Faculty Bibliography
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Following several years of study, the Oxford International Tax Group recently proposed a fundamental reform: the traditional corporate income tax would be replaced by taxation of a corporation’s domestic cash flows. One, perhaps surprising, argument for this proposal is that its incidence would fall primarily on a country’s residents who own shares in domestic and foreign companies. For example, equilibrating changes in floating exchange rates would transform a U.S. tax on U.S. sales by U.S. and foreign corporations into a tax on U.S. shareholders of U.S. and foreign corporations, wherever their sales occurred. The Oxford Group indicates that resulting tax burden is very likely to be progressive. If, however, a progressive tax borne by individual owners of corporate stock is desirable, why not tax shareholders directly? The purpose of this comment is to illustrate the equivalence of the two taxes with a simple numerical example and to stimulate their comparison.
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Integration of the corporate and individual income taxes can be achieved by providing shareholders a credit for corporate taxes paid with respect to corporate earnings distributed as dividends. When such integration was previously considered in the United States, proponents emphasized that it could reduce or eliminate many of the familiar distortions of a classical corporate income tax. Integration would also provide a framework for addressing current concerns for tax incentives for U.S. companies to shift income to foreign affiliates in lower-taxed countries or to expatriate in "inversion" transactions. A recent Congressional proposal for a corporate dividend deduction coupled with withholding on dividends could achieve equivalent results, while also reducing effective U.S. corporate tax rates.
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This article uses simple numerical examples to study the relationship between interest rates and the familiar problem of "lock-in" that arises from deferred taxation of unrealized appreciation. In the cases we study, lock-in comes about because of positive taxpayer borrowing costs, and realization and deferral remain significant problems for income taxation even in periods of low government borrowing rates. We also find that it is the relative size, rather than the absolute size, of the borrowing costs that matters. Specifically, lock-in prevents a taxpayer from selling an asset and buying another with a higher pre-tax return only when the incremental after-tax return increase is greater than the borrowing cost necessary to pay the tax triggered as a result of the sale. Thus the magnitude of the lock-in problem does not necessarily diminish as borrowing costs fall, but rather it depends upon a complex relationship between and among the falling interest rates, the incremental increased returns that are available, and the amount of unrealized appreciation in assets.
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A credit for foreign taxes paid by a multinational company is usually described as fundamentally different from a deduction for foreign taxes. The credit has been criticized for eliminating the taxpayer's incentive to reduce foreign taxes, whereas a deduction is said to maintain that incentive. On the other hand, the credit is traditionally defended as a method of eliminating double taxation of cross-border income, whereas the deduction is often criticized for producing multiple levels of taxation (and is therefore not an acceptable method of dealing with double taxation under the standard international tax treaties). The argument of this note is that a credit and a deduction for foreign taxes paid by a multinational company are not as different as the foregoing assertions would suggest. Indeed, credits and deductions can be interchangeable, with the distinction only a matter of labels or nominal tax rates.
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Current proposals to replace the U.S. foreign tax credit with an exemption for the income of foreign subsidiaries of U.S. companies make timely a review of the basic analytics of taxation under the two systems. This brief note reviews the key relationships, highlighting some that are not always fully appreciated in policy discussions.
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Alvin C. Warren, Income of Foreign Subsidiaries: A Review of the Basic Analytics, 145 Tax Notes 321 (2014).
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Alvin C. Warren reviews the basic analytics of deferral and exemption systems for taxing the income of foreign corporate subsidiaries, highlighting some relationships that are not always appreciated in policy discussions.
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Michael J. Graetz & Alvin C. Warren Jr., Unlocking Business Tax Reform, 145 Tax Notes 707 (2014).
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In this article, Graetz and Warren explain why integration should be on today's tax reform agenda and discuss how that change could be structured.
