201702

February 28, 2017 6:22PM

Trump’s Budget Situation

President Donald Trump will lay out some of his budget priorities in an address to Congress tonight. He wants to increase spending on defense, a border wall, and perhaps infrastructure. He also wants to cut taxes and balance the budget, yet does not favor reductions to Medicare or Social Security. His budget chief, Mick Mulvaney, faces a challenge in meshing all those priorities.

The chart shows federal spending in four categories as a percent of gross domestic product (GDP). No doubt, Mulvaney is pondering the CBO baseline projections to the right of the vertical line for 2018-2027. As a share of GDP, entitlement and interest spending are expected to soar, while defense and nondefense discretionary spending are expected to fall. Below the chart, I discuss the ups and downs of the four categories since 1970.

Media Name: 201702_blog_edwards28.png

Here are some of the causes of the fluctuations seen in the chart:

1970s: Defense spending plunges as the Vietnam War subsides in the early 1970s. But the cost of new Lyndon Johnson/Richard Nixon entitlement and discretionary programs skyrockets.

1980s: Ronald Reagan boosts defense spending, and interest costs soar due to the rising debt. But Reagan cuts numerous discretionary and entitlement programs. For example, “income security” programs fall from 1.6 percent of GDP in 1981 to 1.1 percent by 1989.

1990s: The end of the Cold War prompts large defense cuts. But the recession and spendthrift approach of George H.W. Bush causes other spending to rise early in the decade. Bill Clinton lucks out as Social Security spending falls from 4.4 percent in 1992 to 4.0 percent by the end of the decade, while spending on Medicare and Medicaid remains fairly flat.

2000s: Medicare spending soars under George W. Bush, partly due to his Part D drug plan. Bush also pushes up spending on defense, homeland security, food stamps, education subsidies, and other programs. However, Bush benefits from the Fed’s policy of low interest rates, which moderates federal interest costs.

2010s: The recession of 2007 to 2009 causes spending on entitlements—such as unemployment insurance and food stamps—to soar. The Obama stimulus package includes big increases for many discretionary and entitlement programs in 2009 and subsequent years. The early Obama years also include high levels of Iraq and Afghanistan war spending. However, Obama also benefits from the Fed’s interest rate policies.

2018-2027: CBO projections show entitlement and interest costs rising rapidly, and deficits topping $1 trillion by 2023. To sustain economic growth and avert a fiscal disaster, Trump should push to terminate and privatize programs in every federal department. He talks a good game, but we will see whether he is interested in actual budget reforms in coming weeks as he rolls out specific proposals.




Notes: CBO data is here. I adjusted the entitlement line to take out TARP from 2009-2011 because it ended up costing taxpayers little or nothing.

For ways to cut federal spending, see this essay at DownsizingGovernment.org.
February 28, 2017 4:10PM

The End of Self Government?

In Federalist 39, James Madison asks whether the 1787 Constitution

be strictly republican. It is evident that no other form would be reconcilable with the genius of the people of America; with the fundamental principles of the Revolution; or with that honorable determination which animates every votary of freedom, to rest all our political experiments on the capacity of mankind for self-government.

The political scientist John DiIulio, Jr. answers ten questions about big government. He shows that regulations and spending by the federal government have risen a lot over the past half century. At the same time, representatives of the people have less control over the people who implement big government. The feds delegate implementation to state and local governments and contractors. These “agents of the people” by and large, he argues, do a poor job.

DiIulio concludes that Americans “want big government benefits and programs, but they do not want to pay big government taxes and they prefer not to receive their goods and services directly from the hand of big government bureaucracies.” Add some lobbying by contractors and state and local officials, and you have big, incompetent government.

DiIulio recalls Alexander Hamilton’s claim that “the true test of good government is its aptitude and tendency to produce a good administration.” That’s a Hamiltonian thing to say!

Madisonian things ought also be said. The U.S. Constitution promised republican self-government, not efficient tax collection and a skilled civil service. The government DiIulio outlines involves so many people doing so much that elected representatives can hardly be expected to control this vast administrative state. The old hope for republican liberty too has been diminished by the rise of big government.

