Trump’s magical economic thinking – Simon Johnson

MIT Sloan Professor Simon Johnson

MIT Sloan Professor Simon Johnson

From Project Syndicate

Donald Trump has finally put out a detailed economic plan. Authored by Peter Navarro (an economist at the University of California-Irvine) and Wilbur Ross (an investor), the plan claims that a President Trump would boost growth and reduce the national debt. But its projections are based on assumptions so unrealistic that they seem to have come from a different planet. If the United States really did adopt Trump’s plan, the result would be an immediate and unmitigated disaster.

At the heart of the plan is a very large tax cut. The authors claim this would boost economic growth, despite the fact that similar cuts in the past (for example, under President George W. Bush) had no such effect. There is a lot of sensible evidence available on precisely this point, all of which is completely ignored.

The Trump plan concedes that the tax cut per se would reduce revenue by at least $2.6 trillion over ten years – and its authors are willing to cite the non-partisan Tax Foundation on this point. But the Trump team claims this would be offset by a growth miracle spurred by deregulation.

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Fed’s focus on ‘too big to fail’ won’t save taxpayers from next bank bailout – Oz Shy

MIT Sloan Senior Lecturer Oz Shy

MIT Sloan Senior Lecturer Oz Shy

From The Conversation

Last month, the Federal Reserve announced that 31 out of 33 U.S. banks had passed its latest “stress test,” designed to ensure that the largest financial institutions have enough capital to withstand a severe economic shock.

Passing the test amounts to being given a clean bill of health by the Fed. So are taxpayers – who were on the hook for the initial US$700 billion TARP bill to bail out the banks in 2008 – now safe?

Yes, but only until the next crisis.

Skeptics of these tests (myself included) argue that passing them will not prevent any bank (large or small) from failing, in part because they’re not stressful enough and the proposed capital requirements are not high enough.

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What to say to constituents about potentially cutting the corporate tax rate? — Michelle Hanlon

MIT Sloan Professor Michelle Hanlon

MIT Sloan Professor Michelle Hanlon

From The Hill

I recently testified at a Ways and Means Committee hearing about tax reform. While there is broad agreement about the need to reduce the U.S. corporate tax rate, which is now highest among the world’s advanced economies, Committee members asked how they could explain this to constituents.  Would this be perceived as fair?

When businesses choose their legal form for tax purposes in the United States they have several options. The simplest option is that the owner can operate the business without a separate legal entity in which case the income is taxed directly to the individual on their tax return. This is known as a sole proprietorship. An alternative is a pass-through entity, which is not taxed at the entity level (generally) but instead “flows through” income to the owner(s) who are taxed on their individual income tax returns. These entities include partnerships, LLCs, and S-corporations.

The other common type of organizational form is the C-corporation, which is subject to an entity level tax. In addition, when dividends are paid, the shareholders are taxed on the dividend income. Thus, the C-corporation form of business organization may result in double taxation. Almost all publicly traded businesses are taxed as C-corporations, while many small business are organized as pass-through entities.

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The lose-lose tax policy driving away U.S. business — Michelle Hanlon

MIT Sloan Prof. Michelle Hanlon

From The Wall Street Journal 

Apple issued $12 billion of U.S. debt in April, which gave the company a domestic cash infusion that allowed it to keep more earnings overseas. Last month Pfizer PFE attempted to acquire AstraZeneca, a transaction that would have made Pfizer a subsidiary of the U.K.-based company. These were useful examples in the taxation classes I teach at MIT’s business school, but the real-world implications of these decisions are troubling. Even worse, legislators have responded with proposals that seek to prevent companies from escaping the U.S. tax system.

The U.S. corporate statutory tax rate is one of the highest in the world at 35%. In addition, the U.S. has a world-wide tax system under which profits earned abroad face U.S. taxation when brought back to America. The other G-7 countries, however, all have some form of a territorial tax system that imposes little or no tax on repatriated earnings.

To compete with foreign-based companies that have lower tax burdens, U.S. corporations have developed do-it-yourself territorial tax strategies. They accumulate foreign earnings rather than repatriate the earnings and pay the U.S. taxes. This lowers a company’s tax burden, but it imposes other costs.

For example, U.S. corporations hold more than $2 trillion in unremitted foreign earnings, a substantial portion of which is in cash. This is cash that currently can’t be reinvested in the U.S. or given to shareholders. As a consequence, companies are borrowing more in the U.S. to fund domestic operations and pay dividends. Another potential effect is that companies invest the earnings in foreign locations.

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Easy money won’t save Corporate America — S.P. Kothari

MIT Sloan Deputy Dean S.P. Kothari

From WSJ MarketWatch

Since the onset of the global financial crisis in 2007-08, the administration and the Federal Reserve have implemented policies explicitly designed to spur investment, grow GDP, and reduce unemployment. These actions haven’t worked — certainly not as expected.

The weapons of choice to boost the U.S. economy have been low interest rates, deficit spending, and increased money supply through the Fed’s balance-sheet expansion to over $3 trillion. Yet almost five years later, GDP growth has been anemic at below 2% and at times negative, and aggregate domestic investment is about where it was in 2004, and considerably below the 2006-2007 level.

Optimists believe it’s still too early and that we have spent too little. More of the same would eventually produce good fortune — at least, that’s the hope.

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S.P. Kothari is deputy dean and professor of accounting at the MIT Sloan School of Management. He is the author, with Jonathan Lewellen and Jerold Warner, of ”The Behavior of Aggregate Corporate Investment”.