Fun with the tax code

Posted by Deepish Thinker on April 21, 2013
Economics, US Politics / No Comments

My favorite Daily Beaster, Megan McCardle, recently posted some pretty interesting observations on the tax code:

Anyway, I’ve got a better idea: let’s get rid of the corporate income tax entirely.

No, really, hear me out.  The corporate income tax is the source of almost all the tax-dodging activity in America.  This activity is extremely expensive, and millions of valuable man-hours are diverted into it.  As well as into writing semi-numerate op-eds about the corporate income tax.

Why not get rid of the tax, and the tax avoidance, by radically simplifying the tax code?  Eliminate the corporate income tax–and then also eliminate the special rates for capital gains and dividends.  Tax all income once, progressively, when it’s realized by a person.

This is a very attractive idea.  Any plan that drastically simplifies the tax code, saves untold billions in compliance costs, eliminates opportunities for tax evasion, and removes the motivation for employing half of K street, is worthy of serious consideration (even if the politics suck and the chances on enactment are approximately zero).

In particular, it’s interesting (to me anyway) to speculate on how enacting this reform might change individual and corporate behavior:

    • It would create a fairly powerful incentive for companies to retain earnings since this would allow shareholders to defer, though not ultimately avoid, taxation.  Dividends would probably become far less common.
    • Capital structure of firms would likely become more conservative (i.e. leverage would decrease) for two reasons:
      • Firms that retain their earnings have less need to borrow
      • Elimination of corporate taxes also eliminates the tax advantages of debt financing (corporate interest payments are tax deductible, which ceases to matter if the tax rate is zero)
    • Reductions in corporate dividends and issuance of corporate debt might have some interesting impacts on investment behavior.  Financial instruments like annuities may become more popular as investors look for ways to convert their portfolios into reliable income streams.
    • Personal loans with stock as collateral are likely to become much more popular, and may attract the attention of the IRS.
    • There would be a pretty dramatic adjustment period as firms scale back or abandon activities that were made economic by corporate tax breaks (bye-bye wind energy).
    • Since the denizens of K Street aren’t going to go quietly, and politicians will remain found of doling out goodies to their favorite industries, we may see an expansion of subsidies, regulatory boondoggles, and unfunded mandates (welcome back wind energy).
    • The adjustment period may be very painful, but the long term payoff would be huge.  Eliminating the misallocation of resources for tax reasons, and the massive waste of time and energy associated with managing corporate tax issues, would probably add a few tenths of a percent to our long term growth rate.  Over time this would make the country much richer.
    • There is likely to be an expansion of audit activity at publically traded firms.  The loss of the tax cross check would likely cause greater scrutiny of corporate earnings, and there would be a lot of tax and finance people looking for new ways to justify their salaries.
    • There is likely to be a big movement of liquid assets that currently reside overseas back to Wall Street.  For tax reasons multinationals have a ton of cash in overseas accounts.  With no corporate tax there’s no reason not to bring that money home.  This would help Wall Street, but hammer other financial centers.
    • On the down side, a great deal of tax driven financial engineering will suddenly become unnecessary.  Combine this with reduced issuance of corporate debt and Wall Street firms would probably take big hit (oh dear, so sad).
    • The impact on M&A activity is not totally easy to foresee.  On one hand firms are likely to accumulate cash and want to spend it on something.  On the other, any transaction creates a major taxable event for shareholders in the acquired firm.  On balance, I suspect firms may develop a bias for organic growth over acquisitions.
    • Cheating on your personal taxes would become much harder.  Eliminating corporate taxes would free up a ton of resources and greatly enhance incentives for the IRS to go after individual “evil-doers”.  Anybody trying to run their personal expenses through a corporation would get crucified.
    • Tax collections are likely to be disappointing in the first few years as people take advantage of the opportunity to postpone taxes through opting for capital appreciation over income.  Tax revenue is likely to be higher than expected in the out years.  Eventually people want to spend, so they’ll start cashing out and paying regular tax rates on their capital gains.  Combined with the aforementioned higher growth rate this would significantly improve the long term fiscal outlook.
      • If the switch happened tomorrow this would amount to a nice little bout of Keynesian stimulus, but not the kind of which Mr Krugman would approve.
    • If you think the politics of personal income taxes are brutal now, just wait until they become the vehicle for collecting taxes on all income.
      • Whatever business K Street loses from corporate clients is liable to be made up by new business lobbying congress on the individual tax code.
    • The change would have all kinds of international consequences:
      • Tax havens would likely lose a lot of corporate business, but see an increase in individual business.  The incentive for US taxpayers to push the envelope in order to minimize personal income taxes would increase dramatically.
      • In a major turnaround, the US may become a tax haven for foreign multi-nationals.
      • Since tax competition is not exactly popular in some major European capitals, a trade war with the EU wouldn’t be out of the question.
      • Alternatively, the huge competitive advantage handed to US firms may force the same policy on foreign governments, which would set off a cascade of unpredictable consequences.  For example, the part of the Irish economy that didn’t implode (European operations hub for US multi-nationals) exists largely because of Ireland’s favorable corporate tax rate.  If corporate tax rates went to zero everywhere it could be farewell to the remaining remnants of the Celtic Tiger, and welcome back to the basket case exporter of music, whiskey and people.

