Macro Roundup

“…“Repatriation has little effect on real investment in the United States,” said Alan Viard, a tax expert at the conservative American Enterprise Institute and a former senior economist at the Federal Reserve Bank of Dallas. That’s because repatriation is not really about geography. Most of the money is not stashed in some underground vault overseas, but already in American financial institutions and capital markets. Repatriation is in effect a legal category that requires a company to book the money in the United States — and pay taxes on it — before it can be distributed to shareholders or invested domestically. The whole notion of earnings trapped offshore is misleading, Steven M. Rosenthal, a tax lawyer and senior fellow at the Urban-Brookings Tax Policy Center. “The earnings are not ‘trapped,’” he said. “They’re not offshore. They’re not even earnings. They’re accounting gimmicks that allow earnings to be shifted abroad.” What’s more, companies already get something akin to tax-free repatriation by borrowing against those funds, with the added bonus of being able to deduct the interest paid on those loans from their tax bill. A shortage of cash does not seem to be what is holding back companies from expanding. Corporate profits are higher as a share of the nation’s gross domestic product now than they have been in decades, said Kimberly A. Clausing, an economist at Reed College who studies the taxation of multinationals. According to a study by Treasury Department economists, “excess” or above-average profits by a few global giants have increased. “It’s not clear that giving them an even higher share of profits, or a windfall, is going to lead to extra investment,” she said….”

Patricia Cohen, "Trump Tax Plan May Free Up Corporate Dollars, but Then What?,"New York Times, August 29, 2017, https://www.nytimes.com/2017/08/29/business/economy/trump-corporate-tax-plan.html

Trump Tax Plan May Free Up Corporate Dollars, but Then What?

The tax overhaul promised by President Trump and Republican congressional leaders is lugging a remarkably heavy load. The goal is not only to reduce the tax bills of corporations and small businesses, but also to stimulate investment, create jobs, increase global competitiveness and promote economic growth.

Whatever the intentions, though, pushing the world’s largest and most diversified economy in any particular direction is a colossal undertaking. In addition, there is a large and sophisticated tax avoidance industry dedicated to frustrating the most carefully worded proposals.

And as Mr. Trump prepares to outline his corporate tax overhaul ideas in a speech on Wednesday in Springfield, Mo., economists and tax experts warn that the path is likely to be treacherous.

Consider the tantalizing $2.6 trillion in global profits that American companies are keeping out of their home accounts and out of the Internal Revenue Service’s reach.

A pro-growth tax policy would presumably aim not only to reach profits kept abroad as a tax dodge, but also to encourage companies to use that money to expand their business and hire more workers.

That was what President George W. Bush set out to do in 2004 when he imposed what was meant to be a one-time reprieve and lowered the tax on those funds to 5.25 percent from a potential top rate of 35 percent. More than $300 billion flowed back into the United States, but despite safeguards, companies used most of the money to pay shareholder dividends or buy back stock, not to reinvest.

“Repatriation has little effect on real investment in the United States,” said Alan Viard, a tax expert at the conservative American Enterprise Institute and a former senior economist at the Federal Reserve Bank of Dallas.

That’s because repatriation is not really about geography. Most of the money is not stashed in some underground vault overseas, but already in American financial institutions and capital markets. Repatriation is in effect a legal category that requires a company to book the money in the United States — and pay taxes on it — before it can be distributed to shareholders or invested domestically.

The whole notion of earnings trapped offshore is misleading, Steven M. Rosenthal, a tax lawyer and senior fellow at the Urban-Brookings Tax Policy Center. “The earnings are not ‘trapped,’” he said. “They’re not offshore. They’re not even earnings. They’re accounting gimmicks that allow earnings to be shifted abroad.”

What’s more, companies already get something akin to tax-free repatriation by borrowing against those funds, with the added bonus of being able to deduct the interest paid on those loans from their tax bill.

A shortage of cash does not seem to be what is holding back companies from expanding. Corporate profits are higher as a share of the nation’s gross domestic product now than they have been in decades, said Kimberly A. Clausing, an economist at Reed College who studies the taxation of multinationals. According to a study by Treasury Department economists, “excess” or above-average profits by a few global giants have increased.

“It’s not clear that giving them an even higher share of profits, or a windfall, is going to lead to extra investment,” she said.

A survey of business leaders by the international accounting and advisory firm Friedman, for example, found that just 23 percent would reinvest repatriated funds. Most would use the money to pay dividends or engage in share buybacks.

To some economists, offering technology companies like Apple and Microsoft and pharmaceutical companies like Merck and Pfizer a discount on the corporate taxes they would normally owe simply rewards bad behavior.

“A lot of the funds got overseas in the first place via tax dodges, so giving firms a tax break on the money coming back seems like compounding the problem,” said William Gale, co-director of the Tax Policy Center and a former economic adviser to the first President George Bush. Repatriation at a discount rate “is a tax break,” he said.

