Stephen M. Breitstone on Trump's Tax Reform

To the Editor of Tax Note:

Licking their wounds from the healthcare reform debacle, the Trump administration and Republican Congress seem poised to move to comprehensive tax reform, which commentators have suggested may be less controversial. Reforming the tax system without creating a major disruption to our economy may prove to be a surprisingly difficult task. Everyone loves to hate the tax code. But major changes will undoubtedly have unintended consequences — which could turn out to be very bad. While healthcare represents one-sixth of the economy, its size is no doubt dwarfed by our tax system — which aside from borrowing, is how our government pays for just about everything.

The time may be right for comprehensive tax reform. However, certain of the GOP Blueprint proposals could do more harm than good — they are, frankly, misguided. Particularly troubling are proposals to change the taxation of real estate investments.

Harkening back to the 1986 tax reform, the GOP Blueprint purports to broaden the tax base by eliminating deductions and special tax preferences while decreasing rates. In fact, the Blueprint proposals would do exactly the opposite by creating an immediate tax shelter of unprecedented proportions. This would be accomplished by allowing investors to immediately expense newly acquired buildings (but not land). The GOP Blueprint would use immediate expensing to justify eliminating deductions on mortgages, depreciation, and likely section 1031 exchanges. The short-term tax shelter that would result from immediate expensing would be followed by an increase in the effective tax rates on real estate investments, since deductions for mortgage and depreciation would be eliminated as well as section 1031 exchanges, which play a major role in facilitating the real estate market generally.

Ultimately, these changes would almost certainly result in higher rent levels. For multifamily residential owners, to survive they would be forced to increase rents on tenants with modest or low income. As to office and industrial real estate, the rents charged to small businesses would similarly have to rise. As to agricultural real estate, there would be an immediate increase in the effective rate of taxation on these investments, since they would not benefit from immediate expensing but would lose their interest deductions.

The GOP Blueprint purports to take tax planning out of the economic decision-making process, but it would do the exact opposite. These changes would likely overstimulate the real estate industry in the short term by effectively eliminating taxation of these investments (except land) and thus create a bubble. Once the benefit of immediate expensing wears off, the loss of the interest deduction on mortgages would no doubt cause that bubble to burst. Our current system of taxing real estate is much more tax neutral by taxing what is much more reflective of economic income.

Let’s not repeat the mistakes of the 1980s. Aggressive tax incentives were enacted by Congress when Ronald Reagan entered the White House in 1980. At that time, the economy was in the doldrums. Reagan came to office with a mandate to jump-start the economy, and his legislative agenda did just that. Since real estate was in recession, they cut the amortization schedule in half and allowed investors to write off their investment over 15 years. This treatment incentivized capital to flow into real estate investments on a gigantic scale. But it went too far, creating a bubble.

The last comprehensive tax reform passed a bipartisan Congress in 1986. The laudable theme of the Tax Reform Act of 1986 was simplification, base broadening, and the reduction in special tax preferences and so-called “loopholes,” which enabled maximum marginal rates to be reduced from 50 percent to 28 percent. With the passage of the 1986 Act, they corrected the mistake they made in 1980 with real estate by lengthening the depreciation schedule to what we still use today. But the excessive flow of capital into real estate came to an abrupt end. This caused a significant correction and decline in values. This was a major contributing cause of the Savings and Loan crisis, in which thousands of financial institutions failed, demanding a government bailout of more than $125 billion paid for by the taxpayers. In today’s dollars, that would be $281 billion.

Congress now seems poised to repeat the mistakes of the 1980s — perhaps even worse. The GOP Blueprint would enact a much more aggressive tax stimulus than Ronald Reagan’s by allowing buildings to be immediately expensed. Indeed, this may help the GOP with the 2018 mid-term elections. However, it should not go unnoticed that this short-term stimulus will be followed by an effective tax rate increase on these investments that would result from the denial of interest deductions on mortgages — frankly the lifeblood of real estate. This will be coupled with a loss of depreciation deductions and possibly section 1031 exchanges, leaving a tax code in place that would be hostile to real estate investment.

The underlying premise for these fundamental policy changes as stated in the Blueprint is to “reduce tax-induced distortions in investment financing decisions.” Moreover, the Blueprint justifies the elimination of the deduction for interest (coupled with immediate expensing) as a way to avoid a “distortive . . . tax subsidy for debt-financed investment.” In fact, the Blueprint’s proposals would create unprecedented distortions and short-term incentives to make investments whether or not those investments make economic sense. Moreover, denial of interest deductions imposes a penalty on debt financed investments — even those that are not overleveraged. Contrary to the assertions in the Blueprint, in the context of domestically owned real estate held by pass-through entities, the interest deduction does not present an abuse and does not get favored treatment over returns paid on equity. This point is irrefutable.

