August 5, 2021

Forget ICE. Tax Law is Becoming the New Border Patrol

[Cross-posted from the San Francisco Chronicle]

By Shayak Sarkar

In the coming months, parents will receive hundreds of dollars as the Internal Revenue Service begins paying out the Advance Child Tax Credit, providing financial support to families and combating child poverty. Yet one significant group will be left out: parents of undocumented and certain non-citizen children.

The tax code excludes these parents because of immigration status, even though many have spent years in the United States dutifully paying state and federal income taxes along with property and sales taxes.

Using tax law to patrol the border is not new. In the 19th century, several states enacted constitutionally unsound tax laws to target migrants. New York raised a tax on oceanic migrants for “hospital moneys.” Massachusetts supplemented its foreign passenger tax by requiring a bond of $1,000 for any newly arrived “lunatic, idiot, maimed, aged, or infirm person.”

The Supreme Court found the taxes unconstitutional, explaining that whether foreigners will “be compelled to pay a tax, before they will be permitted to put their feet ashore” is exclusively a federal question. Even after this decision, California imposed special taxes on Chinese migrants until the state supreme court intervened.

Migrant taxes have largely evolved from explicit fees at entry ports to punitive federal tax provisions that cast immigrants financially adrift.

Although federal tax law allows and requires people without Social Security numbers to file taxes using an Individual Tax Identification Number, those filers are excluded from many tax credits. Consider that the CARES Act conditioned COVID-era stimulus payments on not only the recipients’ Social Security numbers, but also their loved ones’. The law initially excluded even citizen spouses from receiving the payment, if they filed jointly with a non-citizen without a Social Security number. Meanwhile, citizen children of parents without Social Security numbers were likewise left aside.

These exclusions echoed immigration-status restrictions in the federal Earned Income Tax Credit (EITC) and Child Tax Credit — two provisions upon which working-class and poor families depend. They also evoke the IRS’s direct collaboration with the Department of Homeland Security in violent workplace raids. (An IRS investigation into a Tennessee meatpacker’s tax compliance ended with allegations of armed state and federal officers violating workers’ civil rights with machine guns, racial slurs and mass detentions.)

Americans appear skeptical of tax-based immigration enforcement, which also treads on uncertain legal ground. In a poll from last year, there was more support than opposition to extending pandemic payments to “those who pay U.S. taxes,” even as support for other punitive enforcement measures prevailed.

Recent lawsuits challenged the CARES Act’s exclusion of citizen relatives of undocumented workers. In R.V. v. Yellen, citizen plaintiffs alleged that the denial of emergency tax relief to otherwise-eligible children for their parents’ lack of a social security number violated equal protection. In another case, lead plaintiff Ivania Amador and her three children possessed Social Security Numbers while her husband did not. She argued that denials based on their spouses’ undocumented status violated their marriage-based due process and equal protection rights, as well as their First Amendment speech and associational rights. Tax law’s policing of borders may unconstitutionally cross the boundaries of familial integrity.

As the federal government financially casts undocumented immigrants aside, some individual states are starting to offer lifelines. New York recently created an Excluded Workers Fund to provide financial relief to noncitizens excluded from unemployment insurance and federal programs. States including California and Oregon, meanwhile, have extended their state-level EITCs to undocumented immigrants, potentially including employment considered illegal under federal law. These financial and tax laws generate thorny questions about where state authority ends and federal power dominates.

Federalism limits states and cities’ abilities to directly regulate immigration. Yet despite these limitations, states still possess unique tax powers, particularly to promote residents’ health and safety across immigration statuses. Cities and states are choosing to foster inclusion to balance the weaponization of federal tax law against immigrants. While the Supreme Court may ultimately weigh in again on limits to state and local action, for now, states and localities should feel legally comfortable pursuing a range of immigrant-inclusive financial and tax policies.

Federally, effective methods exist to deal with tax noncompliance beyond cooperation with immigration enforcement. In 2017, the Treasury Inspector General suggested a more “focused strategy” on employers and payroll service providers to reduce tax noncompliance. Unlike using tax law to deport migrants, focusing on employers could raise needed revenue and comply with the Supreme Court’s employer-focused interpretation of immigration enforcement statutes. In contrast, cooperation between tax and immigration authorities could inhibit undocumented immigrants’ tax compliance, for fear that information sharing could lead to deportation.

Policing poor immigrants through tax law weakens the borders between immigration and tax law meant to protect citizens and noncitizens alike. Respecting those borders is as important as respecting territorial ones.

May 3, 2021

GILTI and California: Show Me the Money Edition

Back of the envelope calculations indicate significant revenue can be raised if California conforms to GILTI.

 

[Cross-posted from Medium]

By Darien Shanske

The California Legislature is considering a bill (AB 71) that would subject 50% of a category of income derived from federal tax law, known as Global Intangible Low-Taxed Income (GILTI), to California’s corporate income tax. In short, GILTI represents an attempt by the federal government to estimate, by formula, how much income — really earned in the US — has been shifted to low-tax jurisdictions to avoid US tax.

I have written extensively about what GILTI is, why states should tax it, why they can tax it and even why this is likely to raise a lot of revenue.

 

The current serious consideration of including GILTI in the California corporate income tax base merits a deeper dive into the data in order to arrive at a necessarily rough range of estimates. To be clear, I am not an economist and am not offering a model. Rather, I am extrapolating from publicly available information provided by leading economists through the use of what I believe to be reasonable assumptions.

On the high side, I will start with an analysis done by the Penn Wharton Business Model (PWBM), based primarily on IRS data. According to the PWBM, the GILTI formula should produce $388 billion of GILTI at the national level in 2021. This number, not surprisingly, reflects a good estimate as to the total amount of income shifted by US-based MNCs. Based on this number, the California proposal would raise about $1.7 billion in revenue per year. To arrive at this estimate, I am assuming that 10% of (50%) GILTI would be apportioned to Ca, which is a reasonable guess based on recent reports issued by the FTB (average factor of about 11% in 2017, 8% in 2018).

New Jersey has seen its CIT flourish after conforming to GILTI (and making several other substantive changes in 2018, including a rate increase and taxing 5% of the repatriation) and so the notion that GILTI conformity can yield substantial revenues is not outlandish.

