Relevant and even prescient commentary on news, politics and the economy.


Brad DeLong offers a long post on economists on the Romney team.


Notes on HHMT: Kevin Hassett, Glenn Hubbard, Gregory Mankiw, and John Taylor, “The Romney Program for Economic Recovery, Growth, and Jobs”

HHMT: We are presently in the most anemic economic recovery in the memory of most Americans, with significant joblessness and long-term unemployment, as well as lost income and savings.
WRONG: We are in the worst downturn, but we are not in the “most anemic” recovery–the recovery of 2001-2004 was more anemic. HHMT should know: three of them held high federal office in the George W. Bush administration that managed that recovery,and back then all four attempted (uncovincingly, IMHO) to rebut claims from people (like me) that the early 2000s recovery was anemic and that more stimulative policies were then needed.Why don’t HHMT make the true claim that we are in the worst downturn? Why do they make the wrong claim that we are in the most anemic recovery? Because they do not want to talk about how back when they were in office they played their role in failing to use their leverage to argue for more expansionary fiscal and monetary policies to speed the then-recovery.Why weren’t HHMT arguing, back in 2001-4, either inside or outside the government, for more expansionary fiscal and monetary policies to speed the then-recovery? I don’t know.Those of us who were so arguing would have found their help most welcome.

The list is long for a post….worth reading.

David Glaser tackles Art Laffer in Arthur Laffer, Anti-Enlightenmen Economist from the Wall Street Journal.

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Guest post: Greg Mankiw doesn’t understand competitio​n for investment

by Kenneth Thomas of Middle Class Political Economy

Greg Mankiw doesn’t understand competitio​n for investment

Greg Mankiw’s column in Sunday’s New York Times makes the case that competition between governments is a good thing, that it makes them more efficient in the same way that competition among firms does. He paints it as also being about choosing re-distributionist policies or not, with Brad DeLong and Harold Pollack both ably making the case that of course governments should engage in redistribution.

As author of Competing for Capital, however, I am more interested in the question of whether government competition for investment leads to more efficient outcomes. The answer, in short, is that it does not. Indeed, competition for investment leads to economic inefficiency, heightened income inequality, and rent-seeking behavior by firms (a further cause ofinefficiency).

Mankiw claims:

…competition among governments leads to better governance. In choosing where to live, people can compare public services and taxes. They are attracted to towns that use tax dollars wisely….The argument applies not only to people but also to capital. Because capital is more mobile than labor, competition among governments significantly constrains how capital is taxed. Corporations benefit from various government services, including infrastructure, the protection of property rights and the enforcement of contracts. But if taxes vastly exceed these benefits, businesses can – and often – move to places offering a better mix of tax and services.

Mankiw doesn’t stop to think about what this competition looks like in the real world. To attract mobile capital, immobile governments offer a dizzying array of fiscal, financial, and regulatory incentives to companies in sums that have been growing over time for U.S. state and local governments, as I document in Competing for Capital and Investment Incentives and the Global Competition for Capital. His discussion centers on the reduction of corporate income tax rates, which is surely a part of the competition, but which is no longer an issue when an individual firm is negotiating with an individual government.

At that level, the issues then become more concrete: Can we keep our employees’ state withholding tax? Can we get out of paying taxes every other company has to pay? Will you give us a cash grant? The list goes on and on. As governments make varying concessions on these issues, you then begin to see the consequences: discrimination among firms (especially to the detriment of small business); overuse and mis-location of capital as subsidies distort investment decisions; a more unequal post-tax, post-subsidy distribution of income than would have existed in the absence of incentive use (a corollary of the fact noted by Mankiw that “capital is more mobile than labor”); and at times the subsidization of environmentally harmful projects. Moreover, many location incentives are actually relocation incentives, paying companies at times over $100 million to move across a state line while staying in the same metropolitan area, with no economic benefit for the region or the country as a whole (Cerner-OnGoal, now in Kansas rather than Kansas City, is a good case in point).

Once upon a time, about 50 years ago in this country, companies made their investment decisions based on their best estimate of the economic case for various locations without requesting subsidies. On the rare occasion when a company did ask for government support, it was at levels that would appear quaint today. For example, when Chrysler built its Belvidere, Illinois, assembly plant in the early 1960s, it asked for the city to run a sewer line out to the facility–and it even lent the city the money to do it.

Today, companies have learned that the site location decision is a great opportunity to extract rents from immobile governments, and invest considerable resources into doing just that. An entire industry has sprung up to take advantage of businesses’ informational advantages over governments–and, indeed, intensify that asymmetry–to make rent extraction as effective (not “efficient”!) as possible.

