Meet the Author: Professor David Gamage on Tax

In our latest author interview we chat with David Gamage, Law Professor and Whistler Faculty Fellow at Indiana University Maurer School of Law. He’s spent time outside academia, working with the US Treasury Department as an advisor during the Obama Administration on the Affordable Care Act, and also happens to be one of topmost downloaded Law authors on SSRN. We spoke about wealth, fairness and the challenges of taxing global corporations…

Q: Tax is in the news this month as the UK Prime Minister has finally released his tax return, which revealed that on his income of £4.8m over the last three years he paid just over £1m in tax over the course of the three years. This gave him an effective tax rate of 22%, which is lower than many people who earn far less. The issue is that tax earnings from work in both the UK and the US tend to be taxed at a far higher rate than earnings from wealth such as shares and investments – why is that?

In the US, and in most parts of the world, it turns out it’s very hard to tax really wealthy people. We talk about the strategy of ‘Buy, borrow, die…’ If you are wealthy, you want to get your income treated within the tax system as an investment return. Then when you need money, you borrow from those returns, and as that borrowing isn’t treated as income you aren’t taxed on it. Then you have a lot of money you can do stuff with. The final step, ‘Die’ is that in the US you aren’t taxed on investment gains at death. Most taxpayers don’t play all these games, but a lot of very rich taxpayers do play these games to a very substantial extent. As a result, taxpayers with many millions of dollars in wealth can often end up paying an effective tax rate on their true income of something like 8% or less in the US, and unlike in the UK we don’t have any Value Added Tax (VAT) on consumption. Overall, the very wealthy who do this type of tax planning just don’t pay much tax compared to ordinary people.

Q: That sounds like something people might want to change…

Right, so the question is why can’t we just fix this? The reality is that there is no straightforward easy fix, so what I have tried to do in much of my work and my research is to devise better systems. The Canadian system doesn’t have the die step, for example, but there are still a whole variety of things the very wealthy can do to forever defer paying taxes. Another promising reform strategy is to adopt some form of wealth tax, like in Switzerland. In the United States, Senators Warren and Sanders, among others, have proposed wealth tax reforms. I was heavily involved in consulting on Senator Warren’s proposed wealth tax reforms, and I have also been heavily involved in a number of similar state-level reform efforts. As another approach for reform, President Biden has proposed a Billionaires Minimum Income Tax reform proposal. I helped develop this reform proposal and co-drafted the legislation to enact this reform. The basic idea is to end deferral for most extremely wealth taxpayers by measuring their investment gains annually without waiting for sale transactions, for purposes of levying an alternative minimum tax. In other words, the idea is to try to tax very wealthy peoples’ income as it accrues, as their wealth accumulates.

Q: I’m interested in this idea about taxing wealth being all about timing – if you bring in a wealth tax that the wealthy don’t like, they postpone realising gains until a new regime appears that taxes them less. Is this why an annual wealth tax would be so powerful?

The fact that wealthy taxpayers can take planning steps to defer their tax liabilities until some future date, and then later take steps to completely escape taxation, has long been understood as the Achilles’ Heel of a realization-based tax system. For that reason, I have argued in my scholarship that some sort of accrual-based measurement system that limits deferral is needed in order to effectively tax extremely wealthy taxpayers. Among other reasons, this is because both history and theory suggest that if you don’t tax now, you will never successfully tax ever. The odds that a political environment supporting robust and comprehensive taxation will last long enough to effectively tax these deferred tax liabilities on the back end, are just low! 

Q: In the paper you wrote recently on SSRN with Darien Shanske, you made the case for an Alternative Minimum Tax (AMT) at the state level, to deal with Corporates using profit shifting to avoid tax. I’m fascinated by the idea of profit shifting, can you talk a bit about what corporations are doing and how an AMT could help?

Many large corporations, especially most large US Tech and Pharma corporations, set up subsidiaries in low-tax or no-tax jurisdictions, such as Ireland, or more aggressively in places such as the Caymans.

So then, once a corporate taxpayer has a subsidiary in a low-tax or a zero-tax country, they then find a way to have that subsidiary charge very high charges to the US parent, such as for interest on a loan or rent for intellectual property or the like. This is the problem of transfer pricing. If the US parent and a subsidiary in a low-tax country are engaged in a transaction wherein the subsidiary is charging the parent for something, how should we treat this transaction for tax purposes? There isn’t a real market transaction, because it’s in a sense just one hand talking to the other hand –  so if my right hand charged my left hand high rents, all of a sudden it looks like my hand being charged high rents doesn’t have much profit –  and so the reported profits for tax purposes go to the hand charging the high rents where it turns out taxes just happened to be low…

The truth is that there is no perfect solution to global profit shifting. Instead, there are two different sets of approaches, one is “Let’s tax global income of our corporations.” The US income tax system used to do that in theory, but it was pretty easy to get out of it. Under that approach, the problem is that if you do tax these corporations more, they might just leave the US. 

The other set of approaches is to just tax just the domestic income of the corporations, but the problem there is profit shifting. The corporations can play accounting games to move the profits to low or no-tax countries. 

