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Friday, December 23, 2011

U.S. Health Not #1: Deconstructing Legatum Part 1

As I reported on December 9, the Legatum Prosperity Index claims that the U.S. ranks #1 in the world in health. Like Aaron Carroll, I find this to be a dubious proposition. In the meantime, Nathan Gamester of the Legatum Institute was kind enough to help me learn my way around the website and find the data I wanted. He is not responsible for my conclusions, which still view the idea that the U.S. has the best health in the world as unsupported by the evidence.

To review, Legatum ranks the U.S. #1 largely based on the fact that it has by far the highest level of health care spending per capita in the world. In a defense of this outcome, the report states (p. 46):

Furthermore, the health expenditure variable is only one of the 17 variables in our Health sub-index and one of modest importance in comparison to the others....To further explore the importance of the healthcare expenditure on the overall performance of the United States, we conducted a simple exercise in which we substituted US expenditure with that of Norway. The result is that United States would rank 7th, still among the top 10 best performing countries in the Health sub index.
 This is more confusing than illuminating. While some variables are more highly weighted than health spending, for example, individuals' satisfaction with their health, the difference in scores are tiny; by contrast, the differences in health care spending are gigantic. As the report states, the U.S. spends "66% more than the next country (Norway), 84% more than Canada, 133% more than the UK, and 205% more than New Zealand." Let's take a look at the actual values for the 17 variables, which I will divide up between objective measures of health care outcomes, subjective measures of satisfaction with aspects of health, and health care inputs. I will compare the U.S. (health sub-index score of 3.54) with France (7th ranked with a health sub-index score of 2.77, but once ranked best in the world by the World Health Organization.


France U.S. Measure

Infant mortality

3.2 6.8 Per 1000 live births
Life expectancy

81.07 78.66 Years

73 70 Years
Death from respiratory disease

26 66 Per 100,000 population
Tuberculosis incidence

6.1 4.1 Per 100,000 population

5 5 Percent
DPT immunization rate

99 95 Percent
Measles immunization rate

90 92 Percent

Water quality satisfaction

85.72 89.65 Percent
Health satisfaction

86.49 85.81 Percent
Level of worrying

30.04 33 Percent
Well rested

67.07 71.72 Percent
Health problems

22.86 21.26 Percent
Environmental beauty satisfaction

90.57 89.91 Percent

Health expend per capita

3778 7536 PPP USD
Hospital beds

7.11 3.1 Per 1000 population
Sanitation 100% 100%

100 100 Percent

Health sub-index score

2.77 3.54

* Health-adjusted life expectancy

France has substantial edges on all but one of the objective measures (infant mortality is less than half the U.S. rate), is essentially tied on the satisfaction measures, provides more than twice as many hospital beds per thousand population, and only trails - by a huge margin, of course - in spending on health care. Spending almost exactly half what the U.S. spends, the French get an extra 3 years of healthy life, fewer than half the deaths from respiratory diseases, and less than half the infant mortality. As Carroll asked, how is spending a measure of health? This is a more methodological question I'll take up in a future post.

Why am I taking the time to show the weakness in this analysis? The short answer is that Legatum will not be going away anytime in the near future. It is funded by a Dubai-based investment firm that has founded, in addition to the Legatum Institute in London, the Legatum Center for Development and Entrepreneurship at MIT. We will be seeing a lot more of this report in the future.

Saturday, December 17, 2011

Democrats' Continued Caves Threaten Middle Class

Via Mark Thoma, David Graham points out that Senate Democrats are caving in on an issue that looked won a week ago, the millionaire's tax.
 [Democrats] were calling for a tax cut, after all, and they had Republicans tying themselves in knots explaining why the party of Reagan and Tea didn't want lower taxes. All the Democrats wanted in exchange for extending the reduction was a small increase in how much the wealthy paid -- a position that was widely popular among voters.
And then Senate Democrats caved, without a peep from the President, despite his "big speech" in Kansas last week on economic inequality.

So what did Democrats get from the apparent deal to avert a government shutdown? A measly two months' extension of unemployment benefits and the payroll tax cut with the extraneous inclusion of language to force a decision within 60 days on the Keystone XL pipeline. No millionaire's tax. And it's not like tax cuts are the most effective form of economic stimulus anyway -- and this one takes money from Social Security.

Let's get a little historical perspective here. Political scientist Sven Steinmo, in his book Taxation and Democracy (1996), wrote that polls had long showed that Americans thought a major problem with the tax system was that the wealthy didn't pay enough tax. Yet the political system then, and in the 15 years since, has been delivering "tax reform" that has done exactly the opposite, reducing taxes on the rich. One has to question exactly how democratic a political system is that cannot deliver a reform favored by a large majority for at least 30 years.

So, here we stood on the verge of getting at least a little movement in the direction favored by a big majority, and Senate Democrats pull the rug out from under us again. As the Occupy movement has pointed out, something is very rotten in the state of American democracy.

As I wrote earlier, we face lots of hostage-taking opportunities in the future, especially if we are getting shutdown-averting deals that only last two months. If the Democrats keep caving in at this rate, they could give away most of the welfare state by election day.

Friday, December 16, 2011

Good story at Atlantic Cities on Job Piracy

Julie Irwin Zimmerman has a story at Atlantic Cities on job piracy, "The Folly or Corporate Relocation Incentives." She tells the story of Sears and other job blackmailers in Illinois in detail and quotes me on the failure of previous no-raiding agreements by states in the past. She points out that there are multiple reasons for opposing these subsidies, an equity argument that attracts liberals and an efficiency argument that brings conservatives and libertarians to the issue of investment subsidies.

Zimmerman does a great job; go read it.

FYI, when she quotes me as saying the cost of location incentives is almost $50 billion a year, that's correct. My other frequently quoted estimate of $70 billion annually includes all subsidies to business, including those which do not require an investment to receive them. Many sales tax subsidies don't require an investment, for example.

Thursday, December 15, 2011

Whatever Happened to John Kasich?

Back in the 1990s, there was a Republican Congressman from Ohio named John Kasich who was a scourge on corporate subsidies. He even ran a "Stop Corporate Welfare Coalition" and had a joint news conference with Ralph Nader, Grover Norquist, and others to oppose it on January 29, 1997. "We've reformed welfare for those who don't have money or powerful Washington lobbyists," he said there. "Now it's time we did the same for those corporate welfare programs that aid the rich and powerful." (Newark Star-Ledger, Jan. 29, 1997, no link).

Interestingly, a guy with a similar name was elected governor of Ohio last year. But this Kasich indulges in the worst kind of subsidy abuse, offering incentives to companies to move existing facilities. Governor Kasich is offering Sears $400 million to move its headquarters, with 6100 jobs, from the Chicago suburbs to Columbus. At a time when the state is engaging in substantial budget cuts including, according to the linked story, funds for local governments and school districts, it's hard to justify $400 million subsidies that create zero net jobs for the country. Moreover, by dangling these subsidies in front of Sears, Kasich (and others like him in other states) is enabling the company to extort retention subsidies out of Illinois, just like it did in 1989 when it left the Sears Tower for Hoffman Estates.

