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What is Noah thinking? Part 2

Noah Smith has replied to my recent post criticizing his use of median household income to measure middle class living standards. He raises some interesting questions, but some of them still leave me scratching my head.

Smith writes:

I don’t understand the idea that “households have had to” compensate for lower weekly wages (also the choice of weekly over hourly wages continues to mystify me, since long workweeks suck, but OK).

Of course, no one literally had to compensate for the fact that their wages were falling, but people do prefer to maintain (if not improve!) their current level of consumption. So, if wages are falling, and you want to maintain your standard of living, you have to adjust something.

Let’s make no mistake, real wages were falling (see Table B-15), and even today remain below their all-time peak. The Bureau of Labor Statistics (BLS) likes to use the period 1982-84 as its base period for inflation calculations, so the numbers that follow are in 1982-84 dollars to adjust for inflation. Smith likes to talk about 1980-2000, working from one business cycle peak to another, but he ignores the previous business cycle peak, 1973, which is a very interesting and important one since that is the year of peak real hourly wages (equal to 1972) and real weekly wages were just 37 cents less than 1972. It seems to me that it’s more interesting to ask if middle class workers are as well off as they were at their peak than to ask if they are as well off in 1979 or 1980.

What happened to real wages? In inflation-adjusted dollars, the hourly wage peak of 1972-73 was $9.26 per hour; in 1980 it was $8.26 per hour, in 2000 it was $8.30 per hour, and in 2013 it had increased to $8.78 per hour.

But it’s actually worse than that. Unlike professors, whose working time is pretty much their own as long as they teach well enough and publish enough to get tenure, most people cannot choose how much they work: Their employer decides that for them. Your paycheck is hourly wage times hours worked, and hours worked by production and non-supervisory workers has fallen from 36.9 in 1972 and 1973 to a low of 33.1 in 2009 and in 2013 was 33.7 hours per week. That is why we can’t look at just the hourly wage, but need to use the weekly wage (hours per year would be an even better metric, but BLS does not publish the data that way). By the way, this category of workers is no small slice: It makes up about 62% of the entire non-farm workforce and 80% of the non-government workforce.

Because both hourly real wages and hours per week fell, real weekly earnings fell even more: From $341.73 (again, 1982-84 dollars) in 1972 to $290.80 in 1980, $284.78 in 2000, and $295.51 in 2013. If you’re keeping track at home, that’s a fall of 15% from 1972 to 1980, a 16.67% fall from 1972 to 2000, and still 13.5% below the 1972 peak in 2013.

But wait! After directly quoting and discussing what I said about real weekly wages, Smith suddenly, with no documentation, rejects that premise: “So, median real wages in America stayed roughly flat in America in 1980-2000, and people worked more – actually, what happened is that many women stopped being housewives and began working.” Nothing I said in my post was about median real wages, but weekly real wages of production and non-supervisory workers. And he knows this is my view, because he clicked through, and even linked to, my much longer post, “The best data on middle class decline.” He suddenly introduces a different measure entirely, and gives no argument for why it’s better.

That’s not to say there’s no argument one could make for that measure. In fact, Dean Baker in an email a few years back pointed out to me that the real weekly wage measure I have used does not include McDonald’s supervisors, who certainly are not well paid by any stretch of the imagination. But likewise, it does not include everyone from CEO on down. To clarify the difference, my preferred measure is the average (mean) of what’s close to the bottom 62% of workers, while the median is of course the median of everyone. Which better captures the situation of the middle class?

I submit that my measure is better. Smith is right that real median wages have stayed fairly flat from 1980 to 2000, and in fact they have also varied little from 2000 to 2013. But that does not seem consistent with increasing cries of economic distress, as people have lost jobs, homes, and, too often, their pensions. I have always thought that declining real wages were fairly invisible at first: People might have made less than the previous generation, but for any given individual, that effect was offset by their increasing experience over time, leading to a slightly higher  real income for that person. It was only when large numbers of people began to lose jobs, and could not find anything that paid as much as their old job, that the issue of middle class decline rose more to public consciousness.

Having shifted measures in midstream, Smith’s final comments are rather less compelling. He has via  this shift precluded the answer that women entered the workforce in large numbers from 1980 to 2000 to help maintain consumption, a position buttressed by the finding of Elizabeth Warren and co-researchers that private debt has increased sharply. I would also point out that women entered the workforce more rapidly in the 1973-79 period (when incomes were falling the most consistently) than in 1980-2000, as a close inspection of this FRED chart will show. Finally, going back to Warren’s work, she argues that the rapid rise of home prices swallowed up the nominal income increase due to women entering the workforce, and that the average house grew in size by less than half a room in over 20 years, even while new single-family houses were growing by the much larger percentages Smith gave in his initial article.

