The policy-making committee of the Federal Reserve Board meets again tomorrow, and the news won’t be encouraging. The one-percent decline in GDP in the first quarter disposed of the Fed’s forecast for 2.9 percent growth this year, and they have to lower it to the range of 2.0 percent to 2.5 percent. That’s just what the IMF did yesterday, forecasting as well that the United States won’t reach full employment again until 2017. So the Fed will leave interest rates at rock-bottom levels through at least next year. But Fed chair Janet Yellen will also continue to wind-down the quantitative easing program, because doing otherwise would signal big troubles ahead for the U.S. economy and scare the daylights out of the markets. In short, happy days are still out of reach, and there’s little the Fed can do about it.
We know it could be a lot worse, since it was much worse not very long ago. And it is much worse in other places. Consider Argentina: On Monday, the Supreme Court refused to let the Argentine government arbitrarily void its contracts with selected American lenders. So, now Argentina – with admittedly the world’s most irrepressibly, irresponsible, freely-elected government – may face another sovereign debt default by the end of the month. And according to the ratings agencies, the place next in line for a debt default is Puerto Rico. If it happens, the Obama administration will have to swallow hard and bail out our island Commonwealth – or risk economic chaos there and new problems for important banks here and in Puerto Rico.
Across the pond, Yellen’s counterpart at the European Central Bank (ECB), Mario Draghi, continues to work overtime to stave off a European financial crisis. Two years ago, Greece, Spain, Portugal and Italy were all teetering towards sovereign debt crises, until Draghi stepped in and pledged that the ECB would purchase as many of their bonds as it took to support their debt markets. Two years later, those debts continue to rise, though not as fast as before. But their economies are still not productive enough to attract the foreign investors they need to support their large public debt burdens. And the large European banks which hold more of those bonds than anyone except the ECB are still unprepared to weather a serious crisis. Yet, you wouldn’t know it from official pronouncements: Wolfgang Munchau reported this week in the Financial Times that the “adverse scenario” designed by the ECB to stress-test those banks’ ability to weather a big shock is, in certain respects, more optimistic than the ECB’s own forecast.
Finally, while China blusters that its renminbi should be an exchangeable, global currency on par with the dollar, the flood of credit it unleashed to maintain high growth in recent years has left much of its banking system technically insolvent. And its “shadow banking system” – the network of arrangements that many Chinese municipalities and businesses use to borrow funds outside the regular banking system – is in equally precarious shape. The only things protecting China from its own financial crisis are strict credit controls and the fact that the renminbi is not an exchangeable currency, which insulate it from the judgments of global capital markets.
The fact is, financial crises have become as common as they were in the 19th century before the rise of central banking. This new cycle started in Latin America in 1985-1986, followed by Spain, Japan and Sweden in 1990-1991, moved on to Mexico in 1995 and East Asia in 1997-1998, and then to the United States in 2008-2009. The European Union has barely skirted its own crisis for the last three years, and the strains are intensifying in China. In ways that no one understands, the ultimate source of these cascading crises almost certainly lies in the globalization of capital markets. Until we figure out how and why this is happening, everyone’s prosperity will be hostage to upheavals that governments cannot control and can only barely manage.
This post was originally published on Dr. Shapiro's blog
The World Bank shook up a lot of people this week with its declaration that by a new accounting, China’s GDP will top America’s this year. But the meaning and significance of that accounting remain at best elusive. Last year, the World Bank reported that using prevailing exchange rates, China’s GDP in 2012 was barely half that of America ($8.2 trillion versus $16.2 trillion). The new report draws on a statistical adjustment called “purchasing power parity” or PPP, often used to compare GDP in two or more countries when exchange rates fluctuate widely. In analytic shorthand, PPP calculates GDP by looking at what it costs households in one country to feed, house, educate and otherwise take care of itself – including the costs of doing business and maintaining government –compared to households in another country.
