Tuesday, July 29, 2014

Corporate Inversions, Profits and Taxes

How many of you vote yes for inversions? What? What the hell is an inversion? I looked at Wikipedia and found that inversions occur in music, arts, natural sciences, mathematics, and just about everything. Typically it means you have turned things backwards or stood things on their heads. For example, the air nearest to the earth’s surface is warmer because solar radiation warms the earth’s surface. In a temperature inversion the air gets warmer, instead, at higher levels. When temperature inversions occur we get a lot of awful things like smog entrapment and freezing rain.

As such it seems almost obvious that the President would want to halt business inversions going on today. In a business inversion a successful domestic company decides it wants to move its headquarters to a foreign country. Imagine if GM decided it wanted to move its headquarters to Cuba! Now that would be an inversion! One way to conduct an inversion is to merge or be acquired by a foreign company. Suppose Toyota bought GM. In that case GM’s productive and other activities would continue in America – but GM America would become a subsidiary of a Japanese company.

Why would a US company do such a thing? According to the President the reason is taxes. Where a company like GM pays its taxes is an important issue. Many American companies are global and increasingly so. This means they have international activities all over the world. Important for the inversion issue is where they sell their goods. If GM sells cars in Hungary – then the sales revenue flows directly to a GM subsidiary in Hungary. The subsidiary is technically a Hungarian company because the Hungarian government licenses it to do business within Hungarian borders – but it is run by GM.

So American companies have sales in many different countries. The sales revenue goes to pay for business costs. Typically the American companies will report and pay profits taxes in those countries. If there is anything remaining after all that the rest of the revenue flows back to America. When and if it flows back, it is taxed again by the USA. According to an Economist Magazine article (http://www.economist.com/news/leaders/21608751-restricting-companies-moving-abroad-no-substitute-corporate-tax-reform-how-stop ) , the US is the only large rich country to tax these repatriated earnings. And since the US has the highest corporate tax rates of most major countries, US companies feel put upon and dislike the extra taxes they have to pay. An inversion, accordingly, feels good to these companies. Becoming a foreign company means they no longer have to pay the extra taxes. According to the article, most large countries have gone to a territorial tax system and few pay double taxes as in the USA.

Please notice one thing that is often not said or written adequately in inversion discussions. This has nothing to do with corporate taxes paid or earned on sales within the USA. With or without an inversion, US sales and operations will be taxed as usual. Inversions only have to do with repatriations of the already-taxed profits in other countries.

Still, the President and others do not want to reverse these tax laws. They want US companies to pay significant tax rates on repatriated earning despite being taxed once already in other countries. Instead they prefer to introduce new and more stringent regulations on how and where US companies can merge or be acquired by other companies. Interesting is the signal sent by these new regulations. The US government proposes to allow inversions in cases where real managerial control is NOT kept by the US company. That is, if the foreign merger results in the US company losing control to a larger foreign entity over its decisions, then that is okay. Talk about perverse! This is a true inversion in logic. Okay US company – we do not want you to control your operations. Let’s let the foreign company really take you over. All that risk is incurred so that the government gets a little more from the repatriated foreign earnings. Wow – now that is really backward and dangerous. You put at risk ALL the earnings and taxes of the US companies for the sake of chicken feed.

One more thing. Most mergers and acquisitions are notoriously difficult, complicated, and uncertain endeavors for large corporations. Most of them fail. Companies spend huge sums of money trying to predict the many impacts of corporate marriages. Just like in human marriages much is unknown about your partner in a corporate marriage. Despite sometimes spending billions most of these corporate marriages fail. It is not reasonable to conclude that any of the high profile large company inversions causing the President’s concern were solely done to reduce US taxes. Taxes might matter, yes, but the overwhelming reasons for inversions are for strategic reasons.

And why not for strategic reasons? It is no secret that business is increasingly global. As the President acknowledges, he would love to increase US export sales. This is because few serious companies can be profitable without taking advantage of a huge world marketplace. He wants to find ways to encourage US companies to seek out and successfully enter these international markets. He wants to do this because more profitable US companies hire more workers, pay better wages, give more to charity, and more. So why does he say he wants to motivate more exports one day and then the next day penalize the profits of these same companies with an extraordinary corporate tax system?

