Blog by Nate Archive: Blogging about our profession (Sept 14, 2013)

[This old post includes a lot of links to my old blog.  And I am too lazy to update each link.  Sorry.  This is an unpaid blogging position.]

Blogging about our profession: Follow-up on my previous post

I’m shooting off another quick blog post while my two boys nap.

I’m a little surprised by the amount of positive feedback I have received on my blog post about the multi-year process of getting my paper published at International Studies Quarterly.  Lots of people on twitter have been very supportive.  Many scholars have very similar stories.

Nothing fancy here.  I just documented my experience with a single paper.  It wasn’t my worst experience, but far from my best.  I hated the outcome (years of waiting for publication) but I felt that the process was fair.  Editors and reviewers gave me a fair shake at every turn.  i eventually got the paper published in a very good journal.

I made the mistake of checking out political science rumors to see if there was any talk of my post.

Let me be honest.  I do read the rumor blog (I’ve mention this on my blog previously), but I am pretty embarrassed to admit it.  It is like tabloid filled with very little news and some really lame attempts at sensationalism.  I stopped taking it seriously when I was on a search at WashU many years ago and most of the facts posted about the search were wrong.  I started hating it when anonymous posters started attacking faculty and graduate students for their publication records and discussing their personal lives.  Believe it or not, I do not post there.

I’m always a little disappointed that my posts on research get a lot less attention than posts on the job market, job talks, or publication process.  But this is probably a function of both having a lot wider audience and having less completion.  There are tons of great posts out their on interesting research projects, but not a lot of posts on the discipline.

I’m probably not the best person to be providing insights on our discipline.  I have mostly fumbled through my career, doing my best to do good research, be a good teacher, and provding service to my university and the discipline.  I don’t have especially strong opinions on most aspects of our profession, but I do have years of experience on search committees, APSA and MPSA section organizers, author and reviewer.  So I might as well embrace my role of at least providing some details on my own experience.

So I will take a quick stab at filling in a few more details from my previous post.  I had a paper that I started many, many years ago that was just published in ISQ yesterday.  Some more facts about the paper.

  • I am a tenured faculty member now, but I started this project midway on my tenure clock.  I thought that I would have three papers using this data and a grant prior to tenure.  This is my only paper that came out of that project.
  • Someone on the rumor blog asked about how much the paper changed over time.  To be honest, I don’t really remember.  I’ve published around 25 papers, each of them going to an average of 3 journals.  I’m sure I have at least 7-8 papers that died in the review process and quite a few in the pipeline.  I’d say I’ve made 100+ submissions in a little over 10 years.  I don’t really keep good records on the previous submissions, so I don’t know the exact changes.  What I do know is that more core result was the same throughout the process, but my framing, literature review, and robustness tests changed substantially over time.  This paper definitely got better through the review process.
  • I had a sense that this was a high risk project, but I didn’t think too much about it.  I definitely wouldn’t have guessed that I would get one paper out of this project after all of these years.  (Chris Blattman has anice post on risky field experiments that is relevant to this point.)
  • This study uses confidential data.  I archieved that data at the Bureau of Economic Analysis and have full replication materials there. But only a handful of people have access to this.  Many journal and NSF reviewers were very hostile to using confidential data.  This was probably the most unique part of my experience.  I have mixed feelings on the use of confidential data.
  • As far as I can remember, the core results didn’t change much and I was always using the same data.  But what was stunning to me is how much reviewer tone changed based on my framing of the paper.  A friend of mine says that most reviewers make up their minds in the first five pages of a manuscript.  I don’t know if that is true in general, but it certainly felt like it with this paper.
  • I made a lot of mistakes with this project.  I didn’t have a very clear testable theory, and made the classic mistake of presenting regression after regression which actually muddled my contribution.  This was far from a perfect paper when it started the review process so I should be clear that much of the blame for this delay is on my shoulders.

This is what I can remember from this project.  I have a companion paper that I actually scrapped for a number of reasons.  When to quit a project might make a good blog post as well.

I’m not sure of what to make about the lack of blog posts about personal experiences in the profession.  There certainly are scholars willing to post their exeriences, but there seems to be a real undersupply of factual information.  It could be that many of us are embarrssed by these experiences.  It could also be that most of the attention that comes from these sorts of posts isn’t good.  Being famous for a blog post is probably one of the worst professional outcomes.

My kid nap window is closing and I have to get back to a bunch of work emails.  Here is a quick set of links on my previous posts of our discipline.

Brands and Fads in Academia

The Stability of  US News Graduate Student Rankings

My Experience with Big(ish) Data

Posts on academic job talks here, here and here

Failed Research Log

Reviewing Articles, Lots of Articles

The Academic Job Market here, here, here, here and here

NOTE ON COMMENTS:

Blog by Nate Archives: My paper’s journey through the review process (Sept 13, 2013)

[My blog migration includes a number of personal stories on my life as an academic.  I am always surprised by how much interest these posts get relative to other posts.  Here is one on a “successful” research paper.]

My paper’s journey through the review process: Plus some reflections

In a previous blog post I mentioned the perils of big data. I can also use the paper from that post to talk about the publication process.  Today I received an email that this paper has just been published at International Studies Quarterly.  This is a very good journal and I am very excited to have people read this paper.

