Macro Roundup

“…Earlier this month, the Joint Committee on Taxation, a nonpartisan congressional body, found that the two other breaks — those that allow people to deduct only-on-paper losses from their tax bills — would go largely to people making at least $1 million a year…. As part of the economic rescue package that became law last month, the federal government is giving away $174 billion in temporary tax breaks overwhelmingly to rich individuals and large companies, according to interviews and government estimates…..”

Jesse Drucker, "The Tax-Break Bonanza Inside the Economic Rescue Package,"New York Times, April 24, 2020, https://www.nytimes.com/2020/04/24/business/tax-breaks-wealthy-virus.html

As the federal government dispenses trillions of dollars to save the economy, small businesses and out-of-work individuals are jostling to grab small slices of aid before the funds run out.

But another group is in no danger of missing out: wealthy individuals and big companies that are poised for tax windfalls.

As part of the economic rescue package that became law last month, the federal government is giving away $174 billion in temporary tax breaks overwhelmingly to rich individuals and large companies, according to interviews and government estimates.

Some of the breaks apply to taxes have long been in the cross hairs of corporate lobbyists. They undo limitations that were imposed to rein in the giveaways embedded in a $1.5 trillion tax-cut package enacted in 2017. None specifically target businesses or individuals harmed by the coronavirus.

One provision tucked into the federal economic-rescue law increases the amount of deductions companies are permitted to take on the interest they pay on large quantities of debt. Only companies with at least $25 million in annual receipts can qualify for that break.

Another change lets people deduct even more of their businesses’ losses from any winnings they reaped in the stock market, sharply reducing what they owe in capital gains taxes. Only households earning at least $500,000 a year — the top 1 percent of American taxpayers — are eligible.

And yet another provision in last month’s rescue package allows companies to deduct losses in one year against profits that they earned years earlier. The tax break most likely won’t put any extra cash directly into the hands of companies hit by the current crisis for at least a year.

The bottom line is that, barely two years after congressional Republicans and President Trump lavished America’s wealthiest families and companies with a series of lucrative tax cuts, those same beneficiaries are now receiving a second helping.

Many of the tax benefits in the stimulus are “just shoveling money to rich people,” said Victor Fleischer, a tax law professor at the University of California, Irvine. While the 2017 tax-cut package was a bonanza for big companies and wealthy individuals, in order to keep the law’s overall costs down it imposed a number of restrictions on who could take advantage of certain tax breaks and how much those taxpayers could reap.

Now, with the 2020 stimulus package, Congress has temporarily repealed a number of those limitations.

“Under the cover of the pandemic, they are undoing the perfectly sensible limitations” that moderated the size of the 2017 tax cuts, said H. David Rosenbloom, a corporate tax lawyer at Caplin & Drysdale and head of the international tax program at New York University’s law school. “And taking into account the giveaways in that act, it’s a joke.”

The new law temporarily undoes a restriction on companies using losses in one year to obtain refunds for previous profitable years. Big companies, including Morgan Stanley, have lobbied on related issues as recently as this year, according to the Center for Responsive Politics.Credit...Jeenah Moon for The New York Times

Senator Charles Grassley, the Iowa Republican who is chairman of the Senate Finance Committee, defended the changes. The stimulus law “threw a much-needed financial lifeline to businesses of all sizes, types and industries to give them the best chance to survive,” he said. He added, “The attempt to paint these bipartisan tax provisions as a boon for particular industries or investors completely misses the mark.”

One of the breaks temporarily rolls back the 2017 restriction on how much debt some companies can deduct from their taxes. That restriction was the subject of lobbying for the last two years by big companies, including Coca-Cola and Hewlett Packard Enterprise, according to federal lobbying records. The National Association of Manufacturers, whose board includes executives from Exxon Mobil, Raytheon, and Caterpillar, has pushed lawmakers for similar changes.

