Law & Economics Prof Blog

Law & Economics Prof Blog Seeks New Editors

The Law & Economics Prof Blog is on hiatus while we try to put together a new team of editors.  The Law Professor Blogs Network offers law professors the premier blogging platform and the opportunity to share in growing sponsorship and advertising revenues (more information here).  If you are interested in joining the new team of editors in re-launching Law & Economics Prof Blog, please email Paul Caron, owner of the Law Professor Blogs Network.

Comma Heterodoxy

In my last post I wrote:

A. “This is an ingenious, and, after a bit of thought, plausible, justification.”

An alternative is: 

B. “This is an ingenious, and after a bit of thought plausible, justification.”

    The conventional punctuation would be, I think, 

C. “This is an ingenious, and, after a bit of thought, plausible justification.”

or 

D. “This is an ingenious and, after a bit of thought, plausible justification.”

   Which is best?  I like A and B because they follow the spoken rhythm better, with a preference for B now that I've thought about it longer. I'm not sure about whether there should be a comma after "ingenious". Any thoughts? 

 

"To Each According to His Need," Including Opera

Taxprof reports on Miranda Fleischer's latest: 

Miranda Perry Fleischer (San Diego), How is the Opera Like a Soup Kitchen?, in The Philosophical Foundations of Tax Law (Oxford University Press, 2016):

The charitable tax subsidies are, at heart, redistributive. Some individuals (the recipients of charitable goods and services, such as students, museum-goers, and soup kitchen patrons) receive benefits. Other individuals pay for these benefits, both voluntarily (through donations) and involuntarily (in the form of higher taxes or reduced benefits). At first glance, it appears that the redistribution effectuated by the subsidies violates commonly-held notions of distributive justice. After all, the subsidies treat charities that serve the wealthy (like the opera) the same as charities that aid the poor (such as the soup kitchen). How can spending public funds on the wealthy in this manner be considered just? As this Chapter shows, so doing is just under expansive interpretations of resource egalitarianism and left-libertarianism that account for expensive tastes and talent-pooling. These understandings argue that individuals with expensive tastes deserve compensation to put them on equal footing with individuals with ordinary tastes when pursuing their visions of the good life – just as individuals who lack financial resources deserve compensation to put them on equal footing with the financially-advantaged when pursuing their life plans. Subsidizing not only the soup kitchen but also the opera thus helps a variety of individuals who are disadvantaged in their ability to pursue their visions of a good life to achieve those visions.

This is an ingenious, and, after a bit of thought, plausible, justification. It is related to me and my brother. I became a professor, he an investment advisor, and he earns much more money. That is good and just, though, because ever since he was a boy he has had more expensive tastes. "To each according to his need" has implications Marx didn't think about. 

At Missouri, Humanities Professors Support a Communications Professor; at Yale, Science Professors Support a Sociology and Psychology Professor

   What induces professors to sign letters of support for their colleagues  who are under attack? I was under public attack a few years back, and although few actual faculty members attacked me (the Chancellor being  an exception,  while chairing a faculty senate meeting and sitting fifteen feet away from me), none publicly supported me either, and I sensed an atmosphere of fear of public opinion. A couple of recent cases provide interesting data. Roughly speaking, at Missouri  faculty from the humanities supported a colleague under attack, and at Yale faculty from the sciences did, both with a few exceptions from other fields. What is interesting is that of the 116 Missouri signers, 84 were from humanities departments and just 4 were from science departments, while of the 90 Yale signers, 41 were from science departments and 6 from the humanities (all from language or music departments). I excluded psychology from science, but added math and computer science, and did the best I could for Yale to decide which professors in the medical school were scientists.

    Missouri had 0 signers from economics, 0 from the business school and 1 from law. Yale had 3 from economics,  11 from the business school, and 1 from law.  The Missouri professor was in communications and journalism (5 signers) and the Yale professors were in psychology and sociology (18 signers).

Continue reading

Must the Directors Keep the Corporation's Taxes Low If They Can?

