The Export-Import Bank: Crony capitalism or useful tool?

“Crony capitalism is alive and well...”

“[American] manufacturers can’t afford to be defenseless in the global marketplace”

“The federal government shouldn’t be involved in picking winners and losers”

Vandelay_Industries.pngIf these quotes sound familiar to you, you might think that these were phrases uttered during the 2008 debates over federal bailouts of large banks and General Motors. While longstanding disputes over the relationship between government and business were at the heart of the 2008 controversies, these quotes actually refer to a new debate over the same issue.

This time, the debate concerns an agency that even some veteran Hill staffers acknowledge they’ve never heard of: the Export-Import Bank (Ex-Im) of the United States, which must be reauthorized by September 30th. It’s hard to blame them: with a staff of just 402 employees and an operating budget of $90 million, Ex-Im is one of the smallest federal agencies and as such often escapes the public eye.

So what’s the fuss? To understand the controversy, let’s use a hypothetical to demonstrate how Ex-Im works. Suppose that a small Serbian copper mining company wants to buy Caterpillar dump trucks to work at its mine. Let’s suppose that, for the sake of argument, the company can’t secure an affordable loan from a private bank. What might the company do? If it can’t get financing, it won’t be able to purchase the U.S. trucks, and might instead purchase cheaper models from Russia or China. 

Ex-Im’s existence can prevent the company from having to make that choice. By offering low-interest loans to companies looking to purchase U.S. products, Ex-Im can therefore offer our hypothetical company low-cost financing that would allow it to purchase American trucks instead of those of foreign competitors. Everyone wins: the company can purchase the trucks it wants, and Caterpillar’s production line is humming with orders for new equipment.

In 2013, Ex-Im financed more than $27.3 billion in new loans to foreign corporations, a total which the bank says supported more than 205,000 export related American jobs. Ex-Im had particular success with financing new exports in manufactured goods, financing more than $8.5 billion worth of sales last year. Ex-Im’s efforts helped companies large and small: whether selling fire trucks to Nigeria, pickles to China, leather laces to Indonesia, or honey to Bahrain, the bank supported 3,842 distinct transactions in 2012, 90% of which were with small businesses. And, to top it all off, Ex-Im did so without adding a single penny to the deficit- it actually returned more than $1 billion to Treasury’s coffers.

So what’s the controversy? Some lawmakers have expressed opposition to the bank on the grounds that it “picks winners and losers” and disproportionately favors large companies over smaller businesses. Among the most vocal opponents of the bank is new House Majority Leader Kevin McCarthy (R-CA). Speaking on Fox News Sunday in June, McCarthy claimed that Ex-Im performed functions that “government does not have to be involved in. The private sector can do it”. The Majority Leader went on to say that he thought the bank was symptomatic of one of the bigger faults of modern government, in which “hard-earned [taxpayer] money” went to enterprises that produced little, if any public benefit. McCarthy’s personal opposition means an uncertain future for the bank, as witnessed by his omission of the reauthorization bill from a list of legislative priorities for September.

Mr. McCarthy makes a good point. In an ideal economy, there would be no need for institutions such as the Export-Import Bank. Ideally, companies would rise and fall on their own merits and be able to freely market their goods across the world without significant obstacles. 

That said, we don’t live in an ideal economy.  In reality, global trade is still limited by national barriers to cross-border investment as well as various protection mechanisms. As such, it can be difficult for firms- U.S. or non-U.S.- to sell their products abroad. That’s why most major developed countries have institutions similar to Ex-Im, and support them to a far greater degree than the U.S. supports Ex-Im.

Indeed, most countries spend more than the U.S. on export credit authorizations, according to a recent report from the National Association of Manufacturers. Canada, with a GDP just 1/8th of our own, authorizes its Ex-Im equivalent to lend 338% more than Ex-Im. South Korea’s bank, with a GDP 1/10th of that of the U.S., lends 232% more than Ex-Im. Examining credit authorizations as a percentage of GDP paints an even more dire picture. The U.S. spends just 0.16% of its GDP on export credit authorizations- dead last among the countries surveyed, and even behind developing economies such as Brazil and Mexico.

Failing to reauthorize Ex-Im would needlessly handicap U.S. companies in their ability to market their products abroad, while not addressing the fact that most nations will continue to support their firms’ exports. Our future economic competitiveness depends on our firms having access to a full policy toolbox- and that toolbox, for good or ill, contains Ex-Im.

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Corporate Inversion. What's that?

