Macro Roundup

Updated research from Matthew Smith, Danny Yagan, Owen Zidar and Eric Zwick finds that reallocating activity to the form it would have taken prior to the Tax Reform Act of 1986 accounts for one third of the decline in the corporate sector labor share between 1978 and 2017. Bottomline“… Our key finding is that adjusting for pass-through growth raises the 2017 corporate-sector labor share by 1.6 percentage points and implies the 1978-2017 decline is overstated by 31.9%.While our emphasis on pass-throughs does not preclude the importance of other mechanisms, it does provide new evidence that can help guide future investigation….”

They note/speculate this phenomenon has current implications given the 2017 tax reform, “…Following the 2017 tax reform, firms face new incentives to select the tax-minimizing corporate form and owner-manager compensation due to, for example, the lower C-corporation tax rate and the qualified business income deduction for pass-through firms. As these incentives are understood, investigating future trends in the labor share will require grappling with the nuances of the tax code….”

“.. .In the past forty years in the United States, the share of corporate-sector value added accruing to labor in national accounts fell from 62.9% to 57.9% (Figure 1A). This period coincided with a striking rise in the share of business activity organized in “pass-through” form (Figure 1B).This paper shows that these trends are related. Why would growth of the pass-through sector, which now accounts for the majority of business income, matter for the corporate-sector labor share?The simple answer is taxes. First, entrepreneurs have flexibility to characterize their income as labor payments or as profits. They typically choose the label that minimizes taxes subject to the law. In recent years, that label has been pro t for a growing number of firms. Second, the composition of corporate-sector rms has changed: many labor-intensive rms are now organized outside the corporate sector as tax-preferred partnerships. The joint quantitative importance of these factors for falling labor shares and rising capital shares is an open question with implications for the analysis of technological change, inequality, and tax policy. The historical turning point for the rise of pass-throughs is the Tax Reform Act of 1986 (TRA86). TRA86 lowered personal income tax rates substantially and raised the tax burden on (non-pass-through) C-corporations. As a result, by organizing in pass-through form, entrepreneurs avoid C-corporation taxes and bene t from lower effective tax rates. Subsequent changes in payroll taxation and in the legal treatment of pass-throughs raised the benefits and feasibility of adopting pass-through form, accelerating the pace of this sector’s growth

Effect by firm size, “…More than half of the adjustment comes from skilled service firms in capital-light industries. Firms in these industries include law firms, consultancies, doctors’ and dentists’ offices, and financial service rms such as hedge funds and private equity funds. Such medium-sized firms account for a disproportionate share of pass-through value added, while large, capital intensive manufacturers are more prominent as C-corporations (Figure 1D). By correcting for downward bias among mid-market service firms, our adjusted series implies a larger role for superstar firms and the manufacturing sector to drive the remaining decline in the labor share…….To map micro estimates to aggregate quantities, we depart from Smith et al. (2019) and estimate heterogeneous impacts by firms size. Figure 2A estimates the effects on labor payments for firms divided into groups based on mean firm sales. We partition firms based on mean sales with boundaries at $100K, $500K, $1M, $10M, and $100M in 2014 dollars. Scope for relabeled labor income is greater among smaller firms, as effect sizes monotonically decrease with firms size. Effect sizes exceed 2% of sales even among firms with $1M to $10M in sales and are meaningful (1.1% of sales) for rms in the $10M to $100M size group. Only the largest firms show no relabeling response upon switching. Other variables do not experience major declines following switching events (Appendix B). Among S-corporations, mid-market rms account for a substantial share of aggregate activity. Firms with less than $10M and rms with $10M to $100M in average sales respectively account for 51% and 30% of total S-corporation value added, 38% and 34% of total sales, and 65% and 25% of total owner pay in the most recent available years (Figure 2B)….”

