Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: Biden’s tax plans go global, the return of the doom loop, Germany’s green new dud, robots and jobs, and problems with index funds. To sign up for the Capital Note, follow this link.
A Tax Hike So Destructive that It Needs (But Won’t Get) a Cartel to Contain the Damage
Cartels generally operate in predictable ways. One of those predictable ways is that they attempt to keep prices high. Part of the price of government is tax. It is unsurprising, therefore, that Janet Yellen has floated the “bold” (NPR’s adjective, not mine) idea of a global minimum corporate tax, in the wake of what is planned to be a substantial increase in America’s corporate-tax burden.
Three things about any such increase really should not be up for debate.
Firstly, those voters who believe that corporate taxes are (in the end) paid by greedy corporations will be in for a disappointment.
In his article on the proposed tax hikes on the Capital Matters page, CEI’s Ryan Young writes:
In a 2020 study by Scott R. Baker of Northwestern University, Stephen Teng Sun of City University of Hong Kong, and Constantine Yannelis of the University of Chicago estimate that 31 percent of the cost of an increase in corporate taxes is borne by consumers, 38 percent by workers, and 31 percent by shareholders, or about a third each. Other studies have found different ratios. A 2020 Tax Policy Center study, a joint effort between the Urban Institute and the Brookings Institution, estimates an 80–20 split between investors and labor. The Tax Foundation’s Stephen J. Entin estimated in 2017 that labor pays 70 percent or more of the corporate tax. Differences aside, these studies share a common conclusion: Ultimately, corporations themselves pay no corporate tax.
Our estimates imply that, on average, 51 per cent of the corporate tax burden is passed onto workers. This average effect is similar to other studies analysing the corporate tax incidence on wages . . .
We show that higher taxes reduce wages most for the low-skilled, for women, and for young workers. These results qualify the widespread view that the corporate income tax is highly progressive . . .
Secondly, significant increases in corporate taxes (and the impact on shareholders, in all probability reinforced by higher rates of taxation on dividend income and capital gains) will increase the cost of capital, not normally the best recipe for sustained recovery. Of course, some of the resulting shortfall in investment will be filled by those parts of the trillions planned to be spent on projects that can legitimately described as infrastructure (there are some). But to believe that even that spending will, as a whole, work out well is to believe that central planners can make more productive use of capital than their private-sector equivalents. And to have faith in that involves ignoring a great deal of history.
And thirdly, yes, the proposed tax changes will put American companies at a disadvantage when compared with their international competitors.
An increase in the federal corporate tax rate to 28 percent would raise the U.S. federal-state combined tax rate to 32.34 percent, higher than every country in the OECD, the G7, and all our major trade partners and competitors including China. This would harm U.S. economic competitiveness and diminish our role in the world.
When the U.S. last had the highest corporate tax rate in the OECD, prior to tax reform in 2017 with the Tax Cuts and Jobs Act (TCJA), the U.S. experienced several years of economic malaise, including chronically low levels of investment, productivity, and wage growth, as well as major distortions and avoidance schemes in the corporate sector. This included corporate inversions to lower-tax countries, migration out of the corporate sector and into the noncorporate sector, and a decline in business dynamism. This is why the U.S. lowered the corporate tax rate, to compete with other countries around the world that lowered theirs long ago.
Whether we use corporate tax collections as a portion of GDP, average effective tax rates, or marginal tax rates, each measure shows that the U.S. effective corporate tax burden is close to or above the average compared to its OECD peers. Raising corporate income taxes would put the U.S. at a competitive disadvantage, whether one looks at statutory tax rates or effective corporate tax rates.
As so often with tax hikes, the proposed government grab is not confined to increasing just one rate. The Tax Foundation discuss the grisly details, but other proposed changes include the introduction of a minimum tax of 15 percent on corporate book income for firms with revenue above $100 million, which could, somewhat loosely, be seen as a corporate equivalent of the alternative minimum tax for individuals. The complexity it will bring with it will, of course, add to its cost. Other treats include (roughly) doubling the global minimum tax on U.S. multinationals and toughening it too.
Treasury secretary Janet Yellen is clearly aware of the effects that this poisonous package will have on the competitiveness of U.S. companies (and, for that matter, the willingness of foreign enterprises to set up shop over here), thus her interest in a tax cartel.
Janet Yellen on Monday urged the adoption of a minimum global corporate income tax, an effort to at least partially offset any disadvantages that might arise from the Biden administration’s proposed increase in the U.S. corporate tax rate.
