Chess Break

I'm playing  in a chess tournament this weekend, so I won't have any new posts until it's over. I will be checking in to moderate comments, though.

Ireland's Recent Success Not Built on Low Taxes

As we survey the wreckage of the Irish economy (14.3% unemployment rate in July, average July interest rate of 12.45% vs. Germany's 2.74%), it's worth remembering that not so long ago, Ireland was lauded as a miracle economy we could all learn lessons from. But many people have drawn the wrong lessons from Ireland's success in the 1990s and early 2000s, in particular by claiming that low taxes were a major cause of Ireland's dramatic growth.

One important example of this comes from Sean Dorgan, who was head of Ireland's Industrial Development Authority, now known as IDA Ireland, until 2007. He wrote a “backgrounder” for the Heritage Foundation in June 2006, in which he emphasized free trade, low taxes, and investment in education as the keys to “le(aving) behind” Ireland's “past of declining population, poor living standards, and economic stagnation...”

OK, so the US is currently doing everything possible to reduce investment in education, especially by going after teachers' unions and cutting K-12 and university spending. It doesn't measure up against what was publishable at Heritage just 5 years ago. (And heaven forbid we should adopt Heritage recommendations from the 1980s, like the individual mandate!). At least we've got free trade and low taxes. But what did they do for Ireland?

As I show in my book, Investment Incentives and the Global Competition for Capital, the answer for the first 30 years of low-tax foreign investment attraction (1958-87) was “Not much.” Ireland grew modestly, but it did not grow any faster than the average of the first 15 European Union members (the EU-15). Ireland started out with a 0% tax on foreign multinationals export profits, which of course was virtually all their profits. After Ireland joined the European Union in 1973, it had to get rid of that export subsidy, but replaced it with a mere 10% tax on manufacturing starting in 1983. Yet by 1987, unemployment was 16.8% even though about 27,000 people, almost 1% of the population, were leaving annually (net emigration).

Things started changing in 1987. In that year, Ireland inaugurated a “Social Partnership” of government, capital, and labor, which cut the budget sharply, but also traded lower personal income taxes for wage restraint, leading to after-tax wage gains that were larger than the pre-tax gains. In 1988, the European Union sharply increased the money going into the Structural Funds, which paid for infrastructure, training, and investment attraction. Ireland's allocation equaled 2.5-3.0% of its gross domestic product throughout the 1990s. Several officials I interviewed in March 2009 argued that the EU's “Single Market” program (1985-92) helped the country substantially by giving it better access to the continental European market by reducing other countries' use of subsidies and restrictive government procurement rules.

Then, of course, there was education. Ireland made high school free in 1966; later, the country built several new technological universities. Finally, many observers see Ireland as having gotten lucky by achieving the preconditions for growth just as the world economy began a growth and foreign investment boom in the 1990s.

In the 50+ years Ireland has spent using low corporate income taxes (and high investment subsidies) to attract investment, the country has seen both failure and success. In fact, corporations faced a higher tax rate in the Celtic Tiger years than during the slow-growth era (10% vs. 0). For the very reason that both success and failure accompanied the low tax rates, we can conclude that tax rates cannot explain success: we need something that was present during the boom years but not the slow-growth years. Education, infrastructure, training, and the Social Partnership are the most plausible explanations.

The right lesson to draw in the U.S., then, is that we need to resist the drumbeat for lower corporate income taxes, which in 2008 (the latest year for complete OECD data) came to 1.8% of U.S. GDP versus an OECD average of 3.5% (in most recent years, the difference is smaller, but the U.S. is consistently below average). Similarly, rather than reward corporate tax scofflaws for hiding their money in tax havens with a “one-time” low rate on repatriated profits, we should move away decisively from tax deferral for overseas profits.

I'll have more to say about tax havens in future columns.

Entitlement Programs are the Target of this Downgrade

The following is a special comment by Timothy J. Sinclair, of the UK's University of Warwick. He is the author of The New Masters of Capital (Cornell University Press, 2005) and numerous articles on the credit rating agencies.

