The Faculty Lounge

Why Are Capital Gains Preferentially Taxed?

In Sunday's New York Times, as part of its Sunday Dialogue, there was a discussion of whether capital gains should be preferentially taxed.  Unfortunately, I don't think the discussion really identified the important issues.  And I'm always frustrated by the public discourse about capital gains taxes.  So, here's a summary of the best arguments pro and con in 500 or so words.

The problems with taxing capital gains preferentially are pretty easy to identify.  The capital gains preference means that unearned income is taxed at lower rates than earned income, a result that many believe is unfair.  The preference also requires the IRS to police the line between capital gains and ordinary income, and it encourages taxpayers to in engage in transactions that turn ordinary income into capitals (or capital losses into ordinary losses).  Finally, an administrable line between capital gain and ordinary income can lead to bizarre results where items that should be ordinary income are mis-characterized as capital gains (see, e.g., carried interest).

So, what are the best arguments in favor of the preference?  The preference is a result of the realization rule, which is the Achilles heel of the income tax.  Investment gains are taxed (and investment losses deductible) only upon a realization event (most commonly a sale).  Until then, the built-in gains and losses are ignored for tax purposes.  Such a realization-based system is not a very good way to track increases and decreases in wealth (consider Mark Zuckerberg), but the other option (mark-to-market) is thought to be too difficult and costly to administer.  Because of the realization rule, taxpayers have a tax incentive to hold onto their winners while selling their losers, thereby deferring tax.  The incentive to hold onto appreciated investments is a tax-created friction that impairs the ability of capital to move to its most productive uses.  This lock-in effect means that a taxpayer may hold onto Investment A even though Investment B is better because the tax toll charge for selling A is too high.  The capital gain preference reduces this toll charge. 

The realization rule also requires that limitations on investment losses must be curtailed.  Otherwise, taxpayers with large, diversified portfolios would be able to sell their losers (while holding onto their winners) and avoid tax on their non-investment income like salary.  To prevent this, the tax code allows deductions for capital losses only to offset the taxpayer's capital gains (plus a measly $3,000 against ordinary income).  But this capital loss limitation creates its own problems.  If a taxpayer is not very diversified, or if the overall market declines substantially, it's quite possible that a taxpayer will actually have overall net losses.  In such a case, the capital loss limitation is unnecessary and merely adds injury (no deduction) to insult (a real overall investment loss).  The prospect of this can discourage appropriate investment risk-taking because the government could, like a bad betting partner, participate in your gains if you win but not your losses if you lose.  The capital gains preference reduces the impact of this assymetry. 

Other common arguments in favor of the capital gains preference, such as that it offsets inflation or the problem of bunching multiple years worth of income into one year, are not as persuasive as the ones above.  Inflation rates are not very high and tax rates are pretty flat, making inflation and bunching concerns less significant than they have been in the past.  Even if they were significant,  a more narrowly tailored solution (e.g., indexing basis or income averaging) could easily be devised.

Updated Author Submission Information For Law Reviews

Allen Rostron and Nancy Levit have updated their SSRN document Information for Submitting Articles to Law Reviews & Journals.  It's ready for the Spring 2012 season and encompasses 202 law reviews.

BEST Best Picture Ever: Round One, Match #2

                                                                 versus 

 

 

 

 

 

 

 

Additional info here (and cast your vote).

I'm voting for the film on the left.  Can't say that I've watched more than fifteen minutes of any of the LOTR movies.

Yesterday's result?  Godfather (89.8%) defeats Terms of Endearment (10.2%).  Next up for Godfather?  The winner of On the Waterfront v. Titanic.

Inside the Jury Room

Some reflections from a jury foreman, posted yesterday at the FCPA Professor blog.

North Carolina Sterilization Victims Compensation

I'm going to be talking on Wednesday about two topics I was once mightily interested in -- the history of sterilization and reparations.  First a little background: North Carolina has been for several decades now revisiting its history with sterilization from the late 1920s to the early 1970s.  In 1992 the state issued an apology and more recently the movement to provide some sort of compensation to vicitms has been gathering stream.  Back in 2010 North Carolina Governor Bev Perdue established the North Carolina Justice for Sterilization Victims Foundation, with the goal of providing some sort of justice and to make recommendations regarding compensation.  The NCJSVF had a number of public meetings and has been studying both what happened and what should be done now.  The published their extensive final report at the end of last month.

