Policymakers have to make choices based on imperfect information. Scholars such as Professor Stacie Laplante make their jobs easier by showing them what tax policy tools like “patent boxes” can deliver (increase the number of patent filings) and what they can’t (some of those additional patents may not be so great). Laplante doesn’t have all the answers, but she’s not done exploring how policymakers should promote innovation or how the Tax Cuts and Jobs Act will affect the way multinationals shift income. Also, she explains what implicit taxes are with thoroughbreds. Laplante faces a tough pencil question about Thomas Adams, a leading figure in early 20th century tax policy—and once the Wisconsin tax commissioner—from an article by Ajay K. Mehrotra.
Stacie Laplante is an associate professor of accounting and information systems and the James L. Henderson Professor at University of Wisconsin-Madison’s Wisconsin School of Business. Laplante has nine years of experience in public accounting industry as a certified public accountant. Her research focuses on the intersection of financial and tax reporting and is particularly interested in information related to tax reporting that is reflected in firms’ publicly available financial statements and what the information reveals about the firm’s tax-planning strategies, as well as how the market uses or values that information.
Our student quote is by Stephanie Tapp from Bountiful, Utah.
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SPEAKER 1: All of us should be willing to pay whatever taxes are necessary to enable efficient government. To improve or expand any essential service.
SPEAKER 2: You have a beautiful tax return, the nicest one I've ever seen.
SPEAKER 3: Okay folks, but remember your manners. No stampeding, walk slow like you do when you come to pay your taxes.
STEVEN DEAN: Hi, I'm Steven Dean. This is "The Tax Maven". Here we are going to in each episode, talk to our Tax Maven. Who'd be a person proving Archimedes's point that a single person with a lever long enough and a place to put it can change the world. The lever in this case is tax and the place to put it is here at NYU Law.
I'm Steven Dean, the faculty director of the Graduate Tax Program at NYU Law. I'm here today with Stacie Laplante who is an associate professor of accounting and information systems at university of Wisconsin Madison. And she's also the David J. Lesar Chair in Business [Note: Laplante is now the James L. Henderson Professor]. Thank you for coming today.
STACIE LAPLANTE: Thank you for having me.
DEAN: Policymakers operate in a world of imperfect information. Fortunately, they can count on a helping hand from people like today's Tax Maven.
LAPLANTE: A Patent Box is a tax tool that some governments use to try to encourage innovation within their countries.
DEAN: Laplante uses her accounting training to measure how successful legislators are when they try to spur innovation.
LAPLANTE: Now, as the empirical evidence suggest as to whether or not these things work or not. And there's very little empirical evidence out there. And the evidence that is out there really at a very broad level says yes, it does encourage some additional patent activities, it does encourage some income shifting into a country. And—but most of the studies to date have looked at broad cut cross-country settings. And so what we were trying to do is look at a very simple setting where we look at one country and compare it to control firms in other countries and say, gosh, is there within this one country where we have a very simple setting, does it look like there is an increase in activity after this Patent Box was implemented? And what we show is that for our setting yet it does look like patent applications increase, patent grants increase, but the quality of those patents doesn't necessarily increase. It looks like it actually goes down. And so we look at, you know, whether after the Patent Box, firms appear to be employing more highly skilled employees which are people who have college degrees. And we do show that yet, it looks like after this patent box, that firms that are patenting or that are subject to this IP box do in fact hire more highly skilled employees.
DEAN: All of this matters because leaders must make choices. Even once they have decided to encourage more research and development, they have to decide how.
LAPLANTE: Actually there's two ways for countries to encourage innovation. One is sort of an upfront or ex-ante encouragement that provides a benefit, a tax benefit to firms that engage in any type of research and development. And they do that by—countries do that by providing either a tax deduction or a tax credit for any research activity regardless of whether it's successful or not. The IP box is more of a ex-post tax benefit only to successful innovation. So only those products that are actually successful and that go on to make money, then can take advantage of this other tax policy benefit if you will. So the RND credit, there's a lot of research that suggests that yes, RND credits do encourage more research across a variety of settings. In order to get the RND credit, firms have to essentially spend money on RND. And one of...
