Fed Study Shows "Persistent Fed Overoptimism about Economic Growth"; What Will They Do About It?

Since 2007 nearly every Fed economic forecast has been on the optimistic side.

In an attempt to explain, a new Federal Reserve Bank of San Francisco dives into the Persistent Overoptimism about Economic Growth.

My friend "BC" commented "It has taken 7-8 years for Fed economists to get around to this brilliant insight."

I provide the real reasons following this excerpt from the report ...

Since 2007, Federal Open Market Committee participants have been persistently too optimistic about future U.S. economic growth. Real GDP growth forecasts have typically started high, but then are revised down over time as the incoming data continue to disappoint. Possible explanations for this pattern include missed warning signals about the buildup of imbalances before the crisis, overestimation of the efficacy of monetary policy following a balance-sheet recession, and the natural tendency of forecasters to extrapolate from recent data.




Explaining the persistent overoptimism

Economic forecasting can be a humbling endeavor. In a cross-country study of private-sector forecasts from 1989 to 1998, Loungani (2001) finds that “the record of failure to predict recessions is virtually unblemished.” He also finds that forecast revisions in one direction tend to be followed by further revisions in the same direction and that one-year-ahead growth forecasts are typically too optimistic.

Implications for economic models

Research has identified numerous instances of persistent bias in the track records of professional forecasters. These findings apply not only to forecasts of growth, but also of inflation and unemployment (Coibion and Gorodnichencko 2012). Overall, the evidence raises doubts about the theory of “rational expectations.” This theory, which is the dominant paradigm in macroeconomics, assumes that peoples’ forecasts exhibit no systematic bias towards optimism or pessimism. Allowing for departures from rational expectations in economic models would be a way to more accurately capture features of real-world behavior

An updated study by Ahir and Loungani (2014) finds that the private-sector’s record of failure to predict recessions remained intact through 2008 and 2009. A study by Alessi, et al. (2014) finds that one-year-ahead growth forecasts from the Federal Reserve Bank of New York and the European Central Bank from 2008 to 2012 exhibited substantial overoptimism, averaging 1.6 to 2.4 percentage points above actual growth. The SEP growth forecasts fit the pattern of these various studies.

What Will They Do About It?

That question is easy to answer: absolutely nothing. There is a systemic bias towards optimism from economists in general, not just central banks.

I have mentioned that numerous times in recent years, even after it was long understood the recession of 2007-2009 was a balance-sheet recession.

For example, on January 6, I noted Economists Upbeat Despite 4th Consecutive Decline in Factory Orders; Auto Orders vs. Expectations.

Economists are among the most optimistic groups on the planet. Year in, year out they project improvements in growth.

So today, despite 4th Consecutive Decline in Factory Orders, it's no surprise that economists remain optimistic.

Private Pep Rally

On January 29, Fed Chair Janet Yellen met with Senate Democrats at a private luncheon. She told the Democrats that the U.S. Economy is Strong.

“She went through the issues of unemployment and inflation. Very positive. And economic growth numbers were good, have been good. There’s work to be done,” Sen. Richard Durbin (D-Ill.) said after the luncheon.

Could the Fed be rear-view mirror forecasting once again? I think so. Third quarter GDP rebounded strongly, so Yellen did what economists do, project strength into the future. Somehow this tendency is one-sided. Economists seldom project weakness the same way.

Diving Into the Details

On January 31, I went Diving Into the 4th Quarter GDP Report and noticed some ominous trends.

On February 1, I made a pretty bold statement Canada in Recession, US Will Follow in 2015.

Today, I noted Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction.

Also today, but something I did not comment on, U.S. Consumer Spending in December Weakest Since 2009.

U.S. consumer spending recorded its biggest decline since late 2009 in December with households saving the extra cash from cheaper gasoline.

Other data on Monday showed factory activity cooled in January, suggesting the economy may have entered the new year on a slightly softer footing than had been expected.

Nevertheless, upbeat and cash-flush consumers are expected to step-up spending and buoy the economy this year.