I just read about  Freedman v. Adams, 2012 Del. Ch. LEXIS 74, at *45-46 (Del. Ch. Mar. 30, 2012) at Taxprof and the original discussion by Prof. Hemel at the Chicago Law blog.  It's a good example of  a corporate law case, the kind of situation good for an exam, perhaps.  Part of it is about whether the shareholder plaintiff should get a million dollars in "legal fees" (quantum meruit would be vastly smaller, another issue) because the directors paid unnecessary taxes by using a thoughtless compensation plan. 

It isn't a "duty" to avoid taxes, but only in the technical legal sense. Director and CEO are supposed to act for the good of the shareholders. That generally means they are supposed to maximize profits, though I, and I think most others, think that the director can sacrifice profits if the shareholders prefer something else (e.g., closing on Sundays).

What the Freedman court holds is sound: that tax decisions fall under the business judgement rule. That means the directors can make stupid decisions, as long as it's not on purpose, to help themselves, or by being exceptionally lazy. In Freedman, their decision seems stupid, but innocent.
Question: If the CEO and chief counsel have contracts that allow them to be fired without severance pay "for cause", and they advised on this decision (I don't remember those details), can the Board fire them for cause?

 

 

The Cost to Harvard Law School of Repudiating the Royall Bequest

   Some students at Harvard Law School want to eliminate the Royall crest from its seal on account of donor Royall’s slaveowning.  Presumably this means they want to repudiate the Royall gift. How much money would that cost the Law School,  how would it pay for it, and who should get the money instead?

   First, the gift. Mr. Royall left land to Harvard, in a will that was probated in 1786.  If Harvard Law returns the value of the gift and all the money it earned for the school along the way now, that's equivalent to asking what was the value of the original gift plus everything it earned along the way.

  By 1815, the land's  value was $7,593 and the school had kept $432 of its past income, for a total of $8,025. My source says Harvard earned 6% annually.  It's 2015 now, so let see what the value would be if reinvested for those 200 years at 6%.   That 2015 value is, using  the standard future value formula from finance (in which 2.7 =  Euler's constant),

Continue reading

The Value of Skadden's Tax Opinion Letter in the Yahoo Alibaba Spinoff Deal

Professor Victor Fleischer's just written Yahoo’s Spinoff Plan Could Be Risky Business for the New York Times. Yahoo is thinking of spinning off its stock in Alibaba as a separate entity, but this could result in huge taxes on the capital gains. Thus (with my boldface in this lengthy excerpt): 

Continue reading

Zuckerberg's use of an LLC for giving away his fortune--what good is it?

Mark Zuckerberg has announced he is setting up an LLC as a way to give away 99% of his fortune, which consists mainly of Facebook stock. I was puzzled by this at first, because doing it this way has no tax advantages. The LLC is a for-profit enterprise, so (a) he gets no deduction for giving away his stock, (b) if the LLC sells the stock, Zuckerberg pays the capital gains (it must be the basis is *not* stepped up to the time of donation, since that would be too good as a tax dodge), and (c) Zuckerberg needs to pay tax on the LLC income.

What I think is going on is that this is a personal accounting device, like having a separate bank account for charitable giving. The LLC will donate the stock to charities and never earn capital gains. The stock pays no dividends, so it has no income. And Zuckerberg is retaining enough stock that he can give away directly that he will hit the 50% limit on donation deductions each year anyway, so he can't use the stock donations for deductions in any case.

Anybody know if this is correct?

Schmeiser et al.: Informing student borrowers about debt burdens reduces borrowing

"Does Salient Financial Information Affect Academic Performance and Borrowing Behavior Among College Students?"  
FEDS Working Paper No. FEDGFE2015-75

MAXIMILIAN D. SCHMEISER, Federal Reserve Board
CHRISTIANA STODDARD, Montana State University - Bozeman
CARLY URBAN, Montana State University - Bozeman - Department of Agricultural Economics and Economics

While rising student loan debt can plague college students future finances, few federal programs have been instituted to educate college students on the mechanics of student loan borrowing. This paper exploits a natural experiment in which some students received "Know Your Debt" letters with incentivized offers for one-on-one financial counseling. Montana State University students who reached a specific debt threshold received these letters; University of Montana students did not. We use a difference-in-difference-in-differences strategy to compare students above and below the thresholds across campuses and before and after the intervention to determine how the letters affect student behavior. Employing a rich administrative dataset on individual-level academic records and financial aid packages, we find that students receiving the letters borrow an average of $1,360, less in the subsequent semester -- a reduction of one-third. This does not adversely affect their academic performance. In fact, those who receive the intervention take more credits and have higher GPAs in the subsequent semester.