I had a little twitter exchange about this paper so I very quickly wrote up a little post.  Sorry if this is a bit half assed, but I am on leave with my 3 month old son.  I have very little time to do work…and even less to blog. And it is a Friday night.  Shooting from the hip.

But here is a quick rundown of my paper.

My paper won an award for the best paper presented in the American Political Science Association Political Economy section 2008 and was first sent to the American Political Science Review on January 10, 2008.  It was finally published in ISQ on September 13, 2013.

What took so long?  It was rejected by multiple journals, often for very fair criticisms.  But this paper, more than many other papers, had a bunch of near misses.

Here is my recollection (with the aid of emails) of the publication process:

Submitted APSR 1/20/08.  Rejected 5/13/08

Submitted IO 10/14/2008, Rejected 1/06/09

Submitted JOP 7/11/09, Rejected 11/23/09

Submitted AJPS  6/19/10, R&R 12/?/10, Rejected 8/19/2011

Submitted ISQ 9/30/11, R&R on 2/24/12, resubmitted 6/6/12

Accepted: 6/22/12

I swear I had another R&R in there, but I might have this mixed up with another paper that shared a similar fate. I can think of at least five papers that have gone through more than five journals.

In my previous post I mentioned that this was a very labor-intensive project.  It required me to apply for a special access to the data data, obtain a security clearance, and then fly to Washington DC to do the analysis, and then to do more analysis for each reviewer.  So in between each one of these rejects are a series of flights to Washington DC, analysis, rewriting and finally resubmitting.

I finally quit on future projects with this data when we had my first child two years ago.

It was a pretty painful experience.

I’m a tenured professor at a great institution (WashU) and I’m moving as a tenured professor to another great institution (GWU).  If anything, I think I have caught a lot of breaks in my career and have encountered lots of reviewers that gave me more constructive feedback than I could have ever expected.  I have few complaints about how things have worked out for me.

But I think the point is that you can often look at the CV of a person and you only see the published papers and don’t see any of the failures along the way.  This paper is definitely on the long side from writing to publication, but the process rarely is quick and clean.  Here are a few quick facts.

  • My most cited paper (a 2003 International Organization paper) went through 3 rounds of Revise and Resubmit.
  • I have submitted three career NSF grants and one cross-division grant that were rejects.  I think I’m at seven or eight other rejected regular grants. NSF 12 Nate 0
  • In the last two weeks I received two rejections from the American Political Science Review.  I have also received two Reject and Resubmits from the APSR in the last three years.  Both of these were rejected on the second go round as well.  Not sure of my total APSR rejects, but I know the accepts are zero.
  • I have publish over 25 papers and I can only think of three that hit on the first submission.  I would guess that the modal number of journals before publication is three.  But that is a guess.

These are stories from mostly my own papers.  I’ve had some other crazy experiences with my co-authored papers.  This includes what seemed to be something like six rounds of R&R with a journal, a three line review after 9 month of waiting (basically saying that they didn’t like this kind of work), and a few projects that simply died in the publication process.

What are my own person conclusions from this process?

1. Editors have a lot of power, but they tend to be fair.

In my many, many rejected publications, I have only complained to the editor once.  This was a case where a reviewer basically vetoed the paper saying that they didn’t like it, but without any real explanation.  This was the pivotal review and my paper was rejected.  I complained to the editor  and the editor agreed to go out for a new review.

But other than that, I have found that most editors and reviewers are fair.  I often disagree with some of the points in a review, but I can’t think of a case where an editor has unfairly read the reviews and rejected my manuscript.  It is often a judgment call, and sometimes it has gone my way.  Probably the majority of times it went the other direction. But I can’t call it unfair.

I actually have a lot of sympathy for editors given the volume of submissions, the difficulty of getting good reviewers, and the complexity of making a decision of accept, reject, or R&R on some many difficult cases.

2. Sloppiness kills

As I noted above, I think most reviewers do their job.  But you can really, really piss off a reviewer in the first few pages.  This can be a typo, an incorrect reference, or a flashy intro that oversells your contribution.  There are lots of ways to set off a reviewer, and I can’t say for certain if this is why a review turns nasty, but I can say it is strongly correlated.  Ironically, this post probably has a bunch of typos.  Not peer reviewed.

3. Work on multiple projects…

I would often ask senior job candidates and speaker series visitors about their most famous projects.  Did they think it was their best work?  In general, can they gauge where a piece will land?  Most of these people were surprised what stuck and what didn’t.

This isn’t to say that quality isn’t correlated with where a paper lands, but there is a lot of uncertainty even with the strongest paper.  If it gets published, does it get cited?  I think this is even more of a mystery.

My personal response to this uncertainty is to diversify.  This also fits my own personality and interests.  I love working on and finishing projects, often with co-authors.  Obviously this isn’t a strategy that works for all types of research.

4.But…

There is some tradeoff between quantity and quality.  This seems so obvious that it isn’t worth mentioning. But, I’m not sure how much better my work would be if I cut the number of papers I write in half.  There are tradeoffs you have to make, but remember that even the most famous people have trouble telling ex ante what is their best work.  Make sure you have a real diamond that has been vetted by others if you’re going to polish and polish and polish. This is especially important for grad students who want to have a great project.  A great project doesn’t emerge from sitting in a room working and working and working.  It comes from writing, feedback, failure and trying again.

