Archives: July, 2013

Entrepreneurs and Capital Gains Taxes

I testified to the Senate Small Business Committee last week about capital gains taxation.

I noted to the committee that reduced capital gains taxes can generate greater financing of young companies by angel investors and venture capitalists. Lower capital gains taxes can also encourage people to become entrepreneurs because the payoff from a successful start-up is improved compared to a wage job. Entrepreneurs put their own money into their ventures and want to maximize the financial returns from their hard work and sacrifice.

The higher capital gains taxes that were recently enacted risk killing off future Apples and Amazons, which we will need to power tomorrow’s economic growth. Congress raised the top federal tax rate on long-term capital gains from 15 percent to 23.8 percent. When state-level taxes are included, the average top U.S. tax rate on long-term capital gains is 27.9 percent.

U.S. policymakers need to understand that capital gains are different than ordinary income, which is why most nations have top capital gains tax rates that are much lower than their top rates on ordinary income. The U.S. capital gains tax rate is much higher than the average rate of just 16.4 percent in the 34 nations of the Organization for Economic Cooperation and Development (OECD).

Long-term capital gains should be subject to low or zero tax rates. Hopefully, federal policymakers will reconsider capital gains tax policy in coming months and reduce our tax rate to at least the average rate of our OECD trading partners. A lower capital gains tax rate would boost innovation, spur entrepreneurship, and help America regain its competitive edge.

See my recent report for a full discussion.

Egypt’s Vanishing Currency Black Markets

Despite escalating tensions between Egypt’s new military-backed government and supporters of ousted president Mohammed Morsi, there is at least one positive development coming out of the Land of the Nile. Yes, at long last, some semblance of stability appears to be returning to Egypt’s economy.

After the ouster of President Hosni Mubarak in 2011, the Egyptian economy took a turn for the worse. In particular, the Egyptian pound began to slide shortly after Morsi and his Muslim Brotherhood-backed government took power, sparking the development of a black market for foreign currency. The accompanying chart tells the tale: the official and black-market EGP/USD exchange rates began to diverge sharply in late 2012. In recent weeks, however, they have converged.

Recent currency auctions by the central bank, coupled with improved expectations about the country’s economic prospects, have begun to buoy the struggling pound. Indeed, the black-market exchange rate is now 7.13 EGP/USD, very close to the official rate of 7.00 EGP/USD. So, with Morsi, the black market appeared, and with the military’s re-entry, the black market has all but vanished.

The Egyptian stock market is echoing the confident sentiments displayed by the foreign exchange markets (see the accompanying chart). But, it remains to be seen if this newfound confidence in the Egyptian economy will be sustained.

An Intriguing New Argument In Favour of “Buy American”

In a new article posted on Al Jazeera online, Dean Baker, co-founder of the Center for Economic and Policy Research, a left-leaning and generally trade-skeptic think tank (not to be confused with the London-based Centre for Economic Policy Research network of academic economists) outlines an interesting new way of examining the worth of ‘Buy American’ policies. (I blogged a little about those last week, and drew readers’ attention to the growing use of “Buy American” initiatives at the state level. They are a bad idea.) I may be flattering myself, but I believe that I may be one of the people in “intellectual circles” among whom Dr. Baker believes it is “fashionable… to treat “Buy American” provisions in government spending packages as silly relics that appeal to ill-educated people…” (although I don’t believe I have ever sneered at my intellectual opponents, or seen them as being ill-educated. Misinformed– or simply wrong–maybe, but that has nothing to do with education.)

Anyway, according to Dr. Baker, us “folks in intellectual circles don’t have a clue what [we] are talking about.” But he goes beyond dismissing our arguments, and builds one of his own that I believe is a new one:

We must recognise that most governments seem to have a bias against running large budget deficits, even when large deficits are needed to boost their economies back to full employment. In this context, the political value of including home country preferences in stimulus packages is likely to dwarf whatever losses might be incurred by paying higher prices for goods and services. [emphasis added]

In other words, we needed “Buy American” provisions in the 2009 stimulus plan, or else the plan would have failed. And, insufficient though it may well have been, the stimulus saved us from all sorts of doom.

Two things in Dr. Baker’s article, and in the above quote specifically, jump out at me as novel arguments, or at least novel twists on old arguments. First, Dr. Baker seems to be arguing that “Buy American” policies make sense not in and of themselves, but as political “inducements” (i.e., bribes) to win support for stimulus programs, which seem to be the real goal in Dr. Baker’s eyes. “Buy American” policies are basically a means to an end, an end that American politicians can’t or won’t endorse unless simplistic and nationalistic provisions are attached. Now who’s implying those who support “Buy American” are ill-educated?