February 28, 2017 11:24AM

Deductions Could Spell WTO Trouble for the GOP “Border Adjustable Tax” Plan

In a previous Cato blog post, I explained how the House Republican “Better Way” corporate tax plan, which replaces our current 35% corporate income tax with a 20% “destination-based cash flow tax” (DBCFT), could theoretically avoid litigation at the World Trade Organization (WTO) and member countries’ eventual, WTO-approved retaliation against billions of dollars worth of US exports. I concluded therein that, while there wasn’t yet enough concrete information about the DBCFT’s final form to determine its WTO-consistency, the conventional wisdom was wrong to assume that any US corporate tax plan would violate the United States’ international trade obligations. Today, on the other hand, I’ll explain the quickest way that the DBCFT could get into trouble at the WTO. 

Spoiler: it’s all about the deductions.

I won’t reiterate here how the DBCFT is intended to operate and again will acknowledge that we haven’t actually seen any legislative text yet. That said, there is a pretty clear consensus view among economists that the DBCFT would essentially operate as a modified “subtraction-method” value-added tax (VAT) on US corporations’ domestic sales revenue, minus taxable input purchases. This was helpfully summarized in a recent Paul Krugman blog post (emphasis mine):

[A] VAT is just a sales tax, with no competitive impact. But a DBCFT isn’t quite the same as a VAT. With a VAT, a firm pays tax on the value of its sales, minus the cost of intermediate inputs—the goods it buys from other companies. With a DBCFT, firms similarly get to deduct the cost of intermediate inputs. But they also get to deduct the cost of factors of production, mostly labor but also land. So one way to think of a DBCFT is as a VAT combined with a subsidy for employment of domestic factors of production. The VAT part has no competitive effect, but the subsidy part would lead to expanded domestic production if wages and exchange rates didn’t change.

Just so we’re clear that I’m not playing partisan favorites here, Krugman’s view was essentially echoed by Republican/conservative economist Greg Mankiw, who called the DBCFT “like a value-added tax” on corporations’ US sales with “a deduction for labor payments.”

While economists disagree about the economic and trade effects of the DBCFT, the aforementioned descriptions have generated significant (though certainly not consensus) concerns with respect the whether the new tax would be consistent with WTO rules—concerns that don’t arise with a VAT. As I discussed last time, the DBCFT would have to clear at least three hurdles at the WTO—two on the export subsidy side and one on the import side:

  • Export subsidy: The DBCFT would be found to confer prohibited export subsidies under the Article 3 of the WTO Subsidies Agreement where (1) the tax is found to be a “direct tax,” which the Agreement defines as “taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of real property” (VATs are a type of “indirect tax”); and (2) the “border adjustment” (i.e., tax exemption or rebate) for a company’s export sales is greater than the actual amount of tax due or collected.
  • Import discrimination: The DBCFT would violate the “national treatment” principle of GATT Articles II and III (on internal taxes) where it imposes a higher tax burden on an imported good than that imposed on an identical domestically produced product.

The concern among us trade lawyers rests in the deductions for labor and (maybe) land that a VAT doesn’t have but the DBCFT does—deductions that could generate violations of one or more of the aforementioned disciplines. This can be pretty difficult to see in the abstract, but the problems—as well as their absence for a normal VAT—become clearer through a simple hypothetical assessment of the tax’s effect on two identical US companies selling and exporting the same product, with one company selling only imported final goods and the other selling identical products with 100% US content. So let’s do that now, starting with a classic example used by the US Government Accounting Office to show how a standard subtraction-method VAT, which taxes corporations’ domestic (not export) sales revenue and permits one deduction for domestic (and thus taxable) input purchases, works in practice.

Effect of Basic Subtraction-Method VAT (No Export Sales)

The table below illustrates the tax treatment under a standard, 10% subtraction-method VAT for two different value chain scenarios. In this example, we presume no export sales by any company involved to make it as simple as possible.


Scenario 1: US-Only Value Chain (VAT=10%)


 


US Lumber Company


US Baseball Bat Manufacturer


US Retailer


Total


Sales

$20 $70 $80 $170

Taxable (US) Purchases

$0 $20 $70 $90

Net Receipts (i.e., Tax Base)

$20 $50 $10 $80

VAT Amount

$2 $5 $1 $8

 


Scenario 2: Import-Only Value Chain (VAT=10%)


 


US Retailer


Sales

$80

Taxable (US) Purchases

$0

Net Receipts (i.e., Tax Base)

$80

VAT Amount

$8

As shown above, the total effective tax paid on the final product (baseball bats) is the same in both value chain scenarios: $8. (This assumes, consistent with economic theory, that the full amount of the VAT in the US-only scenario is passed through in each stage to the final sale, so the retailer in this example is in effect paying the full $8 tax, even though he’s only paying $1 directly to the IRS. The tax is thus embedded in the “taxable purchases” value in each of the Scenario 1 tables shown throughout.) As a result, concerns that the VAT imposes a higher tax burden on the import-only retailer (Scenario 2)—thus raising a potential import discrimination problem under GATT Articles II and III—are minimal.

