Does Science Prove that the Modern GOP Favors the Rich?

Does Science Prove that the Modern GOP Favors the Rich?

December 7, 2017

Virtually everyone outside the Trump administration agrees that the GOP tax plans passed by the House and the Senate will aggravate income inequality.  In fact, the party-line votes on both plans are the latest instance of a remarkable fact:  Over the last 40 years, income inequality has accelerated when Republicans held the White House, the Congress or both, and slowed when Democrats were in charge.

No one is claiming that the GOP created America’s dramatic increase in income inequality.  In a recent study issued by the Center for Business and Public Policy at Georgetown University’s McDonough School of Business, our analysis showed that changes in the U.S. and global economies and technology did most of that.

Between 1977 and 2014, the average pre-tax income of the bottom 50 percent of Americans—everyone below median income – increased just 1.7 percent, inching up from $15,948 to $16,216 (2014 dollars).  Over the same years, the average pre-tax income of the top one percent soared 207 percent, jumping from $424,631 to $1,305,301.

During these years, Washington stepped in with new spending and tax credits that modestly helped the bottom half of Americans: Their average post-tax income rose 22 percent, from $20,390 in 1977 to $24,047 in 2014.  But tax and spending changes had little effect on the top one percent, whose average post-tax incomes still rose 196 percent, from $342,328 to $1,012,429.

Partisan politics also played a major role: The actual income paths of both groups from 1977 to 2014 depended on whether Republicans or Democrats controlled the White House and/or Congress.  For example, when Republicans held the presidency, the top one percent’s rising share of all post-tax income accelerated on average by 0.4 percentage-points, while under Democratic presidents their rise correspondingly slowed by 0.4 percentage points.  Similarly, the bottom 50 percent’s falling share of post-tax income accelerated under GOP Presidents by an average of 0.5 percentage-points – and again, their decline decelerated by that much under Democratic presidents.

The story is the same with Congress.  During years of GOP control, the decline of the bottom half’s share of national income accelerated, on average, by more than 0.5 percentage-points – and then slowed by about that much when Democrats were in charge of Congress.  Party control of the legislative branch had the least effect on the income path of the top one percent: Their rising share of post-tax income accelerated by an average of 0.3 percentage-points during GOP Congresses, and decelerated by that much during years of Democratic control.

Finally, the results when either party controlled both the White House and Congress were the sum of the results for each branch.

This isn’t conventional wisdom dressed up as science; it is a scientific demonstration of how much elections matter. To test the limits, we also conducted a thought experiment: What would the incomes of the bottom half and the top on percent look like, if one or the other party had controlled both branches of government for the entire 37 years? We assume here that the economy’s course was unaffected by our hypothetical one-party government, and that each party maintains the distributional tendencies in tax and spending policy uncovered in our analysis.

With these assumption, we calculate that if Democrats had been in charge the entire time, the post-tax income of the bottom 50 percent, on average, would have been an estimated $526 higher per-year or a total of $19,539 more for the whole period.  Moreover, the top one percent would have taken home $14,226 less per-year, on average, or $526,373 less for the whole period.

Operating on the same assumptions, we calculate that Republican control of both branches for the entire period would have increased the post-tax income of the top one percent by $28,029 per year, on average, or $1,037,086 for the whole period; while the incomes of the bottom 50 percent of Americans, on average, would have been $563 less per year, or $20,848 less for the entire period..

Helping the rich and letting those in the bottom half fend for themselves, it seems, is now part of the modern GOP’s DNA – and moderate resistance to that course seems to be embedded in the Democrats’ genes.

 



Evaluating the Claim that Cutting Corporate Taxes Will Raise Your Wages

October 18, 2017

Real disputes among professional economists rarely make their way into political debates. But that’s what’s happened with the issue of whether the Trump administration’s proposal to cut the corporate tax rate from 35 percent to 20 percent would mainly benefit shareholders or workers. Both sides make coherent arguments – but in the end, the evidence supports the proposal’s opponents.

Those opponents start with a traditional tenet of public finance: Taxes on assets are borne by the owners of those assets, so cutting taxes on corporations would mainly benefit their shareholders. .

The proponents cite another tenet of public finance: Taxes are borne by those unable to escape them or, in more technical terms, corporate taxes fall on the least mobile factors of production.   U.S. multinational companies have shifted substantial capital assets to other countries, from their patents to factories;. But American workers are stuck here. This suggests that much of the burden of U.S. corporate taxes could fall on workers – and consequently cutting corporate taxes should benefit them.

Economic researchers have found support for both tenets, but most of the economic literature has estimated that 70 percent to 85 percent of the burden of corporate taxes falls on shareholders and 15 percent to 30 percent on workers. A 2012 study by the U.S. Treasury – one recently excised from the Department’s website – calculated those proportions at 82 percent for shareholders and 18 percent for workers.

Conservatives insist that globalization has rendered those findings outdated. Citing research by Kevin Hassett, chair of the Council of Economic Advisers (and my friend) and others, they point to strong statistical associations between reductions in corporate tax rates over the last two decades and strong wage gains, especially in Eastern and Western Europe. Their logic is as follows: As U.S. and native corporations sited more production in low-tax countries, those capital investments raised both the demand for and productivity of workers in those places, driving up their wages.