Setting aside the fact that U.S.-China exchange rates have been pretty stable, here’s how PPP works. You start with a basket of personal and business goods and services in each country, taking account of habits, tastes and preferences. So, the Chinese basket will be different from its American counterpart because, for example, Americans eat potatoes and subscribe to premium cable stations while Chinese eat rice and go to outdoor cinemas. Since a serving of potatoes in America costs more than a serving of rice in China, China’s GDP is adjusted (upward) to take that into account. These comparisons also require adjustments for quality. Americans pay much more for health care and housing than Chinese – but the quality and quantity per-household of these services and goods as Americans consume them is much higher and larger than Chinese enjoy. So, World Bank statisticians have to not only observe prices and levels of consumption, but also come up with adjustment factors for differences in quality for each country. The truth is, nobody knows how to do that for countless goods and services, including the Bank’s PPP experts.
The United States is the baseline for PPP calculations. So if China’s basket of goods and services takes half as much income to buy there as the American basket does in the United States, after accounting for quality differences, China’s GDP is adjusted up by that increment. I should also mention that PPP analysis can produce a range of results based not only on all of the adjustments, but also on which of four distinct and accepted ways of calculating PPP the analyst uses. This week’s announcement of PPP-based GDP came after the World Bank applied a new weighting regimen to one of the four methods. What it means, then, depends on all of those assumptions and calculations, which makes any conclusions based on that accounting problematic, at best. As the Bank itself noted, “Because of the complexity of the process used to collect the data and calculate the PPPs, it is not possible to directly estimate their margins of error.
By any accounting, China’s GDP has been growing very rapidly for several decades. The reasons are pretty basic. They start with the world’s largest workforce producing Chinese goods and services. And thanks to the foreign direct investments of advanced technologies and business methods, much of it from America, Western multinationals have given China the means to make all those workers more productive. Yet, the lives led by China’s people remain a world away from the lives of Americans. Even using the World Bank’s PPP calculations, per-capita GDP in China is just $9,844, compared to $53,101 in the United States.
One more caveat: China’s PPP-adjusted GDP may be said to statistically rival America’s – whatever that means – only because U.S. growth has been unusually slow for more than a decade. If the American economy had continued to expand since 2001 at the rate it grew in the 1990s, our GDP would still be more than 20 percent bigger than China’s even using the World Bank’s new adjustments and accounting. For that, we have no one to blame but our policymakers and ourselves.
This post was originally published on Dr. Shapiro's blog
The political struggle over Obamacare has reached a critical inflection point as real events have overtaken its opponents’ basic arguments. That opposition has always drawn on, and encouraged, doubts about the public’s real interest in a federal guarantee to health insurance and their tolerance for a mandate to enforce it. After the program’s fitful start, it is now clear that large numbers of Americans are prepared to spend the considerable time and money required to sign on. The Rand Corporation estimates that 9.5 million people who had no coverage a month or a year ago now do, thanks to the Affordable Care Act (ACA). I also analyzed the data and found that the newly-insured number at least 7.8 million and as many as 10.9 million. And if the governors and legislatures in 24 states had not inexplicably turned down the ACA’s Medicaid expansion – a decision three of those states are reconsidering -- the total number of newly-insured today would range from 11 million to 14 million.
These numbers create a political inflection point, because the program’s demonstrated appeal renders it virtually impossible to repeal. Arguing against a new federal benefit is an easy political challenge for conservatives. By contrast, withdrawing a benefit that millions already depend on is, at best, a herculean task. Just try to imagine any future Congress or President actually withdrawing practical access to medical coverage from millions of moderate-income families, millions of young adults covered by their parents’ policies, and millions of more people with preexisting medical conditions.
This political inflection point will strengthen not only as more people enroll, but also, and even more important politically, as Obamacare generates benefits for everyone else. To begin, surveys show that several million people would like to change jobs but stay where they are, out of concerns about losing their healthcare coverage. Now, they can do as they like – and the enhanced labor mobility should help the economy.
More important, by enrolling large numbers of previously-uninsured people, Obamacare should slow increases in everyone’s insurance premiums -- or even lower premiums. As countless studies have shown, most people without coverage get their medical care in emergency rooms. Since they usually cannot pay the bills for that care, hospitals pass along those costs through higher charges on everyone else, which in turn leads to higher insurance premiums. The ACA will not only relieve some of those direct pressures on premiums; its mandated coverage also will generate more income for insurers, further easing upward pressures on premiums.
