Here’s a simple thought experiment. There are ten people. They have an income distribution and a tax bill that look like this:
# Income Tax Effective rate
1 – 50 15 30%
2 – 20 5 25%
3 – 8 1.5 19%
4 – 6 0.8 13%
5 – 5 0.5 10%
6 – 4 0.2 5%
7 – 3 0 0%
8 – 2 0 0%
9 – 1 0 0%
10 – 1 0 0%
Total 100 23 23%
In other words, our little group roughly represents the distribution of income and income taxes in many developed countries. Now, let’s say that the government wanted to raise additional income by raising the top marginal rate, which would be felt exclusively by the top earner. Let’s say the effect of that increase would raise his tax from 15 to 16, or his effective tax rate from 30% to 32%. That would boost overall tax revenue from 23 to 24, a 4.3% gain.
Now, 4.3% would be considered a huge gain in total income for a government from just a tax rate increase. Here is why they would not be likely to see it.
Wealthy people are sensitive to their effective tax rates as much as the rest of us, and possibly more (they didn’t get wealthy by being indifferent to money). The wealthy and their income are highly mobile in every country except the U.S., Libya, and North Korea. All it would take is a 7% chance of the top earner decamping for, say, Switzerland to make this tax increase lose money for the government on an expected value basis. When things get too far out of whack, high-tax nations have a lot to worry about on this score. And that is before counting any effects on marginal productivity.
If a country’s tax rates were at some equilibrium, it would most likely be the equilibrium for maximizing the country’s tax revenues. I don’t know if any country is exactly at that point, but it’s unlikely that any country is on the strongly upward-sloping part of the Laffer Curve. All of which probably explains why overall revenue seems relatively insensitive to individual tax rates.
The unions have made a number of concessions to ensure the survival of Chrysler. The question now is what the company’s creditors will do… They have to look at the broad economic impact (of Chrysler collapsing) and not just their own short-term financial interest.
Representative Schauer understands what it takes to look beyond his short-term financial interest. He’s a community service kind of guy. Never worked at a productive job a day in his life. And just because 25 of the top 40 campaign contributors were unions (UAW was #8) doesn’t mean he’s serving his financial interests in arguing for the altruism of others. I don’t doubt this guy sincerely believes that stiffing the creditors will be good for the economy in a “broad impact” sort of way.
But if sacrifice is what this is really about, Congressman, please show us the way. I know a Chrysler bondholder, one of the “little guys” who hasn’t accepted government money. He voted for Obama, FWIW. He figures he can get about 65 cents on the dollar in bankruptcy, a little less on liquidation than restructuring. The politicians are asking them to take about 15 cents. My friend, hearing the Congressman from the UAW asking for some sacrifice, is willing to match him, dollar for dollar.
He says, “I’m willing to take my lumps to the tune of what I contractually signed up for, i.e., a 35 percent loss. I bought the bonds. I screwed up. If you, Mr. Congressman (or Senator Levin, or Governor Granholm, or any other of the politicians standing in front of your union masters and asking us bondholders for an additional sacrifice) are willing to look beyond your short-term financial interest, and share in my loss beyond what the market says I could get from bankruptcy, then I’ll do it.”
So, if you, Congressman Schauer, put up $30,000, my friend says he will take an additional $30,000 hit, below the 60 cents he currently expects. Put $100,000 into the Chrysler kitty, and he’ll put up $100,000. What do you say, Congressman? Senator? Governor?
I will pre-emtively and perhaps unfairly say, “I thought so. You’re happy to ask for sacrifice, as long as it’s coming from others.”
I’ll give my friend the last word:
There are people who have bought into these securities at already depressed prices. I’m not one of them. We picked them up at issuance. While the unions were happy to collect their well above-market wages and benefits, I watched the value of my bonds drop. Now that they’re willing to work for only slightly above market wages and benefits, they’re expecting me to suck up much worse losses.
He closed with an unprintable invitation for the politicians to engage in something that sounded like self-copulation.
Speak clearly directly into the mic, please. Now say again? At the moment you realized that your shareholders would be screwed by the ML transaction, and it was time to invoke ‘material adverse change’ to back out of it, why didn’t you do it?
I can’t recall if [Hank Paulson] said “we would remove the board and management if you [invoked the material adverse change clause to block the Merrill deal]” or if he said “we would do it if you intended to.” I don’t remember which one it was, before or after, and I said, “Hank, let’s deescalate this for a while. Let me talk to our board.”