Yet this Kasich has no shame. After poaching 500 jobs from Kentucky in September, he told Sean Hannity, "I was accused in the front page of the Cincinnati Enquirer by people in Kentucky of wanting to steal all their jobs. And guess what? They're right."

The John Kasich I remember would have seen that since the states can't help themselves (two voluntary no-raiding agreements between states have collapsed in the past), there is a need for federal action. Only the federal government can pass laws to prevent subsidies from being given for relocations, or tax them so heavily a company would have no incentive to accept such inducements. If he were still in Congress, maybe he could even be persuaded to author a bill like that.

I wonder whatever happened to that guy.

Sunday, December 11, 2011

Cost of Tax Evasion Estimated at Over $3 Trillion Annually

The Tax Justice Network late last month published a new report that deserves much wider notice than it has received so far. Authored by Richard Murphy, it uses recent estimates by the World Bank on the size of the underground or shadow economy covering 98% of world gross domestic product to calculate the amount of tax lost as a result. The totals are simply staggering.

The report finds that over $3.1 trillion annually is lost to tax evasion worldwide. The calculation is quite simple, though necessarily imprecise. It takes the average size of the underground economy as given in the World Bank paper (1999-2006 average) and multiplies it by each country's GDP (mostly 2010) to determine the size of the shadow economy. This figure was then multiplied by the country's average tax burden (tax/GDP; 2010 or most recent available) as reported by the Heritage Foundation's 2011 Index of Economic Freedom.

Here are the top 10 countries in terms of gross dollars lost to tax evasion. The U.S. is number 1, by virtue of having the largest economy by far, even though it has relatively low tax rates and the second-smallest underground economy by percentage of GDP.

Country             GDP ($t)          Shadow Economy/GDP        Tax/GDP              Evasion ($b)

US                     14.6                          8.6%                           26.9%                   337.3
Brazil                    2.1                       39.0%                           34.4%                   280.1
Italy                      2.1                       27.0%                           43.1%                   238.7
Russia                  1.5                       43.8%                            34.1%                   221.0
Germany              3.3                       16.0%                            40.6%                   215.0
France                 2.6                       15.0%                            44.6%                   171.2
Japan                   5.5                       11.0%                            28.3%                   171.1
China                   5.9                       12.7%                            18.0%                   134.4
UK                      2.2                       12.5%                            38.9%                   109.2
Spain                   1.4                       22.5%                            33.9%                   107.4

As an example of the scale of tax evasion, the study ranks countries by tax evasion relative to a country's health care expenditures. Bolivia was the worst off, with tax evasion equal to 419% of health care spending; Russia was second at 311%. Overall, 67 countries saw tax evasion exceed health care spending, and for 119 countries total, it was 50% or greater.

The consequences of tax evasion are enormous. When we consider the European debt crisis or funding stress on social programs worldwide, it is clear that these figures mean the difference between solvency and insolvency for many countries. As a result, countries need a policy response equal to the task.

Friday, December 9, 2011

U.S. Health Care #1? Color Me Dubious, Too

Aaron Carroll has a good catch on The Hill's "Healthwatch" blog giving an uncritical eye to a recent study by a British conservative thinktank, the Legatum Institute. Its 2011 "Prosperity Index" ranks the United States #1 in the world for health. Not only that, the U.S. is far ahead of #2 Switzerland, with an index of 3.54 vs. 3.03, over 16% higher. Problem is, the U.S. scores only so-so on what both Carroll and I would consider the most important variables, healthy life expectancy (27th) and infant mortality (36th), does pretty well on some measures (tuberculosis, sanitation) and poorly on others (respiratory diseases), and only ranks #1 on one of the index components: health care spending. Since the U.S. has been seeing worsening bang for our health care spending bucks, this does not compute.

As Carroll notes, it is not clear how you weight these variables in such a way that the U.S. could possibly come out #1, and the explanation gives no real clue of the relative weights, just longer and shorter lines that are supposed to tell us the relative weights without any actual numbers. More confusing still (and I think Carroll misses this), the health variables have weight in both "income" and "well-being" regression analyses. While health spending per capita is more highly weighted than life expectancy and infant mortality on the "well-being" side, as Carroll notes, on the "income" side the reverse is true. Not that the weights, whatever they really are, make sense.

Searching the website for the promised detail on the methodology, I was unable to find any rationale for the choice of variables (let alone their weights) beyond the bland claim that the eight sub-indices were based "on decades of empirical and theoretical research done by established experts." That certainly clears it up. More curiously still, in response to why it uses such a complicated methodology, the FAQs answer, "The Prosperity Index is an assessment of the DRIVERS of prosperity. We do not seek to identify which countries are prosperous or not." I would have thought the latter was the whole point, given that they have already imposed a concept of "prosperity" that is 50% income and 50% "well-being." Compare this with the UN's Human Development Index, which is 1/3 income, 1/3 health, and 1/3 education.

So I'll email the folks at and see if I can find out the answers to these methodological questions. Meanwhile, like Aaron Carroll, color me dubious, too.

Sunday, December 4, 2011

Are Incentives Ever Good Policy?

Most of my work on investment incentives is quite critical of their use. As a result, I often get questions about whether there are any good uses of incentives, or whether states have no choice but to offer them because other states or nations are using them. The research of Tim Bartik sheds important light on this topic, in terms of identifying types of incentives that can have positive national benefits. I consider also some circumstances in which using investment subsidies can be politically justified, as well as the question of whether governments are trapped in the incentive game.

According to Bartik, two types of intervention can have positive national benefits, as opposed to benefits for the local jurisdiction.His work shows that typical "smokestack chasing" incentives, while they have a positive local benefit, have negative consequences for other states, that exceeds the benefit to the state that offers the incentive: hence, a negative net national impact. This is consistent with my work at the theoretical level that governments face a collective action problem in their use of subsidies. It also is consistent with empirical finding in international work that when other countries in your region use incentives, it decreases the amount of investment your country receives.

As I said , Bartik identifies two types of cost-effective incentives: customized training for companies on the demand side, and early childhood education programs and generalized job training programs on the supply side. Neither of these is smokestack chasing, and they make up a small portion of the incentives most states offer. For example, in North Carolina, in fiscal year 2008-9, the state's Economic Development Inventory reports that total economic development spending came to $1.2 billion. Of this, less than $11 million (1%) was spent on all types of training programs. North Carolina has a well-known early childhood education program called Smart Start, which is not considered part of the economic development budget. After a "one-time reduction" (quotes because there was another reduction the following year), the program had $194 million in FY 2008-9, about 16% of what was spent on economic development subsidies.

