Wall Street Is Trying to Embezzle Puerto Rico’s Hurricane Relief Money [feedly]

Wall Street Is Trying to Embezzle Puerto Rico's Hurricane Relief Money
http://cepr.net/publications/op-eds-columns/wall-street-is-trying-to-embezzle-puerto-rico-s-hurricane-relief-money

Glancing over last week's headlines, one might think there's been some sort of significant improvement in the outlook for Puerto Rico's beleaguered economy. With bond prices trading at their highest levels since the hurricanes, The Wall Street Journal referred to Puerto Rico's debt as "the top-performing bond investment of 2018," a development it attributes to "unexpected improvement in the island's economy."

This statement is deceptive at best. If anything, Puerto Rico's economic prospects have only worsened.

The surge in bond prices comes in response to a new version of the proposed "Fiscal Plan," released by Puerto Rico's government, which predicts a much higher fiscal surplus over the next six years than a previous version, released in February. Creditors are assuming they will be able to claim these funds for debt repayment, which pushed bond prices up. However, the newest plan downgrades growth predictions, prompting the question of where this new surplus is supposed to come from.

As part of the process outlined by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) passed by the US Congress, the Financial Oversight and Management Board (FOMB) is in charge of certifying a long-term fiscal plan for Puerto Rico, giving the Board a final say in all major policy decisions. Prior to last year's hurricanes, the Board had approved a 10-year plan, widely seen as unrealistic by economists, that projected a fiscal surplus of $8 billion over 10 years. Despite ensuring a lost decade in terms of economic growth, that surplus would be made available for debt repayment. Now, in the wake of widespread devastation and extensive damage caused by Hurricane Maria, the Board and the government of Puerto Rico are in the process of agreeing on a new fiscal plan.

Since January, Puerto Rico's governor has already released four versions of the fiscal plan ― none of which the Board was willing to certify. One of the most notable differences among the plans has been the gradual increase in the predicted fiscal balance over the next six years. The first version, released in January, predicted a $3.4 billion deficit over the next five years. However, the subsequent versions included a six-year forecast and went on to predict surpluses. The February release predicted a surplus of $3.4 billion, the March version a surplus of $6 billion, and the latest version, released in April, estimated a surplus of $6.3 billion.

While this most recent plan predicts the highest fiscal surplus, it actually forecasts no overall growth. While the initial versions of the plan predicted some sort of GNP growth over the six-year period, the according to the latest release, GNP in 2023 will barely reach its 2017 level.

Even these already grim predictions need to be taken with a grain of salt. Hidden among an array of euphemisms, every version of the plan includes large cuts to many essential services, cloaked in terms such as "new government model," "right-sizing," and "efficiency." The government is also counting on savings that would materialize from privatizing various government agencies and services, despite past experiences with private operators that have actually resulted in increased costs over time.

Wall Street's Hand in the Cookie Jar

As I and my co-authors argued in the context of the previous fiscal plan, these types of measures and reforms have a track record of significant negative feedback, particularly in a depressed economy, that are likely to push Puerto Rico into a downward spiral of further economic contraction. Puerto Rico has been in a recession for over a decade and had very bleak economic projections for the future even prior to being hit by an extremely powerful storm that wiped out a large part of its infrastructure. In the immediate aftermath of Hurricane Maria, even President Trump was among those who made the case for debt cancellation.

A letter signed by prominent economists explains that, given this context, in order for Puerto Rico to actually recover, there can be no reasonable expectation for the island to make any kind of debt payments until it returns to sustained growth. The letter makes the case for ample relief support and a fiscal plan that allows the island to return to economic growth, explaining that diverting funds from relief efforts to debt repayment would prolong the crisis, accelerate economic decline, and cause more human suffering.

