Saturday, January 24, 2015

Economic Insanity

"There is a fifth dimension beyond that which is known to man. It is a dimension as vast as space and timeless as infinity. It is the middle ground between light and shadow, between science and superstition, and it lies between the pit of man's fears and the summit of his knowledge. This is the dimension of imagination. It is an area we call the Twilight Zone."

This is where I believe many economists, politicians and policymakers exist — in a fifth dimension — because here's what I could never understand...

If the decline in the unemployment-to-population ratio and the labor force participation rate is being attributed (by some economists) to people who are leaving (or avoiding) the work force (such as retirees, the disabled and students), then shouldn't that create more job openings (and thereby absorbing the supply of unused labor), which would consequently bring down the unemployment rate?

And if an "aging work force" was really a valid reason for this decline, wouldn't that create more churn in the labor force, making more room for younger (prime-age) workers — employing millions more who are currently counted as "unemployed"? (And how could raising the age for retirement be a factor?)

And after this untapped labor were brought back into the labor force, wouldn't that reverse the trend in the decline of the unemployment-to-population ratio and the labor force participation rate?

Or is A LACK OF JOBS the real reason for the decline in the unemployment-to-population ratio and the labor force participation rate? Wouldn't A LACK OF JOBS (because of low "demand") be the major factor for an increase in the number of people currently "not in the labor force"?

And if so, how do we increase demand (to increase employment) — besides using helicopter drops instead of QE? Maybe by setting a maximum wage for corporate executives; increasing the minimum wage for their workers; and raising the capital gains tax — so that company profits go towards reinvestment, rather than stuffing most of the gains into the executive's and shareholder's pockets?

I was thinking that, if a company paid more in corporate taxes (35%) than they do in capital gains taxes (23.8%) — on realized gains from vested stock-option grants awarded to company executives as "pay for performance" — they won't reinvest and hire more people, like they currently don't.

And no, we can't lower the corporate tax rate to make it lower than the current capital gains tax rate, because then we'd have less revenue for non-discretionary spending (because neither political party will cut defense spending, because both the Democrats and the Republicans benefits from this pork in all 50 States). We need to increase revenues if we want to invest in our decaying infrastructure and pay off our enormous debt.

But if we raised the capital gains tax to 40% — which is higher than the current corporate tax rate (35%) and higher than the top marginal tax rate on regular wages (39.6%) — and we also repealed the tax laws ("loopholes") that allows corporations to write of their executive compensation packages (and remove the tax incentives to offshore jobs, purchase stock buy-backs, keep profits overseas, and prevent businesses from using "inversion" to move their company overseas to escape taxation) — then maybe the CEOs would be more inclined to reinvest and hire more employees (here, in America).

Obama's last proposal was to raise the capital gains tax from 23.8% to 28% — a very meager tax hike, but one that the GOP would never authorize. Obama's earlier proposal (the Buffett Rule) would have taxed individuals making more than $1 million a year 30% — and would have only affected 0.3 percent of taxpayers (and that was shot down as well). The GOP always wants to cut taxes for the top 1 percent, not increase them — even though (yet another study shows) that the Bush tax cuts did very little for the other 99 percent's economy.

Those who mostly benefit from capital gains income always argue that raising this tax would deter investment. But capital gains income isn't always necessarily "investment capital" — not unless you also include SWAG investments (such as a $100 million painting resold for $150 million), or a million-dollar wine collection, or precious metals like gold and silver, or precious stones like diamonds, rubies and sapphires. And of course, there are also real estate investments (such as a $50 million beachfront mansion resold for $75 million).

Retirement funds, such as Mitt Romney's infamous IRA account, had only been an investment in his future, not Bain Capital's. Profits from a corporation, that are reinvested into a business (and new employees), now that would be considered "investment capital" — and an investment in America as well. (Instead, they just siphon profits off the top and pocket most of the gains.)

Here's the GOP's example of "tax reform" --- Rep. David Jolly (R-Florida) thinks the rich pay too much, and introduced "H.R. 144: Alternative Maximum Tax Act." --- and Rep. Mac Thornberry (R-Texas) wants to eliminate a tax that applies only to the estates of the richest 0.15 percent (H.R. 173: Death Tax Repeal Act). It won't help you, but it saves the Koch brothers $17.4 billion. --- and Rep. Rob Woodall (R-Georgia) wants to get rid of the income tax, investment tax, corporate tax and replace it with a sales tax (that would disproportionately burden working and poor people).

And finally, there's also the big problem we have with our trade agreements (and the trade deficit as well). We'll have to stop forcing American workers into "a race to the bottom" when competing with workers in low-wage countries. I would rather NOT buy all my electronics from Asia, but I'm force to, because they're all manufactured there.

So please tell me — where exactly in this post does my logic begin to break down, when I start slipping into the Abyss of insanity, and begin drifting off into the Twilight Zone? When I first started typing?

Technical sub-notes (That will bore you.)

The U.S. Government Accountability Office (GAO) found that the Foreign-Controlled Domestic Corporation (FCDC) ownership structure could provide a tax avoidance or evasion advantage relative to a structure where U.S. parents own foreign subsidiaries ... A multinational corporate group, whether U.S.-owned or foreign-owned, with subsidiaries inside and outside of the United States can shift income to its subsidiaries in countries where corporate taxes are lower in order to avoid or evade U.S. taxes.