The NCJSVF website has a lot of resources, including some case files of people who were sterilized and minutes of the Sterilization Board, which summarize their deliberations.  I find this particularly haunting, especially the pre-printed forms used to collect information on people who were being recommended for sterilization.  The NCJSVF's report builds on a lot of work that has been done by journalists -- like the Winston Salem Journal's extensive coverage back in 2002, which was based on historian Johanna Schoen's extensive and important work.  (Schoen's book, Choice and Coercion, appeared from UNC Press in 2005).

North Carolina has been one of the leaders in revisiting historical injustice.  We had a state commission to study the 1898 Wilmington riot and also a truth and reconciliation committee to revisit the 1979 Greensboro massacre.  The current proposal is to provide $50,000 to every now-living victim of sterilization.  This has a long way to go before it becomes law, of course; but that's what's being discussed now.  There is an important discussion that should take place here about what happened and why; I think we need to delve more deeply who was selected for sterilization and why.  And then there's a very important discussion about the moral case for payments and why the current generation should pay for the crimes of past.

Here's a recent article on this from CNN and here is a recent NPR story.  Michael Waterstone of Loyola Law School has more on this at Huffington Post.  Also, here's a link to the State Library's digital collections page with extensive documents on North Carolina Sterilization.

Thoughts on the Super Bowl

I think that NFL head coaches are generally uncreative and extremely risk-averse, and they are absolutely terrible at clock management.  There were several important questionable coaching decisions in the Super Bowl:

1)  Up 9-3 with 10 minutes to go in the first half at the New England 41, Coughlin decides to punt on 4th and 4.  With an expected net punt of 30 yards and against a prolific offense, I'd have taken my chances against the weak Patriots defense.  There's been lots of discussion (in academic circles and elsewhere--see, e.g., the recent HBO Realsports report on the very successful high school coach that literally never punts) about coaches punting too much on 4th and short and this was a classic case.

2)  Down 17-15 early in the 4th quarter, the Giants burn two timeouts because the coaches get the play in too late.  This stuff drives me crazy. In a tight game, timeouts are hugely valuable and coaches throw them away because they obsess over the right play call.  Belichick is great at not doing this.  The extra 5 seconds to choose the "perfect" play is simply not worth the risk of burning a timeout.  And in each case it would've been better to take the 5 yard penalty than burn the timeout. (More on 5 yard penalties being not so bad below.)  Lucky for the Giants it didn't turn out to matter, but this was terrible.  Chris Collinsworth was excellent at criticizing this.

3)  Down 17-15, 1st and goal at the NE 7, 1:07 left, clock is stopped, and NE has two timeouts.  If the Giants kneel down three times (centering the ball in the middle of the field), NE burns its last two timeouts, and the Giants have a perfectly centered 27 yard field goal indoors to win the Super Bowl.  By running the ball, they risk a bad handoff and a fumble and scoring quickly.  At the very least, Coughlin should have told Bradshaw not to score until third down.

4)  Same situation.  New England stuffs the 1st down run, takes a timeout, and then on 2nd down, lets Bradshaw coast into the endzone.  Nice decision (in fact, the NE players should have pushed  or carried Bradshaw into the end zone if they saw he was reluctant to go in himself; while there is a forward progress rule, there's nothing that prevents the defense from pushing an offensive player forward), but the decision was one play too late, costing NE 5 seconds and, much more importantly, one timeout.  Instead of down 4 with 1:00 to and 2 timeouts, NE had only 1 timeout and a few less seconds.  The only explanation for why the "escort into the end zone" strategy came one play late is that Belichick had to explain it to his players and needed a timeout to do so.  But he could have prepared his team for the possibility over the two minute warning.  And, for a supposedly detail-oriented guy, I'm very surprised that he didn't prepare his team for this possibility during practices.  (Again, Collinsworth was right on top of this, well before Belichick appeared to be.) 

5)  Coughlin goes for 2, up 4 with :57 to go and NE has 1 timeout.  If they make it, then NE needs to score a TD and convert the 99.9% PAT to win.  I'd have taken the traditional extra point in case NE happened to score a quick TD.  Then a FG by the Giants wins the game rather than sending it into OT (after they miss the 2 point conversion).  Very unlikely, of course, that NE would score a TD that quickly but I think more likely than a missed PAT in pristene conditions with the Super Bowl on the line.

