I wanted to make a few observations about Lawrence B. Lindsey’s post at The Weekly Standard on the Republican tax reform plan. I agree with him that “the American economy really is sick”:
From 2011-2016, we observed the poorest economic expansion on record. Usually, recoveries from sharp recessions are equally sharp. This recovery was a dud. Barack Obama was the first president without a year of 3 percent real GDP growth while in office. Further, from 2011-2016, annual growth averaged more than a full point less than growth from 1965-2010, a period that includes drag from multiple recessions. Similarly, growth in real personal incomes and wages lagged behind the long-term historic average, and by several measures income inequality increased.
However, I think it’s been sick for much, much longer than Mr. Lindsey appears to going well back past 2011. I also think that the response that recovery is slow because the late recession was a balance sheet recession has gone past its shelf life.
I was nonplussed, however, by his diagnosis of the problem:
Three factors drive an economy: growth of the labor force, growth of the capital stock, and what economists call total factor productivity—how much output is produced by each unit of labor and capital. The poor economic performance of late cannot be blamed on the labor market. From 2011-2016, employment expanded rapidly, though the wages paid by those jobs were decidedly subpar. But from 2011-2015 (the last year for which data are available), capital formation plummeted—by almost 50 percent compared to the average annual growth rate observed from 1965-2010. Total factor productivity declined even more, from a long-term historic average of 1.1 percent to just 0.4 percent, a plunge of nearly two-thirds.
I have never encountered a definition of productivity that did not include business investment. “Capital stock” is the common and preferred stock issued by a company. It’s also a balance sheet term that accountants use to describe equity. I know of no straightforward, direct relationship between business investment and capital stock. There may be an indirect relationship. There may not. It’s contingent.
As I have noted regularly, business investment has declined as a proportion of real GDP and IMO that’s a disaster. It’s been a problem for fifteen years or more, too widely discounted, and misdiagnosed by most.
Using his eccentric definition of productivity, the prescription he proposes has to do with capital formation when what is needed is increased domestic non-residential business investment.
I agree with him that the slow rate of new business formation is a problem:
Part of this can be blamed on overregulation, part on an anti-business attitude (remember “If you’ve got a business—you didn’t built that”?), and part on excessive and complicated taxation.
He ignores another major component of the slow rate of business formation: too many large companies and the crony capitalism that goes hand in hand with too many large companies.
This is absolutely correct:
Under current law, the cost of a new factory or machine is a deduction for tax purposes only over a period of years. Under the House plan, all investments can be expensed—that is, they’re eligible to receive an immediate deduction in the year they are placed in service. Since new investments typically do not produce enough income to offset their cost in the first year, the firm usually has a “net operating loss,” meaning that their costs exceed their income. As under current law, this loss can be carried forward into the succeeding years until the year’s income finally exceeds its expenses. By allowing expensing of new investments, most new firms will not owe any tax in their first few years of operation—the period when cashflow is most critical. That need for positive cashflow is particularly important now when banking regulations make it tougher than usual to secure loans to produce operating capital.
European countries allow current year expensing. To the best of my knowledge we’re the only OECD country that has our byzantine scheme of depreciation.
I believe there need to be limits to current year expensing. For example, I think it should only apply to domestic investmente and should not apply to the acquisition of land.
I also agree with the plan to reduce the corporate income tax to 20%. Zero would be the optimal corporate tax rate but at the very least the corporate tax rate should be brought within OECD norms. Whether in the headline corporate tax rate or the effective corporate tax rate, the U. S. is an outlier with by far the highest rates.
I’m convinced that a spate of trust-busting would have a beneficial effect both on jobs and economic growth but I don’t expect any foreseeable Congress or administration, Republican or Democratic, to tackle that. The simile I’ve used before is that small trees can’t grow in the shadow of big trees. The reality is actually much worse than that since big trees generally don’t go around stomping on small ones or getting the Congress to pass laws that help them while injuring small trees.
I’m having a hard time getting past Lindsey’s nakedly partisan notion that the problems started in 2011. He’s very upset over the slow recovery from. . . from what? From a sound economy? Did we slowly recover from perfect health? How’s the chemotherapy going, you perfectly healthy specimen?
As a corporation myself I’m happy to see corporate tax rates lowered. (Because I like money.) But I have to wonder if it’s a magic cure-all why all those OECD countries with low corporate rates aren’t outperforming us left and right. To continue the illness analogy, it looks like the whole western world caught tuberculosis and many therapies were tried, and none brought anything better than a slow improvement. Ireland has a corporate tax rate a third of ours and yet has grown more slowly. So where is the real world proof of the proposition?
