Results for “corporate tax”

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I thought the original Paulson plan was terrible with regard to rule of law, and in that sense I thought the equity stake idea of Dodd was better.  A modified Paulson plan might be as good, it is hard to say.

[Eric now blogs that the Dodd plan gives the Treasury more power than current versions of the Paulson plan.  His post is very important.]

In reality I expect that either the Paulson or the Dodd plan would have to move quickly to incorporate some aspects of the other.  We’ll likely get some version of both loan-buying and equity shares, in any case.

The key factor is what kind of institutions are set up for making the next round of decisions.  That’s not getting much attention but of course there is no reason to think this is the final step or the final change in conditions.

Think of a barrel of apples, some good, some less good.  To oversimplify, the Paulson plan has the government buy some of the bad apples.  The Dodd plan has the government buy a 20 percent share in the barrel.  In both cases government buys something.

My intuitive rule of thumb is to want the government to be doing its buying in the better organized, more liquid market.  They are less likely to screw that up.  That tends to favor the Dodd plan in my view.

I like one other feature of the Dodd plan.  Our government loves cash revenue.  Furthermore the U.S. economy is set up so the "public choice" advantage of the government owning banks for the long haul is not so obvious.  We don’t have "insider-based" capital markets, for instance, so owning a bank wouldn’t give a politician so much chance to dole out loan favors.  I believe our government would be in a hurry to reprivatize those banks in return for the cash.  The Paulson plan, as I understand it, does not have an equally clear end game.

I may put this email of mine, or an edited version of it, on MR, check there for reader comments…

Tyler

Night thoughts: How or whether do equity holdings give the government "upside" in eventual bank recovery?  Holding equity yields nothing if the banks never recover.  If the banks will recover, you would think a loan from the Fed would suffice.  But we’ve already tried that.  So what exactly are the assumptions here?  Somehow it is the Fed/Treasury actions which *cause* the banks to recover.  How does that happen?  They overpay for the loans at mysterious prices?  That just puts the Dodd plan back into all the problems of the Paulson plan.  If the government ends up overpaying for loans in the Dodd plan, and then someday gets 20 percent of that overpayment back through its equity share, is not a huge positive advertisement.  (Isn’t simply "knowing when to stop the subsidies" the best way to protect the taxpayers?)  And in the meantime, what kind of credit guarantees is the government offering these banks and their creditors?

Don’t forget Mark Thoma’s good analysis: "So, by having the government take a share of any upside, the result may
be less willingness of the private sector to participate in
recapitalization."

It is easy to say that the Paulson plan is worse.  (Oddly I think the Paulson plan makes most sense in Paul Krugman’s multiple equilibria model for asset values.)  But you shouldn’t think that the Dodd plan is very good.  Most of the Dodd plan boosterism I’ve seen doesn’t look very closely at how it actually going to work.  There’s lots of talk about justice and the taxpayers getting upside and then a reference to the RFC from the New Deal.

Finally, in my view the Paulson plan makes (partial) sense if a) the major banks are in much worse shape than anyone is letting on, and b) you believe in multiple equilibria confidence models for these underlying asset markets.  I’m not saying those assumptions are true, but it would be nice to start by confronting the exact assumptions under which each plan might prove better than the other.

A government bailout of the GSEs should not be a surprise.   After all, for a long time the markets have been predicting that sooner or later there will be a very expensive bailout.  What do I mean?  According to Freddie Mac (quoting the OMB)  "mortgage rates are 25 – 50 basis points lower because Fannie Mae and Freddie Mac exist in the form and size they do."  Now, that is almost certainly an exaggeration but to the extent that interest rates are lower due to the GSEs some significant part of that is due to the market valuing the government’s implicit guarantee.  In other words, interest rates are lower because the market is valuing the implied insurance.  Now, the whole point of insurance is that sometimes the insurer must pay.  Thus the market has been telling us all along that sooner or later the taxpayer was going to pay.

Maybe the taxpayers will have to pay today or maybe in some future tomorrow but the benefits of the GSEs are intimately tied to the costs – there is no such thing as a free lunch.  The lunch may look free for a long time – as in the classic peso problem – but what that means is that when the bill comes due it will be big. 

