PNC Bank: Next in Line at the Bailout Trough
In the wake of revelations that Wells Fargo Bank stands to reap $20 billion in federal tax cuts from a probably-illegal tax giveaway imposed on us by departing leaders in the Bush Treasury Department, the most obvious question was which other large corporation would be next in line to cash in on this particular tax break. The answer: PNC, which just bought Ohio-based National City Bank.
As with the Wells Fargo case, the generosity of the tax break leaves one dumbfounded. As the Cleveland Plain Dealer asks:
How can PNC pay $5.6 billion for National City and get back more than $5 billion in tax breaks?
It’s a rhetorical question, of course: the Plain-D guys know that this tax break exists because of clever back-room maneuvering by Bush Administration Treasury officials. The short explanation: 20 years ago, Congress passed a law (as part of the justly-celebrated Tax Reform Act of 1986) that prohibited banks from buying loss-ridden banks as a tax dodge. While lobbyists pushed hard for Congress to undo this change for, well, the next 20 years, they were unsuccessful– until the Treasury Department decided to change the law themselves by issuing a notice saying that they’ve changed their interpretation of the law. Oversimplying a bit, Treasury officials have taken a law that says “this tax scam is not allowed” and basically crossed out the “not”.
Plenty of people are now paying attention to this anti-democratic outrage, not least among which are the members of Congress who view the creation of absurd tax breaks as their domain alone. (They’re right, for better or for worse.) But the real question remains: what can be done about this?
An incoming Obama Administration can (and should, if all else fails) simply rewrite the administrative regulations. Again resorting to a gross oversimplification, this means un-crossing-out the “not” mentioned above.
Alternatively, tax writers in Congress (who are peeved that Treasury usurped their authority on this one) could pass a law preventing banks from using this made-up loophole going forward.
A stickier issue is whether anything can be done to take away the tax breaks already claimed by Wells Fargo and PNC. If their purchases of unprofitable banks were driven by the tax break, it may seem unfair to take the tax breaks away retrospectively, but there’s enough unfairness to go around: Wells Fargo got a tax break that Citigroup didn’t, entirely because Wells Fargo tried to buy Wachovia right after Treasury’s announcement– and Citigroup had the bad luck to make its acquisition bid right BEFORE Treasury’s announcement. Ain’t nothing fair about that.
It would probably be best for Congress to tackle this one head on, even as it deals with allegations that the direct bailout costs (the much-ballyhooed $700 billion) are being doled out indiscriminately. Let’s hope they do!
It is About Credit Markets, Not Just Stimulus
Washington has kicked off a perfectly predictable donnybrook over stimulus. Democrats, who spent the past eight years bashing George Bush for turning a Clinton-era surplus into a big deficit, are now defending what will be nearly $1 trillion in new tax cuts and spending. Republicans, who presided over decades of deficits, suddenly are worried about the debt we are leaving to our grandchildren.
Yet, this entire squabble may be missing the point. If Washington is going to help dig the economy out of its very deep hole, it must do more than just stimulate demand. It must also restore the health of the credit markets.
That is not to say that designing a good stimulus bill is not important. It is. But we need to recognize the limits of what all this government spending and tax cutting can do.
For now, Washington is falling back on recipes that have been tried many times before with only limited success. On the tax side, proposals such as allowing businesses to write-off capital costs more quickly, or giving cash payments to workers, have been tried repeatedly in past recessions. As a new TPC report card shows, there are no magic bullets here. While some pieces of the tax stimulus working its way through Congress will be better than others at jump-starting the economy, none will have a major impact.
The same goes for spending. A new CBO report concludes it will take years for the proposed new outlays to work through the economy. For instance, CBO figures only about one-third of $30 billion in proposed highway money could be spent within the next 20 months.
My sense is that, at best, the stimulus package will keep things from getting worse. Necessary, as they say, but not sufficient for recovery. The IMF recently published an interesting paper that noted the importance of both stimulus and credit market reform, even as it called for massive efforts to boost demand. Christy Romer, a key adviser to President Obama and a highly respected economic historian, has argued that New Deal fiscal policy did almost nothing to end the Great Depression.
Think of stimulus as a life preserver. It may keep the economy from drowning, but won’t do much to get us back on a course of sustained economic growth.
It will be up to the Fed and the much-maligned TARP (and its costly progeny) to accomplish that. The problem, of course, is that when it comes to fixing the credit markets, we are sailing in unchartered waters. Do we create a “bad bank” that will offload toxic loans from troubled financial institutions? Do we nationalize some brand-name banks? In desperation, we find ourselves looking to the experiences of Sweden or Japan for answers that are not obvious.
After a lot of arguing, we’ll enact a nearly $1 trillion stimulus. It will help, though much of the money will inevitably be wasted. But keep your eyes on what the Fed and the Obama Administration do to get the credit markets working again. That, more than tax cuts and spending, will be key to how quickly the economy gets back on track.
