Risky Venture: Income Dynamics among Pass-Through Business Owners

We employ a large panel of US income tax returns for the period 1987–2018 to extensively characterize and quantify business income risk. Our findings show business income to be much riskier than labor income. Business income is less persistent and is characterized by higher tail risk. Furthermore, when compared to labor income, heterogeneity across households is less important in explaining the cross-sectional variation in business income, and within-household income variation is more important. Our results underscore the income risks business owners face and provide stylized facts and parameter estimates useful for quantitative macroeconomic models and policy analysis. (JEL D31, G51, H24, J23, J31, K34, L26)

Why Is Wealth White?

Racial wealth inequality is no accident of history. Rather, it is the intended result of the southern Democrats in Congress who controlled federal tax policy throughout most of the twentieth century. Beginning in the 1930s, champions of white supremacy, such as Senator Pat Harrison (D-MI), Senator Walter George (D-GA), and Senator Harry F. Byrd, Sr. (D-VA), turned to an ostensibly race-neutral provision of the US income tax code—the preferential treatment of gains from investment—to uphold their (im)moral economy of “whites-only” wealth. After 1965, these segregationists’ successors—particularly Senator Russell B. Long (D-LA) and Senator Lloyd Bentsen (D-TX)—furtively rebuilt and shored up the structure of racial inequality with additional tax breaks (called “tax expenditures”) for investors. Our income tax system embodies—and immortalizes—a Jim Crow–era moral economy of “whites-only” wealth. Thanks to pro-investment tax expenditures, the racial wealth gap has widened over the last four decades as the very richest American households—the white 1 percent—compounded their wealth, at the expense of everyone else.

Homeownership and taxes: How the TCJA altered the tax code's treatment of housing

AbstractThe federal government has long promoted homeownership through various provisions in the US income tax code. The Tax Cuts and Jobs Act of 2017 (TCJA) renewed interest and debate about the treatment of housing via the tax code, particularly with respect to the mortgage interest deduction and the limitation on deductions for state and local taxes. We document the extent that the TCJA magnifies the long‐standing unequal treatment of debt and equity financing of homeownership in the tax code. Our analysis indicates that most households no longer benefit from mortgage interest and property tax deductions. We also show how the limitations on the deduction of state and local taxes alter the costs associated with homeownership across geographic areas, and we provide detailed calculations of the average and marginal tax rates at which housing‐related expenses are deducted. The former are relevant to the tenure choice decision, the latter to the quantity demanded decision. Finally, we document that the lost tax savings associated with the inability to benefit from mortgage interest and property tax expenditures are often small relative to the primary tax benefit owners still enjoy: the nontaxation of the return on equity invested in the home.

Reregulating Indonesian Stock Buyback: A Lesson From United States

This article compares the corporate income tax cuts enacted by the Indonesian COVID-19 Relief Law and the US Tax Cuts and Jobs Act. It investigates the correlation between the tax cuts in the Tax Cuts and Jobs Act, economic development, and share repurchases in the US. It seeks to identify appropriate limitations on share repurchases in Indonesia following the enactment of the COVID-19 Relief Law. This research was carried out using the juridical normative method by tracing the literature and laws concerning share repurchase arrangements in Indonesia and the US. The results show that there is a slight positive correlation between the reduction of corporate income tax and economic development in the US and that the US income tax cuts have caused significant growth in share repurchases. After the enactment of the Indonesian COVID-19 Relief Law, which also reduced corporate income taxes, Indonesia may be on the verge of extensive share repurchase activity, as occurred in the US. To tackle this problem, we recommend amending Law No. 40 of 2007 concerning limited liability companies to re-regulate the restriction on share repurchases.