I vote for inversions. If the President wants more tax revenues, let him try another way that doesn’t damage the competitiveness of US companies and US exports in general. Focusing on tax loopholes and tax reform might be a place to get started. 


Tuesday, July 22, 2014

Exports Are Cool but Geographically Challenged

Exports are cool. Not cool enough to be in the lyrics of any rock song I know of but definitely cool enough that President Obama declared in 2010 his goal was to double USA exports to the world. I wrote about that in this blog space a while ago. It looks even less doable now than it did a while ago. So here I go again! I have some new data that shines a light on why it is next to impossible to make large gains in exports now.
It also suggests that attacking the EX-IM bank right now would be highly counter-productive. 

Before I get to that data it helps to see why the President and others think exports are so cool.  An export exists when a business firm on US soil produces a good or service and sells it to someone living outside of US soil. These people might be Canadians buying auto parts from Kokomo Indiana, Mexicans buying industrial equipment from Columbus Indiana, or UK citizens purchasing an Amtrak ticket that will take them from Indianapolis’ Union Station to the Grand Canyon.  You might say that such sales amount to the same thing as when the buyer lives on US soil – but you would be only partially right.

The important difference is the impact that exports have on our national ability to grow. USA buyer purchases are ultimately limited by what they earn. Let’s suppose you can earn $100 and you spend locally $80. The rest goes into saving or to goods and services produced abroad.  From time to time you can spend more than $80 but it can't last. The “equilibrium” spending for income of $100 is $80.  Now let’s imagine that a foreigner decides to buy from us and we are able to hire more people to produce these extra goods and services. The foreigner, therefore, expands how much our nation produces and how much income we earn.

So long as foreigners want our goods and services, this export sale permanently increases national output beyond what our own citizens earn. It raises our incomes as well. The increased income means we can buy more domestic and foreign goods. This is what is so cool about exports.

Trace the steps…more exports…more output…more income…more domestic spending…even more output.

If a country like Germany or Japan or the USA is able to win the global competition for goods and services, it can use this ongoing competitiveness as a way of permanently increasing its output and economic growth.  If you are still reading and are somewhat awake you might say something like – hold on fella. Whoa Nellie. Won’t other less competitive countries get a little irritated and make unhappy noises? The answer is yes. We have a term “beggar they neighbor” to characterize countries like China who are notorious for playing the export game. But the truth is that while the others feel jilted they can always reduce the unwanted impacts by raising the competitiveness of their own products and services. And while China is well-known for using exports for growth, there are many countries that use this strategy to a lesser degree and therefore are not as notorious. The game goes on.

So exports are cool and we in the USA would like to beggar our neighbors. But the data have not been kind to the President’s goals for expansion. Notice that before the recession hit, US exports were exploding. Between 2003 and 2008 USA exports of goods and services in current dollars increased by 81%. In the five years after the recession started, from 2008 to 2013, exports increased by only 24%. That is quite a slowdown. While it is true that exports declined in 2009, they have increased in every other year and totaled $2.28 trillion in 2013. They have, however, been growing slowly.

If your horse is running too slowly you give it more JD. Right? Or you do something to speed it up. In past blogs I have pooh poohed efforts to reduce the value of the dollar among other policy remedies. In this blog my focus is geography. Before you come up with a solution for exports it might be a good idea to see which countries are buying more or less from the USA. Luckily the Bureau of Economic Analysis has data on USA exports by country destination.

It might surprise you but Canada and Mexico are the largest purchasers of US products. Apparently closeness counts when it comes to kissing and international trade. In the table below I list some key export destinations – countries and world regions. The table order is in terms of how much each destination bought from the USA in 2008 (because I inter-mix countries with regions the totals do not add).

The table below has three columns. The first column tells you export sales from the USA in 2008. The second tells you the percentage change in exports for two different time periods: between 2008 and 2013/ and 2003 to 2008. The final column tells you how much higher USA exports would have been “if” they had grown at the rate from 2003 to 2008. It shows you how much dollar exports we lost because of the slowdown in the past five years.