I have no doubt that those findings are correct – but it does not follow that cutting U.S. corporate taxes would drive up investment and the wages of American workers. .

First, the studies do not show that U.S. companies invested in those countries to avoid high U.S. corporate taxes. Certainly, the large U.S. software and pharmaceutical companies that transferred the ownership of their patents and copyrights to their Irish subsidiaries did so to elude U.S. taxes – transfers which created very few jobs in Ireland. By contrast, U.S. foreign direct investments that involve building factories and setting up new organizations in other countries occur to serve foreign customers in the regions of those investments. Lowering our corporate tax rate will not change that.

Similarly, U.S. and foreign companies invest here to serve the world’s largest national market. Moreover, taxes are not a barrier, since Congress provides a cornucopia of tax breaks to reduce corporate tax burdens well below 35 percent. According to a 2016 Treasury study, the effective corporate tax burden averaged 22 percent over the period 2007 to 2011. Some of that certainly reflected U.S. companies’ foreign earnings that remain untaxed by the United States. But some industries with few foreign operations also paid below-average rates. For example, the effective tax burden on U.S. utilities and real estate companies averaged, respectively, 10 percent and 20 percent. Right now, then, companies can operate in the United States at an effective tax rate equal to or lower than the administration’s proposal.

In the end, the only real issue is whether the tax proposal would induce U.S. or foreign companies to expand their American operations in ways that raise the demand for and productivity of U.S. workers. We cannot know for certain. Nevertheless, the 2016 Treasury study does provide on-point support for its opponents.

The Treasury found that while the effective corporate tax rate averaged 22 percent from 2007 to 2011, it actually fell substantially over those years — from 26 percent in 2007 to 20 percent in 2011. We did experience four years of strong employment gains from 2013 to 2016, which mainly restored jobs lost in the financial collapse and deep recession. Yet, alas, the falling corporate tax burden did not ignite the surge in business investment and wage gains predicted by the administration’s logic. That’s game, set and match for its opponents.



Blame the Economy for Widening Inequality – And Washington for Doing Little about It

October 3, 2017

America’s widening income inequality has become a subtext across most debates in domestic policy.  GOP plans to repeal and replace Obamacare failed in large part because virtually every expert warned that the changes would end coverage for millions of people with modest incomes and cut taxes for high-income people.  President Donald Trump’s push to cut business taxes will likely meet a similar fate.  He shouldn’t be surprised: The populist revolt that helped elect him has been fueled by popular anger over Washington’s incapacity to do anything about how the economy skews its rewards towards those at the top and away from most everyone else.

Ask the right questions, and the income data reveal a great deal about how this inequality took hold over the last 40 years.  It is given that the American economy and politics both changed dramatically over this period.  But how did each of those forces affect the distribution of incomes? In a new study just issued by the Center for Business and Public Policy at the McDonough School of Business at Georgetown, I used statistical analysis to explore this question.  It turns out that we can track the economy’s role in growing inequality by following the changing distribution of all pre-tax income, and then track the role of politics and the government by following the changing distribution of all post-tax income.

It also turns out that the new populists, or at least their feelings, are justified:  As economic changes have produced widening income inequality, the government has remained largely though not entirely on the sidelines.

To begin, the data show that rising inequality in the United States began in 1977, and the same data series ends with 2014, giving us 37 years of income information on both a pre-tax and post-tax basis.  Over those years, the share of pre-tax national income going to the bottom 50 percent of Americans – that is, not taking account of changes in taxes and government transfers – slumped from 20 percent to 12.5 percent.  This was the doing of a changing economy as globalization and technological advances steadily squeezed the wages and working hours of tens of millions of low, moderate and middle-income Americans.

Over the same years, the share of all pre-tax income going to the top one percent of Americans soared from 10.7 percent to 20.1 percent.  The economic drivers were the same.  In their case, the rapid progress of globalization and new technologies boosted both the returns on capital – think of soaring stock markets – and the compensation of millions of American business executives and professionals.

“Income shares” are economist-speak, so let’s translate them into the average incomes for each group.  The results are sobering.  The average pre-tax income of the bottom 50 percent of Americans, in 2014 dollars, inched up from $15,948 in 1977 to $16,216 in 2014, for a raise of $268 or 1.7 percent over 37 years.  The top one percent lived in a different economy:  Their average pre-tax income in 2014 dollars jumped from $424,631 in 1977 to $1,305,301 in 2014, a raise of $880,670 or more than 207 percent.

To see what the government did about all this, we shift the analysis to the two groups’ income shares and average incomes on a post-tax basis.  The data show, first, that the government took some steps to soften the blow for the bottom 50 percent of the country and were modestly effective.  After taking account of changing tax and spending policies since 1977, the share of all post-tax income going to the bottom half of the country fell from 25.6 percent in 1977 to 19.4 percent in 2014.  So, their income share dropped 24.2 percent on a post-tax basis, compared to 37.5 percent on a pre-tax basis.

