Archive for the ‘Budget Deficit’ Category
With the election over, the news is now focused, somewhat hysterically, on the threat of the fiscal cliff.
The fiscal cliff refers to the fact that at the end of this calendar year several temporary tax cuts are scheduled to expire (including those that lowered rates on income and capital gains as well as payroll taxes) and early in the next year spending cuts are scheduled for military and non-military federal programs. See here for details on the taxes and programs.
Most analysts agree that if tax rates rise and federal spending is cut the result will be a significant contraction in aggregate demand, pushing the U.S. economy into recession in 2013.
The U.S. economy is already losing steam. GDP growth in the second half of 2009, which marked the start of the recovery, averaged 2.7% on an annualized basis. GDP growth in 2010 was a lower 2.4%. GDP growth in 2011 averaged a still lower 2.0%. And growth in the first half of this year declined again, to an annualized rate of 1.8%.
With banks unwilling to loan, businesses unwilling to invest or hire, and government spending already on the decline, there can be little doubt that a further fiscal tightening will indeed mean recession.
So, assuming we don’t want to go over the fiscal cliff, what are our choices?
Both Republicans and Democrats face this moment in agreement that our national deficits and debt are out of control and must be reduced regardless of the consequences for overall economic activity. What they disagree on is how best to achieve the reduction. Most Republicans argue that we should renew the existing tax cuts and protect the military budget. Deficit reduction should come from slashing the non-military discretionary portion of the budget, which, as Ethan Pollack explains, includes:
safety net programs like housing vouchers and nutrition assistance for women and infants; most of the funding for the enforcement of consumer protection, environmental protection, and financial regulation; and practically all of the federal government’s civilian public investments, such as infrastructure, education, training, and research and development.
The table below shows the various programs/budgets that make up the non-security discretionary budget and their relative size. The chart that follows shows how spending on this part of the budget is already under attack by both Democrats and Republicans.
Unfortunately, the Democrat’s response to the fiscal cliff is only marginally better than that of the Republicans. President Obama also wants to shrink the deficit and national debt, but in “a more balanced way.” He wants both tax increases and spending cuts. He is on record seeking $4 trillion in deficit reduction over a ten year period, with a ratio of $2.50 in spending cuts for every $1 in new revenue.
The additional revenue in his plan will come from allowing tax cuts for the wealthy to expire, raising the tax rate on the top income tax bracket, and limiting the value of tax deductions. While an important improvement, President Obama is also committed to significant cuts in non-military discretionary spending. Although his cuts would not be as great as those advocated by the Republicans, reducing spending on most of the targeted programs makes little social or economic sense given current economic conditions.
So, how do we scale the fiscal cliff in a responsible way?
We need to start with the understanding that we do not face a serious national deficit or debt problem. As Jamie Galbraith notes:
. . . is there a looming crisis of debt or deficits, such that sacrifices in general are necessary? No, there is not. Not in the short run – as almost everyone agrees. But also: not in the long run. What we have are computer projections, based on arbitrary – and in fact capricious – assumptions. But even the computer projections no longer show much of a crisis. CBO has adjusted its interest rate forecast, and even under its “alternative fiscal scenario” the debt/GDP ratio now stabilizes after a few years.
Actually, as the chart below shows, the deficit is already rapidly falling. In fact, the decline in government spending over the last few years is likely one of the reasons why our economic growth is slowing so dramatically.
As Jed Graham points out:
From fiscal 2009 to fiscal 2012, the deficit shrank 3.1 percentage points, from 10.1% to 7.0% of GDP. That’s just a bit faster than the 3.0 percentage point deficit improvement from 1995 to ’98, but at that point, the economy had everything going for it.
Other occasions when the federal deficit contracted by much more than 1 percentage point a year have coincided with recession. Some examples include 1937, 1960 and 1969.
In short, we do not face a serious problem of growing government deficits. Rather the problem is one of too fast a reduction in the deficit in light of our slowing economy.
As to the challenge of the fiscal cliff—here we have to recognize, as Josh Bivens and Andrew Fieldhouse explain, that:
the budget impact and the economic impact are not necessarily the same. Some policies that are expensive in budgetary terms have only modest economic impacts (for example, the 2001 and 2003 tax cuts aimed at high-income households are costly but do not have much economic impact). Conversely, other policies with small budgetary costs have big economic impacts (for example, extended unemployment insurance benefits).