Heterogeneous Workers and Federal Income Taxes in a Spatial Equilibrium

We study the geographic incidence and efficiency of an income tax by estimating a spatial equilibrium model with heterogeneous workers. The US income tax shifts households out of high-productivity cities, leading to locational inefficiency of 0.25 percent of output. Removing spatial tax distortions increases inequality because more educated households are more mobile and own larger shares of land. Flattening the tax schedule, or introducing cost-of-living adjustments or local wage adjustments leads to efficiency gains but causes substantial increases in inequality. Differences in mobility and land ownership across skill groups create an equity-efficiency trade-off that is unique to spatial settings. (JEL H24, H22, D31, J31, J24, R23)

Income Tax Evasion: Tax Elasticity, Welfare, and Revenue

This paper provides a general equilibrium model of income tax evasion. As functions of the share of income reported, the paper contributes an analytic derivation of the tax elasticity of taxable income, the welfare cost of the tax, and government revenue as a percent of output. It shows how an increase in the tax rate causes the tax elasticity and welfare cost to increase in magnitude by more than with zero evasion. Keeping constant the ratio of income tax revenue to output, as shown to be consistent with certain US evidence, a rising productivity of the goods sector induces less evasion and thereby allows tax rate reduction. The paper derives conditions for a stable share of income tax revenue in output with dependence upon the tax elasticity of reporting income. Examples are provided with less and more productive economies in terms of the tax elasticity of reported income, the welfare cost of taxation and the tax revenue as a percent of output, with sensitivity analysis with respect to leisure preference and goods productivity. Discussion focuses on how the tax evasion analysis may help explain such fiscal tax policy as the postwar US income tax rate reductions with discussion of tax acts and government fiscal multipliers. Fiscal policy with tax evasion included shows how tax rate reduction induces less tax evasion, a lower welfare cost of taxation, and makes for a stable income tax share of output.

Income tax evasion: tax elasticity, welfare, and revenue

This paper provides a general equilibrium model of income tax evasion. As functions of the share of income reported, the paper contributes an analytic derivation of the tax elasticity of taxable income, the welfare cost of the tax, and government revenue as a percent of output. It shows how an increase in the tax rate causes the tax elasticity and welfare cost to increase in magnitude by more than with zero evasion. Keeping constant the ratio of income tax revenue to output, as shown to be consistent with certain US evidence, a rising productivity of the goods sector induces less evasion and thereby allows tax rate reduction. The paper derives conditions for a stable share of income tax revenue in output with dependence upon the tax elasticity of reporting income. Examples are provided with less and more productive economies in terms of the tax elasticity of reported income, the welfare cost of taxation and the tax revenue as a percent of output, with sensitivity analysis with respect to leisure preference and goods productivity. Discussion focuses on how the tax evasion analysis may help explain such fiscal tax policy as the postwar US income tax rate reductions along with discussion of government fiscal multipliers. Fiscal policy with tax evasion included shows how tax rate reduction induces less tax evasion, a lower welfare cost of taxation, and makes for a stable income tax share of output.

Measuring economic efficiency using inverse-optimum weights

This paper provides a method to measure the traditional Kaldor-Hicks notion of “economic efficiency” when taxes affect behavior. In contrast to traditional unweighted surplus, measuring efficiency requires weighting individual benefits (or surplus) by the marginal cost to the government of providing a $1 transfer at each income level. These weights correspond to the solution to the “inverse-optimum” program in the optimal tax literature: they are the social planning weights that would rationalize the status quo tax schedule as optimal. I estimate the weights using the universe of US income tax returns from 2012. The results suggest that measuring economic efficiency requires weighting surplus accruing to the poor roughly 1.5–2 times more than surplus accruing to the rich. This is because $1 of surplus to the poor can be turned into roughly $1.5–$2 of surplus to the rich by reducing the progressivity of the tax schedule. Following Kaldor and Hicks' original applications, I compare income distributions over time in the US and across countries. The results suggest US economic growth is 15–20% lower due to increased inequality than is suggested by changes in GDP. Because of its higher inequality, the U.S. is unable to replicate the income distribution of countries like Austria and the Netherlands, despite having higher national income per capita.

Endogenous Longevity and Optimal Tax Progressivity

We study the impact of endogenous longevity on optimal tax progressivity and inequality in an overlapping generations model with skill heterogeneity. Higher tax progressivity decreases both the longevity gap and net income inequality, but at the expense of lower average lifetime and lower aggregate labor supply and income. We find that the welfare-maximizing income tax is less progressive than in the case of exogenous longevity and that the present US income tax should redistribute less. Our result is robust to the empirically observed range of labor supply elasticity and the assumptions of both missing annuity markets and tax deductibility of private health expenditures.