The difference tells us what the government actually accomplished:  Washington managed to offset a little over one-third of the adverse impact of globalization and new technologies for the bottom 50 percent of Americans [1 – (24.2 / 37.5) = 0.355].  Their relief came mainly from government steps to expand the earned income tax credit, broaden access to Medicaid, and provide subsidies for health insurance under Obamacare.  Other tax changes made the federal income tax moot for most of this group, but increases in payroll tax rates offset those gains.

Turning to actual incomes, we find that the average post-tax income of the bottom half of the country increased over this period, in 2014 dollars, from $20,390 in 1977 to $24,925 in 2014.  That signifies a raise of $4,535 or 22 percent over 37 years – not much, but better than the 1.7 percent gains in average pre-tax income.

Washington has been more solicitous of the top one percent of the country.  After taking account of changes in tax and spending policies, their share of all post-tax income jumped from 8.6 percent in 1977 to 15.6 percent in 2014.  So, the income share going to the top one percent of Americans increased 81.4 percent on a post-tax basis, compared to 87.8 percent on a pre-tax basis.

Once again, the difference tells us what Washington did: 37 years of tax changes and spending offset about 7 percent of the fast-rising income gains claimed by the top one percent [1 – (81.4 / 87.8) = 0.073].  In more concrete terms, the average post-tax income of the top one percent of Americans increased, in 2014 dollars, from $342,328 in 1977 to $1,012,429 in 2014.  That’s a sweet raise of $670,101 or 196 percent over 37 years.

Over nearly four decades, then, Washington demonstrated moderate concern about the declining position of the bottom half of the country while affirming the rising position of those already at the top.

This record tells us it is time to address the real drivers of widening inequality:  Shift our focus from half-hearted redistribution to serious economic reforms — aggressive anti-trust for all concentrated industries, for example, and universal access to free retraining at community colleges — that can put average Americans in a better positions to capture the rewards of globalization and technological change.



A New GOP Nightmare: Trump and Democrats Cut a Deal on Taxes

September 26, 2017

Here they go again.  Despite the Republicans’ control of the presidency and both houses of Congress, their internal divisions keep on frustrating their plans to accomplish anything of consequence. So, the most polarizing GOP president since Abraham Lincoln has come up with a startling work-around:  Cut deals with the Democrats on selected major matters, including funding the government, raising the debt limit and, perhaps soon, legalizing the Dreamers.

The next big test is tax reform.  If (when) Mitch McConnell and Paul Ryan can’t deliver the goods, could President Trump and the Democrats find common grounds on taxes?

We know what tax reform means to the President and congressional Republicans – much lower taxes for corporations and other businesses; lower taxes for individuals and households, especially on their investment income; and an end to the pesky estate tax.  The problem for Republicans is not their relentless itch to cut taxes for businesses and wealthy people, which is a given for the GOP.  The catch is that their current agenda would cost the Treasury several trillion dollars – and their preferred ways to pay for at least a part of it, by paring corporate tax preferences and personal deductions for mortgage interest and state and local taxes, only aggravate the party’s internal divisions.

Could Trump win on taxes (hugely) by cutting another deal with Democrats? He went along with virtually everything that Nancy Pelosi and Chuck Schumer asked for to seal the previous agreements.  What might the Democrats demand on taxes?

Since Democrats typically favor more federal spending, their traditional wish-list on taxes is heavy on ways to raise revenues rather than options for cutting them. That predilection could provide a basis for another agreement of convenience:  Cut taxes the way that President Trump wants, and pay for it the way that Democrats want.

For years, many Democrats have called for an end to “deferral,” the tax provision that lets multinational companies delay paying any U.S. tax on their foreign earnings, usually for years and sometimes in perpetuity.  It’s the opposite of the GOP’s call for a “territorial” tax system that would permanently exempt from U.S. tax any income that American businesses earn outside the United States.  Tax deferral matters most to the subset of companies that are most successful in worldwide markets. – think of the Internet and software giants, big pharma, and brands like Coca Cola.  If both sides are prepared to cast them aside, there might be a deal that trades a lower corporate tax rate for the prompt taxation of foreign earnings.

It doesn’t make much sense economically:  Since most other countries have “territorial” tax systems, deferral helps level the playing field on taxes for U.S. companies in foreign markets. But economics doesn’t seem to matter much anymore – and consider that the White House could trumpet rolling back deferral as a powerful way to Make America Great Again by convincing companies to produce more goods and services at home, and Democrats could sell it as a way to keep jobs in America.

Democrats also generally favor taxing the investment income of wealthy Americans at the same rates as the wages and salaries of everyone else.  Their call for an end to lower tax rates for capital gains, interest and dividends, of course, is the opposite of the GOP’s current economic faith and tax plans.  Nevertheless, perhaps Trump and the Democrats could agree to raise the tax rate on capital income to the level of labor income in exchange for lowering the tax rates on all income.  Wall Street Republicans would hate it, but some in the GOP might just remember that it’s precisely what Ronald Reagan did in 1986.

There is also a variation on this deal based on Democratic support for higher payroll taxes on high-income people.  Schumer and Pelosi might be willing to trade lower personal tax rates, especially at the top, for subjecting capital income to the payroll tax.  This deal would also require tinkering with Social Security to ensure that payroll tax payments on capital income did not figure into the size of a taxpayer’s subsequent Social Security benefits.  But Democrats could also insist that the Treasury divide the additional revenues between the Social Security Trust Fund and the funding for lower personal tax rates.  This scenario may seem far-fetched until you consider that it would give Trump the opportunity to claim credit for lowering tax rates and saving Social Security.

