Abstract of the Week

With budget issues returning to the fore with the expiration of the debt ceiling deal and this week’s focus on Apple’s tax avoidance strategies, policymakers may once again turn their attention to reforming the corporate income tax. Reihan Salam highlights a paper by Bob Pozen and Lucas Goodman looking at one interesting strategy.

“Many lawmakers have indicated support for reducing the statutory corporate tax rate from 35 to 25 percent on a revenue-neutral basis. However, they have not made clear how they would broaden the base enough to pay for that rate reduction. This report proposes a specific approach for revenue neutral corporate tax reform: limiting the tax deductibility of interest expense for C corporations. That would significantly reduce the tax code’s bias in favor of debt-financed investment relative to equity-financed investment, while keeping the overall cost of capital roughly the same.”

“The authors propose reform that lowers the corporate tax rate from 35 to 25 percent and allows nonfinancial C corporations to deduct only 65 percent of their interest expense, with special treatment for the financial sector and for companies that would have otherwise realized taxable losses. Based on a static analysis of aggregate data between 2000 and 2009, the authors calculate that the revenue loss from lowering the corporate tax rate to 25 percent would have been about the same as the revenue gain from their proposed limits on interest deductions.”

Chart of the Day

– FT Alphaville highlights a scorecard from Standard Chartered ranking “looking at how a selection of developed economies are doing post-2008.” More stars means better performance.

“The short answer is that the US has largely recovered from the crisis, with growth there likely to be above trend in 2014. The UK and Japan, meanwhile, are still behind in terms of balance sheet adjustment and effective monetary policy.”

Tesla Pays Back Government Loan Ahead of Schedule

This week “Tesla, the maker of electric cars, paid off a $465 million loan…that the Energy Department made in 2010… repaying the government nine years before its loan was due,” NYT DealBook reports.

“Tesla’s payment will be the latest source of excitement to its supporters. But whether Tesla remains a good advertisement for government aid partly depends on how the company now performs.”

“Tesla’s exit from the government loan may now refresh the debate over how much support to give young, clean-energy firms… The Energy Department on Wednesday said that losses on its loans were equivalent to 2 percent of its $34 billion portfolio.”

California Exchange Premiums Come in Below Expectations

“California said it has selected 13 health plans for a new state-run insurance marketplace where as many as 5 million people will shop for coverage next year,” according to the Los Angeles Times, and “the rates submitted for next year’s individual market ranged from 2% higher to 29% below the average premium now for small-employer plans in the state’s biggest metro areas.”

“Officials said consumers shopping in the state-run exchange will have five health insurance plans, on average, to choose from in most areas of the state. Rural areas may feature two to three plans. The exchange splits the state into 19 regions.”

The Hill: “Experts had been especially eager to see California’s rates, and it is the first large state to release price information for next year. The average plan will carry a monthly premium of $300, regulators said. Most people will receive a subsidy to help cover part of that cost, and cheaper options are also available.”

“The Congressional Budget Office predicted in 2009 that premiums for a middle-of-the-road exchange plan would come to about $5,200 per year. Other states have seen their rates track relatively close to that figure, but California’s plans came in substantially lower.”

What Would a Carbon Tax Actually Do?

Even as climate legislation languishes in Congress, the Congressional Budget Office has released an analysis of what may be the least likely of the mainstream proposals to reduce carbon dioxide emissions: a tax. Brad Plumer looks at what CBO found.

“A carbon tax that starts at $20 per ton would raise $1.2 trillion in the next decade… That same carbon tax would hike gasoline prices by about 20 cents a gallon: Since the United States is so reliant on fossil fuels, any carbon tax would raise the price of stuff… That carbon tax would also hike U.S. electricity bills by 16 percent on average, though coal-heavy states would see bigger hikes.”

“The biggest question, by far, is what to do with the revenue. Rebate it? Cut other taxes? If carbon-tax revenue is used to cut other taxes — say, payroll taxes or even corporate taxes — that could mitigate the economic impacts considerably, depending on how the tax was designed.”