"The consumer is poised to do well in early 2015. Lower gasoline prices are going to provide a big lift to consumption," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania.

Reasons for Optimism

1. Missed warning signals about the buildup of imbalances before the crisis
2. Overestimation of the efficacy of monetary policy following a balance-sheet recession
3. Natural tendency of forecasters to extrapolate from recent data. 

Comment on Reason #1

Bernanke like Greenspan could not see the obvious. This is a general statement. Buildup of imbalances has nothing to do with it. Neither Greenspan nor Bernanke could spot bubbles.

Janet Yellen right now is virtually blind as a bat. She cannot see the bubbles in bonds and equities the Fed created. When those bubbles burst, the slowdown should smack some sense into the Fed, but it won't. Moreover, the bigger this equity bubble gets, the bigger the crash. The Fed cannot see that either.

Comment on Reason #2

These arrogant fools actually believe they are economic wizards who can steer the economy like a truck on a highway. The idea that central banks can set interest rates is as faulty as Russian central planners can correctly set the price of oranges. But that's what they believe.

Comment on Reason #3

They are extrapolating 3rd quarter GDP into the future again right now. They miss the bond and equity bubbles, factory orders, and countless other things. All strong reports are thought to be representative. All weak reports are deemed to be a "soft patch".

Judging from the "strong economy" statement of Yellen, the Fed seems to believe the US will "decouple" from the clearly slowing global economy. It has for a while, but it cannot last.

Too Much Faith in Models

Here is the first of two bonus reasons to help explain overoptimism:

The Fed (economists in general) have far too much faith in economic models and far too little common sense. The economy cannot be driven like a truck. Fat tails appear far more than theory suggests. Why? Because many widely-held theories are complete nonsense.

Anyone recall the widespread belief people would not walk away from their homes? And what about the idiotic Keynesian theory that recessions and inflation could not happen at the same time.

Economists widely believed that bit of nonsense. Yet, instead of abandoning Keynesian theories, they went further down the rabbit hole to explain things.

System Runs on Lies

Here's a final bonus explanation the San Francisco Fed failed to mention: Good news sells. People do not like the truth. They would rather hear lies. And the Fed is willing to provide lies, especially in difficult times.

The entire system runs on lies such as

• Pro-forma data
• Beat-the-street nonsense where corporations provide analysts with numbers the corporations know they can beat by a penny
• Analysts are more than willing to downgrade expectations to help corporations beat-the-street

When it Becomes Serious

The Fed does not want an audit? What pray tell does it have to hide?

European politician Jean Claude Juncker summed it up nicely: "When it becomes serious, you have to lie".

And so the Fed does. Sometimes, as a matter of arrogant belief in their own wizardry, they even start to believe the lies they tell.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Diving Into the ISM: What's It All Mean?

This morning the Institute for Supply Management released its much followed Manufacturing ISM® Report On Business®.

Index	Jan	Dec	PP Change	Direction	Rate of Change	Trend in Months
PMI®	53.5	55.5	-1.6	Growing	Slower	20
New Orders	52.9	57.8	-4.9	Growing	Slower	20
Production	56.5	57.7	-1.2	growing	Slower	11
Employment	54.1	56.0	-1.9	Growing	Slower	19
Supplier Deliveries	52.9	58.6	-5.7	Slowing	Slower	20
Inventories	51.0	45.5	5.5	Growing	From Contracting	1
Customers' Inventories	42.5	44.5	-2.0	Too Low	Faster	2
Prices	35.0	38.5	-3.5	Decreasing	Faster	3
Backlog of Orders	46.0	52.5	-6.5	Contracting	From Growing	1
Exports	49.5	52.0	-2.5	Contracting	From Growing	1
Imports	55.5	55.0	0.5	Growing	Faster	24

What's It Mean?

The PMI is a diffusion index. Numbers above 50 indicate expansion, numbers below 50 indicate contraction.