Meanwhile, a close look at the three plans reveals the source of the additional forecasted revenue that caused bond prices to soar: increased federal support. The January plan had estimated about $35 billion in federal assistance and did not include $5 billion in Medicaid funding Puerto Rico was granted for the next two years. The second, third, and forth versions both assume almost $50 billion in federal assistance. But only the latest two versions account for the increased Medicaid support.

This federal support is clearly earmarked for relief efforts, meant to aid Puerto Rico's recovery. This was made clear to the oversight board in a letterfrom Representative Nydia Velázquez's office, who has been at the forefront of congressional efforts to secure more support for Puerto Rico, especially after a slow initial response to the island's crisis from the federal government.

Furthermore, the support secured by Puerto Rico is still below its own request for federal funds, which estimated the cost of rebuilding and putting the island back on a path to recovery at over $94 billion. It is clearly not the case that Puerto Rico will receive more money than it needs for recovery, so there will not be any fiscal basis for paying off debt as the bond markets are apparently assuming.

The board's disapproval of the submitted plan proposals is unrelated to any misuse of relief funds for debt payments, or to the fiscal drag on the economy. On the contrary, the Board is demanding further and more severe cuts, many of which directly target welfare recipients, public sector employees, and retirees, along with other labor reforms that would weaken protections and benefits for workers and that offer little evidence of any resulting increase in overall employment. This approach will prolong the crisis, while allowing creditors to seize a share of the money meant to ease the suffering of the people of Puerto Rico.

The board is aggressively pushing for measures such as cutting Christmas bonuses for public sector employees ― which have historically been part of their compensation ― so this would effectively entail a pay cut. Yet, while it would punish public sector employees under the pretense that the estimated $69 million in savings is essential, the Board continues to lavishly spend Puerto Rican resources on hefty consulting and legal fees and on generous compensation for its own employees.

Rather than ask for more cuts, the Board should follow its own core principles for a fiscal plan that prioritizes improving living standards and avoiding more outmigration, and that emphasizes the need to rebuild the island's infrastructure. Allowing any relief support to be diverted to creditors, while demanding steep cuts to government services, goes against those principles. The post-hurricane circumstances in Puerto Rico are extraordinarily difficult, and the island still has a long way to go to recover.

Immediately after the storm, it seemed rather odd that some hedge funds were buying distressed bonds in bulk, mostly at huge discounts, given the low probability that they would ever be repaid. Yet, under the latest proposed fiscal plan, it looks like their bet might result in a substantial payout. Those who predicted that Puerto Rico would not be able to make any debt payments in the near future, at least until it fully recovered, were not wrong about the situation on the island, but they did not consider the scenario that relief funds could become a source for creditor bailouts. Indeed, allowing the people of Puerto Rico to continue suffering, while rewarding bondholders ― many of whom purchased their bonds as a speculative investment at a steep discount ― is indefensible.

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Lara Merling is a research assistant at the Center for Economic and Policy Research (www.cepr.net) in Washington, DC.

 -- via my feedly newsfeed

Triple Crisis: What’s Different About Trump’s Tariffs? [feedly]

What's Different About Trump's Tariffs?
http://triplecrisis.com/whats-different-about-trumps-tariffs/

By Jomo Kwame Sundaram

Cross-posted at Inter Press Service. 

At Davos in January, US President Donald Trump warned that the US "will no longer turn a blind eye to unfair economic practices" of others, interpreted by many as declaring world trade war. Before the US mid-term elections in November, Washington is expected to focus on others' alleged "massive intellectual property theft, industrial subsidies and pervasive state-led economic planning" pointing to China without always naming names. With the Republican Party already united behind his tax bill, Trump senses an opportunity to finally unite the party behind him and to continue his campaign for re-election in 2020.

Since January, Trump has taken steps threatened in his mid-2016 election economic policy document, drafted by US's National Trade Council head Peter Navarro and Commerce Secretary Wilbur Ross. In particular, he has imposed tariffs and other restrictions on imports to revive US manufacturing. Import tariffs of 25% and 10% on steel and aluminium respectively have been imposed by invoking Section 232 of the US 1962 Trade Expansion Act, allowing unilateral measures to protect domestic industries for "national defence" and "national security".

