The Financial Review
PUBLISHED: 24 Mar 2012
Anna Bernasek, New York
At one time or another most people dream of writing a scathing resignation letter, excoriating a boss or a company that seems out of touch with good business principles. But by any standard Greg Smith wrote one for the ages when he resigned publicly from Goldman Sachs by writing a piece in The New York Times.
So far there have been two reactions to Smith’s principal allegation that Goldmans rips off its clients. For some, a Goldmans “executive” finally spoke the truth about the firm’s moral bankruptcy. But for others, Smith’s letter was a juvenile reaction to a completely normal situation in a tough, competitive business.
The letter certainly touched a nerve. Many people, including some finance professionals, agree with Smith’s critique. Just think about the implications for a moment. How could the world’s pre-eminent financial institution have succeeded by ripping off its clients? Is that even possible?
Well, maybe.
First of all, Goldmans didn’t become the world’s leading investment house without doing a lot of things right. Before its ascendance, names like Morgan Stanley and First Boston reigned on Wall Street while Goldmans remained a smart, scrappy outsider. Goldmans plugged away at the industry for decades, hiring the best and brightest and outworking the competition.
But success is a mixed blessing. It brings greater scrutiny, and greater arrogance. When you’ve made it there’s less reason to worry about what people think. Your mentality changes when clients are competing for your attention. Not too long ago when the IPO market was booming, having Goldman Sachs as lead underwriter on your company’s offering was a mark of distinction. With that kind of power and reputation comes enormous temptation to extract profits even at the risk of losing long-term relationships.
And not all clients are created equal. There are clients that Goldman cares about deeply, providing superb value and service with an eye to the longer term. And then there are clients it can live without. Clients who are clueless, small, or with one-off needs are potential targets for less stellar treatment.
Goldmans certainly doesn’t gouge all its clients. But it’s a safe bet it makes decisions about each client and how important it is.
Then there are the clients who don’t mind being ripped off. Some people who are in the business of managing other people’s money are willing to buy mispriced or faulty products because they can personally benefit. By exploiting accounting rules investment managers can show good results in the near term even if over the longer haul things don’t pay off. For some clients the appearance of value is worth paying a lot for.
Whether financial “innovation”, complex securities, proprietary products, or illiquid markets, Goldman Sachs can be found in the areas where money is being made. And the bulk of Goldman’s clients – corporate management and investment fund managers – are stewards of other people’s money. The firm works hand in hand to make those managers look good, with mutual rewards. Executive pay, and in particular the pay of money managers, has skyrocketed; so have finance industry profits. But company profits, and investment performance, hasn’t matched the growth rate in pay.
Goldmans reinforces a culture where the people in charge get paid far above anyone else, with pay closely linked to stock prices. Meanwhile, it and other banks work hard to come up with schemes for companies to boost their share price.
Take M&A for instance. There is a long-running debate on the benefits of mergers and acquisitions as a strategy. It seems that for every spectacular success there’s a spectacular failure. Looking at aggregates over time, the benefits are not particularly clear. But it is clear that management tends to get paid a lot for doing M&A. And so do the advisers, of which Goldman is one. Whether other stakeholders are doing well doesn’t seem to be a prime concern.
Then there’s all the illiquid, complex and opaque financial instruments Goldmans provides that can obscure a company’s performance or give the appearance of profit.
Goldmans looks after its customers well, at least the ones that matter. But often the relationship between the firm and its client is between two individuals. It’s between the banker and the hedge fund manager, not the underlying investors. So while the banker provides excellent service on an individual basis that might not be in the interest of either the client’s institution or the public at large.
One day another scrappy outsider will unseat Goldmans from the top spot. Unless Goldmans focuses on building trust more broadly, that might happen sooner rather than later.
Monday, March 26, 2012
Sunday, March 18, 2012
Jobs growth needs more work
Financial Review
Published March 17
Anna Bernasek, New York
For the past three months the job market in the United States has confounded the pessimists. Non-farm payrolls rose by a seasonally adjusted 227,000 in February, the third straight month of growth over 200,000 and the fastest growth spurt in two years. That’s created a perception the economic recovery is finally gaining momentum.