“A carbon tax starting at $20 per ton would cut U.S. emissions an extra 8 percent by 2021. This would get the United States in range of its Copenhagen pledge to cut emissions 17 percent by 2020″

How to Dodge Taxes Like Apple

In the wake of a congressional investigation into Apple’s tax avoidance strategies, Jonathan Weil explains exactly how the tech company pulled it off.

“Consider an Apple subsidiary called Apple Operations International… Its net income accounted for 30 percent of Apple’s worldwide profit from 2009 to 2011. Apple Operations is incorporated in Ireland. It is managed and controlled in the U.S. Yet Apple says the unit isn’t a resident of either country — or any country. So it paid no corporate-income taxes.”

“Take another example that the senators pointed to… When Apple transfers intellectual-property rights to an Irish unit, it uses a so-called cost-sharing agreement… The rules say companies are supposed to be honest about the numbers they assign to these transactions between subsidiaries. But the tax authorities have a hard time challenging them because there are rarely correct answers when it comes to valuing intellectual property or allocating research-and-development costs… The Senate report said Apple shifted $74 billion in income to Ireland from the U.S. through its cost-sharing agreement from 2009 to 2012.”

Venture Capital Stays on the Sidelines

“In the first three months of this year a mere 35 US venture capital funds raised just $4bn – 12 per cent lower than a year before,” says Gillian Tett, noting that “in 2012, venture capital raised a mere $28bn of funds… lower than in 2011, let alone 2007.”

“If nothing else, it raises important questions about who will fund big speculative innovation bets in the future. After all, in recent decades…technological innovation in America has been driven by a combination of state investment (say, via the military) and private sector gambles on research and development (via venture capital). But government largesse is now drying up, even as private money appears to be wilting too.”

“Of course, if you believe in the self-correcting power of capital markets, this pattern should eventually change… But don’t bet on that happening yet… For the moment, in other words, the sector stands as a sad reminder of just how bifurcated the financial system remains.”

Obama Lays Out National Security Policies

President Obama gave a wide-ranging speech on national security and terrorism issues and released an accompanying fact sheet touching on everything from the use of unmanned aerial vehicles better known as drones to the Guantanamo Bay detention facility. John Bellinger breaks it down into the good, the bad, and the ugly.

“The most significant part of the speech was the President’s description of clearer standards for use of force against terrorists, including by drones… Together, the speech and fact sheet set forth more restrictive standards, including that the same targeting standard applies to Americans and non-Americans; that the targeted individual must pose a ‘continuing and imminent’ threat…that the threat must be to U.S. persons (not simply ‘U.S. interests’); and that there must be a ‘near certainty’ that non-combatants will not be injured or killed.”

“Other parts of the speech were less clear… the actions the President announced with respect to Guantanamo are simply to re-start actions that he had stopped, including appointing a special envoy at the State Department and Defense Department (two envoys?) to handle transfers; lifting the moratorium on transfers to Yemen; transferring detainees who have been cleared for release; and insisting on judicial review for every detainee.”

Who Writes All That Legislation?

Apparently not Congress. NYT DealBook has an inside look at how lobbyists help lawmakers draft interest group-friendly legislation.

“In a sign of Wall Street’s resurgent influence in Washington, Citigroup’s recommendations were reflected in more than 70 lines of the House committee’s 85-line bill. Two crucial paragraphs, prepared by Citigroup in conjunction with other Wall Street banks, were copied nearly word for word. (Lawmakers changed two words to make them plural.)”

“Industry officials acknowledged that they played a role in drafting the legislation, but argued that the practice was common in Washington.”

There’s Not as Much Job Market Churn as You Think

Peter Orszag looks at a recent paper from the Census Bureau showing that from 1998 to 2010, “rates of job creation, job destruction, hiring and separation declined dramatically, and the rate of job-to-job flows fell by about half.”

“This, in turn, largely explains why fewer Americans than ever are moving across state lines… roughly three-quarters of people who move across state lines change employers when they do so. However, the wage gain from switching employers has fallen to essentially zero. The result…is that people change jobs less often and therefore have less incentive to move to another state.”