Hence, Smith’s claim that I’m saying increased women’s labor force participation “represents a deterioration in the living standards of the average American” is mistaken, based on his using a different measure of middle class income than I do. I have tried to indicate why I think my measure is better, which would make women’s labor force participation indeed at least in part a response to the falling incomes his measure doesn’t show.

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What is Noah thinking?

Noah Smith put up a post Sunday purporting to show that things aren’t so bad for the middle class. Then he immediately shows us a chart of median household income. Stop right there. As I have argued before, this is always going to give you a rosier picture than reality. We need to look at individual data, aggregated weekly (because average hours per week have fallen for non-supervisory workers), to know what’s going on.

Because the individual real weekly wage is still below 1972 levels, households have had to compensate by having more incomes and going into debt. They have traded time and debt for current consumption. This is not an improvement in the middle class lifestyle. Commenter Richard Serlin points out that we also need to consider risk as well as average incomes, and he is right. The middle class is less secure than it was in 1972.

Noah has lots of interesting things to say, and you should check out his blog if you haven’t already. But this is an error on his part, and I don’t understand what he’s thinking.

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My GASB comments

Well, I should have taken my own advice and not waited until the last minute to submit my own comments on the proposed standards for government accounting of subsidies. But, at long last, they are in. Below please find them in their entirety.

Director of Research and Technical Activities

Project No. 19-20E

Government Accounting Standards Board

January 14, 2015

Dear Director:

I am writing to comment on the proposed standards for reporting the “tax abatements” given by state and local governments as part of their Comprehensive Annual Financial Reports (CAFRs). Let me begin by saying that I welcome this proposal and want to urge the Board to be sure these standards are truly comprehensive.

I write from a unique vantage point because my best-known academic work consists of making estimates of the value of subsidies given to companies by state and local governments. This includes two books: Competing for Capital: Europe and North America in a Global Era (Georgetown University Press, 2000) and Investment Incentives and the Global Competition for Capital (Palgrave Macmillan, 2011). In my latter book, I estimate that in 2005 state and local governments gave just under $50 billion in business attraction subsidies and perhaps another $20 billion in subsidies not tied to making an investment. In addition, I have written numerous journal articles and book chapters on tax incentives and other forms of subsidies to attract investment. The proposed standards, if done correctly, would put me out of the estimation business, and that would be a great thing. In the United States, there is a terrible lack of transparency in the use of these incentives, which makes informed policy analysis very difficult and, in some cases, impossible. Not only that, the lack of transparency hinders the ability of bond and other financial analysts to determine the true long-term financial position of a government entity that may be seeking to borrow through the bond market.

I am regularly interviewed by, and have my work cited in, well-known publications such as The Wall Street Journal, Bloomberg, The St. Louis Post-Dispatch, Los Angeles Times, etc. I have consulted on these issues for the Organization for Economic Cooperation and Development (OECD), the International Institute for Sustainable Development, the North Carolina Budget and Tax Center, and the Missouri chapter of the Sierra Club. I hold the position of Professor of Political Science at the University of Missouri-St. Louis, where I have taught for 23 years. Let me note for the record that the comments which follow are my own personal recommendations and my views are not necessarily shared by my employer or consulting clients.

Let me begin by highlighting an important terminological problem caused by the Board’s use of the term “tax abatement” as its catch-all term for the policies under discussion. In fact, a “tax abatement,” properly so called, is only one form of subsidy to attract investment to a state or locality, and most likely not the most important one, depending on the governmental entity in question. A true tax abatement relieves its recipient from having to pay certain taxes that would otherwise be due, most usually the local property tax. It is merely one form of a broader category of support for business investment that I generally call an “investment incentive,” “location incentive,” or “location subsidy.” I define all three of these terms as “a subsidy to affect the location of investment.”

What, then, is a “subsidy”? To answer this question, we can turn to the “Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, April 15, 1994,” which was adopted into U.S. law via Public Law no. 103-465. Thus, the definition of a “subsidy” established in the Uruguay Round’s “Agreement on Subsidies and Countervailing Measures” (SCM) is in fact a provision of U.S. law. This is important to keep in mind in the discussion that follows.

Article 1 of the SCM defines a subsidy as follows:

1.1 For the purpose of this Agreement, a subsidy shall be deemed to exist if:

(a)(1) there is a financial contribution by a government or any public body [note that his means this section applies to all state and local governments within the United States] within the territory of the Member (referred to in this Agreement as “government”), i.e. where

(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);

(ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits); [footnote omitted]

(iii) a government provides good or services other than general infrastructure, or purchases goods;

(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments; [an anti-evasion rule]

Or

(a)(2) there is any form of income or price support in the sense of Article XVI of GATT 1994;

And

(b) a benefit is thereby conferred.

