Goldman Sachs, Income Taxes, and Transfer Pricing

Bloomberg reports:

Goldman Sachs Group Inc., which got $10 billion and debt guarantees from the U.S. government in October, expects to pay $14 million in taxes worldwide for 2008 compared with $6 billion in 2007. The company’s effective income tax rate dropped to 1 percent from 34.1 percent … The rate decline looks “a little extreme,” said Robert Willens, president and chief executive officer of tax and accounting advisory firm Robert Willens LLC. “I was definitely taken aback,” Willens said. “Clearly they have taken steps to ensure that a lot of their income is earned in lower-tax jurisdictions.” U.S. Representative Lloyd Doggett, a Texas Democrat who serves on the tax-writing House Ways and Means Committee, said steps by Goldman Sachs and other banks shifting income to countries with lower taxes is cause for concern.

There may be lots of reasons for the drop in the effective tax rate but the most recent 10-Q filing for Goldman Sachs admits the following:

The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. During fiscal 2007, the IRS substantially concluded its examination of fiscal years 2003 and 2004. Tax audits that have been substantially concluded in other jurisdictions in which the firm has significant business operations include New York State’s examination of fiscal years through 2003, the United Kingdom’s review of fiscal years through 2003 and Hong Kong’s review of fiscal years through 2001. The firm does not expect that potential additional assessments from these examinations will be material to its results of operations … The effective income tax rate for the first half of 2008 was 27.7%, down from 29.5% for the first quarter of 2008 and 34.1% for fiscal year 2007. The decreases in the effective tax rate were primarily due to changes in geographic earnings mix.

In other words, less taxable income has been declared in high tax areas such as the US, Japan, and the UK. I wonder if the IRS Examination will scrutinize the transfer pricing policy for this company which recently received debt guarantees from the U.S. government.

Deflation

David Goldman reports:

The Consumer Price Index, a key inflation reading, fell 1.7% last month, according to the Labor Department. That was much weaker than October's 1% drop and exceeded the 1.3% decline forecast by a consensus of economists surveyed by Briefing.com. Prices fell by the greatest amount since the Department of Labor began publishing seasonally adjusted changes in February 1947. Though falling prices may seem like a good thing for consumers, deflation is generally bad for the economy. If prices fall below the cost it takes to produce products, businesses will likely be forced to cut production and slash payrolls. Rising unemployment would cut demand even further, sending the economy into a vicious circle. Deflation usually represents a system-wide contraction in demand, with consumers waiting on the sidelines as they wait for prices to decline even further. Economists expect more drops in consumer prices for several months, but most say deflation is still a long way off. Deflation usually represents large, sustained drops in consumer prices, but so far the economy has only recorded two consecutive declines. "It's a bit premature to say we're in a period of deflation," said Anika Khan, economist at Wachovia. "We've had two months of record declines, [and] deflation may be a far-off worry if that continues."

Is it really premature to worry about deflation? Then why is the yield on inflation indexed government bonds for 5-year and 7-year maturities higher than the yield on their nominal counterparts?

Kudlow on Corker’s Plan to Save GM

Forgive me but I did a silly thing this morning – I ventured over to read what the National Review was saying about the automobile bailout controversy. Is Lawrence Kudlow guilty of more mendacity or stupidity or both:

“Who lost the U.S. car business?” Right after the UAW vetoed a compromise, bankruptcy-lite, Detroit-little-three rescue plan put together by Tennessee Republican Bob Corker, UAW president Ron Gettelfinger played the blame game by blasting Corker and the Republican party for “singling out” union workers to shoulder the burden of reviving the U.S. car business. In truth, the UAW is to blame. If Sen. Corker’s plan had prevailed, with UAW support, many believe it would have had 90 votes in the Senate. GM could have gone forward with a clean-as-a-whistle balance sheet under a three-part restructuring plan that included a $60 billion bond-refinancing cram-down, a renegotiation of the $30 billion VEBA health-care trust, and a pay-restructuring plan that would put Detroit compensation levels in line with those of foreign transplants Honda, Toyota, Nissan, and BMW. Average compensation for the Detroit little three is $72.31. Toyota’s average wage is $47.60, Honda’s is $42.05, and Nissan’s is $41.97, for an average of $44.20. So Corker’s idea was to bring that $72 a lot closer to that $44.