6)  NE has the ball, down 4, on its own 44, with :17 left and no timeouts.  The Giants end up getting called for 12 men on the field, which actually I think is a great coaching  move, though I'm sure it was unintentional.  There are many endgame (or end-of-the-half) situations where a defensive team will gladly trade 5 yards for 6 seconds.  This was one of them.  Unless NE gets at least 30 yards, the only chance is a hail mary.  So, if I was Coughlin I'd put extra guys on the field and tell everyone to grab an eligible receiver and hold on for dear life (and leave 4 or so safeties back for good measure).  2 plays just like that and NE has the ball at the Giants 45 with at most :06 left.  You can't foul on the last play because the offense will get another play, but the last play is a hail mary.  (Brady might get wise the second time if he sees extra guys on the field and spike the ball immediately, costing only a second or two, but probably not.)   Even better to do this intentioanl foul strategy when the other team has timeouts left, since the clock will stop after each play regardless.   Basketball coaches always use intentional fouls, but football coaches never do it. 

Carrots, Strings, and Power: The New York Times on Ruth Grant’s Strings Attached

My fabulous colleague, Ruth Grant’s, new book, Strings Attached, is reviewed in yesterday’s New York Times.  As a bit of background, Ruth is a Professor of Political Science at Duke University, specializing in political theory with a particular interest in early modern philosophy and political ethics. She is the author of John Locke's Liberalism and of Hypocrisy and Integrity: Machiavelli, Rousseau and the Ethics of Politics. She is also the editor of two collections of essays; Naming Evil, Judging Evil and In Search of Goodness.

But it is her newest book, Strings Attached, that currently has the NY Times’ attention, and mine as well.  In it, Grant frames the ethics of incentives within a broader framework that I find infinitely richer than most that I have come across recently.  Specifically, Grant frames the ethics of incentives within an analysis of power.  In doing so, Grant insists that incentives are more than just a voluntary bargained-for-exchange.  Instead, they are one of the mechanisms employed to get people to do things that they otherwise would not.  As such, they are – like all kinds of power – subject to abuse. 

One of the things that I particularly appreciate about Grant’s analysis is the triad of coercion, persuasion, and incentives that Ruth sets up – all three are exercises of power and all three entail ethical considerations.   All three are also judged under the same standards of legitimacy of purpose, voluntariness, and effect on the character of the parties involved. 

Ruth is quite a bit more skeptical of incentives, and quite a bit more accepting of persuasion, than I am, but her critique of some of the assumptions regarding incentives is important and, for me at least, eye opening.  For example, her historical treatment of the rise of incentives and the insight that incentives are often employed in the context of an authority relationship – adult/child, employer/employee, and government/citizen, for example – is a helpful means of getting a handle on what it is about some incentives that instinctively rub many people the wrong way. 

I am not yet persuaded by Grant’s preference for persuasion versus incentives as a means of facilitating democratic deliberation and decision-making.  Says Grant:

When incentives are employed, there is no need to convince people that collective goals are good or to motivate them to pursue those goals by appeals to rational argument, personal conviction, or intrinsic motivation.  Experts and powerful elites can thus direct institutions and shape people’s choices without the sort of public discussion and consent that ideally characterize democratic processes and decision-making. 

But when we move away from ideal democratic processes to real ones, I am not so sure that the types of persuasion employed by powerful elites or the decision-making processes of those subject to their influence are so benign, or that they fare so well as compared to incentives. 

One last comment on crowding out, which I think is more complex than one would gather from the book and the Times review.  There is a large literature on crowding out, some of which finds support for the crowding out theory and some of which does not.  Moreover, the findings appear to be very sensitive to experimental conditions, such that it is not always clear what factors are driving the experimental outcomes.  Finally, any crowding out effects can sometimes be overcome through other interventions, such as an option to donate any monetary rewards to charity.  In other words, crowding out appears to be a very complicated phenomenon and, in most settings, at least, it would, to my mind, be premature to conclude that we might predict with confidence the outcome of a well-designed incentive structure.