The steadily declining yield of California’s corporate income tax similarly suggests there is a substantial upside to reforming the corporate income tax base. (Observe that the small reduction in rates on its own does not look like a good explanation for such a steep decline.)

 

[See chart on page 3 of this document: https://calbudgetcenter.org/wp-content/uploads/2021/03/IB-FP-Corporate-Taxes.pdf]


(Note that this high-end estimate derived from PWBM might actually be conservative if one believes that there is going to be an economic boom over the next few years.)

 

What of the low end of the range? We do have one piece of actual data on the amount of GILTI that has actually been reported to the IRS, which is that 81 of the largest corporations, with ¼ of total corporate income, reported about $100bn in GILTI in 2018. Note that if we just multiply 100bn by 4, then we are back to our high-end estimate of about $400bn in GILTI per year. Yet one might reasonably believe that these large companies represent a disproportionate amount of GILTI. One might also believe that these sophisticated taxpayers have found numerous ways to reduce their tax liability — perhaps by gaming the formula or by transmuting GILTI income into something else (e.g., so-called subpart F income). In California, it might turn out that some of the taxpayers with GILTI are already not taking a water’s edge election, which take them out of the GILTI inclusion proposal because, as to these taxpayers, income shifting is being countered in another way.


Note that California conformity proposal is written in such a way that it does not conform to federal regulations governing the GILTI calculation that are very likely to undermine it further. And, California already includes a different kind of suspect income (subpart F) into which GILTI income can be transformed in its tax base and so that particular stratagem will not reduce California revenue.

 

And so I think a lower bound of 200bn in GILTI at the national level for 2021 is reasonable — that means that between the vagaries of revenue estimation and taxpayer strategies, aggressive and benign, the estimate from PWBM is about 100% too high. In that case, conforming to GILTI would raise about $850 million/year.


This would mean a range of between $850mn and $1.7bn annually, subject to substantial caveats.


AB 71 would also subject the deemed repatriation of IRC 965 to taxation. This is another topic I have written about. The amount of revenue that could be raised by this change is also hard to estimate. It is not clear how much revenue was deemed repatriated, how much might have already been subject to California tax and how much corporations have chosen to pay on a deferred schedule (which is what AB 71 would tax). First, as to the repatriation that was formally subject to California tax already because the revenue was actually repatriated (about $1 trillion — again, based on FTB data), I think that not much tax was already paid on this revenue because so many of these same taxpayers had (and have) a surfeit of tax credits to use against the California corporate income tax. AB 71 caps the use of these credits against the repatriation (or GILTI) at $5mn. Second, I think a conservative estimate of how much of the repatriation taxpayers chose to defer is about $1.6 trillion. This takes into account the original $2.4 trillion estimate for the total amount of revenue to be repatriated, as well as the reported fact that 2/3 of taxpayers with repatriated tax liability chose to defer their tax liability on the repatriation (and only these deferrals would be taxed). Note we do not know how much of the repatriation those taxpayers represented.


Based on these reasonable, but rough, assumptions, taxing the repatriation would result in roughly $4.3 billion in taxes paid to California over the next 5 years. Acknowledging the significant uncertainties here, starting with the original estimate of how much revenue there was to be repatriated, a lower bound of figure of $2 billion over 5 years seems reasonable or again discounting by a factor of 2.

A final note on the larger bill. One of AB 71’s core policy insights is that the state needs to provide a stable stream of revenue to combat homelessness. Tying the state’s contribution to the vagaries of how much taxpayers pay on their GILTI income would undermine that stability. What is most important about the revenue estimates is that making a change to California’s corporate tax that should have been made anyway is reasonably likely to roughly pay for the state’s revenue commitment to combat homelessness over time so that these new programs are not taking away from other essential programs.

 

To make this point more concrete, consider that we want taxpayers to have less GILTI because we want them to shift less income. California’s conforming to GILTI could contribute to taxpayers changing their tax structures in this way. Indeed, the Biden Administration is proposing to strengthen the GILTI regime in various ways. Suppose then that there is less GILTI income because less income is being shifted. If that were to occur, then that would mean there is more tax paid on ordinary corporate income and so California would still receive more revenue from GILTI inclusion, but not with the GILTI label.

 

Accordingly, it makes sense to appropriate about $2 billion/year to homelessness mitigation programs, knowing that the GILTI conformity and repatriation provisions are at least reasonably likely to roughly cover these expenditures over time if one takes a broad view of how these provisions are meant to operate.

April 26, 2021

Op-Ed: California Should Pass a Small Tax on Big Wealth

[Cross-posted from the Los Angeles Times]

 

By Darien Shanske, David Gamage and Emmanuel Saez

 

California’s tax system is upside down at the top: Millionaires pay higher rates than billionaires. California’s wealthiest residents — who have partaken in a $4-trillion increase in billionaire wealth in the last year — contribute next to nothing to state coffers. Meanwhile, many less fortunate Californians are suffering.

 

The ordinary rich — say, a well-compensated doctor — pay a lot in California income tax; they do their share to help support the state. Indeed, many working-class individuals, such as nurses, teachers or firefighters, pay tax on a much larger share of their economic gains than do the wealthiest Californians.

So how do mega-millionaires and billionaires escape the state’s Franchise Tax Board?

The answer is that our tax system does not reach large fortunes unless property is sold or money is paid out in salaries or in stock dividends. Playing Wall Street games, the very rich in the state can avoid taxation and still fund their lavish lifestyles.

Consider Elon Musk. He built a fortune in California currently valued at about $180 billion, the largest ever seen in the state. We don’t know exactly how much state income tax he has paid, but because he hasn’t sold his Tesla stock or taken a substantial salary or dividends, we can surmise that he has paid very little. Musk now claims to have moved to Texas, so he will probably never pay income tax to California on the billions he accumulated while benefiting from the services and protections provided by the state.

The state Legislature is now considering a pair of bills — Assembly Constitutional Amendment 8 and Assembly Bill 310 — that would levy a 1% tax on extreme wealth: anything above $50 million, with an additional 0.5% tax on fortunes worth more than $1 billion. With Georgetown University law professor Brian Galle, we helped draft these bills to deter tax avoidance and to restore fairness to California’s tax system.