A key problem with diffusion indices is the size of the company does not matter.  For example, a chemical company with 300 employees carries the same weight as an auto manufacturer with 200,000 employees.

Moreover, there are some peculiarities with the break-even number of 50.

The ISM says A PMI® in excess of 43.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the January PMI® indicates growth for the 68th consecutive month in the overall economy, and indicates expansion in the manufacturing sector for the 20th consecutive month. Holcomb stated, "The past relationship between the PMI® and the overall economy indicates that the PMI® for January (53.5 percent) corresponds to a 3.3 percent increase in real gross domestic product (GDP) on an annualized basis."

Thus, a manufacturing PMI above or below 50, does not imply similar overall economic activity as one might expect. Also, month-to-month changes show a lot a variances so it's important to look at trends over a longer period of time.

Manufacturing ISM Historical



The NBER (the historical arbiter of when recessions start and end) says a US recession began in November of 1973. The Manufacturing ISM was 68.1 at the time.

The above chart also shows some recessions began with the manufacturing PMI in negative territory. In isolation, the PMI itself does not say a lot. One needs to incorporate other data.

Manufacturing ISM Percent Change From Year Ago




Upturns from deeply negative tend to end recessions (purple circles), but spikes below the zero-growth tend line don't necessarily mean anything.

There were 10 occasions since 1950 in which the year-over-year growth of manufacturing PMI sunk to -20% that were not associated with a recession.

On the other hand, the chart shows that recessions generally start with the PMI near the zero-growth line. In those occasions where recessions started with PMIs well above 50, the PMI quickly crashed into negative territory.

Manufacturing ISM Percent Change From Year Ago Detail



Far too much reliance is given to these indicators, even though flirting around the zero-line is generally not associated with high growth.

The Manufacturing ISM is now at a spot where recessions frequently begin. Yet, far more often than not, recessions do not begin at this spot.

Nonetheless, please note the weakening trends in the table at the top.

• Exports are slowing
• Imports are up
• Prices falling rapidly
• Backlog of orders in contraction
• Growth slowing nearly everywhere
• Customer inventories rising

None of those imply strong growth.

The ISM says today's report "corresponds to a 3.3 percent increase in real gross domestic product (GDP) on an annualized basis". I will take the under for numerous reasons stated previously.

For more GDP look-ahead analysis, please see ...

• January 31: Diving Into the GDP Report - Some Ominous Trends - Yellen Yap - Decoupling or Not?
 
• February 02: Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction
 
• February 02: Four Trade War Questions; PMI Reports; Currency Manipulation Charges

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Total Construction Spending Weaker Than Expected; Residential Construction Spending in Contraction

Construction spending for December was weaker than expected. Lots of reports recently have been "weaker than expected". From Bloomberg.

Highlights

Construction outlays rebounded 0.4 percent in December after dipping 0.2 percent the month before. December was below market expectations which were for a 0.6 percent gain.

December's increase was led by public outlays which rebounded 1.1 percent after dropping 1.8 percent jump in November. Private residential spending rose 0.3 percent after edging up 0.1 percent in November. Private nonresidential construction spending eased 0.2 percent in December after a 0.8 percent rise the month before.

On a year-ago basis, total outlays were up 2.2 percent in December compared to 2.7 percent in November.

Recent History Of This Indicator

Construction spending slipped 0.3 percent in November after a sharp 1.2 percent rebound in October. Market expectations were for a 0.5 percent gain. November's decrease was led by public outlays which fell 1.7 percent after a 2.8 percent jump in October. Private residential spending rose 0.9 percent, matching the pace the month before. Private nonresidential construction spending dipped 0.3 percent in November after edging up 0.1 percent in October.

Total Construction Spending Percent Change From Year Ago



click on any chart for sharper image

This is another trend that looks ominous. Year-over-year growth in total construction spending has fallen from 8% in February of 2014 to 2% in December.