To illustrate, the Times discusses a study, referenced in Strings Attached, in which women offered cash to donate blood were almost 50% less likely to give blood than women who were offered no money.  Male subjects exhibited no such crowding out.  (The NY Times references a “study of British women,” though I believe they mean this study, which is also the one Ruth cites to in the book).  But there is no mention that the study actually measured the willingness of subjects to undergo a health examination, which was a precondition to donate blood, rather than actual blood donations (a test condition that could operate differently on men and women), that the monetary offer was only about US $7, and that the crowding out effect disappeared when subjects were given the option to donate the proceeds to charity.

A more recent NBER working paper by Nicola Lacetera, et. al., Rewarding Altruism? (released after the book was in press, I believe), a natural field experiment involving nearly 100,000 individuals, contradicts these findings.   Lacetera finds a large, positive effect of economic incentives on blood donations, with limited or no crowding out in both the short and long term. They find no gender effects.  All of this is just to say that crowding out appears a complicated phenomenon, and one that we’re still learning about.

Don’t be fooled into thinking that because Grant is a respected political theorist and the book deals with weighty ethical issues it will be dry or abstract.  Grant’s theories and examples are extraordinarily timely and relevant.  The section on IMF loan conditionality caused me to reframe the entire Greek debt crisis debate in terms of coercion, persuasion, and incentives.  And the sections on recruiting medical research subjects (which, perhaps surprisingly, Grant finds relatively benign) and pleas bargaining will be of interest to those working on medical ethics and the criminal justice system, respectively.  A highly recommended read!

BEST Best Picture Ever: Round One, Match #1

                                                    versus       

 

 

 

 

 

 

Additional info here (where you can cast your vote).

My pick?  The one on the left.

More Live Blogging from the Archives

Last week I wrote about a charming vignette from William Henry Holcombe's diary, about one of Holcombe's uncles who drafted a will for a client (later his wife).  Now I want to talk about a more serious topic --  his parents' antislavery action.  Because of his mother's growing antislavery beliefs, the family freed the sixteen human beings they owned.  Still, Holcombe's mother had growing qualms about living in a slave state.  The final push came "when a childless old uncle deposited a will in bank leaving her children two plantations and eighty negroes."  Mrs. Holcombe then "declared the crisis had come and my father, to the amazement of all his friends, sold out, surrendered the most scared ties of his being, sacrificed apparently his best interests, and took al his family, except my oldest brother who had just married, to Indiana."

This is a decision many people made in the South in the years leading into Civil War; what's of particular interest to me is that though they were anti-slavery and took serious action against the institution, their son James P. Holcombe became one of the leading defenders of slavery in 1850s -- and spoke powerfully in favor of secession in the Virginia legislature in March 1861.  That's quite a difference between the generations; but it's a move we hear a lot about in the 1850s, as young Virginians became substantially more conservative than their parents.  Peter Carmichael's fabulous book The Last Generation details this important shift.

What I want to focus on in particular is William Henry's description of the family's conflict with an uncle who prepared a will leaving two plantations and eighty human beings to them.  Don't you love how he mentioned that a will had been deposited in a bank?  Never ceases to surprise me how we can pick up little details of life (and legal culture) from scraps of writing.  Anyway; William Henry described his mother's conflict with her uncle and her effort to get him to change his will:

From their new home, where all were free, this worthy couple opened epistolary fires upon the childless old uncle who had been left behind in a state of great disgust and indignation.  They besought him to change his will to liberate all the slaves, and to leave them all his property, so that they could be comfortably established in some western community.  The old gentleman responded with great bitterness, denouncing their infatuation and folly, but when he died a few years afterwards, his will was found to have been made in exact accordance with my mother’s wishes, and the negroes obtained their liberty and property, without having the slightest knowledge of the sacrifices and efforts of their real benefactors.

Rankings In Lieu Of Book Reviews

Looking at yesterday's New York Times Book Review - the physical version - I was struck by the expansive Best Sellers section.  Back in the halcyon days of my childhood - OK, they weren't particularly halcyon - the Times would run a best-seller list for hardback and paper, with a column each for fiction and non-fiction.  That might take up most of two pages.  In the February 5, 2012 issue, however, Best Sellers (now clearly its own section) starts on page 24 and runs to page 30.  There are ads, to be sure, but the lists take up part or all of six pages. 