Present at the Creation: Archival Research and Evidence on the Origins of the Single Tax Principle

This is the first of a series of articles on the origins of the so-called “single tax principle,” whose normative value has been denied or at least undermined by some tax legal scholars. It is based on archival research conducted at Harvard Law School Library - Historical & Special Collections on the unpublished Stanley S. Surrey’s papers and on unpublished minutes of meetings of the League of Nations available at the United Nations Archives in Geneva. The purpose is to contextualize and provide an historical background for the single tax principle by guiding the readers through these unpublished materials. It aims at identifying who theorized (Clavier) and practically implemented (Thomas Adams) the single tax principle at the international level as well as at domestic level (published and unpublished materials show that Adams and Surrey were the two main architects of both US international tax rules and the international tax regime). The author shows how the single tax principle originated in 1927 when Clavier theorized that, ‘international incomes be prevented from escaping taxation altogether is as desirable as that the same income shall not be taxed by several different countries;’ but only reached its maturity during the nine years 1957 – 1966 when Surrey, firstly, was successful in persuading Senate not to ratify Art. XV(I) of the Pakistan - US Income Tax Treaty (1957); secondly, adopted the Subpart F regime; thirdly, introduced the Investment or Holding Company article in the treaty with Luxembourg; and, finally, closed the loophole in the US-Canadian tax treaty. Claiming that the single tax principle does not have any normative value at all simply clashes with the above statutory provisions whose original intent was to suppress anomalies such as double exemptions as well as with what Martin Norr wrote in his 1964 Tax Law Review article, ‘the presumption that international income should pay tax at least once is becoming part of the common law of the Western industrial community, our new law merchant. If international income does not bear tax in some country, the burden will increasingly be on its recipients to justify the deviation from the norm.’

Personal Tax Planning: GILTI—Introduction to GILTI and Its Application to US Shareholders of Canadian Corporations

The new global intangible low-taxed income (GILTI) regime, introduced as part of the 2017 US tax reform, attributes income of certain foreign corporations in excess of an arbitrary 10 percent return to intangible assets and subjects such income to US tax on a current basis for certain US individual shareholders. This article explains how US citizens resident in Canada who are subject to the GILTI rules may effectively manage the adverse implications of the regime by utilizing an election under section 962 of the Internal Revenue Code. The election allows individual shareholders to be taxed at the US domestic corporate tax rate of 21 percent (instead of a maximum personal tax rate of 37 percent), claim a deduction for 50 percent of the GILTI inclusion, and claim foreign tax credits for a portion of Canadian corporate taxes paid. With this election, a combined corporate and personal global tax liability may remain mostly consistent with the pre-GILTI era. On the other hand, if the GILTI exposure is not appropriately managed, the result is significantly different. With proper advice and reporting, for some US shareholders, the GILTI provisions may be a case of "much ado about nothing." However, for US shareholders of corporations that pay the small business rate, there is a small tax cost to the GILTI inclusion for maintaining the benefit of deferral. For all US shareholders of Canadian corporations, there are still some unaddressed issues that add complexity and uncertainty to the preparation of those individuals' US income tax returns.

Side constrained optimisation to capture capacity of choices in the multinomial logit model: case study of income tax policy in the USA prior to the 2009 economic crisis

The choices' limited capacities of the discrete choice models must be taken into account. We propose a convex optimisation formulation in which the exponential formulation of the logit model is upheld in the Karush-Kuhn-Tucker (KKT) conditions. The capacities of the choices are then added to the formulation as side constraints. A solution algorithm based on the successive coordinate descent is proposed. For numerical evaluation, we investigate US income tax policies for the years prior to the 2009 crisis using multinomial logit models. The tendency of the states for choice of income tax versus other tax sources is assessed and it is found that: 1) all states show a propensity to levy more income tax; 2) this propensity has a ceiling cap similar to what is already known from the 'Laffer curve'; 3) residents in the states with already high income tax are more likely to be subjected to even heavier income tax within caps.

