The Tax Gap's Many Shades of Gray
Daniel Hemel, Janet Holtzblatt & Steve Rosenthal
University of Chicago Working Paper, September 2021
The "tax gap" -- the difference between the amount of "true tax" and the amount of tax actually paid -- has garnered widespread attention in recent months. Much of the commentary on the subject equates the tax gap with "tax evasion," a term broadly understood to connote intentional (and potentially criminal) underreporting. This paper cautions against conflating the tax gap with tax evasion. The tax gap includes substantial gray areas where the law is ambiguous and the IRS's determination of "true tax" is debatable. On top of that, the IRS's methodology for measuring the tax gap includes upward adjustments that are recommended by front-line examiners but reversed on administrative appeal or judicial review. Moreover, a substantial portion of the estimated tax gap is derived from a statistical technique called "detection controlled estimation" that potentially magnifies the impact of later-reversed recommendations on the ultimate tax gap measure. Weighing in the opposite direction, the IRS's approach to measuring the tax gap excludes some amounts that clearly constitute tax evasion (most significantly, underreporting of tax on illegal-source income). Understanding the tax gap's shades of gray can inform discussions of tax law and policy. We explain how proposals to use the tax gap as a performance target may produce perverse incentives for the IRS. We further explain how additional IRS funding -- though necessary to improve the agency's ability to enforce the tax laws -- may have counterintuitive effects on the estimates of the tax gap. We also illustrate -- using examples from the taxation of passthrough entities -- how legislative reforms can reduce the size and scope of legal gray areas that contribute to the tax gap. Our analysis highlights the importance of increased IRS funding levels and substantive tax law changes as complementary strategies for improving tax compliance.
Presidents in Deficit: Are there Historical Rewards to Deficits?
Vincent Geloso & Marcus Shera
George Mason University Working Paper, October 2021
Buchanan and Wagner (1977) pointed to an asymmetry in the political rewards of deficits and surpluses with the former being preferable to the latter. We test this claim by relying on the historical reputation surveys of American presidents. Historical reputations have long been something presidents have cared for and they constitute a reliable way to assess whether their reputations suffer or gain from having run deficits. We find evidence that the size of deficits tends to be associated with greater presidential scores.
Tax Policy Design with Low Interest Rates
Alan Auerbach & William Gale
NBER Working Paper, October 2021
Interest rates on government debt have fallen in many countries over the last several decades, with markets indicating that rates may stay low well into the future. It is by now well understood that sustained low interest rates can change the nature of long-run fiscal policy choices. In this paper, we examine a related issue: the implications of sustained low interest rates for the structure of tax policy. We show that low interest rates (a) reduce the differences between consumption and income taxes; (b) make wealth taxes less efficient relative to capital income taxes, at given rates of tax; (c) reduce the value of firm-level investment incentives, and (d) substantially raise the valuation of benefits of carbon abatement policies relative to their costs.
COBOLing Together UI Benefits: How Delays in Fiscal Stabilizers Impact Aggregate Consumption
University of Maryland Working Paper, September 2021
The United States experienced an unprecedented increase in unemployment insurance (UI) claims starting in March 2020, mainly due to layoffs caused by COVID-19. State unemployment insurance systems were inadequately prepared to process these claims. Those states using an antiquated programming language, COBOL, to process UI claims experienced longer delays in benefit disbursement. Using daily card consumption data from Affinity Solutions, I employ a two-way fixed effects estimator to measure the causal impact of COBOL-induced delays in UI benefits on aggregate consumption. The delays caused a 4.4 percentage point relative decline in total card consumption in COBOL states relative to non-COBOL states. Performing a back-of-the-envelope calculation using 2019 data, I find that real GDP declined by $181 billion (in 2012 dollars).
The Macroeconomic Effects of Corporate Tax Reform
NYU Working Paper, November 2021
This paper extends a standard general equilibrium framework with a corporate tax code featuring two key elements: tax depreciation policy and the distinction between c-corporations and pass-through businesses. In the model, the stimulative effect of a tax rate cut on c-corporations is smaller when tax depreciation policy is accelerated, and is further diluted in the aggregate by the presence of pass-through entities. Because of a highly accelerated tax depreciation policy and a large share of pass-through activity in 2017, the model predicts small stimulus, large payouts to shareholders, and a dramatic loss of corporate tax revenues following the Tax Cuts and Jobs Act (TCJA17). These predictions are consistent with novel micro- and macro-level evidence from professional forecasters and sectoral tax returns. At the same time, because of less-accelerated tax depreciation and a lower pass-through share in the early 1960s, the model predicts sizable stimulus in response to the Kennedy’s corporate tax cuts – also supported by the data. The model-implied corporate tax multipliers for Trump’s TCJA-17 and Kennedy’s tax cuts are +0.6 and +2.5, respectively.
The Economic Burden of Pension Shortfalls: Evidence from House Prices
Darren Aiello et al.
NBER Working Paper, October 2021
U.S. state pensions are underfunded by trillions of dollars, but their economic burden is unclear. In a model of inefficient taxation, real estate fully reflects the cost of pension shortfalls when it is the only form of immobile capital. We study the effect of pension shortfalls on real estate values at state borders, where labor and physical capital could more easily relocate to a state with a smaller shortfall. Using plausibly exogenous variation driven by pension asset returns, we find that one dollar of pension underfunding reduces house prices near state borders by approximately two dollars. Our estimates imply a deadweight loss associated with addressing pension shortfalls that is consistent with prior research in settings with high returns to public spending and costs of taxation.
Do deferred benefit cuts for current employees increase separation?