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In previous articles, we have argued that European Court of Justice’s reliance on nondiscrimination as the basis for its decisions did not (and could not) satisfy commonly accepted tax policy norms, such as fairness, adminstrability, production of desired levels of revenues, avoidance of double taxation, fiscal policy goals, inter-nation fiscal equity, and so on. In addition, we argued that the Court cannot achieve consistent and coherent results by requiring nondiscrimination in both origin and destination countries for transactions involving the tax systems of more than one member state. We demonstrated that - in the absence of harmonized income tax bases and rates - the Court had entered a “labyrinth of impossibility.” Ruth Mason and Michael Knoll claim to have discovered a single, normative criterion that not only resolves this dilemma, but also explains the existing nondiscrimination tax jurisprudence of both the European Court of Justice and the United States Supreme Court. In fact, their crucial, but unrealistic, assumption that taxpayers can never move from one state to another confines the actual scope of their analysis to a very small set of cases involving cross-border workers. Although they endorse economic efficiency as the guidestar for judicial decisions regarding tax discrimination, Mason and Knoll fail to provide any evidence that their proposed norm would reduce tax-induced distortions more than competing norms, even in the limited situations to which their analysis applies. Nor do they make a convincing case that they have found the key to understanding the confusing and inconsistent U.S. and EU judicial decisions, which are not confined to cross-border workers. Finally, implementation of their proposed norm by legislation or litigation is not practical, given the particular tax systems that they say would be required. In short, their proposed norm does not provide a way out of the “labyrinth of impossibility” created by a nondiscrimination approach to taxation of international transactions.
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Alvin C. Warren, The Business Enterprise Income Tax: A First Appraisal, 118 Tax Notes 921 (2008).
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This report analyzes a proposal, recently published by the Hamilton Project of the Brookings Institution, for a new division of the tax base between businesses and individuals. The discussion proceeds in three steps: a review of certain equivalences that underlie the logic of the proposal, a brief examination of 10 related divisions of the tax base, and an analysis of the major components of the proposal. The principal conclusions of the report are that the objectives of the tax proposed for businesses could be more simply accomplished with expensing; that the tax proposed for individuals is impractical; that the tax subsidy proposed for foreign investment by U.S. companies is undesirable; and that the rationale for applying graduated rates to some, but not all, components of capital income is not apparent.
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This article analyzes a complex line of recent decisions in which the European Court of Justice has set forth its vision of a nondiscriminatory system for taxing corporate income distributed as dividends within the European Union. We begin by identifying the principal tax policy issues that arise in constructing a system for taxing cross-border dividends and then review the standard solutions found in national legislation and international tax treaties. Against that background, we examine in detail a dozen of the Court's decisions, half of which have been handed down since 2006. Our conclusion is that the ECJ is applying a standard of nondiscrimination to evaluate national tax laws in a manner totally divorced from the underlying tax policy norms that produced the legislation at issue. Some, but not all, of the decisions seem to require nondiscrimination based on the destination, but not the origin, of corporate investment. The result is a jurisprudence that fails to hold together substantively, functionally, and rhetorically. In many instances, this result follows from largely formalistic distinctions made by the Court, such as whether a withholding tax on dividends should be considered corporate or shareholder taxation.
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In recent years, the European Court of Justice (ECJ) has invalidated many income tax law provisions of European Union (EU) member states as violating European constitutional treaty guarantees of freedom of movement for goods, services, persons, and capital. These decisions have not, however, been matched by significant EU income tax legislation, because no EU political institution has the power to enact such legislation without unanimous consent from the member states. In this Article, we describe how the developing ECJ jurisprudence threatens the ability of member states to use tax incentives to stimulate their domestic economies and to resolve problems of international double taxation. We conclude that the ECJ approach is ultimately incoherent because it is a quest for an unattainable goal in the absence of harmonized income tax bases and rates: to eliminate discrimination based on both origin and destination of economic activity. We also compare the ECJ's jurisprudence with the resolution of related issues in international taxation and the U.S. taxation of interstate commerce, and we consider the potential responses of both the European Union and the United States to these developments.