Under these two measures, a household worth $51 million, for example, would pay a tax of $10,000 a year (1% of $1 million). That would be a small burden for such a household but a big boon to California because about one-quarter of all American billionaires reside in the state. As we lay out in a white paper on the legislation, the reforms would raise about $22 billion a year, and more as wealth increases in the state.

California may be able to weather the pandemic without budget cuts, helped by President Biden’s COVID-19 relief package. But soon enough, the state will again face deficits and a host of unmet needs. Sacramento must invest in climate change resilience, such as power line and power grid upgrades to help prevent catastrophic wildfires. The state’s school systems are facing teacher shortages. Housing and mental health facilities are needed to help those living on our streets.

Most fundamentally, it is time to make the tax system fairer.

We estimate that about 15,000 families would be subject to the new wealth tax — the richest 0.07% of the state. According to Forbes magazine, there are about 170 California billionaires, and their total wealth is now around $1 trillion. It was only $700 billion two years ago, before COVID-19, and $300 billion 10 years ago. During the pandemic, while 7.8 million unemployment claims were filed in the state, the state’s richest people gained $300 billion. About half of the $22 billion the new tax would raise would be paid by these billionaires.

Those opposed to a new wealth tax claim that the very rich would flee California in droves, a la Musk, who has made no secret of his objections to the state’s regulations. Much the same warnings were sounded in 2012 and 2016 when California raised income taxes on millionaires. And yet our research shows that the state has gained millionaires and billionaires, along with added revenue from those earlier taxes on the rich.

Other researchers who have studied the question of whether millionaires leave states when taxes are raised have generally found that such movement is uncommon and that when the rich do relocate, taxes aren’t the main reason.

Think about it: For many of the ultra-wealthy, paying a 1% or even 1.5% tax on their fortunes would amount to less than the usual fluctuations of their net worth because of weekly swings in the stock market. And those who made a lot of noise about departing because of the tax would probably have left anyway, seeking a lower-tax state when they finally sell off some of their holdings.

Don’t buy the scare stories about taxing extreme wealth. We need such a tax so that California’s economy benefits all its residents, not just the rich, and to make sure that the wealthiest in the state pay their fair share.

Darien Shanske is a professor of law at UC Davis, David Gamage is a professor of law at Indiana University Bloomington, and Emmanuel Saez is a professor of economics at UC Berkeley.

March 5, 2021

Local Taxes Have Lots of Untapped Potential

[Cross-posted from The Recorder]

By Darien Shanske and David A. Carrillo

Help may be coming at long last from the federal government, but California local governments are likely to face fiscal challenges as a result of the pandemic and recession for a long time. After all, many of those local governments faced major issues before the current crisis. It turns out that a 2017 decision by the California Supreme Court might offer some communities the ability to help themselves.

When the California Supreme Court decided California Cannabis Coalition v. City of Upland (2017) 3 Cal.5th 924, we — and others — argued that the court opened the door for local initiative measures to adopt special taxes by majority vote rather than the supermajority that ordinarily applies to taxes. The issue of whether local tax initiatives can be passed by majority vote has now been litigated in three court of appeal decisions, and our prediction is coming true: All three decisions expressly adopted a majority vote rule for local special tax initiatives.

In City and County of San Francisco v. All Persons Interested in Proposition C (2020) 51 Cal.App.5th 703, 61% of the local voters approved a proposed initiative tax. Opponents argued that California constitution Article XIII A, Section 4 and Article XIII C, Section 2(d) (Proposition 13 and Proposition 218, which require special taxes proposed by local governments to be approved by two-thirds of the voting electorate) applied to special taxes adopted by local initiative. Following Upland’s reasoning, the court of appeal relied on the electorate’s reserved initiative power to reject that argument and held that local voters may exercise their initiative power to adopt a special tax by a simple majority. The same issue was presented in City of Fresno v. Fresno Building Healthy Communities (2020) 58 Cal.App.5th 884, and Howard Jarvis Taxpayers Association v. City and County of San Francisco (A157983). Both decisions adopted the reasoning in San Francisco and adopted the majority vote rule for local special tax initiatives.

All three decisions were unanimous, and the court of appeal published all three decisions. That makes them the only controlling law on this issue, so Superior Court judges have little choice but to follow them. And absent an appellate division split, the California Supreme Court is unlikely to disturb these rulings. Indeed, the state high court denied review in San Francisco; a review petition is pending in Fresno; and the court of appeal denied rehearing in Howard Jarvis.

These rulings are correct; they are natural extensions of Upland and properly build on doctrine that preexisted Upland. Courts have long held that the initiative power is not subject to the same constraints that apply to local governments or the legislature and have historically been skeptical of two-thirds vote requirements.

The San Francisco decision noted that two-thirds requirements must be “strictly construed” in the initiative context due to the “fundamentally undemocratic nature of the requirement for an extraordinary majority.” That principle derives from City and County of San Francisco v. Farrell (1982) 32 Cal.3d 47—a decision that was overturned by Proposition 218. Relying on Farrell now shows both how skeptical courts are of supermajority requirements, and how compelling the judicial imperative to jealously guard the initiative power is. Look for this skepticism of supermajority voting rules in future initiative cases.

The concern about supermajority requirements partly flows from the fact that the simple majority rule for initiatives has been in effect from direct democracy’s inception. Since then California voters have permitted just three modifications to their direct democracy powers—and none of those changes reduced their powers. It would be a significant departure from that history for the initiative power to be limited by the voters, which is another reason we think the court in Upland was correct to hold that such a limitation “require[s] clear evidence of an intended purpose to constrain exercise of the initiative power.”

This trend is also consistent with the California Supreme Court’s treatment of local control over taxation. Unlike many states, the California Supreme Court has interpreted a charter city’s home rule power to extend to taxation. Our state high court has also interpreted the initiative power broadly in the taxation context. Though it would not be an outright contradiction to apply a supermajority rule to local tax initiatives, it would be at least incongruous for the courts to take away the local electorate’s power over taxation after recognizing the importance of local control over finances in these related contexts.

We think the more interesting question is not whether a court should or would depart from these three decisions, but how their implications can be harnessed to make life better for Californians. The initiative power is explicitly granted to counties and cities, but not to school district electorates. Yet there is a strong argument that school district voters retain the initiative power and could pass tax measures by majority vote. It would be even better, of course, if the legislature gave school district voters this power by statute. It would be better still if the legislature also expressly permitted local governments to impose tiered parcel taxes so local voters could approve measures that do a better job of spreading the tax burden.