Trump's action was supported by a US Department of Commerce Bureau of Industry and Security report, released earlier. It made the case for imposing import tariffs on both metals for national security reasons as "national security can be interpreted more broadly to include the general security and welfare of certain industries, beyond those necessary to satisfy national defense requirements…."

Trade war memories
After his announcement, several major trading countries and blocs retaliated or threatened to retaliate against US imports, raising the prospect of a trade war. The resurgence of US trade protectionism poses two threats. The US has a long history of using 'anti-dumping measures', especially on steel. Earlier, imports of washing machines and solar panels were restricted by Trump after the US International Trade Commission declared that they unfairly hurt domestic manufacturers.

The US President has also threatened to impose "reciprocal taxes" against countries imposing tariffs on US exports. This threat has invoked references to the 1930 Smoot-Hawley Tariff Act. Its Republican sponsors, Senator Reed Smoot and Congressman Walter Hawley then argued that it would protect US jobs by shielding American industries from import competition by imposing tariffs on over 20,000 imported goods.

This aggressive protectionism then precipitated the collapse of global trade, as its trade partners then restricted US export access into their own markets. The ensuing trade war undoubtedly exacerbated the Great Depression. Recent developments have understandably revived fears of a new trade war, with similar consequences.

Undermining trade multilateralism
The US's unilateral actions have seriously challenged the multilateral framework of World Trade Organization (WTO) trade rules. The Trump administration has been challenging post-Bretton Woods rules-based trade multilateralism, which sought to develop international trade regulation. Besides many rhetorical attacks on the multilateral trading system, the Trump administration has largely avoided engaging with the WTO while also avoiding violating the letter of existing trade agreements.

Undermining the WTO and its rules is hardly new for the Trump administration, but what is rarely acknowledged is that it also represents continuity with previous presidents including his arch-nemesis, Obama's. Both administrations have blocked appointing WTO Appellate Body (AB) members, effectively undermining the WTO's dispute settlement process. The AB should have seven members, but will soon only have three members left, undermining its functioning. Aggrieved WTO members wishing to challenge alleged violations of its rules have no redress without a functioning AB.

Advocates of international trade liberalization have long claimed that it boosts growth and makes everyone better off in the long run, although many acknowledge shorter term casualties in 'uncompetitive' economic activities. With successful political mobilization around growing doubts over such claims, these claims have lost credibility, feeding the tide of ethno-populist-nationalism in the West.

Freer trade has widely distributed benefits in terms of lower consumer prices while seemingly concentrating costs on displaced producers. Conversely, tariffs meant to protect particular industries have concentrated benefits while widely distributing costs. Thus, even without considering the consequences of retaliatory trade measures by others, some (e.g., US steel) jobs may be saved while consumers pay more for 'downstream' products, threatening related jobs downstream. Consumers, however, are unlikely to act politically because they have to pay a little more for some goods, whereas workers are more likely to be mobilized if their livelihoods are threatened by foreign import competition.

Is Trump all that different?
Trump has long complained about US and foreign trade policies. He seems to believe that trade is a zero-sum game in which the goal is to export more and to eliminate the US trade deficit. Importing from another country implies that country has "won" and the United States has "lost". Thus, his version of US 'sovereigntism' links trade to national pride. Thus, he accuses others, especially China, of "laughing at us". As trade issues are about US jobs, pride and dignity, costs or losses become "a small price to pay". Thus, imposing tariffs will show foreigners that the US is strong, and cannot be taken advantage of.

With this logic, "winning" may involve losing although the tariffs will benefit relatively few workers in protected industries at the expense of the vast majority of other workers in downstream industries and consumers. But longstanding economic imbalances and inequities are unlikely to be well addressed by protecting a few politically influential industries.

