Understanding Piketty, part 1

Thomas Piketty's (CV) Capital in the Twenty-First Century is the most important book on economics published in this century. The book has made a huge splash, and drawn the ire of conservatives, for its straightforward argument that recent increases in inequality in numerous countries are likely to rise to unprecedented heights unless governments can reach democratically based solutions to this problem.

As I mentioned previously, the book's success is built on a mountain of data that a multinational team of researchers has been compiling for 10 years, the World Top Incomes Database, as well as long-term wealth records dating back to 1790 in the case of France. Piketty, in fact, has been working on inequality issues for 20 years. As he remarks in the book, until the creation of these datasets, debate on inequality was a "dialogue of the deaf" with precious few facts to back up anyone's arguments. A lot of this work has been taking place out of sight of most pundits, as Piketty's early books and papers are published in French, with the exception of the reasonably well-known papers he co-authored with Emmanuel Saez on U.S. inequality.

Most notably, there has been only one significant challenge to Piketty's data, and it was easily swatted down. Chris Giles of the Financial Times claimed that wealth inequality in the United Kingdom had declined since 1980, not risen as given in Piketty's book. But Giles made the error of taking survey-based wealth data (which sharply underestimates the wealth of the rich) and splicing it on to much more accurate estate tax-based data, to get a declining share of wealth for the top 10% and the top 1%. As Piketty says in his response:

Also note that a 44% wealth share for the top 10% (and a 12.5% wealth share for the top 1%, according to the FT) would mean that Britain is currently one the most egalitarian countries in history in terms of wealth distribution; in particular this would mean that Britain is a lot more equal that Sweden, and in fact a lot more equal than what Sweden has ever been (including in the 1980s). This does not look particularly plausible.

Obviously I agree with Piketty, but don't take my word for it. According to Eurostat, the Gini index for income inequality (which runs from 0 to 1, but is often multiplied by 100, as here; higher is more unequal) in 2012 was 32.8 for the United Kingdom versus 24.8 for Sweden. (For comparison, the United States was at 45.0 in 2007, according to the CIA World Factbook.) Combine that with the fact that wealth is more unevenly distributed than income in every country, and it is impossible for U.K. wealth to be more equally distributed than Sweden's is today, let alone at its most equal point in the 1980s. Moreover, according to Piketty's data on Sweden, which Giles does not dispute, the top 10% there owned just a tad under 60% of wealth, and the top 1% fully 20% of wealth, in 2010 (Figure 10.4, p. 345).

So what does all this new data show? First of all, the data show that the optimistic post-war notion that inequality had been solved for good was an illusion. As Piketty points out, economist Simon Kuznets had posited that as countries developed from very poor to very rich, as their GDP per capita increased, countries became more unequal at low levels of income (think China today). However, after a certain tipping point was reached, as countries raised their per capita GDP, their income distribution would become more equal. This was based on what Kuznets saw in the 1950s, a situation where income inequality was indeed declining in the industrialized countries. Many people expected that as more countries developed, they would pass the tipping point, and income inequality would decline in more and more countries. Alas, since 1980, we have seen a resurgence of inequality in the wealthy countries, turning the second half of Kuznets' story into a "fairy tale."

According to Piketty, the reasons we saw a sharp decline in wealth inequality in the wealthy countries from 1910 to 1980 are that there were substantial destructions of capital in the two World Wars, plus high taxes levied on the wealthy to finance the wars, which could not be paid for otherwise. Then, after World War II, there were very rapid growth rates possible as the various countries played catch-up to get back to their pre-war growth trends.

This brings us to a second major point of Piketty's book. He argues that the relationship between the rate of return on investments (r) and the country's growth rate (g) is a critical determinant of how concentrated wealth becomes in a society. If r exceeds g, over time capital ownership becomes more concentrated and society less equal. In all probability, developed countries can only expect to see growth, after inflation, of 1% to 1.5% per year. Of course, China and some other developing countries are growing more rapidly, but as they reach the technological frontier, their growth will slow. Meanwhile, the return on investment is more on the order of 4-5% annually. Thus, for industrialized countries, there is considerable danger that the wealth will become significantly more concentrated, and Piketty considers it obvious that high inequality is dangerous to democracy.

