TAXES | What Trump's Returns Show about Tax Laws

Gene Steuerle of the Urban Institute this week has posted a fine summary of lessons from Trump's tax returns as reported by The New York Times. 

Trump's returns show how U.S. tax laws can break the link between wealth and income, increasing wealth concentration. 

His  returns illustrate many ways individuals and businesses with large  accumulated assets can shelter income that would otherwise generate tax liabilities. Steuerle says tax policies since the early 1990s have hiked the ratio of household wealth to income, generating $25 trillion of nominal wealth above normal growth. The Fed's recent buying of debt has further protected wealth holders.

Examples: 

• Underreported capital gains. Income from appreciated property is not included in taxable income until the underlying asset is sold. Steuerle found in the 1980s less than one-third of net income from capital reported.
• Tax exemptions for real estate owners. Large real estate investors typically use a pass-through business and are thereby able to claim exemptions from corporate and individual taxation. If property is held until death, no income tax is owed on accrued but unrealized gains. Gains can be deferred or excluded from tax at death, but property owners can immediately deduct almost all expenses on their tax returns. Investors in real estate can swap real estate properties with another owner and defer recognition of capital gains income.
• Incentives for risky lending. Lending officers at an institution like Deutsche Bank make big money on loans even if their loans go sour. They earn bonuses by boosting the bank's cash flow. By the time the loan sours, it is usually too late to claw back bonuses.
• Incentives for risky borrowing.  Borrowers can write off nominal interest costs that are a multiple of the real cost of borrowing. Near-zero-interest federal fund rates, while taxpayers deduct their nominal interest costs, mean that in real terms some investors are being paid to borrow money.
• Tax incentives to declare bankruptcy.  An owner of two companies where #1 earns $5 million and #2 loses $6 million has an incentive to declare bankruptcy on #2 and avoid taxes on #1. Others bear the bankruptcy cost.

FOMC | Questions About Fed Models

Gov. Lael Brainard (top center) addressing the NYABE,
Cornell Club, NYC, May 30, 2017.

On Tuesday, Federal Reserve Board Governor Lael Brainard spoke to the New York Association for Business Economics. 

At the heart of the Federal Reserve System is the Federal Open Market Committee (FOMC), which since the days of Ralph Young in the 1950s and 1960s has, as its primary task, engaged in carrying out open market operations in Treasury bills to influence interest rates.

The idea behind FOMC intervention in the marketplace is that the Fed can fine-tune the economy, by buying Treasury bills to inject cash and lower short-term interest rates, or by selling Treasurys to remove cash and raise interest rates. 

Lower interest rates create "easy money" and that is supposed to encourage investment. However, the Fed has been at the "zero bound" in its interest-rate targeting since its statement of December 16, 2008. I wrote a piece for Huffington Post  on January 17, 2009, that quoted former Fed Vice-Chair Laurence Meyer. Speaking to the New York Association for Business Economics, Meyer said that the FOMC could go on vacation "for the next two years" until it lifted off from its zero-bound policy.

It's been more than eight years now and the Fed's interest-rate target is still below 1 percent. A quarter-point increase is expected at the next FOMC meeting in mid-June.

The worry about raising interest rates is that it will discourage investment, and also that in the absence of inflation it is not necessary. 

A full table of reporters in the back.
Bloomberg, Dow-Jones...

It is a time when basic questions are being asked about the implicit model on which FOMC model is based. Is it possible that the model-builders have lost touch with the data on which the models are based? Is inflation understated, for example?

After the lunch I asked Gov. Brainard what she thought about this. Her answers were helpful:

Marlin: "When I was working at the Federal Reserve Board more than fifty years ago..."
Brainard: "Fifty!?"
Marlin: "Fifty, under Chairman William McChesney Martin. The prevailing faith then was that higher [but moderate] inflation would encourage demand, and lower interest rates would stimulate investment. Is this still the faith?"
Brainard: "I think we are less confident now than we were then."
Marlin: "Is that because of a new theory, or less faith in the data?"
Brainard: "It's not because of change in the theory. It's more a question of alternative views about the econometrics, rather than the data."

The data and econometric issues are related, because models use high-level aggregate averages. For example, "inflation targeting" at 2 percent per annum is based on a few overall-average price levels. The expansion of the money supply during and after 1933 is given full credit by Christina Romer for the stimulus to the economy that ended the Great Depression.

But what if average-price components move in different directions and then one of them changes direction? As the economy changes, the time horizons over which averages are computed may also need to change. Here are some charts from the "Fed Dashboard" of how prices have been diverging.

Similarly, both the slow response of the economy to massive new debt creation since 2008 and the zero-bound interest target from January 2009 raise questions about the Keynesian narrative in changed financial markets. The markets responded as predicted when short-term interest rates were hiked, but lowering rates to the zero bound did not spur investment as expected.

If the theory on which FOMC policies are based hasn't changed, and interest-rate and inflation-targeting policies based on the theory have not achieved their goals, doesn't that imply problems with the models or the data?

Related Posts: FDR Nullifies Gold Contracts . Glass-Steagall . FDR's First Fireside Chat

The U.S. Recovery and the Fed - Global Concern

The euro sank below $1.05, a new 12-year low, last night briefly, before recovering above $1.06.

As the markets reflect Friday's good BLS report on U.S. jobs and unemployment, the likelihood of higher interest rates in the United States later this year is being discounted.

Money is flowing into dollar bonds out of bonds in Europe, where yields are falling.

The strong dollar is good for American tourists in Europe (not so much Britain, as sterling is also strong). It is also good for the ailing European economy, as is the U.S. recovery.

All eyes are now on the Federal Reserve, which has had its hands tied since 2008 trying to help the U.S. financial markets recover - with near-zero Treasury bill rates and then a quantitative easing program to try to lower bond rates. Europe and Asia are worried that if the Fed's likely move to higher rates within a few months is premature, it will damage the recovery in the United States and world-wide.