Commercial Construction Spending Percent Change From Year Ago



Residential Construction Spending Percent Change From Year Ago



Residential construction spending will be a net contraction from 1st quarter GDP unless the trend reverses soon. But why should it? And if residential drops deep enough, total construction spending will subtract from 1st quarter GDP.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Debt of Six Eurozone Countries Exceeds 100% of GDP, Two More Coming in 2015 (France and Spain)

In 2014 there were six eurozone countries whose debt-to-GDP ratio went over the 100% threshold. Two additional countries will pass that barrier in 2015.

The Maastricht Treaty on which the euro was founded was designed to keep "sound fiscal policies", with debt limited to 60% of GDP (not 100%), and annual deficits no greater than 3% of GDP."

Every country in the eurozone, including Germany, has been in violation of those rules. Let's take a look at the biggest violators as reported by El Economista. Data is from second quarter of 2014 (undoubtedly worse now).

100% Debt-to-GDP List

1. Italy 133%
2. Portugal 129.4%
3. Ireland 116.7%
4. Cyprus 112.2%
5. Belgium 105.1%
6. Greece 174.9%
7. Spain 100.3% (2015 estimate)
8. France 100% (2015 estimate)

In regards to France, Laurent Bigorgne, director of the Institut Montaigne, predict that French liabilities will not stabilize, but will continue to progress."

That certainly seems like a very safe prediction.

Wild Blue Yonder

And as debts soar off into the wild blue yonder, the need to keep interest rates at 0% to perpetually mask the problem increases.

I offer this musical tribute to celebrate the Keynesian policies that perpetuate wild blue yonder government spending and absurd central bank policies.



Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Four Trade War Questions; PMI Reports; Currency Manipulation Charges

With the declining yen, Japan's manufacturing PMI has risen eight months. In contrast, China has been wavering near the stagnation line since early 2011.

Trade war questions relate to the just-released PMI reports and also the 4th quarter US GDP report. Let's start with today's PMI releases on China and Japan.

HSBC China Manufacturing PMI

The HSBC China Manufacturing PMI shows Chinese Operating Conditions Deteriorate Fractionally in January.

Chinese manufacturers saw a fractional deterioration in operating conditions at the start of 2015. Although output rose slightly and new orders broadly stabilised, staffing levels were cut for the fifteenth successive month. Meanwhile, relatively subdued client demand led companies to reduce their stock holdings of both post and pre-production goods in January. On the costs front, lower raw material prices led to the steepest reduction in average input costs since March 2009, which contributed to a sharp decline in prices charged.

After adjusting for seasonal factors, the HSBC Purchasing Managers’ Index™ (PMI™) posted at 49.7 in January, down slightly from the earlier flash reading (49.8), but up fractionally from 49.6 in December. This signalled a second successive monthly deterioration in the health of the sector, albeit only slight.

Latest data indicated a renewed expansion of Chinese manufacturing output in January, though the rate of increase was only fractional. This was the first time that production has risen in three months.

Manufacturing companies reduced their headcounts again in January. That said, the rate of job shedding was the weakest recorded in 15 months and only slight.

China Manufacturing PMI Index



China's manufacturing PMI has been flirting just above and just below the stagnation line since early 2011. More time has been spent in contraction than expansion in that period.

Japan Posts "Solid" Growth

In contrast to China, the Markit/JMMA Japan Manufacturing PMI shows solid production growth at start of 2015.

Key Points

• Headline PMI posts above 50.0 for eighth month running
• Further increases in output and new orders
• Inflationary pressures remain amid reports of yen depreciation

Summary

Data at the start of 2015 signalled a solid improvement in operating conditions in the Japanese manufacturing sector. Production growth continued for the sixth month running, supported by a further rise in new orders. Subsequently, payroll numbers remained in growth territory, with the latest expansion broadly in-line with the previous month. Meanwhile, upward pressures on both input and output prices remained.

The headline PMI posted at 52.2 in January, little changed from 52.0 in December and above the 50.0 no-change mark for the eight month running, thereby signalling sustained growth in the Japanese manufacturing sector at the start of 2015.