Alas, it's late; I have to stop for the night (but not at Hotel California). I'll have more to say very soon.

Cross-posted at Angry Bear.

Tesla wants $500 million for its Gigafactory

Leigh McIlvaine (@Leigh M.) of Good Jobs First alerted me to this article on what Tesla Motors wants in incentives to land its $5 billion Gigafactory: $500 million. This massive 6500 worker facility will produce the next generation of batteries in order to introduce a less expensive line of cars in 2017, the Tesla Model 3. This would be a more affordable vehicle than the widely praised Model S, which starts at $69,900.

I'm not joking about the praise: Consumer Reports, my go-to source for product testing due to the fact that it does not accept ads and thus has complete independence, gave the Model S its best-ever score of 99 out of 100 when it tested the car earlier this year. It also leads the magazine's subscriber survey of customer satisfaction, with 99% of owners saying they would buy the car again. This is a vehicle, and a company, that is generating some serious excitement.

It's no surprise that the Gigafactory is generating serious excitement, too. 6500 jobs, a $5 billion investment, and cutting-edge technology is a heady mix for an economic development official. San Antonio, where Toyota makes pickup trucks, jumped into the auction quickly, offering "almost $800 million in incentives." Although Tesla has broken ground at a location near Reno, Nevada, last week CEO Elon Musk announced plans to break ground at one or two other sites as well. The company clearly considers speed to be of the essence.

It's unclear exactly what the company wants financially, and Tesla did not respond to my request for an interview to seek clarification of some important points. To be specific, does it want that $500 million in cash, in the form of property tax breaks over some number of years, land and infrastructure, or what? Most importantly, is Tesla's goal speed plus $500 million, or speed plus the highest bid? The company has sent mixed signals on this question.

As Forbes wrote, "Last week, Musk said that Tesla wanted to make sure a package was right for the winning state, as well as for Tesla." In the article's very next sentence, however, Tesla VP for communications and marketing, Simon Sproule, said, "Any publicly traded company has a fiduciary responsibility to get the best deal for its investment." Musk's comment seems to imply that $500 million is all the company wants. By contrast, fiduciary responsibility has often been used to justify a company going after the maximum incentives possible. Forbes quotes the business editor of the San Antonio Express-News that it was hard to tell if Tesla is conducting "a search (or) a shakedown."

Sproule disputed the shakedown thesis, despite invoking "fiduciary responsibility." How should we think about this project?

On the one hand, we could take Musk's comments as meaning that the company wants $500 million, no more, no less. Given that he expressed it as a percentage of the investment, my intuition is that we should assume that means $500 million in cash or cash equivalents like free land (my guess is that San Antonio's "$800 million" was mainly tax breaks, which would have a lower present value). If that's true, Sproule's contention that the incentive is not really so expensive is actually true in a comparative sense. A 10% aid intensity (subsidy/investment) would be the second-lowest for a large automotive facility in the modern history of megadeals. It would even probably be legal in the European Union under its Regional Aid Guidelines, if it were located in one of the EU's poorer regions. Moreover, the cost per job would be $76,923, substantially below the $100,000-$150,000 level common for most U.S. automobile assembly plants.

Of course, cost alone doesn't make a deal a good one. In particular, if Tesla wants its incentives up front, there is a substantial risk that the project won't ultimately produce 6500 jobs, or that changes in the market could even lead to the Gigafactory closing. New Mexico lawmakers have certainly recognized the importance of this vis-a-vis Tesla. In my email to Tesla, I asked what taxpayer protections, like clawbacks, the company is prepared to accept. Alas, no response, but I will update if I do hear back from Tesla.

On the other hand, if $500 million really is just meant as the minimum acceptable opening bid, all bets are off for saying how (comparatively) good a deal it might be.

Once again, we are confronting the issue of information asymmetry: government officials have less information about what the company really wants than the company has about the various governments, and of course its own intentions. This is a major source of bargaining power for companies shopping around for an investment location. If Musk really means that Tesla will voluntarily limit the incentives it requires, that would be a refreshing change from the typical bidding wars we have seen in so many industries. Or, it could just be business as usual, with the highest bid (adjusted for cost structure at the different locations) winning. We just don't know, but the decision is expected by the end of the year.