We understand that extending the Upland reasoning has already stirred up some opposition, even a threat of a constitutional amendment imposing a supermajority rule on local voters. But, as we have argued, it’s not clear that Upland can be undone that way. Upland’s clear statement rule is, we think, predicated on the notion that certain powers are reserved for the local electorate. And thus the state electorate could not change the power of local voters unless the change resulted from a constitutional revision. As a result, we think the power of local voters to impose taxes on themselves by majority vote using the initiative power is here to stay.

March 1, 2021

This is a good time for the Legislature to invest in California by taxing large, profitable corporations

[Cross-posted from CalMatters]

By Reuven S. Avi-Yonah, David Gamage and Darien Shanske

A year into the COVID-19 crisis, the gap between corporate profits and economic security for the average American is wider than ever. Since March 2020, 45 out of 50 of America’s largest companies have made a profit and in some cases the profit has been quite substantial

Meanwhile, unemployment in California increased dramatically in 2020, from 5.5% in March to 9% in December. Many more Californians have been thrown into housing instability, worsening an already urgent issue. 

Reversing the housing crisis and addressing homelessness in particular will require large and regular investments. Assembly Bill 71, introduced by Democratic Assemblymember Luz Rivas, is a bold step to making these investments and takes into consideration that California has a lot of needs, and its current budget surplus is not expected to last. Hence, AB 71 funds itself by means of a targeted tax increase that will be paid for only by the largest corporations best able to pay.

This is an appropriate revenue source, as corporations have paid an ever smaller share of their profits in taxes over the last several decades. Some of this decline was the result of deliberate decisions: Between 1980 and 1997 California lawmakers cut the corporate tax rate from 9.6% to 8.84% – and it hasn’t changed since then. 

Bottom of Form

This decline in taxes paid by large corporations was also because the state failed to act as certain very profitable corporations got cannier about exploiting major loopholes that allow them to avoid paying taxes even further.  

Corporate tax avoidance is so rampant that even the 2017 tax bill, which was loaded with breaks for large corporations and the wealthy, included several provisions meant to combat these loopholes. In particular, the Trump tax bill established a methodology to both identify and tax income improperly shifted out of the U.S. tax base.  This income is known by the acronym “GILTI,” which stands for Global Intangible Low-Taxed Income.

Restoring California’s corporate tax rate to 9.6% on corporations making more than $5 million in profits per year, as well as taxing the shifted income known as GILTI, are two sensible tax reforms that on their own are projected to provide sufficient funds for AB 71’s robust approach to reversing the cycle of homelessness.  

Don’t buy the scare tactics of multinational corporations threatening to move their headquarters from California because of this bill. California’s corporate income tax is based on sales made in California and applies regardless of whether a corporation has its headquarters in California or elsewhere. Thus, bolstering California’s corporate income tax would not create any incentives for California-based corporations to move out of the state.

Even before the pandemic, it made excellent sense to ask our largest and most profitable corporations to pay as much as they did in the 1980s. Given the state’s current urgent needs, what was once a good idea is now vital for the future health of our state.

January 5, 2021

How to solve the transit budget crunch: Price the private use of public streets

[Cross-posted from SPUR]

By Chris Elmendorf and Darien Shanske

COVID-19 has been catastrophic for public transit. Plunging fare and tax revenues are forcing drastic cuts. San Francisco’s transit agency could lay off more than one in five workers. Los Angeles is cutting service by 20%. Washington, DC is proposing to shutter 16% of its stations and eliminate weekend rail service. State governments can’t provide stopgap funding because they’re constitutionally constrained to balance budgets (though there is some room for creativity). Congress ought to step up, but Mitch McConnell stands in the way.

We think there’s a solution right under our feet: Make private drivers pay market rates to use the public’s roads. Traditionally, transit customers have had to fork over hefty fares, while private drivers go for free. The result is congestion, endless circling for parking spaces, Ubers and Lyfts blocking bike lanes and bus stops, and, at this precarious fiscal moment, a huge pot of potential revenue waiting to be claimed.

The place to start is residential parking. San Francisco has 275,000 curb parking spaces, only 10% of which are metered. Another 80,000 are in restricted residential parking zones. For a trivial annual fee, residents park without limit in their zone. Meanwhile, garage parking in the city costs on the order of $200 to $500 a month. Street parking isn’t worth as much as garage parking, and the value of a curb space would vary a lot from one neighborhood to the next. But even if the average curb space in the city were worth only $100 per month, the city could be earning $300 million a year from the street parking it now gives away. That’s almost double the transit agency’s forecasted deficit next year.

Cities less dense and affluent than San Francisco probably couldn't generate as much revenue this way. But with a little creativity, they could use the future value of street parking to close present budget gaps. For example, they could sell market-rate parking passes that would be valid for several years, or issue annual permits while converting the future revenue stream into marketable securities. Similarly, if a city is concerned about introducing a new charge during the pandemic, it could commit to imposing the charge next year or later — but start borrowing against the revenue stream now.

How would a city that decides to charge market rates for residential parking figure out the price? UCLA professor Donald Shoup recommends a uniform-price auction. The city would determine the number of parking spaces on a block or in a zone, and then invite bids for annual permits to park in that area. Permits would be allocated to the top bidders at the lowest price that any of them offered. For example, if a block has 20 spaces, the top 20 bidders would each win a space, and they’d pay the amount of the 20th highest bid.  
Another pricing strategy is to adapt the “variable rate” model that San Francisco and other cities are already using for metered parking in commercial districts. In these districts, the metered rate adjusts gradually in response to demand, ensuring that there’s usually an open space (but no excess of open spaces) on each block. Street parking in residential neighborhoods could operate on the same principle, albeit with parking allocated through residential permits rather than meters. The city would set the initial price for residential permits in each zone based on a “guestimate” of their value, and then gradually adjust the price upward or downward every few months until the number of subscribed permits is equal to the number of curb parking spaces in the zone. 
Charging market rates to use the curb lane would yield all sorts of other benefits, too. Some residents would decide the costs of private car ownership are no longer worth it. They’d sell their cars, decongesting crowded streets and reducing greenhouse gas emissions. Car-sharing, bike-sharing and ride-sharing companies could bid for curb space, expanding services throughout the city. Visionaries who foresee non-parking uses of the curb should be invited to join the bidding, too. More parklets and street-side eateries would enliven the city scene.

