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.”

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.”

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.”

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.”

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.”

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.

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.”

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.”

US, EU Seek to End Solar Panel War With China

“The Obama administration is engaged in preliminary talks with the European Union and China to settle a dispute over trade in solar-energy equipment and avoid a conflict among the world’s largest economies,” according to Bloomberg.

“Government support for renewable-energy products including solar panels has led to disputes as the price of polysilicon, the main ingredient in solar cells, has dropped 64 percent since December 2010.”

The New York Times has details of a potential deal.

“The plan that is starting to take shape would essentially carve up the global solar panel market into a series of regional markets. It would sharply raise the price of solar panels exported from China, the world’s dominant producer, by requiring Chinese companies to charge more while limiting the total number of solar panels they could ship.”

“In exchange, Chinese companies would no longer be charged steep taxes on their exports of solar panels. The United States is already collecting tariffs totaling about 30 percent while the European Union is expected to impose similar tariffs of about 50 percent on June 5, and may backdate them to March 5.”

Fed Signals Confusion As Exit Strategy Nears

With various Federal Reserve bank presidents and board governors offering conflicting statements about the eventual tapering off of the quantitative easing program, Tim Duy looks at the key areas of confusion.

“I think there is strong interest in tapering QE now that we have a string of job reports pointing to substantial and sustainable improvement in labor markets, but, given the fiscal contraction, little willingness to pull the trigger on tapering until we see another two or three similar reports.”

“Still, at the same time, the Fed wants to keep its options open, as they are very much cognizant that past efforts to pull back on easing have been premature.  Hence the talk that future moves could be up or down, which is really just plain confusing… It is even more confusing given that some officials seem to care about inflation, but others labor markets.”

“Hence, we are all looking toward…Federal Reserve Chairman Ben Bernanke to provide the clarity that appears very much needed. “

Senate Hits Apple Over Corporate Tax Avoidance

The Senate Permanent Subcommittee on Investigations held a hearing in which it grilled Apple CEO Tim Cook after releasing a report (PDF) on Apple’s tax avoidance strategies. Matthew Yglesias says that the “most striking fact is that this isn’t just a matter of shifting profits to lower-tax jurisdictions, but that some of Apple’s profits aren’t taxed by anyone anywhere due to jurisdictional gaps.”

“The issue here is with the tax code not with Apple. Portraying it as a showdown between the Senate and a CEO makes for better television, but the actual issue here is one of legislators versus legislators… It’s a question of public policy how much revenue we want to raise via corporate income tax and what sectors do we want to coddle with loopholes.”

Felix Salmon: “What we’re seeing here is a corporate class which is vastly more effective at evading taxes than individuals are; I don’t see that trend going away any time soon. Instead, I have a modest proposal of my own: why not at least require all public US companies to file their federal tax returns with the SEC… at least we’d be able to see which ones are evading taxes most effectively.”

FT Tech Blog has a detailed look at the back-and-forth in the hearing.

Bonus Chart of the Day

– Joe Weisenthal notes an interesting similarity between the decline in the labor force participation rate (in blue) and the fall in per capita vehicle miles driven (in red).

“As you can see, per capita miles driven peaked just before the recession, and hasn’t recovered at all… It reminds us of the chart of the Labor-Force Participation Rate (the share of workers working or looking or work), which also started sliding before the recession, and hasn’t stopped sliding at all during the recovery.”

“There’s a logical connection between the two. Not in the workforce? You’re less inclined to drive.”

Why the Shrinking Deficit Won’t Allay Conservatives’ Fears

Cullen Roche explains why recent reports that the budget deficit is shrinking will not be enough to assuage conservatives’ deficit concerns.

“The conservatives who understand the monetary system are more concerned that the growing influence of the US government will reduce the productive base of the country therefore making us less competitive and at greater risk of becoming a high inflation country in the future.  I don’t think those fears are necessarily all that valid in the present environment, but I know what the concern is and can appreciate the worry over a longer time horizon.”

“It’s the absolute size of government spending relative to the economy that worries conservatives.  To the informed conservative who is worried about the long-term impact of growing government the continued growth in the deficit is nothing to celebrate at all.”

Employers Continue Search for Low-Cost Health Care Options

“Employers are increasingly recognizing they may be able to avoid certain penalties under the federal health law by offering very limited plans that can lack key benefits such as hospital coverage,” according to the Wall Street Journal.

“Many employers and benefits experts have understood the rules to require robust insurance, covering a list of ‘essential’ benefits such as mental-health services and a high percentage of workers’ overall costs… But a close reading of the rules makes it clear that those mandates affect only plans sponsored by insurers that are sold to small businesses and individuals.”

“Larger employers, generally with more than 50 workers, need cover only preventive services, without a lifetime or annual dollar-value limit, in order to avoid the across-the-workforce penalty… Limited plans may not appeal to all workers, and while employers would avoid the broader $2,000-per-worker penalty for all employees not offered coverage, they could still face a $3,000 individual fee for any employee who opts out and gets a subsidized policy on the exchanges.”

Ignore the Bubble Doomsayers

James Surowiecki rejects the stock market bears who argue that the recent stock boom and high corporate profits are based on a speculative bubble created by the Federal Reserve.

“It’s certainly unusual for corporate profits to soar during a slow recovery. But…when it comes to the role that corporations play in the U.S. economy, the present looks very different from the past… Take taxes: one big reason that after-tax corporate profits are much higher than their historical norm is that corporations pay much less in taxes than they used to.”

“Then, there’s globalization… The global economy, even with its current woes, is projected to grow more briskly than the U.S. economy over the next decade, so corporations will continue to benefit. Finally, the decline of unions and the sluggish labor market have enabled corporations to cut payrolls, thus keeping profits high.”

FT Alphaville highlights a new forecast from Goldman Sachs predicting that the S&P 500 stock index will soar to 2,100 in 2015.

Chart of the Day

– Walter Kurtz charts the difference between total corporate debt (in black) and total net corporate debt (in gray) to demonstrate how low risk tolerance and low interest rates are combining for potential future instability.

“Corporate treasurers’ risk tolerance remains low as they prefer to hold record amounts of cash on their balance sheets… This is taking place at the time when companies have issued record amounts of debt to take advantage of ridiculously low rates. Increasingly however the proceeds of those bond sales and other borrowings sit in cash. The difference between total and net debt…is cash.”

“Markets are betting that some of this cash will ultimately turn into stock buybacks or dividends. Shareholders are certainly demanding it. Over time that will leave some of these firms more leveraged, and unless they ‘grow into’ this debt, more vulnerable to downturns.”