But the jobs picture may not be as rosy as it seems.
Start with the numbers. The labour market needs to add 100,000 new jobs a month just to keep up with population growth. Even though 227,000 seems like a lot, especially after the paltry growth of recent years, only about half of that is actually helping to reduce unemployment.
So while the US economy has added a total of 1.2 million jobs in the past six months, 5 million more jobs are still needed to get back to where the economy was before the recession hit.
What’s more, at the current rate of jobs growth, it could take between three and four years for unemployment to shrink to a more typical rate of 5 per cent from a current 8.3 per cent, according to the Federal Reserve Bank of Atlanta’s job calculator.
Then there’s the long-term unemployment rate which, despite recent jobs growth, remains disturbingly high. The number of long-term unemployed, defined as those jobless for at least 27 weeks, was unchanged at 5.4 million last month. That means 42.6 per cent of those without jobs are long-term unemployed.
Yet even as the labour market becomes stronger, there’s growing scepticism among economists and policymakers that the pace of job gains can be sustained.
Federal Reserve chairman Ben Bernanke told Congress that unless economic growth picked up from its current level of about 2 per cent, recent labour market strength was unlikely to last.
That’s because the jobs spurt and aggregate economic growth don’t seem to match. Typically, monthly job growth of 200,000-plus occurs when economic growth is far higher, about 4 per cent or more. Last year the economy grew at 1.7 per cent and since the end of 2009, 2.5 per cent. Even in the face of the stronger labour market, economists have been revising growth forecasts lower for 2012.
Christina Romer, an economist at the University of California Berkeley and former chair of the Council of Economic Advisers to President Barack Obama, believes overreaction may explain recent hiring. Romer recalls that as the financial crisis hit, managers panicked and fired staff more aggressively that most forecasters expected. Now that the world hasn’t ended, they may be hiring to fill some of those positions they slashed. If so, the hiring trend may run out of steam unless the pace of economic growth picks up.
Wages are perhaps the most revealing sign of the health of the labour market. While jobs are growing, they’re not necessarily good-quality jobs, making the path back to a pre-recession economy even more arduous.
You can detect the destruction of good-quality jobs in the employment report. Good jobs in finance and government are shrinking while low-quality jobs in services, particularly restaurants and retail, have grown.
The overall wages picture has been grim for a while. In the past 10 years, even workers with a college degree have failed to see any real wage growth.
According to the Economic Policy Institute, young workers’ labour market prospects are a good barometer of the strength of the overall labour market.
From 2000 to 2011, when overall wage growth was disappointing, wages actually fell among every entry-level group regardless of education. Wage losses occurred for each group of entry-level workers between 2000 and 2007, as well as during the recession years between 2007 and 2011.
Inflation-adjusted hourly wages of college-educated men in their 20s dropped 5.2 per cent from 2007 to 2011 and for female college graduates 4.4 per cent. This is on top of declining wages before the recession hit, between 2000 and 2007, of 2.5 per cent for college-educated men and 1.6 per cent for college-educated women.
Inflation-adjusted hourly wages of recent high-school graduates are worse, dropping about 9 per cent overall from 2000 to 2011.
“In short, in the most recent decade, the most-educated workers [college graduates] with the newest skills [recent degrees] did not fare well at all; their wage opportunities fell even as overall productivity in the economy continued to soar,” the Economic Policy Institute reported.
The further back you go, the worse the trend looks. Save for a brief period between 1995 and 2000, when wages grew, real wages have been declining for entry-level workers since the late 1970s.
Health and pension benefits have also been declining for workers, adding to a reduction in overall compensation levels.
So the recent monthly job numbers are a welcome relief. But they don’t change the overall jobs picture very much – at least not yet.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. She is the author of The Economics of Integrity.