What should we make of the decision by Standard and Poor's to apply a
modest downgrade to the US sovereign rating? Outside America this seems
to have been greeted as a recognition of reality, of America's changing
position in the world, although a very unwelcome one given the many
other problems faced by people in Europe, Japan and elsewhere at this
time. There is no doubt that the global financial crisis challenged
America's corporate and government institutions like nothing since the
Great Depression of the 1930s. These organizations have not responded as
effectively as we might have wished. To me, this is hardly surprising
given almost three decades of erosion by partisan forces determined to
roll back the frontiers of state intervention in the US. Part of this
domestic effort to degrade the American government has been determined
attempts to sabotage public finance starting in the Reagan era. The idea
seems to have been to stimulate public outrage at efforts to make the
books balance via tax increases, so as to force elected officials to
reshape government itself. I interpret the S&P downgrade as another
effort to hold America's 'feet to the fire' and force policy change in
the US, to make a public crisis out of the fiscal deficit. Predictably,
this means the gearing up of a budgetary assault on the welfare programs
created by President Johnson and his successors. Medicare as you know it
today will be the ultimate victim of the bankers' folly.

Timothy J. Sinclair
University of Warwick

S&P Downgrades U.S. Debt

As you have probably heard by now, Standard and Poor's has downgraded U.S. debt one notch from AAA to AA+ with a negative outlook. This will be bad for the country because it will likely increase borrowing costs; in turn, this is bad for the middle class because it increases the deflationary pressures on the government.

The go-to analysis of the rating agencies in political science is the work of Timothy Sinclair of the University of Warwick, especially his book The New Masters of Capital (Cornell University Press, 2005). (Disclosure: he and I co-edited Structure and Agency in International Capital Mobility, Palgrave, 2001, and have known each other for over 15 years.)

Sinclair argues that credit rating has become a form of "private regulation," which governments have had to pay increasing attention to since the rapid internationalization of financial markets. This regulatory power is based on the agencies' perceived expertise, which comes into occasional question after spectacular failures like Enron (analyzed in his book) or the 2008 financial meltdown but persists after those analytical disasters.

As Sinclair has long argued, the role of the agencies is not neutral politically. They have pushed for market liberalization in Latin America, put enormous pressure on city governments like those of New York, and shown favor to financial orthodoxy generally. We have seen this in S&P's recent statements that a $4 trillion package of debt reduction was necessary to prevent a downgrade; and S&P has now followed through on its implied threat.

As Paul Krugman has discussed, most of the reasoning behind the downgrade stems from the ungovernability of the United States due to the intransigence of Congressional Republicans on increased tax revenue. He argues that after the failure of S&P on mortgage derivatives, it has no right to pass judgment on the US. However, Sinclair's analysis of the credit raters' failures on Enron, WorldCom, etc., suggests that S&P's power has probably remained intact despite its failure on mortgages.

Krugman is right to challenge the legitimacy of S&P's decision; this is an enormously important moment in the battle against deflationary policies being undertaken during a jobs crisis. Indeed, the agency has complained about the country's "ungovernability," while at the same time rewarding the very people who are making it ungovernable with a decision that ultimately promotes their preferred policies. We cannot afford for this to stand.

Coming Attraction: The Battle Against Job Piracy in Canada

I just got word that my article, “Regulating Investment Attraction: Canada's Code of Conduct on Incentives in a Comparative Context,” will appear next month in the journal Canadian Public Policy.

I will post a complete analysis then, but let me leave you with a teaser for now. In the US, we often see subsidies used to move existing jobs from one state to another, or even one city to another. Good Jobs First recently did an analysis of this problem in the Cleveland and Cincinnati metropolitan areas. I have also mentioned how both New York City and Kansas City have been targeted by neighboring states raiding successful companies there. This kind of poaching has no benefit for the country as a whole, yet states and cities continue to give up parts of their tax bases simply to rearrange the deck chairs.

In 1994, Canada's provincial and federal governments signed the Agreement on Internal Trade, creating freer trade among the provinces. The Commerce Clause of the US Constitution serves a similar function in this country. One provision of the Agreement, not explicitly in the Commerce Clause (though the case Cuno v. Daimler-Chrysler argued for such an interpretation), legally bans the provinces from giving subsidies to companies that are moving in from another province. The point of my article, which I researched as a Fulbright Scholar at Carleton University in Ottawa, was simply to determine whether this ban has worked in practice.

The short answer is no: I document at least eight subsidized relocations from one province to another since 1996, and one case where Nova Scotia had to pay a retention subsidy because Ontario was trying to poach the headquarters of the grocery chain Sobey's. The longer answer is “a little bit”: all the relocations were under 100 jobs, far smaller than the 1990s poaching incidents that had motivated the ban in the first place. The lesson for the United States is that if similar rules were in place and enforceable in US courts, they would work better than they do in Canada, where the enforcement mechanism is very weak.