In other words, we should indeed allow the temporary tax rate deductions for the wealthy to expire, on both income and capital gains taxes. These deductions cost us dearly on the budget side without adding much on the economic side. As shown here and here, the evidence is strong that the only thing produced by lowering taxes on the wealthy is greater income inequality.
Letting existing tax rates rise for individuals making over $200,000 and families making over $250,000 a year, raising the top income tax bracket for both couples and singles that make more than $388,350, and limiting tax deductions will generate close to $1.5 trillion dollars over ten years as highlighted below in a Wall Street Journal graphic .
However, in contrast to President Obama’s proposal, we should also support the planned $500 billion in cuts to the military budget. We don’t need the new weapons and studies are clear that spending on the military (as well as tax cuts) is a poor way to generate jobs. For example, the table below shows the employment effects of spending $1 billion on the military versus spending the same amount on education, health care, clean energy, or tax cuts.
And, we should also oppose any cuts in our non-security discretionary budget. Instead, we should take at least half the savings from the higher tax revenues and military spending cuts–that would be a minimum of $1 trillion–and spend it on programs designed to boost our physical and social infrastructure. Here I have in mind retrofitting buildings, improving our mass transit systems, increasing our development and use of safe and renewable energy sources like wind and solar, and expanding and strengthening our social services, including education, health care, libraries, and the like.
Our goal should be a strong and accountable public sector, good jobs for all, and healthy communities, not debt reduction. The above policy begins to move us in the right direction.
A big debate is underway about fiscal multipliers. Sounds esoteric but it is not—it reveals that economics is far from an exact science and the outcome appears to confirm what most working people thought, which is that government spending can help an economy grow.
A fiscal multiplier is an estimate of the economic impact of a change in government spending. The debate was triggered, surprisingly enough, by a small box in the International Monetary Fund’s annual publication, World Economic Outlook. There, the International Monetary Fund (IMF) admitted that its previous estimates of fiscal multipliers were too low.
Here is what the IMF chief economist Olivier Blanchard wrote:
The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.
As part of the attack on the role of government in the economy, many economists, prior to the Great Recession, argued that fiscal multipliers were roughly equal to 1. That meant a 1% reduction in government spending would likely cause a 1% decline in GDP, and a 1% increase in government spending would likely generate a 1% increase in GDP.
As the Great Recession got under way, many economists, including those at the IMF, began arguing for substantially lower multipliers, on the order of 0.5%. On the basis of this reduced value, many forecasters argued for the benefits of austerity. Debt was seen as a major problem and if fiscal multipliers were only 0.5%, a $1 cut in government spending would reduce debt by $1 but GDP by only 50 cents.
Well, after watching how austerity policies collapsed many economies around the world, especially in Europe, the IMF acknowledged that it had badly misjudged the size of the fiscal multiplier. As Cornel Ban explains:
In contrast [to its previous low estimates], the October 2012 WEO found that in fact [fiscal multipliers] ranged between .9 to 1.7 (the Eurozone periphery is closer to the higher end of the range), an error that explained the IMF’s extremely optimistic growth projections for countries who front-loaded fiscal consolidation. Assuming the multiplier was 1.5, a fiscal adjustment of 3 percent of GDP-as much as Spain has to do next year- would lead to a GDP contraction of 4.5 percent. It was momentous finding and those who had been skeptical of the virtues of austerity felt vindicated.
Barry Eichengreen and Kevin H O’Rourke provide additional evidence for large fiscal multipliers, in fact for larger multipliers than those proposed by the IMF. According to them:
The problem is that standard theory doesn’t tell us much about the precise magnitude of the multiplier under [current] conditions. The IMF’s analysis, moreover, relies on observations for only a handful of national experiences. It is limited to the post-2009 period. And it has been criticized for its sensitivity to the inclusion of influential outliers.
Fortunately, history provides more evidence on the relevant magnitudes. In a paper written together with Miguel Almunia, Agustin Bénétrix and Gisela Rua, we considered the experience of 27 countries in the 1930s, the last time when interest rates were at or near the zero lower bound, and when post-2009-like monetary conditions therefore applied (Almunia et al. 2010).