If taxing foreign earnings that have already accumulated overseas is difficult, so is eliminating incentives that reward companies for continuing to keep profits in tax havens. To that end, Mr. Trump and the Republican leadership have pushed to slash the corporate tax rate and switch to what is known as a territorial system that would tax only profits earned in the United States and not those earned in other countries.

Mihir Desai, an economist at Harvard Business School, likes that approach. “We currently have the worst of all worlds,” he wrote in an email. “We have a high marginal rate,” which encourages companies to avoid taxes and puts the United States at a global disadvantage.

“And we have low average rates” — because of all the loopholes — “which indicate that we’re not collecting as much as we used to, given the very high level of corporate profits.”

The crucial questions are how to pay for a lower rate and how to prevent abuses. Corporate tax cuts that lead to huge deficits could hobble the economy. And a territorial system without sufficient safeguards could end up encouraging even more businesses to shift profits, operations and jobs to countries with lower tax rates.

Other nations with territorial systems have tried to prevent companies from wriggling out of paying taxes, while tax experts have suggested proposals ranging from a minimum global tax to tighter rules to prevent companies from relocating their patents and copyrights to tax havens like Bermuda and the Cayman Islands.

But skeptics worry that making the system airtight is impossible. “It’s an endless cat-and-mouse game,” said Matthew Gardner, senior fellow at the Institute on Taxation and Economic Policy, a research group based in Washington. “What’s driving companies to engage in paper transactions is not our 35 percent tax rate,” he said, but other countries’ willingness to undercut whatever rate the United States settles on. “You can never win if you are competing against their zero tax rate.”

Mr. Gardner argued that a broader definition of American competitiveness is needed that includes not only the tax system, but also the business infrastructure that the tax system supports — bridges and roads, health care, education and research and development. “If all you think about is the tax rate, then it should be zero,” he said. “Competitiveness is about finding the right balance.”

The damage inflicted by Hurricane Harvey on Texas — which Mr. Trump has promised to help address with federal money — shows how quickly new budget demands can materialize.

Establishing rates that are sustainable over the long haul contributes to economic growth. “If Republicans cut tax rates to levels that are unsustainable, everyone will believe rates will go up,” said Joseph E. Stiglitz, a Nobel Prize-winning economist and the author of several books on globalization and economic inequality. “And that means you’re going to get even less investment, because they are looking at future tax rates.”

In general, though, Mr. Stiglitz argued that the link between tax cuts and economic growth is vastly overstated. “There is no evidence that cutting the tax rates stimulates more investment,” he said.

“Growth is low because labor force growth is slow,” and it is only going to grow slower because of immigration restrictions, he said. “And we’re not investing in education and research, which is why productivity is slow. The notion that changing taxes is going to lead to a growth spurt is pure nonsense.”

but market power!

"...Even as awave of mergers has cut the number of major carriers to fourand significantly reduced competition, lower-cost airlines continue to play a role in moderating ticket costs....Thecost of a round-trip domestic ticket averaged more than $490 in the first half of the year, up slightly compared with 2016, according to Airlines Reporting Corporation, a company that settles flight transactions between a number of carriers and booking services like Expedia.... The jostling, however, has left airline investors skittish. As the publicly traded airlines in July reported earnings for the second quarter, shareholders sold off their shares, worried about the fight over fares and capacity increases...."

Micah Maidenberg, "How Low-Cost Airlines Alter the Economics of Flying,"New York Times, September 1, 2017, https://mobile.nytimes.com/2017/09/01/business/budget-airlines-ticket-prices.html

How Low-Cost Airlines Alter the Economics of Flying

When Spirit Airlines began offering flights between Detroit and Philadelphia, the average price for a one-way ticket dropped by as much as 50 percent.

For more than three years, the average one-way fare between Detroit and Philadelphia never dipped below $308, and sometimes moved higher, topping $385 at one point.

But then, early in 2016, fares suddenly started to fall, according to data from the Bureau of Transportation Statistics. By the end of the year, the average one-way ticket between the two cities stood at just $183.

What changed? The primary factor was Spirit Airlines.

The low-cost carrier began operating flights from Philadelphia International Airport to Detroit in April 2016, offering one-way fares for less than $100, in some cases. Spirit’s move into the route pushed down average ticket costs at all carriers on it, including Delta Air Lines and American Airlines.

“Without the low-cost carriers, we would have been looking at a pretty significant downturn in activity,” said James Tyrrell, chief revenue officer at Philadelphia International Airport.

Frontier Airlines, another low-cost carrier, had also added flights from Philadelphia, Mr. Tyrrell said. Without such airlines, he added, “you would have absolutely seen a different pricing structure.”

Even as a wave of mergers has cut the number of major carriers to four and significantly reduced competition, lower-cost airlines continue to play a role in moderating ticket costs.