5. And…

It can be hard to manage workflow when you have a lot of papers floating around. This gets even more complicated with co-authors that are also juggling multiple projects.  It is very easy to ignore a project and let it sit for a year while you work on other projects.  For some people it might be better to work on sequential projects finishing one and then moving on to the next.

I work on multiple projects at the same time.  Mostly because I enjoy it, but I also have found some ways to really manage my workflow.  The most obvious of these is to make sure to get projects done and out the door.  The other is to make sure to make the best use of “downtime”.  When I have some free work hours, I write.

6. Most importantly…

Take reviewing manuscripts seriously.  Like most senior scholars, I get 20-40 manuscripts to review a year.  Add to this tenure reviews, papers by grad students, conference discussant duties and I’m sure I end up commenting on at least one research paper per week of the year.  Maybe two.

But these reviews really matter.  In a few cases I have taken to complaining to editors if I think another one of the reviewers has been unfair to a paper that I reviewed.

I’m not sure if these complaints matter and I am as guilty as anyone of some sloppy reviews.  But reviews matter.

This is a reminder to myself.  Reviews matter.

DISCLAIMER:  This is a blog post I whipped up in an hour or so.  It is rough and probably make some pretty stupid points.  I am tempted to delete it and not post it until I have a more polished version and some clearer thoughts.  But I have done this a few other times, only to never get back to the post.  So I am taking my own advice.  I’m going to throw a few ideas out there and see what sticks.  See what people say about them, and use this feedback to revise my own thoughts.  The only advice I didn’t take is the one on sloppiness.  Sorry for all of the typos Mom.

Blog by Nate Archives: International Tax and Legal Structures and Strategies II (Aug 21, 2013)

[My blog migration from WashU can hopefully include both old post and new posts by my friend and very smart tax expert Adam Rosenzweig.  Here is one from last year.]

International Tax Legal Structures and Strategies: Part II, Season-and-Sell

Guest Blog Post by Adam Rosenzweig

My parental leave has officially started and I have limited time for blogging (or sleeping).  Friend and WashU law faculty member Adam Rosenzweig has written up another guest post on how firms can avoid (or minimize) corporate taxes.  See below.

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Imagine you are a hedge fund in the business of investing in high-yield bonds (otherwise known as junk debt).  Investors in the hedge fund come from all over the world, including US individuals, foreign individuals, corporations and pension plans.  An opportunity arises to make a loan to a US company as part of a leveraged buyout of the company.  You are extremely interested in making the loan.  Should you do it?

Of course, the answer ultimately is a business decision.  But what if I told you that the LBO loan would always have a thirty-five percent lower return than junk bonds purchased on the market?  How could this be the case?  Taxes.

For the most part, hedge funds are organized offshore so as not to be subject to US tax.  This is primarily for the benefit of their foreign investors who typically are not subject to US tax themselves and thus do not want to invest in entities that would be subject to US tax.  The problem is that foreign entities investing in US assets can be subject to US tax if they look too much like US business.

More specifically, under US international tax rules non-US persons (such as offshore hedge funds) are not subject to tax on their income unless that income is either, (1) fixed, determinable, annual or periodic income (“FDAP”) paid from sources within the United States, or (2) effectively connected with the conduct of a US trade or business (“ECI”).  The first refers to payments such as interest and dividends.  Such payments made by a US corporation to a non-US person are subject to a thirty-percent gross withholding tax (unless a treaty applies to reduce the rate).  Hedge funds can relatively easily avoid this provision, either by buying assets that do not pay FDAP type income or by entering into derivatives against the assets paying FDAP income instead of owning them directly (subject, as always, to certain anti-abuse rules).

The second refers to non-US persons engaged in a trade or business in the United States (or if a treaty applies have a permanent establishment in the United States).  This rule treats all income effectively connected with such a business as if it were earned by a US business.  The idea is to put US and non-US companies competing in the United States on equal footing.  This ECI is subject to a net income tax (meaning income less deductions) under the same rates as US people.

The problem arises because investing one’s own money is not treated as a trade or business for these purposes but banking is.  The tax law has a hard time figuring out which is which, however.  An entity need not take deposits and make individual loans to be in the banking business.  Rather, any entity that advances money and seeks out borrowers for the money (or “originates” the loan) can potentially be in the banking business for US tax purposes.  So if the hedge fund seeks out the US company, negotiates the terms of the loan, and advances the money, it sure looks like it is in the US trade or business of banking.  If so, all interest on the loan would be subject to US tax.

The solution is for the hedge fund not to originate the loan but instead to passively buy and sell an existing loan (for bank loans this is accomplished by buying “participations” in the loan).  But if the hedge fund truly was passive and waited to see what loans came on the market it would not be able to control the terms of the deal in the first place, meaning the payout may not be as good as the fund expected when it found the business opportunity.

The “season-and-sell” solves this problem.  Under the season-and-sell, a hedge fund identifies a lending opportunity in the United States.  It then forwards the opportunity to a friendly US bank with the proposed terms.  The US bank negotiates and makes the loan.  Then, the US bank waits for a period of time (how long is an issue of contention, discussed below) and then sells a participation in the loan to the hedge fund.  Assuming each step is respected, it now looks like the US bank originated the loan and that the hedge fund merely purchased a passive investment in debt.