This would be very good news for the American economy. Over the last decade, healthcare coverage has been the single, fastest-rising cost for most U.S employers. But as globalization intensifies competition, many of those employers find themselves unable to pass along their higher healthcare costs by simply raising their prices. Their only recourse, as I have written many times, has been to cut other costs – beginning with jobs and wages. In the end, therefore, the ACA could contribute to broader gains in employment and incomes – and that could produce a political inflection point that could support political realignment.
This post was originally published on Dr. Shapiro's blog
The crisis over Ukraine is quickly becoming a geostrategic conflict. As Vladimir Putin maneuvers to restore Russia’s right to behave with a superpower’s impunity, particularly in its own backyard, the West pushes back. But economic forces also have shaped this confrontation, especially Ukraine’s record as the world’s worst-performing industrial economy over the last twenty years. It was popular discontent with this disastrous performance that drove the recent dissent, which in turn triggered such a bloody response from Viktor Yanukovych — and that response consolidated the opposition and cost Yanukovych his job. Beyond this week’s political and military maneuvers, the outstanding question is, who will bail out the Ukrainian economy — Russia, or the EU and the United States — as the price of drawing the country into its trading system?
Stated simply, Ukraine is the economic equivalent of a failed state. After gaining independence in 1991, the country moved briefly to liberalize its economy along the same lines as most of Eastern and Central Europe. But Ukraine soon jettisoned its reforms in favor of the state-oligarch model also evolving in Russia. Some twenty years later, Ukraine’s GDP has shrunk 30 percent. Even Russia’s sorry economy is 20 percent bigger than it was in 1991 — and Poland’s economy, which looked much like Ukraine’s in 1991, grew 130 percent over the same period. Ukraine’s economic performance has been so terrible, for so long, that its sovereign debts are now considered the equivalent of junk bonds. Even before the crisis, Ukraine’s credit rating was worse than Greece’s — no small feat — and no better than that of Argentina, a global financial pariah for its mismanaged debt defaults and summary expropriations of foreign-owned companies.
Ukraine’s debts soon come due, with some $15 billion in sovereign bonds maturing this year and another $15 billion in 2015. With a current account deficit equal to 8 percent of its GDP, Ukraine cannot pay off and refinance those debts without large-scale aid — some $20 billion to $25 billion — and affiliating itself with a larger trading system. An economic and trade alliance with Russia would deliver the bailout, but with little prospects of improving the underlying economy. The EU and the United States (through the IMF) also are prepared to provide the bailout, if the Ukrainian government will accept far-reaching economic reforms. The EU-US/IMF reforms should lead to better economic times down the road. But they also would mean more short-term hardships for ordinary Ukrainians. That’s why Yanukovych sided with Putin: He feared that he could lose his grip on power if times got even worse — and yet, of course, he lost power anyway.
With a new, pro-Western government in charge in Kiev, Ukraine’s fate may well lie in the hands of Europe and the United States. Their choice is simple to state, if difficult to execute — namely, do they put sufficient economic and diplomatic pressure on Putin, to convince him to pocket his own bailout and let the West pick up the pieces.
This post was originally published on Dr. Shapiro's blog
President Obama’s drive to complete new open trade agreements with the European Union and 11 Pacific Rim nations are the most critical economic initiatives of his second term. Their importance reflects the basic patterns of economic growth across the world. After a decade of unusually weak growth, job creation and income gains, America’s prospects for rising wages and employment are increasingly linked to how successfully American businesses can tap into foreign demand. Beyond the big demand issues, the two agreements also should subtly affect the tradeoffs that American multinationals face between exporting goods and services produced here, versus expanding their European and Asian operations. And those more subtle effects could produce large long-term benefits for American workers.
The Transatlantic Trade and Investment Partnership (TTIP) talks would end most tariffs and reduce countless other barriers to open trade between the United States and the 27 countries of the European Union, with their combined GDP of some $17 trillion. Not only would the agreement give American businesses and investors nearly as much access to European consumers and businesses as Germany or France, including the fast-growing emerging economies of Central and Eastern Europe. Equally important, such an agreement would recalibrate the choices that U.S. companies face today between exporting to Europe and increasing their foreign direct investments there. For the first time, America’s multinationals could enjoy nearly unfettered access to the European market without setting up more operations there.