There it is. When the BAC board, including Lewis, came face-to-face with doing right by their shareholders or keeping their jobs, they chose to “deescalate.” Later they rationalized: getting fired = systemic risk.
So, Ken, you decided not to back out of the deal, what about at least telling your shareholders what you were getting them into?
Q: Were you instructed not to tell your shareholders what the transaction was going to be?
A: I was instructed that ‘We do not want a public disclosure.’
Q: Who said that to you?
A: Paulson…
Q: Had it been up to you would you [have] made the disclosure?
A: It wasn’t up to me.
So, the government ordered you to shoot your shareholders from behind a curtain, and you pulled the trigger.
I speak for a lot of people who are just amazed at the depth and breadth of the hypocrisy here — the liberal New York Times and the liberal Globe… at one point in the negotiations, the company proposed eliminating all sick days for Guild members, like an Alabama sweat shop.
That from a sweatshop worker writer at the Boston Globe, which has been told by their NYT overlords that they the Guild must find $20 million in cuts, presumably from their labor contract, or face the shutdown of their paper. And the Grey Lady is not just picking on their Boston subsidiary; all NYT employees took a 5 percent salary cut in order to avoid layoffs.
Except for the CEO. She made $5.58 million in 2008, versus $4.14 million in 2007.
Asked if the bonuses and extra executive compensation were appropriate at a time when employees are being forced to absorb salary cuts and joblessness, Catherine J. Mathis, NYT Senior Vice President for Corporate Communications, told the Huffington Post:
“With regard to shared sacrifice, please remember that for 2008, non-equity incentive compensation (which many think of as bonuses) for these folks was roughly half of what it was the year before and stock awards were down more than 80 percent in value.”
Translation: “If we can convince you to look only at certain selected parts of the compensation equation, over here (snap, snap), you’ll see they went down versus the year before.” Of course, that means other parts went up, i.e., grants of stock and options. The NYT clearly assumes that their shareholders are as innumerate as their readers, and can be lead away from the “total” numbers to just the numbers management wants to discuss. Sorry, Cathy. The equity counts, too.
Mathis cautioned that the total compensation numbers in the proxy report…
“…include the value of the compensation — not the amount of cash they received. For example, they were all granted options. But those options are of value only in the stock price increases over the exercise price…For proxy purposes a value is assigned to the options even though the executives received no cash at the time they were granted.”
Uh, yeah. Actually, the options are valuable even though they’re granted at the money. That’s how the NYT counts options when they evaluate the pay of CEOs.
Now, if the NYT’s CEO wishes, via her mouthpiece, to insist that at-the-money, or even out-of-the-money options are not really worth anything, I will gladly give her $1 for them, and she can claim to be ahead. Just mail them to…
What? She’s not interested? How about if I offer $2? She wants how much? Oh, $1.5 million. Yeah, that is how much they’re worth.
I’m used to having my intelligence insulted by the NYT, which is why I dropped my subscription a couple years ago, apparently with tens of thousands of others. The little sympathy as I have for management in this affair is barely topped by my sympathy for those wondering “if the bonuses and extra executive compensation were appropriate at a time when employees are being forced to absorb salary cuts and joblessness.”
If the cuts improve the odds of the paper becoming profitable, that is precisely the kind of thing that should be rewarded with bonuses. If management doesn’t have an incentive to push for profits, then who can the shareholders count on to make the paper viable? The unions?
Barofsky’s boss, Geithner, disagrees. But Geithner is not the house lawyer.
If Barofsky is right and Congress refuses to clarify that buyers won’t be subject to the comp constraints, PPIP is dead. At this point, even if Congress has to act because of the way the law is currently written, a lot of potential buyers will be scared away.
The second installment of my Lombard Street article here. Sample:
The clearest evidence of popular envy being the root of these provisions is the clause requiring the board to review “luxury” expenditures—a kind of Optics Committee—for items like office decorations and corporate jets. Clearly, these expenditures are far more material to the press and public than they are to the shareholders. Does it really matter to the shareholders if the company’s most valued employees benefit from nice offices? Sure, there is a crude sense of entitlement that drives an executive to spend a lot on lavish appointments, but such appointments tend to be personalized, which arguably creates a retention benefit, especially in situations where bonuses are otherwise being suppressed. Corporate jets might be a frivolous expense, or they may be a cost effective way to provide efficient and secure transportation to busy executives. The ARRA law leaves it up to the board to make such determinations on behalf of the shareholders, but this is a canard; boards already make these determinations. The real purpose of this clause is use public sentiment to eliminate perks on no firmer grounds than the grade school “chewing gum rule”—if I can’t have some, nobody else can.