Panellists attributed the latest increase to a combination of improved advertising, stronger demand conditions and the launching of new products. Similarly, new orders from abroad rose in January.

Japan Manufacturing PMI



Four Trade War Questions

1. How long will China let Japan debase the Yen without a response?
2. How long before US manufacturers whine about loss of exports?
3. Will exports add to or subtract from US GDP next quarter?
4. Will the US economy decouple from the global economy?

1A. China will not let Japan (and increasingly Europe) get the upper hand forever. China will soon take strong action to reduce the value of the yuan.

2A.  Manufacturers will start whining loudly if they are not already. Expect to see currency manipulation charges in the news again soon. Those charges will escalate as soon as China responds to Bank of Japan and ECB moves to reduce the value of the yen and euro.

3A. Subtract. Not only are US exports getting more expensive relative to Europe and Japan, the entire rest of the global economy is slowing rapidly.

Our biggest trading partner is Canada, and Canada is in recession, with a rapidly sinking Canadian dollar on top of it. (See Canada in Recession, US Will Follow in 2015)

4A. No. The US will not decouple as economists assume.

Diving Into the GDP Report - Some Ominous Trends

I addressed questions three and four in more detail in my Saturday, January 31 post: Diving Into the GDP Report - Some Ominous Trends - Yellen Yap - Decoupling or Not?

There's much more analysis of autos, imports, inventories, and other US GDP factors in the above link, including a discussion of US recession possibilities. Please give it a look if you missed it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com 

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Cyborg Silliness; No Glory in Stupidity; If Jackasses Could Think

On January 18, in Graves Waiting For Bodies: Major War Escalation in Ukraine; In 5 Weeks Ukraine Out of Money I noted the rebels captured the airport at Donetsk.

Donetsk Airport Battle is Over

Dreizin also informs me that "The battle for the Donetsk airport is over. The rebels expelled Ukraine's most elite units from their last redoubts in the new terminal building."

Also on January 18, Reuters reported Ukrainian Troops Retake Most of Donetsk Airport From Rebels.

Ukrainian troops recaptured almost all the territory of Donetsk airport in eastern Ukraine they had lost to separatists in recent weeks, as thousands gathered in Kiev for a state-sponsored peace march on Sunday.

The offensive brought fighting close to the industrial city of Donetsk, centre of a pro-Russian rebellion, while shelling intensified in other parts of the region known as "Donbass".

Military spokesman Andriy Lysenko said "We succeeded in almost completely cleansing the territory of the airport, which belongs to the territory of Ukrainian forces as marked by military separation lines."

Colonel Cassad and Jacob Dreizin got the story correct. Western media outlets instead believe totally discredited sources in Kiev.

No Glory in Stupidity

On January 28, the LA Times reported How Ukraine's Outgunned 'Cyborgs' Lost Donetsk Airport.

Some of the LA Times report is accurate, albeit late.

Other parts seemed to glorify the "cyborgs" who "for 242 days, had held out against pro-Russia separatists who bombarded them from beyond the runways and prowled above and below them in the wreckage of the terminal."

In my view, there is no glory in stupidity. But there's even less in sheer madness.

Here are some snips from the LA Times article.

Brigade commander Col. Yevgeny Moysyuk noted "We couldn't get our tanks or armored vehicles there anymore because they had used the truce time to fortify all the side approaches and deploy all kinds of heavy weapons."

"We should have evacuated our men a few days earlier, then waited for the separs [separatists] to converge on the premises and bury them under the ruins," he said.

At one point, in a desperate bid to rescue his men, Moysyuk borrowed a couple of armored vehicles with drivers from another brigade. But the drivers refused to go into what they knew was a fiery hell. [smart decision]

So Moysyuk's own officers drove into the fog that had descended on the tarmac. Misled by the fog, they arrived at a different building, where they were surrounded by the enemy. The next day, the remaining paratroopers were ordered to attack the airport head-on.