Obama’s $300 Billion Tax Cut: Lots of Buck, Not Much Bang
The soon-to-be Obama Administration floated quite a trial balloon over the weekend: $300 billion in tax cuts for workers and business over the next couple of years. When you get past the eye-popping number, perhaps the most striking element is how conventional most of the ideas are.
For individuals, they’d include some version of Obama’s Making Work Pay Credit, a refundable tax credit (aka cash payment) for everyone making roughly $200,000 or less. Obama aides did not say how this money would be distributed, although they hinted they’d try something other than the rebates that the Bush White House turned to three times over the past eight years. One idea: reduced withholding, which would release the funds more slowly than a lump-sum payment would.
The research on the last three rebates suggests that people spent between one-third and one-half of the money within nine months of the time it got into their pockets. If Obama pumped $150 billion into these tax cuts and 40 percent, or $60 billion, got spent, the impact on the U.S.’s $14 trillion economy would be real, though modest.
On the business side, Obama aides leaked three ideas. The first: extending bonus depreciation, another Bush measure that would allow companies to write-off the cost of equipment faster. The second: giving companies immediate refunds by letting them use using last year’s losses to reduce prior year tax liabilities. Idea #3: giving businesses a refundable tax credit for each new worker they hire or even each employee they don’t lay off.
The net operating loss idea makes some sense. But other than trying to buy votes from pro-business Capitol Hill Republicans, it is hard to see what the other two schemes would accomplish. Bonus depreciation in its many incarnations has been tried a half-dozen times over the past four decades and its benefits are, shall we say, hard to find. It won’t help companies with losses (most of them, these days), or non-profits. A year ago, while both were at The Brookings Institution and TPC, Obama advisor Jason Furman and CBO director-designate Doug Elmendorf wrote of the 2001-2003 versions, “bonus depreciation for business investment did not seem to be very effective in spurring economic activity.”
Refundable tax credits for hiring new workers promise to be an administrative nightmare and won’t create many new jobs. It is tough to see how a company that is seeing its sales slaughtered in today’s recession is going to hire just because it gets a few thousand dollars per new worker from the government. Profitable firms would merely take the credit for bringing on workers they were already planning on hiring.
I can’t begin to imagine how the variation on this idea–credits for not laying someone off–would work. My head throbs at the concept of the IRS trying to administer a rebate based on intentions. Worse, these breaks would never work unless they are refundable and, to be honest, giving such credits to failing business makes my skin crawl. In reality, it would become yet one more bailout—only this time taxpayers wouldn’t even get stock for their trouble.
Let’s hope that many of these trial balloons crash to earth long before they have a chance to become law, though I fear they won’t.
Top Destinations in 2009
Last week’s travel section of the New York Times lists the top 44 vacation destinations for 2009. Neither Bermuda nor the Cayman Islands were on the list. And it looks like neither will make the top destination list for the headquarters of U.S. multinational corporations. The “hot” tax haven this year is cool Switzerland.
In the last few months, three large U.S. businesses that are currently chartered in Bermuda have announced that they are packing up and moving to Switzerland. Meanwhile, former hot spot, The Cayman Islands, seems to have lost its allure. Two U.S. companies incorporated there have announced headquarter moves to Switzerland and one plans to reincorporate in Ireland in 2009.
What is driving companies away from the islands of corporate tax relief? It appears to be Obamaphobia. As a Senator, the president-elect sponsored the Stop Tax Haven Abuse Act (which never came to a vote) that would have reduced the effectiveness of tax havens (and his campaign promised to crack down on havens.)
So why Switzerland? The Swiss impose a low corporate tax rate and exempt the foreign profits of home corporations from Swiss corporate taxes (unlike the United States, which taxes the worldwide profits of corporations based here). In addition, the Swiss have a tax treaty with the United States. Such agreements prevent the double-taxation of income and provide mechanisms that allow taxing authorities to exchange information with each other. The companies are betting that any legislation will target only countries like Bermuda and the Caymans that are not part of our treaty network.
What can we learn from these recent moves? First, headquarters are clearly quite mobile. Second, any corporate tax reform must consider how rates and tax systems influence where companies invest as well as where they choose to locate their headquarters. (These companies could have settled back in the United States but chose not to!) Maybe we don’t care that much where companies are located as long as they continue to invest in the U.S. Third, we need to take a closer look at the role of tax havens in any international tax system and what are the best ways to combat abuse.
Finally, we need to look more carefully at our tax treaty network. When and if the Obama administration tries to crack down on havens, should a treaty immunize a country’s corporations from scrutiny? Instead of lamenting the mobility of headquarters, let’s use this episode as a call to action for informed reform of our international tax system.
Stimulus: Something for Everyone
The stimulus plan unveiled by House Democrats today includes a little something for everyone. With an eye-popping price tag of $825 billion, I suppose it should.
