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Brad Setser on Offshoring Life Science Production and Transfer Pricing

Brad Setser on Offshoring Life Science Production and Transfer Pricing

I just posted a discussion of an interesting proposal from Biden written by Alex Parker who mentioned some February 5, 2020 testimony from Brad Setser. The gist of this testimony was noted back in a March 26, 2019 blog post entitled When Tax Drives the Trade Data:

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.

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Ken Melvin

The times they are a changing.

And they are changing at pandemic speed. Five months ago is ancient history. Now is a but a fleeting interval. From now, the future. What will our world look like six months from now? What will it look like in three years?

So much for being the ‘Greatest Nation Ever Known’. We just got rolled by a virus whilst beset with incompetent leadership, inadequate healthcare, a global warming crisis, and a failed economic model. We weren’t prepared. Could’ve been, should’ve been, but we weren’t. For now, we must learn how to live with the virus while charting a new course. Can we rise to the challenge of dealing with the pandemic and its aftermath, and of correcting those existing, pre-pandemic, problems? We really need to do both.

There will be changes. Chances are that we will see a diminishment of globalization. The offshoring of medical supplies, such as protective equipment, and critical medicines has hurt. Those will probably return onshore. Such dependence was always a risk. The production of other ‘self-sufficient’ goods should be brought back. Some of the jobs will return; return to a much-diminished economy. Education, at all levels, will probably be changed forever. We are going to hear, “We can’t afford to do —-, a lot, when, in truth, we can’t afford to not do something about the pre-existing problems of healthcare, economic disparity, global warming, and a few other small things. In these short few months, the world was changed, changed forever, before our very eyes. If we are very wise and really lucky, we will get this mostly right.

Somethings stay the same.

During the Great Depression, jobs were scarce. Asked; the old men who came of age during the era would say, “there just weren’t any jobs.” When there are no jobs; education, gender, ethnicity, and race didn’t matter much. Many of those with good jobs got them because of who they knew or were related to. Whence the expression often heard from those of a certain age at the time, “It’s not what you know but who you know.”

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The 2020 Presidential election nowcast based on State polling: Trump support deteriorating even in red States

The 2020 Presidential election nowcast based on State polling: Trump support deteriorating even in red States

For the past four weeks I have posted a projection of the Electoral College vote based solely on State rather than national polls (since after all that is how the College operates) that have been reported in the last 30 days.

Here’s how it works:
– States where the race is closer than 3% are shown as toss-ups.
– States where the range is between 3% to 5% are light colors.
– States where the range is between 5% and 10% are medium colors.
– States where the candidate is leading by 10% plus are dark colors.

Before I proceed further, let me emphasize that polls are *not* forecasts, only nowcasts. They tell us the likely result if the election were held today. Since voters, campaigns, and decision-makers respond to the polling, it is inherently fluid. The only true “forecasts” are those which make us of leading indicators, which forecast where the data will be in a few months. One model, based on the Q1 Index of Leading Indicators, already forecasts a bad Trump loss. Another model, based on real disposable personal income through Q2, will be locked in when June’s data is reported in two weeks. Tomorrow or Tuesday I will look at the status of the short leading indicators, which will give a forecast “locked in” through Q3.

With that said, here is the updated map through July 19:

In the past two weeks, 6 red States have been downgraded to “lean” or toss-up for Trump, and two Congressional districts in Maine and Nebraska have flipped to Biden. Only Iowa has moved from toss-up to lean Trump. As of now, only 10 States, none of which has more than 9 Electoral votes, are “solid” Trump. In several of them – the Dakotas, Idaho, West Virginia, and Wyoming – there has not been any new State polling in months, so there could well be more Electoral votes and GOP Senators at risk who we simply don’t know about.

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Is McConnell trying to destroy the economy for Biden?

Paul Waldman asks the question I’ve been worrying about for a few weeks:

Do Republicans even want to help the American economy through this crisis?

. . .

