Monday, December 24, 2012

The US "Fiscal Paraglide"

First off, Merry Christmas to all the readers of my blog, and may you also have a Happy, Healthy and Prosperous New Year!

I am currently out in the middle of Indian Ocean (just sailing towards Madagascar passed Reunion Island an hour ago) this Christmas Eve night, having spent a wonderful 3 days on the island of Mauritius.  While cruising the south Indian Ocean I have been reading the New York Times on virtually a daily basis and have been mesmorized by all the drama that unfolded in Washington DC over the past week or so connected with the so-called “fiscal cliff”.  So as there is only a week remaining to do anything about the approaching 
sequester that will happen after January 1st, I thought it probably time to say something about it.

My immediate reaction to reading the news was to think “oh no, so if the US Senate democrats will not propose anything unless the Senate Republican leadership in the shape of Mitch McConnell undertake not to filibuster the measure put forward, how will that work, given that the Republicans just don’t seem to be able to unite their disparate factions?”  I think that we indeed are about to go over to the so-called “fiscal cliff”, and it is now likely that taxes will go up and that spending will be cut over the next few years. 
But then I started to think about this a little more deeply and I realized that there are a few things that are really important here from both an economic and a political point of view; first, US debt has already been downgraded over the difficulty in finding agreement over raising the debt limit - which caused the US to be in the situation that it is now in – and the world didn’t end; second, that the “fiscal cliff” will really not be a cliff but will act more like a “fiscal paraglide”; and third, that we are currently witnessing the end of the Republican party as we know it, and therefore a completely fractured political structure that will not lead to agreements on economics for many years to come. 

Let’s deal with each issue in turn.  First, the actual economic measures in the fiscal cliff and the size of the US national debt are not the most important issues – economic growth is.  The real issue is how does the US maintain the impetus behind US economic growth, and clearly tax hikes and spending cuts will not help, but these tax hikes and spending cuts are not exactly as draconian as those already implemented in the UK, and yet the UK has managed to totter on with anemic rates of economic growth despite the fact that further cuts were recently announced. What I’m really trying to say is that this is not a question of action, it is a question of timing.  The UK adopted fiscal austerity with increases in sales taxes and quite drastic reductions in spending just as the country was coming out of recession, which led to a “double dip” recession.  The timing in the UK was all wrong.  So the question is, given where the US is right now, can it withstand some small tax increases and cuts to military and some social programs right now, or is the economy already sputtering or heading into a private sector downturn?  I would argue that the US economy is now resilient enough to withstand some corrective fiscal action, particularly as even if President Obama manages to get a so-called “stripped down” bill agreed upon which leaves taxes for all but the wealthy where they currently are, the country will once again face raising the debt ceiling again in late February or March.  Also the Fed is still maintaining and in fact expanding what is already an extremely expansionary monetary policy that is tied to the labor market, so given that the housing market is definitely on a track to recovery, some corrective action to taxes and spending should not derail economic recovery like it did the UK.

In fact I believe that US economic growth impetus right now is being somewhat underestimated, so that if there is enough “upwind” to growth, the increase in taxes and the cuts to spending could restore some confidence that the country is once getting back on track with its fiscal policy and therefore (using a “paraglide” analogy), falling off the cliff might only at worst provide one quarter of negative growth followed by a strong cyclical upswing.

Last point – the Republican Party.  What has been distressing to watch in all this drama in Washington DC is that our politicians just don’t seem to be able to bridge their gaps anymore on fiscal policy, partly because the Republican Party appears so divided on what compromise (if any) is feasible ( - thanks mostly to Grover Norquist).  So if these gaps in fiscal policy cannot be bridged, we need a new mechanism to deal with fiscal policy-making in the largest economy in the world.  If the debt ceilings are maintained, then are we really going to impose periodic sequesters?  If debt ceilings are scrapped, what constraints should US fiscal policy have? 

More on this next time!

Tuesday, December 4, 2012

Are Corporations Immoral When They Don't Pay (Much) Tax?