The second proposed agreement, the Trans-Pacific Partnership (TPP), also would reduce tariffs and other barriers between and among ourselves and Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Not counting ourselves and our NAFTA partners Mexico and Canada, where we already enjoy open trade, the other TPP countries represent nearly $9 trillion of potential demand for our goods and services. And much like the proposed EU-US partnership, the Pacific agreement would, at once, lower barriers to U.S. exports to those countries and change the calculus of foreign direct investment (FDI) versus exports in ways that would tilt more towards exports. If 10 percent of our current FDI flows to countries involved in the two agreements shifts to domestic investments or simply higher profits, it could boost U.S. employment by as much as 450,000 jobs.
These initiatives present a singular opportunity to open up markets that represent nearly half of all non-U.S. global GDP. As the world’s most comprehensive and productive economy, the United States will be well positioned to use this enhanced access to increase our global market shares in countless advanced goods and services. And by reducing the costs of exporting into foreign markets, as compared to setting up more new factories and offices inside those markets, these agreements could be the first new trade pacts for a global economy that genuinely favor U.S. workers.
This post was originally published on Dr. Shapiro's blog.
"The jobless rate fell sharply again – from 7.0 percent to 6.7 percent – but the reason wasn’t a burst of new job creation. In fact, total employment was up by just 74,000. What changed in December was that new layoffs fell sharply, which we usually see in the first two years of an expansion. It’s some two year behind schedule, but the number of newly unemployed people was down by 365,000 in December. The rest of it was mainly demographics, not economics. Yes, the labor participation rate fell 0.2 percentage points – but it had risen by as much the month before. Moreover, the number of “discouraged workers” (those no longer looking for work) and those “marginally attached” to the labor force (who haven’t tried to get hired for a month) did not go up. What continues to rise are the numbers of baby boomers retiring, because the numbers of boomers reaching ages 60, 62 or 65 continues to accelerate."
As Michael Bloomberg prepares his exit as New York City’s mayor, a new analysis suggests that his signature reforms of public education will comprise much of his legacy. Unsurprisingly, the reason is hard economics. Under his reforms, the share of NYC youths earning their high school diplomas and the share going on to college both rose sharply. For some 71,000 young New Yorkers, the “income premiums” associated with those improvements should add more than $15 billion to their lifetime incomes — and the benefits are not limited to those students. The study also found that home property values rose substantially in the neighborhoods where schools improved the most, by as much as $60 billion.
I conducted the study with my colleague Kevin Hassett, in conjunction with The Fund for Public Schools. We focused on changes in three objective measures of student performance: test scores by NYC public school students on statewide tests, high school graduation rates, and rates of college attendance.
We started with the test scores on statewide tests, to see if those scores tracked the improvements in graduation and college attendance rates. With other researchers, we found that they did: From 2006 to 2012, the “mean scale” scores of NYC students on English Language Arts tests rose two percent, twice the gains of all students across New York State. Similarly, NYC students’ scores on the statewide mathematics tests increased four percent, compared to a three percent gain across the State. Moreover, students from the poorest parts of the City, the Bronx and Brooklyn, showed the greatest improvements.
Students from low-income, minority backgrounds also account for much of the improvements in high-school graduation rates. From 2006 to 2012, the four-year graduation rate of NYC students increased from 49 percent to more than 60 percent, a jump of 23 percent. Progress by African-American and Hispanic students drove much of those increases. From 2006 to 2012, graduation rates for African-American students increased from less than 43 percent to 55 percent, a 28 percent jump. Similarly, the graduation rates of Hispanic students rose from 40 percent to nearly 53 percent, a 31 percent improvement.
It hardly bears repeating that students who graduate high school earn substantially higher incomes throughout the working lives than those who drop out. Economists use those differences to calculate the “net present value” of a high school diploma — the value in today’s dollars of the additional income which, on average, they will earn over their lifetimes. Today, that net present value comes to $218,000. Using 2006 graduation rates as our reference, we calculated that from 2008 to 2012, 41,000 more NYC public high school students earned their diplomas than would have occurred if the same share of students had graduated as in 2006. That tells us that the improvements in graduation rates under the Bloomberg reforms will raise their lifetime earnings by nearly $9 billion.