“Most Americans feel their lives are more fluid than in the past, while the data suggest otherwise. At least with regard to job changes, big moves and mobility across generations, America appears to be getting stuck in place.”

The Bush Tax Cuts Didn’t Work

Bruce Bartlett rounds up economic research showing that the tax cuts passed by President George W. Bush from 2001 to 2003 failed to meet even the administration’s promised results.

“This initiative originated with the economist R. Glenn Hubbard, who had been chairman of the Council of Economic Advisers when the proposal was sent to Congress… Mr. Hubbard had also spearheaded enactment of big tax cuts in 2001 and 2002 that he said would jump-start the American economy… There is no evidence that the tax cut had any such effect… Hence the need for yet another big tax cut.”

“The idea of the 2003 legislation was to raise dividend payouts, thereby bolstering personal income, and raise the prices of common stock, which would improve household balance sheets… Subsequent research, however, found that the increase in dividends was a short-term phenomenon and mainly at companies where stock options were a major form of executive compensation.”

“It is hard to find even a reputable conservative economist willing to say anything good these days about President Bush’s tax and economic policies.”

Planning for Year Two of the Sequester

Most of the across-the-board spending cuts imposed by the “fiscal cliff” sequester remain in place, and with no budget deal in sight, lawmakers are starting to plan for the second of ten years of cuts. The Washington Post has details of House Republicans’ effort to restore “cuts to the military while making cuts to domestic programs favored by Democrats even deeper.”

“Veterans Affairs, Homeland Security and the Pentagon would be spared under the plan approved by the House Appropriations Committee on a party-line vote, but legislation responsible for federal firefighting efforts and Indian health care would absorb a cut of 18 percent below legislation adopted in March.”

“The panel’s move came as Democrats and Republicans remain sharply apart on broader budget issues like taxes… Neither House not Senate are likely to have much luck in advancing the measures very far unless a broader deal is made.”

Not Every Bull Market is a Bubble

Felix Salmon explains the difference between a bull market and a speculative bubble, arguing that the current recovery is no bubble.

“The word ‘bubble’, at least for me, is a loaded term, with a specific meaning. For one thing, it implies speculation: people buying an asset which is going up in price, just because they think they’re going to be able to sell it… The reason to be worried about bubbles has nothing to do with fear of what happens when everybody is happily making money. Rather, the problem with bubbles is that they burst… if asset prices simply decline without causing substantial collateral damage, then you weren’t in a bubble to begin with; you were simply in a bull market which then became a bear market.”

“Looking at the markets today, they show every indication of being bull markets rather than bubbles. For one thing, there’s not much speculation going on: no one’s day-trading junk bonds…  the One Percent are getting wealthier just because they own stocks and those stocks are going up… That’s real investment, it’s not speculation… when asset prices start to fall, the main people to be hurt will be the ones owning the assets in question.”

Obama Quietly Promotes Energy Efficiency

USA Today looks at one of President Obama’s least-known strategies to promote energy efficiency without any government spending: the Better Building Challenge.

“More than 110 partners — including schools, universities and cities, such as Atlanta, Chicago, Los Angeles and Seattle — have signed on to the voluntary Better Building Challenge, launched by President Obama in December 2011… which provides technical but no financial help to its partners.”

“Unlike some aspects of Obama’s ‘all-of-the-above’ energy strategy, efficiency has garnered broad support… the DOE program aims to provide strategies, already proven by leaders in energy efficiency, that other organizations can follow… the trick was getting companies to share data and tips — a sort of playbook — for what works.”

Congress is Wrong About Economic Policy

Federal Reserve Chairman Ben Bernanke testified yesterday before Congress’s Joint Economic Committee and brought a simple message: You’re wrong.

