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Economic Outlook: Business Tax Reform is a Social Justice Issue

Since President Obama’s SOTU address, the term “middle class economics” has penetrated mainstream political discourse. These were not all new ideas, but rather a catchy phrase to sum up the priorities of the Obama administration and provide direction for the Democratic party going forward.

Of course, in a functioning democracy, broad based growth is not (or should not be) a partisan position. A recent NYT news analysis article highlighted how the G.O.P. has, in recent years, attempted to re-brand itself to be more appealing to low and middle class Americans (i.e. engage in “middle class economics”).

One potential avenue for such re-branding is compromising on a long overdue overhaul of the American tax system (the last major overhaul was in 1986). According to a recent Al Jazeera America poll, a majority of self-proclaimed Democrats (79%) and Republicans (68%) are “somewhat” or “very” willing to have their congressional leaders compromise on taxes.

Fortunately, bipartisan support for tax reform is not limited to the general public. Both the Democratic party and the G.O.P. have powerful voices in the Federal Executive and Legislative branches (respectively) advocating for compromise on tax reform:

G.O.P Stance:

“Though there are disagreements on the details, there is bipartisan support for tax reform in Congress,” said Orrin Hatch, Republican chairman of the Senate Finance Committee, at a conference for tax lawyers, analysts and economists.

“Members of both parties have expressed their support for a tax overhaul. And, I believe there is real momentum to get something done on tax reform this year, if we remain committed. And, believe me, I’m committed,” he said.

The U.S. tax code has not been overhauled thoroughly in 28 years. In that time it has become riddled with loopholes. As a result, tax avoidance is a growing problem.

At the same time, tax experts also generally agree that the system is so complex and often contradictory that compliance costs are excessive and economic productivity is harmed.

Hatch has laid out basic principles for reform. At the conference, he said he has the impression that Democratic President Barack Obama might be willing to do a deal on business tax reform alone, setting aside individual income tax issues.

“We need to lower corporate tax rates and transition toward a territorial tax system,” Hatch said. A territorial system is one that would exempt all or most of the foreign profits of U.S. corporations from the corporate income tax.

Democratic Party Stance:

Let me (Secretary of Treasury Jacob Lew) say at the outset that our entire federal tax code needs to be overhauled.  It has been almost 30 years since we last rewrote it, and since then, the tax system has become heavily burdened by loopholes and inefficiencies

I continue to believe that the best way to achieve reform today is to start with pro-growth business tax reform that protects and strengthens the middle class, lowers rates, simplifies the system, levels the playing field, and eliminates unfair and inefficient loopholes.

The fact is, there is a growing bipartisan consensus in Washington on how to achieve business tax reform, and we have a unique opportunity now to get this done.

On paper, we have one of the highest corporate income tax rates in the world, but in practice, there is a wide disparity in effective corporate tax rates.  Some corporations pay little or no income tax at all, while others pay the highest rate in the developed world.

Moreover, our business tax system is far too complicated — particularly for small businesses.  One estimate suggests that a small business, on average, devotes hundreds of hours plus spends thousands of dollars, to comply with the tax code.  We can and must reduce this burden.

Our business tax system actually skews business decisions in ways that make it harder for the economy to grow.  Too many investment decisions are shaped by tax considerations when they should be driven by what will best enhance productivity and growth.  Our tax code should favor the best businesses that create the most economic value — not those that are best at taking advantage of tax deductions.

The international tax system is often looked at in terms of either what is known as a territorial system, in which a company located in a particular country only pays taxes on income earned in that country, or a system like that of the United States, in which that company must pay tax on worldwide income, regardless of the country where it is earned.  The President’s proposal strikes a sensible balance, and would move us towards a more hybrid system.  What that means is we would create a new minimum tax on foreign earnings and make it simpler for a business to bring income back to the United States.  It would also tighten the rules so that companies cannot use accounting techniques to avoid paying taxes, such as shifting profits to low-tax countries (inversions).

Of course, there are tax expenditures that make sense and that need to be protected — like the New Markets Tax Credit, expensing for small businesses, and the Research and Experimentation Tax Credit.  But these tax incentives cost money and need to be paid for to maintain adequate revenue levels.  And we cannot apply a double standard, as some have proposed, where we permanently extend business provisions without paying for them, without permanently extending critical improvements to the EITC, child tax credit, and college credits that help working families at the same time.

