My GASB Comments

Well, I should have taken my own advice and not waited until the last minute to submit my own comments on the proposed standards for government accounting of subsidies. But, at long last, they are in. Below please find them in their entirety.

Director of Research and Technical Activities

Project No. 19-20E

Government Accounting Standards Board

January 14, 2015

Dear Director:

I am writing to comment on the proposed standards for reporting the “tax abatements” given by state and local governments as part of their Comprehensive Annual Financial Reports (CAFRs). Let me begin by saying that I welcome this proposal and want to urge the Board to be sure these standards are truly comprehensive.

I write from a unique vantage point because my best-known academic work consists of making estimates of the value of subsidies given to companies by state and local governments. This includes two books: Competing for Capital: Europe and North America in a Global Era (Georgetown University Press, 2000) and Investment Incentives and the Global Competition for Capital (Palgrave Macmillan, 2011). In my latter book, I estimate that in 2005 state and local governments gave just under $50 billion in business attraction subsidies and perhaps another $20 billion in subsidies not tied to making an investment. In addition, I have written numerous journal articles and book chapters on tax incentives and other forms of subsidies to attract investment. The proposed standards, if done correctly, would put me out of the estimation business, and that would be a great thing. In the United States, there is a terrible lack of transparency in the use of these incentives, which makes informed policy analysis very difficult and, in some cases, impossible. Not only that, the lack of transparency hinders the ability of bond and other financial analysts to determine the true long-term financial position of a government entity that may be seeking to borrow through the bond market.

I am regularly interviewed by, and have my work cited in, well-known publications such as The Wall Street Journal, Bloomberg, The St. Louis Post-Dispatch, Los Angeles Times, etc. I have consulted on these issues for the Organization for Economic Cooperation and Development (OECD), the International Institute for Sustainable Development, the North Carolina Budget and Tax Center, and the Missouri chapter of the Sierra Club. I hold the position of Professor of Political Science at the University of Missouri-St. Louis, where I have taught for 23 years. Let me note for the record that the comments which follow are my own personal recommendations and my views are not necessarily shared by my employer or consulting clients.

Let me begin by highlighting an important terminological problem caused by the Board’s use of the term “tax abatement” as its catch-all term for the policies under discussion. In fact, a “tax abatement,” properly so called, is only one form of subsidy to attract investment to a state or locality, and most likely not the most important one, depending on the governmental entity in question. A true tax abatement relieves its recipient from having to pay certain taxes that would otherwise be due, most usually the local property tax. It is merely one form of a broader category of support for business investment that I generally call an “investment incentive,” “location incentive,” or “location subsidy.” I define all three of these terms as “a subsidy to affect the location of investment.”

What, then, is a “subsidy”? To answer this question, we can turn to the “Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, April 15, 1994,” which was adopted into U.S. law via Public Law no. 103-465. Thus, the definition of a “subsidy” established in the Uruguay Round’s “Agreement on Subsidies and Countervailing Measures” (SCM) is in fact a provision of U.S. law. This is important to keep in mind in the discussion that follows.

Article 1 of the SCM defines a subsidy as follows:

1.1 For the purpose of this Agreement, a subsidy shall be deemed to exist if:

            (a)(1) there is a financial contribution by a government or any public body [note that his means this section applies to all state and local governments within the United States] within the territory of the Member (referred to in this Agreement as “government”), i.e. where

                        (i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);

                        (ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits); [footnote omitted]

                        (iii) a government provides good or services other than general infrastructure, or purchases goods;

                        (iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments; [an anti-evasion rule]

                                    Or

            (a)(2) there is any form of income or price support in the sense of Article XVI of GATT 1994;

                                    And

(b) a benefit is thereby conferred.

To sum all this up, the Agreement on SCM establishes a definition of “subsidy” that includes any potential subsidy mechanism, carried out by any level of government (for example, the Washington B&O tax reduction that was a major element of the European Union’s complaint against subsidies to Boeing, a case the EU won), one not evaded by simply claiming that it was a private body carrying out the subsidy. In effect, if the subsidy exists in law or in fact, the subsidy rules come into play.