03272012_Corp_Tax_Reform_article.jpgUpdated on August 5th

The tax reform debate has recently centered on “corporate inversions”, in which companies restructure and reorganize themselves overseas in a lower-tax jurisdiction while maintaining their everyday material operations within the United States. In essence, what was previously an American company is now technically a foreign corporation, while still doing the majority of its business in the United States. An increasing number of US companies are doing this in an effort to avoid US corporate tax, which is the highest in the developed world. Inversion is an increasingly popular option: the number of U.S. companies relocating abroad citing inversion as the primary motivation jumped from just 1% in 2011 to an astonishing 66% in 2014

But since this concept is one that confuses even the best of tax policy professionals, we’ll try to illustrate with a brief, slightly humorous example. 

Suppose that the Acme Corporation, the world’s foremost supplier of cartoon anvils, has finally decided that it no longer wishes to pay high American corporate tax. What could Acme do? Acme’s options to avoid American tax law are limited, given that we operate on a global, not a territorial, tax system that taxes income of American companies no matter where it is earned. 

To avoid this penalty, Acme needs to transform itself from being a U.S. company into a non-U.S. company. How does it do this? It does so through the acquisition of a foreign competitor-- let’s call it Wernham Hogg (the British Dunder Mifflin). By purchasing this firm, Acme can then reincorporate in the UK, and avoid paying U.S. taxes. Acme’s factories in the United States will remain, as will their workers, but it will pay British corporate tax rather than American.

While this practice sounds questionable, it’s perfectly permissible under current U.S. tax law. As long as at least 20% of the new firm’s stock is owned by shareholders who were not shareholders of the old American company, and the firm has at least 25% of its employees, sales, and assets abroad, the firm is considered foreign and is not subject to American tax law. 

As you might imagine, policymakers on both the left and the right have decried the practice. President Obama and congressional Democrats have denounced the practice as unfair “cherry-picking” of the rules, and have called for American firms to display more “economic patriotism”. Republicans, including Senator Orrin Hatch of Utah, agree that corporate inversion is a problem, but argue that it is symptomatic of larger faults with the tax system and insist that comprehensive tax reform is needed. Treasury Secretary Jacob Lew wrote an op-ed last week arguing that while comprehensive corporate tax reform is desirable and should be a top priority, action is needed immediately to stem the rising tide of corporate inversions. According to recent data from the Congressional Research Service, 47 American companies have reincorporated themselves abroad since 2003-- 18 more than reincorporated abroad in the preceding two decades.

Two legislative proposals have been offered to address the immediate problem. In May, Michigan Senator Carl Levin introduced the Stop Corporate Inversions Act of 2014, which would change the criteria for an inverted corporation. Under Sen. Levin’s legislation, an inverted corporation that has less than 50% of its stock owned by new foreign investors and has 25% or more of its employees, sales, or assets in the United States would continue to be treated as a domestic corporation for tax purposes. Estimates from the Joint Committee on Taxation contend that, if enacted, the Levin proposal would recover nearly $19.5 billion in lost tax revenue between 2015 and 2024. 

Supporting Levin’s effort, Illinois Senator Dick Durbin introduced the No Federal Contracts for Corporate Deserters Act this week, which would forbid inverted corporations from receiving federal contracts. Like the Levin bill, Durbin’s uses the same narrower criteria to define an inverted corporation, thus broadening the number of companies affected by the bill.

While these proposals take steps to deter companies from acquiring foreign companies to avoid US corporate taxes, what’s really needed is comprehensive tax reform that includes reforms to the corporate tax code; reforms that make US businesses more competitive globally will be the greatest deterrence to corporate inversion. 

 

Image source: Fiscal Times

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Infrastructure Investment Hits Another Pothole in Congress

Updated on August 4th

Last week, Americans breathed a sigh of relief after it appeared that Congress came to an agreement on the future of the Highway Trust Fund. The Senate announced that it would accept the basic concept of a short-term fix endorsed by the House Ways and Means Committee; a move supported by President Obama, who had originally called for a long-term solution, but nevertheless insisted that Congress act to avoid an imminent “disaster” from letting funding lapse. crumbling_infrastructure.jpgOnce more, it appeared that Congress had dodged a potential crisis and could now focus on addressing topics of great concern to Americans such as entitlement reform and tax reform. Well, we wish, anyway.