Cross-posted at Angry Bear.

Illinois' next governor may make Romney look like a saint UPDATED

Does the name Bruce Rauner ring a bell? No, me neither. It turns out he's the Republican nominee for governor in Illinois, which under normal circumstances would mean he's a nobody. But he's been leading incumbent Democrat Pat Quinn in polls all summer, and could actually end up as the state's next governor.

This is a problem, because he is even more out of touch with the middle class than Mitt Romney (Rauner is a private equity near-billionaire) whose idea of transparency is to release the first two pages of his 1040 tax return for 2010-12, and nothing else. Romney at least released his full tax return for each of two years. As Think Progress points out, Rauner is also a big fan of the Cayman Islands as a tax haven, just like Romney. In fact, Rauner is invested in at least five funds there. Also like Romney, Rauner takes full advantage of the "carried interest" tax break that lets him treat his fees, which should be ordinary income taxed at 35 39.6%, as capital gains, subject only to a 15 20% tax rate.

Rauner's agenda is insistent on the need to spur job growth, but somehow misses the fact that Illinois' unemployment rate has fallen from 9.2% (seasonally adjusted) in June 2013 to 7.5% in May 2013 (the figure Rauner used) and even more since the agenda was published, to 7.1% in June, the third-largest drop in the country year-over-year. Still a full point worse than the June national unemployment rate, but a lot better than it was.

One place where Rauner is worse than Romney is the minimum wage. Romney, rather surprisingly, supports an increase in the minimum wage, though he did not specify a number. Rauner, in both December and January, called for Illinois to lower its minimum from $8.25 to $7.25, the national rate. After getting a tremendous amount of blowback, he now claims to support an increase.

His agenda says the state "should implement a phased-in minimum wage increase, coupled with workers' compensation and lawsuit reforms to bring down employer costs." No mention of what the rate would be, or the period over which it would be phased it. He references an op-ed he wrote in the January 9th Chicago Tribune (now only available through the Nexis subscription service), where he clearly buys into the "job-killer" meme and drops a reference to the futility of a "$20 per hour" minimum wage, for good measure. Somehow I don't think he really supports an increase.

Not only that, but Rauner proposes turning the Illinois Department of Commerce and Economic Opportunity, the state's investment promotion agency, into what he calls a "public-private partnership." He doesn't say it, but this means there will be less public oversight into the agency's affairs. As Good Jobs First has shown, such privatized agencies have exhibited high levels of abuse in recent years.

Rauner is a living, breathing example of how we have one tax system for the 1%, and another one for the rest of us. His flip-flop on the minimum wage is as phony as the concern he professes for the middle class. Yet there's a very good chance he will be the next governor of Illinois.

UPDATE: Crooks and Liars links to a brief video where Rauner says it may be necessary to go through a period in Illinois like that when President Ronald Reagan fired the air traffic controllers.

Argyrios at Daily Kos reminds me that the tax brackets have increased. Thanks.

Cross-posted at Angry Bear.

Jon Stewart nails corporate tax inversions

Last night Jon Stewart (h/t BruinKid) went after tax inversion with style, showing up Republican hypocrisy on welfare programs vs. "corporate welfare," all the subsidies one company has received from multiple levels of government, government contracts, and government-funded research. His primary target was Mylan, a Pennsylvania-based generic drugmaker. Mylan, as Ron Fournier recently pointed out, has as its chief executive officer Heather Bresch, the daughter of West Virgina Senator Joe Manchin. Manchin now says inversions should be illegal, according to Fournier in a follow-up article.

As Stewart shows, while Republicans are outraged by one person apparently abusing the Food Stamp program while mainly surfing in California, they all cheer inversions, at least on Fox News. Mylan has benefited from millions in government subsidies and billions in government contracts. But it has to move to the Netherlands anyway. Stewart concludes that since corporations have been people only since the 2010 Citizens United decision, they are just toddlers and we need to be firm with them: "You're grounded!"