In the course of my research, I also learned why some Canadians call Manitoba's capital, Winnipeg, “Winterpeg;” saw Paul Krugman give a speech to economic development officials in Edmonton; and went to West Edmonton Mall, the largest mall in North America, where I saw a casino, striking casino workers picketing inside the mall, and heard a word I won't let you use in the comments section broadcast on the mall's music system (in Green Day's “American Idiot”).

Jobs falling, income dropping, according to 2009 tax data

David Cay Johnston (h/t Mark Thoma) has a new column up on the results of the latest income tax data (2009). With the economy back at stall speed, things probably won't look much better when the 2010 data becomes available next year. Or the 2011 data, either. Some excerpts:

(Reuters) - U.S. incomes plummeted again in 2009, with total income down 15.2 percent in real terms since 2007, new tax data showed on Wednesday.

The data showed an alarming drop in the number of taxpayers reporting any earnings from a job -- down by nearly 4.2 million from 2007 -- meaning every 33rd household that had work in 2007 had no work in 2009.

Average income in 2009 fell to $54,283, down $3,516, or 6.1 percent in real terms compared with 2008, the first Internal Revenue Service analysis of 2009 tax returns showed. Compared with 2007, average income was down $8,588 or 13.7 percent.

Average income in 2009 was at its lowest level since 1997 when it was $54,265 in 2009 dollars, just $18 less than in 2009. The data come from annual Statistics of Income tables that were updated Wednesday...

The share of households filing a tax return but paying no income tax results from two key factors:
* One is the drop in incomes because a married couple does not pay income tax until they make at least $18,300, and families with two children pay no income tax until they make more than $40,000 under policies started in 1997 and since expanded at the behest of Congressional Republicans, many of whom complain that too many households do not pay income taxes....

 So, we have a full 12 years of no income growth. (Remember, this is average income; it would be useful to see what happened to median income as well.) Millions of jobs lost. And the priority out of the White House and Congress is fixing a long-run deficit problem caused primarily by rising health care costs rather than doing anything about the immediate job deficit. Depressing.
 

How Bad Was the Debt Deal for the Middle Class?

John Boehner says he got 98% of everything he wanted. That's a bad sign. More concretely, the Economic Policy Institute estimated that between the cuts in the deal, and the expiration of two stimulative measures that could have been renewed as part of the deal, the country will lose 1.8 million jobs in 2012 alone. Hint: those won't be high-finance jobs.

If EPI is too left-leaning for you, J.P. Morgan (via Calculated Risk) estimates the “fiscal drag” on the economy from federal fiscal policy to be 1.5% of GDP in 2012. That's a big deal. Economic growth is critical for the middle class.

Going forward, Mitch McConnell (“the most honest man in Washington,” according to Ezra Klein) says that taking the debt ceiling hostage will now be the norm. There's also the budget resolution vote coming up in September, with the possibility of a government shutdown. Lots of hostage taking opportunities lie ahead.

Then there's the “Super Congress” tasked with determining another $1.5 trillion in deficit reduction. Since the six Republicans on that committee will reject any revenue increases, that means $1.5 trillion in cuts. Remember, Y = C + I + G + (X – M), so that's another $1.5 trillion hit to GDP over the next 10 years, ignoring any multiplier effects.

If this committee cannot reach agreement and Congress does not pass a balanced budget amendment (“the worst idea in Washington,” again according to Ezra Klein, and he is absolutely right), we get $1.2 trillion in cuts anyway. Social Security and Medicaid are exempt from budget slashing, but Medicare is on the table, perhaps with the self-inflicted wound of the President's offer to raise the eligibility age from 65 to 67. As has been pointed out by Sarah Kliff, doing this hurts the health exchanges by putting relatively expensive 65- and 66-year olds into the pool, driving up rates for everyone else and giving the healthy more incentive to drop out and game the system.

Supposedly, about half of the $1.2 trillion will come out of the Defense Department, but I think Markos Moulitsos might be on to something when he predicts Republicans will turn around and offer a separate bill to cancel those cuts, and accuse the Democrats of “not supporting the troops” in an election year.

Bottom line: bad for middle-class jobs, bad for Medicare, bad for health care reform. We're likely to be in recession again come the 2012 elections. This is not the time to get discouraged: the stakes are much higher in the 2012 elections, where we've got to elect a lot more people attuned to middle-class needs or a lot worse things will happen than were in this debt deal.