In the end – and perhaps it’s a good thing — none of these scenarios is likely to happen for two reasons.  The Republicans probably will split over tax reform, but the odds they can stick together are greater on taxes than healthcare: It’s always easier to agree on how to give away money than on how to take it away.  Beyond that, agreeing on taxes would require more imagination and nerve by the White House, and probably Democratic leaders too, than either has displayed recently.  Nevertheless, the bare possibility of collaboration on taxes between President Trump and the Democrats reminds us that governing can divide a political party, and being in opposition can unite it.

An earlier version of this essay was published by the Brookings Institution: https://www.brookings.edu/blog/fixgov/2017/09/22/a-gop-nightmare-trump-and-democrats-cut-a-deal-on-taxes/



The Three Choices for Tax Reform

September 13, 2017

Trump administration officials and GOP leaders in Congress are still putting together their tax plan. Nevertheless, the early signs point to decisions that could sink the project or produce changes that would jeopardize economic growth.

Congress can approach changing the corporate tax in one of three ways. It can try to simplify the code, it can reform it, or it can cut it back. The GOP’s current approach appears to start with simplification. Simplifying the corporate tax normally means phasing out a package of tax preferences for particular industries or business activities, and using the revenues to bring down the current 35 percent tax rate to 28, 25 or even 20 percent. This model shifts the burden of the tax among industries but not among income groups, since shareholders continue to bear most of the burden. Such simplification can also attract bipartisan support and produce real economic benefits. At a minimum, it lowers tax compliance costs for most businesses; and if it’s done thoughtfully, it can increase economic efficiency. To be sure, any efficiency benefits will be marginal unless the simplifications are fairly broad and sweeping.

The record also shows that serious tax simplification is very hard to achieve. Support from President Obama and congressional GOP leaders wasn’t enough to advance it in 2014, for the simple reason that most companies prefer their tax preferences to a lower tax rate. They’re not wrong economically: The Treasury calculated in 2016 that tax preferences lower the average effective corporate tax rate to 22 percent, and companies in many industries pay substantially less. Why give up those preferences for a 28 or 25 percent rate? A 20 percent rate could solve the problem for most industries, if anyone had a plausible way to pay for it. Of course, financing a deep rate cut was the border adjustment tax promoted by Speaker Paul Ryan, and which the White House and big importers and retailers quickly squashed.

The second option is genuine reform, where Congress changes the structure of the corporate tax. Economically, the most promising reform would give U.S. companies a choice of tax treatments when they invest in equipment. They could deduct the full cost of those investments in the year they make them (“expensing”) while giving up the current deduction for interest on funds borrowed to finance the investments. Or they could stick with the current depreciation system for their investments, including the deduction for interest costs. If enough companies choose the first route, as they likely would, this reform would spur investment and sharply reduce the tax code’s nonsensical bias towards financing business growth with debt rather than equity. Such a structural reform would make sound economic sense. It also seems as unlikely as serious simplification, because it foregoes the pixie dust of marginal tax rate cuts that GOP supply-siders demand.

That leaves the Trump administration and Republican leaders with option three: Cut the corporate tax rate without paying for it. The President seems to favor this approach. He has called repeatedly for slashing the corporate rate to 15 percent, a multi-trillion dollar change, and paying for a small piece of it by limiting a few personal tax deductions for higher-income people. It’s also catnip for GOP supply-siders who continue to proclaim that a deep rate cut will boost economic growth enough to pay for itself. We’ve tried this t several times already, so we now have hard evidence to evaluate those claims. The actual record shows, beyond question, that such turbo-charged dynamic effects do not occur. The most recent example is George W. Bush’s 2001 personal income tax cuts. His “success” enacting them produced huge deficits and ultimately contributed to the financial collapse that closed down his presidency.

A largely-unfunded cut in the corporate tax rate in 2018 would boost corporate profits as well as budget deficits, but it won’t increase business investment, productivity or employment. Prime interest rates in this period have been lower than at any time since the 1950s, so companies have had easy and cheap access to funds for investment for years. At a minimum, this tells us that there’s no real economic basis to expect businesses to use their windfall profits from a big tax cut to expand investment.

Instead, they’re likely to use some of their additional profits to fund stock buy-backs. The rest will flow through as dividends and capital gains, mainly for the top one percent of Americans who hold 49.8 percent of stock in public companies, and the next nine percent who own another 41.2 percent of all shares. Those lucky shareholders will use much of their windfall gains to buy more stock; and coupled with the corporate stock buy-backs, the boost in demand for stocks will pump up the markets. To be sure, those shareholders will also spend some of their unexpected gains, which will modestly stimulate growth. Once that stimulus dissipates, as it will fairly quickly, the ballooning budget deficits will drive up interest rates and slow the economy for everyone else.