Some takeaways from the table:
·       
The 28 countries of the European Union accounted for the largest share of US exports in 2008. After growing by 86% between 2003 and 2008, the EU barely increased its purchases from the USA in the next five years.

·        You can understand the overall EU changes by looking down the table at the UK and Germany. Those countries were buying less USA goods and services in 2013 than they bought in 2008. That performance came after very strong increases in the previous five years of 67% and 81% respectively.

·        Nafta partners, Canada and Mexico, were the largest country destinations of USA goods and services in 2008. They bought more from the USA in the time period from 2008 to 2013, but the decline in growth was much less pronounced than for Europe. Similarly S. Korea and the Newly Industrialized Countries (NICs) slowed in their USA purchases but had relatively strong rates.

·        OPEC and China had the fastest purchases from the USA in 2003 to 2008, 153% and 233% respectively. During the next five years OPEC’s purchases of USA goods and services fell off dramatically while China’s continued growing at 84%.

·        Japan had the slowest growth of USA purchases in first five year period (31%) which fell to growth of only 6% in the last five years.

·        The final column shows what the USA lost because of these slower growth rates of exports. For example, if USA exports to these regions or countries had maintained the pace from 2003 to 2008, exports to the EU and NAFTA between 2008 and 2013 would have been much higher: $404 billion and $129 billion higher, respectively.

Between 2008 and 2013 total USA exports of goods and services to the world rose by about $440 billion. This table shows that a repeat of the growth during 2003 to 2008 would have added another $434 billion just from the EU and NAFTA in 2008 to 2013.

USA Export growth fell during the global recession but then grew slowly thereafter. While we might want to discuss national competitiveness or the overall value of the dollar or unfair trade practices – this little exercise today says that our export challenge is very much geographically oriented. Europe struggles with post crisis economic growth. OPEC is trying to adapt to new competition. Other countries, including S. Korea and China are not growing like they used to. Japan languishes.

This little exercise suggests that raising US exports will be neither easy nor global. It won’t be easy because most of our main trading partners continue to be weak. It will not be easy or global because the problems or issues in each country are not the same. Mexico is not Germany and Canada is not the UK. Discussions about the US EX-IM bank suggest old-style thinking. Europe has demonstrated its importance to US exports – but without some US financial assistance to EU buyers of USA products, it is hard to see why or how they can afford to buy even what they are buying now. We won’t double USA exports in the near future but our policies should realistically address a country/regional set of issues.


          Table. USA Export Destination
                      2008           %
                    Exports      Chg*    Higher?
        Billions                     billions
EU                   471          1/86          404
Canada            308        19/56           114
Mexico            178        44/53             15
NICs               147        34/56             32
UK                  114         -5/67             81
Japan               107          6/31             27
OPEC               92        22/233          192
China                87        84/153            59
Germany           83         -9/81              75
S. Korea           50        28/57               15
Brazil                45        56/183             56


% Chg column has two numbers. Both are percentage 
changes over a five year period. The first is from 
2008 to 2013. The second is from 2003 to 2008. 

Tuesday, July 15, 2014

Five Years of Chuggin' Along by Guest Blogger Buck Klemkosky


Buck was a finance professor at the Kelley School and the founding dean of SKK Graduate School of Business in Seoul. He is now affiliated with Wallington Asset Management. see http://wallingtonasset.com/robertklemkosky.html

The U.S. has experienced 11 recessions since the end of WWII and the most recent one has been the most severe. The Great Recession started in December 2007 and ended in June 2009 as determined by the National Bureau of Economic Research, an independent group of economists that has officially called the beginning and end of business cycles since the 1920s. So June 2014 marks the fifth anniversary of the end of the Great Recession.

What is the prognosis of the economic recovery thus far? Not good. It has been the slowest recovery in terms of economic growth than any other; it’s been more like a long, slow slog with growth averaging 2 percent annually over the 20 quarters. The first quarter of 2011 and 2014 even experienced negative growth although the latter may be due somewhat to the harsh winter. Economic growth in normal recoveries averages 4 to 5 percent annually. U.S. gross domestic product (GDP), the final value of all goods and services produced, did not recover from the 2007 peak until the third quarter of 2011 and it wasn’t until the second quarter of 2013 that GDP per capita surpassed the earlier peak. This is because there are 15 million more working-age people in the U.S. today than in the pre-financial crisis era. So technically, the economy has passed from recovery to an expansionary phase.