DEAN: One hopes.
LAPLANTE: One hopes, and one of the sources of you know, one of the sources to support the spending on RND to receive the tax credit are their financial statements. And some of my research looks into this incentive that firms have and to put more of their expenses into the RND bucket if you will. And in order to obtain that tax credit. Because a tax credit is much more valuable to a firm than just a tax deduction. Yeah, I think the big picture is I'm interested really in you know, how tax policy or tax rules affect firms behavior. And because I'm an accountant, I'm always interested in what's happening with the financial statements because the financial statements are the way that firms communicate with their stakeholders in general. And so if those financial statements reflect incentives that are sort of imposed by the tax rules and they might not really give other stakeholders or give the stakeholders a true view of the economic foundation of the firm. There are two sets of rules, really. And so we have financial accounting on the one hand that's really trying to explain or reveal the underlying economics of the firm. And we have tax accounting that has a very different goal. And the goal essentially is to raise money for the government. It's also to encourage certain behaviors, you know redistribute income, that it has a different goal than our financial accounting income. And one of the big differences between what's reported in the financial statements, and what's reported on the tax return, is that the entities differ. Because we have different consolidation rules for financial accounting versus tax accounting. So that's, that's a big difference.
DEAN: In practice, the amount of information policy makers and managers need to sift through to make good choices is enormous.
LAPLANTE: There's a nice big tax footnote in the back of the financial statements that explain essentially you know, the permanent book tax differences. How we get from a firm who has a, prior to the TCJA, a 35% tax rate how you know, or statutory rates 35%. How do we get from there down to the 21% tax rate that they're reporting on the face of their financial statements? And so there's a lot of detail in the tax footnote. And on the tax return as well, we now have a schedule M3 that essentially gives the IRS, you know, the step-by-step, how do I get from my financial statements to my taxable income on my tax return? And it, it, it documents all the permanent and temporary book tax differences to get to the, from one to the other. So there's more information out there. A simple example was this timing difference between income report on the financial statements versus the tax return. For created can create big deferred tax assets and liabilities on the financial statements. And when that tax rate changed from 35% to 21% at the end of 2017, suddenly firms that had big deferred tax assets had a smaller deferred tax asset which affected their financial statements and vice versa firms that had big deferred tax liabilities. That reduction in the tax rate was a good thing for them. purely from a financial reporting perspective. The end of 2017 when the tax rate decreased, you know clearly you don't get a deduction for your pension contributions until you actually make the contribution. So it made a lot of sense for firms to try to push their actual contributions to their pensions back into 2017 to take advantage of the big, bigger tax rate that was in effect in 2017. And one could argue that that's a positive externality because then these pensions are better funded for going forward. So I think there's some initial evidence such as that that shows, yeah, there's some changes to, you know some changes to behavior specifically related to the act. I think some of the other changes are going to take a little while to figure out really. Sort of trickle down and figure out how that's going to change firms behavior. Simply because it was it's pretty complicated.
DEAN: Yeah...
LAPLANTE: Trying to figure out you know, does the beat interact with the fitty and the guilty? How does that fit in?
DEAN: The world does not always cooperate. But the Holy Grail for researchers like Laplante is information that allows you to compare apples to apples.
LAPLANTE: I went and talked to the librarian at the, essentially the, the place in Kentucky that that, that does the Kentucky Derby and does some of these massive sales thoroughbreds. And it was a, a fun learning experience because essentially what happened is there was a tax break for the sale of certain types of horses for a certain period of time. And it was a nice setting. Because it allowed us, it allowed the authors of that paper. And I believe Kim Key was one of the primary authors of the paper. She might've been the sole author paper. It, it allowed her to look at a situation where she could sort of try to determine whether implicit taxes existed. And implicit tax essentially is really hard to measure in the real world 'cause it really looks at it requires two identical assets that are taxed differently. And we seldom have those. So in class, I look, I use the example of, you know a corporate bond and a municipal bond. And then I assume away risk differences to calculate this implicit tax. And it's essentially the idea that the tax favored municipal bond is more valuable to some taxpayers and they're willing to pay more for it. Which drives down the pre-tax rate of return for that asset relative to the less tax-favored return. And with respect to the thoroughbreds the, this similar setting, where they had the same horses, but for a period of time one of them had a tax advantage. It was taxed less than the other one, and it essentially changed the prices.