Buonanno & Vanin: Social Cohesion Lowers Some Crime, Increases Tax Avoidance

"Social Closure, Surnames and Crime"  
Quaderni - Working Paper DSE N° 1032

PAOLO BUONANNO, University of Bergamo - Department of Economics
PAOLO VANIN, University of Bologna - Department of Economics

This paper studies the effect of social closure on crime and tax evasion rates using disaggregated data for Italian municipalities. It measures the degree of social openness of a community by the diversity of its surname distribution, which reflects the history of migration and inbreeding. It shows that, all else equal, communities with a history of social closure have lower crime rates and higher tax evasion rates than more open communities. The effect of social closure is likely to be causal, it is relevant in magnitude, statistically significant, and robust to changes in the set of included controls, in the specific measures of dependent and independent variables, in the specification of the regression equation, and in the possible sample splits. Our findings are consistent with the idea that social closure strengthens social sanctions and social control, thus leading to more cooperative outcomes in local interactions, but it reduces cooperation on a larger scale.

[Ed.: Another fun, if not 100% convincing, identification strategy.]

Anderson et al. on Traffic and Happiness

"Superstitions, Street Traffic, and Subjective Well-Being"  
NBER Working Paper No. w21551

MICHAEL L. ANDERSON, U.C. Berkeley - Department of Agricultural and Resource Economics
FANGWEN LU, University of California, Berkeley; YIRAN ZHANG, Renmin University of China
JUN YANG, Beijing Transportation Research Center; PING QIN, Renmin University of China

Congestion plays a central role in urban and transportation economics. Existing estimates of congestion costs rely on stated or revealed preferences studies. We explore a complementary measure of congestion costs based on self-reported happiness. Exploiting quasi-random variation in daily congestion in Beijing that arises because of superstitions about the number four, we estimate a strong effect of daily congestion on self-reported happiness. When benchmarking this effect against the relationship between income and self-reported happiness we compute implied congestion costs that are several times larger than conventional estimates. Several factors, including the value of reliability and externalities on non-travelers, can reconcile our alternative estimates with the existing literature.

[Ed.: A fun and clever new identification strategy.]

Lawyers Bite Apple, Declare It's an Orange

Bar scores for new lawyers dropped last year.  This lead the administrators of the nationwide portion of the state tests to declare that us law professors were either admitting weaker students, or failing to prepare them adequately (too much "practice ready" and not enough doctrine, maybe?).  It could be true that scores were lower because the test-takers were not as able, but then I could also be a Martian or a Soviet spy.  There's really no evidence of any of those.

What about those lower scores?  Well, the administrators served up a different test, adding a new section (civil procedure) to the prior six subjects.  A basic statistics quiz: you have two populations, A and B, and two treatments, gamma and delta.  You apply treatment gamma to A and delta to B, and observe different results.  What can you infer about the differences between A and B?

So, yeah, I will start paying attention to this story right after I get back from my meeting with Kruschev.  

Who Wants the Fed to Raise Rates?

The Fed left interest rates alone, and not everyone is happy about that.  As Matt Yglesias argues, leaving rates low indefinitely is at least defensible, as long as inflation stays as low as it is (fuel prices are creating a lot of deflationary pressure here and elsewhere).  So who are the people clamoring for higher rates, and why are they clamoring?  

Maybe some of the clamor is related to compensation structures.   Lots of fund managers get paid based on their clients' returns -- most famously, private equity managers get 2 & 20, where the 20 is a slice of the nominal gain in asset value.   In an environment where the fed funds rate is so low, returns to all assets are lower.   The manager gets paid the same 20% regardless of whether the client could have earned almost the same money investing in treasuries.  So, from the manager's perspective, why not push that rate up?