Why the slow recovery? Unlike the other 10 recessions since WWII, the Great Recession was caused by a financial crisis which in turn was caused by too much household debt (mostly mortgage) and an overleveraged financial system. Basically the U.S. experienced a credit bubble which imploded and caused the Great Recession. Evidence by Reinhart and Rogoff in This Time It’s Different: 800 Years of Financial Crises shows that recoveries from recessions caused by a financial crisis are weaker and take longer than from the normal cyclical recession. Debt has to be pared down and balance sheets strengthened before a return to normal growth. So the pace and length of the recovery was predictable.

Deleveraging since the Great Recession has occurred in households, mostly in the form of less mortgage debt, which fell from 73 percent of GDP in 2008 to 55 percent today. U.S. financial sector debt fell from 118 percent of GDP in 2008 to 82 percent today. Conversely, the federal government has levered up with debt rising from 72 percent of GDP in 2008 to 102 percent today. The government debt includes public as well as debt held by government agencies such as Social Security. The debt of non-financial corporations and state and local governments and consumer credit has been relatively stable relative to GDP, so overall the total U.S. debt-to-GDP ratio has fallen from 409 percent of GDP in 2008 to 392 percent today.

So what does the five-year recovery mean for American households? On average it has made them wealthier than ever. The aggregate wealth of U.S. households, including stocks, bonds, cash, real estate and other assets, hit an all-time high of $81.8 trillion in the first quarter of 2014, up $26 trillion since the low point in 2009. Most of this has been due to the stock market, where the S&P 500 has risen nearly 200 percent from its low of 667 in March 2009 to an all-time high recently of 1963. Housing prices have also rebounded; after falling 33 percent from 2007 to 2010, prices have rebounded 19 percent, still leaving house prices 20 percent below their peak.

So for owners of stocks, bonds and homes, balance sheets have been repaired and some households are now wealthier. The burden of household debt also has fallen as the debt-service cost (principal and interest) has fallen from more than 13 percent of after-tax disposal income to below 10 percent today. However, about half of American households do not own stocks and more than one-third don’t own homes. For many it doesn’t’ feel like a recovery has occurred.

While household wealth has more than recovered, the news for jobs and income hasn’t been as rosy. A key milestone was reached in May 2014 when U.S. payrolls surpassed the peak number employed in 2008. In other words, more jobs have been created in the recovery than lost during the recession. It took two years to wipe out 8.7 million American jobs, but more than four years to recover than all, making this the longest job recovery of any recession since WWII. Even though the unemployment rate has fallen from 10 percent in 2010 to 6.3 percent in May 2014, a look behind the jobs numbers shows that many of the jobs recovered are not necessarily the same ones lost. For example, over 3 million net jobs have been added in the healthcare, hospitality and food service areas, while over 3 million jobs have been lost in construction and manufacturing. The former are low-paying jobs and the latter higher paying jobs. 

Almost another 1 million higher-paying jobs in finance and government have been lost, and many of the new jobs created have been part-time. Also, the long-term joblessness rate is stubbornly and historically high at over a third of the unemployed. And the jobs recovery changes by region as energy states like North Dakota and Texas have done well and housing bubble states like Nevada and Arizona not so well.

While the jobs recovery has lagged normal recoveries, as expected wages also remain subdued; they have increased at about the same rate as economic growth. One constraint on wage growth has been slow growth in labor productivity, which has increased at about 1 percent annually in recent years. Even the middle class is feeling the pinch; median household income has fallen from a peak of $56,080 to $51,017 in 2013. Although improved since the recession years, subdued wages and less job security don’t bode well for consumer confidence, and why many don’t feel like an economic recovery has occurred.