Cash-on-Hand and College Enrollment: Evidence from Population Tax Data and the Earned Income Tax Credit

We estimate causal effects of cash-on-hand on college enrollment decisions of students from low-income families. Using population-level, administrative data from US income tax returns, we exploit variation in tax refunds received in the spring of the high school senior year. The variation in tax refunds results from the kink point between the phase-in and maximum credit portions of the Earned Income Tax Credit schedule. The results suggest tax refunds received in the spring of the high school senior year have meaningful effects on college enrollment. (JEL D14, H24, I22, I23, I24)

The New US Tax Preference for 'Foreign-Derived Intangible Income'

The new US income tax deduction for “foreign-derived intangible income” effectively lowers the corporate tax rate — from 21% to around 13% — on export-generated income attributable to intangible assets. This paper considers the new provision both in relation to international trade and tax agreements and as a matter of national policy. It argues that FDII is not clearly in violation of international agreements — as has been claimed — but is difficult to justify from a national policy perspective.

Designing the Tax Treatment of Litigation-Related Costs

This paper identifies key tax design issues for how income tax law should treat litigation-related costs paid by defendants, such as attorney fees, court courts, and payments to settle claims or to satisfy judgments, fines or penalties. After discussing how US and German income tax law treat litigation-related costs, the paper identifies four important tax-design issues: (1) how to attribute litigation-related costs to any particular income-producing activity; (2) whether to treat liability insurer payments made on a defendant’s behalf as income to that defendant; (3) whether to coordinate the tax treatment of a payer’s damages payments with the tax treatment of those receipts to the payee; and (4) whether litigation-related costs should be treated as capital expenditures related to the right to receipts established or sought to be established by the litigation itself. In addition, the paper models how the tax-deductibility of liability-related costs might affect liability insurance demand and the insured taxpayer’s level of care. Finally, the paper shows how, under current law, private parties can enforce settlement agreements under which a defendant promises not to seek an allowable tax deduction for litigation-related costs. In so doing, this paper substantially extends and reorients tax theory on how an ideal income tax system could or should treat litigation-related costs

Measuring Revenue-maximizing Elasticities of Taxable Income

This article considers the question of whether marginal tax rates (MTRs) in the US income tax system are on the “right” side of their respective Laffer curves. Previous attention has tended to focus specifically on the top MTR. Conceptual expressions for these “revenue-maximizing elasticities of taxable income” (ETI L), based on readily observable tax parameters, are presented for each tax rate in a multi-rate income tax system. Applying these to the US income tax, with its complex effective marginal rate structure, demonstrates that a wide range of revenue-maximizing ETI values can be expected within, and across, tax brackets and for all taxpayers in aggregate. For some significant groups of taxpayers, these revenue-maximizing ETIs appear to be within the range of empirically estimated elasticities.

Bunching to Maximize Tax Credits: Evidence from Kinks in the US Tax Schedule

We explore bunching at US income tax kinks using a panel of 258 million tax returns from 1996 to 2014. We find bunching at seven kinks, with nearly all bunching occurring at kinks maximizing tax credits. In our sample period, the total number of bunchers increased at an 11 percent annualized growth rate, from 134,300 in 1996 to 866,600 in 2014. Approximately two-thirds of these bunchers locate at the unique point that maximizes refunds. Some taxpayers repeatedly bunch at this point, even in consecutive years when different tax kinks are refund maximizing. (JEL H24, H26, H31)

How Taxing is Tax Filing? Leaving Money on the Table Because of Compliance Costs

I use a quasi-experimental design and a novel identification strategy to estimate the burden of filing taxes. Employing a sample of US income tax returns, I observe the preferences of taxpayers when choosing between itemizing deductions and claiming the standard deduction. Taxpayers forego tax savings to avoid the hassle cost of itemizing, resulting in an average burden of itemizing of $644, with substantial heterogeneity. A revealed preference argument implies that itemizing deductions is as painful as working 19 hours. The burden of tax filing is larger for richer households, consistent with the fact that the value of time increases with income. I explore two explanations for the result. First, it could be due to an extreme aversion to filing taxes. Such aversion implies that itemizing deductions imposes aggregate hassles costs of 0.2% of GDP and back-of-the-envelope extrapolations to filing federal taxes yields an overall burden of 1.25% of GDP. Second, if taxpayers are time inconsistent they may forego large benefits even when hassle costs are relatively small due to procrastination. I provide evidence most consistent with taxpayers being present-biased. Both explanations – whether driven by preferences or mistakes – suggest that the tax filing burden is significantly larger than previously estimated. I discuss policy implications of the result.