To sum all this up, the Agreement on SCM establishes a definition of “subsidy” that includes any potential subsidy mechanism, carried out by any level of government (for example, the Washington B&O tax reduction that was a major element of the European Union’s complaint against subsidies to Boeing, a case the EU won), one not evaded by simply claiming that it was a private body carrying out the subsidy. In effect, if the subsidy exists in law or in fact, the subsidy rules come into play.

This principle that a subsidy existing in law or in fact must be counted is an important one when examining the Board’s proposed rules. Some tax measures that are obviously subsidies under the SCM definition (again, something incorporated into U.S. law) might not be considered “tax abatements” using a strict reading of the definition of that term. Consider the case of tax increment financing (TIF). In the states with which I am most familiar, a TIF recipient is legally considered to have paid its property tax even though its payment flows immediately back to its own benefit. If the entity has legally paid its property tax, how can one say that government has “foregone” the revenue? The answer, of course, is to look at the facts as well as the law. GASB’s rules must ensure that they follow the facts and ignore legal fictions. Otherwise, huge swathes of tax-based subsidies will not be counted, and bond analysts and other researchers will not have the facts they need to establish the true financial situation of a government. This is similarly true of situations where the tax foregone is not due from the subsidy recipient. For example, many states allow companies to keep personal income tax withholding from their employees. In Missouri, local taxing districts called transportation development districts collect an extra sales tax from customers, but keep the money until they have received the entire subsidy they negotiated from a municipal government. It does not matter whose taxes are foregone; the rules must capture the subsidy itself in order to be useful. These are not small programs, either. In California, by 2010 TIF was generating $8 billion a year in tax increment for local governments, which was largely plowed back into paying the subsidies they were tied to (or equivalently, paying off bonds which funded the subsidies). In the much smaller Missouri economy, both TIF and transportation development districts see hundreds of millions of dollars of new subsidies committed annually by municipal governments.

In light of the fact that investment incentives may not be entirely tax-based, I believe it to be important to at least cross-list cash grants paid to companies with the “tax abatement” they receive. From anecdotally talking to reporters calling me about various incentive packages they are covering, it appears to me that there is an increasing trend for cash to make up a significant chunk of these packages. If the new rules require such cross-listing, we can then see in one place how much money a state or local government is committing in subsidies to attract businesses. This information gives us important clues about future fiscal trends from a government, as heavy users of incentives tend to remain such well into the future; however, there is no telling from one year to the next what the split will be between cash and tax-based subsidies.

On a related point, the rules absolutely need to include future amounts committed for tax incentives. Once again, without such transparency it is impossible for bond or other analysts to derive a true financial picture for a particular government.

Last, I would urge that the reporting of location subsidies be made on a firm-specific basis. If a single company is receiving tens of millions of dollars in tax breaks per year from a given municipality, with many more tens of millions committed in the future, it could signal that the municipality is highly vulnerable to anything which adversely affected the recipient. A city like Flint, Michigan, was devastated when the numerous subsidized General Motors facilities in the city began to go out of business in the 1980s.

In summary, then, the most important principle to consider is that transparency must be comprehensive. If the rules have loopholes allowing governments to not report certain types of subsidies, those subsidies will not be reported, and everyone relying on data reported under the new rules for accurate financial information – from citizens to investors – will be misled by numbers that don’t reveal a government’s true financial situation. Please require the most comprehensive reporting possible, for your efforts to live up to their potentially game-changing value.

Sincerely,

Kenneth P. Thomas

Professor of Political Science

University of Missouri-St. Louis

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Eleven richest Americans have all received government subsidies

A new report by Good Jobs First shows how the very wealthy in America have benefited from government subsidies as one element in building their fortunes. According to the study, the 11 richest Americans, and 23 of the 25 richest, all have significant ownership in companies that have received at least $1 million in investment incentives.

The study compares the most recent Forbes 400 ranking of wealthiest Americans with the Good Jobs First Subsidy Tracker database. Not only do Bill Gates, Warren Buffett, Larry Ellison, the Koch Brothers, the Waltons, Michael Bloomberg, and Mark Zuckerberg own companies that have received millions or even billions in taxpayer funds, 99 of the 258 companies connected with the Forbes 400 have such subsidies.

