Most of the news media has reported that President Donald J. Trump has signed four “executive orders” involving extending unemployment benefits at a $400 rate, deferring (or ending?) payroll taxes for Social Security (opposed by both parties in Congress), extending a ban on evicting renters, and extending student loan deferments.  An important detail not mentioned in most reports that of these three of them are not actual orders but rather memoranda, which can count as “actions,” that essentially implore others to do something that requires Congressional action in order to be done, basically the first two of these, or is already happening (deferment of student loans, although this is complicated).  Only one of them is an actual order that must be followed, the one regarding evicting renters, although all this order does is to make HUD “consider” extending the ban on evicting renters.  The order itself does not actually do it.  In short, these orders amount to a campaign list of wannabe actions, no actual real actions.

This is all obviously the brainchild of the incompetent and brainless Chief of Staff, Mark Meadows, who is apparently incapable of making any deals and totally focused on the reelection campaign.  So he “blew up” the two-week negotiations with Congressional leaders by most accounts by making rigid demands.  I am not going into details, but there were obvious compromises available, just to pick one on the total size of the relief package.  The Dems were proposing $3 trillion based on what the House passed months ago while the White House and some GOPs held to $1 trillion. Reportedly the Dems offered the obvious compromise of $2 trillion, but that was blocked by Meadows who simply made demands and warned if they were not accepted, Trump would issue “executive orders” to do what he wants.  But, as careful analysis shows, only one of these is ab actual order and even the one that is an order that only orders a department to consider doing something.

We have had dramatic headlines and commentary in recent days since the BEA issued its initial estimate of quarterly changes in GDP, which they do not officially measure on an shorter time period. This is a measure of the average GDP in one quarter compared to the average GDP in the next quarter.  Looking at Q1 of this year and Q2 of this year, they reported the largest quarterly decline ever recorded, -32.9% on an annualized rate, about -9.5% on a quarterly rate. This is a sharper decline than seen either for any pair of quarters in the Great Depression or the immediate post-WW II demobilization, much less such later events as the Great Recession of 2007-09.  Of course this generated big headlines and much breathless commentary, including quite a few commentators who did not get it that the -32.9% number was the annualized rate rather than the quarterly rate, so we had quite a few of them foolishly talking about how the economy had “fallen by a third.”  Yikes.

As I have noted in previous posts here, the economy has been doing a lot better than a lot of reporting and forecasts have let on, even as it is certainly slowing down now.  But if rather than looking at quarterly averages, which are heavily influenced by the fact that the economy did not “fall off a cliff” until mid-March, about 5/6 of the way through Q1 so that most of Q1 was at the high pre-fall level, one looks at where the economy was at the end of Q1 and compare it to where it was at the end of Q2, one gets a dramatically different story.  Over on Econbrowser Menzie Chinn has produced a figure from IHS Markit that estimates these shorter period changes. According to them the US GDP at the end of March (end of Q1) was at about $17.6 trillion annual amount while at the end of June it was at about $18.0 trillion, about 2.2% higher on a quarterly rate, which is about 9% higher on an annualized rate.  Needless to say, there is a dramatic contrast between -32.9% and +9.0%, but I have seen zero media commentary on this.

Alex Parker reports on a proposal from Representative Darin LaHood:

As part of the next round of pandemic relief, House Republicans are pushing new incentives for companies to bring home offshore intellectual property — something that they contend could boost job growth but that critics see as another corporate giveaway … While the 2017 Tax Cuts and Jobs Act overhauled the federal tax code and eliminated many of the incentives for offshore income-shifting, it left the structures themselves intact, and companies have been reluctant to undo them as the law remains young.

I think we admitted these 2017 tax cuts for the rich were complex so permit me to slightly disagree with Mr. Parker’s excellent reporting. If the intellectual property (IP) were left offshore, the GILTI income would face a tax rate of only 10.5% whereas onshore IP would face that FDII rate of 13.125%. Why bring the IP back home and face a higher rate? But I interrupted Mr. Parker who basically notes all these nuances:

Current law gives companies plenty of reasons to onshore the intellectual property they spent decades pushing offshore in licensing and cost-sharing agreements. Income from intangible assets held domestically may qualify for a reduced 13.125% tax rate as foreign-derived intangible income. The same income, held offshore, may fall under the global intangible low-taxed income regime, which is meant to penalize companies for holding intangibles abroad. Those carrot-and-stick provisions ultimately ensure neutrality in decisions about where to locate IP, the TCJA’s authors said when it was passed. The TCJA also included a deemed repatriation that allowed companies to bring home offshore income after it had paid a one-time transition tax. But the intangible assets that generated that income were not brought home with it, and they must be repatriated under the normal tax rules. And companies still face a potential tax charge when bringing a valuable asset home. Upon repatriation, if the property has gained value offshore, the company’s taxable income will increase based on that gain for that year, depending on how it classifies the transaction. Even though it’s a one-time payment, it could be enough to discourage the transaction.