There is one time when I consider smokestack chasing to be politically justifiable, when it is restricted to locations that meet objective criteria of economic deprivation. This is what the European Union does, and I show in Investment Incentives and the Global Competition for Capital that EU policy has reduced what individual governments have spent on incentives, and only allowed them in the poorer regions of the EU. Some U.S. states have crafted their incentive laws to favor poorer counties, but that targeting usually is weakened over time as big companies say they'll only come if they get the maximum subsidy in a richer county. With no centralized (federal) law to enforce targeting, states have repeatedly weakened it when they do have it. This is one reason I favor federal regulation of incentives.

The bigger reason is that the states don't take the impact of their incentives on other states into account when deciding their policies. Kansas' government is not elected to care if the jobs it "creates" are merely lured across the state line from Kansas City, Missouri, let alone whether Kansas' job creation indirectly reduces jobs in other states. Therefore, the states have to be restrained by federal action to get rid of the scores of billions spent on subsidies annually.

But what should states do until then? Can states unilaterally disarm? I think the answer is probably not, although the province of Alberta in Canada has done so (oil revenues are probably the reason it can do this). But you won't get credit from me for "responsible" policy if you aren't actively working for a federal solution to the problem. And as we saw as recently as 2006 when the U.S. Supreme Court ruled on Cuno v. Daimler-Chrysler, states were actively lobbying Congress to overturn the ruling should it have followed the Appellate Court's ruling in favor of plaintiffs. In other words, states don't want to give up their economic development tools, because they still fail to appreciate how they are bound in a collective action problem that is ultimately only solvable at the federal level.

In the meantime, critics need to highlight the enormous cost in cash and lost government jobs. Local successes do occur, such as the defeat this year of the $360 million Aerotropolis subsidy in St. Louis opposed by the liberal Missouri Budget Project and the libertarian Show-Me Institute. But there is still much work to do in ending the economic war between the states.

Friday, December 2, 2011

Update on Boeing: Union to Drop NLRB Complaint, but Will Subsidy Shoe Drop, Too?

As I reported in September, Boeing and the Machinists' union were in a big dispute about awarding the second Dreamliner assembly line to South Carolina, rather than keeping it in Washington state, where the company had received $2 billion in tax breaks (present value) for the original production line. The battle reached the National Labor Relations Board because Boeing officials made public comments suggesting their decision was prompted by labor strife in Washington -- a prima facie violation of the National Labor Relations Act, because it is illegal to retaliate against workers engaging in their legally protected right to strike.

After rumors yesterday afternoon, it was officially announced late last night that a pact had been reached (h/t Talking Points Memo): in exchange for locating production of the new Boeing 737 MAX in Renton, Washington, Boeing and the union would sign a 4-year contract extension, and the union would drop its NLRB complaint against Boeing over the South Carolina plant. The company also said it would relocate defense work from Kansas to Washington if it closes what is reported to be a money-losing Kansas plant. The contract provides for a $5000 signing bonus for Boeing workers, 2% annual increases, and potential bonuses that could reach 4% per year. Boeing workers vote on the agreement December 7.

I can't help asking: what about subsidies? Basic bargaining theory in international political economy would say that if Boeing has no choice in where it locates the 737 MAX facility because of the union contract, it should not have any bargaining leverage over Washington state. Assuming the contract is ratified next week, Boeing can no longer tell state and local governments in Washington that it could move the plant somewhere else. It would be under a contractual obligation to put them in Washington, which should put the state in the driver's seat in subsidy negotiations. As we all know, that would be a very unusual outcome here in the U.S. After all, Boeing got a package for the Dreamliner equivalent to a $2 billion cash grant, more than twice the cost of the $900 million factory (see my new paper I mentioned in my last post). Are we going to find out in a couple of weeks, or a couple of months, that the state guaranteed subsidies as part of this deal? I'd say it's very possible, but if the Boeing-Machinists' union deal really did tie down the company, there is no reason for the state to give away the store again. As President Bush so eloquently put it, "You can't get fooled again."

Sunday, November 27, 2011

State and Local Subsidies to Business More Out of Control than Ever

I've just completed a new paper (not yet published, so I can't present it all here) showing the effectiveness of the European Union's rules to control investment incentives. Comparing U.S. bidding wars for investment with what happens under the EU's state of the art rules (see below) helps show just how much money is wasted by state and local governments here. As I have posted here before, the annual subsidies given could hire all laid-off state and local government workers. In this post, we examine incentives over $100 million as well as the top 25 incentives since 2000 in both the EU and U.S.

Since the beginning of 2010, there have been at least 20 $100 million incentive packages given in the U.S., compared to just four in the EU. This includes a $1 billion package (present value) given by the state of Michigan to Chrysler in 2010. By contrast, the largest package in the EU in this time was about $285 million. Overall, nine of the top 25 investment subsidies given since 2000 have been given in 2010 and 2011. This is twice as many as you would expect randomly (25*2/11=4.5), which suggests to me that things are more out of control than ever.

An important metric for comparing the size of incentives is what the EU calls “aid intensity,” which is the subsidy divided by the investment. This lets you compare incentives for projects of different sizes. Under the EU's current rules for large investments, which came into effect in 2002, the largest subsidy by aid intensity was 23.19%, a $161 million package that went to Ford Craiova in Romania in 2008. Of the top 25 packages in the U.S. since 2000, only three had a lower aid intensity than Ford Craiova, one was about equal, and the rest were higher, including four over 100%, with one as high as 385%, almost four times the cost of the investment! Thus, the highest aid intensity in the EU was virtually the lowest aid intensity for large projects in the U.S. And EU rules limit the highest subsidies to the poorest regions; the higher the GDP per capita, the lower the maximum allowable incentive, with the richest regions not allowed to give investment incentives at all.

What the EU originally called the Multisectoral Framework on Regional Aid to Large Investment Projects came into effect in 1998, and in 2002 the rules were tightened to sharply reduce the maximum subsidy the European Commission would allow* for investment projects over € 50 million. This can be clearly seen in a list of the top 25 incentives in the EU (you'll have to wait for the paper, or see Table 6.2 in Investment Incentives and the Global Competition for Capital as the top five have not changed since the book was published), where four of the five largest were given before the 2002 reform. Similarly, companies that received incentives under both the original rules and the reformed rules received much lower aid intensity under the new rules. For example, Advanced Micro Devices received a subsidy equal to 22.67% of its investment to locate in Dresden, Germany, in 2004 under the old rules, but only 11.9% in Dresden under the new rules in 2007, and 10.83% when its joint venture, Global Foundries, set up shop in Dresden in 2011. The rule change clearly worked to ratchet down incentives.

The European Union rules show that there is an alternative to giving large incentives to attract investment, that there is no reason to give away free factories to rich companies. But even in rich areas of the U.S., government officials do not want to give up their subsidy powers, so it will take constant political pressure to obtain what is ultimately a federal solution. The only way to make this politically feasible is through constantly reminding people of the high costs, what we have to give up to pay them, and pointing out feasible alternatives.