Earlier this month, the Joint Committee on Taxation, a nonpartisan congressional body, found that the two other breaks — those that allow people to deduct only-on-paper losses from their tax bills — would go largely to people making at least $1 million a year.

That analysis came in response to requests by the Democratic lawmakers Representative Lloyd Doggett of Texas and Senator Sheldon Whitehouse of Rhode Island. On Tuesday, Mr. Doggett introduced legislation that would roll back major chunks of the tax breaks. Among other things, it would no longer let people who earn more than $500,000 to immediately deduct all of that year’s business losses from their capital gains.

“Tax giveaways for a wealthy few shouldn’t have come near a coronavirus relief bill,” said Senator Whitehouse, who plans to introduce a Senate version.

The biggest tax break permits wealthy investors in, say, the real estate or energy businesses to use only-on-paper financial losses — such as from writing down, or depreciating, the value of assets — to reduce the taxes they owe on profits from stock market investments.

The provision does not single out real estate. But the industry is well known for generating tax losses from depreciation even in profitable years.

The 2017 tax-cut law limited the ability to use those losses. A married couple could shelter only the first $500,000 of their nonbusiness income — such as capital gains from investments — in the year that the loss was generated. Any leftover losses would be rolled over into future years.

The stimulus undoes those restrictions for this year and, retroactively, for 2018 and 2019 — meaning that wealthy households will be able to shield far more of their capital gains from taxation.

The 2017 law also restricted the ability of companies to use so-called net operating losses — which are losses that companies report on their tax returns, even if they are otherwise profitable — to reduce their tax bills. (Net operating losses can include expenses that are only for tax purposes and that don’t reduce profits reported to shareholders.) No longer could such losses from one year be used to retroactively cancel out profits accumulated in previous years, thus generating tax refunds.

The new law temporarily undoes that restriction, enabling companies to use losses in one year to get refunds for previous profitable years.

Big companies, including Morgan Stanley, have lobbied on issues relating to such tax losses as recently as the first few months of this year, according to records compiled by the Center for Responsive Politics.

Among the problems with this tax break, critics say, is that it isn’t aimed at the companies hit by the coronavirus pandemic. Under the new law, companies that will suffer big losses in 2020 won’t be able to use those losses to obtain refunds until they file their tax returns at least a year from now.

The provision will quickly put cash into a company’s pockets if it had tax losses from 2019 or earlier — well before the pandemic — that can be applied against profits from preceding years.

“There’s no reason to send money in a blanket form to all the companies that have net operating losses,” said Mr. Fleischer. “We have some amazingly successful companies that don’t pay tax and have net operating losses, and there’s no reason to be subsidizing these companies or expect that money will find its way down to the employees.”

The tax breaks for companies that report losses are likely to be especially lucrative because the 2017 tax law created new deductions that could generate large paper losses — for tax purposes only — for otherwise profitable companies in 2018 and 2019. For example, the 2017 law permitted companies to fully write off certain types of investments in the first year, instead of stretching those deductions over several years. That, in turn, meant companies could report profits to their shareholders but losses on their tax returns.

A third break, worth more than $13 billion over a decade, temporarily loosens 2017 restrictions on how much interest big companies can deduct on their tax returns. Private equity firms, which rely on borrowed money to generate big profits, have been urging the Treasury Department to write favorable rules governing the restrictions on how much interest on their debt companies can deduct from taxes.

The private equity industry is poised to benefit from the rescue package. Companies with at least $25 million in annual revenue are now eligible to deduct more interest from their tax bills — a change that will make the private-equity business model even more lucrative. Private equity firms amplify their profits by using borrowed money to finance their investments. Deducting even more of the interest on that debt from their taxes would further boost their profits.

The tax break “allows private equity to swoop in and scoop up struggling businesses,” said Matthew Rappaport, a tax lawyer who specializes in private equity at Falcon Rappaport & Berkman in New York.

