Why Supply Side Economics Doesn't Work: An Intro

From Alex Berenson, NY Times, 7/24:

"

Tax Break Used by Drug Makers Failed to Add Jobs

Two years ago, when companies received a big tax break to bring home their offshore profits, the president and Congress justified it as a one-time tax amnesty that would create American jobs

Drug makers were the biggest beneficiaries of the amnesty program, repatriating about $100 billion in foreign profits and paying only minimal taxes. But the companies did not create many jobs in return. Instead, since 2005 the American drug industry has laid off tens of thousands of workers in this country.

And now drug companies are once again using complex strategies, many of them demonstrably legal, to shelter billions of dollars in profits in international tax havens, according to their financial statements and independent tax experts.

In one popular accounting move, companies declare their foreign markets as far more profitable than their American businesses — even though drug prices are typically higher in the United States than anywhere else in the world.

Drug makers are not the only American multinationals using tax loopholes to declare large portions of their income beyond the reach of the Internal Revenue Service. The Brookings Institution estimates that multinational companies are using overseas tax shelters to lower their payments to the Treasury by about $50 billion a year.

But the drug industry accounts for one of the biggest portions of that shortfall, according to the I.R.S. and independent tax experts. And the nature of their business gives drug makers techniques, like sheltering valuable pharmaceutical patents in tax-friendly havens like Ireland, that many other industries cannot use.

Moreover, the sheer heft of the American drug industry, which had about $60 billion in pretax profits last year, can give disproportionate weight to the economic impact of its tax sheltering techniques.

Even though the tax amnesty legislation has expired, its passage encouraged companies to be even more aggressive about sheltering money, expecting another holiday in the future, said H. David Rosenbloom, director of the international tax program at New York University. Democrats and Republicans supported the legislation, which passed with sizable majorities in October 2004.

“Congress can swear on two stacks of Bibles that it’ll never do it again,” Mr. Rosenbloom said, “but they’ve lost their virginity.”

With a few narrow exceptions, the drug companies are supposed to be paying as much as 35 percent of their worldwide profits in United States federal taxes. In reality they pay much less.

Last year, for example Eli Lilly, the sixth-largest American drug maker, paid less than 6 percent of its profits of $3.4 billion to the United States government, according to its financial statement.

Amgen, the American biotechnology giant, which reported last year that 80 percent of its $14.3 billion in sales occurred in this country, paid about 22 percent in United States federal tax on its $4 billion in profits.

The discrepancy was possible because Amgen claimed a profit margin of almost 100 percent on its foreign sales, but only 15 percent on its American sales.

The I.R.S. has recently increased the number of examiners trying to find hidden profits overseas. It has even had some victories, as in February when the drug maker Merck agreed to pay $2.3 billion to the government to settle a claim it had hidden profits in a Bermuda partnership.

“This is really a priority for the service right now — there’s a lot of focus on cross-border transactions,” said Frank Y. Ng, the I.R.S. deputy commissioner for international tax matters. But even after adding resources, the I.R.S. has only about 500 examiners to review international returns.

Lilly said in a statement that it complied with the law in taking advantage of the 2005 tax amnesty, which enabled the company to avoid more than $2.3 billion in American taxes. Lilly said it believed that the 2005 tax break had encouraged investment in the United States, noting that the company, which is based in Indianapolis, has invested $1.3 billion in the state of Indiana alone.

Still, since the beginning of 2005, Lilly has cut its United States work force by more than 8 percent, reducing it to 22,000 jobs by last January.

Lilly also noted that its overall reported worldwide tax rate for 2006 — which includes taxes paid to other countries and taxes that it has deferred but will theoretically pay at some future date — was about 20 percent in 2006.

Pfizer, Merck and Amgen declined requests for comment.

Tax experts like Michael J. McIntyre, a law professor at Wayne State University in Detroit, say the drug makers are taking advantage of antiquated rules that work better for manufactured products like steel and automobiles.

Under this system, when companies transfer products between divisions in different countries, they must account for the sales internally through “transfer pricing.” But they have significant discretion in how they set prices for these transactions.