For half a century, the US has gone back and forth with trade liberalization, often coming dangerously close to trade warfare. President Ronald Reagan's 1980s protectionism is rarely acknowledged as he is now the paragon of US economic neoliberalism. (Current US Trade Representative Robert Lighthizer earned his reputation in Reagan's administration.) His trade restrictions used loopholes in trade agreements to raise tariffs and limit many imports besides forcing political allies to accept "voluntary restraints". Dani Rodrik has argued that Reagan's protectionism "let off political steam", enabling the US economy to recover and globalization to accelerate.

International economic liberalization or globalization since Reagan has also transformed the international context and the consequences of Trump's recent measures. Unlike Reagan who arm-twisted political allies to accept his demands as necessary concessions during the Cold War, Trump's 'US sovereigntism' is based on 'victimhood', invoking the image of an ex-hegemon, and makes no pretensions of being mutually advantageous or reciprocal.

Yet, prematurely 'crying wolf' about trade war may also accelerate trade war momentum as it remains unclear how international policy is made and changed in Trump's White House. While possibly ominous of much more to come, premature, exaggerated criticism of his unilateral trade measures may become 'self-fulfilling', given the political need for continued ethno-populist and nationalist mobilization against enemies, real or imagined.

 -- via my feedly newsfeed

Bernstein: Some lynx: Unions, CBO’s new baseline, the Bernstein Rule… [feedly]

Some lynx: Unions, CBO's new baseline, the Bernstein Rule…
http://jaredbernsteinblog.com/some-lynx-unions-cbos-new-baseline-the-bernstein-rule/

The teachers provide us with a teaching moment, over at WaPo. Their actions pose a stark reminder of the essential need for a strong, organized movement to push back on the forces promoting inequality, non-representative government, trickle down tax policy, and more.

CBO released their updated "baseline," or estimate of the US gov't's fiscal outlook. If you like red ink, you're in biz. Instead of deficits between 3 and 4% of GDP over the next few years, we're looking at deficits of 4-5%.

As I've written in many places, when you're closing in on full employment, you want your deficit/GDP to come down and your debt/GDP to stabilize and then fall. It's not that I worry about "crowd out" so much–public borrowing hasn't crowded out private borrowing for a long time, as evidenced by low, stable interest rates (rates are climbing off the mat a bit now, as I'd expect at this stage of the expansion).

It's a) there's a recession out there somewhere are we lack the perceived fiscal space to deal with it, and b) the larger point that this is all part and parcel of the strategy to starve the Treasury of revenues so as to force entitlement cuts.

Which brings me to this oped by a group of former Democratic chairs of the president's CEA. It's a perfectly reasonable call for a balanced approach to meeting our fiscal challenges, and, again, consistent with my view that as we close in on full employment, the deficit should move toward primary balance (another way of saying debt/GDP stabilization).

But two things from this piece, which is a critical response to an earlier oped by a "group of distinguished economists from the Hoover Institution."

First, I didn't realize that the Hoover'ites argued that the "entitlements are the sole cause of the problem, while the budget-busting tax bill that was passed last year is described as a 'good first step.'"

This puts them in direct violation of the Bernstein Rule: if you supported the tax cut, you can't complain about the deficit.

A few of my CBPP colleagues have a new piece out about everything that's wrong with the tax bill, and in this context, look at the section on why "…the nation is facing long-term fiscal challenges that will require more revenue, not less.  The new law…weakens the tax system's ability to deliver on its core responsibility: raising sufficient revenue to adequately finance critical national needs…"

It's really that simple. According to CBO, even including macro offsets, the tax cuts add $1.85 trillion to the debt over the next decade. Readers know my rap on this. The ultimate target of Republican fiscal policy is Social Security, Medicare, Medicaid, SNAP–the "entitlements." Since they can't politically cut them outright, they must starve the Treasury of revenues and then argue, as the Hoover'ites do, that we have no choice. After all, look at those deficits (to which we just added $2 trillion)!