This principle that a subsidy existing in law or in fact must be counted is an important one when examining the Board’s proposed rules. Some tax measures that are obviously subsidies under the SCM definition (again, something incorporated into U.S. law) might not be considered “tax abatements” using a strict reading of the definition of that term. Consider the case of tax increment financing (TIF). In the states with which I am most familiar, a TIF recipient is legally considered to have paid its property tax even though its payment flows immediately back to its own benefit. If the entity has legally paid its property tax, how can one say that government has “foregone” the revenue? The answer, of course, is to look at the facts as well as the law. GASB’s rules must ensure that they follow the facts and ignore legal fictions. Otherwise, huge swathes of tax-based subsidies will not be counted, and bond analysts and other researchers will not have the facts they need to establish the true financial situation of a government. This is similarly true of situations where the tax foregone is not due from the subsidy recipient. For example, many states allow companies to keep personal income tax withholding from their employees. In Missouri, local taxing districts called transportation development districts collect an extra sales tax from customers, but keep the money until they have received the entire subsidy they negotiated from a municipal government. It does not matter whose taxes are foregone; the rules must capture the subsidy itself in order to be useful. These are not small programs, either. In California, by 2010 TIF was generating $8 billion a year in tax increment for local governments, which was largely plowed back into paying the subsidies they were tied to (or equivalently, paying off bonds which funded the subsidies). In the much smaller Missouri economy, both TIF and transportation development districts see hundreds of millions of dollars of new subsidies committed annually by municipal governments.

In light of the fact that investment incentives may not be entirely tax-based, I believe it to be important to at least cross-list cash grants paid to companies with the “tax abatement” they receive. From anecdotally talking to reporters calling me about various incentive packages they are covering, it appears to me that there is an increasing trend for cash to make up a significant chunk of these packages. If the new rules require such cross-listing, we can then see in one place how much money a state or local government is committing in subsidies to attract businesses. This information gives us important clues about future fiscal trends from a government, as heavy users of incentives tend to remain such well into the future; however, there is no telling from one year to the next what the split will be between cash and tax-based subsidies.

On a related point, the rules absolutely need to include future amounts committed for tax incentives. Once again, without such transparency it is impossible for bond or other analysts to derive a true financial picture for a particular government.

Last, I would urge that the reporting of location subsidies be made on a firm-specific basis. If a single company is receiving tens of millions of dollars in tax breaks per year from a given municipality, with many more tens of millions committed in the future, it could signal that the municipality is highly vulnerable to anything which adversely affected the recipient. A city like Flint, Michigan, was devastated when the numerous subsidized General Motors facilities in the city began to go out of business in the 1980s.

In summary, then, the most important principle to consider is that transparency must be comprehensive. If the rules have loopholes allowing governments to not report certain types of subsidies, those subsidies will not be reported, and everyone relying on data reported under the new rules for accurate financial information – from citizens to investors – will be misled by numbers that don’t reveal a government’s true financial situation. Please require the most comprehensive reporting possible, for your efforts to live up to their potentially game-changing value.

Sincerely,

Kenneth P. Thomas

Professor of Political Science

University of Missouri-St. Louis

New Social Security Crisis Set for 2016

The House Republicans, in their eagerness to find a way to cut Social Security benefits, on Tuesday passed a new rule preventing the reallocation of monies between the Social Security Trust Fund and the Social Security Disability program.

No, don't let your eyes glaze over! This is a big deal. The disability portion of Social Security, with 11 million beneficiaries receiving an average $1146 a month in benefits, is expected to exhaust its separate trust fund in late 2016. When that has happened in the past, Congress has reallocated money between the two programs to keep them both solvent. Now, the new House rule prevents it from approving such a reallocation unless "it is included in a proposal that 'improves the overall financial health of the combined Social Security Trust Funds.'"

Of course, that means either raising payroll taxes or cutting benefits. Which do you think House Republicans will support?

