TaxProf Blog

Saturday, April 24, 2004

Christopher House (Michigan) & Matthew Shapiro (Michigan) have posted Phased-In Tax Cuts and Economic Activity on SSRN. Here is the abstract:

Phased-in tax reductions are a common feature of tax legislation. This paper uses a dynamic general equilibrium model to quantify the effects of delaying tax cuts. According to the analysis of the model, the phased-in tax cuts of the 2001 tax law substantially reduced employment, output, and investment during the phase-in period. In contrast, the immediate tax cuts of the 2003 tax law provided significant incentives for immediate production and investment. The paper argues that the rules and accounting procedures used by Congress for formulating tax policy have a significant impact in shaping the details of tax policy and led to the phase-ins, sunsets, and temporary tax changes in both the 2001 and 2003 tax laws.

Friday, April 23, 2004

David Mayo (Gibson, Dunn & Crutcher) has posted Restricted Stock Notes on SSRN. Here is the abstract:

The 1990s saw an increasing use of equity-based compensation, most notably among dot com and other technology companies where stock options were seen as the path to quick riches at no cash cost to the issuer. Along with the increased use of equity-based compensation came increased efforts to avoid the principal downside of stock options, the realization of ordinary income on exercise, through the use of restricted stock. Restricted stock, however, requires the outlay of cash, either to the issuing corporation as a payment for the stock or to the government in payment of the taxes due on its vesting (or issuance, if a section 83(b) election, discussed below, is made). Sufficient cash for either purpose often would not be available to an employee who is to receive equity-based compensation, and in the start-up context the employer often would be unable to lend the employee cash to pay the taxes.

A transaction using a restricted stock note, which provides for the payment for restricted stock with a note issued by the employee, if properly structured, was thought to solve all of these problems. The restricted stock note provided payment for the restricted stock without the immediate outlay of cash by the employee to the employer, and because full fair market value would be paid for the restricted stock, no taxes would be due if the recipient were to make a section 83(b) election. As a result of the section 83(b) election the ordinary income that would arise on the exercise of a stock option would be avoided.

The problems that were not foreseen, however, were those caused by a falling stock market or, more specifically, a drop in the price of the stock of the employer. Most significant to the employee are the problems of repayment and of default on the restricted stock note if the market value of the restricted stock were to fall below the amount of the note. Inability to repay leads to issues regarding the characterization of full or partial forgiveness of the notes for both the employee and the employer.

Part I of this article discusses the structure and treatment of the issuance of restricted stock for restricted stock notes. Part II considers the potential consequences to employees of restructuring a restricted stock note, including partial and complete forgiveness and conversion of recourse notes to nonrecourse notes. Part III deals with the consequences to an employer of the restructuring of a restricted stock note.

Friday, April 23, 2004

Mihir Desai (Harvard) & Dhammika Dharmapala (Connecticut) have posted Corporate Tax Avoidance and High Powered Incentives on SSRN. Here is the abstract:

This paper analyzes the links between corporate tax avoidance, the growth of high-powered incentives for managers, and the structure of corporate governance. We develop and test a simple model that highlights the role of complementarities between tax sheltering and managerial diversion in determining how high-powered incentives influence tax sheltering decisions. The model generates the testable hypothesis that firm governance characteristics determine how incentive compensation changes sheltering decisions. In order to test the model, we construct an empirical measure of corporate tax avoidance – the component of the book-tax gap not attributable to accounting accruals – and investigate the link between this measure of tax avoidance and incentive compensation. We find that, for the full sample of firms, increases in incentive compensation tend to reduce the level of tax sheltering, suggesting a complementary relationship between diversion and sheltering. As predicted by the model, the relationship between incentive compensation and tax sheltering is a function of a firm’s corporate governance. Our results may help explain the growing cross-sectional variation among firms in their levels of tax avoidance, the “undersheltering puzzle,” and why large book-tax gaps are associated with subsequent negative abnormal returns.

Thursday, April 22, 2004

David Weisbach (Chicago) & Jacob Nussim (Chicago) have published The Integration of Tax And Spending Programs, 113 Yale L.J. 955 (2004). They posted an earlier draft of the paper on SSRN. Here is the abstract:

This paper provides a theory for deciding when a spending program should be implemented through the tax system. The decision is traditionally thought to be based on considerations of tax policy. The most common theories are the comprehensive tax base theory and the tax expenditures theory, both of which rely on tax policy to make the determination. We argue instead that the decision should be based solely on consideration of organizational design. Activities should be grouped together in a way that achieves the best performance, much like a corporation decides how to divide its business into divisions. Tax policy is entirely irrelevant to the decision. This paper begins the process of applying organizational design theory to the tax and spending problem, considering theories of hierarchies based on the needs for specialization in and coordination of activities. The paper then analyzes whether food stamps and the earned income credit should be implemented in through the tax system based on this analysis.

Thursday, April 22, 2004

Fred Brown (Baltimore) has posted Whither FIPTA? on SSRN. Here is the abstract:

It is commonly understood that the tax law is composed of a complicated and interrelated set of statutory provisions. This raises the possibility that changes to one area of the law may necessitate revisions to other areas. While statutory change sometimes means that other provisions need to be added or amended, there is also the possibility that the enactment of a new provision allows for the repeal of another rule because it is either deadwood or simply no longer sensible in light of the rule’s intended purpose as well as fundamental tax policies.

A simplification study released by the Joint Committee on Taxation in 2001 indicates the prevalence of this deadwood (and the like) phenomenon. This study recommends the repeal of 105 provisions identified as pure deadwood. The study also proposes the elimination of other provisions that no longer serve sound policy objectives as a result of tax law changes since their enactment. Given the tax law’s interrelated statutory scheme and frequent changes, the extent of the deadwood phenomenon should come as no surprise.

An area that is ripe for such a deadwood analysis is the Foreign Investment in Real Property Tax Act (“FIRPTA”), and in particular section 897. Indeed, FIRPTA has been ripe for such an analysis since the changes effected by the Tax Reform Act of 1986. This Article suggests that the repeal of portions of FIRPTA may be in order and sets forth an analysis of the various considerations in arriving at this conclusion.