As I argued theoretically in Competing for Capital, the new report points out that subsidies for investment increase inequality as average taxpayers subsidize wealthy corporate owners. Location incentives directly put money into their pockets, which then has to be offset by higher taxes on others, reduced government services, or higher levels of government debt. Moreover, as the study notes, despite the huge amount of these subsidies given in the name of economic development, there has not been enough payback to raise real wages even back to their 1970s peak. In other words, if economic development has created so many new jobs, why haven’t wages risen?

Of course, subsidies don’t account for the biggest part of inequality. Read Thomas Piketty for the big picture on the subject. But the new report shows that large numbers of America’s wealthiest (or not so wealthy, like Mitt Romney) have benefited handily from government subsidies.

Cross-posted from Middle Class Political Economist.

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The German euro is undervalued

I keep telling people that the German euro is undervalued, but some folks seem not to believe me. (See the comments section from this post last year for an example.) But this is a really big deal. The dominant narrative about the eurozone crisis is that fiscally irresponsible countries like Greece were bringing the once-proud currency to its knees, and weakening the European project to boot. Meanwhile, the virtuous Germans keep on cranking out trade surpluses and have to bail out Greece, Ireland, Portugal, and Spain. And it’s pretty clear that the Germans believe this version of events.

Never mind that Spain and Ireland, for two, had budget surpluses prior to the crisis, or that Spain’s economy is five times as large as Greece’s. What’s going on in Greece is supposedly the true explanation for the eurozone’s problems.

Let me challenge that narrative that with a simple thought experiment. Instead of one euro, let us reason as if each of the 18 eurozone members had its “own” “euro.” Let’s begin by thinking about what creates the value of the current 18-country euro. We might include interest rates, inflation rates, growth rates, and trade balance, among other things, and of course expectations for all these variables. What we need to remember is that the value of today’s euro represents the averaged effect of all these variables in all 18 countries, rather than reflecting the economic conditions of any one of them.

So the euro is currently worth about $1.25. It used to be higher; what is dragging it down? The simple answer is that conditions in Greece, Spain, Ireland, Portugal, and at time Italy have pulled its value down. As has often been noted, if Greece pulled out of the euro it would then devalue the drachma, becoming internationally competitive again without the need for the brutal austerity that has pushed its unemployment rate over 25%. The same is true for the other peripheral countries. By looking at what would happen to the drachma/punt/peseta/escudo, we can see that, for these countries, the euro is overvalued. Another way to say it is that the “Greek euro,” for example is overvalued.

So why isn’t the value of the euro lower than $1.25? The answer, of course, is that Germany, the Netherlands, Austria, Luxembourg, and so forth, are performing well and pushing the value of the euro upwards. These countries, by contrast, would see their currency values rise if the euro were suddenly abolished. For Germany, for instance, the euro is undervalued; an equivalent DM would rise in value.

U.S. officials constantly rail about the undervalued Chinese yuan and the huge bilateral trade deficit it creates for this country. But officials could (and to some extent do) say the same thing about Germany, which now has a larger trade surplus than the vastly larger Chinese economy. In fact, last year Morgan Stanley estimated that a stand-alone German euro would be worth $1.53, compared to the actual euro exchange rate then of $1.33.

With an undervalued currency, Germany gets a much larger trade surplus than it would have had otherwise, magnifying trade deficits in the United States and elsewhere. At the same time, it gets to pretend that this surplus is simply due to German thrift and virtue, rather than currency misalignment. It then points to its virtue as justification for doing nothing to increase domestic consumption, wages, or inflation, and for demanding austerity from the countries to which Paul Krugman rightly says Germany is exporting deflation.

Let me leave you with Krugman’s chart. You can see at a glance that Germany has throttled nominal wage growth and has inflation far below the European Central Bank’s announced target of just under 2%. When you combine its low inflation with an undervalued exchange rate (remember, low inflation should tend to raise the currency’s value), you come to realize that Germany is a huge part of the world economy’s problems today.

 

Credit OECD and IMF

Source: Paul Krugman

Cross-posted from Middle Class Political Economist.

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Tax haven benefits are not investment incentives

Tim Worstall at Forbes takes issue with my last post, claiming that we actually don’t know that U.S. state and local governments give more in location incentives than EU Member States do. He then says that while it is true that EU states give less in cash grants and other kinds of subsidies defined as “state aid” in EU law, these same states give more than the U.S. in other types of tax benefits. His argument then moves quickly through Ireland’s 12.5% corporate income tax (though he gives no examples) to Amazon’s European sales all being channeled through Luxembourg subsidiaries. Worstall claims that the tax advantages created by this financial gimmickry comprise a location incentive just like providing Tesla $1.3 billion to build a factory in Nevada is.