Published March 17
Anna Bernasek, New York
For the past three months the job market in the United States has confounded the pessimists. Non-farm payrolls rose by a seasonally adjusted 227,000 in February, the third straight month of growth over 200,000 and the fastest growth spurt in two years. That’s created a perception the economic recovery is finally gaining momentum.
But the jobs picture may not be as rosy as it seems.
Start with the numbers. The labour market needs to add 100,000 new jobs a month just to keep up with population growth. Even though 227,000 seems like a lot, especially after the paltry growth of recent years, only about half of that is actually helping to reduce unemployment.
So while the US economy has added a total of 1.2 million jobs in the past six months, 5 million more jobs are still needed to get back to where the economy was before the recession hit.
What’s more, at the current rate of jobs growth, it could take between three and four years for unemployment to shrink to a more typical rate of 5 per cent from a current 8.3 per cent, according to the Federal Reserve Bank of Atlanta’s job calculator.
Then there’s the long-term unemployment rate which, despite recent jobs growth, remains disturbingly high. The number of long-term unemployed, defined as those jobless for at least 27 weeks, was unchanged at 5.4 million last month. That means 42.6 per cent of those without jobs are long-term unemployed.
Yet even as the labour market becomes stronger, there’s growing scepticism among economists and policymakers that the pace of job gains can be sustained.
Federal Reserve chairman Ben Bernanke told Congress that unless economic growth picked up from its current level of about 2 per cent, recent labour market strength was unlikely to last.
That’s because the jobs spurt and aggregate economic growth don’t seem to match. Typically, monthly job growth of 200,000-plus occurs when economic growth is far higher, about 4 per cent or more. Last year the economy grew at 1.7 per cent and since the end of 2009, 2.5 per cent. Even in the face of the stronger labour market, economists have been revising growth forecasts lower for 2012.
Christina Romer, an economist at the University of California Berkeley and former chair of the Council of Economic Advisers to President Barack Obama, believes overreaction may explain recent hiring. Romer recalls that as the financial crisis hit, managers panicked and fired staff more aggressively that most forecasters expected. Now that the world hasn’t ended, they may be hiring to fill some of those positions they slashed. If so, the hiring trend may run out of steam unless the pace of economic growth picks up.
Wages are perhaps the most revealing sign of the health of the labour market. While jobs are growing, they’re not necessarily good-quality jobs, making the path back to a pre-recession economy even more arduous.
You can detect the destruction of good-quality jobs in the employment report. Good jobs in finance and government are shrinking while low-quality jobs in services, particularly restaurants and retail, have grown.
The overall wages picture has been grim for a while. In the past 10 years, even workers with a college degree have failed to see any real wage growth.
According to the Economic Policy Institute, young workers’ labour market prospects are a good barometer of the strength of the overall labour market.
From 2000 to 2011, when overall wage growth was disappointing, wages actually fell among every entry-level group regardless of education. Wage losses occurred for each group of entry-level workers between 2000 and 2007, as well as during the recession years between 2007 and 2011.
Inflation-adjusted hourly wages of college-educated men in their 20s dropped 5.2 per cent from 2007 to 2011 and for female college graduates 4.4 per cent. This is on top of declining wages before the recession hit, between 2000 and 2007, of 2.5 per cent for college-educated men and 1.6 per cent for college-educated women.
Inflation-adjusted hourly wages of recent high-school graduates are worse, dropping about 9 per cent overall from 2000 to 2011.
“In short, in the most recent decade, the most-educated workers [college graduates] with the newest skills [recent degrees] did not fare well at all; their wage opportunities fell even as overall productivity in the economy continued to soar,” the Economic Policy Institute reported.
The further back you go, the worse the trend looks. Save for a brief period between 1995 and 2000, when wages grew, real wages have been declining for entry-level workers since the late 1970s.
Health and pension benefits have also been declining for workers, adding to a reduction in overall compensation levels.
So the recent monthly job numbers are a welcome relief. But they don’t change the overall jobs picture very much – at least not yet.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. She is the author of The Economics of Integrity.