An objection to more expensive street parking is its potential to hurt people with low incomes. But programs to price the curb lane could be fine-tuned with discounts for low-income residents and small businesses. The revenue could also fund free transit passes for low-income households, since not all of them own cars.

Alternatively, the city could pursue an incremental pricing strategy that would allow everyone who now has a residential permit to continue parking as they always have. San Francisco recently piloted a “Paid + Permit” model for blocks adjoining commercial districts. Residents park for free while visitors pay market rates using meters or their phone. This pilot brought in more than half the revenue of fully metered commercial blocks nearby. Extending the Paid + Permit program to the 80,000 curb spaces now covered by the city’s residential parking program would generate a lot of revenue—and without a political fracas over charging residents for something they’re accustomed to getting for free (or, more precisely: accustomed to paying for with time and gas as they prowl for parking, rather than paying for with money).

But is it legal?

The main argument against market pricing of the curb lane is a legal one. States have constrained local fiscal authority in various ways, so there’s no uniform answer to the legality question. But in California, at least, the answer appears to be “Yes.”  
There is a common perception that the California Constitution, which strictly limits local taxes and fees, or the California Vehicle Code, which sets rules for public streets, allows cities to charge only “cost recovery” fees for residential parking. (A cost-recovery fee raises only enough revenue to cover the costs of administering a program.) We believe this perception is incorrect. 

The constitutional question

The California Constitution elaborately restricts local taxes and fees. But as amended by Proposition 26, it excludes from these limitations “a charge imposed for entrance to or use of local government property, or the purchase, rental, or lease of local government property.” Cal. Const. art. XIII C(1)(e)(4).

As the state supreme court recently explained, “the right to use public streets ... is a property interest [which a local government may] sell or lease … and spend the compensation it receives for whatever purposes it chooses.” Jacks v. City of Santa Barbara, 3 Cal. 5th 248, 254 (2017). Under Jacks, charging people to use public streets would count as a “tax” only if the charge did not bear a "reasonable relationship to the value of the property interest." So long as the city does not set the price for residential parking so high as to result in a large excess of unused curb space, the city’s fee-based parking program should pass muster.
Jacks interpreted “tax” as defined in Prop. 218, not as recently refined by Prop. 26. Nevertheless, the court discussed Prop. 26, and there’s not much reason to think the analysis would come out differently under Prop. 26 because, at least as to this aspect of the definition of tax, Prop. 26 appears to have codified the pre-existing common law analysis applied in Jacks. The court said as much in City of San Buenaventura v. United Water Conservation District, 3 Cal. 5th 1191, 1210 (2017). Two related Prop. 26 cases are now pending before the California Supreme Court. One goes beyond Jacks, holding that fees for use of public property are categorically not taxes, however exorbitant the fee. The other one extends Jacks to Prop. 26. Under either approach, market-rate fees for residential parking would be permissible (“not taxes”).  

The only constitutional issue we’re at all concerned about is the possibility that a residential parking fee would be characterized as an “incident of property ownership.” Under Prop. 218, fees imposed as an incident of property ownership are limited to cost recovery. However, this potential problem could easily be sidestepped by allowing people who don’t own or rent property in a zone to purchase curb-use permits. Even if the permits were restricted to owners and renters in the zone, it’s doubtful that Prop. 218 would be triggered, because the right to park in a zone is not a service provided “to any particular parcel.” See City of San Buenaventura, 3 Cal. 5th at 1207-1208 (holding that groundwater pumping fees are not “incidents of property ownership” because “the agency provides no service to any particular parcels”).  

That fees to park on public streets are not “taxes” under the California constitution has another implication of some practical importance: they can be adopted by any duly authorized governmental body, with no need for a popular vote. Solving the transit agency budget crunch need not wait until the next election.

The Vehicle Code question

As the Attorney General has explained, California’s Vehicle Code gives cities “broad power to restrict parking on public streets, and the … specific power to adopt preferential parking programs that exempt residents, merchants, and their guests from [the general restrictions].” CVC 22507(a). Notably, nothing in CVC 22507(a) says anything about fees that may be used to “restrict parking,” or about fees that may be charged to residents and merchants who benefit from a “preferential parking program.” 
The Vehicle Code does insist that if cities charge homeowners to park across their driveways, the fee be set at the cost-recovery level only (CVC 22507.2). But no such limitation is mentioned in the section of the Code about regular street-parking permits (CVC 22507). In fact, the distinction between 22507.2 (driveway permits) and 22507 (other permits) seems to anticipate Proposition 218’s limitation on fees “imposed … as an incident of property ownership.” The fee to park across one’s own private driveway is arguably incidental to property ownership, whereas a fee to park anywhere in a zone is much less likely to be characterized in that way.  

Section 22508 of the Vehicle Code authorizes metered zones with variable, demand-responsive hourly rates. Perhaps one could argue that by not mentioning demand-responsive rates in other sections of the Code, the legislature implied that cities may not charge market rates for monthly or annual permits on non-metered blocks. That argument’s a reach, but even if it were correct, cities could just meter their residential zones while issuing (market-rate) monthly or annual permits that entitle the permit-holder to park without feeding the meter. Nor is a meter at each space required. One meter can serve several physical blocks, supplemented by permits or pay-per-phone.
Here’s the bottom line: The question of what and whom to charge for using the curb lane is a political and policy question for California cities, not a legal matter. Yes, someone will probably sue if a city raises the price of parking—but they’re not likely to win. Making drastic cuts to the transit budget is a choice, not an inevitability. There is a better way.

September 18, 2018

Blue State Republicans Fret Over 'Tax Reform 2.0' -- rightly so

By Darien Shanske and Dennis Ventry

[Cross-posted from The Hill]

The new tax bill, “Tax Reform 2.0,” is here, and it makes permanent the $10,000 cap on the state and local tax deduction (SALT) created by the Tax Cut and Jobs Act (TCJA) in December 2017.