As I said in my post I think our problems precede the Obama Administration.
I don’t believe there’s a single magic bullet that will solve all of our problems but I think that bringing our corporate tax rate into line with other OECD countries is one step of many. There are lots of differences between the U. S. and Ireland or between the U. S. and Germany. Granting Ireland or Germany a competitive advantage over the U. S. certainly doesn’t help us.
As I have written in the past I believe that but for the massive investment that companies did in computer and networking technology in the 1980s and early 1990s with very little to show for it, we wouldn’t have seen the boom of the late 1990s and we’d have had slow growth then, too.
If there were a single topic of what I’ve been doing here at The Glittering Eye for the last 13 years, it could be this. We need to rationalize immigration and trade, we need to enforce anti-trust laws, there should be no perpetual intellectual property, we need to figure out how to regulate healthcare, finance, and education better.
I guess what I’m missing is how corporate tax cuts will translate into business investment. Cut my corporate taxes and I’ll just leave more money in the corp where it will benefit no one. I wonder how many US corporations even have the capacity to carry out, or have an interest in, business investment.
It may or may not increase business investment. But the high U. S. corporate taxes does encourage investment outside the U. S., discourage investment in the U. S., and motivates U. S. corporations to engage in inversions and other practices to avoid our taxes.
And then there’s the deadweight loss involved. GE’s tax department is 1,000 people.
My preference, as noted before, is smaller companies. Mom and pop shops generally don’t move their headquarters to Dublin.
I’m open to suggestions for increasing U. S. business investment. I’ve made multiple suggestions, including in this post.
I think if you eliminate the corporate income tax and then tax capital gains as regular income, that would create a big incentive for business investment.
” I know of no straightforward, direct relationship between business investment and capital stock. ”
Generally, that’s correct, only in start ups, and much more rare, far down rounds of equity financing. For established companies it’s titled capital spending. For his purposes you’d have to have to view initial capitalizations as proxies for business investment since, unlike buyouts, the use of funds isn’t purchase of the owners’ stock.
“Cut my corporate taxes and I’ll just leave more money in the corp where it will benefit no one. ”
What is your annual capital spending budget and usual use of funds, Michael? About 30 seconds thought should tell you why your personal example has no real applicability.
As I’ve said before, and will, I guess, point out again, a business with capital spending opportunities is prized. Capital spending means growth opportunities.
Contra what I see so much here, is the strange notion that businesses are just there to be milked, with no capital to be invested in growth. (In buyouts, where debt service is a reality, low maintenance capex is advantageous, but not absence of growth capes opportunities).
So if businesses are not investing it doesn’t take a rocket scientist to infer 1) we have a growth problem with rare growth opportunities, 2) returns are not sufficient to attract risk capital, those returns diminished for any number of reasons, 3) low foreign labor cost alternatives have reduced the need for investment, which is really a subset of 2.
There may be some truth to #3 but I also think that the large gains in the return to investment seen in the late 90s and early Aughts have created a distorted notion of the expected return on investment. Today’s managers have forgotten about all of the investment in the 80s and early 90s. The returns to investment of 20 years ago didn’t just fall from the sky.
Drew forgot #4-It means that profits are going to management and/or shareholders rather than being reinvested. #5, really an extension, executives earn larger salaries and bonuses based upon short term results. There is little reward (for an executive) in making long term investments. (We had several years of record profits which went on much longer than Drew said they would. Record profits, think of that. Where did the money go? Not, apparently, into investing for the future.)
Steve
I didn’t want to go there, but it looks like a basic primer in corporate finance and returns on capital is in order.
http://people.stern.nyu.edu/adamodar/pdfiles/papers/returnmeasures.pdf
Note late in the paper the McKinsey work showing the relative stability of returns over time. And yet growth fades. As anyone should know, competitive forces cause fade. But this study makes an additional, and my point; if you want investment in excess return projects you need growth. The next great thing. And that next great thing is the nexus of a good opportunity and a good environment. The latter has been lacking.
This makes Steve’s comment particularly clumsy. And I would ask him, with only three things you can do with profits: build balance sheet assets (cash,) reinvest, or distribute capital, and with reinvestment relatively unattractive………what do you do, distribute or cite banal platitudes like “investing for the future.”