The "Fiscal Cliff" and the Coming Retirement Crisis of the Middle Class

On January 1, Congress approved a tax and spending bill to avert the so-called "fiscal cliff" combination of tax hikes and spending cuts that would have created deflationary pressure on the United States (though Yglesias questioned the conventional wisdom of whether it would necessarily cause a recession). Let's take a look at the deal in some detail, then proceed to the gruesome details of what will happen around the Ides of March.



From Think Progress, here are some of the more critical parts of the deal.



1) The Bush tax cuts expire on only about 0.7% of households, those earning more than $400,000 per year as an individual or $450,000 for a couple. This brings in $600 billion over 10 years. Since rich people don't spend as much of their income as the poor and middle class do, this is less deflationary than a tax increase on the middle class, as I discussed in November.



2) With the expiration of the temporary 2% payroll tax cut, 77% of households will see their taxes go up. Indeed, every single income group will, on average, see their taxes increase, as shown below (via Matt Yglesias):

Since this hits the middle class more directly, the deflationary consequences are larger than they would be for an increase in taxes on the rich. On the other hand, this strengthens the long-run funding of Social Security, an issue I will return to shortly.



3) Unemployment insurance is extended for two million workers. This will get spent and have a definitive stimulative effect on the economy.



However, the second shoe of the fiscal cliff, the automatic cutbacks known as the "sequester" was simply postponed for two months, which is the same time that the Treasury Department will run out of creative ways to keep the country from exceeding the debt ceiling, which it hit on December 31.



Combining these two negotiations, the debt ceiling and the sequester, will be an extremely high-stakes battle where the middle class has a lot to lose. The big problem here is that some Tea Party Republicans really do want to use the debt ceiling to take the economy hostage and force cutbacks in Social Security, Medicare, and Medicaid. Despite the fact that Republicans lost the Presidency as well as both Senate and House seats (with a majority of the votes cast for the House going to Democrats), they see their gerrymandered House majority as giving them license to wreak havoc.



The consensus among most commentators (Krugman, Klein, and Yglesias, for example) is that the fiscal cliff deal will work out okay as long as the President does not cave in to the Republicans' threats over the debt ceiling.  I agree as far as that goes. But, as Yglesias points out, there is nothing great about what Klein says is the most likely scenario, where the President gets $1 trillion in new tax revenue for $1 trillion in cuts over 10 years. That is still $2 trillion in austerity measures at a time when unemployment is barely below 8%!



The looming problem rarely mentioned, even in the context of the Republican campaign against Social Security, is that my children's generation (Generation X, if you will) faces a retirement crisis that many of my generation will avoid, based on the end of pension plans. According to one Social Security Administration report, the percentage of private-sector workers with a traditional defined-benefit pension plan fell from 38% in 1980 to 20% in 2008. Over the same period, private-sector workers who only received defined contribution plans rose from 8% to 31%. Note that this means that 49% of private-sector workers are not covered by any pension plan at all. Moreover, while governments have more commonly provided defined-benefit plans than private employers have, they are under attack in many states.



Let's do the math. With 49% of private workers having no pension, and another 31% having an on-average less generous defined contribution pension, how will seniors support themselves if Social Security is cut? Hint: It won't be pretty.



Get ready for a bumpy March.



Cross-posted at Angry Bear.

Conservative ALEC Economic Policies Have No Benefit, Some Risks, for States

The economic policies proposed for states by the conservative American Legislative Council Exchange (ALEC) not only don't work, but carry risks for states' economies, according to new research by the Iowa Policy Project and Good Jobs First.



As we have seen most recently with Michigan's passage of anti-union so-called "right to work" legislation (which lets people free ride on union contracts and makes union organization and representation more difficult), the legislative agenda of ALEC proclaims that states should follow a low-tax, low-wage, non-union route to economic prosperity. Now, you or I might wonder how creating low-wage jobs is supposed to create prosperity, but luckily for us ALEC has ranked the states by how "competitive" their economic policies were beginning in 2007, giving us the chance to see how well their recommended policies have done.