Secretary Lew laid out the five pillars of the administration’s proposal for a new business tax system:

1. Lower rates and close wasteful loopholes.
2. Build on the resurgence of manufacturing in the United States.
3. Reform the international tax rules that encourage companies to shift income and investment overseas.
4. Simplify and reduce taxes for small businesses.
5. Fix “our broken tax code and increase investment in a way that maintains current revenues.”

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Sounds like both parties want many of the same things.

However, “revenue neutral” business tax reform does not go far enough. Looking at the Federal OMBs Historic Tables (p34-35) tells the story. Since 1934, individual income taxes have consistently made up 40+% of government receipts, while corporate income taxes have varied from as high as 30% to around 10% of receipts in recent years.

True this declining share is partially due to rising Social Security taxes, but since those are split evenly between employers and employees, it is clear that the burden of financing our government has shifted from corporations to people and small businesses. Looking at contributions as a % of GDP (p36-37) further supports this narrative.

These meager contributions by corporations are symptoms of an outdated and unfair tax code, and should not be enshrined in a new one.

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Lower tax receipts skew the debate over how to invest in America and her people. Operating from a position of high debt and primary deficit, it is easy to drum up fears that accommodative economic policies will result in rising borrowing costs, ballooning deficits, and [hyper]inflation (despite the fact that America is facing the opposite–historically low borrowing costs, a shrinking deficit, and a very strong dollar).

Implementing business tax reforms would help push America into primary surplus, changing the context of this national debate.

I do not claim to know the exact amount or proper allocation of resources between public goods (education, infrastructure) and welfare programs needed to achieve greater “equality of opportunity” / social mobility. But I can say with confidence that more resources need to go to these causes, as the status-quo has long failed the vast majority of Americans.

The sooner we can have a clear-eyed debate on what policies are needed to promote broad based, sustainable American growth, the better. Holding back this debate, aside from uncompromising politicians, is a failure to overhaul our tax code.

In the interest of balance, work also needs to be done on individual tax reform, to fix high marginal tax rates affecting people who benefit from welfare programs. However, the importance of this issue has been, in my opinion, overblown by those on the political right.

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Lastly, the Congressional Budget Office’s use of “dynamic scoring”, as it as been pushed through by the G.O.P. dominated congress (using it for tax proposals but not for spending bills) is another impediment to achieving social justice through tax reform and fiscal policy. 

Van Hollen (D-MD) added that while the bill requires the CBO to run dynamic analyses on major bills, it specifically excludes appropriations bills. He said that exemption shows that Republicans want to downplay how federal spending on education, infrastructure and other areas can also help the economy.

Ryan replied by saying that exemption is there because subjecting all spending bills to dynamic scoring would create significantly more work for the budget office. Rep. Gerry Connolly (D-Va.) proposed an amendment to include major spending bills, but the House rejected it 182-214.

Ryan’s argument is unfounded and offensive to the talented people employed by the CBO. It is a weak attempt to defend wealthy interests, while downplaying the awesome potential of the American people.

Ideally, this method would be implemented for both tax and spending proposals. If that is not possible, dynamic scoring should not be used at all.

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Transparency Report: Not All Regulations are Equal, Not All Compromise is Good

A recent New York Times poll on the achievability of “The American Dream” produced some concerning yet unsurprising results:

Notwithstanding the bleaker view of upward mobility, the majority of those polled said they were more concerned about the possibility that too much regulation in Washington could stymie the economy than they were about the prospect of inequality. Fifty-four percent of respondents said that “over-regulation that may interfere with economic growth” was a bigger problem than “too little regulation that may create an unequal distribution of wealth.” Only 38 percent said that too little regulation posed a bigger problem.

That answer was particularly noteworthy given the persistent concerns among economists and politicians from both parties about a growing gap between the wealthiest Americans and the middle class.

Still, almost six years after the height of the financial crisis, Americans’ wariness about the banking industry that was at its center remains. Only 4 percent of respondents said they had “a lot” of confidence “in Wall Street bankers and brokers,” though 31 percent said they had “some” confidence in Wall Street. Nonetheless, 44 percent said they trusted their own bank “a lot,” and 37 percent said they trusted their banks “some.”

My question is, if not the federal government, who can regulate Wall St?

Recently attention has focused on the Federal Reserve Bank of NY, which plays an outsized roll in financial regulation as NYC is the world’s largest financial hub. However, the NY Fed’s role in financial regulation is complementary to federal regulation–it is not a substitute. 

People may not be enamored with federal financial regulation, but the answer is more regulatory power, not rolling back key provisions of the already insufficient Dodd-Frank Act.