Effect of Basic Subtraction-Method VAT (Export Sales)

The next example shows the effects of a US corporation exempting 100% of its export sales value from its tax base (a “border adjustment”). For the sake of simplicity, only the retailer here exports—50% of total sales—in these scenarios.


Scenario 1A: US-Only Value Chain (VAT=10%)


 


US Lumber Company


US Baseball Bat Manufacturer


US Retailer


Total


Sales


US


Export


US


Export


US


Export


US


Export

$20 $0 $70 $0 $40 $40 $130 $40

Taxable (US) Purchases

$0 $20 $70 $90

Net Receipts (i.e., Tax Base)

$20 $50 $-30 $40

VAT Amount

$2 $5 $-3 (credit) $4

 


Scenario 2A: Import-Only Value Chain (VAT=10%)


 


US Retailer


 


US


Export


Sales

$40 $40

Taxable (US) Purchases

$0

Net Receipts (i.e., Tax Base)

$40

VAT Amount

$4

Even with the border adjustment on export sales, the effective tax burden is the same in both value scenarios, thus obviating concerns regarding discriminatory tax treatment against imports under the GATT. Furthermore, this tax raises no concerns regarding prohibited export subsidies because (i) VATs aren’t a “direct tax” under the Subsidies Agreement and (ii) the amount of the tax exemption ($4) for export sales isn’t greater than the amount of the tax that the exporter (retailer) in each scenario would have owed if the baseball bats had just been sold in the United States instead of exported (also $4). As a result, the risk of a WTO challenge to this type of tax system is low.

This risk increases significantly, however, once you add other deductions—such as the wage/salary deduction mentioned by Krugman and Mankiw above—to the corporate tax. This is shown in the next examples.

Effect of a “Modified” Subtraction-Method VAT with Wage/Salary Deduction (No Export Sales)

A provision that permits US corporations to deduct from the tax base both taxable input purchases and domestic wages and salaries would reduce the tax base for all upstream participants in the “US-only” value chain (Scenario 1), thus lowering the total tax paid on the product(s) at issue. However, because a retailer/importer (Scenario 2) would only be able to deduct its own wages/salaries, the imported baseball bats would face higher total tax burden than the 100% American-made baseball bats


Scenario 1B: US-Only Value Chain (VAT=10%)


 


US Lumber Company


US Baseball Bat Manufacturer


US Retailer


Total


Sales

$20 $70 $80 $170

Taxable (US) Purchases

$0 $20 $70 $90

Wages/Salaries

$10 $10 $5 $25

Net Receipts (i.e., Tax Base)

$10 $40 $5 $55

VAT Amount

$1 $4 $0.50 $5.50

 


Scenario 2B: Import-Only Value Chain (VAT=10%)


 


US Retailer


Sales

$80

Taxable (US) Purchases

$0

Wages/Salaries

$5

Net Receipts (i.e., Tax Base)

$75

VAT Amount

$7.50

In the example above, the total VAT paid on the imported good (baseball bats) is now greater ($7.50) than the VAT paid on the American baseball bats ($5.50), thus creating an apparent disincentive to sell the imported bats. In other words, if given the choice between selling an imported bat and an identical American-made bat, the US retailer operating under this “modified” VAT would have a financial incentive to buy American because he’d be paying higher total tax on the import. This same incentive would apply to other companies in the United States, and not just at the retail level. As such, the additional wage/salary deduction—very similar to the one described by Krugman and Mankiw above for the DBCFT—raises serious concerns that the DBCFT would be found to impermissibly discriminate against imports in violation of the United States’ national treatment obligations for internal taxes under GATT Articles II and III. 

One could try to argue that this discrimination is not a WTO violation because (i) it’s equivalent to a labor/wage deduction provided through a separate tax measure like the payroll tax (which raises no WTO concerns); or (ii) its discriminatory effects are eliminated through currency adjustments or through an examination of the actual economic effects of US tax reform as a whole. However, there’s little indication that a WTO panel would undertake such a comprehensive analysis, instead of simply examining the basic, superficial impact of the DBCFT measure itself in a manner similar to what I just did above. Indeed, I doubt WTO Members—including the United States!—would want the WTO to undertake such a speculative economic and legal analysis (and panels have in the past shied away from examining actual trade effects).