As Joan McCarter points out, the strategy behind this is to pit retirees against the disabled. How long will it take older Republican voters to see the endgame of this strategy ("First they came for...")? With the crisis scheduled for the 2016 election season, we may soon find out.

Travel break

I'm on the road for a few days, so no new posts for just a bit. Like Middle Class Political Economist on Facebook for links to important articles elsewhere.

Eleven Richest Americans Have All Received Government Subsidies

A new report by Good Jobs First shows how the very wealthy in America have benefited from government subsidies as one element in building their fortunes. According to the study, the 11 richest Americans, and 23 of the 25 richest, all have significant ownership in companies that have received at least $1 million in investment incentives.

The study compares the most recent Forbes 400 ranking of wealthiest Americans with the Good Jobs First Subsidy Tracker database. Not only do Bill Gates, Warren Buffett, Larry Ellison, the Koch Brothers, the Waltons, Michael Bloomberg, and Mark Zuckerberg own companies that have received millions or even billions in taxpayer funds, 99 of the 258 companies connected with the Forbes 400 have such subsidies.

As I argued theoretically in Competing for Capital, the new report points out that subsidies for investment increase inequality as average taxpayers subsidize wealthy corporate owners. Location incentives directly put money into their pockets, which then has to be offset by higher taxes on others, reduced government services, or higher levels of government debt. Moreover, as the study notes, despite the huge amount of these subsidies given in the name of economic development, there has not been enough payback to raise real wages even back to their 1970s peak. In other words, if economic development has created so many new jobs, why haven't wages risen?

Of course, subsidies don't account for the biggest part of inequality. Read Thomas Piketty for the big picture on the subject. But the new report shows that large numbers of America's wealthiest (or not so wealthy, like Mitt Romney) have benefited handily from government subsidies.

Cross-posted at Angry Bear.

Basics: The German Euro is Undervalued

I keep telling people that the German euro is undervalued, but some folks seem not to believe me. (See the comments section from this post last year for an example.) But this is a really big deal. The dominant narrative about the eurozone crisis is that fiscally irresponsible countries like Greece were bringing the once-proud currency to its knees, and weakening the European project to boot. Meanwhile, the virtuous Germans keep on cranking out trade surpluses and have to bail out Greece, Ireland, Portugal, and Spain. And it's pretty clear that the Germans believe this version of events.

Never mind that Spain and Ireland, for two, had budget surpluses prior to the crisis, or that Spain's economy is five times as large as Greece's. What's going on in Greece is supposedly the true explanation for the eurozone's problems.

Let me challenge that narrative that with a simple thought experiment. Instead of one euro, let us reason as if each of the 18 eurozone members had its "own" "euro." Let's begin by thinking about what creates the value of the current 18-country euro. We might include interest rates, inflation rates, growth rates, and trade balance, among other things, and of course expectations for all these variables. What we need to remember is that the value of today's euro represents the averaged effect of all these variables in all 18 countries, rather than reflecting the economic conditions of any one of them.

So the euro is currently worth about $1.25. It used to be higher; what is dragging it down? The simple answer is that conditions in Greece, Spain, Ireland, Portugal, and at time Italy have pulled its value down. As has often been noted, if Greece pulled out of the euro it would then devalue the drachma, becoming internationally competitive again without the need for the brutal austerity that has pushed its unemployment rate over 25%. The same is true for the other peripheral countries. By looking at what would happen to the drachma/punt/peseta/escudo, we can see that, for these countries, the euro is overvalued. Another way to say it is that the "Greek euro," for example is overvalued.

So why isn't the value of the euro lower than $1.25? The answer, of course, is that Germany, the Netherlands, Austria, Luxembourg, and so forth, are performing well and pushing the value of the euro upwards. These countries, by contrast, would see their currency values rise if the euro were suddenly abolished. For Germany, for instance, the euro is undervalued; an equivalent DM would rise in value.