For the sake of the world as a whole, I hope that we respond to the trouble with trade not by shutting trade down, but by doing things like strengthening the social safety net.

That is Paul Krugman, here is more.  I have yet to see the evidence that trade has a significant negative impact on middle class wages, but for sake of argument assume it is true.  However benevolent it may sound, strengthening the social safety net would not be my policy recommendation number one.  After all, if Samuelson-Stolper factor price equalization is the main mechanism at work, wages would have a long way to fall downwards and if anyone in the middle class is to keep working, the safety net must eventually be cut, not increased.  You might think we can fund all these trade-losers by taxing capital but of course the incidence of taxes on capital sometimes falls on labor, not to mention that at some point the Laffer Curve kicks in. 

Is not the appropriate policy recommendation to create a budget surplus, create a U.S.A. Sovereign Wealth Fund, and invest the resulting capital in the corporate winners from this entire process?  In other words, we would be giving the trade-losers a more direct share in capital.  Since output is rising and wages are falling, the return to capital must be rising; let’s make money off of that.

You might not trust the government with such investments but it is awkward for Krugman to push that argument too hard.  Alternatively, you might think that share prices already have capitalized these gains, but that is hard to square with the view that Krugman is reporting a new result about trade.  Share prices are driven by liquidity to some extent, and if you know something about the returns to labor and capital that the rest of the world does not, there ought to be a way to make money.  Why spend more on consumption (a stronger safety net today) if the rate of return on investment is rising so high and we are going to need even more of a safety net in the future?

Steve Kaplan and Joshua Rauh write:

We consider how much of the top end of the income distribution can be
attributed to four sectors — top executives of non-financial firms
(Main Street); financial service sector employees from investment
banks, hedge funds, private equity funds, and mutual funds (Wall
Street); corporate lawyers; and professional athletes and celebrities. 
Non-financial public company CEOs and top executives do not represent
more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%,
0.001%, and 0.0001%).  Individuals in the Wall Street category comprise
at least as high a percentage of the top AGI brackets as non-financial
executives of public companies.  While the representation of top
executives in the top AGI brackets has increased from 1994 to 2004, the
representation of Wall Street has likely increased even more.  While the
groups we study represent a substantial portion of the top income
groups, they miss a large number of high-earning individuals.  We
conclude by considering how our results inform different explanations
for the increased skewness at the top end of the distribution.  We argue
the evidence is most consistent with theories of superstars, skill
biased technological change, greater scale and their interaction.

Here is the link, here is the non-gated version.  How about this bit from the text?:

…the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated).

This is important too:

…we do not find that the top brackets are dominated by CEOs and top executives who arguably have the greatest influence over their own pay.  In fact, on an ex ante basis, we find that the representation of CEOs and top executives in the top brackets has remained constant since 1994.  Our evidence, therefore, suggests that poor corporate governance or managerial power over shareholders cannot be more than a small part of the picture of increasing income inequality, even at the very upper end of the distribution.  We also discuss the claim that CEOs and top executives are not paid for performance relative to other groups.  Contrary to this claim, we find that realized CEO pay is highly related to firm industry-adjusted stock performance.  Our evidence also is hard to reconcile with the arguments in Piketty and Saez (2006a) and Levy and Temin (2007) that the increase in pay at the top is driven by the recent removal of social norms regarding pay inequality.  Levy and Temin (2007) emphasize the importance of Federal government policies towards unions, income taxation and the minimum wage.  While top executive pay has increased, so has the pay of other groups, particularly Wall Street groups, who are and have been less subject to disclosure and social norms over a long period of time.  In addition, the compensation arrangements at hedge funds, VC funds, and PE funds have not changed much, if at all, in the last twenty-five or thirty years (see Sahlman (1990) and Metrick and Yasuda (2007)).  Furthermore, it is not clear how greater unionization would have suppressed the pay of those on Wall Street.  In other words, there is no evidence of a change in social norms on Wall Street.  What has changed is the amount of money managed and the concomitant amount of pay.

There is a great deal of analysis and information (though to me, not many surprises) in this important paper.  The authors also find no link between higher pay and the relation of a sector to international trade.