That's some serious chutzpah.

My second point is that the entitlements are actually a somewhat arbitrary target. That is, as long as we're running up the debt, we're increasing not collecting the revenues necessary to support spending. That means one could just as easily argue "we can't afford the military!" as "we can't afford the safety net!"

It's true that the entitlements are on automatic compared to other spending that must be appropriated, but does anyone think the Defense Dept. is going to take a significant hit because we've recklessly cut taxes? That there's a rhetorical question.

The moral of the story is: don't listen to people telling you what we can't afford, especially after they rammed through a huge, complicated, loophole-ridden, revenue-wasting tax cut.

 -- via my feedly newsfeed

Globalization Helps Spread Knowledge and Technology Across Borders [feedly]

Globalization Helps Spread Knowledge and Technology Across Borders
https://blogs.imf.org/2018/04/09/globalization-helps-spread-knowledge-and-technology-across-borders/

Using artificial intelligence at a hospital in Qingdao, China: the spread of knowledge and technology between countries has intensified (photo: Sipa Asia/Sipa USA/Newscom).

It took 1,000 years for the invention of paper to spread from China to Europe. Nowadays, in a world that has become more integrated, innovations spread faster and through many channels.

Our research in Chapter 4 of the April 2018 World Economic Outlook takes a closer look at how technology travels between countries. We find that the spread of knowledge and technology across borders has intensified because of globalization. In emerging markets, the transfer of technology has helped to boost innovation and productivity even in the recent period of weak global productivity growth.

Why spreading technology matters

Technological progress is a key driver of improvements in incomes and standards of living. But new knowledge and technologies do not necessarily develop everywhere and at the same time. Therefore, the way technology spreads across countries is central to how global growth is generated and shared across countries.

Indeed, during 1995–2014, the United States, Japan, Germany, France, and the United Kingdom (the G5) produced three-fourths of all patented innovations globally. Other large countries—notably China and Korea—have started to make significant contributions to the global stock of knowledge in recent years, joining the top five leaders in a number of sectors. While this suggests that in the future they too will be important sources of new technology, during the period under study, the G5 constituted the bulk of the technology frontier.

To trace knowledge flows, our study uses the extent to which countries cite patented innovations from the technology leaders as prior knowledge in their own patent applications. The chart below gives a representation of these cross-country knowledge links. Two features stand out. First, while in 1995 the United States, Europe, and Japan were dominating global patent citations, China and Korea (depicted together as "other Asia") have made increasingly large use of the global knowledge stock as measured by their patent citations. Second, knowledge links have in general intensified over time, both within (red arrows) and across (blue arrows) regions. An alternative measure for the extent to which foreign knowledge is available for domestic use is the intensity of international trade with technology leaders—and our study looks at this as well. 

Globalization boosts technological development                                                                                                    

The increasing intensity of global knowledge flows points to important benefits of globalization. While globalization has been much criticized for its possible negative side effects, our study shows that globalization has amplified the spread of technology across borders in two ways. First, globalization allows countries to gain easier access to foreign knowledge. Second, it enhances international competition—including as a result of the rise of emerging market firms—and this strengthens firms' incentives to innovate and adopt foreign technologies.

The positive impact has been especially large for emerging market economies, which have made increasing use of the available foreign knowledge and technology to boost their innovation capacity and labor productivity growth. For instance, over 2004–14, knowledge flows from the technology leaders may have generated, for an average country-sector, about 0.7 percentage point of labor productivity growth per year. This amounts to about 40 percent of the observed average productivity growth over 2004–14. We find that one important factor behind the build-up of innovation capacity in emerging market economies has been their growing participation in global supply chains with multinational companies, though not all firms have benefitted as multinationals sometimes reallocate some innovation activity to other parts of the global value chain.

The increased transfer of knowledge and technology to emerging market economies has partly offset the effects of the recent slowdown in innovation at the technology frontier and helped drive income convergence for many emerging economies. In contrast, advanced economies have been more affected by the technology slowdown at the frontier.