Unfortunately, partisan bickering between the House and Senate threatened the possibility of agreement on a  near-term solution. This time, Congress could not agree on how long the funding bill should last. As originally authored, the House bill called for funding to be extended through May 2015, whereas the Senate amended it to extend funding only through December. In this case, both sides have accused the other of manipulating the funding date for political gain. Senate Democrats maintain that House Republicans want to extend funding through next year to ensure that a potentially Republican-controlled Senate could draft a comprehensive fix, while House Republicans argue that Senate Democrats want a temporary measure so they can be assured of taking charge of any permanent solution. 

At this time, it’s not clear what will happen with the trust fund. The House voted to strip the amendments from the bill on Thursday afternoon, a move that the Senate then endorsed later that evening. While approval of the House bill does mean that the expected funding shortfall will be avoided, it nevertheless means that Congress will once again postpone the needed structural fixes to the Trust Fund's continually dwindling revenues.

It must be said, though, that a short-term fix is better than no fix it all. Had Congress not acted, state highway budgets would have faced cuts as high as 28% in the coming weeks and thus would have presented a major stumbling block to state governments trying to maintain the existing road network while building capacity for the future. This said, however, it is entirely likely that we will re-enact the same debate next May, when lawmakers will once again need to refill the fund.

Once more, Congress’s reluctance to tackle tough issues such as the future of the Highway Trust Fund means that their focus is on short-term solutions at the expense of long-term investment. While we are pleased that the imminent funding cut has been averted, we again lament Congress kicking the can on the larger debate about infrastructure funding. America’s infrastructure deficit won’t disappear because it is a political inconvenience; without action, it will continue to increase and place a tremendous handicap on future economic growth.

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CBO to Congress: Stop kicking the can!

kicking-the-can-down-the-road.jpgYesterday, the Congressional Budget Office released its 2014 Long-Term Budget Outlook, which outlines the consequences of continually kicking the can on fiscal policy reform. While CBO anticipates slowly decreasing deficits through 2018, CBO projects that, after 2018, increased spending on entitlements and higher interest rates on government debt will balloon the deficit to historically high levels. Deficits between 2015 and 2024 will thus total $7.6 trillion- a staggering total that will help boost the national debt to 78% of GDP by 2024. 

Extending its projections to 2039, CBO predicts that the nation’s fiscal position will severely deteriorate, but notes that the degree of deterioration depends on the projection used. To account for potentially different budgetary realities, CBO prepared two projections: one that is an extension of the current “baseline” projections, and another named the “Alternative Fiscal Scenario.”

What’s the difference between these two scenarios? The first is based on an extension of the agency’s projections for federal spending, debt, and deficits between 2014 and 2024, and assumes that current law will be followed. Following current law means that Congress would, for example, allow the projected 2015 spending cuts to occur; would let the yearly “doc fix” lapse, which would cut Medicare payments to doctors; and resist pressure to reauthorize “tax extenders”.. Under this scenario, CBO projects that the national debt will increase to 106% of GDP by 2039- a level not seen since 1946. 

However, this first scenario assumes that Congress will follow current law, rather than continue its status quo of last minute changes to fiscal policies. Given Congress’s frequent choice to avoid politically difficult subjects such as spending reductions, CBO considers it likely that Congress will change current law and thus continue to increase spending while decreasing revenues- hence the “alternative” scenario. Were this to happen, CBO predicts that the deficit would reach 183% of GDP by 2039- a level not seen in American history, and only matched internationally by troubled Greece and Japan.

In either event, current trends will continue to produce deficits and debt that will reach critically high levels in the next 25 years. CBO recommends policymakers pursue a mix of reforms to current federal spending as well as the tax code, improving the revenue stream while restraining spending growth. Critically, it urges Congress to implement these reforms sooner rather than later. If, for example, Congress wants to bring down the debt to 39% of GDP by 2039, it would need to increase revenues or reduce spending by 1.5% of GDP each year from 2015 on. However, if it does not take action until 2020, it will need to make adjustments to the tune of 3.2% per year, and, if it delays until 2025, by 4.3% per year. The message is clear: kicking the can won’t avoid the need for revenue increases, spending cuts, or a combination of the two. Kicking the can will simply increase the magnitude of reforms required in future years, placing a disproportionate burden on Millennials. 

CBO’s warnings reiterate our own. America is on an unsustainable fiscal path that will bring about a potential fiscal crisis and threaten our future economic growth and stability. Enacting reforms now will mean that the needed adjustments can be implemented gradually, thus lessening the impact on the larger economy and Americans’ pocketbooks. Delayed action, however, will place a sudden, sharp burden on Americans of all ages. 

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