Category: Economic Policy

What’s The Matter With Kansas?

“Masquerading as a man with a reason
My charade is the event of the season
And if I claim to be a wise man
Well, it surely means that I don’t know” – Kansas, 1976

The state, not the group. In 2010, Republican and former US Senator, Sam Brownback was elected governor on promise of restoring the state’s economy. In 2012, he signed a massive tax cut into law, arguing that it would be a big boost the economy. Eventually, he hoped to eliminate individual income taxes entirely:

I think we can, I really do…The experiences in some other states have been that when you cut income taxes, your sales tax increase more than makes up for your income tax cut

Supply-side economics was the basis of his optimism. Tax cut proponents like economist Arthur Laffer insist that if you cut taxes deeply enough, the resultant boom in economic activity will boost revenues. It’s magic, painless. It’s what every politician wants. And Sam Brownback and the Kansas legislature went all-in: In 2012, the Kansas legislature:
• Cut individual tax rates by 25%
• Repealed the tax on sole proprietorships and other “pass-through” businesses
• Increased the standard deduction

In 2013, the legislature cut taxes again, passing a measure to gradually lower rates even more over five years. By 2018, the top rate, which was 6.45% in 2012, will fall to 3.9%. The Center on Budget & Policy Priorities (CBPP) has a nice summary of the tax changes.

So what happened after all those tax cuts? Revenues collapsed. Kansas reported that it took in $338 million less than expected in the 2014 fiscal year and would have to dip heavily into its reserve fund. From June, 2013 to June, 2014, all Kansas tax revenue plunged by 11%. Individual income taxes fell from $2.9 billion to $2.2 billion and all income tax collections plummeted from $3.3 billion to $2.6 billion, a drop of more than 20%. Keep in mind that these are actual year-over-year declines in revenues, not projected shortfalls in revenue. They come at a time when the national economy is recovering, and most other states are enjoying increases in tax collections. The cuts, largely benefiting the wealthy, cost the state 8% of the revenue it needs for schools and other government services. As the CBPP noted, that’s about the same economic effect as a midsize recession.

Yet, there were excuses from Brownback in the past few weeks:

It’s the price of creating jobs

Since the first round of tax cuts, Kansas job growth has lagged the US economy. So has Kansas personal income. While more small businesses were formed, many of them were individuals taking advantage of the newly tax-free status by redefining themselves as businesses, now allowed under the Kansas tax code. Kansas’ non-partisan Legislative Research Department estimates Brownback’s tax cuts will cost the state $5 billion in lost revenue by 2019. To put that in perspective, Kansas currently has an $8 billion annual budget.

As a result, Moody’s cut the state’s debt rating in April for the first time in at least 13 years, citing the tax cuts and a lack of confidence in the state’s fiscal management.

Kansas is required to balance its budget every year, so when its surplus runs out, further spending cuts will be necessary. The declining revenues have necessitated extensive cuts in state education funding, according to the CBPP.

Brownback is up for reelection, but given the problems with his economic program, he is having trouble in the polls. A recent poll by PPP shows that Brownback’s approval rating has plummeted. In the most recent poll of the race, Democrat Paul Davis leads Brownback by 6 points.

You don’t cut revenue based on a theory. If you cut revenues, you cut your expenses by the same amount. You don’t gamble on possibilities, you make sure you will be fiscally sound. By cutting revenues and hoping for a large return because a THEORY says it should happen, means Brownback was gambling with the future of the State of Kansas.

Has Brownback never heard the adage: “Don’t gamble what you cannot afford to lose?”

Some of those old adages are pretty sensible, while some governors are not.

 

 

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Only Chumps Pay Taxes

Corporate America knows it has a problem when Fortune Magazine calls them out. Fortune has an article by Allan Sloane called “Positively un-American tax dodges.” The headline shows their opinion about large US companies who are moving their “headquarters” overseas to dodge billions in taxes, meaning the rest of us will have to pay their share. From Sloane: (brackets by the Wrongologist)

[There is] a new kind of American corporate exceptionalism: companies that have decided to desert our country to avoid paying taxes but expect to keep receiving the full array of benefits that being American confers, and that everyone else is paying for

One of the companies that is moving offshore is Medtronic, a Minnesota-based medical device manufacturer that is heading to Ireland. But only for tax purposes. The Irish Independent quotes Medtronic’s CEO:

Some people have misinterpreted the recent announcement that we are acquiring an Irish company and declaring our principal executives’ offices in that country to mean that we are leaving Minnesota… Nothing could be further from the truth. The Medtronic operating headquarters where I go to work every day will stay right where it is in Fridley, MN