Our results depart from the earlier historical literature. Generalizing from the experience of the US it is frequently said, echoing E Cary Brown, that fiscal policy didn’t work in the 1930s because it wasn’t tried. In fact it was tried, in Japan, Italy, and Germany, for rearmament- and military-related reasons, and even in the US, where a Veterans’ Bonus amounting to 2% of GDP was paid out in 1936. Fiscal policy could have been used more actively, as Keynes was later to lament, but there was at least enough variation across countries and over time to permit systematic quantitative analysis of its effects.
We analyze the size of fiscal multipliers in several ways. First, we estimate panel vector regressions, relying on recursive ordering to identify shocks and using defense spending as our fiscal policy variable. The idea is that levels of defense spending are typically chosen for reasons unrelated to the current state of the economy, so defense spending can thus be placed before output in the recursive ordering. We also let interest rates and government revenues respond to output fluctuations. We find defense-spending multipliers in this 1930s setting as large as 2.5 on impact and 1.2 after the initial year.
Second, we estimate the response of output to government spending using a panel of annual data and defense spending as an instrument for the fiscal stance.
Here too we control for the level of interest rates, although these were low virtually everywhere, reflecting the prevalence of economic slack and ongoing deflation. Using this approach, our estimate of the multiplier is 1.6 when evaluated at the median values of the independent variables.
These estimates based on 1930s data are at the higher end of those in the literature, consistent with the idea that the multiplier will be greater when interest rates do not respond to the fiscal impulse, whether because they are at the lower bound or for other reasons. The 1930s experience thus suggests that the IMF’s new estimates are, if anything, on the conservative side.
Some economists remain unconvinced—in fact, some actually argue that government spending is incapable of creating jobs. The economist Robert J. Samuelson was so upset to read a New York Times editorial which claimed that government spending creates jobs that he had to respond:
In 35 years, I can’t recall ever writing a column refuting an editorial. But this one warrants special treatment because the Times’ argument is so simplistic, the subject is so important and the Times is such an influential institution.
Here is the nub of his argument:
it’s true that, legally, government does expand employment. But economically, it doesn’t — and that’s what people usually mean when they say “government doesn’t create jobs.”
What the Times omits is the money to support all these government jobs. It must come from somewhere — generally, taxes or loans (bonds, bills). But if the people whose money is taken via taxation or borrowing had kept the money, they would have spent most or all of it on something — and that spending would have boosted employment.
In other words, because the government relies on the private sector for the money it spends, the jobs created by its spending cannot be a net addition to the economy. Said differently, jobs supported by public spending are not real jobs. There is a lot that can be said, but here is Dean Baker’s response:
Samuelson tells us that if the government didn’t tax or borrow or the money to pay its workers (he makes a recession exception later in the piece) people “would have spent most or all of it on something — and that spending would have boosted employment.”
Again, this is true, but how does it differ from the private sector? If the new iPhone wasn’t released last month people would have spent most or all of that money on something — and that spending would have boosted employment. Does this mean that workers at Apple don’t have real jobs either?
The confusion gets even greater when we start to consider the range of services that can be provided by either the public or private sector. In Robert Samuelson’s world we know that public school teachers don’t have real jobs, but what about teachers at private schools? Presumably the jobs held by professors at major public universities, like Berkeley or the University of Michigan are not real, but the jobs held at for-profit universities, like Phoenix or the Washington Post’s own Kaplan Inc., are real.
How about health care? Currently the vast majority of workers in the health care industry are employed by the private sector. Presumably these are real jobs according to Samuelson. Suppose that we replace our private health care system with a national health care service like the one they have in the U.K. Would the jobs in the health care no longer be real? . . .
How about when the government finances an industry by granting it a state sanctioned monopoly as when it grants patent monopolies on prescription drugs. Do the researchers at Pfizer have real jobs even though their income is dependent on a government granted monopoly? Would they have real jobs if the government instead paid for research out of tax revenue and let drugs be sold in a free market, saving consumers $250 billion a year?
Robert Samuelson obviously thinks there is something very important about the difference between working for the government and working in the private sector. Unfortunately his column does not do a very good job of explaining why. It would probably be best if he waited another 35 years before again attacking a newspaper editorial.