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This article examines the recent district court decision in Long Term Capital Holdings v. United States, which involved the cloning of an artificial loss that was sold to two different groups of taxpayers for deduction. Professor Warren explains the convoluted transaction and then analyzes the court's decision in favor of the government. Particularly noteworthy, he says, is the court's refusal to let the taxpayers escape penalties on the grounds that they obtained favorable legal opinions from major law firms, when those opinions were, in the court's view, superficial at best. Given the sums of money involved, Warren concludes that such dubious behavior by taxpayers and their professional advisers will change only if the federal courts are willing to sustain penalties in cases such as this.
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This paper discusses the response of the US federal income tax to financial innovation. Income taxation in the US and elsewhere has traditionally relied on distinctions, such as the difference between fixed and contingent returns, that can be undermined by new financial products. The principal tax law responses to innovative products have been: (1) transactional analysis, which aggregates or disaggregates new transactions to conform them to existing legal categories, (2) taxation of changes in market value, rather than realization events, (3) taxation based on an assumed formula, and (4) anti-avoidance administrative approaches.
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Alvin C. Warren, Taxation of Options on the Issuer's Stock, 82 Taxes, Mar. 2004, at 47.
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This paper reconsiders the tax policy question of whether gains and losses on options on the issuer's stock should be excluded from the corporate tax base. The principal conclusions are that nonrecognition provisions of current law are problematic, and that the appropriate legislative response depends on a range of considerations, including the function of the corporate tax and the appropriate treatment of employee stock options. Part I briefly reviews the principal provisions of current law and identifies the role of the corporate tax that provides the tentative normative perspective of the paper. Part II illustrates the inconsistent taxation under present law of options and certain substantially equivalent transactions. Part III examines some combinations of options and substantially equivalent transactions. Part IV considers alternatives to the 1984 legislation. Part V provides a summary of conclusions.
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Taxation and trade are governed by two very different sets of international agreements. The bilateral tax treaties, which originated in the 1920s, do not, for example, contain the rule-oriented dispute-settlement procedures of the multinational trade treaties, which have developed since World War II. In this article, Professor Warren analyzes the constraints imposed by the two sets of agreements on a country's freedom to use its income tax to discriminate against international commerce. His principal conclusions are that the current distinction between permissible and impermissible discrimination is incoherent and that the pre-World War II international tax regime is in need of fundamental reexamination.
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Alvin C. Warren & Michael Graetz, Integration of Corporate and Individual Income Taxes: An Introduction of the Issues, 84 Tax Notes 1769 (1999).
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Alvin C. Warren, Jr., How Much Capital Income Taxed Under an Income Tax is Exempt Under a Cash-Flow Tax?, 52 Tax L. Rev. 1 (1996).
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Cash flow taxation, including some current proposals for U.S. tax reform, would exempt some capital income in the sense that there would be no difference between the pretax and after-tax rates of return on that capital. Although there is wide agreement on this proposition among tax policy analysts, the precise difference between income and cash flow taxation of capital income has been described in quite different ways. Like an income tax, a cash flow tax would include receipts from a variety of sources, including receipts from capital investment. The key distinction between the two taxes is that capital costs are currently deducted (or “expensed”) under the cash flow tax, whereas they are capitalized and later deducted (as depreciation or basis) under the income tax. This Article accordingly examines the effects of expensing in order to evaluate four different responses to the question of how much capital income taxed under an income tax is exempt under a cash flow tax: (1) all, (2) only the normal rate of return, (3) only the riskless rate of return, and (4) none. The goal of the analysis is to elucidate the assumptions underlying the different responses and the relationships among them. The analysis of each response includes a verbal explanation, a numerical example, and a simple algebraic model. In order to facilitate comparison of the two tax bases, the discussion assumes flat rate taxes, full loss offsets, and no inflation. Important transitional issues, such as the treatment of existing capital on substitution of a cash flow tax for an income tax are not considered. “Capital” is used here in the traditional sense of financial or physical capital, and therefore does not include human capital, which presents special problems for income taxation.5 The analysis begins with the simple case of a single rate of return on all capital, and then introduces multiple rates and risk taking.