This is called “Inversion” in tax law circles. Companies buy a foreign-headquarted firm and then make it the parent company for tax purposes. In their quest to maximize shareholder value, multinational companies have outsourced labor to lower-wage countries and shifted profits to subsidiaries in lower-taxed countries. If inversion mergers take hold, it will make matters worse. More from Fortune:

All of this threatens to undermine our tax base, with projected losses in the billions. It also threatens to undermine the American public’s already shrinking respect for big corporations

Here is a picture of how US after-tax corporate profits have grown over the decades:

Corp ATax profits 2014

Since the start of the Reagan era, except for the 2008 recession, it’s been a ride into the stratosphere for Corporate America. Corporations have successfully lobbied Congress for endless deductions and loopholes. From 2009 to 2011, the 280 most profitable companies paid just 18.5% in Corporate Taxes, about half the 35% statutory tax rate. In 1952, corporate taxes accounted for fully one-third of federal revenues, but in 2013 amounted to just under 10%.

And these guys think more is never enough. French economist Gabriel Zucman observes that:
• 20% of all corporate profits in the United States have moved offshore
• Tax avoidance costs the government one-third of the tax revenue it should be receiving from corporations

Zucman also found that $7.6 trillion of personal wealth is hidden in tax havens, which amounts to 8% of the world’s total personal wealth. He estimates the global tax revenues would increase by more than $200 billion if these tax avoidance practices were ended.

The issue is: (h/t Steve Pearlstein) Companies moving their tax jurisdiction want all the rights and privileges of being an American company without paying for the full complement of services that come along with doing business in America.

They want the security that a big military makes possible, one that allows them to operate in all of the advanced economies of the world. They want the world’s most enforceable patent system to protect their intellectual property. They want a fair and efficient judicial system to enforce contracts.

They want a well-educated workforce to design their products, often relying on basic research often done through an extensive network of government-funded institutes and laboratories. They want modern ports and highways and airports to ship products to market.

They require an efficient financial system to provide cheap and plentiful capital. They demand professional, credible regulatory agencies that can expeditiously evaluate products and ensure customers that they are safe and effective.

All of that takes lots of tax revenue. It has to include revenue from corporate income taxes that these firms think is their fiduciary duty to avoid.

It was bound to happen: The government that Corporate America bought for their exclusive use, just isn’t doing a good enough job, so the Corporatists are gonna leave.

Our tax systems must be reformed. We need to take the job of tax reform away from corporate lobbyists. We must make it harder for companies to use internal (“transfer”) pricing to avoid taxes. Companies should be made to book activity where it actually takes place. Barry Ritholtz mentions an idea in the Republican-sponsored Tax Reform Act of 2014 that “fixed” inversion: An annual tax of 8.75% on cash (and equivalents) held offshore, plus 3.5% a year on all other retained offshore earnings. The idea was to reduce the incentive to incorporate offshore by charging taxes on top of the charge by the other locality, be it Ireland or the Cayman Islands. It went nowhere.

Any new system needs to ensure that change results in corporations paying more in taxes with less collection/compliance expenses. The new system must be simpler than today’s.

As Jacques Leslie writes, “there is no economic, political or moral justification for tax evasion.”

 

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China: Competitor, or Enemy?

What’s Wrong Today:

The relationship between China and the US is that of a rising power confronting a status quo power. China’s emergence as a challenger to the current global power structure and to the US as the world’s dominant power is based in part on challenging its neighbors, Japan, the Philippines and Vietnam in order to consolidate its maritime interests in its territorial waters and beyond. In each of these situations,
it will confront our proxies, or it will confront the US.As
Professor David Lai of the US Army War College asks: Is
the Pacific Ocean big enough for China and the US? His answer is, maybe not.

China’s recent assertiveness on the global stage is based upon their economic growth in the past 25 years. China’s spectacular growth is hard to wrap your
mind around. Bill Gates helpfully tweets:

Gates shares Vaclav Simil’s book, Making of the Modern World, in which Simil argues that the most important man-made material is concrete. Concrete is the literal foundation for the massive expansion of urban areas globally for the past several decades. In 1950, the world made roughly as much steel as cement (a key ingredient in concrete); by 2010, steel production had grown by a factor of 8, but cement had increased by a factor of 25. This animated GIF from The Atlantic shows the dramatic transformation of the Shanghai skyline since 1987. Most of what you’re seeing in that picture is new concrete, steel, and glass.