"This is just sheer idiocy!" exclaimed an airborne battalion commander, Maj. Ruslan Prusov.

The man in charge of the operation, Col. Gen. Viktor Muzhenko, Ukraine's military chief of staff, was not inclined to share the pessimism of his subordinates. "A war doesn't proceed without casualties," Muzhenko said.

"The losses of the opposite side are far greater than ours, and we didn't lose the airport, as it just became the front line, that is all."

About a mile away, a doctor examined a large, bleeding wound on the top of a soldier's head. The man said he felt dizzy and the doctor asked him to wait so that he could put some stitches and bandages on it.

"Don't you think he should go to a hospital?" another soldier asked.

The doctor laughed. "If we send everyone with such wounds to a hospital," he said, "we will run out of men to fight the war with."

Lies No One Believes

Note the two lies in a single sentence by Col. Gen. Viktor Muzhenko: "The losses of the opposite side are far greater than ours, and we didn't lose the airport, as it just became the front line, that is all."

Those lies are so preposterous no one can possibly believe them.

The ending sentence to the above article is also worth repeating: "If we send everyone with such wounds to a hospital, we will run out of men to fight the war with."

What Really Happened

ON January 29, I posted a more accurate account of what happened and what's really going on in Ukraine.

In case you missed it, please consider Conscription of People, Cars, Businesses in Ukraine for Mindless Slaughter; Entire Villages Leave to Avoid Servitude; Hop on the Bus Gus.

The short version is conscription of cars, property, and people for the war effort. The smart citizens want no part of it. Entire villages have fled to Russia.

The above link contained a video that describes in detail what happened to the fool's mission to retake the airport.

I repeat it here with the same warning.

The video below is graphic and contains a lot of harsh language. The video is about captured Ukrainian POWs on a fool's mission to retake the Donetsk airport.

Warning aside, I recommend watching the video, entirely. Watch the scenes where locals confront the Ukrainian POWs. The video accurately portrays Ukrainians fighting Ukrainians, not Ukrainians fighting Russians.

Ukrainian POW's Face NAF Commander Givi and the Fury of Donetsk Residents



Link if Video Does not Play: UAF Storms Donetsk Airport and Gets Asses Handed to them by NAF.

Want a translation to Spanish, German, Dutch, Danish, or French? Go to Information Clearing House.

Civil War

This is a f*ing civil war, no more, no less. It is not our battle. It is an internal battle.

Yes, Russia is supporting the separatists. So what? Putin is not on a mission to take over Europe. Nor does he want to exterminate the Jews as a final solution. So please spare me the sap about Hitler and Chamberlain.

Ironically, the US sponsored the civil war in the first place taking sides in the ouster of the former Ukrainian president.

The second irony in these preposterous Putin-to-Hitler comparison is the simple fact the US supports neo-Nazis in Ukraine. (See Email From US Special Forces Veteran; 500 US Blackwater Mercenaries in Ukraine? US Backs Ukrainian Neo-Nazis)

No one has remotely bothered to understand Russia's legitimate concerns.

Just as the US did not want Russian missiles in Cuba, Russia does not want NATO on its border. Why is that so hard to understand?

Jackass Solutions

Unsurprisingly, jackasses at the Financial Times came out with this editorial: West must help Ukraine to defend itself against Russia.

Of course the Times only wants to send "defensive weapons". And if Russia responds? The jackasses then suggest "The US and its allies must intensify their financial assistance to the Kiev government."

Yes indeed, the jackass solution as always is to throw money at it. With Greece dangling in the air, let's "intensify financial assistance" to prolong wars.

If Jackasses Could Think

Instead of figuring out this is not remotely our battle, jackasses want to prolong the fighting with money and military equipment. This of course is expected.

If jackasses could think, they would not be jackasses.

With that, I will conclude this post the same way I did on January 29. ....

Hop on the Bus Gus

In honor of Ukrainian citizens smart enough to disavow the "Small Price Theory" and willing to tell their government to F* off, I offer this musical tribute.