Similarly, from 2008 to 2012, nearly 31,000 more NYC public school students enrolled in institutions of higher learning than would have occurred if the college enrollment rates of NYC students in 2006 had persisted. To calculate the net present value of the additional lifetime income all of the additional NYC students who enrolled in college, compared to ending their educations with a high school diploma, we tracked the income differences, less the average cost of college tuition and their foregone income while in college. We found that the lifetime value of enrolling in college comes to $207,000, in today’s dollars – which tells us that the net present value of the additional income that the additional 31,000 NYC college attendees will earn comes to $6. 4 billion. On top of the income gains derived from higher high-school graduation rates, this suggests that improvements in student performance under Bloomberg’s reforms should raise the lifetime earnings of NYC students by some $15 billion.
Better schools also are associated with higher property values, so we tested whether these improvements had those effects in New York City. Using a technique that tests for statistical causality, called the “Granger Causality” test, we analyzed the relationship between changes in NYC property values by zip code, covering 94 NYC zip codes, and changes in graduation rates in those zip codes. It showed that each one percent improvement in the graduation rates in a zip code led to a 0. 53 percent increase in residential property values in that zip code, in the following year. On this basis, we estimate that NYC’s rising graduation rates from 2008 to 2012 have added more than $37 billion to the total value of NYC residential housing.
We also explored whether New York’s major expansion of charter schools has had economic effects. At a basic level, Bloomberg’s strategy granted schools and their principals much greater autonomy — and large funding increases to accompany it — in exchange for greater accountability for the results. The reforms also expanded school choice for NYC public school students, and then enhanced those choices by adding nearly 200 new public charter schools. This combination of greater accountability and enhanced choice intensified competition for students among schools, especially since funding follows the students.
While two national studies have found that across the country, charter schools do not outperform other public schools, three recent studies of NYC concluded that students at those schools perform better than students at other City public schools. We tested whether Bloomberg’s expansion of charter schools also has affected property values in the City, independent of changes in graduation rates. We found that across nearly 200 NYC zip codes, the addition of one new NYC charter schools in a zip code led to a 3. 8 percent increase in residential property prices in that zip code in the following year. Based on the expansion of those schools in this period, the results suggest that the charter-school reforms have added more than $22 billion to NYC residential property values. On top of the boost in property values tied to higher graduation rates, these results suggest that Bloomberg’s reforms have added nearly $60 billion to NYC residential property values.
Across the country, the record of educational reforms is mixed. Nevertheless, by several objective measures, the academic performance of New York City public school students has improved markedly under the reforms enacted since 2002. Moreover, those improvements can be expected to generate large income benefits for tens of thousands of New York City students, and they already have produced substantial economic benefits for New York City homeowners. These achievements deserve emulation.
This post was originally published on Dr. Shapiro's blog
President Obama deserves at least two cheers for his recent economic address. In an unusually clear-eyed assessment of how the economy has shaped our current politics and national mood, he traced most people’s disillusion with government to their “daily battles to make ends meet.” The “defining challenge of our time,” he declared, is to make “sure our economy works for every working American.” For his part, the President pledged to devote his second term to restoring upward mobility and reducing inequality.
To make progress on these fronts, the President and many progressives should first step back from some common populist myths. In his address, for example, the President stressed the populist trope that the median income today is only 8 percent higher than it was in 1979. The clear implication is that middle-class Americans have been caught in an economic squeeze for nearly 35 years, and Washington should turn away from the policies of the 1980s and 1990s.
This view, at best, is only partly right. It is the case that today’s extraordinary inequality began in the latter-1970s. In 1976, the share of national income claimed by the top 1 percent of Americans fell to less than 9 percent, its lowest point in the 20th century. Since 1977, however, their share of the economy’s rewards has grown steadily and sharply, reaching more than 23 percent in 2008, its highest level since 1928. Nevertheless, most people’s incomes continued to grow at reasonable rates through the 1980s and 1990s. If that strikes many Americans as implausible from today’s vantage, it’s only because much of those income gains were swept away over the last decade. The challenge of restoring upward mobility comes mainly from what has happened economically since 2002.
