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Monday, December 26, 2016

More on Republican economics and trade deficits, corporate raiders and all

by John MacBeath Watkins

I've been giving more thought to the curious fact that we had very little experience with trade deficits before voodoo economics reared its head in the 1980s.

What changed? Well, several things. In fact, our whole attitude to economics seemed to change.

There was a major shift in the tax load. Ronald Reagan famously lowered the top marginal tax rate from 70% to 28%. This encouraged the accumulation of wealth by the highest earners. But tax receipts only went from 18.2% of GDP to 18.1% of GDP. Did that mean that voodoo economics worked?

No, just funnin' ya. It means that while high earners got a lower top marginal rate, others paid more tax, and some was shifted from one pocket to another. Payroll taxes, for example, have been rising for a long time, and that's part of what he did, but the government kept getting just about as much of its income from individual income taxes as before.

Source: Wikipedia

It's just that different people were paying the tax. In addition, the long-term trend for lowering corporate taxes continued. In about 1970, the government started collecting more tax from payrolls than from corporate income tax. In 1952, tax receipts from the corporate income tax amounted to 33% of revenue, in 1982 it was closer to 7%, and it's settled to something less than 10% in most years.

Now, the Tax Foundation argues that high corporate taxes have caused business owners to set up "pass-through" corporations whose only function is to pass income through to the owners without paying corporate income tax. This is because Reagan lowered individual taxes more than corporate taxes.

The Tax Reform Act of 1986 reduced the corporate tax rate, but reduced the individual tax rate further, and raised taxes on corporations in other ways. That marked the peak of U.S. C corporations, at 2.6 million in 1986. As of 2011 (most recent data), there are now 1 million fewer corporations, at 1.6 million. In contrast, S corporations grew from about 800 thousand in 1986 to 4.2 million in 2011, and partnerships grew from 1.7 million to 3.3 million.

It would seem that this encouraged the use of a tax loophole to dodge the higher corporate income tax. The Tax Foundation, based on this information, argues rather improbably that this is wrong, that the reduction in corporate tax receipts is owing to a shrinkage of the corporate sector -- even though their own figures show an explosion of (pass-through) S-corporations. If, in our innocence, we assume that S corporations are corporations, this notion that the corporate sector has shrunk cannot possibly be true.

And since individual tax revenues have pretty much held steady, that means that the big change has been shifting the tax burden from corporations to payrolls. Payroll taxes are paid half by employers and half by the employee, and there is some controversy about whether total compensation to the employee should include the employer's share. But the point of payroll taxes is that both sides of the tax are really costs to the employer, whether the employee regards them as pay or not.

In essence, what we've come to call Reaganomics involves making it more expensive to hire employees and letting corporations keep more money (or pass it through to their owners.)

At the same time, healthcare costs were going through the roof, and the only practical way for most people to have health insurance was to have it through the employer. So again, the cost of employing Americans was going up.

The Affordable Care Act, AKA Obamacare, was in part an attempt to "bend the curve" of healthcare cost increases, which it seems to have succeeded in doing, and in part an effort to decouple health insurance from employment.

Both are things that need to happen if hiring Americans to make things and export them is to continue to  be a viable enterprise.

Now, increases in payroll taxes are a long-term trend that didn't start under Reagan, and the decline in corporate tax revenues started long before he came into office as well. What was new?

For one, the claim that tax cuts didn't have to be paid for, that we could cut taxes on the rich and it would stimulate the economy so much that tax revenues wouldn't fall. This was obviously wrong by the mid-1980s, and should have been obvious it was wrong even before it was tried, but the same old snake oil comes on the market with every Republican administration.

The old Keynesian consensus was that you needed to stimulate the economy in downturns and reduce the debt-GDP ratio in good times. Reagan, and later the Cheney administration for which George H.W. Bush's son was a figurehead, changed that calculation. The economy needed to run large deficits during Republican administrations, and cut spending regardless of economic conditions during Democratic administrations.

The result can only be workable as economic policy if by coincidence.

One problem with these changes is that although the numbers sometimes obscure this fact, economics is a science of values. When you increase tax on work and reduce tax on ownership, you are sending a message that you wish to discourage work and valorize ownership. Pretty much everything we've done with economic management since the 1970s, the financialization of everything and the way the change in the basic mission of corporations allowed management to break implicit contracts and go to war against their employees.

As Larry Summers and Andrei Schleiferwere pointed out in their 1988 paper, Breach of Trust in Hostile Takeovers, the financialization of the economy and the breakdown of companies were linked.

When takeover artists could raise huge sums in junk bonds to do a hostile takeover of a corporation, their plan was not actually to make the company more productive. Summers and Schleiferwere put it, "The industrial diversity of many raiders' holdings suggests that their particular skill is value redistribution rather than value creation."

The reason that companies exist, rather than having individuals doing all the tasks of the company on a contract basis is that the transaction costs of contracting everything would be enormous.(see R.H. Coase, The Nature of the Firm, Economica, Nov. 1937.) Value creation requires implicit contracts which enable large groups of people to work for a common goal.

But the credo of the corporate raider was to make war on their own employees, get them to take less pay, and pass the larger profits on to the management and the shareholders. Companies that had for years worked for a partnership between workers and management found they were under financial pressure to do the same, or be a takeover target.

Starting in the 1970s, public corporations stopped being about what Coase had said firms exist for, working together to create value for customers, and became a game of takeaway.

And that's about the point where America started running large trade deficits. As I've previously pointed out, there were some pretty substantial other factors, like the oil shock of 1973 and Chinese financial sterilization in the 1990s and early 2000s. Still, it does seem a bit of a coincidence that we stopped exporting as much as we imported about the time that public corporations stopped being about creating value and started being about redistributing it upward to the managers and shareholders. And that this all happened while the tax burden increasingly discouraged hiring and encouraged speculation.

But then, I"m an amateur. What do I know?

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