Finally, our study finds evidence that technology leaders themselves benefit from each other's innovation. This suggests that, going forward, with the growing contribution of China and Korea to the expansion of the technology frontier, there may be scope for positive spillovers from these new innovators to the traditional innovators. Knowledge and technology do not flow in one direction only.

Spreading the know-how

Globalization brings a key benefit—it stimulates the spread of knowledge and technology, helping spread growth potential across countries. But interconnectedness per se is not enough. The assimilation of foreign knowledge and the capacity to build on it most often requires scientific and engineering know-how. Investments in education, human capital, and domestic research and development are thus essential to build the capacity to absorb and efficiently use foreign knowledge. It also requires an appropriate degree of protection and respect of intellectual property rights—both domestically and internationally—to preserve the ability of innovators to recover costs while ensuring that the new knowledge supports growth globally.

Policymakers must also make certain that the positive growth benefits from globalization and technological innovation are shared widely across the population, including by ensuring that innovating firms do not exploit the newly acquired technology to gain excessive control of a market to the detriment of consumers.

 -- via my feedly newsfeed

The Decline in Manufacturing Jobs: Not Necessarily a Cause for Concern [feedly]

The Decline in Manufacturing Jobs: Not Necessarily a Cause for Concern
https://blogs.imf.org/2018/04/09/the-decline-in-manufacturing-jobs-not-necessarily-a-cause-for-concern/

Textile manufacturing plant in Recife, Brazil: in many countries, the share of manufacturing jobs is declining (photo: Ingram Publishing/Newscom).

Manufacturing jobs are waning. In many emerging market and developing economies, workers are shifting from agriculture to services, bypassing the manufacturing sector. In advanced economies, the rise in service sector employment typically reflects the outright disappearance of manufacturing jobs.

The decline in manufacturing jobs is often met with anxiety. People are concerned that a smaller manufacturing sector implies slower economic growth and a scarcity of well-paying jobs for low- and middle-skilled workers—contributing to worsening inequality. In Chapter 3 of the April 2018 World Economic Outlook, we revisit the evidence supporting those beliefs and find that the declining share of manufacturing jobs need not hurt growth or raise inequality, provided the right policies are in place.

Shifts in economic activity and productivity

Shifts in economic activity are part of a natural process of "structural transformation." As people get richer, they consume more services—such as health and financial services. Technological advances also lead to sizable labor savings, especially in manufacturing.

Our study provides novel evidence of how a stronger expansion of service rather than manufacturing jobs in emerging market and developing economies may affect their ability to catch up with advanced economy income levels. Using data for a large number of countries over the past five decades, we document that some service sectors are very similar to manufacturing in terms of levels, growth rates, and convergence of productivity (output per worker).

Some market service sectors—such as transport, telecommunications, and financial and business services—have higher levels and growth rates of output per worker than manufacturing. Moreover—just as in manufacturing—labor productivity in several service sectors tends to converge to the global frontier: that is, it grows faster where it is relatively low, allowing countries with low initial productivity levels to catch up toward those with higher levels.

As the highly-productive service sectors—such as communications, finance, and business activities—have been attracting workers faster than other sectors, the shift of employment from agriculture to services since the 2000s has benefited aggregate labor productivity in emerging market and developing countries across all regions—and especially in sub-Saharan Africa.

Of course, these findings should not lead policymakers into complacency. Barriers to international trade in services—which are much higher than for goods—should be reduced so that the expansion of highly-productive service sectors is not constrained by the growth of domestic demand. Policies should also ensure that workers' skills are aligned with those needed in the more tradable service subsectors—such as financial and business services. And in many emerging market and developing countries where productivity remains anemic in all sectors, a comprehensive approach is needed to unlock productivity growth across the board, including by strengthening human capital and physical infrastructure, as well as improving the business and investment climate.