I’ve been researching U.S. and EU incentives for 20 years, and I certainly don’t expect Worstall to have read everything I’ve written on the subject, including two books. So this makes as good a time as any to clarify the terms I use and the analysis I’ve made.

My default term for my object of study is “investment incentives,” as in the title of my last book. But you can’t say that phrase multiple times on every page of the book, so I use a specific set of synonyms when I write: Investment incentive = location incentive = investment subsidy = location subsidy = development incentive and sometimes, as in the headline of the last post, simply “incentive,” though I also use that term in its more generic sense. Note that the term Worstall uses in his headline, “tax incentive,” is not a synonym, because investment incentives and subsidies more generally can take forms other than tax breaks, i.e. cash grants, low-interest loans, free infrastructure, etc.

What, then, is an investment incentive? I define it as a subsidy ( = “state aid” in the EU context) to affect the location of an investment. To get this kind of subsidy from a government, it is necessary to make an investment. An investment incentive can be contrasted with an operating subsidy (“operating aid” in the EU), which is a subsidy for ongoing operations and is, critically, not contingent on making an investment. The distinction between investment incentives and operating subsidies is crucial to what follows.

So an investment incentive requires a subsidy and an investment. Let’s now consider Worstall’s examples on these criteria. As some readers may know, Ireland for many years had a 10% corporate income tax rate on profits from manufacturing, a rate explicitly provided for in Ireland’s EU accession negotiations, and which the European Commission long accepted as being part of the country’s general macroeconomic framework rather than a subsidy (see my book Competing for Capital, pp. 94-95, for an extended discussion). Contra Worstall, I am certainly well aware that Ireland’s tax policy is a method of competing for investment; in 2000, I called it “a clear and unregulated element in the country’s competition for investment” (p. 95; italics in original).

Despite that, when the Commission ruled in July 1998 that manufacturing was specific enough for the tax rate to be considered a state aid, it ruled that it constituted an operating aid. A manufacturing company was entitled to the 10% tax rate forever, whether it made new investment or not, or even if it disinvested, as Intel has done from Ireland. Since there was no link between the subsidy and investment, it did not constitute an investment incentive. In the end, Ireland and the Commission agreed that a 12.5% tax rate that applied to all corporations would not be considered state aid. Now we no longer have a subsidy, but tax competition. (This of course doesn’t talk about the boutique deals that the EU is now investigating as possible state aid.)

One ironic takeaway is that despite the intentions and nearly unanimous views of Irish policy-makers (many of whom I have interviewed over the years), the evidence doesn’t actually suggest that the country’s low-tax policy contributed to its growth. For the policy’s first 30 years, 1958-87, Ireland grew, but no more rapidly than the rest of the EU. For almost the entire period, it had no tax on foreign multinational corporations. The famed Celtic Tiger came together when the tax rate MNCs faced was 10 percentage points higher, 10%.

What about Amazon and Luxembourg? Amazon has real operations in Luxembourg, employing about 1000 people overall. But the turbocharged financial benefits Amazon receives come not from normal operations using the lower VAT (again, tax competition, not an investment incentive), but from its use of tax haven subsidiaries. As the linked article points out, where Amazon makes its money in Luxembourg is from Amazon Europe Holding Technologies SCS, a partnership with no employees or office, which had completely tax-free profits of €156.7 million in 2013, according to the Wall Street Journal article linked above.

Moreover, according to the huge dump of leaked documents from the International Consortium of Investigative Journalists, in 2009 Amazon Europe Holding Technologies SCS paid Amazon Technologies Inc. (located in the tax haven of Nevada) €105 million in order to license Amazon’s intellectual property. By some miracle, this no-employee company managed to re-license the IP to Amazon EU for €519 million. Given Worstall’s claim in July that transfers of technology to a tax haven subsidiary have to be made at “full market value,” how does he explain the way that “no one,” if you will, raised the value of this IP by €414 million, which just coincidentally was untaxed in Luxembourg? Could it be that Amazon Europe Holding Technologies SCS didn’t actually pay “full market value”?

Worstall also makes the odd claim: “And we do regard different corporation tax rates within the US dependent upon location as being location based incentives and we don’t regard them as such in the EU.” Aside from wondering who his “we” is, I know I’m not part of it: My estimates of U.S. state and local subsidies and investment incentives most definitely do not count differences in corporate income tax rates among states as a “location incentive.” My posts on Tesla take no account of the fact that Nevada has no corporate income tax, while its home state of California levies 8.84%. Yes, it’s tax competition, as in Ireland, but if you were to call it a subsidy, it would be an operating subsidy, not an investment subsidy. I also don’t include the federal government’s many subsidies in these numbers. (Note: Writing this prompted me to go back and look at the data ICA Incentives provided me last year, wherein I found that it did include some federal subsidies. I removed them from the totals from the ASDEQ paper I cited in my last post, leaving U.S. state and local investment incentives 3 1/2 times, not 5 1/2 times, as large as EU investment incentives. See corrected post here.)