While such airlines offer a no-frills passenger experience and charge plenty of fees for such luxuries as additional bags or extra legroom, they are able to stimulate new demand from occasional fliers with relatively cheap prices and even take passengers from the major carriers.

Interactive Feature | Why We Feel So Squeezed When We Fly Here is what happens when people fly more often, in fuller planes and pay higher fees.

This dynamic is not new: In 1993, researchers at the Department of Transportation called the same trend the “Southwest effect,” named for Southwest Airlines, which grew rapidly thanks to basic, low-cost flights. A recent study by a University of Virginia professor and a consultant at the Campbell-Hill Aviation Group calculated that average one-way fares are $45 lower when Southwest serves a market with nonstop flights. Researchers have shown other low-cost carriers also push down fares.

“It’s impossible to underestimate just how important the effect of low-cost carriers are on a given route,” said William McGee, the aviation adviser for Consumers Union.

Carriers like United and American do not compete with carriers like Frontier and Spirit on every type of passenger. Lucrative corporate accounts are owned by the big carriers, and business travelers avoid the cheaper airlines, often choosing to pay premium prices at the last moment to get seats on the flights that best fit their schedules.

But the low-cost carriers nonetheless force the big airlines to figure out a way to draw the most price-sensitive fliers in any given market — those who scour the internet for the cheapest tickets possible. Those customers make up a significant portion of travelers, meaning the major carrier cannot just ignore them.

“Those passengers certainly are important,” said David Weingart, an economist at the aviation consultant GRA. “The larger airlines have proven that in how they’ve reacted, in how they’ve tried to capture or recapture those passengers.”

Delta, American and United Airlines have all rolled out “basic economy” fares. Such tickets are priced competitively against Spirit and Frontier, but do not offer the amenities that most consumers have come to expect on a flight, like receiving a seat assignment ahead of a flight or obtaining a refund for a ticket.

Of all the major carriers, United is fighting on price the most aggressively.

Scott Kirby, who was appointed as United’s president a year ago, has shifted the carrier’s strategy toward the low-cost airlines, mirroring one he helped to drive when he served as a top executive at American.

Pushing back against Wall Street’s wishes to limit capacity growth, United is adding seats in a number of its major markets across the country. It has, for example, swapped out smaller jets for larger planes to increase the number of seats it has available to sell, and matched fares offered by low-cost carriers.

By expanding capacity, United aims to get back to what Mr. Kirby calls its “natural” share of passengers in some of its hubs. The carrier now expects to increase its seat capacity in the domestic market by as much as 4.5 percent this year over last year, double the 2 percent growth Delta has forecast. American does not expect its capacity to change.

United Airlines and other large carriers have rolled out “basic economy” fares, in part to better compete with Spirit and Frontier on price.

“We’re just returning to where United’s natural market share is,” Mr. Kirby told stock analysts in April. “We’re going to be very careful to calibrate how it’s working and how we’re doing.”

United’s new approach has put it into direct competition with Spirit in Newark, Houston and Chicago, according to analysts and executives. Spirit has certainly noticed.

“While we are not surprised that the environment remains very competitive, it is surprising to see our competitors resort to the unusual level of discounting we are currently seeing, especially since we are still in the summer peak period,” Matthew Klein, chief commercial officer at Spirit, said during a call with analysts in July.

Denver has also emerged as a battleground. Frontier, a privately held carrier, announced in July that it planned to add 21 flights from Denver International Airport, mostly to smaller cities like Albuquerque; Louisville, Ky.; and Charleston, S.C. The company said that it planned to double the number of nonstop routes it operates to 314 and its total number of routes to 1,000 by next summer.

Because of the underlying strength of the economy in the Denver area, United, Southwest and Spirit have added flights there in recent years as well. Kim Day, the chief executive at the Denver airport, said fares at the hub are now 15 percent below the national average.

She said that she believed each of the airlines that use the sprawling facility 25 miles from the city’s downtown is drawing different kinds of passengers.

“They’ve all found their niches,” she said. “If they can make money here, they’re going to continue to flow connecting passengers in here.”

The current skirmishes do not amount to a broad-based fare war. Many routes in the United States are dominated by a single carrier, insulating them from price competition.

The cost of a round-trip domestic ticket averaged more than $490 in the first half of the year, up slightly compared with 2016, according to Airlines Reporting Corporation, a company that settles flight transactions between a number of carriers and booking services like Expedia.

The jostling, however, has left airline investors skittish. As the publicly traded airlines in July reported earnings for the second quarter, shareholders sold off their shares, worried about the fight over fares and capacity increases.

But anxiety among investors is good news for fliers. Travelers on routes that are competitive will probably be able to snap up good deals.

“I don’t see the prices really rising that much from year to year, based on that ability to have that competition and keep prices at a normal level,” said Merritt Pullam, a real estate agent who lives with his wife and two young children in Denver and flies to places like California and Hawaii for vacations.