Where does the economy go from here? Hopefully, because the economic recovery has been so weak, the economic expansion will prove to be more resilient than typical. At 60 months, this economic recovery and expansion is already the sixth longest since WWII. Another 13 months and it will match the 2001-2007 expansion, which included the housing boom. It has a long way to go to match the 1991-2001 tech expansion boom. But there are reasons to be optimistic: household budgets and balance sheets are in better shape, the financial system is stronger, Europe is coming out of its recession, fiscal and monetary policies are normalizing, inflation and inflationary expectations appear under control, and interest rates remain at historic lows. The best scenario is that the economy keeps on chuggin’ along but at a little better pace than the 2 percent average growth over the last five years. The economy needs more real income and wage growth to sustain the current economic expansion.

Tuesday, July 8, 2014

Defense and Climate Change: The Value of Waiting

Economists have models and explanations for anything and everything. Relevant to today’s top issues is the value of waiting. I am sure that many women wish they didn’t have to wait nine months to deliver but they know that trying to have a baby at the end of the third month would not have acceptable results. An economist would say something stupid like – the marginal costs of waiting one less month is greater than the marginal benefit and therefore waiting has value. In the case of pregnancy, most of us wait about nine months. Of course we wouldn’t want to wait 18 months because we know the marginal costs of waiting more would outweigh the benefits.

Maybe you don’t love my example, but we face the costs/benefits of waiting all the time. Should I wait at this red traffic signal for another minute? The young guy with slicked back hair wonders how many more songs to sit through before he asks the babe in the pink hot pants to dance. If our wait is too short, we may experience the costs of a hasty decision. Wait too long and the opportunity escapes.

This issue of waiting came to mind as I was playing with my new Nespresso machine and thinking about climate change and national defense. ( I can't drink JD all the time!) With respect to climate change we have one group of people who deem it urgent. These people advocate full speed ahead when it comes to ending reliance on coal and investing in new non-renewable sources of energy. To the climate change advocates, waiting is not a luxury we can afford. With respect to very recent changes in global terrorism and American security there are some people who also think that waiting is not a viable option. To them terrorism is on our global doorstep and needs to be addressed firmly and immediately.

The value of waiting is being evaluated seriously by climatologists and defense planners. Sadly much of the resolution to these waiting issues is ideological. Many of those who would put climate change in a speedboat are the same folks who would see no rush to deal aggressively with terrorism.  And, of course, vice versa many who favor a rapid response by the US military are those who would drag their feet on climate change. This ideological approach needs to be replaced by something more sensible.

The value of waiting is affected by the expected costs and benefits of waiting. I say “expected” because these impacts are not known and will play themselves out in the future. That means several things. First, except for your spouse, no one knows the future with certainty. Second, that means we have to use models or somehow guess about the future. Third, it means we will have plenty to argue about since no one knows the future. Fourth, the less ideology and emotions play into this valuable exercise, the better off we will be.

But we are a long way from that situation. My bearded long-hair friends say that America has suffered enough. We have no stomach left for a fight. As in the recently cited report by former Treasury Secretary Hank Paulson, these groovy dudes are sure that the costs of global warming are ever-present, immediate, and catastrophic. That’s it. Story over. For every person with those beliefs there is one who thinks that if we wait too long to weaken a growing terrorist threat, we will surely be overrun by vicious enemies who will show us no mercy. These khacki-wearing, button-downed,  crew-cuts see the immediate employment and growth impacts of vigorous environmental policies as swamping any possible future benefits.

Okay my depictions of extreme lefties and righties are pretty stupid but the point is not. We are getting nowhere and perhaps risking our future because we are letting extreme views prevent us from hard-headed analysis about our most important policies. Consider that we have four possible SOLUTIONS, two of which hardly ever get considered:

·        Conservative  Defense Fast; Environment Slow
·        Liberal           Defense Slow; Environment Fast
·        Expensive      Defense Fast; Environment Fast
·     Cataclysmic    Defense Slow; Environment Slow

To decide on one of these or perhaps some combination of these solutions means we have to do the work. We might not know the future but perhaps we can throw away the knives and swords and make use of our best experts. What do we need to know?

