The Reverse Robin Hood Effect Of The Trump Tax Cuts
In his best-selling book Capitalism in the 21st Century, Thomas Piketty sparked debate about the ever-increasing income gap. Political analysts have identified this gap as fuelling the voter contempt for the 1%, Wall Street, and politicians who bend to the will of corporations. Solving the income gap is one of the keys to winning elections, and Trump recognized that. Aside from his demagoguery and race-baiting rhetoric, Trump claimed that he would raise taxes on the rich throughout his campaign. As we’ve seen, his actions as President have not matched his words.
When we look at Piketty’s chart below, we see that the income gap began its rise with the first Mr. Make-America-Great-Again, and the former chief evangelist of tax cuts, Ronald Reagan (1981–1989).
Piketty’s chart goes up only to 2010, but other research has confirmed the same trend projects to the present.
Louis Woodhill writing in Forbes noted:
“Things got better for everyone during this period, but quite unequally. The incomes of “the ninety percent” rose by about 17%, while those of “the ten percent” shot up by 106%.”
In spite of the trickle up effect of tax cuts, the corporate elite and their sympathetic economists propagate the fake news that this time will be different. In this article, we’ll get to why the economists can’t see what the average American worker can see, and the mechanisms that enable the transfer of the benefits of the tax cuts to the 1%.
A Tide That Raises Only Yachts
Reagan’s tax cuts kicked up both the GDP and income inequality. Notice in the first graph that income inequality had dropped after the Great Depression until those Reagan years. The right policies can end income inequality. It was done then and can be done again.
Unexpectedly, income inequality sharply accelerated in the great deregulation era under Clinton (1993–2001). To be fair to Clinton, like all politicians, he depended on economists for these types of policies. All of the economists of influence, especially then Fed Chair Alan Greenspan (a Reagan appointment), believed that the markets would regulate themselves. The Democrats listened and loosened government control on the banks by revoking Glass-Steagall.
The widening of the gap continued through the W. Bush years (2001–2009) and even under Obama (2009–2017) who had pledged to reduce it. If Obama couldn’t do it, what is going on?
It is reliance on the GDP and unemployment stats as measures of success.
Economists are fixated on these as signs of a healthy economy. As long as the GDP is a positive number and unemployment a low one, we’re all good, they say. Under the Reagan tax cuts, GDP increased, therefore economists reason, tax cuts are good for America.
Similarly, if the unemployment rate is low, then all is good in America. Yet look at the next chart which shows dramatically falling unemployment rates under Obama. The unemployment curve took a steady drop from 10 % to below 5%.
In spite of this supposedly beneficial reduction of unemployment, so many salaried workers felt abandoned by traditional politicians.
Why? Because data on charts like these don’t always reflect what is actually going on in the real world. Economists are misled by these statistical criteria, politicians who rely on advice from economists are misled by them, but the average working American is not!
In the outside world, at the same time that employment statistics were rising, the middle class was hollowing out.
There may have been employment, but it was with low-paying or temporary jobs with no benefits and no job security. Average citizens were (and still are) often forced to work two or three jobs just to make ends meet and with no hope of any savings.
The more accurate measure is income inequality.
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Trickle Up Economics: The Golden Age Of CEO Pay Yet To Come
A 2012 paper by Williams College economist Jon Bakija and two co-authors used tax data to focus on the move of income from the middle class upward. Who was getting it and how? They found that it was executive pay and bankers. Corporate executives, managers, and supervisors accounted for 45% of the top 0.1% of national earners. If financial professionals are included, the group accounted for 70% of the increase in the share of national income going to the top 0.1% from 1979–2005.
It will be more of the same after the tax cuts savings. The greatest upward gush will result in even more obscene levels of executive pay. We’ve all seen the headlines. Most CEOs make more before lunchtime on the first working day of the year than most workers make the entire year. In 2015, CEOs made on average 276 times worker pay.
Note the similarity of the curves in the first and third graphs: as CEO pay begins its upward swing (first curve above) starting in the Reagan years (1980), so does income inequality.
Shortly after the collapse of 2008, former Fed chair Paul Volcker, an economist respected for breaking inflation in the 1980s, blamed excessive executive pay for leaving the world with a “broken financial system.” His insight was soon forgotten.
How The Money Trickles Up: The CEO Two Step
It’s not base salary alone, but other forms of compensation such as stock options that are the key to the obscene levels of piggish pay. In what is touted as an example of the law of unintended consequences, Congress noted the rise in executive pay in its early days of 1993. It passed a section of the tax code limiting the deduction of executive pay to $1 million. That should be an incentive to keep executive pay under control it reasoned.
But of course, it also passed a loophole. And where there is a loophole, there is a way. The new law gave an exemption for performance-based compensation which included stock options.