Matthew Smith, Danny Yagan, Owen Zidar and Eric Zwick, “The Rise of Pass-Throughs and the Decline of the Labor Share,” National Bureau Of Economic Research, October 2021, https://www.nber.org/papers/w29400

Matt Klein argues the US should make no concessions to the PRC in terms of climate change, rapid decarbonization is in China's security interest and they will act accordingly, "... The good news is that China’s leaders are keen on rapidly decarbonizing for their own reasons: national security and public health. Importing oil and gas from across the oceans is risky, while burning coal to generate heat and electricity makes the air unbreathable... More than 40% of China’s gas needs are now satisfied by imports, up from essentially zero as recently as 2008. Most of China’s additional gas imports since 2015 have come from liquefied natural gas (LNG) rather than from pipelines. About 30% of China’s total gas consumption comes in by ship as LNG, with much of that gas coming from countries that might not supply Chinese customers depending on the international situation. Australia and the U.S. alone supply half of China’s LNG imports....China is even more dependent on imports of crude oil....the deficit between Chinese oil production and consumption is now worth about 10.3 million barrels a day, or 73% of total oil consumption. That’s up from 31% in 2000 and 52% as recently as 2008....the Chinese government has been rapidly greening the electric grid. A third of all terawatt hours of electricity generated in 2020 came from sources other than coal, oil, and gas, up from 19% as recently as 2011. From 2011 through 2020, coal-fired generation was up 33%, but hydroelectric power doubled, nuclear power quadrupled, geothermal and biomass output quintupled, wind power sextupled, and solar power increased by 95 times. If recent trends continue, China’s electric grid will be fully decarbonized before Xi’s 2060 deadline—and it’s likely that recent trends will only accelerate as natural gas and coal become increasingly unattractive...."

Matt Klein, "Appeasing the Chinese Government "For the Climate" Makes No Sense,"The Overshoot, October 22, 2021, https://theovershoot.co/p/appeasing-the-chinese-government

Appeasing the Chinese Government "For the Climate" Makes No Sense

China is the world’s largest polluter, responsible for 31% of global carbon emissions as of 2020. Moreover, about two thirds of the increase in global emissions since 2007 can be attributed to rising pollution from China. There is no effective response to climate change that excludes China.

The good news is that China’s leaders are keen on rapidly decarbonizing for their own reasons: national security and public health. Importing oil and gas from across the oceans is risky, while burning coal to generate heat and electricity makes the air unbreathable. We should all hope that they succeed in greening their energy system—but if they fail, it won’t be because of anything Western diplomats did or didn’t do. What matters are China’s internal dynamics.

Some people, however, seem to believe that the Chinese government will only cut emissions if it’s given a free hand to continue committing atrocities against the Uyghur and Tibetan minorities. Appeasing the Chinese government on these issues for the sake of the climate might sound like the type of diplomatic “grand bargain” that Metternich or Kissinger might have negotiated—but it would be a catastrophic mistake grounded in a misunderstanding of China’s own priorities.

China’s own diplomats seem happy to perpetuate this misunderstanding, with Foreign Minister Wang Yi warning that “China-U.S. cooperation on climate change…cannot sustain without an improved bilateral relationship.”

Thus, Robert Kuttner of The American Prospect claims that senior officials within the Biden administration have been pressuring members of Congress to hold off on passing legislation that would ban U.S. imports of Chinese goods made by Uyghur slave labor. Spokesmen for both the National Security Council and the State Deparment have vehemently denied the report, with the NSC calling it “absolutely false”. I hope that the denials are correct and that Kuttner is wrong, because there is no good reason to appease China “for the climate”.

China’s dependence on fossil fuels is dangerous for China

China is rapidly becoming dependent on imported energy—and the only way it can guarantee that it won’t get cut off from essential supplies in faraway countries is by totally decarbonizing.

China consumed about 145.5 exajoules of energy in 2020, according to the latest BP Statistical Review of World Energy. Of that, just over 82 exajoules came from burning coal, 28.5 from oil, 12 from natural gas, 12 from hydroelectric power, and the rest from wind, nuclear, solar, and other alternative energy sources such as geothermal and biomass. In other words, fossil fuels satisfied about 84% of China’s total energy needs. But that’s down from 94% as recently as 2007, because Chinese consumption of alternative energy has grown much faster than demand for dirty fossil fuels.

The relative decline of coal is significant not just because coal is dirtier, but also because it’s the only fossil fuel that China produces domestically in sufficient quantities. More oil and gas means more imports—and therefore less energy security.

But it’s not as if the Chinese government has a choice to stick with coal. In 2020, China had about 143 billion tons of proved coal reserves and Chinese coal miners dug up about 3.9 billion tons. That means that China would completely run out of domestic coal by 2057 if there were no new discoveries and a constant rate of mining. This helps explain why the Chinese government has been so aggressive in pushing the transition to alternative energy sources.