Worstall, then, is trying to mix apples and oranges. For a tax provision to be a subsidy, it needs to be a derogation from a country’s normal tax rules. Yet Amazon tells us it is “subject to the same tax laws as other companies operating” in Luxembourg. Of course, Amazon may be stretching the truth here. But if Worstall thinks that creating arcane tax haven arrangements (as in his examples of Apple, Google, Facebook and Microsoft sales flowing through Ireland for tax purposes) is the same thing as, you know, actually building things, I’m here to tell him he is mistaken. Using the same term, “location incentive,” to try to cover two completely different types of economic activity, is certain to detract from our understanding of the policy issues, not increase it.

Cross-posted from Middle Class Political Economist.

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Further proof that the U.S. uses incentives more than the EU

As if any more proof were needed, I recently came across yet more evidence that U.S. state and local governments give far more in location incentives than EU Member States do. A paper given this spring at the annual meeting of the Association des Économistes Québécois (Association of Quebecois Economists) includes a summary of project-by-project subsidy reporting by the consulting firm ICA Incentives.

ICA Incentives, which has on several occasions provided me data on $100+ million incentives in Europe and the United States, reports on the announcements of large investment projects. Thus, the data summarized in the paper will omit the thousands of smaller projects in the United States that are subsidized by state and local governments. My guess (I have not seen the underlying data) is that the coverage of EU projects is more complete, since EU rules require pre-notification of subsidies to the European Commission and the Commission posts all state aid decisions on its website.

From page 10 of the paper, the total of incentive packages in 2011 through 2013 inclusive, is as follows:

United State: $37.2 billion

European Union: $6.6 billion

Canada: $2.2 billion

South America: $8.4 billion (more than the EU, which has a GDP over 3 times as large)

Asia: $1 billion (I would guess this is an underestimate)

We can see that the United States gave more than 5 1/2 times as much as the European Union did over the three years analyzed. Given that these economies are approximately the same size, that is a gigantic disparity, and it shows, as I have argued on numerous occasions, that the EU state aid controls work to reduce location incentives. The result for South America also suggests this.

Moreover, the consequences of giving such large state and local incentives are enormous. As I have reported before, the value of state and local subsidies ($70 billion per year) substantially exceeds the cost of the state and local government jobs that were cut in the wake of the Great Recession. This is a huge opportunity cost for these governments as well as representing efficiency and equity losses as a result of the subsidies. With this additional evidence, the need for incentive reform is stronger than ever.

Cross-posted from Middle Class Political Economist.

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Time to comment on the GASB standards!

As I reported last month, the Government Accounting Standards Board (GASB) has proposed new rules that would require state and local governments to disclose subsidies in their financial reports. The proposal is now open for public comment from now until January 15, 2015.

Good Jobs First, which has long advocated for this change in accounting rules, has produced a detailed analysis and critique of the proposal. While any improvement in transparency is welcome, for governments’ Comprehensive Annual Financial Reports (CAFRs, as they are called) to provide useful information to citizens and investors alike, they need to truly be comprehensive. The problem, as Good Jobs First points out, is that the way GASB has defined “tax abatements” (its rather odd choice for the broad category of economic development tax incentives — odd because tax abatements per se make up only a subset of such incentives) leaves open the possibility that major categories of subsidies could be omitted altogether.

As Good Jobs First points out, GASB’s specification that a “tax abatement” includes a government forgoing tax revenue means that tax increment financing (TIF) may not fall under the definition. The reason, as I have analyzed for the Sierra Club, is that a TIF recipient is legally deemed to have paid its property taxes in full, even though it individually benefits from the diversion of the incremental taxes. If someone has “paid” all her/his taxes, then how does one say that government has foregone the tax due? GASB has to make clear that it won’t be blinded by the legalese here, but will instead be guided by what actually happens. One possibility would be to use phrasing seen in the WTO Agreement on Subsidies and Countervailing Measures, that the government promises to abate taxes “in law or in fact.” Using this phrase has the advantage that the Agreement has been adopted verbatim into U.S. law, that being the way that the United States “signed” the Uruguay Round agreements, rather than ratify them as a treaty.

Tax increment financing is a high value subsidy in the United States. TIF in California was generating $8 billion per year in tax increment by 2010. Even in Missouri, local governments adopt TIFs worth hundreds of millions of dollars every year. It would be very problematic if GASB allowed its revised Generally Accepted Accounting Principles (GAAP) to ignore tax increment financing.