So what would you expect if you gave the people in control of the company and who could easily manipulate short-term results that would benefit themselves? Wouldn’t you expect that they would do exactly that?
It’s easy for CEOs to drive up their companies’ stock in the short term. If they want good quarterly sales results, cut prices for a while — the long-term health of the corporation be damned. When the fall out from their short-termism hits, they’ll be gone. Or, if they’re kicked out because of eventual poor results, they will leave with all their gains and a billowing golden parachute on top.
We have our first example of legislation on corporate control which appeared to do something but did nothing.
A geek point: a stock option gives the executives the right to purchase new stock (treasury stock) from the corporation at a fixed price, say $100 per share. If the share price goes up to $200, the executives can cause the corporation to issue new shares to them at $100. However, the more shares issued, the less value of each individual share. The trick is how to get the shares and convert them into immediate cash without causing a drop in the stock price.
With A Little Help From Their Friends (At The SEC)
With the tax incentives, corporate executives are now highly motivated to take as much of their compensation in stock options instead of salary as possible. Once the CEOs have artificially inflated the stock price of their companies and exercised their stock options so they have stock in hand, they use corporate profit to buyback that stock and not for the future benefit of the corporation.
But wait a minute, you must be thinking. Surely, this allows for limitless stock manipulation. There must be a law! And there is one against stock manipulation—and (yes, you guessed it with) a special loophole for corporate executives.
However, in 1982 (a Reagan year), the SEC passed a safe harbor rule (10b-18), that permitted corporations to buy back shares so that the transactions were ‘deemed’ not to violate the anti-fraud provisions of securities legislation, provided that they met four very complicated conditions.
Another geek point: ‘Deeming’ is a legal concept that means you are actually doing this bad thing, but the law will pretend you’re not.
A former head of the SEC, Mary Jo White, admitted that the SEC did not even attempt to monitor buybacks to see if they complied because the very rule prohibited them from getting the data that they needed to do their investigation. And yes, that prohibition has stayed on the books since 1982, probably because very few voters understand this arcane area of securities law.
You have read that correctly. Since 1982 there have been unlimited opportunities for stock manipulation in corporate buybacks of securities owned by executives who are in a position to manipulate the share price.
The Buy-Back Economy
There was an earlier offshore tax break under the W. Bush administration in 2004 by the above mentioned The American Jobs Creation Act. Congress believed that if it gave the corporations this one-time tax break, corporations would bring in their offshore hoard to invest in America and create jobs. But Congress was not so naïve as to believe corporations would do this out of the goodness of their corporate hearts. It put restrictions on the use of the repatriated funds. They could not use them to benefit shareholders.
Of course, as you well know, laws do not apply to corporations, at least the wealthy ones, the way they do to you and I. A Congressional Research Service Report in 2011 found that the corporations had thumbed their noses at the restriction and used the funds to benefit shareholders by buybacks of corporate shares:
“In short, the studies generally conclude that the reduction in the tax rate on repatriated earnings led to a sharp increase in the level of repatriated earnings, but that the repatriations did not increase domestic investment or employment. They further conclude that much of the repatriations were returned to shareholders through stock repurchases.”
The government could not enforce the restriction on the use of funds because the law did not require the corporations to keep track of the funds separately. Once they were co-mingled with general funds, there was no way of telling what the repatriated funds were used for.
Here we have our second example of legislation on corporate control which appeared to do something but did nothing.
Could the government, with all its advisers: sophisticated accountants, the cream of the crop of economists and the best of Wall Street manning the Treasury Department, not have foreseen such a loophole?
I owe the above subtitle to William Lazonick, an economist at the University of Massachusetts. Lowell has taken a special interest in stock buybacks. He noted in a Brookings paper published in 2015 that corporations have essentially established a buyback economy.
“Between 2004 and 2013, 454 companies in the S&P 500 Index did $3.4 trillion in stock buybacks, ‘representing 51 percent of net income.’”
So how much executive compensation has been taken in stock options? I go back to professor William Lazonick who has documented that the 500 highest-paid U.S. corporate executives received 76 percent of their income in stock-based compensation between 2006 and 2014.
In his 2017 fix for the economy, The Tax Cuts and Jobs Act, Trump mirrors the title of the first failure, The American Jobs Creation Act, of 2004. History will repeat itself—guaranteed!
Hillary Clinton campaigned on eliminating this safe haven exemption for stock options. It appears that few voters understood the significance of her proposal because there is not enough public education on this issue.
Why are the Trump-led Republicans so keen on giving tax credits to corporations that will use them to benefit executives through buybacks? They have read the writing on the wall. They know that many of them will not be reelected in the 2018 midterm elections. So they have to do as much damage as they can in the short time they have an office. Soon they will go to executive positions in corporations they have well served and be able to take advantage of all the corporate tax benefits they have created—and translate the benefits into cash through stock option compensation and buybacks.