The plan, written in close consultation with the incoming Obama Administration, includes $275 billion in business and individual tax cuts, and $550 billion in direct spending for everything from smart appliances to repairing hiking trails in national parks. A huge chunk—roughly half—would be direct assistance to state and local governments.
There are few surprises among the tax cuts. In his campaign, Obama proposed most of the individual tax breaks– including his Making Work Pay Credit, and expansions of the Earned Income Tax Credit and the child care credit. The business breaks, including bonus depreciation to encourage investment, a quick cash infusion through the extension of Net Operating Losses, and extending the ability of small business to expense capital equipment, have been on the radar screen for months. The House Democrats dropped a controversial plan to give businesses a new tax incentive to hire workers, although they did expand a tax break aimed at hiring veterans and at-risk youth.
The $825 billion question, of course, is will this provide the advertised Keynesian boost to what is an obviously struggling economy? The less-than-satisfying answer: Some will. An awful lot won’t.
Some relatively good ideas: Temporarily increasing federal assistance to states for Medicaid, education, and public safety. Some of this money will be wasted, for sure, and it would be nice to see the Medicaid money tied to proposals for restructuring this troubled program. But without the cash, states would have to cut spending or raise taxes—counterproductive in a slumping economy.
Some not-so-good ideas: I know we are all green these days, but I’ve got my doubts about $32 billion in energy subsidies. Thirty years ago, the Carter Administration created the Synfuels Corporation that was supposed to wean us off of foreign energy. That didn’t work out so well, and there are troubling echoes of that failed industrial policy in this plan.
Some dogs: Bonus depreciation. We keep trying this, and there is little evidence that it encourages new investment. Tax-exempt bonds for economic development in low-income “recovery zones.” This will move some jobs around, but it is not likely to create many new ones. Six billion dollars for wireless and broadband services in rural and “underserved” areas. I don’t know that wi-fi in places like Aspen ought to be a national priority. Five billion dollars to repair public housing. Why not spend the money to put people in foreclosed homes rather than fix dangerous housing projects?
The problem with many of these ideas is they attempt to do two things at once: create jobs and help the environment, or create jobs and help the long-term poor. This is an ambitious and laudable goal, but I fear that in the real world, it will be tough enough to accomplish just one task. With the amount of debt we are accumulating, it is critical that we spend money on projects that make some sense on their own, and not just throw cash around for its own sake.
Will Recession Make Health Reform Easier for Obama?
It seems paradoxical, but some well-connected health reformers are arguing that a costly remake of U.S. insurance may be more likely in the wake of the economic slump. Their theory: Since we are already spending hundreds of billions to bail out the financial system and since the Obama Administration is likely to pump out a similar amount in fiscal stimulus early next year, the time may be right to spend a few hundred billion more on health coverage for the uninsured.
$13 Billion Down the Drain
George Bush just spent $13.4 billion of your money to kick the automaker mess into the Obama Administration. Funny how easily so many billions slip through our fingers these days.
Seemingly unable to decide whether to let Chrysler and GM reorganize in bankruptcy or engineer a full-blown government bailout of the deeply troubled automakers, President Bush tried to split the difference. He is offering a $17.4 billion loan–$13.4 billion upfront and another $4 billion in February. The deal is filled with demands for cosmetic concessions such as limits on executive comp and corporate jets—none of which are financially meaningful in any way. The White House calls this a loan, but don’t count on a dime ever being repaid.
This plan is supposed to give the automakers time to restructure themselves. It won’t. In truth, besides getting Bush out from under the mess, this plan won’t accomplish a thing. Bush says it would be dangerous for the auto companies to fail while the economy is in crisis. Does he think things will be any better in three months? Unless the economy miraculously turns around in the first quarter of 2009, Detroit’s collapse won’t be any easier to take.
As far as Chrysler is concerned, its majority owner, the private equity firm Cerberus Capital Management, has reportedly refused to put up any additional cash to help save its own investment. The Cerberus investors understand better than anyone the futility of doubling down now. But they are perfectly happy to let taxpayers do it for them. Chrysler is a goner. It will either be acquired (for little more than the value of its access to a government loan) or it will die.
GM may survive, but only as vastly restructured and downsized company. That will mean throwing tens of thousands of employees out of work and drastically cutting the wages of those who stay. It will require the company to offload dozens of underperforming lines and cut loose hundreds of dealers. Bush insists that plans for all of this be in place in 90 days. He, of course, will be gone in 30.
GMs loudest objection to bankruptcy has been its claim that consumers won’t buy cars from a company in Chapter 11. But why would they be any more likely to purchase from a producer living hand-to-mouth on a short-term government loan, with bankruptcy still far from foreclosed. Bush is only prolonging the uncertainty.
It was not surprising that GM stock rose on the Bush announcement. This is the new game for speculators: betting on whether or not Obama will let these companies go. In the end, shareholders, who would presumably lose everything in a bankruptcy but not in a government rescue, may be the only winners in this game.