David Brooks, "Who Is Driving Inequality? You Are,"New York Times, April 23, 2020, https://www.nytimes.com/2020/04/23/opinion/income-inequality.html

Who is driving inequality in America? You are. I am. We are.

Did you read to your kids before bed when they were young? If you did, you gave them an advantage over kids whose parents were working the evening shift at 7-Eleven. Did you spend extra on tutoring or music lessons? Since 1996, affluent families have spent almost 300 percent more educating their young while everybody else’s spending has been mostly flat.

Did you marry before having kids and raise your kids in a two-parent home? The children of the well educated are now much more likely to grow up in stable families, and those differences in family structure explain 32 percent of the growth of family income inequality since 1979.

If you did these things, you did nothing wrong. You invested in your children’s flourishing as any decent parent would.

But here’s the situation: The information economy rains money on highly trained professionals — doctors, lawyers, corporate managers, engineers and so on.

Daniel Markovits, author of “The Meritocracy Trap,” estimates there are about one million of these workers in America today. They work really hard, are really productive and earn a lot more. In the mid-1960s, profits per partner at elite law firms were less than five times a secretary’s salary. Now, Markovits notes, they are over 40 times.

These professionals invest heavily in their children’s education. By eighth grade, students from affluent families are four grade levels ahead of students from poor families. Seventy-two percent of students at the 150 most competitive colleges come from the richest quarter of families, and only 3 percent come from the poorest.

Inherited inequality is bad enough. But it’s the geographic concentration that is really turning America into a caste society. Affluent people used to be spread around: owning the local bank or factory, sending their kids to the local schools.

Now those of us in the top 20 percent of earners are concentrated in talent-rich zones around New York, D.C., the Bay Area, etc. The already advantaged build rich communities and multiply one another’s advantages even more. It takes a village to raise a Stanford grad.

You don’t have to drive very far outside these top 20 percent communities to find yourself in a different universe. In February I drove from Manhattan Beach, Calif., to Watts in South Central L.A. and Compton, where I spent a few days interviewing residents.

People in Compton and Watts — almost exclusively Latino and black — talked about all the things that have been stripped away from their communities: good schools, public amenities, school choirs, music festivals. Fear was a constant subject of conversation. Most of the people I spoke with had lost a family member to gun violence.

People spoke about intense levels of social distrust; the locals had been betrayed again and again by outsiders and now are very skeptical of people promising to make improvements. They talked about trauma. “There are Compton riots on the inside now,” one resident told me.

I chose to go to Compton and Watts for a specific reason, which offers a way forward. Harvard economist Raj Chetty recently led a study that showed that though these two neighborhoods are demographically similar and only 2.3 miles apart, 44 percent of the black men who grew up in Watts were incarcerated on April 1, 2010, compared with only 6.2 percent of the black men who grew up in families with similar incomes in Central Compton. Similarly, social mobility was much lower in Watts than in Compton.

Why are some neighborhoods, including some in Compton, able to give their kids better chances in life despite so many disadvantages? Chetty points to several factors: better schools, more fathers present in the neighborhoods and more cohesive community organizations.

I found all those things in my reporting in Compton — and something else. Watts is part of Los Angeles. Compton is its own city with its own mayor. I met a lot of great people in Watts, but Compton has more civic infrastructure — community groups and locally controlled government agencies. Compton has a lot of homegrown civic reformers, like Rafer Owens, who is a deputy Los Angeles County sheriff and pastor at a Baptist church. There’s also a mentality: We have faith in our ability to take care of ourselves; only people in the neighborhood really know what’s going on.

Some people who talk about inequality focus on the top 1 percent, and if you want to go after the hedge fund billionaires feel free. But as inequality is actually lived out, it’s the 20/80 gap that is most glaring and most unjust.

But we can reduce the opportunity gap if we follow the lessons of Compton: First, the neighborhood is the unit of change. Social mobility rises village by village. Second, the people in the community have to be in charge. They need resources from outside, but only local control does the trick. Third, spending money on preschool, apprenticeship and other human capital programs really works.