So, in the next 25 years, the US won’t grow as fast as China has for the past 25 years. That means that China is likely to become the world’s largest economy.
What will that mean for America? Let’s compare our economies today. Start by remembering what makes up GDP. From our barely remembered college econ 101
course comes the formula: GDP = Consumer spending + Investment + Government spending + the Net of imports and exports. So to compare the US and China:

 

GDP =

C
+

I
+

G
+

NX

US

$16.6T

71%

13%

16.5%

-.5%

China

$  8.2T

35%

48%

13%

3%

Source: Dr. John Troxell, Army War College

China’s economy is about half the size of ours, and investment spending drives it. That explains all of the new
buildings and new infrastructure that is reshaping its landscape. That investment has brought 600 million people out of poverty and added 200 million Chinese to the middle class. In order to sustain its growth, China’s challenge is to move more of its GDP to consumption, since government investment in infrastructure cannot continue at current levels forever. Looking at GDP/capita, it is $49.9k in the US and $6.1k in China, so they have a ways to go for the average Chinese to meet our standard of living, or to catch the US economy. 

Given that China is a strong economic competitor that is morphing into a challenger to our role as the only superpower, what should our strategy be in dealing with them?

Should we consider them an “enemy”?

In the business world, all companies compete for market share with a variety of other firms. They engage their competitors, at industry meetings, on the golf course, over drinks, and in frequent communication. Along the way, they pick up some industrial espionage, facts that are useful to their strategy and businesses. For the most part, they
maintain active friendships with the top people at their competitors.

To a large degree, that is what was intended with the Obama Administration’s “Rebalancing” of our military as part of the US “pivot” to Asia. This is a good idea, but we have probably not executed it as well as we could have.

We need to have a comprehensive engagement with China, including greater strategic and economic dialogue. The
objective should be to deepen our cooperation across the spectrum of issues confronting the world.

If we are to retain our position as the world’s superpower, we must compete more effectively with China. The issues that we have to confront are here at home. We need to:

  • Improve the quality of our education
  • Modernize our infrastructure: Ports, Airports, Highways and Internet
  • Improve our export competitiveness
  • Strengthen our commitment to innovation

Given the lack of responsibility shown by Congress, our success at achieving these things may be doubtful.

China has the capabilities and ambition to challenge the US as the great superpower. How should we react to
that threat? The question becomes, do we want China to succeed or fail, as an economy and as a nation? The answer is not simple.

Our temptation will be to focus on China’s ring of potential conflicts with our regional partners. It will be difficult for America to let those conflicts play out without intervening and moving the conflict to one between China and the US. If that happens, we will almost certainly decide that the Pacific Ocean is not big enough for the two of us.

On the other hand, China has its own domestic challenges. It is the world’s #1 polluter. It has huge demographic issues that grew out of the one child policy. The one-child policy will reduce China’s labor force by 67 million people by 2030, equivalent to the population of France. While they have moved away from the policy, the economic impact is
already baked in. By 2040, China will face a labor shortage of almost 140 million workers, surely the biggest job crunch the world has ever seen. That will have a big impact on wage inflation and will hurt their export competitiveness.

The Chinese know that they have to move from a low-cost manufacturing country to a value-added innovator. That
will be an enormous challenge, and it will be difficult to bring off, without further reforming their tolerance for entrepreneurship and innovation.

They need to enhance the safety net for the world’s largest elderly population, which will be 300 million (the current size of the US) by 2025. The question of who will pay for these social safety net expenses is an open question. Local governments fund today’s costs by appropriating
local property and then selling it to developers or they use it as collateral for municipal borrowing. That is an unsustainable model.  

We should want China to succeed, because we are now part of a concept that originated with Richard Katz in Foreign Affairs, called Mutually Assured Production. During the Cold War, the United States and the Soviet Union avoided triggering a nuclear war because “mutually assured destruction” meant that each side knew that any conflict would mean the obliteration of both countries.

But, no two nations with integrated economies can realistically go to war with the other. Today, in any potential tensions between China and the US, an economic version of mutual deterrence should preserve the status quo between both sides. Our economic interdependence is profound and likely to grow. Foreign-owned companies in China account for 52.4% of all Chinese exports, they account for 82% of high tech exports, and 99% of computer exports. That means both sides have a stake in staying cool, even in potentially hot situations.

Where do China and the US go from here?

China is challenging the existing world order, and the US will not look the other way. How both countries learn to sublimate their aggressive instincts and actions in favor of healthy competition will determine the shape of the world for the next several decades.

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Republicans Want To Repeal Obscure Tax Law

Reuters reported last week that the Republican National Committee (RNC) approved a resolution that adds the repeal of an Obama administration law to its 2014 platform. The law is designed to crack down on offshore tax dodging.