A WSJ story begins with two facts that appear in tension:
Hospitals and pharmaceutical companies have been pushing through hefty price increases aimed at bolstering earnings, even as government and private insurers are struggling to rein in healthcare costs.
And includes a fleeting nugget about how they are apparently related:
Credit Suisse’s Catherine Arnold said that drug companies have increased prices so aggressively in recent months to wring sales out of products before any healthcare cost-cutting efforts eat into profits.
“When the government is talking about more aggressive discounts, your start price is going to determine your end price,” she said.
The article is otherwise full of examples of price increases, the problems they cause, and what people think about it, including the obligatory denunciation by a “consumer advocate.” The above quote is one of the few clues about why they are happening.
Maybe it’s just me, but I believe that economically relevant facts help a story. I think it’s informative to look at the underlying causes and not just the effects of things like price increases.
Instead of talking about “hospitals” or “drug companies” as unitary agents, it would be interesting to see how these institutions comprise of thousands of economic agents doing what comes naturally–gaming the system they are familiar with to their personal profit. I think its important to show how most of the counterproductive gaming is driven by increasingly complicated rules established by various third parties, including government agencies. I think it’s relevant that as health care costs get more constrained by public policy, they diverge from costs that would be dictated by supply and demand, and that the market will react accordingly. A story could illustrate this in the form of threatened negotiations from an agent positioning itself to be a monopoly buyer, and how dispersed sellers will react with preemptive price increases or, to the extent they can’t implement them themselves, price increases somewhere else along the chain of treatment delivery.
Of course, all we see are the price increase, and that’s all the average journalist sees, too.
The intent of the law was to encourage alternative fuels, and reduce dependence on products like diesel that result in greenhouse gases. But the paper companies figured out how to get paid to do the opposite:
The origins of the credit are innocent enough. In 2005 Congress passed, and George W. Bush signed, the $244 billion transportation bill. It included a variety of tax credits for alternative fuels such as ethanol and biomass. But it also included a fifty-cent-a-gallon credit for the use of fuel mixtures that combined “alternative fuel” with a “taxable fuel” such as diesel or gasoline.
Enter the paper industry. Since the 1930s the overwhelming majority of paper mills have employed what’s called the kraft process to produce paper. Here’s how it works. Wood chips are cooked in a chemical solution to separate the cellulose fibers, which are used to make paper, from the other organic material in wood. The remaining liquid, a sludge containing lignin (the structural glue that binds plant cells together), is called black liquor. Because it’s so rich in carbon, black liquor is a good fuel; the kraft process uses the black liquor to produce the heat and energy necessary to transform pulp into paper. It’s a neat, efficient process that’s cost-effective without any government subsidy.
The paper companies figured out that if they add diesel to the black liquor, voila, a fuel mixture that qualifies for the mixed-fuel tax credit.
“You use the toilet every day,” said one hedge fund analyst who’s been closely following the issue. “Imagine if you could start pouring a little gasoline into the bowl and get fifty cents a gallon every time you flushed.”
No one in Congress seems to have anticipated this creative maneuver. This past fall the Joint Committee on Taxation computed the cost of extending the tax credit for three months and projected it would cost a manageable $61 million. It now appears that the extension (which was passed as part of the TARP) could cost as much as $2 billion before the credits expire at the end of this calendar year.
And yet, because the paper industry has invested in lobbying, and now has even more incentive to do so, Congress will probably not repeal this law before it expires.
The NYT provides a good story about how the Wall Street pay restrictions may be having its effect. Some of the remaining glib tropes we’ll undoubtedly to hear:
– “So what? How much can these people have been worth to companies they helped drive under?”
– “They don’t need these people. The industry had to shrink anyway.”
– “These people are just being greedy, looking for other ways to get rich doing useless things.”
In the meantime, we taxpayers will reap the ‘benefits’ of our government’s politically driven HR policies at institutions completely dependent on the quality of their human resources. What we’ve saved from not “wasting” money on compensation, what we’ve cathartically gained from “tough talk” to the bankers, we will lose a thousand-fold from sub-optimal bank earnings and, in New York’s case, crippled tax collections. Hopefully, the NYT will run a story on those items when they happen, as well.
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