If people are confused about how our economy works, or doesn’t work, it is no wonder.
Presidential candidate Mitt Romney’s low federal tax rate—14.1%—has called attention to the fact that our tax code favors people who make their money from investments rather than labor. According to the conventional wisdom, this is as it should be. It encourages people, like our job creators, to invest their money, thereby boosting growth and the well-being of all working people. Sounds plausible but the facts don’t support the policy.
BusinessWeek lays out the background and political context for our current low taxation rates on investment income as follows:
Since 1950 capital gains have generally been taxed at a lower rate than income, to spur investment. The rate under President George W. Bush went from 20 percent to 15—the lowest ever—and was billed as a way to stimulate the economy. (If nothing’s done by Jan. 1 to change tax and budget provisions already passed by Congress, the rate will snap back to 20 percent, a scenario both parties hope to avoid.) Mitt Romney wants to ditch capital gains tax altogether for people earning less than $250,000. President Barack Obama, in his Affordable Care Act, increased the rate by 3.8 percent for high earners beginning in 2013, and has proposed the so-called Buffett Rule, which would among other things end an accounting interpretation that allows private equity and hedge fund managers (and Romney) to save money by paying tax on their earnings at the capital gains rate. Neither candidate, though, contests the Bush administration’s basic logic: that a lower capital gains rate encourages investment, which creates jobs and helps the economy grow. That doesn’t mean they’re right.
Leonard E. Burman, a tax expert, took on this issue in recent testimony before the House Committee on Ways and Means and the Senate Committee on Finance. A good place to start is with who benefits from lower capital gains taxes.
Not surprisingly, as the figure below (which is taken from Burman’s testimony) shows, the benefits are extremely concentrated. As Burman noted:
In 2010, the highest-income 20 percent realized more than 90 percent of long-term capital gains according to the TaxPolicyCenter. The top 1 percent realized almost 70 percent of gains and the richest 1 in 1,000 households accrued about 47 percent. It is hard to think of another form of income that is more concentrated by income.
Moreover, as the next figure shows, the concentration of capital gains has grown over time. Given that the rich fund political campaigns, this certainly helps to explain why both political parties are so determined to keep the rate low.
But, to the main question—do lower capital gains taxes actually boost growth? This is what Burman had to say in his testimony:
The heated rhetoric notwithstanding, there is no obvious relationship between tax rates on capital gains and economic growth. Figure 4 [below] shows top tax rates on long-term capital gains and real economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, we’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series. The correlation is 0.12, the opposite sign from what capital gains tax cut advocates would expect, and not statistically different from zero. Although not shown, I’ve tried lags up to five years and using moving averages, but there is never a larger or statistically significant relationship.
Burman notes that he posted this figure on his blog and offered the data to anyone interested, challenging readers to find support for lower rates. “A half dozen or so people, including at least one outspoken critic of taxing capital gains, took me up on the offer, but nobody to my knowledge has been able to tease a meaningful relationship between capital gains tax rates and the GDP out of the data.”
As reported in a previous post, Thomes L. Hungerford, writing for the Congressional Research Service, came to the same conclusion about the lack of any relationship between the capital gains tax and GDP. In fact, he concluded raising the top income and capital gains tax rates would likely reduce income inequality without causing harm to the economy.
So, if we are really concerned with the budget deficit, rather than slashing spending on social programs lets raise the top tax rates. Wonder if this will come up during our presidential debates?
The conventional wisdom seems to be that our biggest economic challenge is runaway government spending. The reality is that government spending is contracting and pulling economic growth down with it. And worse is yet to come.
Perhaps the best measure of active government intervention in the economy is something called “government consumption expenditure and gross investment.” It includes total spending by all levels of government (federal, state, and local) on all activities except transfer payments (such as unemployment benefits, social security, and Medicare).
The chart below shows the yearly percentage change in real government consumption expenditure and gross investment over the period 2000 to 2012 (first quarter). As you can see, while the rate of growth in real spending began declining after the end of the recession, it took a nose dive beginning in 2011 and turned negative, which means that government spending (adjusted for inflation) is actually contracting.