Brad Setser has more to say about how the lack of enforcement with respect to transfer pricing in the Big Pharma sector has not only cost us Federal tax revenues but perhaps in American jobs in his “The Irish Shock to U.S. Manufacturing?” (May 25, 2020):

America’s production of pharmaceuticals and medicines peaked in 2006, back before the global financial crisis. Output now is about 20 percent below its 2006 level. Pharmaceuticals tend to be capital not labor intensive. High quality pharmaceuticals aren’t made in sweat shops. Pharmaceuticals certainly weren’t the kind of industry that most economists expected to be on the losing end of trade liberalization twenty years ago. Yet America’s consumption of pharmaceuticals didn’t peak in 2006. Only U.S. output. Imports have increased substantially since 2006. Imports of pharmaceuticals have increased from $65 billion in 2006 to $151 billion in 2019. As a result, the trade deficit in pharmaceuticals has increased from $32 billion at the end of 2006 to $93 billion in March of this year. That is about 0.4 percent of US GDP, or just under 10 percent of the total trade deficit in manufactures. The bulk of these imports are from countries that pay high wages. The two biggest sources of imports are Ireland and Switzerland. Many of the usual arguments around the gains to consumers from trade don’t really apply here. The imports are of patent protected goods, so they don’t expand consumer choice. And U.S. pharmaceutical prices are notoriously high—imports from Ireland and Switzerland haven’t brought U.S. pharmaceutical prices down to European levels. The bulk of the gains from trade here almost certainly go to the owners of the pharmaceutical companies who benefit from lower taxes. And the main loser is the U.S. Treasury. Right now, the United States pays the highest prices in the world for its medicines (many of which derive from NIH research) while U.S. pharmaceutical companies are often taxed at quite low effective rates.

I want to do two things here starting with an explanation of the Irish transfer pricing game and later a small complaint about his Swiss tale. He cites a story about an Irish affiliate of Pfizer by Tom Bergin and Kevin Drawbaugh:

I often hear that pharmaceuticals are one of America’s biggest exports. But that isn’t what is in the actual trade data (see exhibits 7 & 8). American firms (or formerly American firms, if there has been an inversion) may own the intellectual property behind many successful drugs, but the active ingredients themselves are often manufactured abroad. In fact, the (goods) trade deficit in pharmaceuticals now exceeds the surplus in civil aircraft. This trade isn’t obviously driven by differences in labor costs. The biggest sources of pharmaceutical imports, Ireland and Switzerland, aren’t exactly low wage countries. Trade here seems motivated in large part by the ability to use transfer pricing to shift profits to low tax jurisdictions. And the new Tax Cuts and Jobs Act if anything looks to have made those games more not less attractive. The incentive to offshore intellectual property generally remains—the “GILTI” rate on profits shifted to no tax jurisdictions is the lowest rate in the tax code. And the lower tax on intangibles than on tangibles has created an incentive to offshore actual production and jobs as well—the more tangible assets abroad, the higher your deemed tangible income and the lower your tax on your intangible income (the same is true for firms that retain their intellectual property in the United States, as there is a lower tax rate on the export of intangibles than the export of tangibles). To be concrete, a firm with its intellectual property in the Caribbean believes it can reduce its effective tax rate to under 10 percent (a rate somewhat below the global “minimum”). It is too early to say definitively that these incentives drove the increase in the pharmaceutical deficit in 2018. But it doesn’t seem too early to say that there is no evidence that these kind of tax games have gone away after the tax reform.

Brad’s thesis is certainly going to be controversial. As I read what he is saying is that it is not just the GILTI provisions of the 2017 tax cut that led to the increase in the life science trade deficit over the years. Rather it was the weak enforcement of basic transfer pricing rules that allowed Big Pharma to massively evade U.S. corporate taxes and created these perverse incentives. While we were told that the 2017 Republican tax cut for the rich would close the transfer pricing loopholes and perverse incentives they clearly did not. I’m all for scrapping GILTI and FDII for a lot of reasons but these steps alone will not fundamentally change what Brad is suggesting unless we start actually enforcing good old fashion transfer pricing rules. Let’s hope Biden has this in mind.

Alex Parker covers an interesting and important tax policy issue:

Former Vice President Joe Biden’s recent proposal to secure medical supply chains in the wake of the COVID-19 pandemic includes tweaks to the 2017 federal tax overhaul, reigniting the debate about whether its international provisions are pushing manufacturing facilities offshore   .   .   .   the TCJA exempted most foreign income from taxation as part of a shift toward a more territorial tax system, similar to those used in Europe and much of the world. But it also enacted new provisions, including the GILTI tax and the base erosion and anti-abuse tax, which lawmakers said would block companies from shifting U.S. income abroad.

Many of the structures for tax avoidance that have drawn public scrutiny and outrage over the past decade have involved intangibles, which are relatively easy to move from jurisdiction to jurisdiction to chase the lowest tax rate. But the very attribute that makes them difficult to tax also makes them difficult to define. Rather than attempt to pinpoint the intangibles themselves, the TCJA instead targets unusually high returns on tangible assets.

Under the GILTI provision, the total foreign income of a U.S. company, beyond a 10% return on its offshore depreciable tangible assets, is taxed at 10.5%. That rate is half of the overall corporate rate of 21%.

As the bill was passed by Congress in 2017, Democrats and outside critics quickly noted that the GILTI tax could encourage companies to shift investments in tangible assets abroad. Because the GILTI tax kicks in only at a 10% return on foreign tangible property, the more valuable that property is, the smaller the ultimate GILTI tax bill will be.

Even further, because GILTI is calculated at the global level, in most cases it would not matter where new tangible assets were located; as long as they were offshore, they would decrease the GILTI tax. A reduced rate on foreign-derived intangible income, or domestic income defined through a formula similar to GILTI, also creates a similar incentive, critics contend. If a company has tangible assets at home, it will have less income defined as FDII, and less of the tax benefit.

The 2017 tax cut for rich people was written in secret by Republicans who had told us that it would somehow stop transfer pricing manipulation and would encourage onshoring. But when the details were released, a lot of economists including conservative economics were taken back by the complexity of the international provisions.