On the other hand, fund managers also win if Yglesias is wrong and the current loose money policy creates inflation.  The 20 percent is typically based on nominal, not real, returns.  So the client bears most inflation risk.  (This is, of course, quite different from the usual arrangement for salaried workers -- why is this allocation of inflation risk optimal for fund managers but not CFOs?)

So, long story short, two points.  One, as always, is that it's good to be a fund manager.  Another is that, before heeding the money-tightening whispers, it's worth considering what the financial interests of the whisperers might be.  

Manns on Rating the Rating Agencies

"The Reciprocal Oversight Problem"  
Iowa Law Review, Forthcoming

JEFFREY MANNS, George Washington University Law School

Sovereign ratings are designed to mitigate investors’ risk exposure by highlighting the fiscal condition of governments. The problem is that sovereign ratings entail reciprocal oversight of rating agencies and sovereign governments — which raises conflicts of interest and, ironically, creates incentives for distorted risk assessments. Private rating agencies hold sovereign governments accountable by assessing their risk exposure, while sovereign governments hold rating agencies accountable through regulation. Both sovereign governments and rating agencies have incentives to leverage their mutual oversight to obscure risk taking and minimize accountability. During booms, governments and rating agencies have convergent interests in understating risks until market bubbles are on the cusp of bursting because bubbles produce higher tax revenue and profits. During busts, both sides blame one another for failing to accurately gauge risks, which fosters regulatory stalemates that perpetuate the absence of public and private accountability. [...]

Overseeing rating agencies is difficult for sovereign governments because they face the temptation to abuse regulatory powers to neutralize rating agencies’ ability to push back and expose the fiscal overstretch of governments. [...] [T]his Article advocates an intermediation strategy of integrating a broader array of ratings stakeholders into a stakeholder regulatory organization to oversee the industry. A range of stakeholders rely on the accuracy and integrity of ratings and would have an interest in ensuring that rating-agency regulation balances the need for greater procedural and substantive accountability with the need for rating-agency independence from the government. [...] [T]he logic is that integrating end users of ratings into deliberative processes will mitigate industry biases and produce rules that preempt the need for government regulation.

Walker: Understanding the New Performance-Based Pay

"The Way We Pay Now: Understanding and Evaluating Performance-Based Executive Pay"  
Boston Univ. School of Law, Law and Economics Research Paper No. 15-34

DAVID I. WALKER, Boston University School of Law

Over the last ten years, performance-based equity pay, and particularly performance shares, have displaced stock options as the primary instrument for compensating executives of large, public companies in the U.S. This article examines that transformation, analyzing the structure and incentive properties of these newly important instruments and evaluating the benefits and risks from an investor’s perspective. Notable observations include the following: Although technically “stock” instruments, performance shares mimic the incentive characteristics of options. But performance shares avoid the tax, accounting, and other constraints that have led to uniform grants of non-indexed, at the money options. Performance share plans can be designed to be effectively in, at, or out of the money and these plans often employ relative performance measurement that makes them analogous to rarely observed indexed stock options. But the opacity of performance share plans creates risks for investors, and the two accounting approaches applicable to these instruments both result in systematic undervaluation for executive pay disclosure and financial reporting purposes. Given the growing dominance of these instruments, this article advocates the adoption of a mark-to-market accounting regime for all equity compensation

Cuffe & Gibson: The Effect of Payday Lending Limits on Liquor Purchases

"The Effect of Payday Lending Restrictions on Liquor Sales" 

HAROLD CUFFE, Victoria University of Wellington
CHRISTOPHER G. GIBBS, UNSW Business School

We exploit a change in lending laws to estimate the causal effect of restricting access to payday loans on liquor sales. Leveraging lender- and liquor store-level data, we find that the changes reduce sales, with the largest decreases at stores located nearest to lenders. By focusing on states with state-run liquor monopolies, we account for supply side variables that are typically unobserved. Our results are the first to quantify how credit constraints affect spending on liquor, and suggest mechanisms underlying some loan usage. These results illustrate that the benefits of lending restrictions extend beyond personal finance and may be large.