The following chart, which shows the ratio of government consumption expenditure and gross investment to GDP, highlights the fact that government spending is also falling as a share of GDP.
Adding transfer payments, which have indeed grown substantially because of the weak economy, does little to change the picture. As the chart below shows, total government spending in current dollars, which means unadjusted for inflation, has stopped growing. If we take inflation into account, there can be no doubt that total real government spending, including spending on transfer payments, is also contracting.
The same is true for the federal government, everyone’s favorite villain. As the next chart shows, total federal spending, unadjusted for inflation, has also stopped growing.
Not surprisingly, this decline in government spending is having an effect on GDP. Real GDP in the 4th Quarter of 2011 grew at an estimated 3 percent annual rate. The advanced estimate for 1st Quarter 2012 GDP growth was 2.2 percent. A just released second estimate for this same quarter revised that figure down to 1.9 percent. In other words, our economy is rapidly slowing.
What caused the downward revision? The answer says Ed Dolan is the ever deepening contraction in government spending:
What is driving the apparent slowdown? It would be comforting to be able to blame a faltering world economy and a strengthening dollar, but judging by the GDP numbers that does not seem to be the case. The following table (see below) shows the contributions of each sector to real GDP growth according to the advance and second estimates from the Bureau of Economic Analysis. Exports, which we would expect to show the effects of a slowing world economy, held up well in the first quarter. In fact, the second estimate showed them even stronger than did the advance estimate. The contribution of private investment also increased from the advance to the second estimate, although not by as much. Exports and investment, then, turn out to be the relatively good news, not the bad, in the latest GDP report.
Instead, the largest share of the decrease in estimated real GDP growth came from an accelerated shrinkage of the government sector. The negative .78 percentage point decrease of the government sector is the main indicator that we are already on the downward slope toward the fiscal cliff.
If current trends aren’t bad enough, we are rapidly approaching, as Ed Dolan noted, the “fiscal cliff.” That is what I was referring to above when I said that worse is yet to come. As Bloomberg Businessweek explains:
Last summer, as part of its agreement to end the debt-ceiling debate (debacle?), Congress strapped a bomb to the economy and set the timer for January 2013. Into it they packed billions of dollars of mandatory discretionary spending cuts, timed to go off at exactly the same time a number of tax cuts [for example, the Bush tax cuts and the Obama payroll-tax holiday] were set to expire
The congressional deficit supercommittee had a chance to disarm the bomb last fall, but of course it didn’t. And so the timer has kept ticking. The resulting double-whammy explosion of spending cuts and tax increases will likely send the economy careening off a $600 billion “fiscal cliff.”
The fiscal contraction will actually be even worse, since the extended unemployment benefits program is also scheduled to expire at the end of the year.
So, what does all of this mean? According to Bloomberg Businessweek:
If Congress does nothing, the U.S. will almost certainly go into recession early next year, as the combo of spending cuts and tax hikes will wipe out nearly 4 percentage points of economic growth in the first half of 2013, according to research by Goldman’s Alec Phillips, a political analyst and economist. Since most estimates project the economy will grow only about 3 percent next year, that puts the U.S. solidly in the red.
One can only wonder how it has come to pass that we think government spending is growing when it is not and that it is the cause of our problems when quite the opposite is true. Painful lessons lie ahead—if only we are able to learn them.
The situation for the unemployed is a case in point. We have a complex, but comparatively miserly, unemployment compensation system.
Workers are generally entitled to 26 weeks of unemployment benefits. However, there are two programs that potentially extend the benefit period for the unemployed. The first is the Emergency Unemployment Compensation (EUC) program, which was enacted in 2008 in response to the economic crisis. As the table below shows, the EUC offers workers in states with high rates of unemployment up to 53 additional weeks of benefits.
Workers who exhaust both their regular unemployment insurance and EUC benefits can receive additional support through the second program, the permanent federal-state Extended Benefits (EB) program. As the table above shows, that program offers a maximum of 20 extra weeks of benefits depending on state unemployment rate levels. However, there is an additional provision to the EB program that is now coming into play with negative consequences.