The border adjustment for export sales provides one final concern, as shown next.

Effect of a “Modified” Subtraction-Method VAT with Wage/Salary Deduction (Export Sales)

If the “modified” VAT included a border adjustment on exports, while still permitting corporations to deduct 100% of wages/salaries (instead of proportional to export sales), the system could create a higher effective tax on an import-only value chain and a possible subsidy for exports due to the over-exemption of tax otherwise due on export sales. Again, in this scenario only the retailer exports (50% of its sales).


Scenario 1C: US-Only Value Chain (VAT=10%)


 


US Lumber Company


US Baseball Bat Manufacturer


US Retailer


Total


Sales


US


Export


US


Export


US


Export


US


Export

$20 $0 $70 $0 $40 $40 $130 $40

Taxable (US) Purchases

$0 $20 $70 $90

Wages/Salaries

$10 $10 $5 $25

Net Receipts (i.e., Tax Base)

$10 $40 $-35 $15

VAT Amount

$1 $4 $-3.50 (credit) $1.50

 


Scenario 2C: Import-Only Value Chain (VAT=10%)


 


US Retailer


 


US


Export


Sales

$40 $40

Taxable (US) Purchases

$0

Wages/Salaries

$5

Net Receipts (i.e., Tax Base)

$35

VAT Amount

$3.50

In this case, the same import discrimination issue arises as the one noted in the previous example, but the exported baseball bats in the US-only value chain also receive an extra $2.50 tax benefit ($4 in Scenario 1A versus $1.50 in Scenario 1C) due to the labor deductions taken at all stages of the US value chain. It would be difficult to argue, however, that the full value of that labor benefit was due on those exports where only a portion of the labor was used to produce taxable goods (i.e., domestic sales). Put another way, the export sales should not benefit from any tax deduction for labor because they did not generate any tax owed in the first place, and providing this benefit could be considered an export subsidy. Thus, there is a legitimate argument to be made that the DBCFT would generate prohibited export subsidies under Article 3 of the SCM Agreement (over-exemption/rebate of internal taxes owed/due) where it permitted a 100% deduction for a firm’s wages/salaries plus a 100% exemption for that firm’s export sales. That appears to be the case with the DBCFT, though we’ll have to wait for the final legislative text to be sure.

Finally, there is a risk—not shown in the charts above—that the DBCFT would be found to constitute a “direct tax” where it permits so many additional deductions that it more closely resembles a corporate income tax than a VAT or sales tax. In short, the more deductions, the more likely it’s a direct tax (and thus confers prohibited export subsidies, regardless of the over-exemption/rebate of taxes on exports). This question is far murkier, however, that the other two issues above.

Maybe the final DBCFT will resolve these WTO problems by eliminating the extra deductions, or maybe Congress just simply ignores them and takes its chances at the WTO (risking billions in US exports in the process). But that doesn’t mean the problems don’t exist, no matter what some DBCFT cheerleaders might have you believe.

The views expressed herein are those of Scott Lincicome alone and do not necessarily reflect the views of his employers.

February 28, 2017 9:44AM

Why There Is No Fiscal Case for the Fed’s Large Balance Sheet

It is well known that the Federal Reserve System expanded its assets more than four-fold during and after the 2007-09 financial crisis by making massive purchases of mortgage-backed securities and Treasuries. The balance sheet has not returned to normal since. Total Fed assets stand today at $4.45 trillion, up from less than $1 trillion before the crisis. Whether, when, and how to normalize the size of the Fed’s balance sheet have been under discussion for years.

Economist-blogger David Andolfatto — not speaking for his employer the Federal Reserve Bank of St. Louis — now offers “a public finance argument” for “keeping the Fed's balance sheet large.” Viewing the Fed as a financial intermediary, he observes that “The Fed transforms high-interest government debt into low-interest Fed liabilities (money),” and that this is a profitable business.

Curiously, Andolfatto omits to mention two important details: the Fed enjoys such a spread only because it is — for the first times in its history — (a) borrowing short and lending very long, also known as practicing “duration transformation” or “playing the yield curve,” and (b) heavily invested in mortgage-backed securities. The Fed is borrowing short by currently paying 0.75% (not 0.50% as Andolfatto reports) on zero-maturity bank reserves. It lends long by holding 10-year and longer Treasuries (paying 2.42% and up as of 17 Feb. 2017) and long-term mortgage-backed securities.