The new US federal Corporate Alternative Minimum Tax is designed to combat profit shifting by adopting the approach of partially taxing the global income of corporations, but only to a limited degree as a form of alternative minimum tax. The CAMT only applies to very large corporations who are doing a lot of profit shifting, so it’s pretty far from going to a complete world-wide tax system. My article with Darien Shanske argues that profit shifting is also a problem at the US State level, and that the US states should consider conforming to the new federal CAMT in order to combat this profit shifting as it affects state-level corporate taxes.

Q: What do think is the single most inefficient aspect of the US Tax code?

I would say that is the realization rule for the income tax. Or more broadly, I would cite to buy/borrow/die. That is: the ability of wealthy taxpayers to accrue their income in the form of asset appreciation that is not currently taxed, then to access that income tax-free by borrowing, and finally to erase all of those deferred tax liabilities when they die, so as to ultimately escape the tax entirely. This is a giant open door to tax avoidance. It distorts the economy through all the wasteful transactions taxpayers engage in to move their money through this gaping wound to escape tax.

Q: What do think is the single most unfair aspect of the US Tax code?

I think it’s that billionaires and mega-millionaires can have such extremely low effective tax rates. Somebody has to pay for government, so the middle class and working class are paying for government, and we are running very large budget deficits – but the very wealthy are benefiting from the legal system, the military and the security apparatus that keeps them and their wealth secure.

I have also written on how this all builds on historical forms of disadvantage and oppression. For instance, the black descendants of slavery didn’t historically have the opportunities to build wealth and take advantage of the many ways that the government supports wealth building. And now these historically disadvantaged taxpayers end up paying much higher effective rates of tax because of the flaws in the tax system.

Q: What is the one thing we could to increase the transparency of the US tax code?

This is difficult. Transparency is an inherently complex issue. I have written about salience and transparency, and it is often not clear what sort of information about taxation should be provided and in what manner in order to foster the philosophical ideals underlying transparency goals. For instance, some have claimed that a Value Added Tax is not transparent, because you don’t see the price of that tax on the register when purchases are made, by contrast to sales taxes in the United States. But taxpayers don’t see the ways that the government spends the funds raised by a VAT, and how this spending supports the economy, when they make purchases at the register either. 

You could imagine a hypothetical world in which, when you bought an apple, you got a complete report of all the services the government gave you that enabled that apple sale along with all of the costs of all taxes that affect the price of that apple. But this hypothetical is of course absurd. In a world of limited attention spans, limited time, and limited information, we cannot provide complete information about all aspects of taxation at the time when every purchase or transaction is made. 

There are lots of government reports analyzing the tax system and its impacts, and these reports are generally made publicly available – as they should be. What more beyond this should be done to further transparency goals is a difficult set of questions.

I think in the US we currently have an excessively cumbersome tax filing return system, that people hate. Some conservatives think that making people suffer through a painful approach for filing taxes is important for transparency. The UK has a much better system in my view, certainly much less painful in terms of tax filing. I think people in the UK are aware that their tax system exists and are aware they pay taxes, and that no meaningful transparency goals would be furthered by requiring UK taxpayers to jump through more tax filing hoops, painfully, as in the US, forcing them to do paperwork every year which could be done more easily by government computers.

Q: You had some experience working in the Treasury Department under the Obama administration: what’s it like going from an academic discussion about tax policy to actually working on tax policy advice? Did anything about that transition surprise you?

In my prior government position, I was primarily working on the tax provisions of the Affordable Care Act—the major health care reform enacted under former President Obama. The Affordable Care Act was the largest healthcare reform in the US in over 30 years and was substantially enacted through the tax code.

Being in government for a time was a fun, interesting experience which I think has really helped my understanding of the world. But the skill set of being an effective actor in Government is quite different from being an academic, even though the issues are similar. At the end of my time in government, I was quite happy to return to my scholarship and teaching.

Q. What role have preprints in general and SSRN in particular played in your particular academic work?

First, I’m going to tell you one of my pet peeves about SSRN. SSRN doesn’t track legal citations very well, at least US legal citations, because most legal publications use footnotes instead of end notes. As a result, for myself and for other prominent American legal scholars, the number of citations shown on SSRN is embarrassingly and erroneously low. I’d much rather SSRN not count citations at all than falsely undercount citations for legal scholars.

{SSRN writes: Noted! We are painfully aware of this issue, which is caused by technical challenge of extracting that metadata from PDF footnotes that we’ve so far been unable to solve…we will definitely pass on that feedback.}

Today, there are lots of places that people can post their work online to make it accessible, which has been transformative. In my view, it is important for the marketplace of ideas for academic drafts and working papers, as well as final publications, to be accessible and available.

SSRN is my preferred place to put academic work online. One big reason is that SSRN doesn’t charge anyone for access – if it did charge, I would go somewhere else, it’s just great that people don’t have to pay to access research. It’s also critically important that my work is under my control. Universities often create systems for posting papers that have a lot of bureaucracy; I spent eight years at UC Berkeley at the beginning of my career, but my SSRN posted papers move with me and remain under my control.

Here are some recent papers from David Gamage on SSRN:

Why States Should Conform to the New Corporate AMT

Amicus Curiae Brief of Law Professors

Tax Base Diversification as an Enforcement Tool

Phased Mark-to-Market for Billionaire Income Tax Reforms

Billionaire Mark-to-Market Reforms: Response to Susswein and Brown

You can check out David Gamage’s Author Profile here

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