Negative interest rates are on the table

Just two months ago the Federal Reserve (the Fed) hiked the short-term interest rate it controls. The quarter-point increase was the first in nine years after efforts to pump up economic growth by keeping the rate close to zero. Now several members of the Fed are talking about reversing themselves and moving interest rates into negative territory.

It’s not such a far-fetched idea. Sweden, Denmark, Switzerland, Japan and the European Central Bank have introduced negative interest rates. It’s the latest toy in the world of monetary policy, where the economy is seen as an automobile and interest rates are the gas pedal.

When Fed Chair Janet Yellen delivered her semiannual testimony before Congress last week, she said the Fed has not fully researched the issue of charging banks to hold their excess reserves. But the plot took a sinister twist when it was disclosed that the Fed asked banks to consider the impact of negative interest rates during the latest round of bank stress tests.

Under a negative interest rate policy, banks are charged to park their cash with the central bank. The hope is that this will encourage banks to stop hoarding money and instead lend to consumers and businesses to accelerate economic growth.

No one knows if negative interest rates would work in the U.S.; the Fed has never tried them. Fully identifying their impact is very complicated, but we know how the story will play out for the average Joe. If the Fed charges banks for excess deposits, the banks will in turn charge customers for depositing money.

Still further, just because the interest rate is negative does not mean a bank will pay you interest (rather than the other way around) when you pay back a loan. The average customer will not get paid to take out a loan, not now, not ever, never.

Negative interest rates effectively charge the customer for deposits, discourage saving and encourage spending. Forget about saving for retirement and a child’s education; this policy is designed to grow the economy by coercing people to spend. Of course, the customer can at least be held harmless by holding cash and earning a zero percent nominal return.

The Fed has effectively punished the millions of American who rely on their savings to get by. Safe options such as savings accounts, certificates of deposit and treasury bonds offer pitiful returns forcing many people to dig into their principle to make ends meet. Under negative interest rates, the longer funds are on deposit the less money is available for withdrawal as banks charge to hold the money. Also, if people are unable to retire, many will either remain in or re-enter the labor force, thereby competing with younger workers for jobs or risk their savings by putting money in risky investments.

Crazy as it sounds, this may be the new normal. Remember that when the Fed thought they could not cut the interest rate any more, they engaged in quantitative easing: basically creating money out of thin air and releasing it into the economy, mainly by buying bank debt securities.

Bargain-basement interest rates and flooding the system with trillions of dollars in cheap money has produced sharp stock market gains -though even that has ended in recent months – and enabled corporations to buy back their own shares and pursue mergers and acquisitions instead of expanding production and creating jobs. It’s time for the public to ask what we have to show for these aggressive and addictive monetary policies that are a misallocation of resources and contribute to income inequality by shifting wealth to asset owners.

Monetary policy does not make for good presidential debate sound bites, but the time is long overdue for candidates to engage on the issue of federal monetary policy and how it has contributed to income inequality.

originally published: February 20, 2016

How do we keep U.S. companies at home?

Last month Milwaukee-based Johnson Controls became the latest American firm to move overseas in pursuit of tax savings. Politicians of all stripes decry these moves, but they have radically different ideas about what to do about them.

Johnson Controls is renouncing its US corporate citizenship by selling itself to Tyco International, domiciled in Ireland, in a deal valued at $14 billion. The move, called a corporate inversion, is the restructuring of an American company’s corporate form such that it becomes a foreign corporation based in a country with low corporate taxes. It is legal and has become a popular way for American companies to reduce their domestic tax payments.

By moving its headquarters to Ireland, Johnson Controls will pay a corporate tax rate of 12.5 percent and reduce its tax bill by at least $150 million annually. About 50 companies have inverted in the past decade and more are expected to vote with their feet.

These deals allegedly reflect the United States’ failure to change the corporate tax code to make it more attractive for American companies to stay that way. The statutory corporate tax rate of 35 percent (39.1 percent when combined with state rates) is unchanged since 1993 and is the highest among industrialized countries.

The federal government taxes all companies doing business in the U.S. on the income they earn here. It also taxes American firms on their foreign income. This is called a worldwide income tax system. Many countries only tax income generated inside their borders. Because they tax their residents (regardless of citizenship) only on domestic income, such countries are said to use a territorial income tax system.

America is now alone among developed countries in taxing the worldwide income of its corporations. This is in addition to the taxes they pay to foreign governments, but American firms are permitted to avoid double taxation by claiming credits for foreign tax payments.

American companies are also permitted to defer domestic tax liabilities on certain unrepatriated foreign profits until they actually receive such profits in the form of dividends. It is estimated that U.S. firms are keeping roughly $2 trillion in profits abroad to reduce their taxes. If an American citizen tried to play the same game of hide and seek, he or she would be in big trouble with the Internal Revenue Service.

When it comes to arguments in support of lowering the corporate rate, cheerleaders never tire of telling the public that American companies can’t compete in a global economy when they are handicapped by the highest corporate tax rate in the developed world. They argue that a significant reduction in the corporate tax rate would improve America’s competitive position, stem the tide of companies leaving the country and perhaps even reverse it by giving foreign corporations an incentive to locate and invest in the U.S.

Overlooked in these arguments is the fact that while on paper American companies are supposed to pay the 35 percent federal income tax rate, the country’s most successful companies pay at just a 19.4 percent rate after accounting for tax credits, deductions and exemptions, according to the Citizens for Tax Justice. If true, this certainly undermines the primary argument for reducing the corporate tax rate.

Neither Democrats nor Republicans like inversions, but they disagree on what to do about them. The former see the issue as one of corporate abuse and want strong rules to stop the exodus of tax dollars; the latter see it as the result of high corporate tax rates and argue for an overhaul of the corporate tax code.

As with so many issues today, you would be right to conclude that achieving consensus on how to halt corporate inversions is the equivalent of cleaning out the Augean stables with the horses still in them.

originally published: February 2, 2016