Voila – the hedge fund gets the investment it wants, at the terms it wants, but is not engaged in a US trade or business.  Yes, the US bank will charge a fee for this service, but that is much less than the US tax would have been (and also avoids all the messy US tax return filings).

The season-and-sell has proven both popular and controversial.  Some people find it offensive that by using a US bank as a “front” and merely waiting to buy into the deal a hedge fund can completely avoid US tax.  Such people contend that the entire transaction should be collapsed into a single hypothetical transaction since the intervening steps are hard-wired and in substance the hedge fund made the original loan.  Under this hypothetical, the hedge fund would be treated as directly lending to the US borrower and thus would be engaged in a US trade or business for tax purposes.

Proponents of the season-and-sell anticipated this argument, however.  By waiting a certain amount of time before selling the participation to the hedge fund, they contend that the US bank takes on real risk.  If the price of debt drops in that period of time the bank loses real money.  Although it is unlikely that the price of debt would drop that quickly, those around in 2008 can easily remember seeing the value of mortgage loans crashing in a matter of days.  So how could an investment where the US bank takes on real risk of loss be a sham and disregarded for tax purposes?  And if the tax law did pretend like it never occurred, what would happen if the bank really did lose money?  How would the tax law account for that?

Based on these arguments, the market seems comfortable that season-and-sell works for tax purposes so long as the period of time is long enough.  How long would you guess is long enough?  One year?  One month?  As Lee Sheppard, a leading tax journalist, noted “[w]e’re not talking fine wine here. We’re not even talking Beaujolais Nouveau.”  Although there is no clear answer, the practice seems to be that three days is enough.  Yup, three days.  By paying a US bank a fee and waiting three days, the theory goes, the hedge fund can make any US loan it wants without paying US tax.

I am ambivalent about whether season-and-sell works under current law.  More interesting to me, however, season-and-sell demonstrates pretty starkly the limits of the existing US international tax laws to modern finance.  The US corporate tax system was designed to tax real multinational companies selling real stuff like General Motors or Standard Oil.  It is debatable how effectively it does so in the modern world, but season-and-sell seems to make clear that rules meant for companies that sell real stuff are toothless in the face of financial businesses.  After all, to a hedge fund a dollar is a dollar.  They don’t care whether an investment is called a loan, or a participation, a bond, a total-return swap, or anything else, so long as the cash flows are the same under their models.  So they can buy and sell any of these, or turn one into the other, solely for tax savings.  By contrast, I am assuming it would matter to General Motors whether they sold a Chevy Corvette or Ford Mustang, notwithstanding that both are cars.

As a result, it is nearly impossible to apply a substance-over-form analysis to a business model (such as a hedge fund) that is completely indifferent to form.  In other words, when is a participation in “substance” a loan and in “substance” a passive investment when to the hedge fund they are completely identical?  That, ultimately, is the true weakness of the US international tax rules.  Season-and-sell is just one (relatively clever) example.

Blog by Nate Archives: Announcement (Aug 19, 2013)

[My blog migration to GW wouldn’t be complete without the announcement of my taking the job.  Would it?]

I’ve taken a job at The George Washington University!

Blogging has been very light while I have been finalizing details on my new job offer and house hunting in Washington D.C.  I have officially accepted an offer to join the Department of International Business at The George Washington University’s School of Business as an associate professor in Fall 2014!  I’ll also have a courtesy appointment in the Department of Political Science.

I have a full year to say goodbye to WashU and St. Louis.  I will need it.  This place has treated me  and my family very well and I will miss it.  Thank you WashU.  Thank you Lou.

Blog by Nate Archives: International Tax and Legal Structures and Strategies I (Aug 11, 2013)

[I am migrating the old blog content into my new blog.  This includes my outsourced posts to Adam.]

International Tax Legal Structures and Strategies: Part I, Corporate Inversions

Guest Blog Post by Adam Rosenzweig

Blogging has been very light while I am teaching a one-week graduate class before I start parental leave in the Fall.  Here is a guest blog post from my friend Adam Rosenzweig.

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Nate has asked me to write a post on some common international tax structures used by multinational corporations to reduce their worldwide tax liability.  Originally, the idea was to list several of these into a single post.  Rather than do so, however, I thought it might be better to write a series of posts, each one describing a separate strategy.

With that in mind, I thought the best place to start would be where I left off in the prior post – so-called corporate inversions.  In particular, I thought this would be appropriate because of recent news that at least one bidder for Dellis considering a form of corporate inversion transaction as a way to use tax savings to finance the acquisition.

Turning to the basic corporate inversion transaction: assume a multinational corporation with the ultimate parent corporation, let’s call it US Parent, legally formed in Delaware.  Although the company initially focused primarily on the US market, eventually it expanded operations to other countries as well.  For simplicity (it doesn’t matter in the long run) assume that all foreign sales of the company are immediately taxed in the United States.  The foreign source income is eligible for foreign tax credits, but assume that due to the business model and tax structuring of the company the foreign tax credits are capped in some way such that there is a net foreign tax being paid in addition to US tax.  So long as the foreign operations comprise a small portion of the total income of the company this is just a cost of doing business.  But at some point the foreign operations grow to dominate the income of the US operations, say because foreign markets are high growth and US markets are mature.