The worst scenario is that large, deficit-be-damned cuts in the corporate tax rate could produce a stock market bubble that could take down the economy when it bursts. The good news is that the current Congress would never enact it. The odds of Democrats supporting Donald Trump on a tax plan to make shareholders richer are roughly the same as winning the Powerball; and the certainty of soaring budget deficits should scare off enough conservative Republicans to sink the enterprise.



The Trump Administration is Disrupting the 2020 Census – And it Matters More than You Think

September 5, 2017

The decennial Census is a genuinely powerful institution in American life. I didn’t understand its impact until I oversaw the Census Bureau as it prepared and carried out the 2000 decennial Census, when I was Under Secretary of Commerce for Economic Affairs. Believe me, the upcoming 2020 decennial Census will matter more than you think. Yet, Congress and now the Trump administration have set the 2020 decennial on a course that threatens its basic accuracy. In so doing, they put at risk the integrity and effectiveness of some of the national government’s basic missions.

Normally, the Census Bureau spends the first six years of each decade planning the next decennial Census. The Bureau’s funding ramps up in years seven, eight and nine of the decade, when it tests and purchases its technologies, conducts a nationwide inventory of residential addresses, orders forms, letters and advertising, and begins to lease local offices and train temporary workers. It is expensive to accurately locate and count 325 million people in 126 million households (2016). That’s why, for example, Census funding jumped 96 percent from 1997 to 1998, and more than 60 percent from 2007 to 2008.

The problems began in 2014, when the Congress decreed that the 2020 Decennial Census should cost no more than the 2010 count without adjusting for inflation, or some $12.5 billion. The Obama administration objected, but to no effect – although it’s worth recalling that Bill Clinton took a different tack in 1998, when he vetoed an omnibus budget bill and risked a government shutdown to get rid of a provision that would have barred the Census Bureau from using statistical sampling to verify the 2000 count.

The Census Bureau did what it had to do to live within its new budget constraints: it drew up new plans to cut costs by replacing thousands of temporary Census workers and hundreds of temporary offices with new technologies and online capacities. It also had to do what it shouldn’t have done: To save money, the Bureau aborted a planned Spanish-language test census and didn’t test or implement new ways to more accurately count people in remote and rural area. Census also ended its plans to test a range of local outreach and messaging strategies to get people to fill out their census forms, which are crucial to minimizing undercounts in many minority and marginalized communities.

Even so, the Census Bureau prepared to ramp up funding in 2017 and 2018, as it normally did, udner the $12.5 billion cap. Enter the Trump administration, which cut the Obama administration’s 2017 budget request for the Census Bureau by 10 percent and then, this past April, flat-lined the funding for 2018. It is no coincidence that the Director of the Census Bureau, John Thompson, resigned in May, effective in June. It’s a serious loss, since Dr. Thompson directed the 2000 decennial count and is probably the most able person available to contain the coming damage to the 2020 count. For its part, the administration hasn’t even identified, much less nominated, his successor. It is no surprise that the Government Accountability Office recently designated the 2020 Census as one of a handful of federal programs at “High Risk” of failure.

The costs of starving the decennial Census could be great. It not only paints the country’s changing demographic and geographic portrait every 10 years. Its state-by-state counts determine how the 435 members of the House of Representatives are allocated among the states; and its counts by “Census block” (roughly a neighborhood) shape how members of state legislatures and many city councils are allocated in those jurisdictions. That’s just the beginning.

Consider as well that every year, the federal government distributes about $600 billion in funds to state and local governments for education, Medicaid and other health programs, highways, housing, law enforcement and much more. To do so, the government uses formulas with terms for each area’s level of education, income or poverty rate, racial and family composition, and more. The decennial Census provides the baseline for those distributions by counting the people with each of those characteristics in each state and Census block. Similarly, the Census Bureau conducts scores of additional surveys every year on behalf of most domestic departments of government, to help them assess the effectiveness of their programs. Here again, the decennial Census provides the baseline for measuring each program’s progress or lack of it.

Without an accurate Census, many states and cities will be denied the full funding they deserve and need, and the federal government will have to fly blind for a decade across a range of important areas. Moreover, many businesses also rely on decennial data, from retailers and commercial real estate developers to the banks that finance them. Data on the demographics and locations of potential customers not only inform their planning and investments. In some cases, the data actually make their projects possible, for example, when an investment qualifies for special tax treatment if it occurs in places with certain concentrations of low or moderate-income households.

The Trump administration cavalier approach to the 2020 decennial Census is evident in ways other than its funding deficit. A draft executive order, leaked but not issued so far, would direct the Census Bureau, for the first time in over 200 years, to “include questions to determine U.S. citizenship and immigration status.” The Census Bureau is legally required to protect the privacy of all Census data from requests by anyone, including government officials. Unsurprisingly, many people remain skeptical and avoid answering the Census out of fear that other government agencies will access their information. Requiring that Census 2020 probe each respondent’s citizenship and immigration status would turbo-charge those fears among Hispanics and other immigrant groups. The result would be systemic undercounting and underfunding of states, cities and towns with substantial populations of Hispanics and other immigrants.