And second, there is an explicit acknowledgement that “paying higher prices for goods and services” does indeed involve “losses.” We don’t often hear that admission from protectionists, or if we do, the losses are very much downplayed, or even parenthesized, in the more important context of the importance of “creating or saving jobs.”

I don’t buy this new argument, by the way, no more than I bought the old one. Especially because I remain unconvinced of the benefits of the so-called stimulus. Just thought I would flag it as something new under the sun.

Detroit’s High Property Taxes

Why have so many individuals and businesses left Detroit? Presumably, for all kinds of reasons, including crime and political corruption.

Another important reason is probably property taxes. Property taxes are a major relocation driver, not just for homeowners, but also for businesses. Nationwide, business property taxes are an enormous $229 billion burden that stifles job-creating investments. Some states–including Michigan–not only impose property taxes on land and structures, but also on machinery and equipment. If you’ve got a factory with lots of machines, you have a strong incentive to move to a place that doesn’t tax them.

A study by the Lincoln Institute of Land Policy looked at effective property tax rates in the 50 largest U.S. cities in 2011. Detroit had the highest property tax rates of all 50 cities on homes, apartment buildings, commercial buildings, and industrial buildings.

The chart shows the effective tax rates in Detroit vs. the average of the largest 50 cities. The Detroit tax rates are generally twice as high as the U.S. averages. Detroit needs lots of reforms–property taxes would be a good place to start.

Perfect Storm for ITC Patent Reform

Seven weeks ago, the International Trade Commission announced its decision to ban the importation of some late model iPhones and iPads after finding that Apple had infringed patents owned by rival Samsung. In today’s Wall Street Journal, Verizon Vice President Randal Milch has publicly implored President Obama to exercise his power to veto the ITC’s decision. Such a move could be just the thing to prompt real reform of the ITC’s disruptive role in the patent system.

The prospect of a presidential veto of an ITC exclusion order is pretty exciting. The statutory power of the president to disapprove a decision by the ITC has only been exercised five times since the ITC was created in 1975 and the last president to use the power was Ronald Reagan. Disapproving this new order would certainly turn some heads, and it’s not as unlikely as you might think.

Anti-ITC sentiment has been growing steadily in recent years. In 2006, the Supreme Court made it more difficult for U.S. courts to issue injunctive relief in patent cases, dealing a major blow to patent trolls who buy-up patents for the sole purpose of litigating them. The Court’s holding did not apply to the ITC, making the trade agency a more attractive venue for those unsavory litigants. Now the ITC has decided that it can issue injunctions (as it has in the Apple-Samsung dispute) even when the patent owner previously agreed to license the technology to all who offer a reasonable royalty. More and more observers are coming to recognize that the ITC’s powers are inappropriate and need to be reined in.

A presidential veto of the Apple ban could be just the right thing to push Congress or the agency itself to implement real reform. The House has held a number of committee hearings on the topic in the last two years, and bringing ITC remedies in line with district court practices is included in the Obama Administration’s newest outline for patent reform

Even the ITC’s staunchest advocates would rather have transparent and predictable limits than face the specter of ad hoc nullification of orders resulting from expensive litigation.  As Verizon’s Milch explains in his closing paragraph:

If the administration signaled that it would veto ITC relief orders in instances where courts would have found such orders inequitable, it could discourage parties from clogging the ITC’s docket with such cases in the first place. Then the White House could, mercifully, find it unnecessary to veto ITC decisions, perhaps for another 25 years.

Aligning ITC and district court remedies will do a lot to reduce the disruptive impact of having two venues for patent litigation, but a better policy would be to end the agency’s patent jurisdiction entirely. There is simply no need for an import-only specialized patent court. The law the ITC uses to litigate patents was devised in 1922 to prevent “unfair methods of competition” by foreigner manufacturers.  It is a protectionist relic that should be repealed. 

Unless we abolish the institution now, at some point—maybe in 25 years, probably sooner—the ITC will be messing things up again. 