Citing a “30-year race to the bottom” in which countries have slashed corporate tax rates in an effort to attract multinational businesses, Yellen said the Biden administration would work with other advanced economies in the Group of 20 to set a minimum.
So far as that “race to the bottom” is concerned, here’s the Tax Foundation:
Contrary to the proposal’s claims about a “race to the bottom” on corporate tax rates, reductions in corporate rates have plateaued for more than a decade. When the U.S. cut the federal statutory corporate rate from 35 percent to 21 percent in 2017, it was not leading a race to the bottom but moving to the average. The U.S. combined (state and federal) tax rate on corporate income is now 25.77 percent. The average corporate rate among countries in the OECD (excluding the U.S.) is 23.4 percent.
Back to the AP:
“Competitiveness is about more than how U.S.-headquartered companies fare against other companies in global merger and acquisition bids,” Yellen said in a virtual speech to the Chicago Council on Global Affairs. “It is about making sure that governments have stable tax systems that raise sufficient revenue to invest in essential public goods.”
That presumes a general international understanding of what “essential public goods may be.”
“It is important to work with other countries to end the pressures of tax competition and corporate tax base erosion,” Yellen said.
Biden’s corporate tax measure would also penalize other countries without a minimum corporate tax by more heavily taxing their subsidiaries in the U.S.
I am not entirely convinced that that will encourage overseas companies to invest (or invest more) in the U.S.
So, is there any prospect that the G20 will go along with this? No. For years now, there have been steps to take steps toward corporate-tax-rate harmonization within the EU, with some support, shockingly, from greedier governments such as those in Berlin and Paris. But they have gone almost nowhere. Many EU states, notably (but not only) those in the bloc’s poorer east, regard low corporate-tax rates as a source of competitive advantage, and they have been correct to do so. They have no interest in throwing that asset away.
But this issue should not be reduced to one of securing a commercial edge. Different EU member-states have different views on the right balance between the private sector and the public, and, for that matter, on what the “right” level of taxation (where “right” can mean many different things) and spending should be. Above all, perhaps, they regard issues of taxation and sovereignty as inextricably intertwined. If the EU, a reasonably close-knit grouping, cannot agree on a minimum corporate-tax rate, the thought that the G20 would be able to come to any such agreement is absurd.
Instead, the EU and other U.S. competitors will regard the corporate-gains-tax increases (if enacted), as merely the latest stage, in the wake of the president’s green agenda, in a helpful American effort to hobble itself. We can be sure that quite a few of them will do their best to make the best of the business opportunity that will arise as a result.
And if the U.S. tries to bully other nations into compliance — good luck with that — it will add diplomatic fiasco to economic stupidity.
Around the Web
Return of the doom loop?
There is another case on euro zone financing up before the German Constitutional Court, EU countries are struggling to emerge from the pandemic, and now, right on schedule, the “doom loop” is back (if it ever really went away):
Italian and French banks’ exposure to the sovereign debt of their own countries has hit record highs since the pandemic started, reviving fears about the sector’s links to increasingly indebted governments.
Domestic government securities and loans held by eurozone banks rose more than €140bn to just over €2.1tn in the year to February, according to Financial Times calculations based on data from the European Central Bank.
The exposure of Italian banks to domestic government debt hit a record €712bn last August, up more than 9 per cent from February and dipping only slightly since then. French banks had the sharpest post-pandemic rise in their exposure to their own government, which climbed to a record €431bn in September, a jump of more than 18 per cent since February.
The strengthening of ties binding banks to their national governments has reawakened concerns over a faultline in Europe’s monetary union that was exposed during the region’s sovereign debt crisis a decade ago.
At that time, banks’ vast domestic sovereign debt exposure created a “doom loop”, as a vicious circle between private sector lenders and governments weakened each other and ultimately threatened the existence of the single currency zone . . .
Green New Dud
Via Reuters, an update on Germany’s Energiewende, the country’s long-standing transition to renewables (which also includes scrapping nuclear power):
Germany’s energy transition has proved too costly and underestimated the risks to supply, a federal audit office report seen by Reuters has found.
Reforms are needed to state taxes and fees to fix a system that has left Germany with Europe’s highest retail electricity prices and at risk of grid blackouts, the as-yet unpublished report said.