Enjoy!

"Inversion of the Money Snatchers"

Medicare report shows Obamacare is bending the cost curve

The 2014 Medicare Trustees Report has just been released, and it shows that the program is on noticeably sounder financial footing than it was just a year ago. One of the biggest signs of this is that the projected depletion date of the Hospital Insurance (Part A) Trust Fund has been pushed back by four years just since last year's report.

Indeed, Sarah Kliff points out that Part A actually spent $600 million less in 2013 than in 2012, even though it insured 1.6 million more people. As she emphasizes, the big news in this is that per capita Medicare Part A spending has been falling. This is a great sign that there is forward movement in controlling the actual cost of care.



Source: Vox.com, link above

This is a big deal because not only are Baby Boomers like myself inching towards Medicare eligibility in large numbers, but hospitals and other providers (unfortunately, these two groups are merged in OECD statistics) account for most of the excess of US health care spending compared to other industrialized nations. In fact, comparing the United States to Canada, specifically, I found that payments to providers made up 85% of the per capita cost difference between the two countries.

Moreover, as Kliff points out, even when you include Part B and Part D into the calculation, Medicare's per capita cost showed no increase in 2013. Zero.

Indeed, if you want to see a very graphic demonstration in the change in the cost curve, Louise Sheiner and Brendan M. Mochouk of the Brookings Institute (h/t Matt Yglesias) have just what you're looking for.


Source: Brookings Institute, link above

Yes, in just five years, the estimated federal health expenditure has dropped by more than 2 percentage points of GDP by 2035, what would be a difference of $320 billion per year today.

Of course, the Patient Protection and Affordable Care Act cannot take all the credit for this improvement. But, as the Washington Post reported, the law "is slowing payments to Medicare Advantage" and, as also mentioned here, the penalty for hospitals with high re-admission rates has produced a substantial fall in the 30-day re-admission rate, from about 19% in 2011 to less than 18% in 2013. With better care, fewer re-admissions means lower costs.

Thus, while no phenomenon this complex can have a single cause, it is clear that Obamacare is having an impact beyond insuring 10.3 million uninsured, working as designed to improve health outcomes and reduce costs.

Cross-posted at Angry Bear.

Stephen Moore (Heritage, of course) can't even get his cherry-picked data right UPDATED

If you have had the stomach to read the malarkey that the Heritage Foundation puts out, you have no doubt noticed that many of their publications are, well, fact-challenged. Just looking back at this blog, there are stories on how Heritage wants us to think poverty is swell, and multiple versions of how Heritage did not pioneer the ideas underlying the Affordable Care Act.

Today, I turn from Obamacare godfather Stuart Butler to the new Heritage chief economist, Stephen Moore. In a great diary at Daily Kos, SantaFeMarie sums up the sordid story of Moore's July 7 column in the Kansas City Star where, trying to defend himself and Arthur Laffer from the well-deserved ire of Paul Krugman, he claims that 0/low-tax states have seen better job growth than high-tax states. In the original article, he wrote:

No-income-tax Texas gained 1 million jobs over the last five years, California, with its 13 percent tax rate, managed to lose jobs. Oops. Florida gained hundreds of thousands of jobs while New York lost jobs. Oops.

I hope you're sitting down. Although this article was written in July 2014 (and the original version, in Investors Business Daily, appeared July 2), the "last five years" Moore is referring to are: December 2007, the first month of the recession, to December 2012. As you no doubt know, employment data is released monthly, with state-by-state numbers available at a one-month lag from the national numbers. So April or May 2014 was available to Moore when he wrote. But he didn't use that 16 or 17 months' worth of data.

Misleading point #1: This choice of dates excludes California's excellent economic performance subsequent to its 2012 tax and minimum wage increases, as Paul Krugman analyzed in his most recent column. As Star editorial writer Yael T. Abouhalkah (who has long covered everything from fiscal policy to tax increment financing) points out, since Moore's ending date of December 2012, California has added 541,000 jobs, while Texas has an additional 523,400. "So, high taxes are good?" he quipped.