* Yes, you read that right. In the EU, the 27 independent Member States can only give a subsidy to a business if the European Commission authorizes them to do so.

Friday, November 18, 2011

How to Tackle the Tax Havens

As I argued in a recent post, tax havens cost the middle class worldwide hundreds of billions of dollars a year, which has to be made up via higher taxes on the middle class, higher budget deficits, or program cuts. In this post, I will discuss several ways to cut the tax havens down to size. Broadly speaking, we need to expose tax haven activities, neutralize them, and ultimately roll back banking secrecy, the key element of havens' existence.

Just as with subsidies, tax havens can only emerge as a political issue if their activities are widely known. One element of this is simply to report on them and keep them in the spotlight. Stories like "Tax Me If You Can" on Frontline exposed tax scams run out of the Caymans that were promoted by one of the world's major accounting firms, KPMG. But the reform that would illuminate the largest dollar volume of tax haven activity would be to force companies to report their accounts on a country-by-country basis rather than the consolidated accounts they now publish. As Palan, Murphy, and Chavagneux point out, consolidated accounts let companies hide their transfer pricing abuses because they do not report inter-affiliate transactions. Being forced to report sales, profits, size of workforce, taxes paid, etc., by location would immediately expose cases where tiny workforces, or none at all, generated big profits in tax havens. Moreover, Palan et al. note, because this regulation is enforced via the companies, it would not require the cooperation of the tax havens, most of which have been uncooperative in providing information despite agreements they may have signed.

Once exposure generates enough political pressure to get something done, specific reforms can be enacted. One way to neutralize corporate use of tax havens is to prevent transfer pricing. This can be done through what is variously called "combined reporting" or worldwide unitary taxation. This approach ignores the legally separate existence of each of a multinational corporation's subsidiaries and treats them as a single entity, using a formula to determine what percentage of the company's profits to tax. For example, if BP makes $25 billion in 2012 and 20% of its operations are in the U.S., under combined reporting the U.S. would tax BP on $5 billion. If 5% of BP's operations are in Louisiana, the state could tax BP on $1.25 billion of income. Determining the proper percentage is done by formula, using factors such as sales, employment, and assets. With combined reporting, it doesn't matter where a company claims it made its income, because the formula overrides such shenanigans.

It should be noted that the Organization for Economic Cooperation and Development, which began targeting tax havens in 1998, opposes combined reporting, despite its efficacy, because multinational corporations oppose it, and the OECD's model tax rules strongly reflect the preferences of the multinationals. Hence, there is something of a contradiction in the OECD position, as I argued in 2002.

However, these reforms still would not get at individual tax evasion, which by itself is estimated to cost governments worldwide $255 billion a year. This requires tackling secrecy directly. One model is the European Union's Savings Tax Directive, which requires that Member States either withhold 35% of interest income earned or provide complete information on all interest income earned in their territories. As Palan et al. recommend, this can be expanded beyond individuals to corporations and trusts (currently a loophole in the directive); it could obviously be expanded to other forms of income. Other measures have been used over the years that can also be effective. One, used by the U.S. Internal Revenue Service in relation to Caribbean tax havens like the Netherlands Antilles, is simply to step up auditing on transactions involving tax havens.

There is still a long way to go in stamping out tax havens. Nevertheless, progress is being made in the EU, and the political climate in the U.S. is far more favorable now than under President Bush. Palan et al. are optimistic that tax havens will be subject to continuing pressure as a result.

Thursday, November 10, 2011

Mississippi's Eminent Domain Reform Initiative Passes with 73%

While national attention focused on the defeat of the "personhood" initiative in Mississippi on Tuesday, voters there approved Initiative 31, an amendment to the state constitution that bans the use of eminent domain to transfer property from one private owner to another (h/t Jim Roos, Missouri Eminent Domain Abuse Coalition) with 73% of the vote.

Eminent domain, where government takes private property for public use, is regulated by the Fifth Amendment to the Constitution, which says, "...nor shall private property be taken for public use, without just compensation." The issue of what constitutes a "public use" has been expanded by court decisions over several decades, with the U.S. Supreme Court's 5-4 ruling in Kelo v. City of New London that economic development qualifies as a public use, even when the property is being transferred to a different private owner.

Eminent domain is heavily entwined with economic development subsidies, in particular tax increment financing. Removing "blight" is often a reason a government can resort to eminent domain, and some variant of blight must be shown in most states to allow the use of tax increment financing. I argued in Competing for Capital that fighting subsidies often attracts "strange bedfellows" coalitions, because they can be criticized on efficiency, equity, and environmental grounds, potentially pulling opponents to subsidies from across the ideological spectrum.

For similar reasons, we see unusual political coalitions fighting private-to-private eminent domain. For one thing, these cases usually involve subsidies, as did Kelo. People understandably don't want to lose their homes, but they are especially incensed if they are losing their homes to enrich a company or private developer. Moreover, such cases can heavily impact minority communities (if property values are lower there) and small businesses (especially if compensation only takes property value into account, but not the value of the ongoing business). In Mississippi, the Southern Christian Leadership Conference and the National Federation of Independent Businesses filed a joint amicus brief with the state supreme court to keep Initiative 31 on the ballot, represented by the libertarian Institute for Justice. Talk about strange bedfellows!

This coalition can break down, however. As Ilya Somin at the Volokh Conspiracy points out, when eminent domain reform is paired with other measures, it often fails. He gives the examples of Proposition 98 in California, which included rent control restrictions, and Proposition 90, which included "regulatory takings" provisions (these limit government ability to adopt new regulations). Understandably, those additions saw off the liberal wing of the eminent domain reform coalition. "By contrast," he says, "all twelve 'clean' anti-Kelo measures have passed, usually by lopsided margins..."  The Institute for Justice, however, does push "regulatory takings" provisions. To its credit, it did not demand them as a price for defending Initiative 31 in court.

With the passing of Initiative 31, Mississippi has given subsidy opponents leverage as well as protecting property owners from having to transfer their property to private developers, which often translates into an additional subsidy.

Tuesday, November 8, 2011

Republicans Prepare Ground to Renege on Debt Reduction Agreement

Looks like Markos Moulitsas was right, as I suspected. Ali Gharib is reporting at Think Progress Security that Congressional Republicans, including Senators John McCain and Pat Toomey, are laying the groundwork for weaseling out of the August debt ceiling accord provisions that if the Super Committee reaches no agreement, it triggers $600 billion in defense cuts over 10 years. Gharib quotes McCain yesterday (emphasis Gharib's):

The sequestration is not engraved on golden tablets. It is a notional aspiration. And those of us — and I think we’d have sufficient support to prevent those kind of cuts from being enacted because of the impact it would have on national security.