At this point, the problem is that a primarily foreign company from a sales perspective is being treated as a primarily US company from a tax perspective solely because of its place of legal incorporation.  The solution, then, must be to convert the company from a US one to a foreign one for US tax purposes.  There is a huge hurdle to this solution, however.  Any change in form of a corporation, even a change in state of incorporation, is a realization event for US tax purposes.  This means that, absent a non-recognition provision, the owners of the company will have to pay tax on the re-incorporation.  Obviously, paying tax now to reduce tax later is not particularly appealing to US Parent.

So to accomplish the move offshore the corporation must find a tax free non-recognition provision, such as a merger.  This then raises a second problem – special rules (under Section 367 of the Internal Revenue Code) intended to prevent companies from moving assets offshore in a tax-free manner.  These rules “turn off” the non-recognition merger provisions if assets with untaxed US gain are moved offshore in an otherwise tax-free manner.  So the challenge is to find a tax-free reorganization provision that can be utilized without triggering these rules.

So here is one solution the market developed (of course, clever tax lawyers have devised others, but they get to a substantially similar result): (1) have US Parent form a “dummy” foreign corporation, let’s call it Foreign Parent, in the desired jurisdiction, say Bermuda, for one dollar; (2) have Foreign Parent form a Merger Sub in Delaware; (3) merge Merger Sub with and into US Parent with US Parent surviving in exchange for stock of Foreign Parent.  The result is a strange looking creature – the original shareholding public of US Parent owns 100% of the stock Foreign Parent, which owns 100% of the stock of US Parent, which in turn owns one share of Foreign Parent stock.  For specific reasons not particularly relevant to the inversion, it is helpful to leave this one share of stock technically outstanding.

The last step would be for US parent to distribute its foreign business up to Foreign Parent.  In this manner, future foreign earnings would be paid directly to Foreign Parent and not US Parent, thereby avoiding US tax.  This would be taxable to US Parent absent a non-recognition provision.  Sometimes this is ok because there is little gain in those assets and sometimes the distribution can be structured to be considered part of the tax-free reorganization.  If neither is applicable, Foreign Parent can just undertake its new foreign investment directly and over time shift foreign profits out of US Parent.

Why this convoluted structure?  The tax law disregards transitory steps in a transaction that have no independent economic substance.  So the merger of US Parent into Merger Sub with US Parent surviving is treated by the US tax law as an acquisition of the stock of US Parent by Foreign Parent for stock of Foreign Parent.  This is the crucial step.  Treating this as a stock acquisition means that only the shareholders of Foreign Parent have a realization event and thus need the benefit of a non-recognition provision.  Under the Code, a share-for-share exchange in which the former shareholders of the two companies own at least eighty percent of the stock of the resulting corporation is entitled to non-recognition (as either a so-called B Reorganization or collapsed into the formation of Foreign Parent and treated as a Section 351 tax free incorporation).  Thus, the public shareholders pay no tax (large public shareholders would have certain paperwork they need to file, but would mostly pay no tax).

Crucially, under this fictional stock sale, technically US Parent never goes out of existence or transfers any of its assets.  Thus, there is no realization event at the US Parent level at all (prior to any transfers of its foreign business to Foreign Parent).  Consequently, the special rule under Section 367 applicable to corporations moving US assets offshore does not apply as that only kicks in once there has been a realization event.

The final result: all US business of the multinational is owned by US Parent and taxed in the United States, but now all foreign business is owned directly or indirectly by Foreign Parent and no longer taxed by the United States.  This is effectively a self-help form of territorial taxation.

As before, any distributions paid by Foreign Corp to US shareholders will be taxable as dividends to US shareholders, but distributions to foreign shareholders are no longer subject to US withholding taxes.  So long as Foreign Corp is organized in a country with no withholding taxes no shareholders need pay withholding taxes on dividends ever again.  This was the result for a company called “Helen of Troy” that inverted in the 1990s.

The benefits continue.  Dividends from old US Parent to Foreign Parent may be subject to US tax, but this can be resolved either by locating Foreign Parent in a country with a tax treaty with the United States (which Helen of Troy did by organizing in Barbados which used to have a tax treaty with the United States) or by managing the cash flow through transfer pricing and other cash management techniques so that US Parent never pays a dividend.  The only ongoing cost of the structure is any foreign tax liability incurred by Foreign Corp, but so long as Foreign Corp is organized in a country with little to no corporate income tax this is not an issue either (there will typically be annual franchise taxes or fees but these are typically relatively small).  So long as the market does not capitalize a penalty into the price of the shares for owning stock in a foreign corporation rather than a Delaware corporation, which the evidence tends to shows it does not, there is no ongoing cost to shareholders either.

The inversion therefore provides a clean solution to a sticky problem – offshoring the foreign earnings of a US company without changing the actual business activity of the company or the business structure at all, in a tax-free manner.