I recall when the Times split out children's books simply to get the Potter series out of the way.  It was clogging up space for new books.  Then there were e-books.  But it's clear that something else is going on here.  I can think of a couple of possibilities.  One is on the side of writers and and publishers.  A larger number of lists creates new showcase opportunities for books.  That's good for the business - and presumably one reason why the Times was keen to bump the Potter books into a new space.  But the existence of this mass of lists also reflects a certain decline - or, more generously, an interesting shift - in this most stodgy, intellectual space.  Apparently, the Times has concluded that Book Review readers don't just want to learn more about the final volume from Tony Judt; they like the horserace.  Or perhaps the only people still reading the Book Review are folks in the biz itself. 

Her are the 6 Best Seller lists with 15 sub-lists:

Combined Print and E-Book Best Sellers (fiction/non-fiction)
Print Hardcover Best Sellers (fiction/non-fiction)
E-Book Best Sellers (fiction/non-fiction)
Print Ppaerback Best Sellers (trade fiction/mass-market fiction/non-fiction)
Print Advice, How-To and Miscellaneous (hardcover/paperback)
Print Children's Best Sellers (picture books/chapter books/paperback books/series)

 

Law School Rankings?

As we start the Oscar countdown, should we not also be starting a countdown for the new U.S. News and World Report law school rankings?  Am I remembering wrong or did they come out in March last year?  Do we have any predictions about potential big winners and losers?  Likely upsets?

Is there some way the Oscar trivia folks could come up with a way of making speculation about the law school rankings more entertaining?

e.g. Best Law School of All Time?  Most Undervalued Degree of All Time?  We could start a pool alongside the Best Movie Ever Pool perhaps?

Nah, on second thoughts, let's just stick with the movies...

Opening Lines

I've been thinking a lot of late about opening lines.  This is largely because I'm getting to the end game with University, Court, and Slave.  Err, at the the beginning of the end game anyway -- there's still a lot of revising to go and the concluding chapter (on public constitutional arguments about secession) needs a lot of work.  I'll be testing the final chapter at the University of Florida in March and will be talking about this a bunch over the next few weeks.

Long before I get to the end, I have to finish the beginning.  And so I've been thinking on three of my favorite openings to books.  The first is Marshall Sahlins' line in his much-discussed book, How Natives Think: About Captain Cook, For Instance: "Heinrich Zimmerman heard it directly from the Hawaiians: Cook was Lono."   That captures Sahlins' key theme -- that Captain Cook was believed by the native Hawaiians to be a god.  Little bit of backstory here from an essay I published a few years back on Hawaiian property law: 

Sahlins was engaged in a debate with Princeton anthropologist Gananath Obeyesekere over whether native Hawaiians actually thought that Captain Cook was Lono, a god of the new year—or whether that was merely how westerners thought natives thought.  The question whether natives believed Cook was a god has implications for our understanding of how natives thought.  Obeyesekere opened the debate with a challenge to Sahlins:  that Sahlins’ argument that natives believed Cook was a god indicated Sahlins’ adoption of a western viewpoint.  The western viewpoint,in Obeyesekere’s opinion, was that natives would think some westerner was god.  In fact, westerners since the time of Columbus had told themselves that natives believed them to be gods.  Sahlins responded that Obeyesekere imposed his own set of values on the natives about what is rational.  And so Sahlins turns what was an attack on him for imposing western values (what one might phrase as “of course, the unsophisticated natives must have thought that Cook was Lono”) into a claim that he respected natives’ ideas more than Obeyesekere (maybe some in the west think it’s irrational for natives to think that Cook was Lono, but it made sense within their world).  The exchange is complex and an engaging read, in part for Sahlins’ sparkling prose.  The first line of the book captures the essence of the argument.

Similarly, Brown University Steering Committee on Slavery and Justice's Report, begins with a very elegant line: "Let us begin with a clock."  The clock, which now sits in a meeting room at Brown University was once on a ship that carried enslaved human beings to the new world.

There are longer openings, too.  One of my favorites is Anthony F.C. Wallace's Rockdale.  The book, published in 1972, is a great example of blending social history, based often on quantitative sources, with ideology.