ALEC's 15 recommended factors (p. 18) include taxes, debt service, public employees per 10,000 residents, "quality" of the legal system, "right to work," minimum wage, and workers' compensation costs. As pointed out by earlier commentaries, it says nothing about education or infrastructure, which have clear effects on a state's economy. The new report by economist Peter Fisher with Greg LeRoy and Phil Mattera undertakes a statistical analysis of these policies, using the ALEC ranking of all 50 states as of 2007 to see how well their economies have performed since then. Fisher et al. also highlight the shoddy statistical work by Arthur Laffer in creating the ALEC index and reporting results.



Whereas Laffer frequently makes his points simply by comparing the top vs. bottom 8-10 states, Fisher et al. start with a full comparison of all 50 states via a correlation analysis, then proceed to the necessary addition of holding other potential causes constant in what is know as multiple regression analysis. Beginning with the correlations, here is what the new report finds. Correlation runs from -1 (perfect negative relationship) to +1 (perfect positive relationship); the closer to +1 below, the better the ALEC competitiveness index predicted the following outcomes. All changes are from 2007 to 2011.



ALEC Competitiveness Index ranking correlated with--



State gross domestic product:  .02 (not statistically significant)

Percent change in nonfarm employment: -.09 (not statistically significant)

Percent change in per capita income: -.27 (statistically significant)

Percent change in state and local government revenue: -.16 (not statistically significant)

Percent change in median family income: -.30 (statistically significant)

Change in poverty rate: .21 ("statistically significant" at the .1 level*)



What this tells us is that the states which were following ALEC's preferred policies the most in 2007 saw worse performance in per capita income growth and median family income as well as a worse performance n poverty that we can almost be sure was not due to chance. The only thing ALEC's top states did see as predicted was an increase was in  population (Fisher et al. did not report the correlation coefficient, but their discussion makes it clear that it was statistically significant). However, population growth per se is not an economic outcome, as the report points out.



The concluding regression analysis weakens the case for negative consequences, but provides no support for positive effects of ALEC's state policies. Fisher et al. show that the most important determinants of 2007-11 GDP growth, employment growth, and per capita income growth are the components of a state's economy, with the strongest determinants being the presence of extractive industry (primarily due to the higher price of oil during this period) and a large health care industry. Once these are controlled for, none of the ALEC variables are statistically significant, though the closest is that the top personal income tax rate is associated with higher, not lower, per capita income growth.



If none of ALEC's policies work as advertised for job and income growth, what do they do? They are, in fact, a prescription for economic inequality. So-called "right to work" does not increase growth, but it reduces workers' bargaining power. Reducing taxes on the wealthy increases post-tax inequality. And so on, down the panoply of ALEC policies. Fisher et al. (p. 11) put it well:

The ALEC-Laffer strategies are exclusively those that would lower taxes on corporations and the wealthy, reduce public sector revenues (and hence public investments in education, health and infrastructure), and lower wages by eliminating minimum wages and weakening the bargaining power of workers. Yet the book claims that all of these measures would make states, and their populations, richer.

The report is Selling Snake Oil to the States, and that is precisely what ALEC's policies are.





* Technical note: I'm old school on when we should consider something probably not due to chance. For generations, the standard cutoff was that you have to be 95% certain a result was *not* due to chance to call it statistically significant. In economics, and now increasingly in political science, researchers have sometimes called a result statistically significant using a 90% cutoff instead. In my view, this shift has been due to what is called "publication bias": it is easier to get your study published in an academic journal if you have some statistically significant result. But this is a big problem in areas like minimum wage research, where not finding a statistically significant negative effect from increasing the minimum wage actually tells you a great deal. The key analysis of publication bias in minimum wage research can be found in David Card and Alan Krueger's book Myth and Measurement.



Cross-posted at Angry Bear.

Suppression of Congressional Research Service Report Reversed

Just as quietly as it happened, the Republican suppression of a Congressional Research Service (CRS) report showing the lack of relationship between top tax rates and economic growth has apparently been overcome. Jared Bernstein reports today that the report is back up. You can find it on the CRS website here.