We are looking at a stand-alone bill to negate what Republicans supposedly gave up in the debt ceiling negotiations, canceling the $600 billion in defense cuts. If it passes, Democrats will have given up $600 billion in cuts to domestic programs -- for exactly nothing in return. Yet another Lucy pulls away the football moment. Gharib recommends that President Obama issue a veto threat against such a bill now, but it's not like $1.5 trillion in cuts is good policy in a jobs recession. But Gharib may be right, on the grounds that the President needs to hold Republicans to their deals. Will the President hold his ground? Get ready for the cries of "You don't support the troops."

How Transfer Pricing Hurts the Middle Class

One of the basic building blocs for understanding the effect of tax havens is the mechanism by which profits show up in the havens rather than the countries where they are really earned. This tool is known as “transfer pricing,” which at its most basic is simply the centralized setting of prices for transactions between two subsidiaries of the same company. The fact that intra-corporate sales make up much of world trade (estimates range between 33% and 60%) means that how the prices are set can have a huge economic impact.

When one subsidiary of a multinational company sells something to another one, the price for the good or service is not set in a market. A Ford transmission will not work in a Chevrolet, so there is no independent buyer for products like that. But for Ford Motor Company to know how well its various entities are doing, it has to have prices attached to intra-corporate sales. The pricing system is centralized, and can be used for multiple purposes; the most interesting for our purposes is shifting profits into lower tax jurisdictions. The charts below show how this works. In the example, it is the price of the transmission that is set via transfer pricing for the sale of French-made transmissions for use in final assembly in the U.K. All numbers are arbitrary.

Ford France

Ford UK

Price of car
Price of transmission
Price of transmission
Cost of production
All other costs
Pre-tax profit
Pre-tax profit
Tax at 40%
Tax at 20%
Post-tax profit
Post-tax profit

Total post-tax profit: $1900

Ford France

Ford UK

Price of car
Price of transmission
Price of transmission
Cost of production
All other costs
Pre-tax profit
Pre-tax profit
Tax at 40%
Tax at 20%
Post-tax profit
Post-tax profit

Total post-tax profit: $1980

We have the same car, the same final selling price, the same cost of production, the same pre-tax profit. But by reducing how much Ford France charged Ford UK for the transmission, profit was shifted into the lower tax country (in this example, the UK). Post-tax profit increased by the change in sales price ($400) times the difference in the tax rate (20%).

Of course, it is not like tax authorities don't know that shenanigans like this can arise. But it can be hard to detect it even if you're looking for it. Richard Caves' Multinational Enterprise and Economic Analysis provides a good overview of many research studies, which have found that it easier to get away with abusive transfer pricing when there is no real arm's length market for the good. For example, there is obviously a large market for spark plugs, so it's relatively easy to see if the price a company assigns for their sale between subsidiaries makes sense. On the other hand, there is frequently no market for a company's patents, because it often does not want to license them to other firms because they are a source of competitive advantage. That explains why Microsoft put patents in an Irish subsidiary where the royalties are untaxed: there is no good way to determine if the prices charged to other subsidiaries for their use is a reasonable one or not.

We see, then, that by a relatively simple mechanism a company can make its profits show up in lower tax jurisdictions. As previous columns discussed, most multinationals have a substantial network of subsidiaries in tax havens to reduce the taxes they pay in the U.S. and other developed countries. Their reduction, of course, means higher taxes for us, higher deficits, program cuts, or some combination of the three.

My next post will deal with how to combat tax havens.

Monday, November 7, 2011

How Profitable Fortune 500 Companies Save $70 Billion a Year in Taxes

A new report by Citizens for Tax Justice and its sister organization, the Institute for Taxation and Economic Policy (h/t Dirt Diggers Digest), documents the extent to which the Fortune 500 is able to skate around the tax system and pay far less than its fair share. The study covers 280 firms in the F500 that had pre-tax profits in the U.S. every year from 2008 to 2010, excluding companies that reported "ridiculous" geographic allocations of their pre-tax profits

Between subsidies, stock options, indefinite deferral of taxes on income earned abroad, apparently abusive transfer pricing, skillful use of tax havens, and aggressive tax shelters (which can only be identified after the fact), these companies reduced the amount of their global income that was taxable in the United States, and slashed the amount paid on their U.S. taxable income by over $70 billion per year. That is, the difference between what these companies would have paid at the 35% corporate income tax on their $1.4 trillion in U.S. profits over those three years, and what they actually paid, came to $222.7 billion.

This only scratches the surface. Note that this is only the companies' U.S. income--which has already been reduced by transfer pricing, making profits show up in low-tax foreign jurisdictions. The report singles out Google and Microsoft because "almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States." In Microsoft's case, as I report in my latest book, one of its subsidiaries in Ireland had $16 billion in patent assets but almost no employees, draining royalties from the U.S. to Ireland for booking purposes. U.S. companies do not pay taxes on their foreign earnings until they are brought back to the United States. As the CTJ/ITEP report points out, if the U.S. stopped taxing foreign earnings, as for example, Herman Cain and Rick Perry advocate, this would create even bigger incentives to declare profits overseas rather than in this country.

Considering U.S. taxes only, the report shows that 30 companies paid negative tax rates on their 2008-10  domestic income, with General Electric having negative taxes in all three years, receiving $4.7 billion in tax refunds despite $10.5 billion in U.S. pre-tax income.

As I have emphasized repeatedly, what one group does not pay in taxes means higher taxes on others, greater deficits, or budget cuts. One way or the other, those of us who do pay our taxes are harmed by those who do not. This report does a great job spotlighting the worst offenders. In posts in the near future, I will discuss how transfer pricing works, and ways to tackle tax havens.

Tuesday, November 1, 2011

Poll Results: Anti Counterfeiting Trade Agreement

The poll is now closed.

Had you heard of the Anti Counterfeiting Trade Agreement (ACTA) before today?

Yes: 1
No: 9

No surprise here; the agreement is not well known. But as I argued in the related post, this treaty, if it withstands constitutional challenge, will increase the cost of medications in many countries by taking away the ability of government health agencies to negotiate with drug companies for lower prices.

Tax Havens Cost the Middle Class Untold Billions

As I argued yesterday, when taxes are reduced for one group, government must raise taxes on someone else, run bigger deficits, or cut programs. Tax havens, jurisdictions with strong secrecy provisions and low or zero tax rates, are one way that rich individuals and corporations reduce their tax payments, both legally and illegally. A recent book by Ronen Palan, Richard Murphy, and Christian Chavagneux summarizes the latest work on tax havens and contends that they form a central part of the global economy. Tax Havens: How Globalization Really Works presents data that 30% of multinational corporations' foreign direct investment passes through tax havens like Bermuda, Ireland, or Luxembourg, overwhelmingly for tax purposes. Tax havens, then, are far more central to the global economy than we generally suppose.

How much does this cost average taxpayers? In a separate report, Murphy calculated that wealthy individuals have roughly $11.5 trillion in tax havens, which at a 7.5% rate of return would generate $860 billion in income each year. If, on average, these people faced a 30% marginal tax, that would come to $255 billion annually that the rich avoid in taxes. Needless to say, this is a best guess, since the value of these assets is not disclosed publicly. See his report for more details on how he generated those figures.