In response to Helen of Troy, Treasury issued new rules under Section 367 requiring shareholders to recognize gain on a transfer of US stock to a foreign company if the old shareholders end up controlling the new foreign company and the resulting company does not have substantial foreign business.  These regulations were supposed to kill inversions by leveraging shareholder interest against corporate interest.  Unfortunately, all it seemed to do was force companies (such as Tyco) to wait until a drop in the market, when most public shareholders carried stock at a loss, to enter into inversion transactions.

It is for this reason that inversions, notwithstanding the Helen of Troy regulations, were considered an existential threat to the US corporate tax base.  In response, Congress enacted Section 7874 which provides that an inverted company (a technical definition, but Foreign Parent for these purposes) will pay tax on its built in US gain in the year of inversion and, if it remains substantially owned by US shareholders, will be treated as a US corporation notwithstanding that it is legally organized in a foreign country.

There are some minor exceptions to the corporate inversion rule involving acquisitions of US companies by larger foreign competitors and relocations of the actual physical corporate headquarters.  Ironically, other than in the context of corporate inversions, the tax law is completely indifferent to these factors.  A company legally formed in Delaware is a US corporation regardless of its primary place of business.  A merger can be a tax-free reorganization regardless if the larger or smaller business survives.  As a general rule, the tax law is supposed to be as neutral as possible to real business decisions; the corporate inversion rules are precisely the opposite, conditioning tax benefits on the changing the real business of the company.

For these reasons, Section 7874 could be considered a somewhat radical solution, and was considered as such at time (at least by the New York State Bar Association).  In particular, it represents the first time the US has departed significantly from its traditional “place of incorporation” rule for determining the US status of corporate taxpayers.  This could be thought of as, what I call, a “once a US corporation always a US corporation rule.”  This brings us full circle back to Dell.  Dell is a US company because Michael Dell formed a US corporation when it was a small mail-order computer company.  Now that it is a large, multinational public corporation there are significant tax savings to be achieved by unlocking the foreign profits from US tax.  The answer is an inversion.  The problem is that only a foreign buyer can achieve a corporate inversion without triggering the “once a US corporation always a US corporation” rule.  The solution – a foreign hybrid parent entity.  That is a topic for another post.

Blog by Nate Archives: The Problem of Intuition in International Tax Law (July 10, 2013)

[Migrating more old blog content to my new blog.  See:]

The Problem of Intuition in International Tax Law

Guest Blog Post by Adam Rosenzsweig

Below is a guest post by Washington University Law Professor Adam Rosenzsweig on international tax law.

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The Problem of Intuition in International Tax Law

The news is filled with stories of abuse of the international tax system, from General Electric to Apple to Google toPfizer, typically with outrage and scorn.  There seems to be consensus that these are examples of how the system clearly is broken and in need of desperate repair.  What follows is typically calls for obvious solutions to these obvious problems, whether it be replacing transfer pricing with formulary apportionment or adopting minimum foreign tax rates or shifting to a territorial tax system.  Yet, when pushed, few can clearly articulate exactly why these examples are so troubling in the first place.

For example, if Apple pays too little US tax, it would be simple to impose a US excise or excess profits tax on Apple’s cross-border activity.  If Google uses artificial shell companies to hide income in Ireland without any real economic activity, it would be easy to disregard such sham entities.  If GE siphons all of its US profits to other countries it would be easy to impose US tax on its foreign source income.  Yet for the most part nobody has proposed these solutions, presumably because they violate some underlying deeply held norm of the international tax system.  So what are these norms, and why are they not being discussed?

This cycle is not new, however.  In the early 1960s Congress adopted the Subpart F rules as a way to shut down the scourge of tax havens by requiring current inclusion of certain highly mobile income.  This was supposed to kill the use of tax havens by US companies.  By the mid-1970s, however, the system was perceived as broken again, this time because of gaping exceptions permitting deferral for investments in “less developed” countries.  By the end of the decade the less developed country rules were repealed.  And then again a new concern arose about the abuse of the foreign tax credit by cross- crediting income from one country with tax credits from another, leading to the credit being “basketed” on a per-country basis.  And this itself was also repealed once it came to light that taxpayers could simply shift losses around countries rather than pool income and credits, leading to income-type baskets rather than per-country baskets.  Even then the problem continued, leading to calls to prevent companies from “inverting” by moving their headquarters offshore to avoid paying US tax.  This led to the enactment of the so-called anti-inversion legislation, or what could be thought of as the “once a US company, always a US company” rule, in turn leading to our current debate over “Double Irish” sandwiches and the like.

Each of these rule changes was supposed to end the apparent and outrageous abuse of the international tax regime.  Yet we find ourselves once again in the thick of this debate, with new obvious abuses and new obvious solutions.  But if none of the old obvious solutions fixed the problem, what makes us so sure the new ones will?

This is what I refer to as the problem of intuition in the international tax laws.  There is near-uniform scorn and outrage over international tax abuse but very little discussion over precisely what is so troubling about them in the first place.  Is it any surprise, then, that the obvious solutions rarely solve the problem?  How can we measure if we are any closer to an ideal system if we don’t identify the ideal in the first place?

This is not a problem of second-best, as that would require a clear first-best and some constrained variable preventing achievement of that first best.  This is recourse to deep-seated intuitions about a field that should be purely instrumental in its goals.  This, I would contend, is the real problem underlying international tax law.