Shifts in economic activity and income inequality

Another frequently voiced concern is about the disappearance of high-quality manufacturing jobs in many advanced economies that are simply not available in the service sector. As factories close, many middle-skilled workers need to accept low-paying jobs in the service sector, contributing to the "hollowing out" of the income distribution, and a rise in inequality.

Our analysis shows that the level of labor income inequality within industry (70 percent of which is accounted by manufacturing) is indeed somewhat lower than within services in a sample of 20 advanced economies. But country characteristics are more important than the size of the industrial sector for explaining aggregate inequality. For example, inequality in Denmark is about one-third of that in the United States in both industry and services. And the biggest factor driving changes in aggregate inequality in advanced economies since the 1980s has been the increase in earning differences in all sectors—rather than the decline of industry jobs.

CASE: MY BOLD AND EMPHASIS

Still, the negative consequences of disappearing manufacturing jobs can be sizable for individual workers and their communities, especially in regions that developed as manufacturing hubs. To ensure inclusive gains from structural change, policies should facilitate the reskilling of displaced workers and reduce the costs of their reallocation. But policymakers should also be mindful that sectoral reallocation may be very costly or even unfeasible for some workers (such as those close to retirement age) and strengthen safety nets and targeted redistribution policies accordingly.

In sum, the decline of manufacturing as a source of employment need not hurt growth or raise inequality. But the key is to get the policies right.

 -- via my feedly newsfeed

New Tax Law Invites Rampant Tax Sheltering and Gaming [feedly]

New Tax Law Invites Rampant Tax Sheltering and Gaming
https://www.cbpp.org/research/federal-tax/new-tax-law-invites-rampant-tax-sheltering-and-gaming

The major tax legislation enacted last December not only ignores the need for more revenue and is heavily tilted in favor of wealthy people and corporations, but also suffers from a third fundamental flaw: its design invites rampant tax sheltering and gaming.^[1]

True tax reform simplifies the tax code and narrows the gaps between how different types of income are taxed.  The new law does the opposite, adding complexity to the tax code and introducing new, arbitrary distinctions between different kinds of income, thereby creating new gaming opportunities. In particular, its new deduction for "pass-through" income and deep cut in the corporate tax rate risk making the 37 percent top individual tax rate merely theoretical for some very wealthy people.  The new law also confers enormous tax benefits on some industries but not others, makes it easier for wealthy households to shelter their assets and thereby accumulate multi-million-dollar fortunes, and favors business production and investment overseas rather than at home.

Widespread abuse of the bill's loopholes and preferences could cause it to lose even more revenue — and increase inequality even more — than current projections indicate.  Moreover, Congress has depleted the enforcement division of the IRS, cutting its workforce by more than a quarter since 2010, and provided no additional funding for enforcement following enactment of the new law.^[2]

New Law Is Opposite of True Tax Reform

Well-designed tax reform eliminates loopholes and reduces opportunities for gaming the tax system so that individuals and businesses with the same income are treated as similarly as possible. This brings several benefits:

• It increases the degree to which individuals and businesses base their decisions on economics instead of taxes.  This is good for the economy: it encourages resources such as capital and labor to flow to where they are most productive instead of where the tax breaks and gaming opportunities are most plentiful.
• Closing loopholes and eliminating opportunities for gaming raises revenue and may also reduce inequality, since wealthy individuals and corporations are best equipped to exploit these weaknesses in the tax code.
• It reduces the amount of economic resources that are diverted to developing sophisticated tax avoidance schemes that provide little overall economic benefit, allowing those resources to go to more productive uses.

The new tax law moves in the opposite direction.  It creates new loopholes that will result in similar economic activities being taxed, often arbitrarily, at different rates.  Hence, it "has turned us into a nation of tax shelter hunters," as the Tax Policy Center's Howard Gleckman has observed, as various parts of the law have "set off a frenzy of loop-hole seeking."