But McConnell knows what’s happening. He has surely looked around and realized that with the pandemic surging, there is simply no way the economy is going to come roaring back before November. He’s seen the polls showing Trump trailing presumptive Democratic nominee Joe Biden by 10 points or more. He knows that the political environment grows less favorable to the GOP by the day. He understands that the odds his party will retain control of the Senate are probably 50-50 at best.

So from where he [McConnell] sits, the best outcome now may be to use the next stimulus package to win some minor ideological victories, but not allow it to be substantial enough to set the stage for a genuine recovery. That way, if and when Biden becomes president in 2021, the situation will be no less dire than it is now — and maybe more so.

And the worse things are in the country at that point, the better it is for Republicans. Just as they did when Barack Obama was president, they can blame Democrats for their own mistakes, then force austerity measures that sabotage the economy and slow the recovery.

If you were a Republican and you thought that Trump was doomed no matter what, this might be your best-case scenario.

I think there is a possibility that this is what McConnell is doing.  However, I am not sure of this.  It is possible that he is just posturing and angling for more corporate goodies, but will be happy to agree (“reluctantly”) to a large rescue package.

The House Democrats took automatic stabilizers off the table with the HEROES Act, and a large stimulus now that expires just when Biden takes office might be the “best” bet for Republicans – it would maximize their share of seats in the Senate, and position them for “optimal” obstruction even if they lose control.  An inadequate stimulus package that creates a full-fledged economic disaster now would be quite risky for the Republicans in narrow political terms.  Starting out with an inadequate stimulus package and bargaining for more corporate goodies in exchange for more stimulus might be McConnell’s game, just as in prior rounds.

A few further thoughts.

Republicans will argue for austerity – cluelessly or shamelessly, possibly now and certainly after a Biden win in November – to justify opposition to desperately needed stimulus spending.  James Kwak is right to worry that these arguments will lead centrist Democrats to go small.

The $2 trillion stimulus package over 4 years that Biden just proposed last week may not be sufficient, especially if McConnell refuses to pass a substantial bill now.  At a minimum, a Democratic stimulus bill in 2021 should have automatic triggers to extend economic support if the economy does not recover, because public opinion will turn against Biden and the Democrats if the recession drags on, and Democratic centrists may focus too much on current opinion polling about “deficits” rather than “latent” or future opinion about “recession” when voting on additional stimulus.

It is hard to say what the Democrats should bargain for without seeing what the Republicans propose, but I think Democrats should offer to let any state end the $600 weekly UI supplement (a “key” Republican demand) if they instead switch to 100% wage replacement of the first (say) 50k in wages, and 75% replacement up to 80k or 100k.  Let the states decide.  Aid to state and local governments should be close to non-negotiable.

I would seriously consider giving the Republicans corporate liability protection.  Sure, it sucks as a policy, but more because it reflects callous indifference to worker safety than because the status quo will actually benefit many people.  There are very few lawsuits so far and little reason to expect this to change.  If liability protection is symbolically important to Republicans, Democrats could try to pair it with an increase in life insurance and disability payments under Social Security and free coronavirus medical care for all, or they could agree to allow employers to avoid liability if employers agree to pay for workers’ comp that covers lost wages, medical care, and scheduled payments for death and permanent disability due to Covid.  (This tradeoff of negligence liability for workers comp is what greased the wheels for workers’ comp originally.)  These proposals seem hard to reject – you want people to go back to work without any legal protections, and you’re not even willing to support sick workers or the widows, widowers and orphans left behind?  Or Dems can demand that workers remain eligible for UI even if they refuse to return to work.  That would allow the most vulnerable workers to protect themselves.  Any of these trades would probably be good for workers, especially if they get Republicans to agree to a generous UI program and aid to state and local government.

I can’t say I’m looking forward to watching this play out over the next few weeks.

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Biden Proposes Ending the GILTI Loophole

Biden Proposes Ending the GILTI Loophole

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.

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RIP Tonu Puu

RIP Tonu Puu

Seems like more people I know are dying.  In this case it is a good friend of mine and occasional co-author, the Swedish economist, Tonu Puu, who was born in Estonia of an Estonian father and a mother of German ancestry.  As it was, he ended up speaking a very large number of languages, as well as being very cosmopolitan in many other ways. He was 83 years old and had cancer for some time, which is what I presume he did of, although the announcement did not specify a cause, but it happened this past Saturday in Umea in northern Sweden, where he was at the university there for most of his career.

