Category Archives: syndication

Tax Rates and Entrepreneurship

By James Kwak

My friend and co-founder Marcus Ryu wrote an op-ed in the Times today. Here’s how it begins:

The tax cut framework recently put forward by President Trump relies on a central claim: that reducing taxes on corporations and wealthy individuals will open the wellsprings of entrepreneurship and investment, turbocharging job growth and the American economy. Were this premise true, reasonable people might countenance giving a vast majority of benefits to the very rich, as Mr. Trump’s plan does, in exchange for greater prosperity for all. But it’s not.

I don’t have a lot to add, since Marcus makes the case very well. I’ll just expand on two of his points. One is that lower tax rates do not actually encourage people to start companies. When we started our company in 2001, there were a lot of factors I considered: the risk of leaving a well-paying job in the middle of a recession; my simultaneous move across the country to a place without a lot of technology jobs; the difficulty of raising money from venture capital firms; the relatively large pool of talented developers looking for interesting jobs; the poor competition in the field we had chosen; the difficulty of saying “no” to Marcus; and so on. Tax rates weren’t on the list. As I like to say, I didn’t even know what the tax rate on capital gains (the one that matters for startup founders) was, so it’s hard to see how it could have had any effect on me.

The second point, which is only a bit more complicated, has to do with the impact of corporate tax rates on company behavior. One of the common arguments for a corporate tax cut is that it will encourage capital investment, which will create jobs. This happens, in theory, because a lower tax rate increases the after-tax value of corporate profits (technically speaking, expected future dividends) to shareholders. This means investors will pay more for the stock of what is otherwise the same corporation. For the most part, that just results in a one-time increase in the stock price in the secondary market, which has no direct impact on the company itself. The company only benefits if it issues new stock in a secondary offering, because it can raise a bit more cash for the same number of shares. As Marcus points out, however, a corporate tax cut can only increase investment if companies are actually having trouble raising capital, which has emphatically not been the case for the past several years. In other words, if we actually want to increase capital investment by U.S. corporations, lower tax rates are just about the last place where we should look. (Raising workers’ wages, to increase demand for the stuff those corporations sell, is probably a better place to start.)

I haven’t been writing about the Trump tax cut because (a) a bunch of personal reasons, (b) intellectually speaking, it’s like shooting fish in a barrel, and (c) lots of other people with much bigger audiences are doing it anyway. So please read what Marcus has to say.

A New Economic Vision, in 27 Words

By James Kwak

A couple of weeks ago I posted a 6,000-word essay laying out a new economic vision for the Democratic Party. It kind of vanished into the ether, although Stephen Metcalf was kind enough to say this:

So here it is, in 27 words:

All people need a few basic things:

  • An education
  • A job
  • A place to live
  • Health care
  • A decent retirement

Let’s make sure everyone has these things.

If you want more, there is always the long version.

The Importance of Fairness: A New Economic Vision for the Democratic Party

By James Kwak

A lot has been written recently about the direction of the Democratic Party. This is what I think.

I have been a Democrat my entire life. Today, the Democratic Party matters more than ever because it is the only organization currently capable, at least theoretically, of preventing the Republicans from turning the United States into a fully-fledged banana republic, ruled by and for a handful of billionaire families and corporate chieftains, with a stagnant economy and pre-modern levels of inequality. Yet I cannot find anything to disagree with in Senator Bernie Sanders’s assessment:

“The model the Democrats have followed for the last 10 to 20 years has been an ultimate failure. That’s just the objective evidence. We are taking on a right-wing extremist party whose agenda is opposed time after time and on issue after issue by the vast majority of the American people. Yet we have lost the White House, the U.S. House, the U.S. Senate, almost two-thirds of the governors’ chairs and close to 900 legislative seats across this country. How can anyone not conclude that the Democratic agenda and approach has been a failure?”

A central shortcoming of the party is that, on economic issues, it has nothing to say to people trapped on the wrong side of our country’s growing inequality divide. Hillary Clinton won the “working class” (household income less than $50,000) vote, but by a much smaller margin than Barack Obama in 2012 or 2008—despite Donald Trump’s ardent efforts to alienate African-Americans and Latinos. Some people voted for Trump because of racism or misogyny. But Clinton was also flattened by Trump among voters who feel their financial situation was worse than a year before or who think that life will be worse for the next generation. She lost the Electoral College in the “rust belt” states of the Upper Midwest, whose economies have never fully recovered from the decline of American manufacturing.

The Democratic Party was once the party of working people. So why is it increasingly becoming the party of well-educated, socially tolerant, cosmopolitan city-dwellers? Because, in an age of stagnant median incomes and a disintegrating social safety net, Democrats have no economic message for the many people who are struggling to make ends meet, to pay for college, to stay in a home, or to save for retirement.

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Economism and Arbitration Clauses

By James Kwak

As banking scandals go, Wells Fargo opening millions of new accounts for existing customers so that it could pump up its cross-selling metrics for investors is about as clear-cut as it gets. It’s up there with HSBC telling its employees how to get around U.S. regulations in order to launder money for drug cartels, or traders and treasury officials at several banks conspiring to fix LIBOR.