U.S. officials constantly rail about the undervalued Chinese yuan and the huge bilateral trade deficit it creates for this country. But officials could (and to some extent do) say the same thing about Germany, which now has a larger trade surplus than the vastly larger Chinese economy. In fact, last year Morgan Stanley estimated that a stand-alone German euro would be worth $1.53, compared to the actual euro exchange rate then of $1.33.

With an undervalued currency, Germany gets a much larger trade surplus than it would have had otherwise, magnifying trade deficits in the United States and elsewhere. At the same time, it gets to pretend that this surplus is simply due to German thrift and virtue, rather than currency misalignment. It then points to its virtue as justification for doing nothing to increase domestic consumption, wages, or inflation, and for demanding austerity from the countries to which Paul Krugman rightly says Germany is exporting deflation.

Let me leave you with Krugman's chart. You can see at a glance that Germany has throttled nominal wage growth and has inflation far below the European Central Bank's announced target of just under 2%. When you combine its low inflation with an undervalued exchange rate (remember, low inflation should tend to raise the currency's value), you come to realize that Germany is a huge part of the world economy's problems today.

Credit OECD and IMF

Source: Paul Krugman

Cross-posted at Angry Bear.

November Tax-Cast Highlights Lux-Leak, Kenya, Ukraine

So much tax justice news this month that the usually 20 minute podcast runs just shy of 30 minutes. The International Consortium of Investigative Journalists publishes a treasure trove of leaked data from Luxembourg, putting pressure not only on the country but its former Premier, now President of the European Commission, Jean-Claude Juncker. Kenya is abolishing many of its tax subsidies; meanwhile the Ukraine has become the first country to mandate a listing of the beneficial owners of all companies operating within the company. Hear about it here:

www.taxjustice.net/taxcast

Tax haven benefits are not investment incentives

Tim Worstall at Forbes takes issue with my last post, claiming that we actually don't know that U.S. state and local governments give more in location incentives than EU Member States do. He then says that while it is true that EU states give less in cash grants and other kinds of subsidies defined as "state aid" in EU law, these same states give more than the U.S. in other types of tax benefits. His argument then moves quickly through Ireland's 12.5% corporate income tax (though he gives no examples) to Amazon's European sales all being channeled through Luxembourg subsidiaries. Worstall claims that the tax advantages created by this financial gimmickry comprise a location incentive just like providing Tesla $1.3 billion to build a factory in Nevada is.

I've been researching U.S. and EU incentives for 20 years, and I certainly don't expect Worstall to have read everything I've written on the subject, including two books. So this makes as good a time as any to clarify the terms I use and the analysis I've made.

My default term for my object of study is "investment incentives," as in the title of my last book. But you can't say that phrase multiple times on every page of the book, so I use a specific set of synonyms when I write: Investment incentive = location incentive = investment subsidy = location subsidy = development incentive and sometimes, as in the headline of the last post, simply "incentive," though I also use that term in its more generic sense. Note that the term Worstall uses in his headline, "tax incentive," is not a synonym, because investment incentives and subsidies more generally can take forms other than tax breaks, i.e. cash grants, low-interest loans, free infrastructure, etc.

What, then, is an investment incentive? I define it as a subsidy ( = "state aid" in the EU context) to affect the location of an investment. To get this kind of subsidy from a government, it is necessary to make an investment. An investment incentive can be contrasted with an operating subsidy ("operating aid" in the EU), which is a subsidy for ongoing operations and is, critically, not contingent on making an investment. The distinction between investment incentives and operating subsidies is crucial to what follows.

So an investment incentive requires a subsidy and an investment. Let's now consider Worstall's examples on these criteria. As some readers may know, Ireland for many years had a 10% corporate income tax rate on profits from manufacturing, a rate explicitly provided for in Ireland's EU accession negotiations, and which the European Commission long accepted as being part of the country's general macroeconomic framework rather than a subsidy (see my book Competing for Capital, pp. 94-95, for an extended discussion). Contra Worstall, I am certainly well aware that Ireland's tax policy is a method of competing for investment; in 2000, I called it "a clear and unregulated element in the country's competition for investment" (p. 95; italics in original).