Link if Video does not Play: 50-Ways Paul Simon

Hop on the bus Guss
Don't need to discuss much
Just drop off the keys Lee
And get yourself free!

No one has the right to own you. No one. No government. Ever!

To disagree with the above is to support forced slavery.

This War is Over

The Vietnam war ended when public support turned against it, even though fighting continued long after.

The same applies here. Hearts and minds have been lost along with the will to fight. Ukraine is split in two, barring a major military intervention by the US.

Even though the war is over, the fighting can continue. How much longer the battles go on now depends on the US and IMF.

1. The US can fund the bloodshed for a while longer and so can the IMF. US war-mongers may decide no price is too high to pay, even to the absurd point of engaging Russia directly.
2. The US and IMF can force true peace negotiations on Kiev with a partition or federation of the country. But, what may have been acceptable to the separatists and Russia six months ago may no longer be so.

Either way, Ukraine is never going to be a single country again. Such is the madness of arbitrarily drawing borders with no regard to cultural, political, or religious beliefs.

The war is over. Kiev lost, even with the backing of the US. Let the peace process begin before more lives are lost and more needless destruction occurs.

I authorize translation and republication of this individual article, to any language, on any site, as long as it contains a link back to this article.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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More Obama Dead-on-Arrival Tax Proposals

Is there a point to beating your head against a concrete wall? The answer would seem to be "no", yet President Obama continues to do just that with dead-on-arrival proposals.

Please consider Barack Obama Plans to Tax Overseas Cash Piles.

President Barack Obama will propose raising $238bn by levying a one-off tax on the cash piles held by US companies overseas to repair the US’s crumbling roads and bridges.

The measure, a key plank of the US president’s budget to be outlined on Monday, would impose a 14 per cent “transition” tax on the estimated $2tn in earnings US companies have amassed overseas, the White House said on Sunday.

Critics say the existing offshore cash mountains testify to the aggressive foreign tax planning by US companies, while businesses cite them as evidence of the handicaps they face under an uncompetitive US tax regime.

Mr Obama will also propose a 19 per cent tax on future foreign earnings, giving companies a credit on foreign taxes and allowing them to be reinvested in the US with no additional penalty. Under the current system, US companies pay little or no tax on their earnings abroad until they are brought back into the US.

The money raised would be used to fund about half of an ambitious six-year programme of highway, bridge and transit upgrades, one of the president’s main priorities during his final two years in office and an initiative that has attracted some degree of bipartisan support. The remainder of the programme would be financed by the existing highway fund.

“This transition tax would mean that companies have to pay US tax right now on the $2tn they already have overseas, rather than being able to delay paying any US tax indefinitely,” a White House official said.

Wall of Dispute

1. Critics say the existing offshore cash mountains testify to the aggressive foreign tax planning by US companies.
2. Businesses cite aggressive tax planning as evidence of the handicaps they face under an uncompetitive US tax regime.

Curiously, both statements are true. And the president's plan does nothing to fix the fundamental problem.

US tax code encourages capital flight. So, corporations do just that, effectively wasting a mountain of money on lawyers and tax schemes in the process. Then, US corporate profits sit abroad, waiting for repatriation holidays which inevitably come every time there is an economic slowdown.

Mish Proposal

The initial problem is US corporate tax rates are too high. I propose cutting them to zero. Were that to happen, instead of US businesses sheltering money overseas, foreign corporations would setup offices in the US, moving as much here as they can.

I believe growth in economic activity would far outweigh any lost revenue.

In spite of obvious merit, my proposal would never fly. The president would veto it. So how about a more modest corporate flat-tax with no loopholes, at a rate far lower than most of Europe?

Such a proposal would immediately end all this bickering on both sides. Republicans would get what they want (lower taxes). And Obama would get something he wants (ending foreign tax loopholes).

Instead, he proposes dead-on-arrival ideas.

Does Obama love beating his head against the wall with zero-chance proposals? If he's attempting to pound some sense into his head, it's clearly not working.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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