Andolfatto writes that the Fed’s “rate of return has generally followed the path of market interest rates downward.” While that was true in 2007-08, it should be noted that the Fed’s rate of return largely stopped following the downward path of market interest after 2008. As market rates on five-year Treasuries fell closer to the administered interest rate on reserves after 2008, the Fed shifted from a portfolio maturity of 5 years to one of around 12 years, as if determined to keep its interest income large. This is shown in the following two figures from a 2016 Cato Journal article of mine.

Media Name: Larry-White-Feds-Holding-of-Long-Term-Assets.png



Media Name: Larry-White-Figure-5.png



Here is Andolfatto’s closing pitch for embracing the status quo: “Reducing the Fed's balance sheet at this point in time seems like a needless loss for the U.S. taxpayer. … if the Fed holds the debt, the carry cost is generally much lower. This cost-saving constitutes a net gain for the government. So why not take advantage of it?” The Fed faces an “arbitrage opportunity.” Having the Fed hold Treasury debt, in place of the public holding it, yields a pure arbitrage profit, because the Fed can borrow to carry the debt at a rate lower than the rate at which the Treasury borrows.

Characterizing the situation this way, however, neglects the simple difference between borrowing short and borrowing long. When the Fed borrows short from the banks to lend long to the Treasury, it does not do so costlessly. Duration transformation carries a risk of capital loss, also known as duration risk. Suppose the yield curve shifts up, both short and long interest rates rising together. The Fed will experience a decline in present value of its assets that will swamp the smaller decline in the present value of its liabilities. Such an event is not unknown: in 1979-81 it rendered insolvent about two-thirds of US thrift institutions, who were financing 30-year fixed-rate mortgages with 1- and 2-year deposits. In cash-flow terms, such an event would mean that the Fed would quickly have to start paying higher interest rates to borrow, while its asset portfolio continues to pay low yields and roll over much more slowly. The Fed’s annual net transfer to the Treasury might even go negative. Smaller or negative transfers from the Fed to the Treasury would mean a sudden jump in the present value of the public’s ordinary tax liabilities. Net interest income from playing the yield curve is not a free lunch.

The Fed has also been carrying significant default risk by holding $1.7 trillion of its portfolio not in Treasuries but in mortgage-backed securities. It was not so many years ago that MBS were trading well below par because of their default risk. Indeed it was to push their prices back towards par that the Fed purchased so many.

Responding to a commentator on his blog who pointed out the Fed’s duration risk, Andolfatto remarks: “the duration risk … could be mitigated considerably if the Fed restricted itself to short-duration assets.” He proposes that “If a one-year UST is yielding anything significantly higher than the interest on Fed liabilities, then the Fed can make a profit for the government.” But when we look at the actual numbers, we find that the yield on one-year UST is not significantly higher. The Fed could not in fact continue to make a profit for the government. One-year Treasuries are currently yielding just 82 basis points (0.82%), only 7 basis points more than the 75 basis points that the Fed pays on reserves. Multiplying 7 basis points by the Fed’s $4.45 trillion asset portfolio yields only $3.1 billion in net interest income, less than the Fed’s 2016 budget of $4.5 billion or its ex-post 2015 operating expenses of $4.2 billion. Mitigating the duration risk by going to a portfolio of one-year Treasuries would thus eliminate the Fed’s profit from borrowing from banks and relending to the Treasury.

The principal cases for normalizing the Fed’s balance sheet are (1) the Fed should not distort the allocation of credit by holding trillions in MBS, and (2) normalizing the size of the balance sheet would allow the Fed to normalize the conduct of monetary policy by making bank reserves scarce again. There is no fiscal-free-lunch case for holding off on normalization.

[Cross-posted from Alt-M.org]

February 27, 2017 3:10PM

Not Just the Press

How can unelected judges limit the power of an elected official like the president? Two political scientists offer some answers in The Washington Post.

First, the public should broadly agree “about the basic legitimacy of the procedures used to review the powerful.” Second, the public needs “accurate information about the behavior of public officials.”

The authors say a free press should and does provide that information in various ways. That’s a good answer as far as it goes, but it does not go nearly far enough. Many other parts of our polity have the power and responsibility to provide information about government. To name a few: interest groups, bloggers, think tanks, professors, leakers, labor unions, trade associations, grassroots groups, and many others who might spring to mind with more reflection.