Meanwhile, Republican politicians from districts where high percentages of taxpayers will be affected by the cap are wary of making the cap permanent. A deeper dive into theories of taxpayer psychology and tax policy indicates these politicians are right to be concerned.

First, consider how the cap will shrink refunds or increase tax bills for millions of taxpayers.

Early next year, Jane fills out her tax return using her preferred commercial tax prep software. She enters her property tax information, expecting, as in prior years, that her federal tax liability will drop considerably. But she surpassed the SALT cap of $10,000 when she previously entered her $12,000 in-state income taxes paid.

Under prior law, and when added to her $8,000 in property taxes, Jane would have received a $20,000 federal tax deduction. But the new law caps her deduction at $10,000, and so she loses the value of the additional $10,000 deduction.

How much does she lose? If she’s in the 24-percent tax bracket, Jane is worse off by $2,400, either resulting in a smaller refund or more tax.

And it gets worse for higher-income taxpayers. If Jane had a total of $110,000 in SALT paid rather than $20,000, she would lose the value of the additional $100,000 deduction. Since Jane would likely be in the top tax bracket of 37 percent, she’d owe $37,000 more in taxes.

Beyond the sting of owing more in tax, Jane also may feel that she is being punished for doing the right thing: opting to pay more in state and local taxes in exchange for better state and local public goods.

Research indicates that dismay at this tax change might be quite politically salient to the taxpayer when making voting decisions. Compare the large — and explicit — jump in tax liability described above to an increase in withholding taxes from periodic paychecks.

Moreover, millions of taxpayers are likely to react negatively to their higher-than-expected tax liability even if some of those same taxpayers pay lower taxes in the aggregate due to other changes in the law.

Indeed, the SALT cap is arguably already impacting property owners in jurisdictions whether they itemize or not because itemizing home buyers understand that their future property taxes will no longer be deductible over the cap and are accounting for that change in their home-buying budgets.

Homes are typically a taxpayers’ largest asset and voters can be aggressive in voting to protect the value of that asset.

Retaining the SALT cap is also fraught with political peril because taxpayers are sensitive to the reality and perception of procedural and substantive fairness. It is unlikely that the partisan, rushed, secretive and demonstrably flawed processes that produced TCJA and now Tax Reform 2.0 are going to be perceived as fair.

As for substantive fairness, Republicans have claimed repeatedly that most taxpayers will receive lower tax bills. But it is hard to explain why two-earner families in a handful of states should not get a tax cut on account of the SALT cap, to say nothing of the unequal political valence of the jurisdictions targeted by Congress with a tax increase.

It is possible for voters to be convinced by more abstract tax policy arguments. And politicians are to be commended when they pursue the correct policy and endeavor to persuade their constituents. But the policy arguments for the SALT cap are feeble.

One argument is that the cap is progressive in that wealthier taxpayers are affected by it. But the cap was embedded in a very regressive bill. A tax change that only subjects a small sliver of wealthier taxpayers — though not the wealthiest — to higher taxes is not fair.

Another unpersuasive argument is that the SALT cap corrects for the fact that low-tax states were subsidizing high-tax states through the deduction. For starters, this kind of inter-state accounting is corrosive to our polity.

Worse, it leaves out a key piece of information. Specifically, the states that have the most taxpayers affected by the cap are among the wealthiest states and thus are net “givers” to our common government. Capping the SALT deduction makes these states’ relative contribution even higher.

Another argument is that a full deduction for state and local taxes might not be appropriate as a matter of tax principle. Fair enough, but it’s incongruous in the context of a tax bill loaded with tax policy blunders and deviations from income tax principles, most notably new code section 199A, the so-called passthrough deduction, which is a bacchanal of unprincipled and regressive income tax policy.

Phase 2.0 will make this blunder permanent, so the claim that the SALT cap is a principled change rings quite hollow.

In any event, a more typical approach to situations where it is uncertain how much of a deduction is proper would have involved using a percentage cap, like 50 percent. Limiting the SALT deduction in such a way would have been unpopular as well, but it would have been principled. Other principled options exist.

Perhaps the biggest political danger posed by the SALT cap is that it could create millions of apostles carrying a simple message: Ultimately, very few taxpayers will receive their promised tax cut from Republican tax changes.

This is because borrowing trillions of dollars (with interest) to reduce taxes does not a tax cut make. While taxpayers at the very top of the income ladder will realize huge tax savings both now and in the future, the rest of us will ultimately face higher tax bills and/or fewer vital services.

The millions of taxpayers paying more in taxes next year due to the SALT cap are just the harbingers.

Darien Shanske and Dennis Ventry are professors at the University of California, Davis, School of Law. Shanske's areas of academic interest include taxation, particularly state and local taxation, local government law, public finance and political theory. Ventry is an expert in tax policy, tax practice and tax filing and administration.

 

 

July 30, 2018

States Should Conform to -- and Improve -- the New Federal Tax Provisions Meant to Counter Base Erosion

By Darien Shanske

[Cross-posted from Medium]

The United States used to tax multinational corporations (MNCs) on the basis of their worldwide income, except that most foreign source income would only be taxed when actually repatriated to the United States. This structure naturally created considerable incentive to strip income out of the United States and then not to repatriate it.

Now, thanks to the TCJA, the United States is ostensibly only going to tax MNCs on their US source income. This shift to a so-called territorial system means, of course, that MNCs will continue to have incentive to shift income abroad in order to avoid US tax. The TCJA has two separate provisions meant to counter this: GILTI and BEAT. One question for the states is whether they should conform to these provisions. I think the answer is yes. I also think it is clear that states should improve these provisions when they adopt them.

There is a preliminary question as to whether states can — as a matter of federal constitutional law — conform to these provisions. I think the answer is again yes, but the details of the state law will matter a great deal.

Not everyone agrees. For instance, the STAR Partnership, argues here that:

“Under the prior federal tax system, States generally did not include foreign income in their own tax bases, for both policy reasons and Constitutional limitations. States should continue to respect these policy and Constitutional rationales and avoid taxation of foreign income by excluding these provisions from their business tax bases.”

In short, according to a group of top state and local tax lawyers and policy wonks — who are quite explicitly representing the “business community” — states should not and cannot conform to the federal provisions meant to prevent base erosion. It is true that states do not tax foreign source income (in general) and that it is a tricky policy and constitutional question whether they can and/or should, but is it true that this is what states would be doing if they tax the repatriation or conform to GILTI or BEAT?