The Talking Points for NSA’s Dragnet Don’t Hold Up

A bipartisan group of legislators in the House—spearheaded by Rep. Justin Amash (R-Mich) and John Conyers (D-Mich)—is bucking both the Obama administration and Republican party leadership to push an appropriations measure defunding the National Security Agency’s dragnet phone records programs. The measure would forbid the government from using any resources to execute a Patriot Act §215 “business records” order unless it is limited to the specific targets of specific investigations—effectively barring use of that authority to vacuum up the phone records of millions of innocent Americans. Predictably, the intelligence community and its proxies in Congress are pushing back ferociously, circulating an “Open Letter of Support” for the dragnet program from former intelligence officials. It’s worth surveying their main talking points to see just why they aren’t persuasive. Note that they begin, as many defenders of the phone dragnet do, by lumping it together with the very different PRISM program, which involves monitoring of international e-mail and Internet traffic:

We are convinced that both programs are vitally important to our national security. The Director of the NSA, Gen. Keith Alexander, has publicly attested that these programs have been instrumental in helping to prevent attacks on the United States and its allies, including the plot to bomb the New York City subway.

The bundling here is important. Alexander did, at a June 18 hearing, assert that PRISM had been “critical” in disrupting a number of “terror events,” mostly overseas.  But when pressed specifically by Rep. Jim Himes (D-Conn.) on whether the §215 call records program had been “essential” in any cases, Alexander conspicuously dodged the question. He would not identify even a single case in which the bulk phone records collection had been “essential,” or even claim that there was such a case that he couldn’t discuss specifically. 

As for the plot to bomb New York’s subway system, the Atlantic convincingly marshalls evidence from the public record showing that the key initial leads in that case did not come from either PRISM or the §215 program. And with those leads, traditional intelligence authorities would have allowed the investigation to proceed more or less as it did. In particular, there is no indication whatever that the use of phone records to identify associates of plotter Najibullah Zazi required a massive database of all Americans’ calls: Ordinary police, after all, do similar detective work all the time, but with targeted orders based on particularized suspicion.

The crucial general point to understand about these claims for the efficacy of these programs is that if you have unlimited authority, then that will be what you end up using even if more limited authority would have sufficed. If we had never passed the Fourth Amendment, and the government could get “general warrants,” allowing police to search any home at will, they would never bother getting specific warrants based on probable cause. Then, every time police solved a crime through a search, they could accurately say “You see, we used a general warrant!”  But that would be no argument for general warrants. The question to ask is: “Why couldn’t you have done it with a specific warrant instead?”  We haven’t heard, at least publicly, any very good answers to that question when it comes to the NSA call dragnet.

Hurdles to Private Infrastructure Investment

I testified to the congressional Joint Economic Committee today regarding the nation’s infrastructure challenges. Former Governor Ed Rendell also testified, and the hearing was chaired by Senator Amy Klobuchar.

The way ahead for infrastructure is to privatize as much of it as we can. Let’s give America’s entrepreneurs a crack at financing, owning, and managing our airports, seaports, and other facilities.

Infrastructure privatization has swept the world, but there are numerous hurdles to such reforms in this country. Here are some of the issues I raised to the committee:

  • Tax exemption on municipal bond interest. When state and local governments borrow funds to build infrastructure, the interest on the debt is tax-free under the federal income tax. That allows governments to finance infrastructure at a lower cost than private businesses, which stacks the deck against the private provision of infrastructure. Policymakers should consider phasing-out the tax exemption on state and local bond interest, perhaps in exchange for reducing overall tax rates on capital income.
  • Income and Property Taxation. Government facilities don’t pay income taxes. While state-owned airports are tax-exempt, for example, a for-profit airport would have its net earnings taxed at both the state and federal levels. Similarly, government-owned facilities are exempt from property taxes almost everywhere in the United States, while for-profit businesses often bear a heavy burden of property taxes on their land, structures, and machinery and equipment. Note that by privatizing infrastructure and thus subjecting it to taxation, governments would be broadening the tax base. They could use the added revenues from base broadening to reduce overall tax rates, which would spur greater investment of all types in the economy.
  • Crowding Out. The existence of government infrastructure—which is often provided at artificially low prices to the public—deters potential private investments. Private highways, for example, face an uneven playing field because drivers on a private highway would have to pay the private tolls plus the gasoline taxes that fund the government’s “free” highways.
  • Federal subsidies. The crowding out problem is exacerbated when federal subsidies tilt state and local decisionmakers in favor of government provision. Potential private airports, for example, are not eligible for most federal airport subsidies. Consider that before the 1960s, most urban bus and rail services in America were privately owned and operated. But that ended with the passage of the Urban Mass Transportation Act of 1964. The Act provided subsidies only to government-owned bus and rail systems, not private systems. That prompted state and local governments across the country to take over private systems, swiftly ending more than a century of private transit investment in America’s cities.