Mr. Blinder’s answer is not protectionism…he accepts the economic logic that U.S. trade with large low-wage countries like India and China will make all of them richer — eventually.  He acknowledges that trade can create jobs in the U.S. and bolster productivity growth.  But he says the harm done when some lose jobs and others get them will be far more painful and disruptive than trade advocates acknowledge.  He wants government to do far more for displaced workers than the few months of retraining it offers today.  He thinks the U.S. education system must be revamped so it prepares workers for jobs that can’t easily go overseas, and is contemplating changes to the tax code that would reward companies that produce jobs that stay in the U.S.

Here is the article.  Arnold Kling says technological progress will be more important than trade.  I think that China is due for a crack-up and India will soon bump up against its horrible legal and educational systems.  I saw that economists are listed as among the most threatened groups, but I doubt if the United States can look forward to the liberation of so much talented and witty labor.  I also think that corporate welfare is a bad idea, and that universities should not train everyone to be a small town divorce lawyer.  Teaching reading and writing would be a good start.

When our economists start preaching that we should look to economists and higher educators to predict the new, growing economic sectors, I again think that the Chinese are not the major problem.

A loyal MR reader asks:

What are your thoughts on the new dynamic optimal public finance policy models being built and simulated?  Will they yield any new insights applicable for the real world, or are they a fad?

Real insights maybe, real measurements for sure.  I take this paper by Mankiw to be a paradigmatic example.  Through this body of literature we learn, or confirm our previous intuitions, that:

1. Cutting U.S. income tax rates is not, in general, self-financing.  We also get a rough idea of how much revenue we can make up in the long run.

2. Many forms of corporate and capital income taxation are, in the long or even medium run, inefficient.

3. Ideally we should move to a consumption tax.  (NB: Moving outside the models, I am scared that this kind of tax reform will just turn into another tax increase.  We’ll add a VAT to income taxation rather than shift to the VAT.  Yikes.)

These results are the bread and butter of applied public finance.  You can complain all you want about the assumptions, the artificiality, and the use of intuition to throw out unacceptable calibrations, but at the end of the day there is not a better way to do the work. 

A fad, perhaps, but there is nothing wrong with that.  The Beatles were a fad too.

By the way, here is an interesting paper on a different frontier in public finance, namely field experiments.

#10 in a series of 50.

Google is walking down this path:

The ambitious founders of Google…have set up a philanthropy, giving it seed money of about $1 billion and a mandate to tackle poverty, disease and global warming.  But unlike most charities, this one will be for-profit, allowing it to fund start-up companies, form partnerships with venture capitalists and even lobby Congress.  It will also pay taxes.

One of its maiden projects reflects the philanthropy’s nontraditional approach.  According to people briefed on the program, the organization, called Google.org, plans to develop an ultra-fuel-efficient plug-in hybrid car engine that runs on ethanol, electricity and gasoline.

Here is the full story, and look for more of this model in the future.  As wealth grows, and many large benevolent ventures do not need to fundraise, their will opt for more flexible organizational forms.  Of course if these activities turn a profit, Google shareholders can take the profits home as dividends.  So some of these activities will be normal corporate investments, dressed up as "for-profit charity" for public relations purposes.  Here is Eric Posner on for-profit charities.

The lead article in the August 2006 Journal of Political Economy offers the following abstract:

We solve each household’s optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earning and medical expenses, progressive taxation, government transfers, and pension and social security benefits.  With optimal decision rules, we compare, household by household, wealth predictions from the life cycle model using a nationally representative sample.  We find, making use of household-specific earnings histories, that the model accounts for more than 80 percent of the 1992 cross-sectional variation in wealth.  Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are undersaving is generally small.

In other words, most Americans are saving enough for their retirements.  The authors (John Karl Scholz, Ananth Seshardi, and Surachai Khiatrakun) stress that their data cover only the early 90s, although if anything they believe this biases their estimates downwards by missing out on later capital gains.  Here is the paper.

Notes: This result does not deny that America may face coming demographic problems for funding social programs, most of all Medicare.  But next time you read that "the U.S. savings rate is zero," think back on this blog post and on that paper.