There is a village in American called Rockdale where the people used to manufacture cotton cloth.  It lies along the banks of Chester Creek in Delaware County, in southeastern Pennsylvania, between Philadelphia and Wilmington.  None of the people who worked in the first cotton mills is alive anymore, but some of their children's children still live there, and the ruins of stone factories, as well as stone tenements and fine stone mansions, are yet standing.  Nearby are remains of the other hamlets that made up the Rockdale manufacturing district--Lenni, Parkmount, West Branch, Crozerville, Glen Riddle, and Knowlton--where cotton yarn was spun on mules and throstles and cloth was woven on looms powered by water wheels. ...

As I leave my house on the outskirts of the village, drive the car along the roads, stroll along the paths in the cemetery at Calvary Church, I sometimes fell that I can almost reach out and touch the people I have come to know from their letters and diaries and ledgers, that they are near, behind a thin veil of time.  It was just yesterday, just down the road.  And it was so far away, so long ago ... In a certain mood of elegiacal sentimentality I can see old Rockdale glimmering through a golden haze, where the spinster Sunday School teacher Clementina Smith and her sister Harriet ar still sweetly instructing the mill hands int he elements of Christian faith, and the nervous manufacturer John P. Crozer still sweats over preparing a repor to the Board of Directors of the Delaware County National Bank, and John S. Phillips, that clever mechanicians, still drives his horse Mazeppa in a Byronic fury donw the hills and over the bridges to court the Du Pont girls on the Brandywine, fifteen miles away.

Every time I read those words again, I recall that it's one of my great regrets in life that I didn't take a class with him when I was in college.  Too soon old; too late wise.  But I do plan on making a trip by Rockdale next time I'm visiting Filler in Wallingford, because it's just down the road.  I began to investigate this last summer and I think there's some high-end housing there now -- no surprise in that.

What Does Services Does Planned Parenthood Really Provide?

With the renewed attention on Planned Parenthood, as a result of the Susan Komen controversy, the Washington Post republished a chart that shows the distribution of services provided by the organization.  In this chart, which counts the totality of services - rather than bundling services by recipient - we learn that of the 11.4 million services rendered by PP, 35% are for STD diagnosis or treatment, 35% are for contraception, 16% for cancer screeening and prevention, and 3% for abortion services. 

Methodology is everything, of course, and those critical of PP argue that you shouldn't unbundle services because, for example, a person who seeks an abortion may also be receiving other services.  This appears to be true because these 11.4 million services were rendered to a total of 3 million clients.  Of that number, 329,000 received abortion services - something like 11% of all patients.

Of course, another interesting implication of this data is that individuals who come in for abortion services may also be receiving STD or cancer screening.  This suggests that while abortion services may draw individuals to PP, PP is then able to expand ther services to include procedures that that presumably everyone agrees are positive. If this is true, it suggests that a ban on abortion might reduce abortions but could also cause a spike not only in unregulated abortion services but a dip in provision of these other health-improving services offered by PP and received by patients as an unintended (but desirable) byproduct of seeking legitimate abortion services in the first instance.  (Of course, there is an argument that women who, as a result of an abortion ban,  carry to term,  might receive some of these collateral services anyway - either during prenatal care or at delivery.)  

The BEST Best Picture of All Time is ...

TIME is hosting a bracket-style competition to determine the best Best Picture of all time.  Sixteen films have made the cut, and the first round begins tomorrow (Monday).  Additional info here.

I'm throwing down the gauntlet and inviting last year's host of Oscar Trivia experts Jacqie Lipton, Kelly Anders, Lance McMillian, Colin Miller, and Garrett Levin to join me in this online daily competition.  No doubt other friends (Jeff Lipshaw, are you out there?!?!?) will be part of the fun.

And what sixteen films made the cut?  We'll soon find out.  If I had a say in that decision (trying to keep in mind that "best" may not mean "most popular" or "my personal favorite"), my picks would come from the following list of twenty winners (in order by year):

It Happened One Night (1934)

Gone With the Wind (1939)

Casablanca (1943)

All About Eve (1950)

From Here to Eternity (1953)

On the Waterfront (1954)

The Bridge on the River Kwai (1957)

Ben-Hur (1959)

West Side Story (1961)

Lawrence of Arabia (1962)

My Fair Lady (1964)

The Sound of Music (1965)

The Godfather (1972)

The Godfather II (1974)

Annie Hall (1977)

Gandhi (1982)

Amadeus (1984)

The Silence of the Lambs (1991) 

Schindler's List (1993)

Titanic (1997)

We'll see you on Monday!  Let the competition begin!