That turns out to be especially so for high-margin products like drugs, which in pill form cost only a few cents each to make once they have been invented, but can be sold for several dollars apiece. The hefty profit margins result in part from patents that can protect the drugs from competition for years. And by transferring those valuable patents overseas, companies can declare that their profits should follow the patents overseas as well.

Under the rules of transfer pricing, if a company moves patents or other so-called intangibles from its United States division to a foreign subsidiary, the foreign unit is supposed to pay the American division a fair-market price. But outsiders have a difficult time determining if companies have properly assessed the value of patents, trademarks and other intangible properties.

To further complicate matters, some corporate subsidiaries in tax-haven countries, like Singapore and the Netherlands, now directly finance research in the United States. So they own the patents without ever having to “buy” them from their American parents, Mr. McIntyre said.

“They don’t even have to push it offshore,” Mr. McIntyre said. “It’s already offshore. And once it’s offshore, they strip the income from the onshore activity.”

In theory, companies are only deferring taxes on the profits they shelter overseas, not permanently avoiding tax. If they bring the money back to the United States to distribute to their shareholders, they still have to pay American taxes on it.

But those rules were temporarily suspended when President Bush signed legislation in 2004 to let companies return overseas profits at a rate of 5.25 percent, far below the official tax rate of 35 percent, if they moved the money back by 2006.

During that period, multinational companies of all stripes moved a total of about $300 billion into the United States, avoiding about $90 billion in taxes. Among them, the pharmaceutical industry was the largest single beneficiary. Leading the pack was Pfizer, the world’s largest drug company, which repatriated $36 billion.

The quid pro quo was supposed to be that the drug industry would invest some of its tax windfall in American operations and jobs. Instead, struggling with a dearth of new blockbuster drugs, they have had mass layoffs. Again, Pfizer has been the leader, reducing its work force by about 8,000 in 2006 and saying early this year that it would lay off an additional 10,000 employees.

Some experts now say the current system of taxing overseas profits should be scrapped. Even the companies that take advantage of loopholes might benefit if the system were changed, because they could save money on tax planning and have more certainty that the I.R.S. would accept their returns, said Michael C. Durst, a former I.R.S. official who is now special counsel to the law firm Steptoe & Johnson.

The simplest solution, Mr. Durst said, would be shifting to a system in which companies would assign a portion of profit to each country where they made a sale, relative to the size of the sale. Instead of trying to tax profits made overseas, the United States government would simply take its share of the profits on American sales. Such a system would be harder for the companies to game, Mr. Durst said.

But he and other tax experts say that any effort to close loopholes, to be politically viable, might have to be combined with a lowering of the corporate tax rate from its current 35 percent. And no one expects any legislation of that sort, at least not before the next election."

Torture

This one will be short and to the point...

The issue of torture has been in and out of the news recently and particularly has shown up in Republican presidential debates. There have been numerous allegations of use of torture in Guantanamo Bay and through repressive regimes in Egypt, East Europe, and Uzbekistan. Of course there was also the Abu Graib scandal. Some cable news networks have devoted discussions as to whether certain practices (water-boarding, forced standing, sleep deprivation, etc.) should be classified as torture.

Central to any of the recent debates about torture have been two questions:
1. What constitutes torture?
2. Are there situations when the use of torture is permissible?

I believe the first question is irrelevant. The only reason to carefully define torture is in order to inflict punishments that are borderline "not torture." Luckily for us, there is no reason we need to engage in such discussions. This is because the issue was already solved 200 years ago. The Bill of Rights 8th amendment prohibits the use "cruel and unusual punishment." Thus, we don't need to define torture, we need to define cruel and unusual punishment. I'll leave that to the courts, but we all know that all of the borderline practices being practiced in Guantanamo ARE cruel and unusual. As such, they are illegal if they are being inflicted on U.S. citizens, and should not be practiced if they are being used on enemy combatants. End of story. The entire torture debate is like trying to decide if asking who married Cain is blasphemy: it's completely outside the realms of our legal system and somewhat esoteric.