Misleading points #2 through #4: Within Moore's chosen "last five years," he still managed to misstate job performance by over 1.2 million jobs. #2: Texas did not gain "1 million jobs," but only 497,400 (off by 502,600). #3: Florida did not gain "hundreds of thousands of jobs," but lost 461,500, just 30,000 less than the much large California economy (off by at least 661,000). #4: And New York did not lose jobs at all, but added 75,900 (off by 75,900, being generous).

Oops.

On July 24, the Star published a corrected version of Moore's article which, according to Abouhalkah, Moore signed off on. Moore does not acknowledge that the corrections destroy his argument. On Friday afternoon, July 25, I sent a contact form to the editors at Investors Business Daily asking if we could expect a similar correction there. I'll keep you posted.

UPDATE: It's now the evening of July 31, and I have received no response from Investors Business Daily. Nor has Columbia Journalism Review, which reports that the Star's editorial page editor does not plan on using anything from Stephen Moore again (though this could be moot, as she is retiring). And you can see here that there has been no correction made to Moore's original article, which still includes the stats which are 1.2 million jobs off.

Read more here:http://www.kansascity.com/opinion/readers-opinion/as-i-see-it/article685284.html#storylink=cpy

Fun and games with transfer pricing

ProGrowthLiberal in his comments on my last post and in his own post at EconoSpeak highlights the fact that drug-maker AbbVie already makes most of its profits outside the United States, about 87% in fact over 2011-2013 by his calculation. For PGL, then, AbbVie is not the best example of an inversion because the horse is already out of the barn in terms of escaped profits.

I see things a little differently on this, but the case is also highly illustrative of a principle we have discussed before, transfer pricing. Let's take a look at AbbVie's Form 10-K Annual Report, downloadable here, to see what I mean.

Pre-tax profits ($millions)    2013    2012    2011    3-year total

U.S.                                  -581      625     626     670
Foreign                             5913    5100    3042     14,055

Total                                 5332    5725    3668     14,725

Source: AbbVie Annual Report, p. 92

I actually calculate the foreign percentage for these three years as 95%, given that AbbVie claims to have lost money in the United States in 2013. In any event, this is a very strange division of the company's profits given where its sales were made.

Net sales ($billions)    2013    2012    2011

U.S.                           10.2     10.4     9.7
Foreign                        8.6       7.9     7.7

Total                          18.8     18.4    17.4

Source: AbbVie Annual Report, p. 40. Totals may not sum due to rounding.

As you can see, in each of the three years, over half of the company's sales were made in United States, but the company reports that only 5% of its profits are in this country. This is pretty funny math, if you like dark humor. Especially since Humira, AbbVie's biggest-selling drug by far, was developed in the United States. So with the patents in the U.S., and most of the sales in the U.S., the profits have to be in the U.S., right?

In reality, of course they are, but not in the Alice's Wonderland world of transfer pricing. In this byzantine world, the patent for Humira is almost certainly owned by a subsidiary in Ireland, where royalty payments are tax-free. How else could the company show a loss in the United States in 2013 when 54% of its sales are here? Despite this, the company reports paying about 39% of its worldwide income taxes ($226 million of $580 million worldwide, see p. 92), although we have seen that what companies report in taxes on their 10-K annual report is largely fiction

So what can we do? The answers remain simple, though as politically difficult as ever. First, require companies to publish what they pay, country-by-country. No more hiding behind consolidated accounts. Second, enact unitary taxation, using apportionment formulas to make transfer pricing irrelevant. Third, end the deferral of U.S. corporate income tax on foreign profits. Finally, despite what "everyone," including the President, says, don't reduce the corporate income tax rate. We've gone long enough with tax policies that exacerbate inequality; there's no reason to continue down that road when we have the world's largest economy.

Oh, and my tiny disagreement with ProGrowthLiberal: It seems to me that if a company is already draining giant chunks of its profits abroad, then allowing an inversion ratifies losing a bigger amount of tax money than it would for a company like Walgreen's that has not moved its profits offshore yet. But I imagine the IRS could still go after AbbVie post-inversion if it wanted to question its pre-inversion transfer prices, so this is a minor point indeed.

Cross-posted at Angry Bear.