Kudlow should know by now that this $72 an hour compensation claim is a crock. Count this claim as mendacity. But 90 votes in the Senate for Corker’s plan – that is off the charts! As far as a clean-as-a-whistle balance sheet, doesn’t Kudlow know how to read a balance sheet with GM’s showing about $170 billion in liabilities exceeding the book value of its assets by about $60 billion.

The ultimate whopper in this Kudlow canard was that Corker was trying to negotiate in good faith while the “UAW refused to make concessions”. If I were a conservative, I’d be completely embarrassed with the serial garbage that gets published under the name The National Review.

The concept of illegal and illegitimate debt

Last month a special debt audit commission in Ecuador released a report charging that much of that nation's foreign debt was illegitimate or illegal. "The commission evaluated all commercial, multilateral, government-to-government and domestic debt from 1976-2006".

Perhaps the most critical element of this commission's ruling is the charge that Paul Volker's decision to hike US interest rates to extraordinary and unprecedented levels in the late 1970s [1] constituted a "unilateral" increase in global rates that compounded Ecuador's indebtedness.

The loans to Ecuador, according to John Perkins in his 2004 book 'Confessions of an Economic Hit Man' were denominated in US dollars and designed from the outset to "to foment conditions that make [Ecuador] subservient to the corporatocracy running our biggest corporations, our government, and our banks." The conditions of the infrastructure loans were that "engineering and construction companies from our own country must build all these projects. In essence, most of the money never leaves the United States; it is simply transferred from banking offices in Washington to engineering offices in New York, Houston, or San Francisco." [2]

How legitimate can it be for, on the one hand, political leaders to be accepting loans on terms that leave their nations economically vulnerable, and on the other for the US to have the power to 'unilaterally' and unjustly increase loan liabilities for the world's poorest (and other) nations?

The long-term outcomes of such an international lending regimes have been disastrous. Since 1970 – in the period known as the ‘oil boom’ in Ecuador the official poverty level grew from 50 to 70 percent and under or unemployment increased from 15 to 70 percent. Public debt increased from $240 million to $16 billion. At the same time "Vast areas of rain forest have fallen, macaws and jaguars have all but vanished, three Ecuadorian indigenous cultures have been driven to the verge of collapse, and pristine rivers have been transformed into flaming cesspools."[3]

Ecuador's use of legitimacy as a legal argument for defaulting on their loans sets a major precedent in international finance and the global economy. "Indeed, the mere formation of a debt auditing commission does so." [4] There is no doubting, however, that the rapidly increasing poverty and hunger along with the dire state of the world's living environment means attention to the impacts of unreasonable and unjust debt regimes is long overdue.



[1] Paul Volker was then chairman of the US Federal Reserve.
[2] Confessions of an Economic Hit Man by John Perkins
Plume, 2005, paperback, 280 pp.,
http://www.ecobooks.com/books/ecohitman.htm
[3]Confessions of an Economic Hit Man by John Perkins
Plume, 2005, paperback, 280 pp.,
http://www.ecobooks.com/books/ecohitman.htm

As Crisis Mounts, Ecuador Declares Foreign Debt Illegitimate and Illegal
By Daniel Denvir, AlterNet. Posted November 26, 2008.
http://www.alternet.org/audits/108769/as_crisis_mounts,_ecuador_declares_foreign_debt_illegitimate_and_illegal/

Shock Doctrine in California

California is undergoing its own shock treatment. The Republicans are a minority, but they have enough votes to block the supermajority required to pass a budget. They have all signed a no tax pledge. They have a plan to balance the budget without taxes, by drastically cutting spending and destroying environmental and labor protections, such as giving employers flexibility to demand as much work for as many hours without overtime pay on any single day, so long as the number of hours does not exceed 40.

http://sacbee.com/topstories/story/1475895.html

Labor Shortage Among Immigrant Workers?

TalkingPointsMemo points us to an interesting article by Miriam Jordan:

The economic downturn is forcing tens of thousands of Hispanic immigrants to withdraw from the U.S. labor market, according to a new study, a development that suggests the migrants are facing unprecedented competition for blue-collar jobs that may prompt them to return to their countries of origin. In the third quarter of 2008, 71.3% of Latino immigrant workers were either employed or actively seeking work compared with 72.4% in the same quarter a year earlier, according to a new study by the Pew Hispanic Center, a non-partisan research organization. The 1.1 percentage point drop "marks a substantial decrease in the labor market participation of Latino immigrants," says Rakesh Kochhar, the Pew economist who prepared the report ... During the economic boom, immigrants entered the U.S. at the rate of more than one million each year. Last year, however, the country's foreign-born population grew by just half that, or about 500,000. Latin American workers bore the brunt of the collapse of the construction sector, which employs 20% to 30% all foreign-born Hispanics. As the housing market tumbled last year, they lost jobs in ever-greater numbers

.