Holding Wells responsible, however, was a bit trickier. The bank agreed to restitution (i.e, refunding the fees it had collected from its customers for the phony accounts) and a paltry $185 million in fines. When customers sued for damages, however, Wells hid behind its mandatory arbitration clauses, which were so broadly written that they even applied to accounts that the customer never intended to exist and that the bank had fraudulently created. Wells eventually reached a settlement with the class of plaintiff customers, but the settlement amount was no doubt influenced by the bank’s ability to compel arbitration.

The Consumer Financial Protection Bureau has proposed to eliminate the Wells Fargo defense by prohibiting class action waivers—clauses that take away customers’ right to participate in class action lawsuits—in arbitration clauses of financial contracts. (Class actions are crucial to deterring and punishing systematic fraud against consumers, because the harm to any single person will not be worth the expense of pursuing a lawsuit; without a class action, no one will sue, and the company will escape unharmed.)

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How Markets Work

By James Kwak

The Congressional Budget Office’s assessment of the Republican health care plan, as passed in the House, is out. The bottom line is that many more people will lack health coverage than under current law—23 million by 2026—even though the bill allows states to relax the essential health benefits package, which should in theory attract younger, healthier people. This is not a surprise.

I just want to comment on the role of markets in all of this, which I think is not fully understood. For example, the Times article by the very up-to-speed Margot Sanger-Katz explains that the American Health Care Act of 2017 will make markets “dysfunctional.”

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This is consistent with the rosy view that many people, particularly centrist Democrats, have of health care: if we could only get markets to behave properly (correct for market failures, to use the jargon), everything would be great.

But that’s not how markets work.

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Fees Add Up

By James Kwak

Public pension funds are having a tough time. On the one hand, the average funding ratio (assets as a percentage of the present value of future obligations) is below 80% because of inadequate contributions by sponsors (states and municipalities) and poor investment returns since the collapse of the technology bubble in 2000. On the other hand, because pensions responded to low returns by shifting more of their money into hedge funds and private equity funds, a larger proportion of their assets is siphoned off as investment fees each year.

Unlike some people, I am not against hedge funds and private equity funds in principle. I think it’s highly likely that there are people who can beat the market on a sustained basis—particularly if they are people who are especially good with computers—both for theoretical reasons (someone has to be the first person to discover each relevant piece of information or actionable pattern) and empirical reasons (see Fama and French 2010, for example). Hedge funds have lagged the stock market in recent years, but what critics sometimes overlook is that they are supposed to trail the market in boom periods, because many target a beta of around 0.5. But I am mystified by the fact that, in what is supposed to be a highly competitive and innovative industry, the price of investing in a hedge fund has stayed virtually fixed at 2-and-20 (2% of assets, plus 20% of investment returns) for decades.

The consequences of these high prices are added up in The Big Squeeze, a new report sponsored by the American Federation of Teachers. Because true investment fees are usually not disclosed—fund managers insist that they are confidential and require investors not to divulge them—the report simply quantifies the potential savings from reducing fees from 1.8-and-18 to 0.9-and-9. This may seem arbitrary, but I know anecdotally that some funds, even big ones, are charging something like 1-and-10 even to ordinary investors. Since state pension funds are some of the biggest investors that exist, you would think they would be able to negotiate even lower fees.

Not surprisingly, the numbers involved add up quickly. Lower fees over the past five years would have saved the average pension fund included in the study $1.6 billion; to put things in perspective, it would have improved the aggregate funding ratio for these funds by more than two percentage points, which is nothing to sneeze at.

The important question is why high fees persist despite the potential market power of big pension funds. There are probably multiple explanations. One is a culture of secrecy, which makes it difficult for any fund to find out what other funds are paying. Another is the marketing prowess of fund managers, who are adept at explaining when their fund is unlike any other in the world and therefore merits its high fees. A third is that pension fund managers are playing with other people’s money (in this case, the other people are the fund’s beneficiaries—teachers, firefighters, and other government employees)—and may be more interested in ingratiating themselves with the asset management industry than with getting the best deal they can. (This is even more likely the case for the investment consultants who match pension funds with asset managers.) But in a political climate that makes tax increases on rich fund managers unlikely, state governments could achieve the same results by taking a harder line on investment management fees: requiring public disclosure of all fees or even imposing hard fee caps for pension fund investments. With the amount of money involved, it’s hard to imagine that major pension funds couldn’t find anyone competent to take their money for 0.9-and-9.

Soak the Poor, Feed the Rich

By James Kwak

After the dangerous clown show that has been the Trump White House, it’s comforting to return to some good, old-fashioned conservative policymaking: bashing the poor to cut taxes on the rich. I’m talking, of course, about the Republican plan to repeal and replace Obamacare.

Health care financing can sometimes seem like a complicated topic. Adverse selection, risk adjustment, blah blah blah. But it’s easy to understand the American Health Care Act or, as it is sure to be known, Trumpcare. In the medium term, financing policies have little effect on the price of health care. At most we can hope to “bend the [long-term] cost curve.” So health care policy essentially comes down to a single question: Who pays?

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