Finally, let’s reflect on the force that makes this process happen, capital mobility. The fact that capital has far greater ability to move geographically than labor does, and that governments of course are geographically bound to one place, is a source of power for owners of capital. Modern economists, especially conservatives and libertarians, often have great difficulty acknowledging the role of power in market transactions, though their ostensible hero, Adam Smith, did not. To treat this power as a natural phenomenon rather than a social one, as Mankiw does, is dangerously close to saying that might makes right. But that’s not the way things are supposed to work in a democratic society, or a moral one.

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Greg Mankiw attempting to justify carried interest

by Linda Beale

Greg Mankiw attempting to justify carried interest

Greg Mankiw wrote an op-ed in the Sunday Times Money section: Capital Gains, Ordinary Income and Shades of Gray, New York Times (Mar. 4, 2012).

Mankiw notes the historical trend in the US to differentiate between capital gains and ordinary income regarding tax rates (though we have had notable experiements, both in the regular tax and in the AMT, to the contrary). He asserts that there are “good reasons” for the preference for capital gains income–offering only the standard idea of lack of indexation for inflation/deflation as an example.

The purpose of the piece is to justify the carried interest treatment of money managers’ gains from dealing with other people’s money as equivalent to a carpenter who fixes up a dilapidated house and gets capital gains on the sale of the home, though the gains are really paying off the carpenter’s sweat equity. Since the carpenter gets capital gains under our system, he says, why shouldn’t the money manager who does an analogous activity (assuming–which may be a rather big jump– that hedge fund, private equity and other money managers are doing “sweat equity” that adds to the value of the assets under management, and should be viewed analogously to the carpenter).

The problem with making these analogies, especially in the area of capital gains, is that the idea of capital gains is problematic to start with. We’d be much better off with a code that made no such distinction, since there are certainly instances where the distinction is an arbitrary one. Since the line drawing isn’t easy (and it isn’t), then the distinction shouldn’t exist at all in the tax code. That would be the right solution overall.

Nonetheless, the fact that a category is hard to apply generally doesn’t mean that there isn’t a right answer–or at least a better one– in particular circumstances. It is particularly inapt to compare money management with rehabilitation of dilapidated property. Rehabilitation of real property adds “real” value, in that the property is upgraded and will physically last longer than it would have without rehabilitation. Money managers don’t necessarily add any value–they may make money for themselves and others, but there is no real productivity gain in the economy in many (if not most) instances and certainly in any case where the gain is primarily speculative (often the case with hedge funds) or destructive of domestic businesses (often the case with private equity funds).

Private equity fund managers, you will recall, invented the leveraged buyout (or maybe it would be more accurate to say that the idea of the leveraged buyout led to private equity funds). The idea behind leveraged buyouts was to take a stable, money-making company that wasn’t heavily debt-ridden, load it up with debt to cover the acquisition cost of the company, and use the cash flows from the company to pay off the acquisition debt. Private equity funds like Bain Capital could then leverage a minimal investment of their own with the purchased company’s debt to get huge profits, once the debt was paid off with good cash flows (already existing out of the company, with nothing due to the “management” of the money manager). The better the company taken over was, the more its cash flow could be counted on to pay off the debt, the more leverage would be added, the quicker the debt was paid off, and the better the ultimate profit. Sometimes this takeover was relatively harmless for the “good” company, but many times it was harmful–the takeover changes and debt resulted in focus solely on profits and not on long-term investment, and the company’s long-term stability was destroyed. The process was seldom positively beneficial for the company over the long term or for its community (though it may have been for particular shareholders and the managers themselves). The point here, of course, is that the LBO was targeted to (already)”good” companies with low leverage and high cash flow that could easily borrow in the market to cover the cost of the acquisition.

Later, of course, as the age of financial speculation got fully underway, private equity firms started taking over companies that could never expect to pay back the additional debt the LBO loaded them with. The private equity firms made their money in these cases by driving them into bankruptcy and laying off or firing the workers. Equity firms still got their profits out of the deal by selling off the components. But the companies (and especially their workers) were done for–if the companies survived at all, they were just parts of some conglomerate with very different functions.
Making money from managing other people’s money, in other words, is not per se productive for the economy as a whole and is not something we should reward with low taxation that acts as an incentive to the activity. We should recognize the money manager’s take as what it is–compensation for work done–and tax accordingly.