As Hanna Shaw, of the Center on Budget and Policy Priorities, explains:
A state may offer additional weeks of UI benefits through EB if its unemployment rate reaches certain thresholds . . . and if this rate is at least 10 percent higher than it was in any of the three prior years. But unemployment rates have remained so elevated for so long that most states no longer meet this latter criterion (referred to as the “three-year lookback”).
Because of this lookback provision hundreds of thousands of unemployed workers are now losing benefits, not because conditions are improving but because they are not continuing to worsen. The table below highlights the 25 states that have been forced to stop providing EB benefits this year and the number of workers in each state that have been cut adrift as a result. Look at California–more than 95,000 workers have lost their benefits so far this year despite the fact that the state unemployment rate is almost 11 percent.
This is no accidental outcome. In fact, according to Shaw,
Policymakers could have addressed the “lookback” when they extended federal UI at the beginning of the year, but they didn’t. Instead, Congress not only allowed EB payments to fade out, but it also made changes that over the course of the year will reduce the number of weeks of benefits available in the temporary Emergency Unemployment Compensation (EUC) program, which provides up to 53 additional weeks to the long-term unemployed based on the unemployment rate in their state.
How serious is the long term unemployment problem? Check out the chart below. As it shows, the share of the labor force that is unemployed for more than 26 weeks is higher than at any point in the last six decades. Perhaps even more striking is the fact that 41.3 percent of the 12.5 million people who were unemployed in April 2012 had been looking for work for 27 weeks or longer.
In terms of the master narrative, this is just another of the necessary adjustments required to stabilize the “system;” no need for alarm. Makes you wonder about the aims of the system, doesn’t it?
It is no secret that our public sector is in trouble. Our roads and bridges desperately need upgrading. Our schools and libraries are being forced to slash staff and activities. Our social services and program are being cut. And the reason: not enough money.
Yet at the same time, it is also no secret that our most powerful and profitable corporations are merrily finding countless ways to avoid paying taxes. It might seem like this situation would produce a serious discussion about societal aims and values—but it hasn’t. Our political and business leaders appear quite content that business as usual should not be inconvenienced for the sake of the economy.
The New York Times recently provided an excellent study of, in its words, “How Apple Sidesteps Billions in Taxes.” How does the company do it? The answer is tax loopholes and a number of subsidiaries in low tax places like Ireland, the Netherlands, Luxembourg and the British Virgin Islands. Why does it do it? We are talking real money here. According to the New York Times, Apple “paid cash taxes of $3.3 billion around the world on its reported profits of $34.2 billion last year, a tax rate of 9.8 percent.” By comparison, Wal-Mart was downright patriotic—paying a tax rate of 24 percent.
Get your passports ready. If a U.S. consumer buys an Apple product like a song from iTunes or an iPhone the royalties earned are routed to an Irish subsidiary. That is because Apple assigned the rights to royalties on patents developed in its California operations to the subsidiary. The royalities gathered in Ireland are then transferred, with few tax obligations thanks to Irish law, to another Apple subsidiary in the British Virgin Islands, where tax rates are extremely low. Thus, not only does the U.S. lose out on tax revenue, so does Ireland. And in case you have forgotten, Ireland is suffering massive cuts in public spending because of a lack of revenue.
If a product is purchased by someone residing outside the U.S., the patent royalties are routed to a different Irish subsidiary. Apple then transfers those royalties through the Netherlands, tax free thanks to European laws, back to its primary Irish subsidiary and then on to its Caribbean subsidiary.
If this is confusing check out this graphic. How important is Ireland to Apple? In 2004, the country received more than one-third of Apple’s world wide revenue. The U.S. corporate tax rate is 35 percent. The Irish corporate tax rate is 12.5 percent. And the British Virgin Island tax rate is even lower.
Of course Apple’s profits are not limited to patent royalties. That is where its Luxembourg subsidiary comes into play. As the New York Times explains:
when customers across Europe, Africa or the Middle East — and potentially elsewhere — download a song, television show or app, the sale is recorded in this small country . . . In 2011 [the revenue of this Luxembourg subsidiary] exceeded $1 billion, according to an Apple executive, representing roughly 20 percent of iTunes’s worldwide sales.
The advantages of Luxembourg are simple, say Apple executives. The country has promised to tax the payments collected by Apple and numerous other tech corporations at low rates if they route transactions through Luxembourg. Taxes that would have otherwise gone to the governments of Britain, France, the United States and dozens of other nations go to Luxembourg instead, at discounted rates.