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Alvin C. Warren, Alternatives for International Corporate Tax Reform, 49 Tax L. Rev. 599 (1994).
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The innovation in capital market contracts over the last twenty years has been remarkable. A limited set of familiar instruments (essentially stock, debt, convertible debt, and some options and futures) has been replaced by an array of hundreds of contracts, some of which are marketed to retail investors, whereas others are used primarily by financial managers. This innovation has had many sources, including fluctuations in currency and interest rates, avoidance of government regulation, inconsistencies in the income tax, and analytical advances in understanding and managing risk. Much of the innovation can be decomposed into three continuing developments: 1. Disaggregation: Traditional financial contracts, such as stocks and bonds, have been disaggregated into their constituent parts and separately marketed. For example, government debt securities have been "stripped" into principal and interest components. 2. Recombination: The disaggregated parts of traditional instruments have been recombined into new financial products. For example, interest payments on what is otherwise debt may depend on the value of a specified index of stock prices. 3. Risk Re-allocation: A group of innovative products, collectively known as notional principal contracts, has been developed to allow hedging or speculation with respect to commodity prices, interest rates, currency exchange rates, and other risks. Continuous disaggregation, recombination, and risk reallocation have produced a changing array of new financial contracts that pose a serious challenge for the income tax. 6 The purpose of this Commentary is to elucidate one of the underlying reasons for that challenge and to identify potential responses. In brief, the argument is that our realization-based income tax has relied on a dichotomy between fixed and contingent payments that has never been completely coherent. Recent innovations in financial contracts allow taxpayers to further exploit that incoherence. Part I of the Commentary develops this argument, while Part II illustrates the resulting analysis with three examples of new financial contracts. This two-part approach is followed because the basic conceptual analysis is independent of the contracts in existence at any given moment, but the challenge to the income tax is best understood by reference to actual transactions. Simple numerical examples are used to illustrate the points made in both Parts. Although this Commentary focuses on realization, which concerns the timing of taxation, financial innovation presents other significant difficulties for conventional tax distinctions. For example, many commentators have pointed out that the character (capital versus ordinary) and source (domestic versus foreign) of income and deductions are unsettled in many new products.8 Rather than addressing all such questions, the goal of this Commentary is to show why innovative financial contracts provide a serious challenge to an income tax based on realization, even in the simplest case of purely domestic transactions without special treatment for capital gains and losses.
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Alvin C. Warren, Jr., Federal Income Tax Project: Integration of the Individual and Corporate Income Taxes: Reporter's Study of Corporate Tax Integration (American Law Institute 1993).
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The United States has long had what is usually called a classical income tax system, under which income is taxed to shareholders and corporations as distinct taxpayers. As a result, taxable income earned by a corporation and then distributed to individual shareholders as a dividend is taxed twice, once to the corporation and once to the shareholder on receipt of the dividend. Corporate taxable income distributed as dividends to exempt shareholders is taxed only at the corporate level. In contrast, earnings on corporate debt capital are nontaxable at the corporate level to the extent they are distributed as deductible interest payments. Whether interest is taxed to the recipient depends on the recipient's status, with foreign and tax-exempt lenders generally nontaxable on such receipts. Integration of the individual and corporate income taxes refers to various means of eliminating the separate, additional burden of the corporate income tax, in favor of a system in which investor and corporate taxes are interrelated so as to produce a more uniform levy on capital income, whether earned through corporate enterprise or not. ♦The integration proposals in this study would convert the separate U.S. corporate income tax into a withholding tax with respect to income ultimately distributed to shareholders. ♦
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Alvin C. Warren, Commentary: International Tax Policy: Agenda for the Nineties: Competitive Advantage and the Optimal Tax Treatment of the Foreign-Source Income of Multinationals: The Case of the U.S. and Japan, 9 Am. J. Tax Pol'y 145 (1991).