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These reported beliefs on government regulation are not surprising (to me) because the rationale behind them is clearly explained by Matt Taibbi in his book “Griftopia” (which he discusses in an interview on Wall St. Cheat-sheet):

Basically, government regulation is the kind of stuff a lot of them see on a day-to-day basis, but in a different form. If they’re a hardware store owner, they see a local health inspector or an ADA inspector coming by to make sure they’re in compliance with something. These are all little annoyances and costs that they see when they interact with government. Unfortunately, that’s what they think financial regulation is. They don’t get that it’s a completely different ball game when you’re talking about JP Morgan Chase (JPM), Goldman Sachs (GS), and that level of power requiring oversight.

This is how the GOP sells its agenda to the average Americans (aside from exploiting social rifts, which can only go so far): anything provided by the public sector (regulation, welfare programs) is ineffective and holds back growth, therefore the path to prosperity lies in deregulation and slashing the social safety net.

Over-regulation may be a problem for regular Americans at the local level. But federal under-regulation of the financial sector, environmental concerns, and campaign finance, threaten our economic stability, future, and democratic processes respectively (these also happen to be the areas where Republicans are rolling back regulations in the current government spending bill).

But the way the GOP is pushing its deregulation agenda is almost as reprehensible as the socioeconomic consequences. The environmental issue is divisive, but there is a broad consensus among Americans in favor of tighter financial regulation and campaign finance reform.

No Congressman or woman campaigned on financial deregulation or easing campaign finance restrictions, as such an agenda would never be popular enough to get someone elected. But the GOP has essentially tied the ability to run the country to these very issues.

Compromise should be measured not only quantitatively (how often did congress compromise) but also qualitatively (what did congress compromises on). While there certainly needs to be more bipartisan cooperation in Washington, there also needs to be red-lines.


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Much Ado About a “Do Nothing Congress”

A recent NYT article cast a gloomy picture for those hoping for a Democratic super-majority after the 2014 Midterm Elections.

History says President Obama should brace for another round of midterm election losses next year — and be grateful for the opportunity.

Unlike presidents who never got the same chance, Mr. Obama is in line to become only the fifth president since Harry S. Truman to serve long enough for a second midterm election, and the possibility that his party might hold or gain ground in Congress in his sixth year in office. But the unhappy record of his two-term predecessors — none of whom gained control of either legislative chamber — offers scant comfort about his prospects.

However, there is reason to believe the Democrats may retake the House. Two forces in particular are working in their favor.

1) The Democratic Party is more popular than the G.O.P (Gallup Poll):

The two parties’ favorability ratings are at the lower end of the range Gallup has measured for each, although the GOP has the lower absolute rating. The Democratic Party’s current favorability rating of 42% is similar to what it was during most of 2010 — a year in which the Democrats lost 63 House seats and majority control in that chamber.

Moderates More Likely to Prefer Democratic Party Over Republican Party

While the two parties rely on their ideological soul mates for support — Republicans depend on conservatives, while Democrats lean on liberals — both parties also need at least some support from the political center to win elections. Self-described moderates are more likely to have a favorable image of the Democratic Party (47%) than of the Republican Party (27%), which may prove problematic for the GOP next year in the congressional elections. It is worth noting, however, that moderates typically lean more Democratic than Republican.

Parties' Favorability, by Self-Reported Ideology, December 2013

The Republican Party can hardly claim to have locked up its support among conservatives, who are as likely to have a favorable (47%) as an unfavorable (46%) image of the GOP. Liberals, by contrast, are more unified in their support for the Democratic Party, with 71% viewing the party favorably.

2) People don’t like a “Do-Nothing” Congress:

Trend: Do you approve or disapprove of the way Congress is handling its job?

And the 113th Congress is a “Do-Nothing” Congress.

This Friday, the 113th Congress will end its 2013 session with a less-than-distinguished title: one of the least productive ever.

Halfway through its term, Congress has passed 56 laws. By comparison, 10 years ago, the 108thCongress passed 504 laws between 2003 and 2004. A decade before, the 103rd passed 473 laws, according to GovTrack, a site that monitors legislation.

The current Congress’s predecessor, the 112th — thought to be the least productive ever — managed to pass 284. The 113th Congress is on track to underperform even that cohort.

The original “Do-Nothing” Congress, the 80th U.S. Congress, enjoyed a Republican super-majority. By the time the 81st Congress was sworn in, Democrats had taken over the majority in both the House and the Senate.