“We set up in Luxembourg because of the favorable taxes,” said Robert Hatta, who helped oversee Apple’s iTunes retail marketing and sales for European markets until 2007. “Downloads are different from tractors or steel because there’s nothing you can touch, so it doesn’t matter if your computer is in France or England. If you’re buying from Luxembourg, it’s a relationship with Luxembourg.”
Back Home In The U.S.
Of course Apple also makes money from sales in the United States. But it has a way of handling that “problem” as well. The company’s headquarters is in Cupertino, California but it has a Reno subsidiary, Braeburn Capital, collect and manage its profits. According to the New York Times:
When someone in the United States buys an iPhone, iPad or other Apple product, a portion of the profits from that sale is often deposited into accounts controlled by Braeburn, and then invested in stocks, bonds or other financial instruments, say company executives. Then, when those investments turn a profit, some of it is shielded from tax authorities in California by virtue of Braeburn’s Nevada address.
Since founding Braeburn, Apple has earned more than $2.5 billion in interest and dividend income on its cash reserves and investments around the globe. If Braeburn were located in Cupertino, where Apple’s top executives work, a portion of the domestic income would be taxed at California’s 8.84 percent corporate income tax rate.
But in Nevada there is no state corporate income tax and no capital gains tax. What’s more, Braeburn allows Apple to lower its taxes in other states — including Florida, New Jersey and New Mexico — because many of those jurisdictions use formulas that reduce what is owed when a company’s financial management occurs elsewhere.
California has lost billions of dollars in tax revenue—oh yes and is deep in a budget crisis.
In fairness to Apple it is far from alone in using these tricks of the trade. Almost all technology companies do it. So, here is the thing—if we really care about our public infrastructure and programs we have to start getting tough on these companies. Their success was aided by past public investment–there should be payback. But then again perhaps there is no such thing as society–only the corporation counts.
Whenever people propose increasing taxes on the wealthy to maintain our needed public programs and services it doesn’t take long for someone to raise the following objection: if we do that, the rich will flee, thereby weakening rather than strengthening our (fill in the blank: city, state, or national) economy.
How seriously should we take this threat? Opponents of Oregon Measures 66 and 67, which raised taxes on the wealthy and corporations and were approved by voters in 2010, cited just this danger in campaigning against them. Among those business leaders most upset with the outcome were some of Oregon’s most well known corporate leaders, for example Phil Knight (Nike) and Tim Boyle (Columbia Sportswear). Knight gave some $100,000 to the anti-Measures campaign, Boyle approximately $75,000.
Here is what Knight had to say about Measures 66 and 67 in an article he wrote for the Oregonian newspaper:
Measures 66 and 67 should be labeled Oregon’s Assisted Suicide Law II.
They will allow us to watch a state slowly killing itself.
They are anti-business, anti-success, anti-inspirational, anti-humanitarian, and most ironically, in the long run, they will deprive the state of tax revenue, not increase it.
The current state tax codes are all of those things as well. Measures 66 and 67 just take it up and over the top. . . .
Reputable economists forecast 66 and 67 will cost the state thousands — maybe tens of thousands — of jobs, and that thousands of our most successful residents will leave the state.
Well, despite the threats, there is no evidence that the wealthy or jobs fled the state to escape the tax increases. Rather the state got some desperately needed revenue.
Here is another data point, courtesy of the Wall Street Journal, that also suggests we should take this threat of flight with a grain of salt:
According to a new study from Lloyds TSB, nearly one in five affluent Britons plan to leave the country in the next two years. That’s up from 14% a year ago. The study measured those with around $400,000 in investible assets.
Conservatives point out this sudden flight comes on the back of the 50% tax rate that was imposed on top earners during the recession. That hike was widely blamed for U.K. wealth flight and for not raising nearly as much revenue as expected.
But a closer look at the study provides a different picture. The top reason that the study group (it’s a stretch to call them “wealthy”) gave for leaving were crime and “anti-social behavior.” About the same number, however, cited the British weather as the top reason for leaving.
