The Tax Maven

Why Should Only the Tax Code Be Fair? (Zach Liscow)

Episode Summary

Buried at the heart of the tax law are key notions about what the code can do. When economists think about tax rates or deductions, they measure them against those assumptions before they decide how high or how big they should be. Today’s Tax Maven, Yale Law School’s Zach Liscow, explains what they generally get wrong. A big part of the problem is that, however strange it might seem, economists tend to believe that only the tax law should be fair. At the risk of understatement, this notion contradicts much of what we know about the world. As Liscow explains, the tax law can’t right every wrong. But this is what the influential school of thought known as law and economics tells us should happen. And that is what Liscow calls its “esoteric underbelly.” In fact, Liscow explains, people have pretty clear ideas about how tax burdens should be distributed. Just as they believe that damages for an injury should not be higher for a poor person than for a wealthy one, the taxes people pay should not be adjusted solely to offset injustices elsewhere in the legal system. The problem, as Liscow sees it, is when all of these assumptions and beliefs collide, those who need help the most simply just won’t get it. Liscow faces a challenging pencil question drawn from an article by Tom Brennan (Harvard Law School).

Episode Notes

Zachary Liscow is an associate professor of law at Yale Law School. His main research interest is understanding the appropriate policy levers to address income inequality and, in particular, the role that tax policy versus other legal rules should play. He also works in a variety of other areas, including urban economics, environmental policy, and empirical legal studies. Liscow earned his PhD in economics from the University of California, Berkeley, and his JD from Yale Law School. He has been a staff economist at the White House Council of Economic Advisers and worked for the World Bank's inspector general. 

Our student quote is by Rebecca Arnall from New York, NY.

Resources:

  1. Professor Liscow’s bio.
  2. Daniel Shaviro’s blog post about Liscow’s visit to the NYU Tax Policy Colloquium.
  3. Is Efficiency Biased? 85 University of Chicago Law Review 1649 (2018)
  4. The pencil question: Thomas J. Brennan, Perils of Partial Mark-to-Market Taxation.  
  5. The student quote is: "The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing."—Jean Baptist Colbert

Episode Transcription

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 will be a person proving Archimedes' 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.

Steven Dean:
I'm Steven Dean, the Faculty Director of the Graduate Tax Program at NYU Law. I'm here with Zach Liscow, who is Associate Professor of Law at Yale Law School.

Zach Liscow:
Delighted to be here.

Steven Dean:
The most important questions in tax policy tend not to be the specific words used in the tax code or what the rates are. Far more important are the connections between tax and other areas of the law, from criminal justice to contract law. Professor Liscow calls the political assumptions about what the tax law can be the esoteric underbelly of law and economics.

Zach Liscow:
What should the goal of economic policy be? They would typically not say efficiency. They'd say something like "We think maybe something that amounted to wellbeing." Like, "We want to make the country better off," something like that. How do we go from making the country better off to efficient policies? It turns out that the thing that connects the two is the esoteric underbelly of law and economics, which is optimal tax theory.

Steven Dean:
Professor Liscow is a law professor, but he also has a PhD in economics and demands that we reconsider the conclusions of law and economics in general and of optimal tax theory specifically. Even if we believe we can make the tax laws perfect, why should only the tax code be fair?

Zach Liscow:
If you have the Department of Transportation doing cost benefit analysis to decide where to spend money, this is something that they actually do. If it's deciding whether to spend money on buses for poor people, or whether to spend money on airports for richer people, the primary, or the most important thing, in the analysis, is the value of time saved.

Zach Liscow:
You have two projects, each costs a million bucks, that's the cost. How do we look at the benefits of the projects? Well, it turns out the way the Department of Transportation looks at it is that if the project saves the value of time for a poor person on a bus, that counts as $25 an hour. If in contrast a project saves an hour of time for a rich person, that counts over twice as much per hour, $65 an hour.