Not everyone would agree on the underlying normative goals of the international tax regime, or even where to start.  But there is an obvious place to start as an initial matter, and that is where the focus traditionally has been, i.e., on the efficiency of the international tax regime.  From that perspective, the international tax laws have two consequences: (1) they raise revenue, and (2) they distort cross-border activity.  The second has received significant attention, in the form of the debate over “capital export neutrality” and “capital import neutrality” among others.  But the first has received less attention.  At first this would seem strange – isn’t the outrage over Apple and Google and GE all about revenue?  Yes and no.  Most of the outrage over these companies seems to that they are not paying the US enough revenue.  But, by definition, international tax is only relevant when more than one country is involved.  So what about the other country?  What would it do with the revenue?  Is one dollar in revenue for the United States more important than ten cents in revenue for Haiti?  Perhaps that intense need for ten cents is contributing to tax competition in the first place?

The answer, at least from an efficiency standpoint, depends on what the relative countries do with the revenue.  After all, raising tax revenue would never be worth the efficiency losses if the money was simply thrown in the ocean.  Assume the revenue is used to provide for industrial public goods, those public goods that increase returns to private capital within a jurisdiction.  Now the question is whether, at some point, the twentieth or fiftieth or one thousandth port in the United States is always more efficient than the first one in Haiti.  If returns to industrial public goods are constantly increasing in scale, then the answer is yes; if returns diminish in scale, then the answer is no.

This too is not a completely new idea.  Keen and Wildasin modeled a similar concept in 2000, among others.  But the legal literature, and the popular debate, hasn’t seemed to have caught up.  Raising US taxes on companies with activities in Haiti may be good for the US but it may be bad for Haiti.  Raising US taxes may increase distortions to cross-border activity, but it may better allocate returns to revenue.  It is this tradeoff that has been underappreciated in the current debate for the most part.

For example, if opponents of Google really wanted to raise the taxes it pays to the United States doing so would be easy: simply deny Google all of its foreign tax credits (or impose an excise tax on their use).  But nobody proposes this, presumably because it would “double tax” Google on its cross-border activity, a cure considered worse than the disease.  Rather, opponents of Google want Google to pay more tax to the United States and less to other countries.  But this then directly confronts the revenue question.  If building a port in Haiti is better for worldwide growth than paying for social security in the United States, which country should have a greater claim to the tax revenue?  Does the fact that Google is incorporated in the United States answer this question at all?  If not, then why adopt increasingly complex anti-inversion rules to prevent companies like Google from moving its place of incorporation to Haiti?

Perhaps this post raises more questions than it answers.  But at a minimum I would like to start a conversation challenging the intuitions, apparently deeply held, upon which most of the legal debate seems to rest.  Agree or disagree with this normative starting point, as I have done in prior work, but the debate should be engaged explicitly on that level rather than simply labeling some companies good and others bad, some countries cooperative and others tax havens, changing the rules to combat phantom menaces only to discover they were never there in the first place.

Blog by Nate Archives: Foreign Direct Investment Data Note (July 9, 2013)

[The blog migration continues to my new WordPress site.  More data updates to follow.  I hope.  I can’t promise.]

Foreign Direct Investment Data Note

I get a large number of questions from people looking for high quality data on foreign direct investment.  My quick answer is generally, “let me know if you find it.”

Here is a quick guide to some cross-naional FDI data.

1)  The most commonly used FDI data in political science is from the World Bank’s World Development Indicators(or alternatively the IMF International Financial Statistics).  I use FDI/GDP in a 2003 International Organization paperand Quan Li and Adam Resnick use FDI in dollars in their 2003 International Organization paperHere and here are two studies that explore how outliers affect our results.

The major problem with this data is that it is highly aggregated at the country-year level.  We know nothing about the sector of investment, the form of entry (greenfield, brownfield, joint venture, etc) or the country of orgin of the investor.

Another concern is that we know very little about the quality of this data.

2)  An alternative data source is OECD inflow and outflow data which also breaks down the data by sector.

One advantage of this data is that it also includes FDI stock data, not just the flows of foreign investment and this is broken down by sector.  This data can be used to look at OECD inflows, or outflows from the OECD.

In a little working paper we looked at this data and we’re surprised by a number of data quality issues.  First, many of the OECD countries have missing inward and outward data.  Second, many of the observations don’t match.  (This is also discussed in this UNCTAD report). The amount of FDI France says that it sends to Germany doesn’t match the amount of French FDI that Germany recorded as inflows.  We try to deal with this issue in old working paper that needs updating, but it seems like a major problem.

3)  Less commonly used is the UN Conference on Trade and Development FDI data.  This includes data on stocks and flows of FDI.  See Eddy Maleksy’s QJPS article for an example.

These are the three main sources of cross-national data.  I’ll write up another blog post that documents some other sources including US BEA data, Japanese foreign affiliate data, and some other sources of FDI.

Blog by Nate Archive: Brands and Fads in Academia (July 2, 2013)

[Most old blog content is coming to my new blog!  Actually it is already here.  I guess you figured that out.]