I have one small nitpick – TPMs lead was “Study: Labor Shortage Driving Immigrants Out Of the Labor Market”. Jordan was clearly describing a labor market with excess supply – not excess demand. The folks over at TPM are smart enough to know the difference so I trust they will properly adjust their lead.

The report can be found here and notes that the decline in this group’s employment-population ratio was even greater as their measured unemployment rate rose.

Drop in Housing Values and Consumption Demand

CNNMoney reports:

American homeowners will collectively lose more than $2 trillion in home value by the end of 2008, according to a report released Monday. The real estate Web site Zillow.com calculated that home values have dropped 8.4% year-over-year during the first three quarters of 2008, compared with the same period of 2007.

Life-cycle models of consumption tend to suggest that a drop in wealth would lead to a decline in consumption. If one assumed that each $1 decline in wealth leads to a $0.05 decline in consumption, this $2 trillion estimated decline would mean a $100 billion decline in consumption. Real consumption (all figures 2000$) declined by almost $80 billion on an annualized basis last quarter. Since 2006QIV, consumption has increased by only $142.2 billion per year even though real GDP increased by $355.9 billion. Had the ratio of consumption to GDP remained at its 2006QIV level of 71.5 percent, we would be seeing an additional $112 billion in consumption demand.

Maybe a rise in savings might be seen as a good thing if investment demand were also rising, but currently the fall in investment demand is so large that it is largely wiping out the progress in export demand. As private consumption declines, we will need a boost from government purchases if we are to avoid what Keynes called the paradox of thrift.

Speaking of the paradox of thrift – check out this cartoon with hat tip to an Angrybear.

Stupidity, Cowardice, Stimulus

by the Sandwichman

In his "Tour of German Inflation" (in One-Way Street), Walter Benjamin singled out the expression, "things can't go on like this" as exemplifying the "stupidity and cowardice constituting the mode of life of the German bourgeois". Embedded in the expression is the unfounded conviction that, somehow or other, unpleasant conditions cannot be enduring ones. However, as Benjamin noted, "to decline is no less stable, no more surprising, than to rise."

Yesterday, in the New York Times, nine economists weighed in on what, in their opinion, would constitute the ideal stimulus package, given the constraints of a $500 billion total to be either spent, returned in tax cuts or some combination of the two. Of course, the underlying premise of any stimulus package is the growthodox conviction that "things can't go on like this" -- that the accustomed "economic growth" of the recent past should be the norm and interruption of that growth can only be an anomaly.

Get over it, suckers. Bernie Madoff had the economic stimulus package meme down pat. Madoff's estimated $50 billion Ponzi scheme was already 10% of the proposed $500 billion package. O.K., then, in twenty five words or less, what's the difference between a stimulus package and a Ponzi scheme (bearing in mind the operative concept, "German Inflation"; see also "Uh Oh...")?

GM, Chrysler and the Recovery Program

Time to shift frames on the auto bailout. The question lurking behind current thinking is “How can these companies make money again producing and selling cars?” This explains the obsession with labor costs, future product lines and the like. The short answer is probably, they can’t. Even if they do everything right from now on, a steadily shrinking car market is the logical implication of serious, grown-up carbon regulation. (I will post on that topic soon, focusing on the news from Europe.)

For an alternative, step back into history and consider the story of Lucas Aerospace, brilliantly chronicled by Hilary Wainwright and David Elliott in The Lucas Plan: A New Trade Unionism in the Making? Lucas made military aircraft and was facing devastating (but socially desirable) cuts in demand for their wares. Seeing the handwriting on the wall, production workers teamed up with engineers and conducted a detailed inventory of their firm’s capacity: what skills and resources they comprised. Then they canvassed a range of nonprofit organizations to find out what kinds of products served important social needs but were not being provided in the market, like improved prosthetic devices and equipment for upgrading railroad crossings. Putting two and two together, they proposed production plans to give the company a new lease on life. The final piece, however, never materialized. The social agencies needed the government to allocate funds for these new products, but the government didn’t come through, and Lucas eventually folded.