The legislation that the Republicans are targeting is called the Foreign Account Tax Compliance Act (FATCA). What is FATCA? According to Wikipedia, FATCA requires US citizens, including individuals who live outside the US, to report their financial accounts held outside of the US, and requires foreign financial institutions to report to the IRS about their American clients.

Although FATCA was passed by Congress in 2010, it will go into effect on July 1, 2014. It requires foreign banks and investment funds to report to the IRS all assets they hold that exceed $50,000 belonging to US citizens – whether those citizens are living in America or abroad.

The genesis of the law was a 2010 tax-avoidance scandal involving a Swiss bank. One result of FACTA was that last August, Switzerland signed a separate treaty with the US, ending a longstanding tax dispute between the two countries, that gave the IRS unprecedented access to
Swiss accounts held by Americans and US green card holders.

Banks in most tax havens are planning to abide by the new rules because of hefty fines (the IRS can withhold 30% of dividends and interest payments due to the banks from US accounts) since failure to comply with these regulations could seriously impact banks’ ability to do business in America. A successful indictment could bar the bank from the US marketplace. Because of that threat, FATCA is driving a rapid expansion of a network of bilateral, tax-related information-sharing agreements, negotiated by the US Treasury and its overseas counterparts amid heightened global concern about tax dodging.

So, do Republicans want to allow rich individuals and wealthy companies to continue to hold money in off-shore banks without subjecting these monies to federal taxes? Apparently,
and they also want to attract votes and funding from Americans living abroad. The US expatriate community is violently opposed to the law, and some have legitimate concerns about losing
their banking relationships in the foreign country where they live. Their banks are concerned that the costs of flagging the accounts of Americans and maintaining separate reporting formats for them may too high for the less-than-$50k accounts that the US is not interested in. In 2013, nearly 2,400 expatriates gave up their US citizenship or turned in their green cards, some at
least, in an effort to avoid US taxation.

Reuters quotes Solomon Yue, an RNC official from Oregon:

I see FATCA just like Obamacare…It will attract American overseas donors

So, Republicans are eager to use FATCA as a campaign and fundraising issue against the Democrats in the Congressional mid-term elections in November. Repeal seems unlikely, but another issue that raises the political temperature could help defeat Democrats.

The RNC has set up a petition site at MoveOn.org that has about 2200 signers, quite a few from overseas. They have also set up a Repeal FATCA site. Here is a quote from the disinformation available there:

All this supposedly is justified by FATCA’s claim to “recover” lost taxes of less than $1 billion per year – enough to run the government for about two hours. (In fact, the way the U.S. Treasury plans to enforce FATCA, it would probably lose more money than it would take in!)

The Republicans seem to be saying that we don’t need $1 billion if it causes increased tax payments. Politically, it seems strange that this issue should become a hot issue for the Republicans, who are taking a beating in the polls over their stand on income inequality.

On the other hand, US wealthy individuals (Mitt Romney) and corporations that are able to use tax havens and have been able to hide behind account secrecy, would be very happy to see Mr. Boehner take up a bill to repeal FATCA. Foreign banks, many of which contribute to US political campaigns would also like to see the bill repealed

No one is asking the rich to pay unfairly – they already get all kinds of tax breaks − but
to encourage tax evasion seems to be far beyond the Republican’s usual pale.

How about having the rich simply pay their fair share and watch the federal deficit which they
are so concerned about, fall, without requiring Americans to give up food stamp subsidies or funding for long term unemployment benefits? So next time you hear Republicans talking about cutting the deficit, ask them why they are for tax evasion as opposed to tax compliance.

Hopefully, someone will ask Mr. Boehner why repealing a law that will promote the harboring of hidden money and continued tax avoidance is in our best interest. We know it is a key loophole for Mr. Romney. So Mr. Speaker, please tell us again why repealing laws is more important that strengthening them? They were passed for a reason. Maybe you should start pushing for our laws and regulations to be followed, rather than repealed.

Many other countries are striving for better education, better healthcare, a more engaged attitude about our planet and environment, a willingness to regulate guns and business with an eye toward the best interests of the people.

Thanks to US conservatives, we’ve headed in almost the opposite direction.

For Republicans, as long as rich people don’t pay more, undermining our country is okay. There’s just no restraining Republicans if the restraint we need involves the rich. And if responsible politicians try, the conservatives cry, “government overreach” or “socialism.”

But that’s just a red herring, an excuse so that they can continue to pillage America
for all they can get.

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