There is still time for a course correction that could rescue the 2020 decennial Census, in next month’s negotiations over the 2018 budget. With some GOP members of Congress exhibiting a measure of newly-found independence from the Trump administration, Paul Ryan and Mitch McConnell could need Democratic support to pass a budget. A wide range of minority advocacy and business groups, along with most big city mayors, have vital interests in an accurate decennial Census. It’s up to them to pressure Nancy Pelosi and Chuck Schumer to make adequate funding for the Census one of their top priorities. Otherwise, one of the basic mechanisms for fair and competent governance could be disabled for a decade.



It’s Still the Economy, Stupid!

July 24, 2017

Republicans know that the terrain for next year’s midterm elections could be treacherous.  Off the record, they bemoan their inability to enact their agenda and mourn President Donald Trump’s unpopularity.  In principle, the GOP still might get its act together and pass a tax reform with new tax breaks for middle class taxpayers.  Events unforeseen and unimagined could offer Trump a platform to renew his poplar appeal.  Even so, they’re ignoring the signs that a sagging economy next year will dominate the 2018 campaigns.

The current expansion is old – it turned eight years old this month – and its fundamentals are weak.  Neither Trump nor Congress has done anything to perk it up.  Only the 1990s expansion lasted longer, and it expired two years after its eighth birthday.  Comparing the two will not cheer Republicans. At a comparable point in the expansion that defined the Clinton era, March 1999, GDP was growing at nearly a 5 percent rate; over the last year, GDP has edged up barely 2 percent.

The most important difference is what was happening then with productivity, and what’s happening now.  In the three years leading up to each expansion’s eighth birthday, productivity had expanded at a 2.4 percent annual rate in the 1990s, compared to 0.7 percent this time.  Without decent productivity gains to lift wages and fuel demand, incomes stall and growth slows.

The main reason we’re not in a recession today is the strong job gains of the last three years, and the current 4.4 percent unemployment rate is comparable to the 4.2 percent rate in March 1999.   Full employment normally presages a slowdown in job creation.  We avoided that in the late 1990s, because the strong productivity growth supported more demand by raising wages.    The best measure of that is personal consumption spending, which increased at a 5.9 percent rate in the year leading up to March 1999.  But our current predicament includes such weak productivity gains that personal consumption spending edged up just 2.6 percent over the last year.

It’s the same story with business investment, the other domestic source of new demand. In the year preceding the eighth birthday of the 1990s expansion, fixed business investment rose 8.5 percent; over the past year, it grew 4.2 percent or half that rate.

All of these measures presage a slowdown in the U.S. economy next year – GDP gains of 1.5 percent in 2018 is a fair guess — and we could slip into a recession if some adverse event provides the trigger.

Last October, I cautioned Hillary Clinton that she would face these same conditions if she won, but that three initiatives could breathe new life into this old expansion.  The first order of business is a dose of demand stimulus, preferably through large infrastructure investments paid for down the line.  Trump promised the same thing; but he and the GOP Congress moved quickly beyond it.

The second initiative would focus on energizing productivity growth.  My own recommendations last October started with measures to help average Americans upgrade their skills, by giving them free access to training courses at local community colleges.  The Trump and GOP budget proposals would cut the inadequate training programs already in place.

The third initiative is a companion piece to promote higher productivity: Jumpstart business investment in new technologies and equipment.  That will be harder for Trump than it would have been for Secretary Clinton, because it requires setting aside the supply-siders’ faith in the power of cutting marginal corporate tax rates.  Instead, we should focus for now on lowering businesses’ upfront costs to purchase the new technologies and equipment that make skilled workers even more productive.

The measure would offer businesses a choice: deduct the full cost of those new purchases in the year they buy them – it’s called “expensing” – or stick with the current system where businesses depreciate the cost and deduct the interest on funds borrowed to cover it. Expensing is a feature of the Trump and GOP tax proposals, but both plans offer more sweeping and much more expensive changes that appear headed for the same fate as Trumpcare.

The election of Trump and the GOP Congress buoyed business confidence precisely because investors believed they would follow through quickly with an infrastructure stimulus and business tax reforms.  Neither seems likely today; and even if one or the other somehow passes in some form late this year, it will probably be too little and too late to revive growth and wages by November 2018.  If neither happens, it will take more than tweets to explain to voters why Republican control of both branches of government has failed to improve their lives.



How to Raise Incomes and Delay the Next Recession

May 23, 2017

Last October, mulling over the economic environment the next President would face, I sent Hillary Clinton memos on how she should provide some stimulus to sustain the current expansion and raise incomes by boosting business investment and productivity. Alas, she did not become President; but that didn’t change our current economic challenges. To be sure, President Trump’s manifold troubles may preclude Congress from doing anything meaningful until after the 2018 elections. But if that’s not the case, here’s some advice for both sides.

The White House, above all, should appreciate the stakes: Without some form of serious stimulus, the U.S. economy almost certainly will slip into recession well before 2020. From Trump’s recent statements about “priming the pump,” he already understands that the eight-year-old expansion needs a boost. The GOP plan for sweeping tax cuts won’t work here, even if it could pass Congress. To begin, it devotes most of its resources to high-income people and shareholders, who will just save most of their tax savings. More important, the plan would vastly expand federal deficits on a permanent basis. If that happens, the Federal Reserve almost certainly will hike interest rates considerably higher and faster than they now contemplate, and those rate hikes would likely end the expansion.