Monday, March 12, 2012
Credit default swaps get tricky
Financial Review
PUBLISHED: 10 Mar 2012
Anna Bernasek, New York
This week’s Greek debt restructuring lifts the curtain ever so slightly on a private realm in finance. Normally the exclusive domain of big-name hedge fund managers and investment bankers, the inner workings of the multitrillion-dollar credit default swap market have come to light since Greece began negotiating with its bondholders.
A look at how credit default swaps are constructed and how the market actually works raises some interesting questions about the value of these instruments and who benefits from them.
Credit default swaps are often compared with insurance contracts on bond investments. It is estimated that the global CDS market covers about $US32 trillion of bonds. That’s the so-called “notional” amount payable if every CDS were triggered to the maximum possible extent, which would happen if all the underlying debt became worthless.
While credit default swaps were invented in the early 1990s, they gained popularity as a speculative investment about 10 years ago.
There is no detailed reporting on credit default swaps in the US. making the market almost totally opaque here. Outside a select circle of dealers no one knows who holds the contract or who is on the hook to pay, or whether indeed they have the money to pay if required.
The dealers, of course, love it this way. When dealers are the only ones with the details, margins tend to fatten.
Typically, investors buy a credit default swap from a dealer to cover a loan that might sour. In the case of Greece, investors bought credit default swaps in the event Greece defaulted, thereby undermining the value of its bonds.The idea of insurance on a bond is simple. If the bond defaults, the insurer pays. But in a situation such as Greece’s, the devil is in the detail. Literal default isn’t the only way bondholders can lose. It would be a gross failure of imagination for Greece to do something so straightforward as a simple default.
Payment of a credit default swap cannot be made unless there is a credit event ruling by the International Swaps and Derivatives Association (ISDA) that the event is a default or, under the circumstances, amounts to one.
ISDA itself is a consortium of big banks and investment firms. Their names read like a who’s who of Wall Street: Bank of America Merrill Lynch, Barclays Capital, BNP Paribas, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Société Générale, UBS, BlueMountain Capital, Citadel, D. E Shaw, Elliott Management Corporation and PIMCO.
That means whatever Greece does, it will be up to ISDA to decide whether the contract is triggered. So the same people who plump up the CDS market, and the only ones with any visibility on who owes what to whom, will decide whether the swaps will pay out or not. Their ruling is final. There is no option to appeal.
Outright sovereign default is not very common. The last major country to default on part of its debt was Argentina in 2002. So the Greek debt restructuring is really the first big test of the market since credit default swaps have grown in popularity.
What makes this case so intriguing is that it highlights some fairly obvious conflicts of interest, especially surrounding the judgment required to trigger a payout.
On March 1, as the recent Greek debt exchange offer approached, ISDA made an unusual and lawyerly ruling, saying that credit default swaps would not be triggered based on a particular set of circumstances, notwithstanding bondholder losses. That left investors on both sides of Greek credit default swaps with a lingering question: Will the CDS ultimately cover almost certain Greek loan losses?
It’s a bit like having insurance on your home during a flood. You may think you’re covered, but you won’t really know until you hear what the company has to say.
Even after the Greek exchange offer this week, holders of credit default swaps on Greek bonds couldn’t be sure if they would be paid out until ISDA says so. Greece received a majority of investors voluntarily accepting the debt swap and can force those holding out to accept the terms of the deal. As a result of that coercion, most expect ISDA to rule that Greek credit default swaps are triggered and force them to pay out.
Even if CDS in the Greek case are triggered, the process shows the vulnerabilities of a market where interested parties exercise much control. Generally if you have a dispute over a product, you can tell your story to an arbitrator. Not so with credit default swaps. Your dispute goes to a committee of dealers in the product. The identity of each person is a secret.
The Greek case shows that even for seemingly sophisticated players credit default swaps can still prove tricky. We’ll have to see whether these financial instruments stand the test of time.
PUBLISHED: 10 Mar 2012
Anna Bernasek, New York
This week’s Greek debt restructuring lifts the curtain ever so slightly on a private realm in finance. Normally the exclusive domain of big-name hedge fund managers and investment bankers, the inner workings of the multitrillion-dollar credit default swap market have come to light since Greece began negotiating with its bondholders.