As an aside, I’ll note that it wouldn’t be unreasonable to have a handyman take ordinary income on his share of the profit that serves as reasonable compensation for his labor, but in most cases that’s a difficult facts and circumstances issue for the Service to sort out after the fact. One reason carried interest is such an obvious place to repair the problematic categorization of labor income as preferential capital gains is that there will be a partnership and there will be records of “management fees” and “carried interest allocations”. Given our sophistication about partnership allocations, identifying and classifying the carry as ordinary income is a relatively simple endeavor.

crossposted with ataxingmatter

James Kwak
has a take on it also.

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Yesterday in the New York Times Greg Mankiw — a professor of economics at Harvard, an advisor to the governor of Massachusetts, in the campaign for the Republican presidential nomination and a former Chairman of the Council of Economic Advisers under president Bush — had a column in which he argued that a cut in the corporate tax rate would induce greater investment. This is a key premise of Republican campaigns that has driven Republican policy since the early 1980s. The article is here.

We should look at the record and see how well such cuts to corporate taxes actually has worked.

First, average corporate profits versus tax business pays. Contrary to the statutory rate of 39% widely quoted, the effective rate corporations actually pay is now about 22%. That is down from about 50% in 1950 and a local peak of some 44% in the early 1980s. The right likes to compare the statutory rate to other advanced countries statutory rate and claim that the US has about the highest corporate tax among advanced countries. But according to a recent study by the US Treasury the US effective rate is in about the middle of the pack of effective rates for advanced countries.

Second, let’s look at after tax profits as a percent of GDP. Despite cyclical swing there has been a strong secular trend since 1950. From 1950 to the early 1980s taxes as a percent of GDP declined from about 10% of GDP to under 4%. Since 1980 it has rebounded from under 4% back to about 10% of GDP and this measure appears to be on the verge of breaking out to a new record high.

Next look at business investment as a share of GDP . Again, despite cyclical swings there appears to be a secular trend. From 1950 to 1981 it rose and reached an all time peak of 14% in the early 1980s. Since 1980 it has been trending down from 14% and is now back to about the 10% level it was at in 1950.

…and compare it to taxes as a percent of GDP. Note the secular swing in investment is the exact opposite of the secular trend in profits. From 1950 to 1980 profits fell and investment rose. Since 1980 profits rose and investment fell. This is the exact opposite of Mankiw’s theory that cutting corporate taxes will lead to higher investments.

Mankiw writes a column for the NY Times every few weeks. Maybe in his next column he can explain why we should ignore this evidence that directly contradicts his theory.

His theory appears to be like the supply side theory that if we cut personal taxes on savings that people will save more. Since 1980 we have created IRA and other instruments that allow consumers to save on a tax free basis and increase their returns. So what happened to the personal savings rate over this period, it fell from 14% to almost 0%. This has to be about the greatest failure of an economic theory since communism. Remember, Milton Friedman said the most important test of a theory is how its forecasts work. Using Friedman’s basis the supply side theory about personal savings was a abject failure.

Now, I’m going to surprise you by saying that I completely agree with Mankiw that corporate profits taxes should be cut. But of course there is a catch.

What I want corporations to pay taxes on is their profits as defined by the Generally Accepted Accounting Procedures (GAAP) rather than profits as defined by the IRS. Congress does not establish GAAP so this change would massively cut the ability of Congress to create loopholes or special cases in the tax code. As a consequence incentives for firms to buy-off politicians would be massively reduced. If you are a corporate CEO would rather use the money you now have to spend on Washington lobbyist and expensive tax lawyers to actually expand your business. My primary objective is to reduce the power of corporate money in politics and if Mankiw is right that it increases investment all the better.

Almost to a man Republican and business leaders strongly agree that the US should not have industrial planning. Politicians should not be in the business of picking winner and losers. But the US has a major industrial planning system, it is just that we call it the federal tax code. And generally the critics are right, Washington does a poor job of picking winners and losers.

According to the GAO the industries with the highest effective tax rates like information technology are frequently the fastest growing industries. Moreover the slowest growing industries, like oil, have the lowest effective tax rate. The GAO estimate that the oil industries’ effective tax rate is about 11%, or about half the overall corporate tax rate.

Apparently oil executives learned decades ago that the get a much higher return on their capital if they use it to buy political favors rather that actually drilling for more oil. Surprisingly, domestic oil production actually rose in 2009 and 2010. This is the first consecutive annual increase in domestic oil production since Carter was president and oil faced price controls and windfall profits taxes. Maybe the oil executives realized they could not buy-off Obama and decided that to grow profits they had to do something really radical, like increasing domestic oil production.

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