Washington needs to prime the pump in a way that directly supports employment over the next two years and carries no long-term costs for the deficit. As it happens, Trump and Democrats already support a reasonable way to do just that – enact a large, two-year increase in public investments in infrastructure. But the plan will attract Democratic support only if Trump gives up the idea of using tax breaks to leverage private investment in new infrastructure projects. Democrats won’t (and shouldn’t) go along, because that approach tilts the program towards infrastructure projects in high-income areas that can generate strong profits for its investors.

I assume that the President’s economic advisors also have briefed him on the recent, serious slowdown in business investment and productivity growth. Unless Trump addresses those problems as well, most Americans will make little income progress. The challenge here is to focus on changes that will boost business investment in way that strengthen productivity, and do it without raising deficits on a permanent basis.

One approach that congressional Republicans and some Democrats could support entails allowing businesses to “expense” their investments in equipment – that is, deduct the entire cost in the year they purchase the equipment. This change focuses on equipment investments, because they have the greatest impact on growth and productivity. The catch is that this approach still costs the Treasury many tens of billions of dollars per-year, especially if it covers both corporations and privately-held businesses (like the Trump Organization), as it should.

Trump could draw some support for the plan from congressional Democrats by insisting that Wall Street pay for it. First, he could deliver on his campaign promise to end the notorious “carried interest” loophole that lets the managers of private equity, venture capital and hedge funds use the capital gains tax rate to shelter most of their income from their funds. Fund managers certainly can afford to pay the regular income tax like the rest of us: In 2016, the top 25 hedge fund managers altogether earned $11 billion or an average of $440 million each.

To pay for the rest of equipment expensing, Trump should support the call by many Democrats for a small tax on financial transactions – three one-hundredths of one percent of the value of all stock, bond and derivative purchases should do it. (Stock and bond IPOs and currency transactions would be exempt.) Wall Street will howl in protest – music to most Americans’ ears – but the economics are sound. On the plus side, the tax would reduce market volatility by discouraging short-term speculation and ending most high-frequency computer trading. Moreover, today’s short-term speculators and high-frequency traders will have to invest those resources in more productive ways.   The negative is that the tax would raise transaction costs and thus dampen investment on the margins. But since the tax would finance a serious reduction in the cost of business investments in equipment, the overall impact on the markets will be positive.

This plan is far from the dream agenda of either party. A Hillary Clinton presidency would have included many other measures to boost productivity and incomes, from access to tuition-free college for young people and greater access to bank loans for new businesses, to broad retraining opportunities for adults and a path to citizenship to expand job opportunities for immigrants. For their part, congressional Republicans still believe in their trinity of huge tax cuts, drastic deregulation, and deep cutbacks in Medicare, Medicaid and Obamacare benefits. But the economics of stimulating an aging expansion and restoring business investment are non-partisan, and both parties should have an interest in reviving income progress for most Americans.

For President Trump, this plan has three simple parts consistent with his positions: Increase public infrastructure investments, lower the cost of business investments, and make Wall Street pay more of its fair share. If he can cut this deal, nearly everybody will win – but if he can’t, no one will lose more than he will.



Trump’s Tax Plan is Aimed at the 2018 and 2020 Elections, Not U.S. Competitiveness

April 26, 2017

President Trump wants to cut the tax rate for all American businesses to 15 percent, and damn the deficit. If you believe him, any damage from higher deficits will be minor compared to the benefits for US competitiveness, economic efficiency, and tax fairness. The truth is, those claims are nonsense; and the real agenda here is the 2018 and 2020 elections. Without substantial new stimulus, the GOP will likely face voters in 2018 with a very weak economy – and tax cuts, especially for business, are the only form of stimulus most Republicans will tolerate. Moreover, if everything falls into place, just right, deep tax cuts for businesses could spur enough additional capital spending to help Trump survive the 2020 election.

Let’s review the economic case for major tax relief for American companies. It’s undeniable that the current corporate tax is inefficient – but does it actually make U.S. businesses less competitive? The truth fact is, there’s no evidence of any such effects. In fact, the post-tax returns on business investments are higher in the United States than in any advanced country except Australia, and the productivity of U.S. businesses is also higher here than in any advanced country except Norway and Luxembourg.

The critics are right that the 35 percent marginal tax rate on corporate profits is higher than in most countries. But as the data on comparative post-tax returns suggest, that marginal tax rate has less impact on investment and jobs than the “effective tax rate,” which is the actual percentage of net profits that businesses pay. On that score, the GAO reports that U.S. businesses pay an average effective tax rate of just 14 percent, which tells us that U.S. businesses get to use special provisions that protect 60 percent of their profits from tax (14 percent = 40 percent of 35 percent).

Tax experts are certainly correct that a corporate tax plan that closed special provisions and used the additional revenues to lower the 35 percent tax rate would make the overall economy a little more efficient. But lowering the rate alone while leaving most of those provisions in place would have almost no impact on the economy’s efficiency – and the political point of Trump’s plan depends on not paying to lower the tax rate.