A look at how credit default swaps are constructed and how the market actually works raises some interesting questions about the value of these instruments and who benefits from them.
Credit default swaps are often compared with insurance contracts on bond investments. It is estimated that the global CDS market covers about $US32 trillion of bonds. That’s the so-called “notional” amount payable if every CDS were triggered to the maximum possible extent, which would happen if all the underlying debt became worthless.
While credit default swaps were invented in the early 1990s, they gained popularity as a speculative investment about 10 years ago.
There is no detailed reporting on credit default swaps in the US. making the market almost totally opaque here. Outside a select circle of dealers no one knows who holds the contract or who is on the hook to pay, or whether indeed they have the money to pay if required.
The dealers, of course, love it this way. When dealers are the only ones with the details, margins tend to fatten.
Typically, investors buy a credit default swap from a dealer to cover a loan that might sour. In the case of Greece, investors bought credit default swaps in the event Greece defaulted, thereby undermining the value of its bonds.The idea of insurance on a bond is simple. If the bond defaults, the insurer pays. But in a situation such as Greece’s, the devil is in the detail. Literal default isn’t the only way bondholders can lose. It would be a gross failure of imagination for Greece to do something so straightforward as a simple default.
Payment of a credit default swap cannot be made unless there is a credit event ruling by the International Swaps and Derivatives Association (ISDA) that the event is a default or, under the circumstances, amounts to one.
ISDA itself is a consortium of big banks and investment firms. Their names read like a who’s who of Wall Street: Bank of America Merrill Lynch, Barclays Capital, BNP Paribas, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Société Générale, UBS, BlueMountain Capital, Citadel, D. E Shaw, Elliott Management Corporation and PIMCO.
That means whatever Greece does, it will be up to ISDA to decide whether the contract is triggered. So the same people who plump up the CDS market, and the only ones with any visibility on who owes what to whom, will decide whether the swaps will pay out or not. Their ruling is final. There is no option to appeal.
Outright sovereign default is not very common. The last major country to default on part of its debt was Argentina in 2002. So the Greek debt restructuring is really the first big test of the market since credit default swaps have grown in popularity.
What makes this case so intriguing is that it highlights some fairly obvious conflicts of interest, especially surrounding the judgment required to trigger a payout.
On March 1, as the recent Greek debt exchange offer approached, ISDA made an unusual and lawyerly ruling, saying that credit default swaps would not be triggered based on a particular set of circumstances, notwithstanding bondholder losses. That left investors on both sides of Greek credit default swaps with a lingering question: Will the CDS ultimately cover almost certain Greek loan losses?
It’s a bit like having insurance on your home during a flood. You may think you’re covered, but you won’t really know until you hear what the company has to say.
Even after the Greek exchange offer this week, holders of credit default swaps on Greek bonds couldn’t be sure if they would be paid out until ISDA says so. Greece received a majority of investors voluntarily accepting the debt swap and can force those holding out to accept the terms of the deal. As a result of that coercion, most expect ISDA to rule that Greek credit default swaps are triggered and force them to pay out.
Even if CDS in the Greek case are triggered, the process shows the vulnerabilities of a market where interested parties exercise much control. Generally if you have a dispute over a product, you can tell your story to an arbitrator. Not so with credit default swaps. Your dispute goes to a committee of dealers in the product. The identity of each person is a secret.
The Greek case shows that even for seemingly sophisticated players credit default swaps can still prove tricky. We’ll have to see whether these financial instruments stand the test of time.
Monday, March 5, 2012
Hard to see point of Obama’s tax plan
The Financial Review
PUBLISHED: 03 Mar 2012
Anna Bernasek, New York
At the end of February, President Barack Obama announced a new plan for corporate tax reform. His key initiative is to cut the top marginal corporate tax rate sharply while closing loopholes and subsidies. It seems reasonable. After all, who wouldn’t want a simpler, more efficient tax system and lower tax rates?