The study really gets interesting when you look at where these affluent folks want to go to. The top destination is high-tax France, where the leading Presidential contender is pushing a 75% tax rate on the wealthy. The second choice is Spain, followed by the U.S., Australia and New Zealand.
When asked what would make the U.K. a better place to live, most cited infrastructure spending. That was followed by “cutting red tape for business.” Cutting taxes got about the same number of votes as “improving public services like healthcare, education and the police.”
In other words, the affluent want more government services not less. And taxes were a relatively minor concern in their decision to move.
Returning to the U.S., it is important to remember that the rich have not only succeeded in capturing an ever greater share of national income, they have also enjoyed steady and disproportionately large cuts in their tax rates (see below). This trend was the result of deliberate policy, which was defended by claims that lower tax rates on the wealthy would deliver robust investment and job creation. It clearly has not worked out that way; in fact quite the opposite has taken place. This seems a very opportune time to reverse the trend.
While the press cheers on every sign of private sector job creation, little attention is being paid to public sector job destruction. As the Economic Policy Institute reports, while there has been an increase of some 2.8 million private sector jobs since June 2009, public sector employment (federal, state, and local governments combined) has actually fallen by approximately 600,000. This is a very unusual development as the figure below reveals.
According to the Economic Policy Institute, if the percentage growth of public sector employment in this recovery had followed past recovery trends, we would have an additional 1.2 million public sector jobs and some 500,000 additional private sector jobs. A separate reason for concern about this trend is that lost public sector jobs generally means a decline in the services that we need to sustain our communities. The withering away of our public sector during a period of expansion should worry us all.
Representative Paul Ryan (Wisconsin), the chairman of the House Budget Committee, recently put forward his party’s budget plan. Dean Baker reports on the Washington Post story which says of the plan that it “calls for spending cuts and tax changes that would put the nation on course to wipe out deficits and balance the budget by 2040.” He notes that unfortunately the Post forgot to mention that the plan also largely does away with the government.
The following table comes from the Congressional Budget Office analysis of the Ryan budget plan.
In 2011, spending on “health care” came to 5 percent of GDP, spending on “social security” equaled 4.75 percent of GDP, and spending on “other mandatory and defense and nondefense discretionary spending” totaled 12.5 percent of GDP. Congressional Budget Office estimates are that by 2040, the Ryan plan will have reduced spending on “other mandatory and defense and nondefense discretionary spending” to 4.75 percent of GDP. By 2050, that category will be down to 3.75 percent of GDP.
As Baker explains:
The defense budget is currently over 4.0 percent of GDP and Representative Ryan has indicated that he wants to leave it at this level. That would leave little for the Justice Department, Education Department, Park Service, education, transportation and everything else government does in 2040 and nothing in 2050. That fact would have been worth pointing out in this article.
It is worth adding that the Congressional Budget Office noted in its report that “The amounts of revenues and spending to be used in these calculations for 2012 through 2022 were provided by Chairman Ryan and his staff.” In other words, the Congressional Budget Office has taken no position on whether Ryan’s plan would actually produce the balanced budget it predicts. This outcome is especially questionable since his plan projects increases in revenue along with cuts in taxes. The Congressional Budget Office just extended the plan’s assumed values into the future using standard modeling procedures.
At some point we really need to get serious about the destructive nature of private profit driven economic activity and the importance of strengthening the capacity of the state to regulate and redirect economic activity in line with majority needs.
Here is a short (less than 4 minute) video that illustrates the fact that 53% of our tax dollars, conservatively estimated, go to finance our military.
[youtube] http://www.youtube.com/watch?v=kFeduoDWKj4 [/youtube]
And here is a link to a recent study by Robert Pollin and Heidi Garrett-Peltier on the employment effects of military spending versus alternative domestic spending priorities, in particular investments in clean energy, health care, and education.
The authors first examine the employment effects of spending $1 billion on the military versus spending the same amount on clean energy, health care, education or tax cuts. The chart below shows their results.
Moreover, even though jobs in the military provide the highest levels of compensation, the authors still find that “investments in clean energy, health care and education create a much larger number of jobs across all pay ranges, including mid-range jobs (paying between $32,000 and $64,000) and high paying jobs (paying over $64,000).”
Let’s see if these facts come up in the next Congressional budget debate.