Pushing back on “quarterly capitalism” and incentivizing more investment

July 21st, 2015 at 9:37 am

Interesting news out of the HRC campaign yesterday. They’re considering tweaking the capital gains tax rate schedule to incent more patient holdings and push back on what they call “quarterly capitalism.” Though they haven’t formally announced anything, they’re talking about raising the top rate on assets held for the medium term from its current 24% to a number above the 28% proposed by President Obama in his latest budget, and then gradually lowering it for longer-held investments.

First, the motivation is correct. See the second figure in this post, showing that as activist investors have successfully pushed for more share buybacks and dividend payouts, the use of retained earnings for investment has tanked. That’s one reason why we’re stuck in a sluggish growth regime, even with very low interest rates.

From the WSJ:

U.S. companies in the S&P 500 index spent a median 36% of operating cash flow in 2013 on their buybacks and dividends, moves designed to deliver gains to current shareholders, compared with 18% in 2003. Over that same period, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003, according to S&P Capital IQ. When the companies have an activist shareholder, the changes are even sharper, the data show.

Second, the key move here in terms of tax policy, IMHO, is to nudge the capital gains rate closer to the rates of regular income. That both boosts the incentives to hold and reduces the (much stronger) incentive to define your income so as to take advantage of the low cap gains rate.

Remember JB’s first rule of tax policy: the moment there’s a preferential tax rate on X type of income, everyone with a tax lawyer suddenly discovers that X is in fact what they’ve been holding scads of all along. It’s a real coinky-dink!

Third, as tax maven Chuck Marr likes to say, the fact that cap gains is only taxed at realization is already a pretty big incentive to hold onto assets. So, while I think the HRC team is on the right track here, I’d consider more direct policies targeted at excessive buybacks and dividend payouts.

For example, as William Lazonick has explained, there’s an SEC rule that allows corporate executives to engage in stock buybacks as long as a) they announce the buyback program and b) the amount of shares bought back “does not exceed a ‘safe harbor’ [from prosecution for price manipulation] of 25% of the previous four weeks’ average daily trading volume.”

There are two major problems with this rule: first, the 25% limit is too high. Large, highly traded companies like Exxon Mobil and Apple can regularly purchase hundreds of millions worth of their own shares. Second, the fact that the SEC does not require companies to report daily stock repurchases makes the rule impossible to regulate without a special investigation, which the SEC rarely launches. As Lazonick puts it, the rule essentially legalizes “stock market manipulation through open-market repurchases.”

These problems could be fixed by lowering the “safe harbor” share—Lazonick goes further and would ban open-market repurchasing, allowing only “tender” offers (where the company offers to buy outstanding shares at a premium)—and increasing reporting requirements. Either way, public companies who believed their shares are undervalued could still raise their value by buying back shares—just not as much as today, as these rule changes would make such activities less common.

Finally, while I totally endorse these SEC changes (and have a piece out soon on how a financial transaction tax could also help here), I may differ a bit from fellow travelers in this investment incentive space.

Warren Buffet often hits this theme: “Never did anyone mention taxes as a reason to forgo an investment opportunity that I offered.” What drives investment choices is the expected return on that investment. That’s after-tax return, so of course taxes matter. But my sense is that there’s been a dearth of decent investment opportunities with promising returns, again, even at very low interest rates.

What would change that? Actually, the low inflation environment is unhelpful here as it drives low expectations by companies regarding future earnings; firms sitting on cash can beat inflation with financial “innovations” rather than investments in new machines, plants, and workers.

But at the end of the day, what would help most would be good, old-fashioned stronger demand. OTEers know that for me, this also implies a lower trade deficit. The recent strength of the dollar has not been helpful in this regard, as our manufacturers, a key source of capital investment, have been losing competitive ground (the stronger dollar also contributes to lower inflation).

So nothing wrong and a lot right with making policy changes to incent more patient capital and push back on “quarterly capitalism.” But I suspect that’s not where the big investment elasticities lie. To go there, we need more robust demand and growth.

Austerity arithmetic: the dreaded r > g trap.