Before talking about his work in economics, I want to note that probably more important for him was music.  He made baroque instruments such as viols and harpsichords and was so good at it that professional musicians had him make such instruments for them.  For many years he ran an annual Baroque music festival that attracted fine musicians from all over the world to Umea. I shall note here that an important characteristic of Tonu, which some of you may not like, was that he was deeply conservative in many ways. A sign of this in music is that he considered Beethoven to be the “worst thing that ever happened to music,” at least I heard him say that.  He saw Beethoven as being ultimately responsible for there being rock concerts in Venice that knocked off parts of the roof of the opera house.  I happen to disagree with that, seeing that as a pretty shaky link, but this was the sort of long-run perspective that he took to many things, full of his own integrity that ignored popular and transient trends, even if those were centuries long.


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Improvement slows in initial claims; expect recent job growth to slow as well

Improvement slows in initial claims; expect recent job growth to slow as well


A preliminary note: this morning’s report on housing permits and starts showed improvement across the board in June, although the absolute levels are no better than the low points of 2017 and late 2018-early 2019:

I’ll have more at Seeking Alpha later.

Now let’s turn to yesterday’s report on initial and continuing claims, which have been giving the most up-to-date  snapshot of the continuing  economic impacts of the coronavirus on employment. This week continued the trend of slight improvement to “less awful,” as shown in the below graph of the week over week % change:

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Weekly Indicators for July 14 – 18 at Seeking Alpha

by New Deal democrat

Weekly Indicators for July 14 – 18 at Seeking Alpha

My Weekly Indicators post is up at Seeking Alpha.

With the coronavirus beginning to rage out of control again in a majority of US States, improvement in the coincident and short leading indicators has generally halted.

As usual, clicking over and reading will bring you up to the moment, and bring me a penny or two.

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Truth Is The Daughter Of Time

Truth Is The Daughter Of Time

This is a frontispiece to a 1951 mystery novel by Josephine Tey (real name: Elizabeth Makintosh) named _The Daughter of Time_It is about the question of whether or not King Richard III ordered the murder of the “Little Princes in the Tower,” his nephews Edward and Richard, as has  long been alleged, and for a long time was simply accepted as historical fact.  This bestselling and very well and wittily written novel makes the case that Richard was framed by his successor, Henry (Tudor) VII, who usurped him after defeating and killing him in the Battle of Bosworth Field in 1485.  Tey manages to build up through the novel a very convincing case for this view, which I shall not get into the details of, although I highly recommend the novel, which I just finished reading. In any case, if she is right, or even partly right (because  have been many other accusations against Richard made as well), then this is one of those cases where “the victor gets to write the history.”

I note a few points.  The usual argument, still put accepted by many, is that Richard did the little princes in because they were threats to his having succeeded their father, his brother, Edward IV.  But in fact it is now accepted (documents surfaced centuries later on this apparently suppressed by Henry VII) that showed that they were illegitimate and thus not possible heirs to the throne. Richard had no reason to kill them.  He was invited to assume the throne by both houses of parliament and was thus completely legal and legitimate. And after his death, Henry had a Bill of Attainder brought against him in parliament listing all sorts of terrible things he supposedly did that justified the completely illegitimate Henry usurping Richard’s throne.  But murdering the princes was somehow not included in this Bill, which would obviously have been the top charge against Richard if it were true.  Furthermore, given Henry’s lack of any legitimacy, there was a large group of individuals, including the little princes if they were still alive, who had more claim to the throne than Henry.  He  was the British monarch who initially instituted Star Chambers that brought charges against each of these in turn allowing them to be “judicially murdered.” The grounds for these in some cases were as vague as “for certain reasons” (unnamed).  OTOH, a major reform Richard introduced was the right to bail.  There is much more, but this gives some idea of what Tey puts forth, most of which I have verified from other sources.

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