Neil Irwin looks at Bernanke’s criticism of the recent fiscal consolidation: “It might be one thing if the fiscal retrenchment was also solving the country’s longer-term deficits. But, Bernanke says, it has not… Focus on reducing the long-term sustainability of the U.S. government’s finances while moving cautiously, if at all, on short-run fiscal austerity. And the chairman repeats that plea in today’s testimony.”

Meanwhile, FT Alphaville highlights a key portion of Bernanke’s testimony in which he defends the central bank’s monetary policy decisions.

Said Bernanke, “Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets.”

Housing Data Continues to Impress

The National Association of Realtors reported that existing home sales “increased 0.6 percent to a seasonally adjusted annual rate of 4.97 million in April from an upwardly revised 4.94 million in March,” just below the consensus forecast of 5 million sales.

Bill McBride takes a deeper look: “NAR reported that inventory increased 11.9% in April from March, and is only down 13.6% from April 2012… The key points are: 1) inventory is very low, but 2) the inventory decline will probably end soon. With the low level of inventory, there is still upward pressure on prices - but as inventory starts to increase, buyer urgency will wane, and price increases will slow.”

How One Amendment Says Immigration Reform Will Pass

Matthew Yglesias sees rays of hope for immigration reform after a successful markup process where “senators disagreed about the merits of an issue, and  they struck a compromise whose goal was to advance their substantive objectives rather than to provide rationalizations for opposing a bill.”

“The basic issue is that the Gang of 8 immigration framework both expanded the H1-B skilled guest worker program and added some new hoops that companies have to jump through if they want to hire H1-B workers. Sen. Orrin Hatch, R-Utah…had a couple of amendments that would basically pair those hoops back. Dick Durbin…did not like those amendments.”

“If this were the health care bill, the way it would have played out would have been that Hatch would be unable to get 100 percent of what he wanted and then that would have become a key talking point of his over why he can’t support the law. What happened instead is that Hatch and Durbin struck a compromise that advances the key interests of tech companies while retaining some of the protections that H1-B skeptics wanted. Hatch then voted for the bill, not promising to support final passage but saying that he wants the legislative process to move forward.”

Chart of the Day

– FT Alphaville has this chart from Credit Suisse showing that according to just about any standard measure of inflation, the year-over-year rate of inflation is slowing down.

“Inflation is low and, according to every recent measure, it’s been falling. That’s pretty much all there is to it. As to the question of how much (or even whether) this disinflationary trend will influence policy, it’s hard to say.”

“Bernanke suggested…that he wasn’t so worried about it because inflation expectations have remained stable.”

Shift to Part-Time Workers Predates Obamacare

As the federal government prepares to implement major components of President Obama’s health care reform law, some have worried that employers are beginning to utilize more part-time workers, but a new report from the Employee Benefits Research Institute blames the recent shifts on the Great Recession.

“The percentage of workers employed part-time has been rising since 2007, increasing from 16.7 percent to 22.2 percent in 2011… At the same time, while both full-time and part-time workers have experienced drops in coverage, part-time workers have been affected disproportionately. Recent trends provide an important base line against which to measure the impact of PPACA once its 2014 health-coverage mandate takes effect.

Will Congress Finally Update Chemical Safety Rules?

“The current U.S. law on chemical safety is 37 years old, riddled with exceptions, and widely seen as ineffective,” says Brad Plumer, but “that law could soon get a face-lift” after Sens. Frank Lautenberg (D-NJ) and David Vitter (R-LA) announced a deal to overhaul the Toxic Substances Control Act.

“Under the Toxic Substances Control Act, the Environmental Protection Agency (EPA) can only call for testing of a chemical if evidence somehow surfaces that the substance is dangerous. What’s more, tens of thousands of existing chemicals were exempt from review when the law was enacted in 1976.”

Under the proposed changes, the EPA “would review all actively used chemicals and label them as either ‘high’ or ‘low’ priority based on their potential risk to human health and the environment… The EPA will also have greater flexibility to take action on chemicals deemed unsafe, ranging from labeling requirements to outright bans on things like asbestos.”