The media does not have a monopoly on informing the public. “The freedom of speech and of the press” belongs to all Americans. This diffusion of power seems especially valuable at a moment when the media lack credibility for so many Americans.

February 27, 2017 1:56PM

War of the Worst Case Scenarios

A few nightmare scenarios haunt the dreams of civil libertarians—scenes drawn from our long and ignominious history of intelligence abuses.   One—call it the Nixon scenario—is that the machinery of the security state will fall into the hands of an autocratic executive, disdainful of the rule of law, who equates "national security" with the security of his own grip on political authority, who is all too willing to turn powers meant to protect us from foreign adversaries against his domestic political opponents, and who lacks any qualms about quashing inquiries into his own illegal conduct or that of his allies.  Another—call it the Hoover scenario—is that the intelligence agencies anxious to protect their own powers and prerogatives will themselves slip the leash, using their command of embarrassing secrets to intimidate (and in extreme cases perhaps even select) their own nominal masters.  As the American surveillance state has ballooned over the past 15 years, we've often invoked those scenarios to argue out that the slippery slope from a reasonable-sounding security measure a tool of anti-democratic repression is disquietingly short and well-oiled. You may trust that some new authority will only be used to monitor terrorists today, but under a more authoritarian administration, might it be used to suppress dissent—as when civil rights and anti-war activists became the targets of the FBI's notorious COINTELPRO?  You may be reassured by all the rigid rules and layers of oversight designed to keep the Intelligence Community accountable, but will those mechanisms function if the intelligence agencies decide to use their broad powers to cow their own overseers?

We are now, it seems, watching both scenarios play out simultaneously.  Perhaps surprisingly, however, they're playing out in opposition to each other—for the moment. Whatever the outcome of that conflict, it seems unlikely to bode well for American liberal democracy.

On the one hand we have Donald Trump, whose thin-skinned vindictiveness and contempt for judicial checks on his whims are on daily display, and who during his presidential campaign revealed a disturbing instinct for lashing out at political opponents with threats to disclose embarrassing personal information. (Recall his tweets promising to "spill the beans" on Heidi Cruz, wife of primary opponent Ted, or his warning that the Ricketts family, which funded ads opposing him, had "better be careful" because they "have a lot to hide".) As a private citizen, Trump treated the legal system as a tool to harass people who wrote unflattering things about him; as a candidate, he thought nothing of offhandedly suggesting he could use the power of the Justice Department to jail his opponent. Even before taking the Oval Office, then, Trump had provided civil libertarians and intelligence community insiders with a rare point of consensus: Both feared that with control of both the intelligence agencies and the institutional checks on those agencies within the executive branch, Trump would fuse a disposition to abuse power with an institutionally unique ability to get away with it.  On the flip side, Trump's dismissive attitude toward the intelligence consensus that Russia had intervened to aid him in the election; his frankly bizarre, fawning posture toward Russia's strongman leader; and his insistence on defying decades of political norms to shield his finances from public scrutiny signaled that inquiries into illicit conduct by himself or his allies and associates would be likely to wither on the vine once Trump loyalists had been installed at the heads of law enforcement agencies. As Nixon scenarios go, to steal a turn of phrase from my colleague Gene Healy, Trump is a civil libertarian's grimmest thought experiment come to life.

And yet.  

For all that, it's difficult not to be a bit uneasy about the way the way the national security establishment, or factions with in it, appear to be pushing back—at least, assuming the leaks that have dominated headlines in recent weeks are originating within the IC. We have witnessed the torpedoing of the president's appointed national security adviser—by means of a decision to illegally leak the contents (or, more precisely, sources' characterizations of the contents) of foreign intelligence intercepts of his phone conversations with the Russian ambassador. That was followed almost immediately by the explosive, albeit vague, news that—contra the administration's denials—senior Trump associates and campaign aides had regular contact with Russian intelligence officials over the past year, though this time without any description of what those conversations concerned.  

The public interest in knowing these facts is clear enough, and under the circumstances, it is not hard to reconstruct why officials within the intelligence community might regard the drastic step of going directly to the press as necessary under extraordinary circumstances.  We can infer that the ongoing investigation into the Trump campaigns Russian ties hasn't turned up any smoking gun evidence of collusion yet, or that would likely have leaked already as well.  Yet there's presumably enough smoke that investigators are anxious to either render it politically impossible for the new administration to kill any ongoing inquiry, or—failing that—ensure that Congress feels constrained to pick up the baton after the agents working the case are reassigned to Juneau.  Critically, however, this is not traditional "whistleblowing" about misconduct that a leaker has observed within their own agency, but rather disclosure of information gleaned from intelligence collection on Americans. 