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Now, the fact that Congress is currently split–Democrats have the majority in the Senate, while the G.O.P controls the house–paves the way for much more finger-pointing than in the 81st congressional election. The experts believe only 20 something seats are truly “up for grabs”, and the Democrats need to win almost all of them (17) to take a majority in the House. However, given the relative unpopularity of the G.O.P (both among conservatives and moderates), it would appear that Democrats primed to take many of the undecided seats.

Lots of time still remains before the 2014 midterm elections, and the political landscape can change drastically between now and then. If there is one things you can predict in democratic elections, it is unpredictability.

“I don’t think there are any formulas” for midterm election results, said Ken Khachigian, a former Reagan speechwriter. “We underplay the fact that elections are elections with individual candidates.”


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Economic Outlook: U.S. Senate Fails to Pass a Bill Preventing the Doubling of Student Loan Rates

“The U.S. Senate on Thursday thwarted two rival bills aimed at stopping interest rates on millions of federal student loans doubling in less than a month.”

“Student loan debt in America now surpasses $1 trillion, according to the U.S. Consumer Financial Protection Bureau, and is already hindering young people from making important economic decisions such as purchasing new homes or cars.

Last year lawmakers agreed to extend a previous rate-increase freeze on student loans for another year. Unless Congress comes to an alternative agreement, interest rates will double to 6.8 percent on July 1, adding an extra $1,000 to borrowers’ payments every year.”

“The Comprehensive Student Loan Protection Act, a bill introduced by Republican Senators Tom Coburn of Oklahoma, Richard Burr of North Carolina and Lamar Alexander of Tennessee, would have pegged the interest rates to the U.S. Treasury 10-year rate, plus 3 percentage points.

Democrats say that plan would only hurt borrowers by causing them to pay higher rates in the future as the economy recovers and interest rates climb.”

“The Democrat bill introduced by Tom Harkin of Iowa, Jack Reed of Rhode Island, and Majority Leader Harry Reid of Nevada would have frozen interest rates on subsidized Stafford student loans at their current 3.4 percent for two more years.

Democrats said their plan would protect borrowers and give lawmakers time to work on a more comprehensive, long-term solution. Republicans, such as Senate Republican leader Mitch McConnell of Kentucky say any solution should be a permanent one, rather than a “short-term political patch.”

“[Richard] Burr (Senator-R-NC) said Republicans want to provide a predictable mechanism to set interest rates for students, rather than returning to the table every year.’ Congress shouldn’t be sitting in Washington deciding with a dartboard what student loan interest rates should be,’ he said.

“President Barack Obama has also proposed a market-based plan. Under his proposal the borrowing rates would remain fixed for the life of the loan.”

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Wait a minute, haven’t we seen this before? Congress creating a short-term fix and putting an “unthinkable” consequence for not passing a longer term plan within a certain time-frame? Why yes, yes we have. It is essentially the same progression as the “debt-ceiling”, the “fiscal cliff”, and the “sequester”. If we have learned one thing from recently political gridlock it’s that this tactic is ineffective—in Washington today politicians on both sides of the political spectrum are willing to let “unthinkable” events pass in order to avoid compromising (although not evenly distributed between both sides, I’ll let you guess which side I think is more reasonable).

While it is true that another month remains before rates are set to double, anyone banking on a compromise within that time is either incredibly optimistic or has not been following politics for the past half decade.

Recent statements by Senator Bob Dole on “Fox News Sunday”, highlighted in a NYT article, show that not only liberals think Tea Party Politics are hurting America:

“It seems to be almost unreal that we can’t get together on a budget or legislation,” said Mr. Dole, the former Senate majority leader and presidential candidate. “I mean, we weren’t perfect by a long shot, but at least we got our work done.”

The current Congress can’t even do that, thanks to a furiously oppositional Republican Party, and that’s what has left mainstream conservatives like Mr. Dole and Senator John McCain shaking their heads in disgust.

The difference between the current crop of Tea Party lawmakers and Mr. Dole’s generation is not simply one of ideology. While the Tea Partiers are undoubtedly more extreme, Mr. Dole spent years pushing big tax cuts, railing at regulations and blocking international treaties. His party actively courted the religious right in the 1980s and relied on racial innuendo to win elections. But when the time came to actually govern, Republicans used to set aside their grandstanding, recognize that a two-party system requires compromise and make deals to keep the government working on the people’s behalf. “

Barbara Bush, first lady to President George H W Bush, had similar thoughts in the issue of partisan divide:

“’They are going to have to compromise,’ said Barbara, the wife of former President George H.W. Bush. ‘It’s not a dirty word.’”