July 19th, 2015 at 9:50 pm

I’ve got a piece out in PostEverything on a lesson we should learn from some arithmetic embedded in the Greek debt crisis. Basically, I point out that when the interest rate a country must pay to service their sovereign debt is consistently and significantly above their growth rate, their debt/GDP ratio just keeps growing.

In this course of the piece, I say a bit about the US case, stressing that when we’ve reduced our debt/GDP ratio, it’s typically been through strong growth, i.e., by closing the output gap and getting to full employment.

The figure below plots the change in the debt/GDP ratio against the output gap, which is just the % by which real GDP is above or below potential GDP, so a -5% output gap means real GDP is below where it should be at full employment by 5%.

I circled the 1990s as an instructive example. As the economy strengthened, the debt/GDP ratio began to grow more slowly and then, as the output gap more than closed and the federal budget went into surplus, the debt ratio fell quite sharply.

Over the full period, the correlation between the two series is -0.79.

As I stress in the piece, there’s such a thing as fiscal rectitude (and lack thereof), but the history of advanced economies also reveals that growth is often the critical variable in debt and deficit outcomes. Conversely, to the extent that austerity measures strangle growth in high interest rate environments, as in Greece today, it is bound to backfire.


Sources: CBO, BEA, OMB

Where’s JB?…and the troubled state of retirement security

July 18th, 2015 at 9:39 am

Hey, OTE’ers, ready for another round of “where’s JB?” I took the photo below on a bit of a jog yesterday from somewhere within these here United States (somewhere very beautiful). As usual, the winner gets to pick the music for a Friday interlude.

I’m here in ____ talking about the precarious state of financial security here in the US, where maybe half of those heading toward retirement are undersaved in terms of their ability to make ends meet once they stop working. One study shows that about a quarter of those between 50 and 64 have no savings to speak of at all.

The traditional way to think about this is the three-legged retirement stool: Social Security, pensions, and savings. Problem one is that the only healthy leg of that stool is Soc Sec.

Broadly speaking, the long trend in real wage stagnation for many workers began in the mid-1970s, so we’re now at a point where savings–what’s left over after you spend what you need (and want)–ain’t what it used to be for those on the wrong side of the inequality divide.

Defined benefit pensions that paid a guaranteed income in retirement have largely evaporated, to be partially replaced by defined contribution plans, which shifts the locus of risk from the firm to the worker. And many workers, especially those less connected to the job market (or in the “gig”/freelance economy) don’t even have these types of plans.

The good news is that both the government–more at the state than at the Fed level, though the Feds are in the game too–and the private sector are cooking up useful saving vehicles, often with low bars to entry and cheap fees, that enable anyone to start a retirement account, often tax-favored (like IRAs), even if your employer doesn’t offer one.

The bad news is that too many people, even if they have a strong impulse to participate in such a plan, lack the income stream to peel off a significant enough amount to save.

That, in tandem with demographic shifts toward those less likely to have much in the way of these sorts of savings, means we’re very likely headed for a lot more, not less, retirement insecurity.

And that, in turn, suggests the smart policy move would be to strengthen and expand Social Security, a portable, guaranteed pension plan that efficiently covers all workers with very low administrative fees.

A second policy implication is that this is another good reason to “make work pay” as in the Reconnection Agenda’s policy thrust. It’s great that financial service providers, along with states and the federal government, are thinking and acting in this space, but cart, meet horse: we can’t assume ample income and then start getting excited about clever new savings vehicles. We’ve got to simultaneously move the policy agenda that can promote income growth for the undersaved.

Where did I take this lovely photo?


Paul K, the Fed, and asymmetric risk

July 17th, 2015 at 7:37 pm

Ever since Fed officials started talking about raising rates, I and others have raised the spectre of asymmetric risk: the risk that a forthcoming rate hike will lead to slower growth is greater than the risk of faster inflation, and the former would be much more damaging to American households than the latter.