That's just individuals. The situation with corporations is murkier still. While corporations set up subsidiaries in tax havens for the obvious purpose of reducing their tax, Palan et al. say there is no solid estimate of the overall cost of these activities. The Government Accountability Office reported in 2008 that of the largest 100 U.S. companies, 86 had subsidiaries abroad, and 83 of these had subsidiaries in tax havens. Bank of America had 115 subsidiaries in tax havens, including 59 in the Cayman Islands. Citigroup had a whopping 427 tax haven subsidiaries, including 91 in Luxembourg and 90 in the Cayman Islands. Goldman Sachs only had 29, 15 in the Cayman Islands.

I mention the Cayman Islands because President Obama has long been a critic of tax havens, saying during the 2008 campaign of Ugland House in the Cayman Islands, "Either this is the largest building in the world or the largest tax scam in the world. And I think the American people know which it is." Palan et al. report that the Caymans are the sixth largest financial center in the world, with $1.9 trillion in assets in December 2007. However, since taking office, the President has not succeeded in passing a version of the Stop Tax Haven Abuse Act, which in its original form he co-sponsored with Carl Levin, Norm Coleman, Ken Salazar and Sheldon Whitehouse.

Tax havens could not exist without the financial services industry, which provides the tax lawyers, accountants, and other professionals who make it possible for the rich and corporations to reduce their taxes. Collectively, they and their clients are the 1%. Occupy Wall Street has highlighted the abuses benefiting them, and tax havens are most definitely part of their pattern of abuse. Tax havens have proved amazingly resilient, however, and it will take sustained political pressure to shut them down.

Sunday, October 30, 2011

How to Read a Republican Tax Proposal

We've been hearing about Herman Cain's 9-9-9 Plan for a few weeks and now Governor Rick Perry has released his tax proposal, supposedly a 20% flat tax. We will undoubtedly hear more as the Presidential campaign kicks into higher gear. As a public service, I am providing a simple way to understand the impact of these tax plans.

Step 1: Assume revenue neutrality.

Don't laugh; Cain's “9-9-9 Scoring Report” claims to be revenue neutral and Perry says he will keep federal revenue at 18% of gross domestic product

Step 2: Look at what income is no longer taxed.

For example, the 9-9-9 Plan “features zero tax on capital gains and repatriated profits,” eliminates the estate tax, and cuts the corporate income tax from 35% to 9%, while Rick Perry's tax plan eliminates taxes on capital gains, dividends, Social Security, estates, repatriated profits, and cuts the corporate income tax from 35% to 20%.

Step 3: Determine how much of that income you have.

If you're not rich, you've got very little of it, except Social Security in the Perry plan. If you're not retired, you'll get virtually no reductions under either plan.

Step 4: Ask what taxes have to be raised to get to revenue neutrality.

Step 5: Look in the mirror to see who pays them.

Comments: As I argued in Competing for Capital, if you cut one group's tax burden, one of three things has to happen to offset the reduction: someone else's tax burden increases, government runs higher deficits, or programs must be cut. If you maintain revenue neutrality, the first of these options is the only one possible, as flat tax pioneers Robert Hall and Alvin Rabushka admitted as far back as 1983: “It is an obvious mathematical law that lower taxes on the successful will have to be made up by higher taxes on average people” (h/t James Carville, We're Right, They're Wrong).

But in fact, Perry's proposal clearly is not revenue neutral. How could it be, when people have the option of filing under the current tax system or his new system? People who would pay more under the new plan would pay under the old plan and people who would save money under the new plan would pay under the new plan: this necessarily means less revenue. Rich people would save quite a bit of money, as Seth Hanlon at Think Progress has shown. Using published tax returns of famous people and the tax form on the Perry website, he shows that Warren Buffett's tax rate would fall from 11% to 0.2%, former Vice-President Cheney's rate would drop from 19.1% to 6.4%, President Obama would get a $60,000 tax cut, and Governor Perry's rate would fall from 18.6% to 15.8%.

Similarly, Cain's 9-9-9 Plan would raise far less than current taxes do, even as it increases taxes on the middle class and the poor. Michael Linden at Think Progress estimates that it would only bring in 14% of gross domestic product, well below the current low revenue that's giving us a $1 trillion deficit. In addition, many analysts think his corporate income tax is actually a value-added tax in disguise (h/t Michael Linden).

 The bottom line is that if we cut taxes for the wealthy and corporations, it will impact the budget elsewhere, in some combination of tax increases on the middle class, program cuts, and deficit increases. Regardless of the spin surrounding these and other tax plans that may come down the pike, if a proposal reduces some taxes but doesn't reduce your taxes, you will lose out via these three methods of compensating for the lost revenue.

Saturday, October 29, 2011

Great catch by Yglesias on U.S. intellectual property bullying

In the middle of a fairy tale about how trade deals are a vehicle for overcoming special interest opposition to foreign competition, Matt Yglesias hits on what he sees as the exception, but is actually the rule:

But over the past 10-15 years, I think we’ve gotten saddled with a pretty fallen and perverse version of it. The trade deal was supposed to be a political vehicle for overcoming special interest politics, but it’s really just become another venue for interest group politics. Read, for example, this account of U.S. efforts to use trade agreements to coerce foreign governments into paying higher prices for pharmaceutical products.
Matt was in high school when the Uruguay Round trade agreement was signed in 1994, so it's understandable why he's overlooking how the U.S. pharmaceutical, entertainment, publishing, and software industries created the so-called Agreement on Trade-Related Aspects of Intellectual Property. Still, he really should read Susan Sell's Private Power, Public Law to see how industry placed such draconian laws into the TRIPS agreement that even free-trade icon Jagdish Bhagwati harshly criticized it in In Defense of Globalization as a terrible deal for developing countries. Agreeing to TRIPS, as noted by Sell, was what developing countries had to give up to get industrialized countries to end their hypocritical quotas on textile exports from developing countries, the Multi Fiber Agreement.

The new example in Matt's link of bullying by intellectual property industries concerns the Trans Pacific Partnership, which would ban government health services from negotiating prices with pharmaceutical companies. This follows on the Anti Counterfeiting Trade Agreement, which requires countries to institute criminal penalties for all kinds of counterfeiting, while nowhere mentioning "fair use." The U.S. Trade Representative is claiming the executive branch can enter into without Congressional action, something disputed by Senator Ron Wyden. NAFTA and the Uruguay Round agreement (which created the World Trade Organization) were both passed as legislation in the U.S., as opposed to being considered treaties requiring a 2/3 vote in the Senate. ACTA has not been considered by Congress at all, even though it is obviously an international agreement.

TRIPS lengthened patent terms around the world, including in the U.S. (from 17 to 20 years), something Congress had repeatedly voted down when considered on a stand-alone basis. But in the all-or-nothing "fast track" procedure used for the Uruguay Round legislation, Congress had no choice but to accept it if it wanted the other parts of the agreement. With the ACTA and now TPP negotiations, the pharmaceutical and other industries are trying to make it impossible to undo their gains from TRIPS.

