Wednesday, January 9, 2019
Thomas J. Brennan (Harvard) presents Distributed Deferral (with Daniel I. Halperin (Harvard)) at Toronto today as part of its James Hausman Tax Law and Policy Workshop Series:
We show that a current tax on income is equivalent to a future tax levied on both the original income and the investment returns it earns, provided that the tax rate is constant and that neither the taxpayer nor the government is subject to certain investment or borrowing constraints. We then show that instead of deferring a tax to a single future point in time, the tax may be broken into components that are distributed periodically over time. There is not a unique method for distributing deferral, but we introduce examples of particular methods, including a “non-increasing” deferral method that taxes returns to the original income periodically but does not tax the original amount itself until it is no longer invested.
Under idealized assumptions, the deferral method used is irrelevant, but in practice the assumptions may be violated and particular choices can lead to different sorts of risks and planning opportunities. The distributed deferral framework offers a set of tools that can spread the risk of tax rate changes over time, allowing a type of income tax averaging and reducing the ability of taxpayers to benefit from occasional low tax rate environments or tax holidays. In addition, distributed deferral can reduce the ease with which budgetary rules like the Congressional budget window may be manipulated.