That ought to raise disturbing echoes of J. Edgar Hoover's notorious "Official and Confidential" and "Personal and Confidential" archives—troves of salacious dirt on public figures that made the FBI director a dangerous man to cross.  As Hoover's aura of omniscience grew over his three decade tenure, policymakers and even presidents were cowed by the prospect of finding their dirty laundry aired in the tabloids should they earn Hoover's ire.  Whether or not the leakers intend it, the perception that the IC is waging war on Trump is likely to resurrect that toxic chilling effect.  The lesson many commentators are now drawing—some apprehensively, a few with gloating enthusiasm—is "getting on the wrong side of the Deep State can be hazardous to your political health," which is an unhealthy notion for officials in a liberal democracy to have lodged in their heads.    

Moreover, the tension between these two scenarios is inherently unstable.  "If you come at the king," as one great political thinker has observed, "you'd best not miss," and doubly so when the king is your employer.  The New York Times recently reported that the Trump would be tapping an old business associate—who notably lacks any intelligence background—to conduct an overarching review of the intelligence community, perhaps as a prelude to a future leadership role. That has reportedly created a fair amount of anxiety in intelligence circles.  Trump allies like Rep. Steve King (R-Iowa) have already ominously suggested that "people there need to be rooted out," and the narrative of a disloyal or hostile intelligence community could help give Trump cover to launch a purge within the agencies and install his own loyalists.

That might be the truly worst-case scenario. The career bureaucracy of the intelligence agencies, whatever its own biases and pathologies, constitutes in practice one of the few real bulwarks against the twin threats of politicized intelligence and abuse of surveillance powers.  Congress, the secret FISA Court, and the IC's Inspectors General conduct largely reactive oversight over the intelligence agencies, typically relying on internal reports of problems or some public scandal to spur them to action. Day-to-day, the primary guarantor we have that intelligence powers are being used lawfully—and that intelligence products reflect a sincere attempt to assess the truth rather than provide cover for an administration's agenda—is the culture within the intelligence agencies, maintained largely by the middle-tier of career professionals who normally serve across multiple administrations.  In what I've somewhat crudely called the Hoover Scenario, the intelligence establishment can become a kind of unaccountable "double government" free to serve its own interests and agendas. But that may be the lesser evil when compared with an intelligence bureaucracy that is too completely the tool of the political branches—more loyal to the president to whom they owe their careers than to the norms and mission of their agencies, and more concerned with keeping him satisfied than telling uncomfortable truths. 

February 27, 2017 9:27AM

Court: IRS, Unlike Caligula, May Punish Only Under Well‐​Proclaimed Law

Judge Jeffrey Sutton, writing for a Sixth Circuit panel, has reversed a Tax Court ruling in an opinion [Summa Holdings v. Commissioner of Internal Revenue] beginning thus:

Caligula posted the tax laws in such fine print and so high that his subjects could not read them. Suetonius, The Twelve Caesars, bk. 4, para. 41 (Robert Graves, trans., 1957). That’s not a good idea, we can all agree. How can citizens comply with what they can’t see? And how can anyone assess the tax collector’s exercise of power in that setting? The Internal Revenue Code improves matters in one sense, as it is accessible to everyone with the time and patience to pore over its provisions.

In today’s case, however, the Commissioner of the Internal Revenue Service denied relief to a set of taxpayers who complied in full with the printed and accessible words of the tax laws. The Benenson family, to its good fortune, had the time and patience (and money) to understand how a complex set of tax provisions could lower its taxes.

And taking issue with the IRS Commissioner’s decision to disallow the combined use of two Congressionally approved devices, the Roth IRA and DISC (domestic international sales corporation), in a way said to trigger the so-called substance-over-form doctrine:

Each word of the “substance-over-form doctrine,” at least as the Commissioner has used it here, should give pause. If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is “substance” when it comes to law. The words of law (its form) determine content (its substance). How odd, then, to permit the tax collector to reverse the sequence—to allow him to determine the substance of a law and to make it govern “over” the written form of the law—and to call it a “doctrine” no less.

[cross-posted from Overlawyered]