The Blueprint

As stated, immediate expensing can have a stimulative effect by artificially reducing taxable income when a new investment is purchased, but that short-term benefit has a major cost. Once the up-front deduction has been used, there will be no depreciation deductions and no deduction for interest on debt incurred to finance the investment. At that point, the effective tax rate on income from the real estate investment will be significantly increased. Even though the GOP Blueprint purports to reduce tax rates to a maximum of 33 percent, these real estate investments will be subject to tax at effective rates that could exceed 66 percent or more. This tax increase will probably not be survivable for the overwhelming majority of property owners who rely upon debt to finance their investments. The economic distortions that would result from the GOP Blueprint could be catastrophic.

Commercial real estate values have eclipsed their previous peak in 2007 by 23 percent. Real estate doesn’t need immediate expensing. Immediate expensing can only serve to stimulate imprudent speculation and overinvestment in real estate. The real estate industry and the financial institutions they turn to for financing should be literally screaming in opposition to these changes, which would create an enormous economic distortion and penalty for borrowing. While the Blueprint purports to eliminate tax consequences from the decision as to how to finance an investment, it actually creates a penalty for borrowing. It also undermines the basic economics of these investments by imposing a tax penalty for using leverage — which is the lifeblood for economic growth in the real estate industry. Congress should not attempt to fix what is not broken.

Stephen M. Breitstone
Meltzer, Lippe, Goldstein & Breitstone LLP
Apr. 4, 2017

Will the internet of things result in predictable people?

The question of our age might turn out to be the reverse of the Turing test: will people become programmable like machines?

By Professor Brett Frischmann

Via The Guardian- We’re told that eventually sensors will be everywhere. Not just in phones, tablets, and laptops. Not just in the wearables attached to our bodies. Not just at home or in the workplace. Sensors will be implanted in nearly everything imaginable and they will be networked, tightly connected, and looking after us 24-7-365.

So, brace yourself. All the time, you’ll be be monitored and receive fine-grained, hyper-personalised services. That’s the corporate vision encapsulated by the increasingly popular phrase “internet of everything”.

Techno-optimists believe the new world will be better than our current one because it will be “smarter”. They’re fond of saying that if things work according to plan, resources will be allocated more efficiently. Smart grids, for example, will reduce sizeable waste and needless consumption. And, of course, on an individual level, service providers will deliver us the goods and services that we supposedly want more readily and cheaply by capitalising on big data and automation.

While this may seem like a desirable field of dreams, concern has been raised about privacy, security, centralised control, excessive paternalism, and lock-in business models. Fundamentally, though, there’s a more important issue to consider. In order for seamlessly integrated devices to minimise transaction costs, the leash connecting us to the internet needs to tighten. Sure, the dystopian vision of The Matrix won’t be created. But even though we won’t become human batteries that literally power machines, we’ll still be fueling them as perpetual sources of data that they’re programmed to extract, analyse, share, and act upon. What this means for us is hardly ever examined. We’d better start thinking long and hard about what it means for human beings to lose the ability – practically speaking – to go offline.

Digital tethering in an engineered world

The key issue is techno-social engineering. Techno-social engineering involves designing and using technological and social tools to construct, influence, shape, manipulate, nudge, or otherwise design human beings. While “engineering” sounds ominous, it isn’t inherently bad. Without techno-social engineering, cultures couldn’t coordinate behaviour, develop trust, or enforce justice. Since techno-social engineering is inevitable, it’s easy to get used to the forms that develop and forget that alternatives are possible and worth fighting for.

Think about the world we currently live in. While we benefit immensely from the internet, we’ve become digital dependents who feel tethered to it and regularly pay the steep price of constant connectivity disrupting older personal, social, and professional norms. The old advice of “go offline if you’re unhappy” rings hollow when others constantly demand our attention and not providing it conflicts with widespread expectations that being productive and responsible means being online. Amongst other things, being attached to a digital umbilical cord means daily lives under surveillance and showered with laments about unachievable work-life balance, fear of missing out, distracted parents, and screens being easier to talk to than people.

But the problem runs much deeper, and turns out to be more than the sum of its parts. Georgetown professor Julie Cohen gives the right diagnosis by characterising citizens as losing the “breathing room” necessary to meaningfully pursue activities that cultivate self-development – activities that are separated from observation, external judgment, expectations, scripts and plans. Without freedom to experiment, we run the risk of others exerting too much power over us.