I'm in the UK right now, and I'm not sure the fuss over US corporations paying little to no tax in the UK has hit the shores of the US yet, but this subject is causing quite a stir over here. And although no-one is mentioning the fact that the 3 corporations being named are all large US corporations, this is definitely apparent in terms of the 3 multinationals who have been named by the Chair of the UK Parliamentary Public Accounts Committee, Margaret Hodge (a Labour MP), and her use of the word "immoral" to describe the tax avoidance schemes used by Starbucks, Google and Amazon to avoid paying taxes in the UK (see here, here and here for some examples of the UK media coverage).  To be fair, in some articles I have also seen eBay and Ikea (the Swedish discount furniture giant) also mentioned.

In the show that I try to listen to every day on the radio here (The Today programme on Radio 4), Margaret Hodge accused Starbucks in particular of using "transfer pricing" rules which permit Starbucks UK to buy coffee beans from other subsidiaries at higher prices than exist in the market, and book loans at extremely high interest rates from the US Head Office, which then makes the UK subsidiary look like it is making losses when in reality it is making a profit. The basic idea here is to make subsidiaries in high corporate tax countries make losses, and subsidiaries in low corporate tax countries make profits.Thus Starbucks UK has not paid any corporate taxes in the past 3 years, despite having extremely "profitable" UK operations which resulted in the UK CEO being promoted up through the international organization, and yet Starbucks Switzerland (where corporate tax rates are only 12%) has consistently been making profits.

Google UK has also been quite closed-lipped on it's UK subsidiary's activities, but nevertheless was forced to provide some statistics to the UK PAC. Google paid £6m corporation tax on £2.5bn of UK revenues in 2011. That is a tax rate of 0.24%, significantly less than the headline UK corporate tax rate of 24%.

It also emerged, in new figures supplied by Amazon to the PAC, that the online retailer's total UK sales topped £2.9bn last year, while declaring revenues of only £207m.
If Amazon UK is assumed to be paying a 24% corporate tax rate on it's (let's assume net) revenues, then doing the same calculations to obtain a corporate tax rate, that comes to a 1.7% tax rate. Obviously my calculations are wrong because for the past three years, Ltd paid £2.3m in corporation tax ( - our assumption would have had Amazon paying £49m in corporate taxes for one year alone) on UK sales of £7.1bn.

Phillip Stevens of the FT comments that "Societies have sets of norms and ethics that extend beyond tax law. To function well they demand more of individuals and companies that they avoid breaking the letter of the law. Call it moral obligation or corporate responsibility, but the market economy cannot separate itself entirely from this broader notion of fairness.”

In my opinion corporations can either be viewed as collections of citizens who have grouped together to do business, or as separate individual entities in and of themselves.  Each notion of a firm leads to a different conclusion about the way in which corporates should be taxed. In the former case (businesses as collectives of individuals) only the income that is derived by those citizens who are involved in ownership of the business should be taxed and it should be taxed at the same rate as all other individual income. In the latter case (businesses as individual stand-alone entities), businesses should be taxed on the same basis as individuals - in terms of their revenue - not in terms of profits as currently is the case. The same income tax bands (presumably as for families) would apply to corporations, and then they would pay taxes like all the rest of us do. So to sum up, my view is this: either the government should i) tax the returns from company activity (i.e. dividends) as income to invidividuals (and not tax the companies at all); or ii) company revenues should be taxed at the same rate as individual income tax. 

I'm afraid I see things rather differently from Phillip Stevens. Why should the company be responsible to anyone other than their stakeholders - after all, they are the people who are involved in the company, aren't they?  Surely corporate responsibility involves obeying the law, and if the law allows these corporations to pay less taxes, why shouldn't they take advantage of this?

Clearly we don't use a system like my ii) above describes where company revenues are taxed, and this is unlikely to be introduced in the near future if corporations have anything to do with it! So we are left with i) which is the taxation of dividends as income but at the same time phasing out corporation tax. This is what I would advocate should be happening to the talks on the fiscal cliff in the US.  Despite what John Boehner and the Republicans say, we should be taxing dividends as income, but at the same time we should be lowering the rate of corporate taxation in the US to at least match what it is elsewhere.

It is obvious that corporate taxes are messy as not only do they tax profits, something that is easy to hide using international tax loopholes, but also even when we do tax profits paid to shareholders at dividends, we don't tax these payments as income but rather at a different rate to income tax rates.  Clearly a re-think on corporate taxes and capital gains taxes is needed, and the tax rules relating to multinationals are badly in need of reform.

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