Changes Risk Undermining Integrity of Tax Code

Provisions of the new law that create new gaming opportunities include the following:

• Deduction for "pass-through" income invites abuse.  The law introduces a 20 percent deduction for "pass-through" income, or income from businesses such as partnerships, S corporations, and sole proprietorships that business owners claim on their individual tax returns.  This provision never enjoyed a solid policy rationale:  although proponents argued that it was necessary to maintain "parity" between the taxation of corporate and pass-through business income, pass-throughs already enjoyed a tax advantage over regular corporations (known in the tax code as C corporations).  While pass-through income faces only one layer of taxation — at the individual level — C corporation income faces two levels of tax: one when the firm pays the corporate income tax, and another when shareholders pay individual income tax on their dividends or capital gains.  Because of the new deduction, many high-income individuals may now be able to secure very large tax savings by converting their wage and salary income into pass-through income.

  The law includes a series of complex "guardrails" aimed at limiting the scope of the provision and preventing gaming, but these measures are unlikely to be effective.  They consist of a series of questions for taxpayers to determine whether particular income qualifies for the pass-through deduction, with each question drawing a line between qualification and disqualification for the deduction.  (Among other things, the law draws lines between compensation and profits, between different types of services, and between real estate investment trusts and other assets.) This will entice many taxpayers, aided by their accountants or lawyers, to try to place themselves on the tax-saving side of each line.  Such tax avoidance activities produce no gain for the economy and lose revenue for the Treasury.

• Deep cut in corporate rate risks encouraging tax sheltering. The new law creates a powerful incentive for wealthy Americans to shelter large amounts of income in corporations by slashing the corporate rate to 21 percent, far below the top individual tax rate of 40.8 percent (the new 37 percent top individual income tax rate plus the 3.8 percent Medicare payroll tax rate).  This will entice wealthy people to shield their labor or interest income from the top individual rate by setting up a corporation and reclassifying their income as corporate profits in order to pay the lower corporate rate.  They also can defer the second level of tax on their corporate income by electing not to receive dividends immediately or by delaying selling shares and realizing a capital gain.

  The new law also encourages income sheltering by retaining the "stepped-up basis" loophole, which allows the heirs of an estate not to pay any taxes on any appreciation of an asset that occurred during the previous owner's lifetime. The combination of the new low corporate rate and this retained tax loophole risks opening a gaping tax sheltering opportunity for wealthy people, with no gain for the economy.

  For example, an investor with a multi-million-dollar bond portfolio now has an incentive to place it in a corporation and pay roughly half the tax rate on the interest income it produces than she'd pay if that income faced the individual tax rates.  She might eventually have to pay taxes on the dividends or capital gains on the wealth that has accrued in the corporation, but she could defer that second layer of tax for decades and even avoid it altogether by passing the corporation housing her bond portfolio on to her heirs and relying on the stepped-up basis loophole to wipe out her tax liability.

• New international tax regime encourages offshoring and profit shifting. The new law also moves U.S. international tax rules to a "territorial' system that largely exempts multinationals' foreign profits from U.S. tax and thereby encourages them to shift profits and operations overseas.  The drafters of the law put in place a minimum tax to limit this incentive, but it is seriously flawed and could in fact add to incentives to shift both paper profits and real investments and operations overseas since multinationals owe less minimum tax when they invest more abroad. This threatens to reduce investment in the United States and could wind up reducing U.S. workers' wages.

 -- via my feedly newsfeed

New Tax Law Is Fundamentally Flawed and Will Require Basic Restructuring [feedly]

New Tax Law Is Fundamentally Flawed and Will Require Basic Restructuring
https://www.cbpp.org/research/federal-tax/new-tax-law-is-fundamentally-flawed-and-will-require-basic-restructuring

The law will cost approximately $1.5 trillion over the next decade and deliver windfall gains to wealthy households and profitable corporations, further widening the gap between those at the top of the income ladder and the rest of the nation.

 -- via my feedly newsfeed