Paul K put this all very well in an interview the other day:

If the Fed raises rates too soon, we risk getting caught in another lost decade. So the risks are hugely asymmetric. I really find it quite mysterious that the Fed is eager to raise rates given that, they’re going to be wrong one way or the other, we just don’t know which way. But the costs of being wrong in one direction are so much higher than the costs of being the other.

[See my recent piece on the racial implications of these risks.]

It’s not obvious that the FOMC (the committee that sets rates) is necessarily going to be wrong, though I suspect Paul’s right, in that I don’t see pressures from nascent wage or price growth waiting pounce around the next corner…I still see considerable slack, especially in paychecks.

Those who want to argue that the Fed may actually be timing this right are making a preemptive case, but given the asymmetries, they need MUCH more in the way of data to make a persuasive case.

If it were me, I wouldn’t be talking about raising yet, but I do think there’s one reason for doing so: there’s another recession out there somewhere and the Fed, worried about hitting the zero lower bound again, wants the fed funds rate to be on a perch high enough such that they have room to come down without hitting zero.

This is especially important if you believe, as I do, that an austerity-smitten Congress will not move fast enough with counter-cyclical fiscal policy.

If that’s truly their motivation–and again, I wouldn’t go there but I don’t think it’s crazy to do so–then the thing to do is to keep the rate path very shallow at first. The expectation is for the first rate hike to be 25 basis points (0.25%), which meets this criterion.

The Fed and African-American Unemployment

July 16th, 2015 at 11:42 am

Fed Chair Janet Yellen has to engage in a pretty serious balancing act when she speaks publically. She doesn’t want to shock the markets (unless there’s a good reason to do so), and she’s under pressure from hawks and doves to raise and not raise rates, respectively. Meanwhile, in her heart and brain she’s a deeply nerdly and insightful macroeconomist, so she’s also trying to explain the economy, often to people who don’t listen that well. FWIW, I think she does an admirable job juggling all of that.

But everyone under such scrutiny will on occasion say things the wrong way, and I thought she did so yesterday in an exchange with a few members of the House during testimony. She was asked about the extent to which the Fed could make a difference in “the fact that minority communities still face unacceptable high rates of unemployment.”

Her response (beginning with her characteristic “so”):

“So, there really isn’t anything directly that the Federal Reserve can do to affect the structure of unemployment across groups, and unfortunately, it’s long been the case that African-American unemployment rates tend to be higher than those of on average among — in the nation as a whole. It reflects a number of different sources of disadvantage that are operative there.”

What’s missing here—though it was probably implicit in Yellen’s thinking—is the critical observation that black unemployment tends to be twice that of the overall rate, and more than twice the white rate. Moreover, this level difference translates into change differences such that a one percentage point decline in overall unemployment often leads to a two point decline for blacks. See here for more details, e.g., “black unemployment has averaged almost twice that of overall unemployment since the monthly data begin in 1972 (average: 1.9, with standard deviation of 0.15, so not a ton of variation around that mean).”

In that sense, the Fed has the potential to make a huge structural difference in the economic lives of blacks and other minorities by heavily weighting the full employment part of the their mandate relative to the inflation part, especially since there’s still considerable slack in the job market, with lower-wage, minority workers facing the brunt of it, and—importantly—little evidence of inflationary pressure (if anything, the Fed has missed their inflation target on the low side for a few years running now).

“So,” as Chair Yellen might say, it would have been useful to acknowledge this structural relationship and the importance to black workers of getting the “weights” right at this point, emphasizing the critical role of the Fed in holding off on tightening too soon such that the recovery can reach those who still haven’t been lifted by it.

Chair Yellen well knows this 2:1 problem, and I take her comments to mean that there’s not much the Fed can do to change it, though, again, she needed to say that the Fed can tap it to the great benefit of un- and underemployed minorities. However, economist Bill Spriggs, who knows a lot about this, argues something that is true and important in this space—I know this because I’ve seen it with my own eyes, both in the data and in the anecdotes: at full employment, employers cannot afford to discriminate against minorities the same way they can in slack markets.

And what Bill will tell you is that this phenomenon has the potential to reduce that 2:1 ratio, which would be a tremendously beneficial structural advance.