The second question is not a question at all. It's a rhetorical device. Torture or cruel and unusual punishment should not be used at all by anyone. Additionally, it is illegal for our government to use it against its citizens and illegal under international law (to the extent that international law has any jurisdiction in the United States) to use it against enemy combatants. Yet, talking heads keep asking the hypothetical question that goes something like this: "Suppose we caught a member of a terrorist cell trying to attack a major metropolitan area. Should we tie our hands and not allow intelligence personnel to use whatever means necessary to figure out the details of the plans even if it would cost perhaps thousands of American lives?" It's a nice little question that has no relation to reality and seems like a good plot for an action movie. Such a scenario has never happened and probably will never happen. If it does happen, you can bet that the terrorist will be subjected to "any means necessary" to get him to talk. After the torture, whoever green-lighted it would probably be absolved. In reality, it's a non-issue with such a specific set of circumstances that it is almost meaningless. So why does it keep coming up? Because they understand that the slippery slope goes both ways. Because torture in some outlandish scenario would be somewhat reasonable, one could argue that it could be justified in other, more realistic scenarios. Before you know it, "terrorists" are being tortured for all kinds of rationales. Asking the question is an argumentative tool for convincing people that torture is ok. Of course, in specific circumstances just about any action could be justified to some degree, but that doesn't give it legitimacy as public policy. Torture, as a matter of principle, should never be used for any purpose.

Monthly Machiavelli's: A New Feature?

Yes!, a NEW feature on this site. Every month I will award a "Machiavelli" to the person who displays 'Outstanding Political Acumen.'

I was going to wait until the end of the month, but I'll just start prematurely with the first recipient of the award.



And the Machiavelli goes to....:





Senate Majority Leader Harry Reid! [Cheers]

Why he won: As majority leader, Reid organized the overnight debate and vote in the senate over withdrawal from Iraq. From a Machiavellian standpoint, this was absolute genius. A number of Republican senators recently had been defecting from the President's position in Iraq because...well, they'll probably be voted out of office if they hadn't. Despite the "bravery" of openly and belatedly proclaiming that everything in Iraq wasn't peachy pie, most were not willing to push for immediate withdrawal.

In response, Reid put them on the spot, forcing them into an all-night filibuster. Republicans were forced to either vote for immediate (actually by April 2008) withdrawal or support the president. Since most of those Republicans really wanted some make-believe middle course, they were not happy about having to take sides. Most decided to prevent an open vote and continue the filibuster, which can be translated to support for the President's war.

The reason why this move was so brilliant is that it forces the Republicans in the senate, and Republicans in general (including presidential candidates) to become attached to Bush's wildly unpopular position in Iraq. Additionally, it strengthens Democrats credentials as the 'get out of Iraq' party, which is politically wise. To prevent compromise measures that would have allowed Republicans senators to separate themselves from Bush, Reid announced that there wouldn't be any more debate on Iraq until September.

Well done.

Cuba

Michael Moore's recent documentary has redrawn some attention to Cuba. In the movie, Moore takes several 9/11 rescue workers to Cuba to receive medical care. Those rescue workers were refused care by the U.S. government despite the fact that they were harmed during rescue attempts and not told about the dangers to their respiratory system from working so long around the WTC rubble. In Cuba, the rescue workers simply walked into a local pharmacy and then a hospital in Havana to receive free state-of-the-art medical care. For his transgressions, Michael Moore is being investigated for breaking American law by visiting Cuba without permission.

The point of this post is not to talk about Cuba's health care program. The point is to talk about the insanity of our current trade embargo and visiting restrictions on the country. But before I get to that, I want to talk a little about health care in Cuba. The documentary has spawned a reaction form both conservative and mainstream media trying to debunk the myths supposedly perpetuated by Moore in the film. I'll just say it: these "journalists" don't know what they're talking about. They assume that because it's Castro's Cuba, the country could not possibly have a comparable if not better health care system than the United States. There must be some hidden evil. A basic exploration of the country would prove otherwise: Cuba has devoted itself to building an exemplary health and educational system that some Americans would find envious. They have done this by sacrificing GDP growth. You may argue that the cost is too high, but if people are being educated, protected, and remain healthy, who's to say they're worse off? Not only has Cuba provided for its citizens, but it has also sent health workers all across the third world to train and treat the impoverished. It has also brought in people from across the world to train in its prestigious Havana University so that they may return home and use their acquired knowledge in their homeland. In fact, many young Americans have chosen to attend the university in what they believe is a unique educational experience. Many "journalists" have pointed out ways in which Cuba's educational or health care system is inferior (for example, there is only one place in Cuba to really receive this top-shelf medical care--Havana, where Moore goes, although anyone can go there and there are local doctors and pharmacies everywhere), but they neglect to mention that the U.S. is the richest country in the world, while Cuba is one of the poorest, with a GDP per capita of $2,000 and that for Cuba to have a system that in any way compares to the most powerful country on earth is laughable.