Here is what has really happened to incomes, based on data released recently by the Census Bureau. Across all households – all ages, races, and both genders -- the inflation-adjusted median income increased by an average of 1.7 percent per-year from 1983 to 1989, or by nearly 12 percent over the course of the Reagan expansion. The recession of 1990-1991 took back about one-third of that progress, leaving a typical middle-class household with net income gains of just under 8 percent from 1983 to 1991. Those gains were followed by more income growth through the Clinton expansion, averaging another 1.4 percent per-year after inflation. The recession of 2001 took back one-fifth of those gains, leaving a typical middle-class household with net income growth of more than 10 percent from the 1990s and 18 percent from 1982 to 2002. Nor did upward mobility stall out in this period: Throughout the 1980s and 1990s, those who had long lagged behind achieved the greatest gains, namely, households headed by African Americans and by women.
The income squeeze most Americans feel today owes its bite almost entirely to the developments of the last decade. Through the Bush expansion of 2002 to 2007, household income growth plummeted to just 0.2 percent per-year. Moreover, those meager gains were followed by the Great Recession, which cost the average household an unprecedented 5 percent of their incomes. Those losses wiped out not only all of the income growth from 2002 to 2007, but also 40 percent of the net gains of the 1990s. Even worse, the economic damage from the 2008-2009 crisis, on top of some new problems, continued to eat away at incomes. In 2010-2011, American households gave back, on average, another 4 percent of their incomes. Those losses finally stabilized in 2012, when household incomes were virtually unchanged. All told, the median income of American households declined nearly 10 percent from 2002 to 2012.
To get out of this hole, policymakers have to confront the two new dynamics which largely define the last decade economically, globalization and technological change. There is no possible retreat from globalization, a historic advance that has drastically reduced poverty across much of the world and driven innovation and cost savings here at home. But the intense competition generated by globalization also produces unprecedented pressures on businesses to cut their costs, and then directs those pressures to jobs and wages. Policymakers can help relieve some of those cost pressures, starting with a stronger commitment to contain the health care costs for both employers and workers. They also could help jumpstart stronger job creation with financial reforms that link a bank’s access to the Fed’s virtually-free funds to its willingness to provide capital for young businesses.
Washington also can help tens of millions of Americans to upgrade their skills for an economy that now provides few rewards for those without the training and skills to operate effectively in workplaces dense with information and internet technologies. For a modest cost, for example, the federal government can provide grants to hundreds of community colleges to keep their computer labs open and staffed on weekends and evenings, so any adult can walk in and receive free training in information and internet technologies.
The economic record also tells us that the government got a number of things right in the 1980s and 1990s. As in the 1950s and 1960s, usually sensible macroeconomic policies tempered the business cycles, especially after dealing with the oil-shock inflations of the 1970s. Successive presidents and congresses also continued to liberalize trade in the 1980s and 1990s, encouraging businesses and workers to shift their resources to areas where they held powerful advantages even as Germany, Japan and other advanced countries began to compete actively again. And from the late 1970s onward, Washington reinforced those advantages by deregulating transportation, telecommunications, and other sectors -- including finance, where policymakers went too far in the late 1990s.
Public investments in infrastructure remained generally robust until the 1990s, and even then, the private sector sunk tens of billions of dollars into new information and telecommunications infrastructure. Higher education programs helped tens of millions of Americans expand their human capital, building on the GI Bill of the 1950s and 1960s with major expansions in student assistance in the 1980s and 1990s. And science and technology policies continued to promote innovation by aggressively funding government research institutes and through technology competitions sponsored by the Pentagon (including the internet).
To restore income gains and upward mobility, Washington also needs to revisit what works. Recommit macroeconomic policy to healthy growth by ending mindless austerity and doubling down on public investments in infrastructure and basic research and development. Further expand the markets for innovative American goods and services by completing the current trade liberalization talks with the European Union and much of Asia. Help millions of young people complete their higher education by reforming student assistance – for example, by replacing most current loan and grant programs with federally-funded free tuition at public institutions that limit their future cost increases to overall inflation.