Coal has three main uses in China: as the most important fuel for the country’s electric power plants, as an essential ingredient for making steel, and as the main fuel for northern China’s system of centralized heating.

Chinese steel output has risen sharply in the past few years. That’s boosted demand for coking coal, much of which is imported. But this probably isn’t sustainable over the long term given China’s history of steel overproduction and the government’s stated desire to cut back on wasteful construction projects. While demand for metallurgic coal may be strong now, the longer-term outlook is bleaker.

China also continues to build more coal-fired power plants fueled by local supplies, with the number of terawatt hours of electricity coming from coal up more than 20% since 2013. But that’s occurred in a context of soaring investment in alternative energy sources and extremely rapid growth in total demand for electricity. The share of electricity generation coming from coal has dropped from 75% in 2013 to 63% as of 2020.

Chinese coal consumption has been flat even as steelmaking and electric generation have grown because coal has become less important as a heat source in the winter. Burning coal in urban centers is terrible for the breathability of the air—and that’s something the Chinese government cares about. Despite being an authoritarian regime that puts the interests of ordinary people far below the perceived needs of the Communist Party, the Chinese government is sensitive to complaints about the quality of the environment, both as a matter of national pride and because it’s one of the biggest reasons why Chinese choose to emigrate.

The big replacement for coal as a heat source has been natural gas.1 While China produces about 5% of the world’s natural gas, it consumes almost 9%. More than 40% of China’s gas needs are now satisfied by imports, up from essentially zero as recently as 2008.

Most of China’s additional gas imports since 2015 have come from liquefied natural gas (LNG) rather than from pipelines. About 30% of China’s total gas consumption comes in by ship as LNG, with much of that gas coming from countries that might not supply Chinese customers depending on the international situation. Australia and the U.S. alone supply half of China’s LNG imports.

As recently as the early 1990s, China was a net oil exporter, but production growth slowed and began to decline after 2015. As of 2020, Chinese oil production was 20% higher than it was in 2000, but consumption was three times what it was two decades ago. As a result, the deficit between Chinese oil production and consumption is now worth about 10.3 million barrels a day, or 73% of total oil consumption. That’s up from 31% in 2000 and 52% as recently as 2008.

As a result, China’s combined oil and gas energy deficit is worth about 25.6 exajoules—more than double what it was as recently 2011. Including coal imports, almost 20% of China’s energy now comes from abroad. That’s an uncomfortably high—and rising—level of dependence on foreign supplies.

China would be vulnerable to losing access to most of those oil and gas imports if shipping lanes were restricted, particularly at the choke point of the Strait of Malacca. From this perspective, the AUKUS agreement on regional security could be more effective at encouraging China to decarbonize than any other diplomatic initiative.

The Chinese government is aware of all this

That’s probably why Xi Jinping, China’s current paramount leader, committed the country to total decarbonization by mid-century. Here’s exactly what he said in a speech to the U.N. General Assembly on September 22, 2020 (emphasis mine):

Humankind should launch a green revolution and move faster to create a green way of development and life, preserve the environment and make Mother Earth a better place for all…The Paris Agreement on climate change charts the course for the world to transition to green and low-carbon development. It outlines the minimum steps to be taken to protect the Earth, our shared homeland, and all countries must take decisive steps to honor this Agreement. China will scale up its Intended Nationally Determined Contributions by adopting more vigorous policies and measures. We aim to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060.

These aren’t just words. The CO2 intensity of the Chinese economy has plunged in recent years as the government restrained excessive investment in physical infrastructure and real estate. In fact, the recent ructions in global coal and natural gas markets are largely attributable to the Chinese government’s overzealousness in cutting back on domestic coal production and imports, as Alex Turnbull has explained.

Moreover, the Chinese government has been rapidly greening the electric grid. A third of all terawatt hours of electricity generated in 2020 came from sources other than coal, oil, and gas, up from 19% as recently as 2011. From 2011 through 2020, coal-fired generation was up 33%, but hydroelectric power doubled, nuclear power quadrupled, geothermal and biomass output quintupled, wind power sextupled, and solar power increased by 95 times. If recent trends continue, China’s electric grid will be fully decarbonized before Xi’s 2060 deadline—and it’s likely that recent trends will only accelerate as natural gas and coal become increasingly unattractive.