Zach Liscow:
What this will tend to do is mean that we spend more money on airports for rich people instead of bus projects for poor people, even though one might have thought that poor people are the ones who really, really need the access to transportation options so they can get to work.

Zach Liscow:
This is efficient. This is good. The reason why is that rich people, when they get to work, they earn more money per hour. So this is good. It maximizes wealth. Maximizes income. This is good. This is efficient. So this is the first step. Step one, efficient policies like this, spend money on getting rich people to work, don't spend all that much money on poor people getting to work, and this is good because even though poor people may not be able to get to work, they might have to stay home, be unable to work, this is good. This is efficient.

Zach Liscow:
Step two is how we make up for that. Step two is we have optimal taxes, the esoteric underbelly. So we spend lots of money giving cash to poor people. Those rich people, now they're able to get to work more, they can work, spend more time working, so we can tax them more and give larger cash transfers to the poor.

Zach Liscow:
Although this is how econ-wonks think about this, this is miles away from how ordinary folks think about policy issues. And the particular problem that I have in mind is the tax side. So in order to not spend much money on transportation for the poor, or healthcare for the poor, or childcare for the poor, or reducing environmental pollution for the poor, et cetera, you actually need to give them lots of cash. Cash has lots of good features. They can choose what to spend their money on. Choices [inaudible 00:04:22] tends to be good.

Zach Liscow:
There's a problem though, which is that people don't seem to like cash. We have never in history given cash transfers that are sufficiently large based on what the economic models say are needed. Economic models say we would need to give every person $12,000 in cash, roughly. We are nowhere close to that. People think that taxes are not just about transferring money from rich people to poor people, and also about creating incentives to work, people all view tax as a process that has its own internal norms of fairness, including that taxation should be based on dessert.

Zach Liscow:
Rich people, we want to tax them some to transfer money to help out poor people. But to some extent, richer people, this is how I think people think, richer people deserve to keep some of their money because they're skilled and they work hard, and by the same token, poor people, we don't want to just give them cash because they're less deserving. They're not working. They're not able to work. They're lower skilled. This puts major constraints on the ability of taxes to do what they need to do.

Steven Dean:
The esoteric underbelly relies on assumptions about the way the world works that are just plain wrong.

Zach Liscow:
The way that econ-wonks think about this is typically just to ignore politics and institutions altogether to say, "We should have efficient policies. And it makes sense to have lots of taxes, lots of redistributionary taxes too. So that'll all happen." I'm saying we live in a democracy and we should take into account what the [Deimos 00:06:12] Thinks, what the Deimos thinks about policy and the best evidence that I'm aware of suggests that the Deimos does not buy the two step econ story that we've been telling. As a result, we should adjust the policy accordingly.

Steven Dean:
And are there specific... So yes, we should spend more on transportation for the poor than we do. Are there, in terms of tax, are there conclusions you would draw for our tax policy that would be helpful for policy makers to hear?

Zach Liscow:
Yeah. So a couple implications.

Zach Liscow:
So one is on so-called tax expenditures. So tax expenditures are things in the tax code that reduce people's taxes, but that are viewed as kind of one-off things that are not part of what taxing income is really about. So one example of a tax expenditure that was in the code until 2017, but is no longer there for the most part, is letting employees deduct the amounts that employers pay for them to get to work. So before 2017, if your employer paid for your transit pass, you could deduct that. Now no longer the case. Effectively. So it used to be the case. People had part of their transportation paid for by their employers and they didn't have to pay tax on it. Now that's not the case.

Zach Liscow:
And there are good tax reasons why you would not want to allow this so-called tax expenditure. On implication of what I'm saying is that if we think that it's really difficult to give people cash as a matter of political economy, because ordinary people think that taxes have something very strongly to do with desert, then maybe it would make sense to let people deduct those expenses that they spend, or that their employers pay for them to get to work as something that's kind of cash-like.