What made this report so objectionable to Republicans was that it showed no relationship between the top tax rates and economic growth rates, and went beyond simple correlation analysis to more complex analysis that statistically controlled for other potential causes, known as regression.



Moreover, it performed the same series of analyses on the data for tax rates and inequality, showing that a low top tax rate contributes to economic inequality, again controlling for other potential causes.



It is good to see that the non-partisan CRS is still allowed to post the results of its own research. But it's bad that there could ever have been any question of it.

What Senate Republicans Don't Want You to Find Out

There is a lot of buzz now about the fact, discovered over a month after it happened, that the Congressional Research Service (CRS) had withdrawn one of its research reports due to pressure from Republican Senators. Probably the most commonly used adjectives used to describe the CRS are "respected" and "non-partisan," so what is going on here? The simple answer is that the Republicans didn't like the study's conclusions and complained vociferously to CRS. Why did the CRS give in? No one knows yet, although the New York Times reported:

A person with knowledge of the deliberations, who requested anonymity,
said the Sept. 28 decision to withdraw the report was made against the
advice of the research service’s economics division, and that Mr.
Hungerford [the study's author] stood by its findings.

What was in the report that terrified Republican Senators so much? In fact, a lot more than reported in the media: "Tax Cuts for the Rich Do Not Spur Economic Growth," Talking Points Memo, September 17;  "Tax Cuts for the Rich Cause Income Inequality, Not Economic Growth," Think Progress, September 17; for example.



One major finding is contained in a plot of the top personal income tax rate and real economic growth rates for every year from 1945 to 2010. Contrary to conservative arguments, when the top tax rate was from 70-90+ percent, the country had growth rates averaging 4.2% in the 1950s, but only 1.7% in the 2000s, when the top rate was 35%. Overall, according to Figure 5 of the report, there appears to be no relationship at all between the top tax rate and growth.



It's important to remember, though, that a simple comparison of two variables tells us nothing by itself. It's only when we control for other potential causal factors that we can say whether a relationship does or does not exist between two variables like tax rates and growth. In the report's appendix, the author carries out such a regression analysis, as it's called, and still finds that there is no relationship between the top tax rate and real GDP growth rates.



Moreover, the study takes a look at the ways that lower tax rates are supposed to improve the economy, i.e., by increasing private savings, private investment, and labor productivity growth. In no case does the bivariate analysis (some of which shows higher taxes increasing private savings) or the regression analysis show either the top personal tax rate or the capital gains tax rate having an effect on these intervening drivers of economic growth. This completely undermines the economic arguments for tax cuts as the recipe for a better economy.



But wait, there's more! The diagram (scatterplot) showing the relationship between the top tax rate and the private savings rate shows that the highest private savings rates since 1945 were achieved when the top marginal rate was 70% (see top left of Figure 3), which comports well with recent calculations of the top optimal tax rate (70% or higher). In fact, when the top bracket was 90%, the rate of private savings as a percentage of potential GDP exceeded the rate when it was 40% or below in every year but one!



The other discomfiting finding for the Republican Senators is that lower top tax rates and lower capital gains tax rates increase income inequality. Not only is this obvious in the scatterplots for the top 0.1% and top 0.01%, it remains true in the regression analyses after controlling for other potential causes of the high income shares of the rich.



Tax cuts, then, don't increase economic growth (the ultimate zombie idea, as Paul Krugman says) but do worsen economic inequality. It may even be the case that high top marginal tax rates increase private savings, with the country's historical postwar maximum savings rates coming at a rate of 70%.



What the suppression of this study amounts to, then, is part of the present-day Republican Party's war on science, arithmetic, and knowledge in general. Unable to refute the findings of the CRS report, they demand its censorship instead. As Jared Bernstein says, this is simply scary: "this type of suppression is wholly inconsistent with democracy." That Congress' non-partisan research arm is going along with this makes it especially chilling.