·        If we wait on defense, what can we expect from terrorism? What is the most likely outcome? What is the very worst that can happen? How likely is that?
·        If we wait on climate change policy, what can we expect in the way of negative impacts? What is the most likely outcome? How likely is that? 
·        If we move quickly on defense, how much will that cost? What benefits will be gained? Can these policies really accomplish their goals? If the US acts alone, can these policies really accomplish their goals?
·        If we move quickly on climate change, how much will that cost? What benefits will be gained? Can these policies really accomplish their goals? If the US acts alone, can these policies really accomplish their goals?

I know that I am unrealistic to think that our present government representatives can shed their blue and red uniforms to do something sensible for the good of the country. But without a real assessment of these questions I don’t trust either party to do the right things. As in my last post about poverty, I come off sounding na├»ve in the real world for suggesting that real problems have real solutions. Isn’t everything simply political and ideological? Maybe that’s true. But if people don’t demand better processes and outcomes, then it seems to me there is no way to ever get them. So I continue to spout off even if it amounts to urinating into the wind. 

Tuesday, July 1, 2014

Blindly Following Alan Blinder Over a Poverty Cliff

Alan Blinder wrote about income inequality in the Wall Street Journal last week ( Pikettymania and Inequality in the U.S., June 23, 2014, pA13).  The article regurgitates a lot of well-known facts that support the idea that income inequality has grown. But the article is also the poster child for what is missing in our discussions about cause, effect, and policy. Following Blinder’s hasty policy recommendations will likely make things worse and that is what I am spouting off about today.

Blinder starts with the recent work by Thomas Piketty – giving him credit for focusing on the impact on income distribution made by the richest Americans. He agrees with Piketty that among the solutions for correcting income inequality is to make the rich pay more. But Blinder thinks Piketty does not spend enough energy on the bottom half of the income distribution and therefore misses some important other policies that Blinder advocates – “giving poor children preschool education, bolstering Medicaid, raising the minimum wage, expanding the Earned Income Tax Credit, and defending anti-poverty programs like food stamps.”

It would take a cold heart to argue with Blinder. Most of us boomers supported the programs that Blinder lists. We give to our local charities and we pay taxes to support these programs. But what I find to be so irritating about Blinder is his boldness. Nowhere does he admit that there might be even the tiniest problem with any of these approaches that might make a society of people who truly care about poverty want to evaluate the effectiveness of these programs for the ends we value so much.

Notice the words that Blinder chooses in his list above – giving, bolstering, raising, expanding, and defending. These are his words – not mine. Is it abundantly clear that all these programs are perfect and simply need to be expanded and defended? Even if he wants to tax only the rich to pay $2 trillion or more for these programs – it seems fair to want to ask if this $2 trillion is getting the job done.

You and I are bound by budgets and logic when it comes to our own expenditures. When a merchant wants to charge us more for a good or service we get to work. Is the good worth the extra money? Is there a better way to get the benefits of this service? Is there a different provider who can do a better job? Whether it is getting our lawn mowed, buying a health insurance policy, or purchasing the best 10 year old bourbon, most of us try to get the best results with the least amount of outlay.

But Blinder doesn’t think that way. Nowhere in his article is one word devoted to the effectiveness of these programs. Nowhere does he ponder if $2 trillion of our dollars could be used more effectively to eliminate poverty. Nowhere does he even mention how these programs attack systemic or even cyclical causes of poverty.

I know, some of you think that just raising these issues is a smoke screen. A letter published in my local paper recently described Republicans and other fiscal conservatives as greedy, hateful, mean-spirited people who basically hate the poor. I doubt that most people agree with that but that extreme opinion is clearly out there and it makes it easy for some people to love Blinder and to hate anything that interferes with liberal, progressive doctrines.

But let’s face it – Blinder wouldn’t be writing if it weren’t for at least blemishes in these programs. Like Oliver, Blinder wants MORE. In the case of Oliver he wanted more gruel because he was hungry. Blinder wants more money thrown at social programs. But Blinder offers no connection between his policies and the root causes of poverty. He asks us to trust him. The reason policies have not worked in the past is because they weren’t big enough. So let’s add more money. After 50+ years of a Great Society and a War on Poverty with ever more poor people, I’d like to see a little more time and energy devoted to how to best fix these problems.

But that would take time, effort, and an open mind. I am wondering what Professor Blinder thinks about that?