But the more you think about it, the more questions arise. While the US has many problems, corporate taxes aren’t one of them. Strong corporate profits have been the exceptional feature of the post-housing bubble economy.
Unfortunately, that’s had little effect on hiring, which really is a problem. What’s more, it’s hard to identify any industry hurting because of taxes – the car industry wasn’t in trouble. Nor the financial industry. In fact, except for The Wall Street Journal’s editors, corporate tax reform is the last thing most Americans think about.
But first let’s take Obama’s plan at face value. He said he’d cut the top marginal corporate tax rate from 35 per cent to 28 per cent and pay for it by closing loopholes, subsidies and exemptions. Specifically, he’d end subsidies to the oil and gas industry but give manufacturing a bigger tax break by capping its top marginal rate at 25 per cent.
Obama also wants to introduce a new minimum tax on foreign earnings of US companies while, at the same time, simplifying and cutting taxes for small business. Overall, he promises to deliver corporate tax reform without any impact on the federal deficit – revenue losses from lower tax rates would be offset by gains from closing loopholes, subsidies and exemptions and revenue gains from a new foreign earnings tax. So, in effect, whatever one company gains, others will lose.
Why do this? Obama says his corporate tax plan will make US companies more competitive, promote growth and promote fairness. On competitiveness, it’s hard to believe US companies aren’t able to compete with foreign companies because of the taxes they pay at home. For one thing, we haven’t got much evidence that corporate taxes make US companies uncompetitive. In practice, they’re doing OK.
While the top marginal corporate tax rate of 35 per cent is one of the highest in the world, few companies ever pay that. The US Treasury has calculated that the effective tax rate, the amount companies actually pay, is in line with other major countries. In particular, the current treatment of interest payments reduces the headline rate significantly.
Simplifying the rules so that companies don’t have to spend on finding loopholes, subsidies and exemptions would be a good thing. But can Obama take on every interest group with a tax break and win? That would be remarkable even if Congress were in Democratic hands. Which it’s not.
As for promoting jobs, the corporate sector already has more cash than it knows what to do with. For several years now, most companies have been sitting on record cash piles, refusing to hire or invest. Giving companies even more cash doesn’t look like a great way to create jobs. Then there’s the deficit. With so much pressure from Republicans to reduce deficits, this plan seems to take an eventual rise in corporate taxes off the table. Maybe that’s the right policy, but it’s not a great way to negotiate.
As for fairness, that’s in the eye of the beholder. Levelling the playing field seems laudable, but this proposal only goes part-way. Manufacturers may appreciate the special treatment, but the service sector could see things differently. After all, the big issue of fairness in the US isn’t between companies but individuals. Income inequality is at unprecedented levels.
On that front, a major culprit is tax on investment gains, far lower than taxes on wages. Yet Obama has said nothing about changing capital gains taxes. He’s made vague remarks that high-income Americans need to pay their share of taxes but has not promised to overhaul taxes for individuals.
He is not wrong to want to improve the corporate tax system. But his plan seems out of place given his promise to focus on jobs. It’s reminiscent of the healthcare reform he introduced earlier in his presidency. Both were originally Republican ideas, and both only address issues at the margins. They essentially preserve the status quo without fundamental change. What’s more, they don’t seem likely to satisfy anyone.
A more cynical interpretation of Obama’s plan is that it is custom-made to generate campaign contributions. By signalling that corporate taxes are in play, and providing an opening gambit about what he would do, he is inviting those concerned to step forward and make their positions known. Will anyone be surprised if firms curry favour by contributing?
If Obama wins the election, his plan will probably end in one of two ways. Either companies will get a big tax cut, as it proves difficult to convince Congress to close all those loopholes, exemptions and subsidies. Or some firms will gain while others lose. We won’t find out until after November. But rest assured, the lobbying has begun.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. She is the author of The Economics of Integrity.
PUBLISHED: 03 Mar 2012
Anna Bernasek, New York
At the end of February, President Barack Obama announced a new plan for corporate tax reform. His key initiative is to cut the top marginal corporate tax rate sharply while closing loopholes and subsidies. It seems reasonable. After all, who wouldn’t want a simpler, more efficient tax system and lower tax rates?