You can probably see where I’m going with this. Obama is proposing to spend hundreds of billions of dollars on public projects to restart the economy, and forward-thinking observers, like Jamie Galbraith, are pointing out that we need long-term restructuring, not just a quick burst of stimulus. Who will build the transit systems, smart two-way electrical grids and other components of a clean, green America? If the auto companies are liquidated, we lose a ton of capacity it will be difficult and expensive to replace.

Message to the Obama team: begin formulating the reconstruction plan as a set of receivables and be ready to energize producers from the outset, perhaps with contracts having a loan component.

Message to the UAW and progressive-minded professionals in the auto industry: don’t wait for your top management to shuck the business plans they’ve staked their careers on. Begin a Lucas-like process of discovering what you can produce, and convey this directly to the federal recovery folks.

Senate Republicans First Shot Against Organized Labor

Countdown discussed a memo entitled "Action Alert - Auto Bailout," which was sent to Senate Republicans Wednesday morning and states:

This is the democrats first opportunity to payoff organized labor after the election. This is a precursor to card check and other items. Republicans should stand firm and take their first shot against organized labor, instead of taking their first blow from it. This rush to judgment is the same thing that happened with the TARP. Members did not have an opportunity to read or digest the legislation and therefore could not understand the consequences of it. We should not rush to pass this because Detroit says the sky is falling.

But didn’t many of the same Senate Republicans who filibustered the auto bailout bill vote for TARP? Jonathan Chait notes a little irony in how these Senate Republicans played their hand:

if the White House follows through on its suggestion that it might use TARP funds to stave off bankruptcy, the GOP maneuver will have been a total disaster. Remember, the Republicans have leverage because they still have 49 Senate seats and the auto companies need their loans right away.And, indeed, Republicans have used their leverage to force wage concessions and not force the auto companies to start producing low-emissions vehicles. But if they've overplayed their hand to the point where the White House floats a loan until January, then the GOP's leverage will nearly collapse. When the new Senate and White House convene, the Democrats will cut a much better deal for themselves, with fewer or no wage cuts for workers and tougher environmental standards.

In other words, their ploy may have failed and now we know their true motivations was to let millions of workers lose their jobs for raw partisan purposes.

Uh Oh, Is the Dollar About to Collapse?

So, recently here Peter Dorman and I were commiserating over having largely called most of the current crises, only to fail to have seen the surge of the dollar as people "flew to quality," leading ultimately to the absurdity of negative yields on 90 day Treasury bills just a few days ago. A number of other commentators also have been beating themselves over the head for failing to foresee the dollar's strength (Brad DeLong and Arnold Kling, among others), although none of them were as prescient on other matters as Peter and me (ooh, ooh, such self-puffery).

However, in the last two days the euro to dollar rate has gone from about 1.27 to 1.33. Does this mean that the other shoe is about to drop, and that the world is about to become fed up with the dollar and run for their lives in the face of our ongoing massive current account deficit and historically unprecedented net foreign indebtedness, not to mention so much other baloney?

Senate’s Failure to Pass Automobile Bailout

As David Herszenhorn report this sad news, I have a few questions:

The Senate on Thursday night abandoned efforts to fashion a government rescue of the American automobile industry, as Senate Republicans refused to support a bill endorsed by the White House and Congressional Democrats ... So far, the Federal Reserve also has shown no willingness to step in to aid the auto industry, but Democrats have argued that it has the authority to do so and some said the central bank may have no choice but to prevent the automakers from bankruptcy proceedings that could have ruinous ripple effects … the Senate failed to win the 60 votes need to bring up the auto rescue plan for consideration. The Senate voted 52 to 35 with 10 Republicans joining 40 Democrats and 2 independents in favor ... The automakers would also have been required to cut wages and benefits to match the average hourly wage and benefits of Nissan, Toyota and Honda employees in the United States.

First of all – if only 40 Democrats voted for cloture, where were the other guys? Secondly, what is it that the Federal Reserve might do to keep the Big 3 alive until we have a new Congress and White House? Finally, when Mitch McConnell says he wants the UAW to eliminate their gap between their hourly compensation and that of those US employees of the Japanese car manufacturers, does he still (mistakenly) think that their current compensation is over $70 an hour?

Hilzoy suggests that the behavior of McConnell and his minions is not responsible. It is certainly true that some of their arguments against this bailout proposal have been dishonest.