Tragically, we are unlikely to find out if any of the above speculations are remotely close to the mark.  No matter how sound the economic arguments, there is no elected official, living or yet to be born, who is going to cast a vote for a zero tax rate on corporations.  The attack ads practically write themselves.

Disappointing job number

Posted by Deepish Thinker on April 11, 2013
Current Events, Economics, US Politics / No Comments

Last week we went through the monthly ritual of analyzing the jobs number and drawing sweeping economic and political conclusions from this single (provisional) data point.

It seems like we could have more fun drawing sweeping economic and political conclusions from the extended data series.

Job Growth Chart - Mk II

Monthly growth of 200,000 jobs is widely considered to be indicative of a healthy recovery in the labor market (green line).

So far, the president’s record doesn’t look too healthy.

  • The US has added 200K jobs in just 14 of the president’s 50 months in office
  • The longest stretch of ‘healthy’ job growth was 4 consecutive months (Dec-11 through Mar-12)
  • There have been 17 months of negative job growth
  • The 45 months since the official end of the recession (Jun-09) have included 12 months of negative job growth (i.e. one in four)

President says something silly

Posted by Deepish Thinker on July 19, 2012
Current Events, Economics, US Politics / No Comments

The President has received a lot of Republican “feedback” on his statement that, “Somebody invested in roads and bridges. If you’ve got a business—you didn’t build that.”

Leaving aside the astonishingly inept phrasing, the President’s larger point is not unreasonable.  If you own a successful business you do benefit from things the government provide (rule of law, security, infrastructure, healthy educated workforce, basic research, etc).  It is really the logic that flows from this obvious truth that differentiates the President form his Republican critics.

The President appears to believe that success flows from what the government provides.  Therefore the government is justified in taking the fruits of that success.

Republicans tend to believe what the government is a necessary, but not sufficient, condition for individual success (even if they don’t generally state it in this way).  Therefore the government has only a limited claim on the earnings of successful individuals.

Beliefs about the relative importance of government have broader implications.

The President’s apparent belief that prosperity flows from government, implies that more government equals more prosperity.  From this viewpoint the cost of government is almost irrelevant.

The Republican view that things provided by government are merely one of the preconditions for prosperity leads logically to the focus on providing these things at minimum cost.

Unfortunately, we’re unlikely to see much thoughtful debate about the relative merits of these two viewpoints.   Hammering the President for the dimwitted quote above is much more fun.

How to become a billionaire

Posted by Deepish Thinker on June 24, 2012
Current Events, Economics, US Culture, US Politics / 1 Comment

Interesting insight on how people become billionaires in different parts of the world.

Many Americans appear to believe that they are the victims of a hopelessly corrupt economic system run by and for 1% oligarchs.  Before buying this narrative it might be a good idea to look at countries that actually have hopelessly corrupt economic systems run by and for oligarchs.

Now look at Russia, where one hundred billionaires control fortunes worth an astonishing 20 percent of national GDP. Russia has nearly as many billionaires as China but they control twice as much total wealth in an economy one-fourth the size. Just as striking, Russia is missing not only a middle class but also a millionaire class; according to Boston Consulting Group, China ranks third in the world for number of millionaires, while Russia is not even in the top 15 for millionaires.