Starbucks in Hot Water Over British Tax

Reuters (via Tax Research UK) reported on October 15 the results of an extensive investigation into the British unit of coffee giant Starbucks, the second largest restaurant firm in the world after McDonald's. It turns out that the company has reported losing money in every one of the 14 years it has operated in the country, even as it tells investors that the unit is profitable. Reuters documented this latter fact by getting the transcripts of 46 investor conference calls Starbucks has made over the last 12 years.



For the last three years, Starbucks has paid no income tax at all in the United Kingdom. This is a textbook case of using transfer pricing to hide your profits from the taxman and make them show up in tax havens instead.



According to the Reuters report, there are three potential routes the company has to make its profitable British subsidiary legally have no tax liability.



1) The British subsidiary pays a Dutch subsidiary for the use of trademarks and other intellectual property of Starbucks, at a cost of 6% of sales as royalties. An undisclosed amount of this barely profitable unit's revenue is paid to another Starbucks subsidiary in Switzerland. Where the money goes from there only Starbucks and its accountants, Deloitte, know for sure.



2) Starbucks UK buys its beans through another Swiss subsidiary and they are roasted at a second Dutch subsidiary (this may be a pattern: pay a Dutch subsidiary, which pays a Swiss subsidiary). This gives a second opportunity for transfer pricing, although a transfer pricing investigation by Her Majesty's Revenue and Customs (HMRC) in 2009-10 resulted in no penalties, the company told Reuters (HMRC would not comment). However, Richard Murphy reports that HMRC has been cutting audit staff and been subject to regulatory capture by the companies it is supposed to be regulating.



3) Finally, the British subsidiary's operations are financed entirely through debt, for which it pays interest to other Starbucks subsidiaries. The interest is deductible from income in the UK and can accumulate in tax havens as income there. Reuters found that Starbucks UK pays at least 4 percentage points more in interest than McDonald's UK does.



Paying zero corporate income tax (or corporation tax, as they call it in the UK) gives Starbucks a competitive advantage over other coffee companies that are purely domestic and can't get out of the tax. Not surprisingly, this has ignited a firestorm of controversy in the United Kingdom. In the last 6 days, HMRC officials have been summoned for testimony before Parliament, probably in November. The Irish Congress of Trade Unions (which represents unions in Northern Ireland/UK as well as in the Irish Republic) has called for a boycott of Starbucks. And the company's reputation has been simply hammered in the social media there, with studies by YouGov and Buzz showing sharp dips into negative territory on their measures of brand perception.



Of course, if Starbucks goes to all this effort to avoid British taxes, you've got to wonder what strategies it's using to avoid taxes in the United States. Any reporters out there up for the challenge?

Fortune 500 Deferring $433 Billion in Taxes

According to a new report today from Citizens for Tax Justice, the 285 members of the Fortune 500 that have parked money overseas would owe an estimated $433 billion in taxes if and when it is repatriated. No wonder these companies are working so hard to get a "repatriation holiday" even though the one given in 2004 did not yield  any significant new investment, but lots of dividends and stock buybacks.



The new report list 10 companies with $209 billion parked overseas that report the taxes they would owe on these profits (only 47 do so). These companies all report that they would owe 32-35% on their money, which indicates they have not paid any taxes abroad on it; in other words, the money is in tax havens.









Note that some estimates place these figures even higher; in March, I reported that Apple's overseas stash was estimated at $64 billion.



Based on the entire 47 companies that report their estimated tax bill, CTJ came up with an average tax rate of just over 27%. Multiplied by the $1.584 trillion in overseas cash held by the 285 corporations (up from about $1 trillion estimated in March) yields the figure of $433 billion in taxes that would be due if the income were repatriated or the deferral provision for overseas income ended.



What does it all mean? As U.S. companies continue to enjoy record profits, they are declaring them to be foreign profits at a high rate, as we can see in the increase from the March to October estimates. Numerous tech and financial companies have stashed literally tens of billions of dollars, each, in offshore tax havens, which drain billions a year from tax coffers that must be made up with higher taxes on the middle class, larger budget deficits, or cuts in programs. And as we have seen from the two tax returns Mitt Romney has released, there is one tax system for the 1% and another one for the rest of us.