Tax considerations for hedge funds: Offshore Funds, being incorporated open-ended investment vehicles (usually issuing shares) are not "look through" vehicles — and as such, the tax liability, if any, is usually limited to capital gains paid by the non-US or US tax-exempt investors upon liquidation of their shares. Most offshore funds are tax-exempt vehicles; the responsibility to pay tax lies with the institutional investor. Offshore Funds appeal to US tax-exempt investors, who wish to avoid Unrelated Business Income Tax (UBIT). The US tax-exempt investor has, to date, been able to avoid this by investing in the shares of an Offshore Fund, because it is not a "look through" vehicle. As a result, any potential taxable event (on the US tax-exempt investor) will only occur when the investor liquidates its interest in the fund. However, any gain made by purchasing shares of a fund and reselling or redeeming them at a later date, does not realize any UBIT, even if the Offshore Fund's portfolio was hugely leveraged. Ultimately the successful hedge fund manager (HFM) will almost certainly wish to target offshore and US tax-exempt investors. As such, the HFM will require an Offshore Fund. As a result many HFMs have two stand alone funds that they manage - one a US Fund and the other an Offshore Fund, established in one of a variety of jurisdictions.

LLCs and LLPs: Both an LLC (limited liability corporation and a limited liability partnership (LLP) can be treated as a "pass-through" business entity for tax purposes, meaning, the owners list company gains and losses on individual tax returns. An LLP itself is not subject to federal income tax, but an LLC is if the company files as a corporation.

With private-equity funds, the general partners of, say, Bain Capital — people like Mitt Romney and his cohort of 30 or so well-heeled Harvard MBAs who invest the limited partners' capital, get what is called "carried interest" — or 20 percent of the profits on deals, while putting up only a fraction of the equity needed to do a buyout. (You can contribute up to $5,500 annually to an IRA, which jumps to $6,500 if you are age 50 or older. So how did Romney end up with a $102 million IRA?)

New York Times: Hedge fund managers don’t use the carried interest tax loophole [like Mitt Romney]. Carried interest is the share of profits that fund managers receive in exchange for managing investments. In the case of a private equity or venture capital fund, the investors make long-term investments that last more than one year. Thus, when the investment is sold at a profit, the income flows through to investors and managers as long-term capital gains, which are taxed at a lower rate than ordinary income ... For tax purposes, hedge fund profits are usually short-term capital gains, taxed at the ordinary income rate [because they buy and sell a lot of stocks and generally don’t hold on to other people’s investments for that long] ... Like private equity fund managers, hedge fund managers receive carried interest in the form of an incentive fee or incentive allocation, but the arrangement bestows no special tax advantage if the underlying gains are ordinary income or short-term capital gain ... This is not to say that hedge fund managers are paying their fair share. Until recently, many fund managers would defer a portion of their fees in a Cayman Islands corporation, which would act as the equivalent of a titanic tax-deferred retirement account. Congress closed that loophole in 2009, although some investments parked offshore will not be deemed repatriated (and will not be taxed) until 2017 ... To replace the Cayman strategy, many top hedge fund managers have entered the business of reinsurance, using Bermuda-based reinsurance companies as a capital base for investment in their hedge funds. Insurance companies must hold capital in reserve, and there is nothing to stop an insurance company from holding a huge reserve and investing that capital in a hedge fund. By stapling a small reinsurance business onto billions of dollars of hedge fund capital, any profits can be indefinitely deferred from tax offshore. Better yet, when the fund manager sells an interest in the Bermuda company, the gain may be taxed at the lower long-term capital gains rates.

* For more info, contact former Rep. Michele Bachmann (she used to be a tax attorney for the IRS, even though she hates government and the IRS).


  1. LA Times: "The capital gains preference is gold, pure gold."

    The capital gains preference is uncapped. The larger the gain one reports, the greater the tax break — that differential between the 23.8% top cap gains rate and the 39.6% top marginal rate is gold, pure gold.

    There's another aspect that makes the capital gains preference entirely too profitable. Taxpayers can defer it indefinitely simply by deferring the sale of taxable assets [and] put off your capital gains liability for your entire life.

    Then comes the biggest loophole of all, the so-called trust fund loophole. This allows capital assets to be passed on to one's heirs at their appreciated value [and] the accumulated capital gains tax liability is utterly extinguished. Hundreds of billions of dollars escape capital gains taxation each year because of the 'stepped-up' basis loophole that lets the wealthy pass appreciated assets onto [job creators, such as Paris Hilton and Kim kardashian.]

    Sen. Orrin Hatch (R-Utah) claimed eliminating these all tax loopholes would hurt small businesses.

    But the Treasury estimates that 99% of the revenue raised by boosting the capital gains tax rate and closing the inheritance loophole would be paid by the top 1% — and four-fifths of it would come from the richest tenth of 1%.

  2. Billionaire brothers Charles and David Koch presented a policy wish-list at a recent press conference:

    1) A balanced budget (wish of course would mean, cutting the safety net, but not raising taxes.)

    2) Repealing the inheritance tax (they call it a "death tax", although, dead people don't pay taxes.)

    3) The tax-free repatriation of U.S. profits (made from offshoring U.S. jobs overseas.)

  3. State and Local Taxes Hit Lower-Income Families the Hardest

    Where Bill Gates live: "Washington State’s tax system is the most regressive — the bottom 20 percent of taxpayers pay 16.8 percent of their income in taxes, while the top 1 percent pay just 2.4 percent."

    PETITION: Stop the Corporate Tax Giveaway

  4. (Comment from Mark Thoma's blog)

    What's curious is here is economists' bias towards inflation. Prices rise, then wages get increased retroactively, putting workers perpetually behind the inflation curve. Employers pocket the difference, which economists see as mysteriously helping to grease the economy. That it occurs at workers' expense is of no particular concern to them, though when the opposite occurs, economists tend to scream bloody murder. In any case, as I have argued before, the whole mild deflation scare is largely a diversion from the real problems--too little aggregate demand and too much wealth by those who have so much that they don't know what to do with their money except speculate. The excess needs to be given to those who will spend it, thereby increasing aggregate demand, along with opportunities for the wealthy to use their money productively.