Laura Quinby & Gal Wettstein
Labour Economics, forthcoming
This study examines whether deferred benefit cuts increase worker separation. The analysis utilizes a 2005 reform to the Employees’ Retirement System of Rhode Island (ERSRI) that reduced benefits for ERSRI members who had not vested by 2005, and did not affect high-tenure ERSRI members and municipal government employees. A triple-differences research design yields an elasticity of employer-specific labor supply with respect to deferred benefits of 0.28. Although state employees were more sensitive to benefit cuts than teachers, low elasticities for both groups suggest that the labor market for public employees is not highly competitive.
Does Local Autonomy Breed Leviathans? An Empirical Examination of All Cities in the United States
Political Research Quarterly, forthcoming
US states grant their local units different levels of autonomy in several dimensions including fiscal, functional, structural, and legal discretion. This study uses a comprehensive, multidimensional measure of autonomy to test its association with the fiscal behavior of over 19,000 municipalities in the United States. Competing theoretical predictions range from significant increases in government size (Leviathan model), to no effect (median-voter model), and even smaller governments (institutional collective action model). Quantile regression analysis is implemented to test the association between autonomy and fiscal behavior for different city sizes. The empirical findings indicate that cities with more autonomy tend to spend less and have lower taxes and debt. The strength of this relationship, however, varies by city size.
Capital Investment and Labor Demand
Mark Curtis et al.
NBER Working Paper, November 2021
We study how tax policies that lower the cost of capital impact investment and labor demand. Diﬀerence-in-diﬀerences estimates using conﬁdential US Census Data on manufacturing establishments show that tax policies increased both investment and employment, but did not lead to wage or productivity gains. Using a structural model, we show that the primary eﬀect of the policy was to increase the use of all inputs by lowering overall costs of production. The policy further stimulated production employment due to the complementarity of production labor and capital. Supporting this conclusion, we ﬁnd that investment is greater in plants with lower labor costs. Our results show that recent tax policies that incentivize capital investment do not lead manufacturing plants to replace workers with machines.
The Role of Property Tax in California’s Housing Crisis
University of Arizona Working Paper, November 2021
California faces a shortage of housing according to politicians, activists, and residents. In this paper, I leverage differential exposure to the Proposition 13 tax laws to understand the impact of this policy on the production of housing in Southern California. Proposition 13 restricts property tax growth as long as the owner doesn’t sell or redevelop the property, which allows me to exploit differences in market conditions at the time of prior purchase to identify the effect of these property tax limits on property redevelopment. I find that Proposition 13 discourages redevelopment and sales. In a dynamic discrete choice model of land use, I find that adopting a land value tax that replaces Proposition 13 based property taxes would increase housing production by 35% generating a similar or greater amount of new housing as other policies under consideration in California.
Credit unions and earnings management to mitigate political scrutiny over tax-exempt status
James Brushwood, Curtis Hall & Stephen Lusch
Journal of Accounting and Public Policy, forthcoming
In this paper, we examine whether credit unions manage earnings to mitigate political scrutiny. In particular, we study whether credit unions increased loan loss provisions to decrease earnings around a 2005 congressional hearing on the efficacy of credit unions’ tax-exempt status. On average, we find evidence consistent with credit unions managing earnings downward via the loan loss provision in the quarters leading up to and surrounding the congressional hearing. In addition, we find that credit unions with higher earnings before the loan loss provision engaged in more downward earnings management than credit unions with lower earnings before provision. Our findings contribute to the literature examining the use of downward earnings management to avoid political scrutiny and the banking literature. Likewise, our results inform the continued debate as to whether credit unions should be tax-exempt.
Did video gaming expansion boost municipal revenues in Illinois?
Gary Wagner & Douglas Walker
Southern Economic Journal, October 2021, Pages 649-679
One supposed benefit of authorizing video gaming terminals (VGTs) outside of casinos is to improve the fiscal health of local governments. Illinois passed the Video Gaming Act in 2009, enabling individual municipalities to allow VGTs. To date, the machines have generated $400 million in municipal tax revenues and $2 billion for the state. We use a difference-in-differences strategy that adjusts for staggered adoption to isolate the causal effect of VGTs on municipal revenues. We find that VGTs displace other local taxable retail, leaving total municipal revenues unchanged. The video gaming act merely reallocated economic activity and did little to improve municipal finances.
Uniform Mortgage Regulation and Distortion in Capital Allocation
Review of Finance, forthcoming
The federal mortgage policy, the conforming loan limit (CLL), was spatially uniform before the 2008 crisis, despite remarkable heterogeneity across geography. I show that in areas that experienced a larger decline in the jumbo-loan share following an increase in the CLL, lenders raised jumbo-loan approval rates, lowered mortgage rates to defend short-term market share, extended credit to riskier borrowers, and incurred deteriorated asset quality in the long run. This result is not explained away by credit supply or demand changes, the bunching effect, or reverse causality. Instead, my evidence is consistent with a competition channel: the effect of CLL increases on jumbo-loan credit expansion is significantly exaggerated in a more competitive jumbo-lending market. Overall, my findings suggest that the securitization policies of the government-sponsored enterprises (GSEs) can induce spillovers on the jumbo-market segment and influence credit allocation.
Financially constrained mortgage servicers
Journal of Financial Economics, forthcoming
Financially constrained mortgage servicers destroyed substantial MBS investor value during the financial crisis through their management of delinquent mortgages. Servicers advance to investors monthly payments missed by borrowers. In order to minimize this obligation to extend financing to distressed borrowers, constrained servicers aggressively pursued foreclosures and modifications at the expense of investors, borrowers, and future mortgage performance. When agency frictions between the servicer and the investor are higher, the servicer’s financial constraints matter more. IV regressions suggest that, on average per defaulted loan, servicers’ financial constraints are responsible for 20% of the total investor value reduction during the financial crisis.