The growing business influence of the state is reflected in the fact that 69 of those billionaires live in Moscow, the largest concentration for any city in the world. Protected by their patrons, the richest face little competition. Eight of the top 10 are holdovers from 2006. More than 80 percent of the wealth of Russian billionaires comes from non-productive industries like real estate, construction and especially commodities, namely oil and gas, in which political ties can sustain fortunes indefinitely. In no other developing nation is this share greater than 35 percent. Even in Brazil, a commodity economy at the same income level as Russia, the non-productive share of billionaires’ wealth is just 12 percent.


Looking at the Money Supply

Posted by Deepish Thinker on April 26, 2011
Economics / No Comments

The following chart shows the growth in the broad money supply (M2) and BASE money supply as a percentage of M2 over the past 15 years.  BASE money supply is physical currency plus Federal Reserve accounts.  This is the portion of the overall money supply that the Fed directly controls.

Data Source: St Louis Federal Reserve

As you can see, M2 has been growing at a reasonably steady rate for the past 15 years.  BASE made up a reasonably constant proportion of M2 up until the end of 2008.  At that point the Fed had to dramatically increase the BASE money supply in order to keep M2 expanding at roughly the accustomed rate.

There are a number of different ways of looking at this.  It could be that this is simply the new normal and the the Fed’s balance sheet will henceforth make up a higher percentage of the overall money supply than has generally been the case.

Alternatively, you could view the situation as essentially benign.  The Fed’s balance sheet is relatively large because it had to respond to the crisis.  It will shrink over time as the economy recovers.  My guess is that this is Chairman Bernanke’s preferred assessment.

The pessimists among us tend to believe that quantitative easings are a bit like wars in the Middle East.  Much easier to get into than out of.

I’m inclined towards pessimism, or at least skepticism about the existence of free lunches.  The Fed’s extraordinary actions over the past few years may well have taken some of the bite out of the crisis, but my guess is that we pay for them through either inflation or uncomfortably tight monetary policy down the road.

(Data source:  St Louis Federal Reserve)

Unfortunately Serious

Posted by Deepish Thinker on April 11, 2011
Uncategorized / No Comments

James Fallows of the Atlantic has given seven reasons that Paul Ryan’s budget proposal is neither brave nor serious.   I’ll grant that 6 out of 7 are pretty solid.  The exception is:

3) A plan that exempts from future Medicare cuts anyone born before 1957 — about a quarter of the population, which includes me — is neither brave nor serious. See “canny or cynical: take your pick” above.

This may not be brave, but is definitely serious.

Old people are numerous and prone to voting.  They also have a choice.  If you are in your mid-fifties or older today there is a reasonable chance that you will be dead before the country’s fiscal situation implodes.  It therefore makes sense to veto any proposal that reduces benefits.

There are plenty of voters under the age of 54, but they are in a very different situation.  Barring untimely demise, these Americans will live to see the nation’s fiscal Waterloo.  They therefore have an incentive to accept painful reforms in order to avert the otherwise inevitable disaster.

The political reality is that no reform that adversely impacts current AARP members has any chance of adoption.  It is neither brave nor serious to ignore that fact.

Right Price?

Posted by Deepish Thinker on January 16, 2011
Uncategorized / No Comments

I’m not sure exactly how they do it, but Goldman Sachs has an incredible ability to receive credit for being smarter than they probably are.  Consider this from the Wall Street Journal’s Opinion page (gated):

In fact, the firm’s real talent isn’t knowing what the price will be, but what the price is. And Goldman clearly hit the mark with the $50 billion valuation implied by its $450 million investment in Facebook last week. The firm also rigged up a deal to make $1.5 billion in Facebook shares indirectly available to its well-heeled clients, and every sign is that the offer was oversubscribed.

If the offer was oversubscribed then Goldman clearly did not “hit the mark”.  Having more willing buyers than shares to sell means the price was set too low and Goldman left money on the table – to the detriment of their clients, the existing shareholders of Facebook.

How can supposedly professional politicians be so shockingly bad at politics?

Posted by Deepish Thinker on December 10, 2010
Current Events, US Politics / No Comments

House Democrats have decided to make a great show of refusing to support the President’s deal on extending the Bush tax cuts.  It is difficult to understand why any remotely competent politician would take on such a clearly untenable position.  The inevitable climb down is clearly going to be deeply humiliating.