But the more you think about it, the more questions arise. While the US has many problems, corporate taxes aren’t one of them. Strong corporate profits have been the exceptional feature of the post-housing bubble economy.
Unfortunately, that’s had little effect on hiring, which really is a problem. What’s more, it’s hard to identify any industry hurting because of taxes – the car industry wasn’t in trouble. Nor the financial industry. In fact, except for The Wall Street Journal’s editors, corporate tax reform is the last thing most Americans think about.
But first let’s take Obama’s plan at face value. He said he’d cut the top marginal corporate tax rate from 35 per cent to 28 per cent and pay for it by closing loopholes, subsidies and exemptions. Specifically, he’d end subsidies to the oil and gas industry but give manufacturing a bigger tax break by capping its top marginal rate at 25 per cent.
Obama also wants to introduce a new minimum tax on foreign earnings of US companies while, at the same time, simplifying and cutting taxes for small business. Overall, he promises to deliver corporate tax reform without any impact on the federal deficit – revenue losses from lower tax rates would be offset by gains from closing loopholes, subsidies and exemptions and revenue gains from a new foreign earnings tax. So, in effect, whatever one company gains, others will lose.
Why do this? Obama says his corporate tax plan will make US companies more competitive, promote growth and promote fairness. On competitiveness, it’s hard to believe US companies aren’t able to compete with foreign companies because of the taxes they pay at home. For one thing, we haven’t got much evidence that corporate taxes make US companies uncompetitive. In practice, they’re doing OK.
While the top marginal corporate tax rate of 35 per cent is one of the highest in the world, few companies ever pay that. The US Treasury has calculated that the effective tax rate, the amount companies actually pay, is in line with other major countries. In particular, the current treatment of interest payments reduces the headline rate significantly.
Simplifying the rules so that companies don’t have to spend on finding loopholes, subsidies and exemptions would be a good thing. But can Obama take on every interest group with a tax break and win? That would be remarkable even if Congress were in Democratic hands. Which it’s not.
As for promoting jobs, the corporate sector already has more cash than it knows what to do with. For several years now, most companies have been sitting on record cash piles, refusing to hire or invest. Giving companies even more cash doesn’t look like a great way to create jobs. Then there’s the deficit. With so much pressure from Republicans to reduce deficits, this plan seems to take an eventual rise in corporate taxes off the table. Maybe that’s the right policy, but it’s not a great way to negotiate.
As for fairness, that’s in the eye of the beholder. Levelling the playing field seems laudable, but this proposal only goes part-way. Manufacturers may appreciate the special treatment, but the service sector could see things differently. After all, the big issue of fairness in the US isn’t between companies but individuals. Income inequality is at unprecedented levels.
On that front, a major culprit is tax on investment gains, far lower than taxes on wages. Yet Obama has said nothing about changing capital gains taxes. He’s made vague remarks that high-income Americans need to pay their share of taxes but has not promised to overhaul taxes for individuals.
He is not wrong to want to improve the corporate tax system. But his plan seems out of place given his promise to focus on jobs. It’s reminiscent of the healthcare reform he introduced earlier in his presidency. Both were originally Republican ideas, and both only address issues at the margins. They essentially preserve the status quo without fundamental change. What’s more, they don’t seem likely to satisfy anyone.
A more cynical interpretation of Obama’s plan is that it is custom-made to generate campaign contributions. By signalling that corporate taxes are in play, and providing an opening gambit about what he would do, he is inviting those concerned to step forward and make their positions known. Will anyone be surprised if firms curry favour by contributing?
If Obama wins the election, his plan will probably end in one of two ways. Either companies will get a big tax cut, as it proves difficult to convince Congress to close all those loopholes, exemptions and subsidies. Or some firms will gain while others lose. We won’t find out until after November. But rest assured, the lobbying has begun.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. She is the author of The Economics of Integrity.
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