The top 20 percent is not going to stop spending heavily on their kids. We have to give the bottom 80 percent the resources to do the same.

Mian and Sufi summarize both their “savings glut of the rich” paper and “indebted demand” papers (attached) in a short blog post for University of Chicago arguing that lowering inequality is needed to maintain demand

“…..This is where the traditional view breaks down. The investment to national income ratio (which includes both private and government investment) has actually fallen considerably since the 1980s. The savings of the rich have not translated into more capital investment. So where did the savings of the rich go? The answer: more borrowing by the non-rich (think bottom 90 percent of the income distribution) and the government. The large rise in household debt up to the Great Recession was directly tied to the large increase in income inequality through the saving glut of the rich….The only way for the economy to maintain equilibrium in light of this depressed demand is to lower interest rates, which is exactly what has happened across the world as income inequality has risen. For a while, this lower interest rate strategy may work, as financial markets encourage more and more borrowing by the non-rich to sustain demand. Unfortunately, this debt dynamic has a dead end (or perhaps we should say a “debt end”). When interest rates hit their effective lower bound, it is impossible to lower interest rates further to encourage even more borrowing and consumption by the non-rich. The economy cannot maintain equilibrium unless output falls.The world then sees depressed economic growth. This is exactly what we see in the data. When economies around the world approached the effective lower bound on interest rates, economic growth weakened considerably. This simple logic explains how the persistent and large rise in income inequality leads to (a) rising debt levels, (b) falling interest rates, and (c) depressed economic growth. This simple logic also implies that attacking the rise in inequality directly is the most effective way of achieving a healthy economy in the long-term. Reduced inequality is good for fairness and political economy concerns, but policymakers should also consider policies that help dampen income inequality for the sake of the overall economy….”

Atif Mian, Ludwig Straub, and Amir Sufi, “How Inequality Hurts the Economy and Complicates Policy Responses to the Pandemic,” University Of Chicago, April 24, 2020, https://promarket.org/how-inequality-hurts-the-economy-and-complicates-policy-responses-to-the-pandemic/

How Inequality Hurts the Economy and Complicates Policy Responses to the Pandemic

In the years leading up to the pandemic, rising inequality created a saving glut of the rich which pushed down interest rates and fueled a large rise in government and household debt. But with interest rates now hitting their effective lower bound, it is impossible to encourage even more borrowing and consumption by the non-rich.

The Covid-19 health crisis has struck a world economy already suffering from sustained weakness. Extremely low interest rates, lackluster growth, and historically high levels of debt have characterized almost all of the advanced economies of the world even before the health crisis.

Very low interest rates have complicated the economic policy response to the Covid-19 health crisis, as central banks have had little room to maneuver before hitting the effective lower bound.

Our recent research argues that rising income inequality has played a central role in explaining such weakness. Many have argued that rising inequality is problematic for both fairness and political economy reasons, and we agree. However, our recent research argues that rising income inequality is also bad for the overall economy. (The two research studies are The Saving Glut of the Rich and the Rise in Household Debt and Indebted Demand.)

This argument may sound puzzling.

A typical argument in macroeconomics is that inequality is good for growth. According to this argument, the rich save more of their income, and such saving boosts capital investment. More capital investment means that we can produce more goods and services, and therefore have a stronger economy.

Is this argument empirically accurate? Let’s focus on the United States. From the 1980s to recent years, the top 1 percent share of national income rose significantly. And indeed, the rich saved more of this income, generating a substantial rise in saving.

So far, so good. But did investment in capital goods rise?

This is where the traditional view breaks down. The investment to national income ratio (which includes both private and government investment) has actually fallen considerably since the 1980s. The savings of the rich have not translated into more capital investment.

So where did the savings of the rich go? The answer: more borrowing by the non-rich (think bottom 90 percent of the income distribution) and the government.