Consider some well-known and curious facts about the income of MNCs. First, there are some jurisdictions that are just unbelievably profitable for corporations. As Torslov, Wier and Zucman put it: “Foreign corporations . . . have extremely high profitability ratios in tax havens, e.g., 800% in Ireland. . . . By contrast, and strikingly, in almost all non-haven countries foreign firms are less profitable than local firms. Thus, there is a clear trace in global macro data of shifting from high- to low-tax affiliates, in such a way that profitability is systematically over-stated in tax havens and under-stated elsewhere.”

Many of those some super-profitable jurisdictions also house profits worth many multiples of their GDP, which would seem to be a real head scratcher. For example, the profits of US controlled subsidiaries in the Cayman Islands represented over 1000% of that island’s GDP in 2014. It is of course not possible for firms to earn profit in a jurisdiction many times the size of the jurisdiction’s economy.

We know why this money is taking a Caribbean vacation and we also know which legal structures got it there — see here for example.

In short, there was already a great deal of base erosion, and the two new provisions of federal law we are discussing are meant to counter it. (Indeed, there is a good argument that these provisions are roughly consistent with the anti-base erosion principles championed by the OECD.)

If a state were to conform to these base protection provisions or tax the repatriation, then a state is not — counter to the STAR Partnership — trying to tax “foreign” income, but trying to protect domestic income from being stripped out of their tax base.

This fact has an important legal implication. Again, it is true that the legal questions would be trickier for states looking explicitly to tax foreign income. Matters are different if a state is trying to tax domestic income and is simply trying to craft rules that lead to a better reflection of domestic income. As to designing their own tax systems to tax domestic income, states have a lot of leeway.

So, states can conform to these federal backup taxes and they should, but it is important to note that they should and could also improve these taxes. For more on how states should tax the repatriation, see here and kudos to NJ for doing so.

Here are a couple of examples of possible improvements to the backup provisions that are drawn in particular from Rebecca Kysar and Dan Shaviro. GILTI stands for “global intangible low taxed income” and the intuition behind the provision, consistent with the evidence above, is that certain low-tax jurisdictions are suspiciously profitable. Therefore, GILTI income is income that is earned beyond the normal expected return on an investment. There are numerous complexities involved in GILTI, many of which are not resolved, but for our purposes we can note that GILTI assumes a normal rate of return of 10%, which is rather high. A straightforward fix that a states could adopt would be conform to GILTI but use some lower rate tied to actual normal returns — perhaps a long-term corporate bond rate +2%. That would make the rate 6% at the moment.

As for the BEAT, the “Base Anti-Erosion Tax,” this is a minimum tax much like the Alternative Minimum Tax (AMT) for individuals. The idea is that a primary way of shifting income abroad is for MNCs to take large deductions for payments to related foreign corporations — say a US corporation paying a foreign affiliate in a low-tax jurisdiction for the use of intellectual property. The BEAT requires an MNC to add such payments back into the tax base; that broader base is then subject to a 10% rate. If the resulting tax liability is greater than the regular liability, then the taxpayer pays the minimum. As with GILTI, the BEAT has many design flaws. For instance, the BEAT only kicks in for relatively large corporations ($500 mn plus in gross receipts); it would make a lot of sense for states to adopt the BEAT, but at a lower threshold.

The TCJA emerged from such a flawed process that even its most reasonable ideas, like GILTI and the BEAT, are deeply flawed. (Again, don’t take my word on it, ask Kevin Brady.) And the states will be negatively impacted if the TCJA encourages MNCs to strip out even more income because the GILTI and the BEAT are ineffective. So, at a minimum, states should conform to these provisions and ideally they should improve them, but it should be remembered that improvements need not be through tinkering with the mechanics of these provisions.

The states pioneered an anti-income stripping regime that I would argue is simpler and likely more effective than even an improved GILTI and BEAT: mandatory worldwide combination using the single sales factor. This approach does not require the government to identify a particularly problematic form of income or deduction, which can have unexpected and undesired consequences. Instead, all income is income, and income is apportioned according to where an MNC makes its sales. We know that it is unlikely that an MNC makes many sales to final consumers in tax haven jurisdictions. Currently, no states require mandatory worldwide combination, but many permit taxpayers to choose it. If a state is unwilling to require worldwide combination, then an appealing option would be to conform to GILTI and the BEAT, with improvements, and then permit MNCs to choose if they would not prefer the simplicity of worldwide combination.

 

July 23, 2018

Wayfair as a Federalism Decision

By Darien Shanske

[Cross-posted from Medium]

Some first impressions, including pondering how this decision intersects with NCAA v. Murphy

In the end, not a single justice would stand up for the rule of Quill, which rule was that a state can only impose a use tax collection obligation on a vendor if it has a physical presence in the state. All the justices agreed that it was the wrong rule, even apparently, when first imposed in 1967. So then why was this a 5–4 decision?

The four dissenters argued that stare decisis should protect the Quill rule nevertheless because it is an old rule that Congress can change. I take the key part of the majority response to be the following:

While it can be conceded that Congress has the authority to change the physical presence rule, Congress cannot change the constitutional default rule. It is inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation. Courts have acted as the front line of review in this limited sphere; and hence it is important that their principles be accurate and logical, whether or not Congress can or will act in response. It is currently the Court, and not Congress, that is limiting the lawful prerogatives of the States.

This seems exactly right to me and I have argued as much (see here and here). And it is of course not surprising that Justice Kennedy is arguing that federalism values establish a pro-state power default and that it is untenable for a federal court to erect a barrier to state power based on a mistake.

But note that the dissent in Wayfair was written by Chief Justice Roberts, who, in another context wrote: “The dormant Commerce Clause is not a roving license for federal courts to decide what activities are appropriate for state and local government to undertake …” The issue in that case, United Haulers, was whether a public utility could force local users to use its services, and Chief Justice Roberts held for the majority that it could. Justice Alito wrote a powerful dissent in that case and was joined by Justice Kennedy. Justice Alito again joined Justice Kennedy in Wayfair. Thus, according to these two justices, a pro-state constitutional default does not protect local flow control ordinances, but does protect the ability of states to impose a use tax collection obligation. For Chief Justice Roberts, the reverse is apparently true, though in his case he would note that stare decisis was what weighed against the states in the use tax context. (The counter to this is that United Haulers also essentially overturned a precedent, a point well made by Justice Alito in his dissent.)