 Despite that, when the Commission ruled in July 1998 that manufacturing was specific enough for the tax rate to be considered a state aid, it ruled that it constituted an operating aid. A manufacturing company was entitled to the 10% tax rate forever, whether it made new investment or not, or even if it disinvested, as Intel has done from Ireland. Since there was no link between the subsidy and investment, it did not constitute an investment incentive. In the end, Ireland and the Commission agreed that a 12.5% tax rate that applied to all corporations would not be considered state aid. Now we no longer have a subsidy, but tax competition. (This of course doesn't talk about the boutique deals that the EU is now investigating as possible state aid.)

One ironic takeaway is that despite the intentions and nearly unanimous views of Irish policy-makers (many of whom I have interviewed over the years), the evidence doesn't actually suggest that the country's low-tax policy contributed to its growth. For the policy's first 30 years, 1958-87, Ireland grew, but no more rapidly than the rest of the EU. For almost the entire period, it had no tax on foreign multinational corporations. The famed Celtic Tiger came together when the tax rate MNCs faced was 10 percentage points higher, 10%.

What about Amazon and Luxembourg? Amazon has real operations in Luxembourg, employing about 1000 people overall. But the turbocharged financial benefits Amazon receives come not from normal operations using the lower VAT (again, tax competition, not an investment incentive), but from its use of tax haven subsidiaries. As the linked article points out, where Amazon makes its money in Luxembourg is from Amazon Europe Holding Technologies SCS, a partnership with no employees or office, which had completely tax-free profits of €156.7 million in 2013, according to the Wall Street Journal article linked above.

Moreover, according to the huge dump of leaked documents from the International Consortium of Investigative Journalists, in 2009 Amazon Europe Holding Technologies SCS paid Amazon Technologies Inc. (located in the tax haven of Nevada) €105 million in order to license Amazon's intellectual property. By some miracle, this no-employee company managed to re-license the IP to Amazon EU for €519 million. Given Worstall's claim in July that transfers of technology to a tax haven subsidiary have to be made at "full market value," how does he explain the way that "no one," if you will, raised the value of this IP by €414 million, which just coincidentally was untaxed in Luxembourg? Could it be that Amazon Europe Holding Technologies SCS didn't actually pay "full market value"?

Worstall also makes the odd claim: "And we do regard different corporation tax rates within the US dependent upon location as being location based incentives and we don’t regard them as such in the EU." Aside from wondering who his "we" is, I know I'm not part of it: My estimates of U.S. state and local subsidies and investment incentives most definitely do not count differences in corporate income tax rates among states as a "location incentive." My posts on Tesla take no account of the fact that Nevada has no corporate income tax, while its home state of California levies 8.84%. Yes, it's tax competition, as in Ireland, but if you were to call it a subsidy, it would be an operating subsidy, not an investment subsidy. I also don't include the federal government's many subsidies in these numbers. (Note: Writing this prompted me to go back and look at the data ICA Incentives provided me last year, wherein I found that it did include some federal subsidies. I removed them from the totals from the ASDEQ paper I cited in my last post, leaving U.S. state and local investment incentives 3 1/2 times, not 5 1/2 times, as large as EU investment incentives. See corrected post here.)

Worstall, then, is trying to mix apples and oranges. For a tax provision to be a subsidy, it needs to be a derogation from a country's normal tax rules. Yet Amazon tells us it is "subject to the same tax laws as other companies operating" in Luxembourg. Of course, Amazon may be stretching the truth here. But if Worstall thinks that creating arcane tax haven arrangements (as in his examples of Apple, Google, Facebook and Microsoft sales flowing through Ireland for tax purposes) is the same thing as, you know, actually building things, I'm here to tell him he is mistaken. Using the same term, "location incentive," to try to cover two completely different types of economic activity, is certain to detract from our understanding of the policy issues, not increase it.

Cross-posted at Angry Bear.