So, if Cuba isn't evil incarnate, why do we have such strict trade and visiting restrictions? Let's look at the history: in 1959, Castro overthrew a dictator supported by the United States named Batista. Batista was one in a long run of dictators in Cuba that had ruled pretty much none stop since the United States "freed" the island from Spanish tyranny during the Spanish-American War in 1898. When Castro took power, America was not sure what to think. They had never been confronted with a victorious political movement in Cuba that they had not directly sponsored. I'm no communist, and neither was Castro. Castro's main goal was to redistribute Cuba's oligopolized land, establish an educational and health care system, and end Cuba's economic dependence on American purchase of Cuban sugar. He made several diplomatic attempts to work with America in reforming his nation.

However, those feelers were rejected by America. Instead, the U.S. placed an embargo on Cuban sugar, crippling the economy. Castro then traveled to America to try to smooth things over to no avail. It was during this trip that the CIA first attempted to assassinate him. They failed, but Castro found out about it.

It was only after Castro's visit to the U.S. that he even contacted the Soviet Union. Why would he turn to the communists that he had worked so hard to purge from his movement during the revolution? Because the U.S. was trying to kill him! The U.S. was also trying to depose Castro using Cuban exiles in what would become the Bay of Pigs debacle.

Let's look at these Cuban exiles. These "exiles" came in three groups. The first were not exiles at all...they simply ran away. Mostly Batista collaborators and EXTREMELY wealthy sugar plantation owners/ Havana nightclub and casino owners with close links to the American mafia, they had fled because they feared their immense wealth would be ceased by the state and they hated anyone with a hint of leftism. The second group were exiled in the sense that if they didn't leave, they would have been jailed or killed. Again these were often extremely wealthy individuals who had been exploiting agricultural workers for immense financial gain. Albeit, conservatives (basically those that were in or were associated with the military) were also persecuted and fled. What is remarkable about this group was how 'white' these early exiles were. Cuba, then, was strictly divided between its white and "mixed" populations. For the most part, the whites owned all the land and the "mixed" did all the work. The whites were mostly old Spanish creole landowners with a scattering of former American families that fled the South after the Civil War. Fearing attacks from the people that had ruled over for decades, these whites fled to America and began organizing a way to overthrow Castro and his egalitarian message...this would become the Bay of Pigs.

I'll talk about the third group later, so let's go back to why Castro approached the Soviet Union. As I pointed out, the U.S. attempted to kill Castro and would launch an entire campaign throughout the 1960s dedicated to that purpose called Operation Mongoose (documents were completely declassified earlier this month, but they were already widely known), which used everything from poisoned food to exploding cigars. The U.S. was also threatening to invade the island or at least support a takeover attempt by Cuban exiles. Castro and Cuba did not have many resources. To protect itself from America it only had one option: the Soviet Bloc. The Soviets were more than happy to give Cuba everything it wanted if nothing else than to irk America. The Soviets gave Cuba arms, trade deals, and finally nuclear missiles (which gave us the Cuban missile crisis).

In response the United States placed a complete trade embargo on Cuba which included tourism and necessarily meant that Americans could not visit the island. It is this embargo that remains with us today. Until 6 years ago, Americans could not go to Cuba for any reason. Now, with special permission, you may visit the island for educational purposes (basically you have to be a med student or grad student studying Latin American politics or something.) This embargo has remained as the only absolute embargo on any country in the world by the United States despite the fall of communism in 1989 and despite the fact that we have most favored nation status with China, a country actually ran by a communist party.