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Most of Professor Strnad's original article was devoted to a lengthy algebraic argument asserting that a cash flow tax, rather than an income tax, implements the Haig-Simons concept of income in a non-general-equilibrium setting. In our reply, we made two points about this argument: (1) Professor Strnad's complex algebraic demonstration amounted to a simple and familiar tautology, and (2) the argument did not support his conclusion because Professor Strnad was not in fact applying the Haig-Simons concept used by tax policy analysts for over fifty years. We therefore called his quite distinct formulation, which is definitionally implemented by a cash flow tax, "Strnad income." Professor Strnad's specification of his concept of income requires that: (1) after-tax net present values equal those in the no-tax world, reduced by the tax rate, and (2) after-tax changes in present value equal those in the no-tax world, reduced by the tax rate.
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This paper considers the conditions under which the deferral or acceleration of a tax will not affect its present value. Expenditure and wage taxation, estate and gift taxation, dividend taxation, income taxation of deferred compensation, and income taxation of insurance companies are examined to draw some general conclusions about the significance of their common attributes for tax policy analysis.
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Alvin C. Warren, Accelerated Capital Recovery, Debt, and Tax Arbitrage, 38 Tax Law. 549 (1985).
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Alvin C. Warren, Corporate Integration Proposals and ACRS, 21 San Diego L. Rev. 325 (1985).
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The Tax Equity and Fiscal Responsibility Act of 1982 substantially modified the "safe harbor'' leasing provisions enacted by the Economic Recovery Tax Act of 1982. In this Comment, Professors Warren and Auerbach argue that the modifications did not remedy the defects they identified in an earlier Article and that a new category of "finance leases" may prove to be nearly as valuable for some taxpayers as were safe harbor leases before the 1982 changes.
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Corporate income is subject to a federal income tax when earned by the corporation and again when distributed as dividends to individual shareholders. The effects of this "classical system" on financial and investment incentives, the complexity of the current regime, and questions about its fairness have prompted two major proposals for change: a draft proposal of the American Law Institute Federal Income Tax Project and integration of the individual and corporate income taxes. In this Article, Professor Warren compares the two proposals and concludes that integration is preferable in theory and workable in practice.
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The Internal Revenue Service and the courts have used several not entirely distinguishable doctrines to deny transactions their intended effect for tax purposes on the ground that the transactions lacked economic substance. This article examines the requirement that tax motivated transactions must involve a pretax economic profit to be given effect. Three stages in the development of that requirement are traced, followed by discussion of its function under current law. The conclusions advanced are that the requirement of economic profit should not be applied to transactions involving provisions specifically enacted by Congress as incentives, and that, where applicable, the doctrine should require only that the pretax return be positive.
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Alvin Warren, Would a Consumption Tax be Fairer Than an Income Tax? 89 Yale L.J. 1081(1980).
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The consensus that culminated in the adoption of the Sixteenth Amendment and the enactment of the federal income tax has been under attack in both academic and professional circles for several years. The view that consumption, not income, is the fairer basis on which to levy a progressive personal tax can be found in recent law reviews,' economic journals, and Treasury Department study papers, as well as the reports of commissions created to review the tax structures of the United Kingdom and Sweden. And signifying the growing respectability of what is a very old idea among economists, the Brookings Institution has recently sponsored a conference of experts to review the theoretical and practical considerations involved in a personal tax on consumption. The argument that the consumption tax is to be preferred as a matter of fairness has generally involved a comparison of the core ideas of the two taxes-income and consumption. Wealth-the third traditional candidate for taxation on the basis of economic resources-has typically been left out of the comparison on the ground that whatever considerations would support wealth taxation can best be taken into account by enacting a tax on wealth or transfers of wealth, and that those quite distinct considerations should not obscure the direct comparison of the income and consumption taxes on equity grounds. This Article examines the case for consumption-tax superiority in those terms. In keeping with the focus on the core ideas of income and consumption, practical compromises that are necessary to the implementation of the taxes and that can certainly raise questions of fairness are generally not discussed. Rather, this Article is meant to be directly responsive to arguments that the income tax is unfair in basic concept, quite apart from the difficulties that might arise in implementing that concept.
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