Brands and Fads in Academia

This post on the “Myth of Academic Stardom” really disappointed me.  I am often perplexed by how departments convergence on a small number of job market candidates when hiring assistant professors.  I’m also surprised that some fantastic advanced scholars remain “under placed” while others continually get job market offers.
Unfortunately, this post starts with a very odd claim:
“For brands to work as brands, it must be possible to rank them.”
Really?  This seem not only is a silly statement about brands.  Brands are meant to differentiate, but that doesn’t mean that they have to all be ranked.  It also seems like a terrible analogy.
The surprising part of academic stardom is that many of the “stars” don’t actually look that much different from at least some of the non-stars.
For example, when entering the job market, lots of ABD candidates have similar CVs.  There are lots of candidates from very good departments, have great letters, and have presented at numerous conferences.  What tends to differentiate many of the candidates is some unique training, such as methods or formal theory, or has the rare ability to publish while in graduate school.
As I blogged in the past (here, here, here, and here), it turns out that this type of training and publication in graduate school are actually becoming quite common.  43% of ABD candidates have some sort of peer reviewed publication.
At the senior level, it is easier to differentiate candidates in terms of research productivity, but there is a large pool of faculty that have very good CVs that include publications, teaching awards, service, and a record of training graduate students.  What explains the professional success of these candidtes (salary, department, rank, etc)?
What I think this article really gets wrong isn’t the overuse of objective criteria in hiring processes.  Ok, the bean counting of number of articles can be overdone (especially in the British REF), but I also think the “buzz” of market stars is what seems especially problematic.  This looks less like branding gone wrong and more like information cascades.

Blog by Nate Archives: The Company’s Country Matters (June 20, 2014)

[My blog migration includes a number of posts on research projects that are still active.  We have a 95% polished working paper on this topic.  Email me if you want a copy.]

The Company’s Country Matters: Country of Origin in IPE and International Business

I’ve been working on a series of projects that study 1) voter preferences for foreign direct investment and 2) the bribery activity of firms.  These two topics are quite different, but one common link keeps emerging.  The country of origin (of the investment) matters.

Rene Lindsteadt and I conducted a number of survey experiments in the US and UK to examine voter preferences for FDI.

In 2009 we conducted an internet survey experiment in the United State with the following question.

In recent years, [foreign], [Japanese], [Chinese] companies have invested in the United States. Do you think these investments are good for the U.S. economy?

Yes | No | Don’t know

We found a massive drop in support for foreign investment if the company was randomized as “Chinese”.  In 2010 we conducted a follow up experiment with the same structure randomizing between foreign, German, and Saudi Arabian countries.  Saudi investments were perceived much more negatively than the other two treatments.  (The selection of these countries was based on Pew surveys on US perceptions of these four countries.  See the working paper for a description).

Ok, finding that Chinese and Saudi investment aren’t popular might seem obvious.  But why?  One of our non-experimental questions showed that natural security issues weren’t especially salient for FDI preferences, and that this effect (anti-Chinese bias) was present even when we controlled for the sector of investment and differentiated new investment from acquisitions of US firms.

These findings are related to the marketing literature on how country of origin of products not only shapes consumer preferences, but consumer evaluations of products.  (See Pandya and Venkatesan for a great working paper on how French sounding products took a hit in the great Freedom Fries war.)

I’m also working on a paper with Eddy Malesky that is a follow-up piece to this paper studying corruption in Vietnam.  Our original study focused on how high rent sectors lead foreign firms to bribe to gain entry into Vietnam.  Our new piece explores how the country of origin of the firm shapes bribery behavior.  Our preliminary evidence suggests that countries that signed the OECD convention on bribery are less likely to bribe.

Numerous studies in International Business have found similar country of origin effects.  Why? Culture? Institutions?

Shoot me off an email if you have thoughts.

Blog by Nate Archives: Why Now? (June 18, 2013)

[Can I repackage old blog content as new content?  Yes.  Will you read it?]

Why Now?: Corporate Tax Reform

Today’s FT is filled with stories on pressure to crack down on tax havens and calls for reform of OECD corporate taxation.  Why now?

The timing of policy choices, from government expropriations of foreign investment, the signing of trade agreements, to the iniation of intermational conflict are some of the toughest questions in international relations.

I’m curious why is there so much pressure to enact corporate tax reform.  A few quick thoughts

  • NGOs and journalists have broken a number of high profile stories on corporate tax reform.  This is plausible, but I know of of at least one other major investigation from the early 1990s by Time Magazine. 
  • Companies have gone too far in their ability to dodge taxes.  This is plausible, and there is some evidence that effective tax rates have declined over time.
  • Fiscal pressures are forcing governments to make major tax and spending reforms, often calling for some sacrifice by numerous groups in society.  Governments simply can’t ignore corporate tax reform if they are going to make major changes to their tax systems.

These are just some quick thoughts while my newborn naps.  Thoughts?

Comments

 

Dodge? A little pejorative. Anyone who deducts mortgage interest, claims a dependent exemption or benefits from employer provided health insurances also is dodging taxes. To your actual point, foreign tax aspects of the Internal Revenue Code are unbeleivably complicated. It causes unnecessary uncertainty and high compliance costs. In my experience, business like certainty even if a little more expensive. If reform will make things simpler, and more consistent, I think revenue will actually improve.