This position is unsurprising considering her husbands political history. “To reach agreement with Democrats who controlled both the House and the Senate, [H W] Bush accepted a deficit-reduction plan that raised income-tax rates—breaking his “read my lips” tax pledge from the 1988 presidential campaign. In protest, Newt Gingrich, then the House minority whip, quit the talks and led a rebellion that ultimately persuaded nearly half of Republicans in the chamber to abandon Bush and oppose the deal.

Bush’s budget package established the foundation for further deficit reduction under President Clinton in 1993 and 1997. Those agreements fueled the 1990s economic boom and produced three consecutive balanced budgets in Clinton’s second term. But it was Gingrich’s revolt in the name of inviolate principle, not the elder Bush’s flexibility in the face of divided government, that left a lasting imprint on the GOP.”

Economic advisor to Presidents H W Bush and Reagan, Bruce Bartlett, is an Economix blogger for the NYT, and a prominent example of a conservative turned liberal due to the G.O.P’s philosophy on political economy.

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Tea Bagger’s cannot claim core Republican values from some “Golden Age” in the 1980s and 90s, because the very people who were running the G.O.P. back then have renounced the Tea Bag movement:

“I’m not all that interested in the way things have always been done around here,” Senator Marco Rubio of Florida told The Times last week.

I hate to beat a dead horse (elephant?), but if you look at congressional approval ratings over time, perhaps it would make more sense to defer to the more experienced and knowledgeable politicians who once ran your party.

A primary function of the legislative branch, known as “vertical accountability”, is to represent citizen’s voice in government agenda-setting and policy making processes. With only 16% satisfaction, can there be any question that partisan politics have prevented legislators from doing their jobs?

Many countries have mechanism for a disillusion of parliament, based on differing criteria. Perhaps the time has come to consider a Constitutional amendment stipulating instances in which either the House and / or Senate can be dissolved due to incompetence.

It is not too far ahead to look forward to the 2014 midterm elections. These elections represent a major turning point in U.S. political history. An absolute majority for the democrats will further embolden the mandate Obama believes his re-election signified—a more progressive, meritocratic, and egalitarian vision of America. If democrats fail to seize this opportunity, we can expect two more years or relative government inaction leading up to the 2016 elections.

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Back on subject, I believe that Obama’s plan is a reasonable compromise between the two sides. I agree with Senate Republican leader Mitch McConnell that short-term patchwork policies are no way to treat any legislation, particularly one with such long-term implications as student loan repayment. But I also agree with general democratic opposition to tie rates to market values, as the volatility in U.S. bond markets does not offer much security to potential student-loan candidates.

The Obama plan is good because while the current market sets the rate, there is the stability of having that rate locked in place. When the economy is doing well, and there is low unemployment, rates will be higher; signaling that a prospective student may be better served joining the labor force. When there is a lack of jobs, and the opportunity cost of attending college is lower, this will be reinforced by lower borrowing rates (as we see now).

Of course the ultimate factor of how much student debt one accumulates is the cost of their institution. Public state, city, and community colleges offer an affordable alternative that leaves students with much less debt, which mitigates the effect of changes in student loan rates in general (as opposed to someone who takes on more debt at a private college).

Needs-based grants are often available to students who show academic promise but cannot afford to attend schools. Changing affirmative action to a more needs-based socio-economic program, instead of a race-based program, could make the program work as it was originally intended, which was to help disenfranchised Americans realize the “American Dream” of social mobility.

One criticism of this policy is that it is somewhat deterministic, in that at times when T-bill rates are high, many students who would benefit from going to college may decide they cannot afford it.

The opposition to the Obama plan is that by fixing rates at a certain level for the life of the loan, the U.S. government may be on the hook for a large subsidy when T-bill rates go up. Let’s say I lock in a loan at 2%, and the government now has to pay 8% interest to borrow money, the government is taking a large loss there.

But that is the government’s job, to provide financing for important programs. Schooling should be subsidized for all the benefits it produces. Senator Burr is correct, the U.S. government should not unilaterally set rates. It should, however, provide Students with the security of knowing at what rate they will have to pay back student loans, given the long-term benefits that education gives and the financial uncertainty facing 99.99% of Americans (basically anyone who cannot fall back on family wealthy).

Subsidizing student loans, changing affirmative action to a needs based program, and making available cheaper public education alternatives, is three-sided approach that can drastically increase social mobility in America.