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Saturday, July 19, 2014

Corporate "Inversions" Shift the Tax Burden to Us

Corporate "inversions" are back in the news again, as multinational corporations try every "creative" way they can to get out of paying their fair share of taxes for being located in the United States. With inversions, the idea is to pretend to be a foreign company even though it is physically located and the majority of its shareholders are in the U.S.

"What's that?" you say. At its base, what happens with an inversion is that a U.S. corporation claims that its head office is really in Ireland, the Cayman Islands, Jersey, etc. Originally, all you had to do was say that your headquarters was abroad. Literally.

Now, the rules require you to have at least 20% foreign ownership to make this claim, but companies as diverse as Pfizer, AbbVie, and Walgreen's are set to run rings around this low hurdle. The basic idea is that you take over a smaller foreign company and pay for it partly with your own company's stock to give the shareholders of the foreign takeover target at least a 20% ownership stake in your company.

Thus, with pharmaceutical company AbbVie's takeover of the Irish company Shire (legally incorporated in the even worse tax haven Jersey), Shire's shareholders will own about 25% of the new company, thereby qualifying to take advantage of the inversion rules. It expects that its effective tax rate will decline from 22.6% in 2013 to 13% in 2016. Yet nothing will actually change in the new company: it will still be headquartered in Chicago, and the overwhelming majority of shareholders will be American.

As David Cay Johnston points out, even some staunch business advocates like Fortune magazine are calling this tax dodge "positively un-American." Further, as he notes, Walgreen's wants to still benefit from filling Medicare and Medicaid prescriptions even if it ceases to pay much in U.S. corporate income tax. In other words, it will get all the benefits of being in the U.S., including lucrative government contracts, without paying for the costs of government.

As I told The Fiscal Times, if companies like these get their tax burden reduced, there are only three possible reactions that can occur: someone else (i.e., you and me) will pay more taxes; the government must run a higher deficit; or government programs must be cut. Of course, there is a limitless number of combinations of these three changes that can result, but one or more of them has to happen.

What can we do about this? One obvious answer to to raise the bar for foreign ownership to at least 50%+ to call a company foreign. Even more comprehensive, as reported by Citizens for Tax Justice, would be to continue to consider a company "American" for tax purposes as long as it had "substantial operations" in the United States and was managed from the United States. Furthermore, the Obama Administration has proposed limiting the amount of deductions American companies can take for interest paid on loans "from" their foreign subsidiaries, thereby preventing what is often called "profit stripping." Another idea, from Senator Bernie Sanders, would be to bar such companies from government contracts.

The whole concept of "inversions" no doubt sounds very arcane to the average person. But one of the bills to rein them in is estimated to raise $20 billion in tax revenue over the next 10 years. The stakes are substantial, so we need to take a minute to wrap our head around it if we want to head off yet another way in which the tax burden is shifted to the middle class.

Cross-posted at Angry Bear.

Tuesday, July 15, 2014

Piketty on the minimum wage

A lot going on with the minimum wage lately, but I will contextualize it first with Thomas Piketty's analysis in Capital in the Twenty-First Century, pp. 308-313. I'll have more to say about other parts of the book later, but for now it's important to remember that one of the keys to the book's success is that it is built on a gigantic trove of long-term data. His French wealth data, for example, goes all the way back to the immediate aftermath of the French Revolution! (Speaking of which, it's Bastille Day as I write this.)

Piketty writes in this section about increasing labor income inequality in the United States and the importance of labor market institutions in affecting wages in the medium term even as education (though see Jeff Faux's dissent in The Servant Economy) and technology are the keys to the long-run wage possibilities. He counterposes the steady increase in the real (i.e., inflation-adjusted) value of the French minimum wage since 1950 to the decline of the real U.S. minimum wage since it peaked in 1969 at $10.10 in 2013 dollars. At $7.25 today, it is a full 28% below its peak, and 1/3 less than the current French minimum wage at purchasing power parity in 2013 (see, search "data by theme" and select "labour," then "earnings," then "real minimum wages," and set the series to "US$PPP" and the pay period to "hourly.")

This decline of the real value of the minimum wage is why Piketty argues that an increase in the U.S. would make sense, much more so than in France. At this low level, there is much less danger of a negative impact on the number of jobs. His key insight is that if wages are too low, that itself causes economic inefficiencies and can even create inefficiencies for the firm. In particular, if wages are too low, it can cause workers to acquire fewer firm-specific skills than would be optimal for the employer. This would seem to hold economy-wide as well: if the general wage level is too low, workers have less incentive to acquire skills that would make them and the economy as a whole more productive. Additionally, Piketty argues that employers' superior bargaining position and the absence of "pure and perfect" competition in labor markets justifies the limits on companies' power embodied in the minimum wage.

The minimum wage has also been in the news this month. The biggest story is that for the first time Germany has adopted a minimum wage effective in 2015, set at €8.50 ($11.60) an hour. This was the price Angela Merkel had to pay to bring the Social Democratic Party into her governing coalition. In addition, the minimum wage in the future will be set by a national commission made up of labor and business representatives.

Finally, a new study by the Center for Economic Policy Research finds that the 13 states that raised their minimum wage on January 1 had higher rates of job growth (0.99% vs. 0.68%) through May 31 than the 37 states that did not raise their minimum wage. While the study does not claim to be definitive, it is one further piece of evidence that the minimum wage is not a job killer at the levels seen currently in the United States.

Cross-posted with Angry Bear.