Why Housing Growth Hasn’t Brought Recovery

Nick Timiraos highlights a new note from PIMCO explaining why expectations of “a quick return to the ‘virtuous cycle’ by which rising prices, home sales, and housing construction feeds further consumer spending” have not yet been fulfilled.

“First, construction is coming back, but the industry’s muscles have atrophied a bit… construction still needs to double to keep up with population and household growth. How quickly it gets there matters, and the speed with which construction grows could depend on its ability to overcome a series of capacity constraints.”

“Second, banks have to be willing to expand credit beyond today’s conservative standards. New regulations will keep lenders cautious… Third, consumers also have to feel confident enough to borrow… Fourth, mortgage-equity withdrawal—the process by which homeowners take cash out of their homes—isn’t likely to play the same role that it did during the past decade in fueling consumer spending.”

Why the Bubble Debates Aren’t Interesting

Tyler Cowen explains why he generally stays away from debates about whether or not the Federal Reserve’s monetary policies are creating a “bubble recovery.”

“ I don’t find most predictive discussions of bubbles interesting, while admitting that such claims often will prove in a manner correct ex post.  ’OK, the price fell, but was it a bubble?  I mean was there froth, like on your Frappucino?’… Good news and improving conditions may well bring more bubbles or greater likelihood of bubbles, but that is hardly reason to dislike good news and improving conditions.”

“I expect the real economy over the next twenty years to be more volatile than it was say in the 1990s.  In that sense, many current asset market prices may be revised and quite dramatically.  Still, I don’t find the bubble category to be so useful in this regard.  We really don’t know what is going to happen and that is why the current prices are wrong, not because of a ‘bubble.’”

Economic Issues Fall to the Wayside

The Washington Post looks at troubling signs that the stock market boom and the focus on issues that were largely ignored during the financial crisis — including immigration — are pushing economic issues to the back-burner.

“There are no serious negotiations underway between the White House and congressional leaders on legislation to spur growth, and no bipartisan ‘gangs’ of senators are huddling to craft a compromise job-creation package.”

“But lawmakers appear to feel little electoral pressure to address those concerns. They disagree vehemently over what actions would make a difference, and lately they’ve been distracted by other issues and scandals. There also is mounting evidence that the political donor class — wealthier Americans — is feeling a stock-market-fueled surge of optimism about the economy. It all adds up to inaction.”

Will Rail Revolutionize the Oil Industry?

Open Markets looks at how railroads are making “a 21st-century impact on the U.S. crude oil industry.”

“What was first seen as a stop-gap measure to deal with extra output is now being considered a viable complement to pipelines and a permanent part of the energy infrastructure in the U.S…. In 2012, the Association of American Railroads said it moved a record amount of crude oil: 233,811 Class 1 carloads, up 256 percent from the 65,671 carloads moved in 2011.”

“Nothing beats the efficiency and convenience of pipelines, but the use of unit rail car trains, where 100 cars or more are dedicated to one product, helped to significantly lower the cost of using rail… producers who use rail can respond to market forces and send crude oil where prices are higher, rather than being stuck with where the pipeline ends, opening new domestic markets… The third benefit of rail is that rail companies offer shorter-dated contracts of one to four years, versus pipelines, which were 10 to 15 year contracts.”

Watering Down Regulations is a Two-Way Street

Many commentators have lamented the influence of lobbyists as the Dodd-Frank financial reform law works its way through the regulation-writing phase, but David Dayen argues that “this gets things backward. Concessions aren’t made without a regulator willing to sit across the table from Mr. Wall Street Lobbyist and agree to his suggestions.”

“Witness the most recent rollback of Dodd-Frank, a compromise on derivatives regulations by the Commodity Futures Trading Commission… one Democratic commissioner on the CFTC, Mark Wetjen, basically forced through the weaker rules by himself… Wetjen is in line to replace Chair Gary Gensler and run the CFTC.”

“Yet the major reform organizations continue to cite Wall Street lobbyists… Top industry lobbyists have met with Mark Wetjen repeatedly, but if he ignored their concerns, we wouldn’t be talking about how Wall Street killed financial reform.”