DEAN: So now onto the most important question of the day.
LAPLANTE: Oh dear.
DEAN: So this is a question and the stakes are this. If you get the answer right you get this lovely NYU Law Graduate Tax Program pencil. So, you know, this is, this is a very attractive pencil...
LAPLANTE: It is very attractive.
DEAN: So let, let's see if you can win this pencil now. So I'm gonna ask you a question about Thomas Adams, who I you may not know him, but I he's important for two reasons. One, he was just a leading tax policy figure in the early 20th century. Perhaps equally important, he was once the Wisconsin tax commissioner. So I I'll let you decide, which was more important. One of the fathers of the international tax regime or Wisconsin tax commissioner I think we'll have to just leave that. We'll make our own choices about that. So one of many things that he did or tried to do was create innovation that really could have changed the face of US tax policy today. So this is something that could have happened sort of an alternative universe kind of scenario. And I'm gonna give you three things that he proposed or described in a paper. I, I, this cutting edge early 20th century Wisconsin tax commissioner former response tax commissioner. And if, if his vision had to realize, much of what we were talking about in our tax lesson will be very different. So it's either A, a national sales tax, B, a national property tax or C a national financial transaction tax.
LAPLANTE: Gosh, it's tough reveals my ignorance. I would have to go C.
DEAN: So it was in fact A...
LAPLANTE: Oh that was...
DEAN: So in a Seminal 1921 journal article Adams made the case for the administrative simplicity and economic efficiency of a national business sales tax. So this is from Ajay Mehrotra's article, "The Myth of the "overtaxed" American". and the VAT that never was. As published in the modern American history journal. So this is something that, you know, is leading influencer. Can we say that?
LAPLANTE: Influenced her back from the early 20th century? It was really you know, try to make a case for, and if people listened to him, we might've had the American VAT, that we don't have...
DEAN: Right...
LAPLANTE: So...
DEAN: And you might be curing cancer today instead of teaching...
LAPLANTE: Sad, sadly. I'm sad to say that this is clearly my highest and best use. And I was never in danger of curing cancers. I wish I wish that were something that was possible. but not that if, if not that, if not if not tax, I'd probably be baking cookies somewhere. That's probably what I'd be doing. Which is not near as important as curing cancer,right.
LAPLANTE: It is interesting as my students every year ask, you know. What happens if we get rid of all of these income tax and just have a national sales tax?
DEAN: That's what he was saying back in 1921. This guy really had his finger on the future pulse. Anyway well, thank you so much for coming. I'm sorry you didn't get the pencil, but maybe, maybe in the future we can find some way to make it happen. Thank you so much Professor Laplante.
LAPLANTE: Thank you so much for having me.
DEAN: Thank you for listening to "The Tax Maven". And I also want to give a very special thank you to those that helped make the podcast possible. Patrick Kelly, Joe Rivera, Greg Addison, Rebekah Carmichael, Jill Rachlin and Anthony Pietrangelo. And thank you Rachel Burns.
The NYU law graduate tax program has been the premier place to learn about tax law for the past 75 years. So please visit us on the web, visit our graduate tax program website to see the different programs we offer both in-person and online. Both for lawyers and non-lawyers. Take a look at what we offer and I hope you consider joining us. And now we like to end each of our episodes with a quote about taxes read by one of our students.
Today's student quote comes from Stephanie Tap from Bountiful, Utah.
STEPHANIE: The difference between tax avoidance and tax evasion is A). Whatever the IRS says. B). A smart lawyer. C). 10 years in prison. D). All of the above.
DEAN: Please email us at "info@taxmavenpodcast.com". If you have any questions or comments or suggestions. And if you are a student, and want to email us a recording, of your favorite tax quote, please email it there as well. Thanks for tuning in.