Chancellor Angela Merkel’s decision to abandon nuclear power by 2022 following Japan’s Fukushima nuclear disaster in 2011 has forced the sector to radically restructure.
The audit office’s report is a warning about the state of that transition and comes as Germans prepare to go to the polls in September.
Economy minister Peter Altmaier likes to underscore Germany’s role in moving to green energy under his stewardship.
“There is a risk of losing Germany’s competitiveness and acceptance of the energy transition,” the report said . . .
You don’t say.
Read the whole thing, particularly if you are in the Biden administration.
About those warehouse jobs . . .
Boston Dynamics has launched its new robot – the first aimed at only one task.
The company, best known for its robot dogs that are able to move around with uncanny and impressive skill, has named the new machine “stretch”.
It is built for the specific purpose of moving boxes around warehouses, with the aim of bringing automation to the vast buildings that are at the centre of companies such as Amazon.
The company said it had been launched with a view to the ongoing growth of online shopping.
Stretch looks a little less like existing animals than other Boston Dynamics creations. The company’s robots have become popular through their YouTube videos – viewed with a mix of fear and excitement – of robots such as ‘Spot’, which looks like a dog, and the human-shaped Atlas . . .
The writers of the headline for this Atlantic piece ask whether index funds could be “worse than Marxism.” The answer to that question is no, but you knew I’d say that. This is not Das Kapital Matters.
Nevertheless, there is more sense to that question than might at first seem to be the case, and in this article, Annie Lowrey raises some intriguing questions about what the rise of passive investing may be doing to capital allocation, the markets, and competition.
What might be good for retail investors might not be good for the financial markets, public companies, or the American economy writ large, and the passive revolution’s scope has raised all sorts of hand-wringing and red-flagging. Analysts at Bernstein have called passive investing “worse than Marxism.” The investor Michael Burry, of The Big Short fame, has called it a “bubble,” and a co-head of Goldman Sachs’s investment-management division has warned about froth too. Shortly before his death in 2019, Bogle himself warned that index funds’ dominance might not “serve the national interest.”
One primary concern comes from the analysts at Bernstein: “A supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active, market-led capital management.” The point of their research note, if rendered a touch inscrutable with references to Hayek and the Gossnab, is about market signals and capital allocation . . .
Passive investors . . . ignore annual reports and market rumors. They do nothing with trading-floor gossip. They make no attempt to research what to invest in and what to skip. Whether holding international or domestic assets, holding stocks or bonds, or using a mutual-fund structure or an ETF structure, they just mirror the market. Big U.S.-stock index funds buy big U.S. stocks just because they’re big U.S. stocks.
That commitment to inertia worries the Bernstein analysts, who point out that in a world with exclusively passive investors, capital will get allocated only to the big companies and not necessarily to good, promising, or efficient companies. A gravitational, big-getting-bigger effect would dominate stock-price movements. At least in a Soviet-type centrally planned economy, apparatchiks would be making some attempt to allocate resources efficiently.
The word “efficiently” is doing a lot of work in that last sentence. Central planners take the decisions they do (and this was certainly true in the Soviet economy) for any number of reasons, and, amongst their concerns, efficiency can frequently count for very little.
Lowrey also worries about the extent in which co-ownership by the biggest funds in so many companies may be distorting competition. I am not convinced, although it is well worth reading her discussion of this topic.
But the concentration, at least potentially, of power in a handful of funds is, nevertheless worth watching, particularly if those investors, however “passive” they may be in the technical sense of the word, start taking an active interest, on “socially responsible” (rather than purely economic) grounds on how those companies are behaving.
There are certain safeguards created by the nature of these funds (taking an interest in what portfolio companies are getting up to is expensive — and these funds operate on a low-fee basis).
Nevertheless, to read about the degree of control that such funds could wield is something to think about:
The market clout of the indexers raises other questions too. The actual owners of the stocks—not the index-fund managers but the people putting money into index funds—have little say over the companies they own. Vanguard, Fidelity, and State Street, not Mom and Dad, vote in shareholder elections. As John Coates, the Harvard professor, notes: “For the most valuable public company in the world, three individuals can in principle swing the vote of 17 percent of its shares. Generally, a significant fraction of shareholders do not vote, even if in contested battles. As a result, the 17 percent actually represents more like 25 percent or more of the likely votes in contested votes. That share of the vote will generally be pivotal.” In fact, the Big Three cast roughly 25 percent of the votes in S&P 500 companies.
Food for thought.
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