There is no iron-clad guarantee that these approaches will restore the reasonable income gains of the 1980s and 1990s, much less the stronger progress seen in the 1950s and 1960s. Nevertheless, they provide a credible place to begin, one based on the real economic record and the actual nature of our economic problems.
This post was originally published on Dr. Shapiro's blog
In a political environment most notable today for its partisan trench warfare, serious conversations across party lines are nonetheless taking place over a major reform of corporate taxes. This unusual instance of comity comes from a genuine consensus that lowering the corporate tax rate – the favored goal would move it from 35 percent to 28 percent – would be good for the economy. As an economic matter, a revenue-neutral cut in the corporate tax rate has something for almost everyone: It should lead directly to more investment and higher profits, which in turn should produce stronger growth and, with any luck, raise the wages of some workers. Yet, serious corporate tax reform will always be a long shot unless the parties can agree on how to pay for it and what to do about all the businesses that aren’t subject to it.
The hardest piece of this puzzle involves where to find the money for a lower rate. If, as expected, profits, growth and some wages go up, part of the cost should be relatively painless – but those additional revenues would amount to more of free appetizer than a whole lunch. And one popular target for additional revenues, the special tax deductions for certain investments by oil and gas companies, would provide no more than a palate cleanser. In the end, there are only a few pieces of the corporate code large enough to finance meaningful rate reductions – and all of them are fiercely defended by the companies that benefit most from them.
The biggest target is accelerated depreciation – some $550 billion over 10 years to provide in special tax deductions that offset the cost of large corporate investments, and at a rate faster than the equipment or structure actually depreciates. For the biggest beneficiaries, think of the communications equipment industry, aircraft makers, mining and industrial equipment producers, and other heavy manufacturing. Pushing the corporate rate down to 28 percent rate would offset their economic costs, while helping other industries even more. But the revenues from ending accelerated deprivation for corporations would only be enough to lower the rate to a little less than 31 percent.
Another costly provision is “deferral” – the ability of American multinationals to delay paying any U.S. corporate taxes on their foreign profits until they transfer those profits from their foreign subsidiaries to the parent corporation back in America. While experts argue over how much revenues would actually result from ending deferral, it would spread the pain: That’s because the industries affected most by an end to deferral make relatively modest use of accelerated depreciation – think of our leading software, Internet and pharmaceutical firms. The catch lies in the indirect costs. American multinationals earn foreign profits by out-competing their German, British and Japanese rivals in foreign markets. But unlike the United States, Germany, Britain, Japan and nearly every other country taxes corporations only on the income they earn in their home markets. So, ending deferral would force only U.S. companies to pay taxes both abroad and at home, leaving them at a competitive disadvantage. Holding them harmless while ending deferral would require a corporate rate even lower than 28 percent – and the revenues gained by ending deferral, along with accelerated depreciation, wouldn’t be enough to get the rate down to even 28 percent.
Moreover, corporate tax reform is not the same as business tax reform, not by a long shot. More than half of all business profits in America are earned by companies that don’t pay the corporate tax, including most investment and legal practices, hedge funds, private equity funds, and privately held companies. They are all organized as partnerships, LLCs or S-corps, not subject to the corporate tax, and taxed as “pass-throughs:” The income of such firms is distributed among their owners and then taxed at the owners’ personal tax rate, sometimes as ordinary income and more often as capital income.
As an economic matter, the right answer is to tax all business income at the same rate, whether the business is a corporation or something else. It also would help with funding the lower rate: For example, ending accelerated depreciation for all businesses, corporate or not, would raise an estimated $775 billion over 10 years instead of $550 billion. Moreover, a 28 percent rate on all business income mighty well raise substantial revenues, since so much of non-corporate business income today is taxed at the 20 percent rate for capital income. And that’s a political problem. To begin, ending the special “carried interest” tax break for hedge funds, private equity funds and real estate trusts might well ignite a Washington firestorm – which could explain why President Obama didn’t try to do it when he held healthy majorities in both house of Congress. That’s not all: To maintain a level playing field on personal taxes, the current 20 percent tax on the capital gains and dividends of ordinary investors also would have to go to 28 percent up as well. But if that happened, the shareholders of public corporations would be at a costly disadvantage, since the same income would face a single 28 percent rate when earned by a non-corporate pass-through business, and a rate twice as high when generated by a corporation (28 percent at the corporate level and another 28 percent at the owners’ level).