So the question is, why do we hate Cuba so much? As the argument goes, Cuba is an oppressive regime and only a trade embargo will force Castro out of power. Anyone who believes this doesn't know what they're talking about. Firstly, simple trial and error of 50 years should tell us that the embargo will not force Castro from power. It obviously hasn't worked.

Secondly, I don't argue that Cuba is an oppressive country or that it's leader is a corrupt megalomaniac (some estimates put Castro as one of the 20 richest people in the world). Castro allows almost no political dissidence. He uses harsh methods including torture to punish his enemies. In all likelihood thousands of political prisoners have been killed by his regime.
But let's make an incomplete list of countries that the United States has only not placed embargoes upon but has supported and even allied with who were oppressive and used torture as official policy (some of these countries have since reformed, so I'll indicate what period I'm talking about in parentheses when appropriate):

China, Chile (Pinochet), Nicaragua (Somoza), Peru (63-80), Uruguay (73-85), Saudi Arabia, Iran (under the Sha), South Vietnam, Phillipines (Marcos), Indonesia (Suharto), Turkey, Spain (Franco), Portugal (Salazar), Greece (67-75), Argentina (2 military dictatorships), Bolivia (75-80), Brazil (64-85), Guatemala (54-91), El Salvador (32-83), Honduras (50s to 90), Uzbekistan, Romania, Yugoslavia (Tito).

Well, that's all I could think of. The point is that the U.S. since '59 has not had a problem supporting countries with human rights abuses comparable if not worse than those occurring (that occurred) in Cuba. The list includes mostly right-wing military dictatorships, but also includes some lefties like China, Uzbekistan (sorta), and Yugoslavia. In other words, there must be another reason.

So, what's the real reason? One of the real reasons is that the Cuban exiles form a very powerful block of voters and financial resources particularly in the swing state Florida that have forced presidential candidates to remain strictly opposed to Castro and committed to the embargo. Although the initial group of Cuban exiles was relatively small, during the late 1960s and 1970s a flood of Cubans arrived in Florida as refugees constituting the third group I mentioned earlier. Most were not running away from political persecution, although some were, but instead were running away from poverty, ironically caused by the American blockade. Met in Southern Florida by arch-conservative politically active Cubans from the initial fleeing, these "mixed" Cubans that now make up a large majority of the Cuban-American population are equally anti-Castro and have been convinced that the embargo is the best way to punish him. Unfortunately, these ex-Cubans are contributing to the crippling poverty that has struck the country since 1989 as the fall of the Soviet Union not only meant an end to subsidies, but also a viable trade partner (China, as we have learned, are not interested in American much less Cuban goods.)

Instead of blaming the ex-Cubans, we should be blaming the politicians that cowardly continue the ridiculous embargo. President Bush, who will not face another election, could push for an end to the embargo, but he won't because of the harm it will do to his party and possibly the next Bush presidential candidate Jeb Bush (former Gov. of Florida fully committed to making Cuba suffer). Clinton could have done it after 1996, but instead he used his last efforts to pardon ex-Cuban drug smugglers who just happened to reward their legal representatives (Hugh and Tony RODHAM...hmmm...) handsomely for their successful effort to get them clemency.

The embargo doesn't punish Castro, it punishes Cuba and Cubans. Prohibitions against travel to Cuba, with all its harking back to the glorious days of the Soviet Union's migration restrictions, hurts Americans (and Cubans), not Castro. In a post-Cold War world, the embargo is insane. What threat does Cuba give to America? Maybe someone doesn't want you to know about their health and educational system. Maybe someone doesn't want to admit that the Castro problem was an American made problem. Maybe someone is afraid that if they end it now, people will realize there was no reason to have it in the first place.

Michael Moore Movie Gets Two Thumbs Up

I saw Sicko yesterday and it was very good. Most criticisms of the movie, like those of Fahrenheit 9/11, is that he uses factual inaccuracies. Admittedly, there are a few glaring ones that I immediately noticed, but these do not detract from his core message. Unfortunately, I don't think I learned a single thing from the movie and you could probably learn more from my post, "The Great Health Care Debate." With that said, the movie is well-done and a great wake-up call to all those that think we have decent health care.