At the present time Democrats currently have two plausible alternatives:

  1. Pass, however grudgingly, the President’s tax deal
  2. Dig their heals in and ensure that:
    1. The President is severely damaged (What use is a President who can’t even rally his own party?)
    2. Democrats take the blame for everyone’s taxes going (Can’t avoid that when you willfully torpedo a bipartisan deal)
    3. The replacement deal to extend the Bush tax cuts will be done by the next Congress, in which Democrats will have even less leverage (Because that’s what happens when you lose the house)

Since most Democrats are not actually certifiable, it is only a matter of time before they back down and take option 1.

There are a fair number of people who seem to believe that, if they stick to their guns, house Democrats will somehow be able to negotiate a better deal.  This is pure fantasy.  The Democrats have precisely zero leverage in this situation.  Republicans already have a deal they like.  If the Democrats refuse to get on board they will be more than happy to blame Democrats for a tax hike, then force an even better deal next year.

Since all of the above is obvious to pretty much everyone involved, the political tactics being employed by house Democrats seem thoroughly mystifying.

One plausible explanation is that this little piece of political theater is aimed, not at the general public, but at Democratic primary voters.

Democrats who are losing their seats are taking the opportunity to position themselves as true guardians of the faith, just in case they want to run in 2012.  While those Democrats who survived the recent slaughter certainly don’t want to open themselves to a potential primary challenge from the left by being seen as too willing support a deal that the folks who vote in Democratic primaries aren’t too fond of.

Everyone knows a climb down is coming, but precisely which Democrats are held responsible for this humiliation by the party faithful may have a big influence on a lot of Democratic careers.

Directorial Debut

Posted by Deepish Thinker on December 05, 2010
Uncategorized / No Comments

A Dose of Reality for Fiscal Conservatives

Posted by Deepish Thinker on December 01, 2010
Current Events, Economics / No Comments

It appears that Messers. Simpson and Bowles are having some difficulty rounding up support from either Republicans or Democrats for their deficit reduction proposal.

This was entirely predictable, but very disheartening for those of us who would like to see the deficit reduced mainly through expenditure control.  What Republicans have apparently failed to grasp is that time is not on the side of fiscal conservatives.  As this insightful article points out, the longer we wait the more inevitable tax increases become:

To understand the stakes facing fiscal conservatives, one must appreciate how demographics, program indexing methods and political realities combine to stack the deck against them. By bipartisan consensus, we won’t cut the benefits of those already in retirement; we won’t send a $2000 check to an 85-year-old widow in January and then cut it back to $1600 in February. Both parties (including the most conservative members) repeatedly reaffirm their dedication to this principle.

As a result, with each new class of retirees there is a new set of politically inviolate benefit obligations. Moreover, due to the wage-indexation of the initial benefit formula, the minimum threshold of politically acceptable future benefits rises with each subsequent class of retirees. So, with each year of delay the share of the problem eventually solved by tax increases inevitably rises.*

Well before 2037, unless we cut benefits for those already retired, a tax increase could not be avoided even if the entirety of payments to new beneficiaries were shut off. Thus, if action is delayed for several years, virtually all of the “solution” will consist of tax increases.

Our potential success in constraining the growth of taxpayer burdens therefore depends largely on when a solution is enacted. It is not so simple as deciding a particular solution is faulty, tearing it up, and trying again in a few years on the hope that conservatives’ political position will then be stronger. Such a strategy naively ignores demographic realities. Enacting Simpson-Bowles by contrast would allow conservatives to lock in constraints upon cost growth that simply will not be achievable under a delayed solution.

Republicans may not actually be serious about deficit reduction.  Or they may be calculating that they will be able to negotiate a better deal next year.

If the latter is true they are making a serious gamble.  The election largely wiped out Democratic moderates.  The Democrats who remain are likely to be more committed to closing the fiscal gap with new taxes, and very much aware that they only need to stall in order to get their way.

The Republicans have the opportunity right now to shape the deficit debate by endorsing some variant of the ‘bi-partisan’ Simpson-Bowles plan.  If they instead try and push a Republican plan next year the chances of getting a deal drop to near zero.  Unfortunately for the country, failure to get a deal is effectively the same as voting for higher taxes.

* Reference to a chart showing projected increase in Social Security beneficiaries has been omitted from the quote

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