Tuesday, October 25, 2011

Forbes 400 has collected plenty of subsidies

Dirt Diggers Digest has a good post up about how various members of the Forbes 400 have received plenty of government subsidies. Echoing Elizabeth Warren, Phil Mattera writes:

Accumulating a great fortune requires, among other things, a legal system oriented to property rights, a tax system biased in favor of investment income, and government spending on infrastructure ranging from interstate highways to the internet.

 He gives numerous examples of how the 1% have received subsidies on top of these general government provisions. Bill Gates' Microsoft received $32 million in Texas for a data center in Bexar County. Warren Buffett's General Re, an insurance company owned by Berkshire Hathaway, got $28.5 million in various subsidies simply to relocate from one place in Stamford, CT, to another, creating no new jobs. Michael Dell's self-named firm got $242 million (nominal value) from North Carolina for a computer manufacturing facility which closed less than five years later.

As I show in my report for the Global Subsidies Initiative, "Investment Incentives: Growing Use, Uncertain Benefits, Uneven Controls" (free download), Dell received millions more in the U.S. and Canada for call centers, most if not all of which are now closed. The company received millions more in Europe, including a controversial 54.5 million euro subsidy to relocate its computer manufacturing from Ireland to Poland in 2009. (Subsidized relocations are a rarity in the European Union, and I was shocked that the European Commission approved this; when I spoke to them in Brussels in January on my book Investment Incentives and the Global Competition for Capital, most of the Q&A was about my criticism of their decision.)

Mattera gives many more examples, even though he only gets down to #18 of the 400. His basic point is on the money: the richest Americans have exploited government subsidies both here and abroad to grow their fortunes, and the 99% are right to be upset about it. As I've emphasized before, we could more than pay for all government layoffs at the local and state level if we could find a way to end these giveaways.

Thursday, October 20, 2011

The Selling of Trade Agreements from NAFTA to Today

With last week's passage of three trade agreements (Colombia, Panama, and South Korea), and spurred by Suzy Khimm's article on the Korea trade deal, I was reminded of the storm of numbers proponents of NAFTA threw out there in the run-up to its approval.

Gary Hufbauer and Jeffrey Schott, described by the New York Times (2/22/93; no link but available on Lexis-Nexis) as "the two most influential academic experts on the North American Free Trade Agreement," wrote a book entitled NAFTA: An Assessment in 1992, with a second edition in 1993 (all references below are to this edition). They predicted that the U.S. would gain 170,000 jobs by 1995.

This work struck me as flawed for a number of reasons. In the first place, it was odd that two economists would write about the winners and losers from NAFTA without making any reference to the economic theory on the subject, such as the Stolper-Samuelson Theorem (see below). Second, the authors did computer simulations of the effect of the agreement that said in their long-run scenario (Table 2.1, p. 16) that we would gain low-skill jobs and lose high-skill jobs, pretty much the opposite of what you would expect based on economic theory. I questioned what assumptions would be necessary to get that result. Finally, the book assumed that the U.S. would have a merchandise trade surplus with Mexico, "$7 billion to $9 billion annually through the 1990s, and perhaps $9 billion to $12 billion annually in the following decade" (p. 15) They held this view even though the authors showed on on page 4 that the Mexican peso was overvalued. If the value of the peso were to fall, Mexican goods would become cheaper in the U.S., while American products would be more expensive in Mexico, completely upending the likelihood of a U.S. trade surplus. As we know, the peso fell sharply in the December 1994 "tequila crisis," and the U.S. has had a trade deficit with Mexico ever since. See the table for details.

U.S. Goods Trade Balance with Mexico ($billions)

Year                                  Amount

1985                                    -5.5
1986                                    -4.9
1987                                    -5.7
1988                                    -2.6
1989                                    -2.2
1990                                    -1.9
1991                                    +2.1
1992                                    +5.4
1993                                    +1.7
1994                                    +1.3
1995                                   -15.8
1996                                   -17.5
1997                                   -14.5
1998                                   -15.9
1999                                   -22.8
2000                                   -24.6
2001                                   -30.0
2002                                   -37.1
2003                                   -40.6
2004                                   -45.2
2005                                   -49.9
2006                                   -64.5
2007                                   -74.8
2008                                   -64.7
2009                                   -47.8
2010                                   -66.4
Jan-Aug 2011                     -44.8

Source: Census Bureau

So much for that prediction. According to the then-fashionable claim that $1 billion in net trade surpluses created 19,600 jobs, the fact that the trade deficit worsened from $1.9 billion in 1990 to $74.8 billion in 2007 ($72.9 billion deterioration) implies a loss of 1.4 million jobs at its worst point. This number should be taken with a grain of salt, but it is in one sense what we expect. Still, it's only about 1% of the labor force, though we could certainly use the jobs now. But the effect on labor may have been worse, because the expanded option for companies to relocate to Mexico made it possible for them to threaten their workers with job loss and thereby hold down their wages. Kate Bronfenbrenner of Cornell's Institute for Labor Relations found that shutdowns became much more frequent after NAFTA (15% vs. 5% in the late 1980s) during labor organizing and contract campaigns.

At the same time, a contradictory prediction also failed to hold up. Wolfgang Stolper and Paul Samuelson argued that the expansion of trade was good for a country's abundant factors of production (they are land, labor, and capital) because of added markets abroad, but bad for scarce factors of production because of competition from abroad. Here, "bad" means reduction in real (inflation-adjusted) income. The U.S., which is not densely populated by world standards, is thus labor scarce but abundant in land and capital. My expectation was that NAFTA would therefore lead to lower real income for labor. In fact, however, weekly earnings for nonsupervisory workers in the private sector, which fell from a peak of $341.83 (constant 1982-84 dollars) in 1972 to a low of $266.46 in 1992, have risen ever since, despite the NAFTA and WTO agreements, hitting $284.79 in 2000 and $297.31 in 2010, according to the Economic Report of the President 2011, Table B-47. Of course, we are still $44.52 1982-84 dollars below the peak, or about $95.25 per week in 2010 dollars.

While obviously we see plenty of economic misery today, I'm curious why the trend on this measure, which Bill Clinton brilliantly politicized with "It's the Economy, Stupid," has reversed course, and how it relates to other measures of labor income. Perhaps there is a better measure of wages out there, or perhaps inflation is currently underestimated (there was a huge campaign in the mid-1990s claiming it was overestimated; maybe the Bureau of Labor Statistics paid too much attention to critics), which would overstate real income. Let me know what you think in the comments.

As for the three new trade deals, they are being sold with squishy job projections, just like NAFTA was. While Khimm's interviewees are probably right that the deals' effect on labor will be small, I still think we should go with the Stolper-Samuelson expectation that the effect will be negative.