Finally, would a 15 percent tax rate on hundreds of billions of dollars in business profits help most Americans, as the White House insists, since 52 percent of us own stock in U.S. corporations directly or through mutual funds? The data show that most shareholders would gain very little, because with 91 percent of all U.S. stock held by the top 10 percent, most shareholders own very little stock.

Moreover, the proposed 15 percent tax rate would cover not only public corporations but also all privately-held businesses whose profits are currently taxed at the personal tax rate of their owners. So, Trump’s plan would slash taxes not only for public corporations from Goldman Sachs to McDonald’s, but also for every partnership of doctors or lawyers, every hedge fund and private equity fund, and every huge family business from Koch Industries and Bechtel, to the Trump Organization..

There is no doubt that the President’s tax plan would provide enormous windfalls for the richest people in the country. Beyond that, it may or may not sustain growth through the next two elections, since even the best conservative economists commonly overstate the benefits of cutting tax rates. But the truth is, there aren’t many other options that a Republican Congress would accept.

 



Donald Trump and Paul Ryan’s Plan to Put Foreign Investors First

March 29, 2017

The “Border Adjustment Tax” (BAT) endorsed recently by President Trump is his administration’s first foray into international economics. It is an inauspicious start.

BAT advocates like House Speaker Paul Ryan promise it will cut the trade deficit by making U.S. exports cheaper abroad and foreign imports more expensive here. The truth is, a BAT won’t much affect U.S. exports or imports, and it certainly won’t create jobs. It would produce a large stream of new federal revenues, and it could trigger retaliatory tariffs on some U.S. exports. A BAT also would enrich a great many foreign investors and companies, and leave a lot of American investors and large companies poorer. All told, it’s the kind of “bad deal” that Mr. Trump once railed against.

Mr. Trump and Speaker Ryan never mentioned a BAT until recently, and the reason they like it now is that it’s a cash cow to pay for their sharp cuts in corporate taxes. The Trump-Ryan BAT would give U.S. producers a 20 percent rebate on the wholesale price of any goods or services they export – 20 percent, because that’s the GOP’s preferred corporate tax rate – and impose a 20 percent tax on foreign goods and services imported here from abroad. It would raise trillions of dollars, because we import about $500 billion more per-year than we export.

For conservatives at least, all those revenues should be a red flag. In a populist period, a subsequent President and Congress may well decide to raise corporate taxes — and when they do, the BAT’s fat revenue stream could well go to fund progressive causes.

Mr. Trump still has no Council of Economic Advisers, so maybe he believes that a BAT will spur U.S. exports and create jobs. Even Peter Navarro should to be able to tell him why that won’t happen. At first, a BAT would strengthen demand for U.S. exports and weaken demand for foreign imports here. But those shifts in demand would quickly strengthen the dollar and weaken foreign currencies, perhaps enough to offset the BAT’s initial impact on import and export prices. In theory, the currency movements triggered by the changes in prices brought about by the BAT should restore pre-BAT prices for both imports and exports, so the only change would be a lot of new revenues from taxing net imports.

In practice, the BAT’s impact on the dollar and U.S. trade is a roll of the dice. As Federal Reserve chair Janet Yellen noted recently, no one knows how closely the currency changes will mirror the BAT’s direct effects on prices. If they overshoot, U.S. consumers will pay more for imports; if they undershoot, U.S. export prices won’t fall much. On top of that, no one knows how much of the BAT tax U.S. importers will pass along to American consumers, and how much of the BAT rebates U.S. exporters will pass along to their foreign customers. Finally, painful retaliation might follow, since China and others won’t take kindly to paying a 20 percent tariff on their exports to the United States, and China’s competitors won’t like the BAT’s substantial devaluation in the yuan-dollar exchange rate.

One effect is certain: The BAT will harm U.S. investors and reward foreign investors as the currency changes reduce the dollar value of U.S.-owned assets abroad and increase the foreign-currency value of foreign-owned assets here. The Bureau of Economic Analysis tells us that in the second quarter of 2016, Americans held foreign stocks, corporate and government bonds, and derivatives worth $12.9 trillion; and foreign-owned financial assets in the United States totaled $20.3 trillion.

If we assume the Trump-Ryan BAT leads to a 20 percent increase in the value of the dollar and a corresponding 20 percent decline in the trade-weighted value of foreign currencies, it would reduce the value of U.S.-held financial investments abroad by nearly $2.5 trillion and increase the value of foreign-owned financial investments here by more than $4 trillion. What kind of deal is that, Mr. President?

The trillion-dollar losers will include U.S. investors in European or Asian mutual funds; U.S. companies with profitable foreign subsidiaries, from Microsoft and Facebook to Coca Cola and Pfizer; and U.S. banks that lend to foreign companies. The trillion-dollar winners will include foreign investors with U.S. mutual funds; foreign companies with major American subsidiaries, from Toyota and Anheuser Busch to Unilever and Phillips; and foreign banks who lend to U.S. companies.

Perhaps the best motto for the Trump-Ryan BAT is “Put Foreign Investors First.”

Robert J. Shapiro, chairman of the economic and security advisory firm Sonecon, was Under Secretary of Commerce for Economic Affairs in the Clinton administration. In the 2016 campaign, he advised Hillary Clinton.