Corporate Income Tax Incidence

Professor Daniel Shaviro of NYU has a good blog post on September 2, "Arnold Harberger's famous 1962 article on corporate tax incidence."
The simplest way to tink about the corporate income tax is to think that it is borne by capital, because corporations are more capital-intensive than non-corporate businesses (an assumption that might not be true, actually, but let's suppose it is). But Harberger makes a point I hadn't understood before reading Professor Shaviro.

Harberger's insight is that all this changes when only some capital income is being taxed--- from the capital in corporations--- and the capital-labor ratio in a business is flexible. Suppose, as in his particular model,  that non-corporate businesses are less able than corporations to substitute between capital and labor. Then when corporations switch away from capital to labor, pushing capital into the non-corporate sector, the demand for labor increases more in corporations than it falls in non-corporations. Wages rise, so workers win and capital-owners lose. But that's only because of the assumption that corporations have more flexible production, which Harberger himself later came to think was false, and which is certainly debatable.

The Incidence of the Corporation Income Tax. Arnold C. Harberger. The Journal of Political Economy, Vol. 70, No. 3. (Jun., 1962), pp. 215-240.

Harberger is my perennial choice for the Econ Nobel Prize. He's 91 now, still alive!

 

Danaher et al. on Whether Blocking Free Streaming Cites Reduces Piracy

"The Effect of Piracy Website Blocking on Consumer Behavior" 

BRETT DANAHER, Wellesley College - Department of Economics
MICHAEL D. SMITH, Carnegie Mellon University - H. John Heinz III School of Public Policy and Management 
RAHUL TELANG, Carnegie Mellon University - H. John Heinz III School of Public Policy and Management

[...] In this paper we seek to study how consumer behavior changes when Internet Service Providers are required to block access to major piracy websites. We do this in the context of two court-ordered events affecting consumers in the UK: The blocking order directed at The Pirate Bay in May 2012, and blocking orders directed at 19 major piracy sites in October and November 2013.

Our results show that blocking The Pirate Bay had little impact on consumption through legal channels — instead, consumers seemed to turn to other piracy sites, Pirate Bay “mirror” sites, or Virtual Private Networks that allowed them to circumvent the block. In contrast, blocking 19 different major piracy sites caused users of those sites to increase their usage of paid legal streaming sites such as Netflix by 12% on average. The lightest users of the blocked sites (and thus the users least affected by the blocks, other than the control group) increased their clicks on paid streaming sites by 3.5% while the heaviest users of the blocked sites increased their paid streaming clicks by 23.6%, strengthening the causal interpretation of the results.

Our results suggest that website blocking requires persistent blocking of a number of piracy sites in order to effectively migrate pirates to legal channels.

Chan et al. on the interconnection of household debts

"Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays"  
FRB of New York Working Paper No. FEDNSR732

SEWIN CHAN, New York University (NYU) - Robert F. Wagner Graduate School of Public Service
ANDREW T. HAYASHI, University of Virginia - School of Law
ANDREW HAUGHWOUT, Federal Reserve Bank of New York
WILBERT VAN DER KLAAUW, Federal Reserve Banks - Federal Reserve Bank of New York

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and HELOCs at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage non-recourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for both housing and non-housing debts. Our analysis highlights the interconnectedness of debt repayment decisions

In New Jersey, cutting in half the number of drug convictions would reduce prisons by just 3%

From the New York Times via Marginal Revolution: 

A new interactive “prison population forecaster,” posted online Tuesday by the Urban Institute, a liberal-leaning think tank in Washington, aims to help fill that void and yields some sobering conclusions.

The interactive program allows you to assess for yourself the impact of different policy changes. Cut in half the sentences for those convicted of property crimes? Inmates in 2021 are down by 10 percent....

I was startled by these calculations for New Jersey, for example: Cutting in half the number of people sent to prison for drug crimes would reduce the prison population at the end of 2021 by only 3 percent. By contrast, cutting the effective sentences, or time actually served, for violent offenders by just 15 percent would reduce the number of inmates in 2021 by 7 percent — more than twice as much, but still hardly the revolution many reformers seek.