This economic logic has led many conservative economists and Republicans to call for repealing all corporate taxes. Of course, there is no prospect of a bipartisan consensus for doing that. Rather, the Democratic side of the consensus for a lower corporate tax rate has always insisted that the same corporations make up for any and all revenues lost from cutting the rate. And that’s a problem which they haven’t yet solved.
This Post was originally published on Dr. Shapiro's blog
The budget and debt end games are still playing themselves out on Capitol Hill; and judging by its current behavior, Congress has developed the political equivalent of a brain tumor. A toxic byproduct of an ongoing power struggle inside the Republican Party, the cancer has caused incapacitating seizures that have virtually crippled the national government’s capacity to take care of the most elemental aspects of governance. Even if House Republicans finally agree today or tomorrow to fund the government and raise the debt limit, the tumor they have spawned will continue to damage our economy — and the longer term prognosis is not encouraging.
Congress’s recent reckless behavior may not directly affect those aspects of the economy that make the United States so productive — but it does threaten access to the low-cost capital on which the economy depends. The current fight will not diminish the education and skills of American workers, or erode the technological and organizational assets of the businesses they work for. The rash demands of the radical right also won’t lessen the competitive pressures that drive our businesses to develop new goods and services, and to adopt the innovations of others. And whatever Congress does this week, the United States will remain the world’s largest market. The catch, however, is that all of these strengths also depend on steady streams of low-cost capital, which the House GOP has now put at risk.
For nearly 70 years, the United States has been the world’s number one place to invest and lend to. The economic reason is straight-forward — with considerable consistency, American businesses generate stronger returns than their counterparts in other advanced economies. But another factor is at play here as well, one especially important to foreign lenders and investors — namely, confidence that the United States will preserve and maintain the political conditions required to protect those healthy returns.
Investors and lenders, both foreign and domestic, have long seen the United States as the most reliable country for enforcing contracts, respecting intellectual property rights, maintaining generally low taxes and light regulation, and applying the rule of law fairly. The result has been an unusually low level of political risk attached to the economic returns expected by lenders and investors. That’s why U.S. Treasury securities have long been the world’s lowest-risk financial instrument. For the same reasons, the political “risk premium” for private-sector loans and investments — the additional return required to offset any risk that political forces will reduce an investor or lender’s returns — has been negligible for decades.
But a country that finds itself unable to fund its government and unwilling to honor its government’s debts has to expect that lenders and investors will demand a considerable risk premium on any future loans and investments. In short, our current war over government funding and the debt limit is raising interest rates — and the costs could be huge. For example, a one percentage-point increase in the interest rate paid on Treasury securities will cost the government (and taxpayers) some $1 trillion in additional debt paymentsover 10 years — enough to wipe out the savings from a decade of sequester cuts.
A combination of this new risk premium, plus new wariness by foreign lenders and investors, should also push up interest rates on private loans and the required returns on private investments. Interest rates normally rise during booms, when the demand for capital expands faster than its supply. When interest rates rise without an accompanying increase in demand, however, they directly depress demand and growth. For example, a one percentage-point increase in mortgage rates today is expected to depress housing starts, housing sales and demand for related goods and services by 11 percent — and reduce GDP growth this year by 0.4 percent. Across the economy, the same increase in interest rates in the absence of strong demand could take 2 percentage-points off real GDP growth. Even if the House radicals agree to a cease fire this week, it could cost Americans $300 billion in foregone goods and services over the next year, and the 2.75 million jobs required to produce them.
The damage to growth and jobs could be long-lasting. House extremists nearly pushed the economy off the cliff over the same issues in 2011 — and they could be back for another round in a few months, when any agreement this week runs out. Such a sustained pattern of political dysfunction could lower growth for a decade and cost Americans as much as $3 trillion in lost income and wealth. And that assumes that Tea Party Republicans, in the end, will not force the government to default on its debts, a development that would likely cost the American and global economies as much as the 2008-2009 financial collapse.
This Post was originally published in Dr. Shapiro's Blog