Other types of potentially excluded subsidies identified by Good Jobs First include diversion of employees’ withheld income taxes (because the source for the subsidy is not the company’s own taxes) and and sales tax diversions, such as Missouri’s Transportation Development Districts (again because the source of the subsidy is not the company’s own taxes). The latter total hundreds of millions of dollars in Missouri annually. Furthermore, Good Jobs First flags highly ambiguous provisions which could lead to excluding performance-based subsidies (because the subsidy occurs after the investment or hiring, not before) and Payments in Lieu of Taxes or PILOTs (which in some state identify actual payments made by a recipient, but in Tennessee and perhaps others is simply the phrase used to describe property tax abatements).

I would suggest further that GASB require governments to cross-reference cash subsidies paid to companies in the “tax abatement” notes so the notes reflect all subsidies given to companies in one place. Cash subsidies already appear in CAFRs because they are on-budget, but grouping them with the more numerous off-budget tax-based subsidies will simplify research by bond analysts, academics, or anyone else, putting total subsidies in one convenient place within the CAFR.

In addition, Good Jobs First notes other deficiencies on the issue of transparency. There is no requirement for company-specific disclosure, which is especially important for large incentive packages but is best when universal. Furthermore, there is no requirement for governments to disclose their future commitments under multi-year tax agreements. This should be at least as troubling to bond analysts as it is to advocates for good subsidy policy, if not more so. It is impossible to tell the true fiscal position of a state or local government if it is allowed to hide large future liabilities.

Good Jobs First gives detailed instructions for commenting: The easiest way is to email your comments to Director of Research and Technical Activities, Project No. 19-20E, at director@gasb.org. What are you waiting for? It’s time to comment!

Cross-posted from Middle Class Political Economist.

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How to deal with the growing incentives competition

This article was originally published in the Columbia FDI Perspectives series of the Columbia Center for Sustainable Investment, #131, September 29. I have left it largely unchanged, except for adding a link and a comment, and correcting a grammatical error.

 

As I discussed in an earlier Perspective,[1] the use of investment incentives is pervasive and growing. The most recent example [this was completed prior to the Tesla auction] of a big bidding war was when Boeing threatened to move production of its 777-X aircraft out of Washington state, prompting some 20 states to offer incentive packages to the company (including $1.7 billion from Missouri). In the end, Washington gave Boeing a package of tax incentives worth a record-breaking $8.7 billion over the 2025 – 2040 period to stay, and the unions made substantial concessions regarding pensions.

What can be done to control such auctions, which are often international in scope? The most robust control method, regional in scope, is embodied in the European Union (EU) Guidelines on Regional Aid. These rules guarantee transparency, set variable limits (in terms of “aid intensity,” which equals subsidy/investment) for aid levels based on each region’s per capita income, and reduce the value of aid to large investment projects over €50 million. They require projects to stay at least five years and mandate the use of clawbacks for firms that fail to meet their commitments in investment contracts. Moreover, the guidelines provide demerits for firms in a dominant position in their industry, although they do not mandate a particular reduction in aid.

The other international control measure comes under the World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures. While these rules are more tailored to production subsidies than to investment incentives, the latter certainly come under the purview of the Agreement as well, as illustrated by the EU’s successful complaint against subsidies for Boeing in the states of Washington, Illinois and Kansas.

However, this case also illustrates the limits of WTO subsidy control. The EU has already filed a compliance complaint,[2] and there is little likelihood the United States (US) will comply anytime soon (the US Trade Representative’s office claims that the US has complied, but as long as the state and local tax credits continue in Washington state, that is not correct). Indeed, as mentioned, Washington state has approved a new round of subsidies for Boeing that is likely to initiate a new WTO dispute.

While the WTO rules require frequent notification of subsidies, there is no penalty for failure to notify, with the result that subsidy notifications are of very uneven quality. Federal states outside the EU frequently make poor quality notifications regarding subnational subsidies. Finally, the TRIMs and GATS agreements regulate performance requirements, but not investment incentives.

What, then, can be done against incentives competition? First, there must be continuing efforts to improve the transparency of location subsidies. This is necessary for jurisdictions to make effective investment promotion policy (especially in a region such as the European Union and the United States, where there are many competing governments) as well as for international policy discussion.