So Wayfair did hinge on federalism values, I believe, but in a quite complicated way that will require additional unpacking, especially in light of NCAA v. Murphy. This decision, authored by Justice Alito, and joined by Justices Roberts, Kennedy, Thomas, Kagan and Gorsuch, struck down a federal law that made it unlawful for states or their subdivisions to authorize betting on sporting events. The majority thought that this decision followed from the anti-commandeering principle, namely that Congress cannot “issue orders directly to the States.”

As was immediately noted, a broad interpretation of NCAA v. Murphy puts into question numerous federal laws that also restrict the kinds of laws that state legislatures can pass. Such laws are particularly numerous in the field of taxation, where Congress has imposed special rules relating to mobile phones, railroads, pensions etc. And yet both sides in Wayfair seem to agree that Congress could step in and regulate how states can impose a use tax collection obligation. But would not the relevant federal law be, in effect, a prohibition on state legislative power?

This question has been very ably debated by Daniel Hemel, Brian Galle, Rick Hills, Jeff Schmitt and Ilya Somin among others. It seems to me Wayfair is a pretty strong indication that the Court did not mean to undermine the ability of Congress to restrict state taxing power — within limits. Still, Murphy says what it says and so I will add one more way that the Court — and first courts — can reasonably limit Murphy.

In Murphy, Congress was weighing in on a contentious policy matter involving regulating individual conduct on which there is a limited federal interest. The majority in Murphy signals as much in its first line: “Americans have never been of one mind about gambling…” I think that Justices like Kennedy and Alito, relative hawks in other dormant Commerce Clause cases, would argue that preventing balkanization of the national marketplace is a very different matter from imposing a one-size fits all rule about sports betting. Protecting the national marketplace is a core concern of the Commerce Clause and indeed of our whole constitutional order, a point made particularly well by Brain Galle. I know that this kind of analysis is mushy and that the Court in Murphy instead focused on the issue of whether or not the federal government is regulating a private actor, but that rubric does not work to explain how and why Congress can act to limit state taxing power post Wayfair.

Focusing on the importance and centrality of the federal interest means, in effect, that the Court is applying a kind of proportionality analysis, a very common method of deciding constitutional cases, though not in our tradition (at least not explicitly). I think applying some form of the proportionality principle is the right answer not only to the question posed by Murphy, but also to the question posed by Quill/Wayfair. The Court in Wayfair does not explicitly shift to a kind of balancing test (in particular, Pike balancing), but its retention of a “substantial nexus” standard without much further guidance seems to invite the states to engage in balancing. Clearly, a remote vendor can now be asked to collect the use tax even without a physical presence, but, just as clearly, remote vendors can only be asked to do so if there is sufficient nexus. Thoughtful balancing of the legitimately opposing interests is therefore the way forward.

July 23, 2018

State Options After Wayfair


By Darien Shanske (with David Gamage and Adam Thimmesch)

[Cross-posted from Medium]

In Wayfair, the Supreme Court overturned the bright-line physical presence rule imposed by Quill. A state can now require an out-of-state vendor to collect the use tax even if that vendor does not have a physical presence within the state. The underlying standard governing when states can impose a use tax collection obligation remains the same: there must be a “substantial nexus.” But what constitutes a substantial nexus? The Court does not give any general guidance, but does make it clear that this standard was satisfied in this case. Alas, the Court’s reasoning as to this case is reasoning is ambiguous. Here is the key paragraph:

Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods and services into the State on an annual basis. S. B. 106, §1. This quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota. And respondents are large, national companies that undoubtedly maintain an extensive virtual presence. Thus, the substantial nexus requirement of Complete Auto is satisfied in this case.

The first sentence of this paragraph suggests that two inquiries are relevant to nexus: (1) a taxpayer’s economic returns from a state and (2) its activities directed toward a state. The second and third sentences of this paragraph suggest that the South Dakota thresholds require sufficient “economic contacts” for substantial nexus. The fourth sentence, emphasizing the size of respondents, focused on the so-called “virtual contacts” that large, national e-commerce vendors create through their extensive marketing and web presences.

What this paragraph does not do is to address precisely when small sellers have a substantial nexus. What if a small seller has exactly 200 sales, worth $20,000? Given this uncertainty, our advice for states at the moment would be to put in place thresholds similar to South Dakota’s. If they wanted to be better insulated from challenges from very small sellers, and likely at minimal revenue loss, we would suggest adopting even higher thresholds. This would be especially true for non-SSUTA states.

Alas for states looking for guidance, there is more ambiguity in the next paragraph of the opinion. The Court remanded the case to the lower courts to consider other possible challenges to the South Dakota law, including, apparently Pike balancing, which is odd considering that the substantial nexus test is a test for taxes and Pike balancing is a test for regulations. Here is the paragraph:

South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. S. B. 106, §5.Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement. This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability.

Though we agree that Pike balancing should apply, we wish the Court would have explained why it should apply. Furthermore, and more importantly for states, the Court does not offer any guidance as to which of these aspects of South Dakota’s law is the most important. Crucially, it may not be too difficult for a state to emulate South Dakota’s thresholds, but it might be very difficult for a state to join the SSUTA or otherwise simplify its tax system in a comparable manner.

Our advice here is that states that cannot engage in substantial simplification — and perhaps even states that can — should offer meaningful vendor reimbursement for compliance costs and/or offer free compliance software that immunizes vendors who rely upon it. (One of us discussed this first approach at length in a prior article here; and two of us discussed this second approach in a prior essay here.)

We do not think that these approaches are necessarily required by the Court’s opinion; substantial enough simplification of a state’s sales and use tax, roughly equivalent to that required by the SSUTA, should suffice. But we do think that adopting one of these approaches makes for good, sensible policy. If, for whatever reason, a state wants to retain a more complicated sales and use tax system or simply does not wish to conform their sales and use tax system with that of other states, then it is only fair that states compensate vendors for the costs they incur in collecting sales and use taxes.