Preemptive Coverup on Wall Street

The Wall Street Journal reported today that securities firms have a claw back clause that allows them to call back bonuses from people whose screw ups turn out to cost the company big bucks. ok. But Morgan Stanley's contract includes "reputational harm": which sounds like it would include people who tell tales out of school:

Grounds for invoking the provision include "the need for a restatement of results, a significant financial loss or other reputational harm to the Firm or one of its businesses," the memo said. Morgan Stanley's rule applies to 2008 bonuses and cash payouts vesting over a three-year period. The roughly 7,000 employees covered by the policy range from top brass to midlevel workers.

Patterson, Scott. 2008. "Securities Firms Claw Back at Failed Bets." Wall Street Journal (10 December).

Walking Backward into the Future...

by the Sandwichman

For a while in the 1990s I used a quote from a book review by Canada's new Liberal leader, Michael Ignatieff, in my signature file: "Only in mediocre art does life unfold as fate." As fate would have it, 12 years later I can now Google search the phrase and come up with 70 or so of my own musings from a decade ago. I was only able to find the originl source of the quote, "The Illusion of Fate" in the February 13, 1995 New Republic, by truncating the phrase.

Side-shadowing speaks to the contingent and haphazard way our lives unfold. This contingency leaves us with a haunted sense of lives that we might have lived, choices that we might have had good reason to make. Only in mediocre art does life unfold as fate. Yet all of us yearn, in Bernstein's words, for the possibility that our biography "will be revealed as destiny," and that "the life we ended up having was, from the outset, actually the only possible one." This is what makes us suckers for bad books.

Earlier in his review -- commenting on the demise of the "grand narratives" of Marx, Freud, Weber, Durkheim, etc. -- Ignatieff observed that the passing of those commanding theories "leaves us in a curious state of intellectual denudation. For theories of the past are always maps of a possible future. Now we are walking backward into the future, and without maps."

I wonder if Ignatieff will now, as Liberal leader, advocate a "contingent and haphazard" party program.

On Krugman's Nobel Prize Speech

One can access Paul Krugman's Nobel Prize speech at http://nobelprize.org/mediaplayer/index.php?=1072. In it he gives a pretty clear description of the new trade and new economic geography approaches, with some interesting discussion of how this fits with the broad history of urbanization in the US. Unsurprisingly he once again fails to cite important predecessors of these ideas, with him basically deserving credit for linking them and doing a good job of publicizing them with his clear models. The two names not mentioned that most deserved to be were Avinash Dixit, co-developer of the Dixit-Stiglitz model that is the key to "Krugman's" theories, with Krugman briefly noting that the theory ultimately came from industrial organization. The other was the first person to apply the Dixit-Stiglitz model to economic geography, who would be Masahisa Fujita, 1988, "A monopolistic competition model of spatial agglomeration: a differentiated product approach," Regional Science and Urban Economics, vol. 18, pp. 87-13124. Krugman is a better writer than the Japanese Fujita, but Fujita has done far more innovative work in this area than Krugman ever did, which I think Krugman knows as he later coauthored with Fujita, even as he did not cite him in his much cited 1991 paper in the JPE that used the same approach as Fujita. Having Dixit and Fujita share the prize with Krugman would have been appropriate and also given the prize to someone from East Asia for the first time. I hope that Krugman finally gets it right for the written version of his speecch and cites the even longer list than this of people who preceded him and deserve recognition for it by him. The model here is Stiglitz, whose reference list for his Nobel Prize speech paper goes on for 13 pages in the AER.

As for his remarks on the auto industry in Detroit, in the end his only explanation is that wages and medical care costs are too high in Detroit compared to the Deep South (no mention of legacy pension costs). Supposedly he was going to explain the problems of the auto industry in Detroit by his theory, which supposedly explains "agglomeration," but he made no reference to his theory other than a vague statement that economies of scale are declining, which supposedly has been going on since about 1965, according to him. However, how or why they have been declining was not explained by him. This rather puts to shame his bragging that he has explained "agglomeration," in contrast to all those pathetic people prior to him, whom he assiduously avoids citing, except for a couple of ancient scribes who used no math, so he can present himself as the great savior who uses math to lead us all to enlightenment regarding these important matters. If Detroit arose because of the factors laid out in his model, he does not say how this happened nor how they stopped holding so that Detroit is now doomed. Blaming high wage and medical care costs amounts to nothing more than de facto union bashing with no link to any version of his model discernible at all. A pretty pathetic performance all in all, especially after he went after Brian Arthur some years ago in Slate for supposedly overselling his role in describing increasing returns, which took Kenneth Arrow to come in and defend Arthur, noting that he, unlike Krugman, actually cited his appropriate predecessors.