Sunday, October 16, 2011

Occupy Wall Street points in the right direction

The Occupy Wall Street movement has gotten plenty of press and I've sometimes wondered what I can add to the conversation. But I've decided that it is worth echoing that they are pointing in the right direction regarding how we got into the economic mess we're in. To hear many conservatives tell it, the 2008 financial crisis was caused by the Community Reinvestment Act (CRA), Fannie Mae, Freddie Mac, and ACORN. There is a huge analytical problem with this narrative, though: the financial crisis was a change in outcome, and these supposed wrongdoers had all been around for decades. If the cause doesn't change, it can't be the cause of a changed outcome. We have to look somewhere else for what changed.

The CRA was passed in 1977. Fannie Mae was founded in 1938. Freddie Mac was founded in 1970. The ACORN Housing Corporation, now known as Affordable Housing Centers of America, was founded in 1986. Their existence cannot be what caused a financial crisis 22 years after the last of them (and 70 years after the first of them) was founded. Something had to change.

What changed, of course, was bank regulation and securitization. Laws keeping banks from taking on excessive risk, like the Glass-Steagall Act, were targeted by financial firms and eventually repealed. During the housing boom, private loan originators chopped up mortgages into mortgage-backed securities (MBS), and these mortgages had much greater delinquency and default rates than the ones Fannie and Freddie issued. (F&F did buy some of these securities, but they were not the main player even in that role.) As David Min shows (h/t Paul Krugman), even the riskiest of F&F loans had "serious delinquency" rates in the 2nd quarter of 2010 of under 10.5%, whereas subprime mortgages had a serious delinquency rate over 28%. Private actors got the rules changed in their favor, and dramatically increased their risk-taking to earn huge personal incomes, and the taxpayer bailed them out when it all went bust.

This brings us back to Occupy Wall Street. In the group's "Declaration of the Occupation of New York City," we see that OWS identifies the problem as corporations running government and subverting democracy. As Robert Creamer points out, for OWS politicians are only the problem insofar as corporations (especially on Wall Street) control them. The repeal of bank regulation came about through a decades-long campaign based on political contributions and influence by Wall Street firms. This process is what the Occupy Wall Street manifesto highlights. Occupy Wall Street puts the spotlight on private sector power and greed and demands a change. OWS's manifesto also points out the efforts of corporations to take away employee rights and to use outsourcing to reduce pay and benefits. In a future post, I will discuss the decline of real income in much more detail. It has led to a greater need for two-income families, and then an increase in family debt, in order to maintain a standard of living that was possible on one middle-class income in the 1970s.

I'll close for now with some words from one of my favorite books, Charles Lindblom's Politics and Markets (1977). They could easily have been in the Occupy Wall Street manifesto: "The large corporation fits oddly into democratic theory and vision. Indeed, it does not fit."

Wednesday, October 12, 2011

Almost all government layoffs are local, but could be paid for by cutting subsidies

Sometimes I feel like a broken record, but it really can't be emphasized too often: state and local subsidies to business have noticeable negative effects on government finances,which are magnified in times of fiscal crisis like the present.

As Kash Mansori points out (h/t Mark Thoma), of the 532,000 government jobs lost from September 2009 to September 2011, fully 470,000 are at the local level.
Source: Kash Mansori, The Street Light

My research suggests that state and local governments give almost $50 billion per year in location incentives to business, and about $70 in total business subsidies. My best guess is that about half of it is at the local level, meaning $25-35 billion per year comes from local governments. It's easy to see that that much money could pay to rehire all those teachers, police, and  other local government workers, and maybe have money left over. At the top end of the estimate, $35 billion could hire half a million workers earning $70,000 a year in salary and benefits, or 700,000 making $50,000 per year.

Make no mistake: we can't just wish state and local subsidies away. Companies leverage their mobility to extract tax breaks (and, increasingly, grants) from governments that need tax revenue and economic activity. But it's impossible to build a politics to oppose these giveaways unless we can document their extent and show what it really is we're giving up when governments award subsidies. Mansori says local budgets are being balanced on the backs of schoolchildren; it would be equally correct to say that local subsidies are paid for out of school budgets, on the backs of teachers and students alike.

Monday, October 10, 2011

Great reporting in Albany highlights growing trend towards use of cash grants by states

The Times-Union in Albany, New York, has a great series up on the $1.1 billion (present value) incentive package given to Global Foundries (formerly Advanced Micro Devices) in Malta, New York, near Albany. Coming so soon after the Commercial Appeal series on Electrolux's move to Memphis, I am hopeful that we will continue to see more in-depth analyses of large incentive deals around the country.

This facility received the largest-ever cash grant given by a state or local government to attract an investment, as I determined in my research for Investment Incentives and the Global Competition for Capital. In terms of total value, it was second only to Boeing's $1.98 billion package from state and local governments in Washington. But AMD/Global Foundries highlights a new trend in the evolution of U.S. subsidy patterns. Historically, the vast majority of incentive packages in this country were made up of tax breaks, and cash was a negligible part of the equation. By contrast, in Europe, cash grants have long been the main form of subsidies for new investment, although tax incentives have frequently been used as well. As I explained in Competing for Capital: Europe and North America in a Global Era, this supported the European Commission's goal of having subsidies given as transparently as possible.

AMD/Global Foundries is the largest cash grant given, but it is safe to see that we are seeing a trend toward growing use of cash grants by state governments. Nucor's deal with Louisiana last year foresees up to $160 million in cash grants to the company if it meets all its expansion and job targets. Reporters in several states have told me they are seeing more cash grants. A shift from tax break to cash grant means that the true size of the incentive is growing, since the present value of cash is obviously higher than that of an equivalent nominal tax break spread over a number of years. When states are dealing with huge budget deficits, the last thing we need is for incentive packages to keep growing larger.

Based on my research, the Times Union also points out that New York state is paying a lot more per job than other states for similar fabrication facilities. By my calculation, AMD/Global Foundries received $927,000 per job for its facility there. By contrast, Samsung in Texas received only $190,000 per job and Hemlock Semiconductor in Michigan got $248,000 per job in 2007 (all calculations at present value, not nominal value). Moreover, New York paid 35% of the cost of the project, whereas Texas only paid 4% of Samsung's costs, and Michigan paid 12% of Hemlock Semiconductor's costs.

The case that New York is overpaying is strengthened when we compare what Germany has had to pay to get plants from the exact same company, AMD/Global Foundries. In 2004, the European Commission approved a subsidy worth 22.67% of the investment or $710,000 per job (at 1 euro=$1.35), significantly lower than New York but in the same order of magnitude. However, after rule changes that cut the maximum subsidy for large projects, the Commission only approved an 11.9% subsidy for AMD in 2009 and a 10.83% subsidy for Global Foundries earlier this year (no job data available in the decisions). You can search for all EU state aid cases here.

Again, kudos to the Times Union, and I hope more newspapers are willing to devote resources to documenting the large cost of subsidies such as these when state governments are suffering huge deficits.