We enjoy this breathing room throughout our lives. We get it in special places, like homes and hiking trails. We cherish it in the in-between spaces, like the walk home from the train or drive to soccer practice. But none of these locations are sacred. Rather, as the invasive pings of our smartphones demonstrate, they’re always at risk.

Find, gather, serve: the digital self

For the moment, we console ourselves with limited governance strategies. We turn notices off. We leave devices behind. We taketechnology Sabbaths and digital detoxes.

Smart homes of the future might follow suit. Perhaps they’ll be programmed to protect some forms of solitude by automating attention-killing tasks. But it’s hard to place much stock in any of this when neither tool nor technique effectively bridges the gap between individual decisions that are deemed counter-cultural and widespread expectations about online commitments.

To make matters worse, it’s difficult to imagine that new forms of pervasive monitoring won’t be invented. And if they are, folks will be told that that life gets better by using them. Take, for example, David Rose, author of Enchanted Objects: Design, Human Desire, and the Internet of Things. He pines for the day when we can stop pestering our spouses and children with questions about how they’re doing, and instead look to kitchens lined with “enchanted walls” that “display, through lines of coloured light, the trends and patterns in your loved one’s mood”. Ironically, minimising human interaction in the always-on environment with automated reports eliminates our freedom to be off.

Entrepreneurial visions like this will profoundly influence the world we’re building. Writer and activist Cory Doctorow observes: “A lot of our internet of things models proceed from the idea that a human emits a beacon and you gather as much information as you can – often in a very adversarial way – about that human, and then you make predictions about what that human wants, and then you alert them.” Concerned about the persistent public exposure that these models rely on, Doctorow identifies an alternative, a localised “device ecosystem” that would allow internet of things users to only “voluntarily” share information “for your own benefit”.

Doctorow is right. We need to think about alternatives. And in principle, he’s got a fine idea. But at best, it’s a partial fix.

The find, gather, and serve models Doctorow justifiably critiques hide the deeper problem of pervasive techno-social engineering, and so his solution doesn’t address it. Our willingness to volunteer information, even for what we perceive to be for our own benefit, is contingent and can be engineered. Over a decade ago, Facebook aimed to shape our privacy preferences, and as we’ve seen, the company has been incredibly successful. We’ve become active participants, often for fleeting and superficial bits of attention that satiate our craving to be meaningful. And Facebook is just the tip of the iceberg. Throughout the current online environment, consumers are pressured to “choose” corporate services that directly manipulate them or sell their data to manipulative companies.

Intense manipulation in the programmable world

Manipulation is thus the other big techno-social engineering issue that needs to be confronted. The power of traditional mass media – think advertisers and news organisations – to shape culture and public opinion is widely understood. But it seems like child’s play in comparison what we’ve seen on the internet and in visions of the internet of things.

For good reason, there’s already plenty of anxiety about precise and customised forms of manipulation. Marketers want to harvest our big data trail to create behaviourally-targeted advertising that exploits cognitive biases and gets absorbed during moments when algorithms predict we’ll experience heightened vulnerability. Communication tools are being rolled out that perform deep data dives, create psychological profiles, and recommend exactly how we should communicate with one another to get what we want. Facebook has shown it’s ready and willing to non-transparently tweak our emotions – and co-opt us into their agenda – just so we find a product engaging. Given just how much nudging is occurring, it’s no surprise that folks are worried about the potential for elections to be determined by “digital gerrymandering”.

The internet of things is envisioned to be a “programmable world” where the scale, scope, and power of these tools is amplified as we become increasingly predictable: more data about us, more data about our neighbours, and thus more ways to shape our collective beliefs, preferences, attitudes and outlooks. Alan Turing wondered if machines could be human-like, and recently that topic’s been getting a lot of attention. But perhaps a more important question is a reverse Turing test: can humans become machine-like and pervasively programmable.

 

Evan Selinger is an associate professor of philosophy at Rochester Institute of Technology, where he also is the head of research communications, community and ethics at the Media, Arts, Games, Interaction and Creativity (MAGIC) Center. Twitter: @evanselinger.

Brett Frischmann is a professor and co-director of the Intellectual Property and Information Law Program at Cardozo Law School. Twitter: @BrettFrischman.

They are both co-authors of Being Human in the 21st Century (Cambridge University Press, 2017), a book that critically examines why there’s deep disagreement about technology eroding our humanity and offers new theoretical tools for improving how we talk about and analyze dehumanization.