Zach Liscow:
They're going to spend the money, they're going to be getting to work. A decent way to help people out is to let them deduct that money that their employers are paying to help them get to work. This is cash-like, so it lets people have choice. You'd probably want to phase it out at higher income. So you're actually targeting lower income people, but this is a way of helping lower income people in ways that still maintain, it's still giving people cash by lowering people's taxes, but in ways that do not impinge upon the ways that ordinary people might resist, just giving cash to people.

Zach Liscow:
I'm driving along and someone rear ends me. I cause damages to my car that's not compensated, that's a tort, and I can sue to recover that $5,000 in damage from the person who wrongfully caused me $5,000 worth of damage. So one weird implication of this analysis is that if you have two people driving along and each suffers $5,000 worth of damage, but one is rich and one is poor, you'd actually want to require larger damages to the poor person than to the rich person.

Steven Dean:
Instead of justice everywhere. Professor Liscow sees all of these assumptions leading to justice nowhere.

Zach Liscow:
For the same reason that people have views about what right tax policy is. I suspect they also have views about what is fair in torts. And we, I don't have strong empirical evidence on this. My strong sense though, is that because each of us suffered $5,000, that it would seem very wrong to give me more than you.

Steven Dean:
I am going to now ask you a question and if you get the answer right, you are going to get this lovely NYU Law Graduate Tax Program pencil. So this is a beautiful purple pencil and it is yours if you can answer this question right. This is a paper written by Todd Brennan over at Harvard. And I'm going to ask you if you can tell me what Tom is talking about his article. So he's a law professor as well. I think he has a math background rather than econ, but you know, same neighborhood I would say. So he warned in this paper that Congress was doing something and what it was doing would create... Or threaten to do something. It was a proposal and would create the possibility of allowing tax-paying investors to have negative effective tax rates, thereby allowing the extraction of billions of dollars from the US Treasury on an annual basis.

Steven Dean:
So I'm going to give you three choices of what Congress was considering doing that would have this terrifying result in Professor Brennan's view. So it was either A). partial mark to market taxation, B). partial expensing, or C). partial indexing. So this is unfair question in a couple of ways, because maybe more than one of these is true. I'm not asking you which one is true. I'm asking you which one he was writing about.

Zach Liscow:
So definitely not mark to market. That'll raise taxes. Partial expensing could result in negative tax rates on capital. So I would go for B.

Steven Dean:
So I just want to say that you were very quick to dismiss the partial mark to market taxation, although maybe the emphasis should be on that partial part.

Zach Liscow:
Yeah. I think that you're screwing with me and I'm going to stick with partial expensing.

Steven Dean:
All right. I would do that. So you should be warned. So unfortunately the title of the article was "The Perils of Partial Mark to Market Taxation". So I'll just give you a taste of the harms he's talking about. "So the rules for taxation of financial instruments are complex and often allow for inconsistent treatment of economically similar situations. It has long been believed that the imposition of mark to market taxation would eliminate many such problems. And it appears..." This is a few years ago, this is from 2013, he was writing. So that's also why it's unfair. Many reasons unfair. "There's now an opportunity for fundamental tax reform." He was right about that. "That would include a switch to an alternative type of taxation for derivatives. Unfortunately, there was a problem." The proposal that he referred to back then apparently applies only to derivative instruments and not to corresponding underlying assets.

Steven Dean:
So that was the problem he was identifying. And I'm sure if this were a less unfair question, like five levels of unfairness here, that would have been more obvious to you.

Zach Liscow:
Well, I hope that Wyden's plan addresses this problem—.

Steven Dean:
Listen, you know, when reading this article, it was pretty harrowing. So I'm sure I'm sure that his message will be received by those crafting a future and this case present, proposal. So I'm sorry, you didn't get the pencil, but maybe we'll have another chance to get you a pencil in some other way, but I am super grateful, Zach, for you joining us here today, it's been really interesting to hear about your work and I appreciate you coming by.

Zach Liscow:
Great to be here. Thanks for having me.

Steven 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 tax quote comes from Becca Arnall, who hails from right here in New York City.

Becca Arnall:
The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing.

Steven 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.