Second, the EU’s example shows that incorporating subsidies rules into regional agreements can be a fruitful way to bring bidding wars under control. For many products, such as automobile assembly and steel, corporate location decisions still focus on a single region, meaning that such rules would be geographically comprehensive enough for a variety of industries. Consequently, major stakeholders—including the Columbia Center on Sustainable Investment, the International Institute for Sustainable Development, the United Nations Conference on Trade and Development, the World Association of Investment Promotion Agencies, the International Monetary Fund, the World Bank, and the Organisation for Economic Co-operation and Development—should unite in promoting location subsidy guidelines within regional trade areas. There are no doubt numerous other non-governmental organizations that would endorse such a move.

Third, WTO notifications should be strengthened. Incomplete notifications should be flagged and countries involved should be pressured to give cost estimates for subsidies at all levels of government. Still, it is difficult to envision that sanctions for non-compliance will be introduced.

Fourth, no-raiding zones could be a first step for countries to negotiate controls over investment subsidies. A no-raiding agreement simply commits a state to not give a subsidy to relocate an existing facility from another state; it would not apply to new investments. Their track record is mixed—several agreements among US states failed quickly, but Australia (2003-2011) and Canada (1994-present) have been more successful.[3] Despite these mixed results, it is easier to demonstrate to policymakers the futility of relocation subsidies, since they create no new jobs, than it is to do for incentives for new investment, which could make this a more feasible first step.

Though national and subnational jurisdictions have incentives to offer location subsidies, these proposed measures would help keep their value to more reasonable levels with a lower likelihood of distorting competition and international investment flows.

 

[1] Kenneth P. Thomas, “Investment incentives and the global competition for capital,” Columbia FDI Perspectives, No. 54, December 30, 2011.

[2] Emelie Rutherford, “EU wants $12 billion in U.S. sanctions over Boeing subsidy spat,” Defense Daily, September 27, 2012.

[3] Kenneth P. Thomas,  “Regulating investment attraction: Canada’s Code of Conduct on Incentives in a comparative context,” 37 Canadian Public Policy, 3 (2011), pp. 343-357; Kenneth P. Thomas, “EU control of state aid to mobile investment in comparative perspective,” 34 Journal of European Integration 6 (2012), pp. 567-584.

From: Kenneth P. Thomas, “How to deal with the growing incentives competition,” Columbia FDI Perspectives, No. 131, September 29, 2014. Reprinted with permission from the Columbia Center on Sustainable Investment (ccsi.columbia.edu).

Cross-posted from Middle Class Political Economist.

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U.S. median wealth up from 27th to 25th

Yesterday Credit Suisse released its Global Wealth Databook 2014 to go along with the Global Wealth Report issued Monday. Global wealth hit another new record of $263 trillion as of mid-2014, up 8.3% from mid-2013 (Report, p. 3). Rich people are doing well, but how about the middle class? One measure of this is median wealth per adult, the exact midpoint of the wealth distribution.

In the United States, mean wealth per adult reached $347,845, and median wealth per adult hit $53,352 (Databook, Table 2-4). This represents an increase in median wealth of 18.8% over 2013, enough to move the U.S. up two places to 25th in the world.

Before we congratulate ourselves too much, we need to remember that $53,352 is not all that much money, especially for retirement (don’t forget that figure includes home equity). With 49% of Americans in the private sector having no retirement plan at all, and only 20% having a defined-benefit pension, a retirement crisis is looming for younger baby boomers and all later middle-class retirees. Meanwhile, if Republicans take control of the Senate in this year’s elections, we are likely to hear increasing demands for cuts to Social Security, when what we actually need is to raise Social Security benefits.

The relatively low median wealth also points to persistent inequality in the United States. While only 25th in median wealth per adult, the U.S. ranks 5th in mean wealth per adult. With a ratio between mean and median wealth per adult of 6.5:1, this is higher than any of the other top 25 countries. Number one Australia has a ratio of less than 2:1. Without further ado, here is the list of all countries with median wealth per adult above $50,000.

 

Median wealth per adult, mid-2014

 

1. Australia                  225,337

2. Belgium                   172,947

3. Iceland                    164,193

4. Luxembourg            156,267

5. Italy                         142,296

6. France                     140,638

7. United Kingdom     130,590

8. Japan                       112,998

9. Singapore                109.250

10. Switzerland           106,887

11. Canada                    98,756

12. Netherlands             93,116

13. Finland                    88,130

14. Norway                   86,953

15. New Zealand          82,610

16. Ireland                     79,346

17. Spain                       66,752

18. Taiwan                    65,375

19. Austria                    63,741

20. Sweden                   63,376

21. Malta                       63,271

22. Qatar                       56,969

23. Germany                 54,090

24. Greece                     53,375

25. United States          53,352

26. Israel                       51,346

27. Slovenia                  50,329

Source: Credit Suisse Global Wealth Databook 2014, Table 2-4

 

Cross-posted from Middle Class Political Economist.

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