None of this is to say that China can’t do better—we can all do better!—but it does mean that there is nothing to be gained by caving in to PRC demands in the hope that it will encourage greener environmental policies. Even without the existential threat of climate change, China’s leaders are behaving as if decarbonization is in China’s interests.

1 Gas is also increasingly being used as a fuel to generate electricity, although it’s much less significant compared to both coal and renewables. Put another way, gas represents about 8% of China’s total energy consumption but only 3% of China’s electric power generation.

Kyle Pomerleau on American corporations tax burden relative to peer economies, "...This report compares the tax burden on corporations in the United States under current law to the corporate tax burdens of 36 OECD member nations.7 It also considers two leading proposals to reform US corporate income taxation and several alternative policies. Each option is evaluated using three metrics: the statutory corporate income tax rate, the corporate marginal effective tax rate (METR), and the corporate average effective tax rate (AETR)...."

Overall snapshot:

The Statutory Corporate Income Tax Rate, "...Currently, the average value (weighted by gross domestic product) of the combined statutory corporate income tax rate in the OECD is 26 percent. (All references to averages in this report denote gross domestic product-weighted averages.) Combined statutory tax rates range from 9 percent in Hungary to 35 percent in Colombia. Approximately half of OECD countries (19 of 37 member nations surveyed) have combined corporate tax rates between 20 and 25 percent. Only six countries have statutory corporate tax rates below 20 percent. The United States’ combined statutory corporate tax rate of 25.8 percent is 0.2 percentage points below the OECD average and lower than the rate for one-third of OECD members. If the US federal corporate income tax rate is increased to 28 percent, as in Biden’s proposal, the United States would have the second highest combined statutory corporate tax rate in the OECD, at 32.3 percent. The House proposal, which would raise the federal tax rate to 26.5 percent, would increase the United States’ combined statutory corporate tax rate to 30.9 percent, which would be among the highest in the OECD, but still below Portugal and Colombia (Figure 2)..."

The Marginal Effective Tax Rate,"...METRs on corporate investment are lower than statutory tax rates in the OECD. The average METR in the OECD is 15.5 percent. Given the large differences in corporate tax bases, the range of marginal tax rates is greater than the range of statutory corporate tax rates. METRs range from -33.5 percent in Portugal to 23.9 percent in Colombia (Figure 3).The METR on corporate investment in the United States under current law is 18.3 percent, 2.8 percentage points higher than the OECD average. The relatively high METR in the United States is driven by less generous depreciation allowances than in other OECD countries. Recall that the calculations assume that the slated expiration of 100 percent bonus depreciation has occurred and that the slated introduction of amortization of R&D costs has taken effect. Those assumptions raise the tax burden on equipment and R&D..."

Carol Corrado on the potential impact of AI on productivity, basically fails to find support for the J curve camp, key quote, "... Our main finding is that, on our data at least, there is indeed plenty of unmeasured investment but little sign of a ‘J-curve’ effect on TFP growth. The upward ‘swoosh’ of the effects of investments whose returns are long-lasting just is not there..."
Core of paper, "...We have set out a framework to illustrate this effect and used a cross-country-industry-year data set for the US and European economies to examine it. To look for unmeasured investment, we have used the CHS approach, which brings into national accounts unmeasured investment in intangible assets which are likely complementary to artificial intelligence, such as design, training, and business process re-engineering. We have also seen that at least some artificial intelligence investment is likely in software investment and is thus already counted. Thus we have harmonized the deflation of software and hardware investment to facilitate comparison across different countries. At least on these data, we do not find much support for the J-curve view. There is, indeed, plenty of unmeasured investment, but the trend in such investment does not seem to be sufficient to give an effect. In particular, the high depreciation rates mean that the missing capital payments which bias TFP growth up follow quickly after a burst of intangible investment, meaning that the upward-sloping part of the J curve, at least on our data, appears very quickly, too quickly to account for a sustained TFP growth slowdown following the financial crisis. That said, we are in the early stages of measuring AI, and since much of it is taking place within firms on their own account, the detection of such investment is extremely difficult..."

The evidence

"...Figure 8 shows shares of tangible and intangible investment across countries from 1997 to 2017. As the graph shows, intangible investment is generally trended upwards and the US invests considerably more intangible investment then the EU. This immediately suggested accounting for intangible investment might potentially be important...."