The large rise in household debt up to the Great Recession was directly tied to the large increase in income inequality through the saving glut of the rich.

After the Great Recession, the savings of the rich financed dissaving by the government. Inequality has driven the rise in both household and government debt through this “saving glut of the rich.”

This game of lending is not sustainable. As the non-rich and the government continue to borrow from the rich, such borrowing creates a stream of debt service payments that go to the rich. This amplifies income inequality.

Furthermore, the rich have a saving rate that is higher than the non-rich, and as a result these debt service payments that go from the non-rich to the rich weaken aggregate demand.

The only way for the economy to maintain equilibrium in light of this depressed demand is to lower interest rates, which is exactly what has happened across the world as income inequality has risen.

For a while, this lower interest rate strategy may work, as financial markets encourage more and more borrowing by the non-rich to sustain demand.

Unfortunately, this debt dynamic has a dead end (or perhaps we should say a “debt end”).

When interest rates hit their effective lower bound, it is impossible to lower interest rates further to encourage even more borrowing and consumption by the non-rich.

The economy cannot maintain equilibrium unless output falls. The world then sees depressed economic growth. This is exactly what we see in the data. When economies around the world approached the effective lower bound on interest rates, economic growth weakened considerably.

This simple logic explains how the persistent and large rise in income inequality leads to (a) rising debt levels, (b) falling interest rates, and (c) depressed economic growth.

This simple logic also implies that attacking the rise in inequality directly is the most effective way of achieving a healthy economy in the long-term.

Reduced inequality is good for fairness and political economy concerns, but policymakers should also consider policies that help dampen income inequality for the sake of the overall economy.

The framework we have developed implies that a sustained and successful effort to boost income levels of the non-rich would strengthen aggregate demand, boost output, and help economies leave the effective lower bound on interest rates.

Lukasz Rachel, "Leisure-Enhancing Technological Change," Working Paper, April 24, 2020, https://drive.google.com/file/d/14SbcIolO3EBpgPtE466oty351tOkp9Xo/view

“….leisure-enhancing innovations are ubiquitous and yet their cost of production as a share of GDP is relatively small. TV channels, websites, social media and free newspapers are products that billions of people use every day, and businesses involved in supplying these services are highly profitable and very large….Measured at the cost of production the value of free services has been relatively stable at about 1-1.5% of GDP over much of the past century in the United States, rising recently due to the arrival of digital technologies: not negligible, but certainly not large either. The theory developed in this paper stresses the non-rival nature of leisure technologies, and underscores that leisure-enhancing technological change may be of first-order macro importance even if the share of the sector is negligible in aggregate.... The second feature of the data that this theory speaks to is the decline in average hours worked and a corresponding rise in leisure hours across developed economies over the past seven decades. Over the entire post-WW2 period average hours worked have been on a downward trend, with annual growth averaging around −0.5% across advanced world....The model developed here offers a novel way to reconcile the falling hours with other features of balanced growth. It does so bylinking the time allocation decisions to the advancement of leisure technologies. This mechanism is backed up by the evidence that changes in time allocation patterns have indeed been tightly linked to technology....Third, this paper can shed new light on the Solow Paradox (Solow, 1987). Few would disagree that current period features rapid technological change, and yet economy-wide productivity growth remains weak. This paper offers a way to reconcile the paradox: while clearly visible and salient to the consumer, leisure-enhancing innovations can indirectly diminish productivity growth through their impact on the effective growth of labor supply, and their true value is unlikely to be captured in the GDP statistics….”

Interesting new paper (complicated) argues that the growth of leisure technologies (Internet, Television) because the tech is so cheap has pushed people to spend more time on leisure, and this time diversion has contributed to the decline in TFP growth through changes in time allocation.

But I like the theory. I have often wondered why, if consumption is getting better, consumption doesn’t go up and investment go down. I get why work might go down. But both should go down. What is it about investment that allows it to compete with consumption, which keeps getting better? I’ve never seen anyone try to address the question.