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Updated: 2 hours 27 min ago

Markets, IMF send Brazil clear message: Reform your economy - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

3 hours 47 sec ago

One has to hope that Brazil’s presidential candidates in that country’s October elections are listening to the clear signals coming first from the markets and now from the International Monetary Fund about Brazil’s troubling economic prospects.

If not, we should brace ourselves for a major economic crisis in the world’s eighth-largest economy that could send ripples through the global economy.

Over the past few years, in a global environment of very easy money, markets chose to turn a blind eye to Brazil’s shaky public finances and to its poor economic growth record. They did so as investors stretched for yield.

However, this picture seems to have changed abruptly since the start of this year. It did so as U.S. Treasury yields approached 3 percent and as the U.S. dollar began to appreciate in response to clear indications that the Federal Reserve was intent on normalizing U.S. monetary policy and reducing the size of its bloated balance sheet.

With attractive returns now on offer on low-risk U.S. financial assets and with a strengthening U.S. dollar, investors have become more discriminating in their investments, particularly toward the emerging market economies.

The capital that had earlier flooded those latter economies in the easy global money times also started to come back to the U.S. As a result, along with the currencies of Argentina, South Africa and Turkey, the Brazilian real has been pummeled by almost 20 percent since the start of the year. At the same time, its government bonds and its equities have taken a beating.

If Brazilian policymakers might be excused for not fully grasping the clear signal that the markets are now sending them about the need for economic and public financial reform, they have no excuse for not understanding the explicit message about the urgent need for economic reform coming out of the IMF.

At the conclusion of its recent annual economic review, the IMF noted that the Brazilian economy has been underperforming relative to its potential, its public debt is high and increasing, and, more importantly, medium-term growth prospects remain uninspiring, absent further reforms.

The IMF went on to warn that especially against the backdrop of tightening global financial conditions, placing Brazil on a path of strong, balanced and durable growth would require a committed pursuit of fiscal consolidation and ambitious structural economic reforms.

A well-founded concern of both the markets and the IMF is the explosive path on which Brazil’s public debt now seems to be set. Since 2014, Brazil’s public debt as a share of GDP has jumped some 20 percentage points to its present level of around 75 percent.

More troubling yet, on present policies and on rather optimistic assumption about future economic growth, the IMF is projecting that over the next few years, Brazil’s public debt will increase further to 90 percent of GDP. That would take its public debt level well beyond that which in the past has got the country into deep economic and financial trouble.

Against the backdrop of the prospective continued tightening in the global liquidity cycle, one has to be concerned about troubling signs that Brazil might not have the political will to address its poor public finances in a timely manner.

One such sign was that following the recent crippling truckers’ strike against high fuel prices, the current Brazilian government was forced to increase fuel subsidies and to soften its economic policy stance.

More disturbing signs of the lack of political will are the strong showing of populist candidates in the polls for October’s presidential election and the fact that even mainstream candidates are shying away from a discussion of what the country needs to do to turn around its public finances and to jumpstart its economy.

Hopefully, in their setting of monetary and trade policies, U.S. policymakers are taking note of the dangerous path on which the Brazilian economy now finds itself as well as of how Brazil can impact the U.S. and global economies. Unlike Argentina and Turkey, which are already enmeshed in major economic crises, Brazil is South America’s largest economy and is a highly indebted country of systemic importance.

One would think that the last thing that Brazil’s already fragile economy now needs is a further intensification of U.S. import protection or a more rapid increase in U.S. interest rates.

One would also think that at a time that the Chinese economy is slowing and Italian developments are raising the prospect of a return of the U.S. sovereign debt crisis, the last thing that the U.S. economy needs is a full-blown Brazilian economic and financial crisis.

Five reasons why Europe fines Google and the US tech sector - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

5 hours 54 min ago

Since June of last year, the European Union (EU) has grabbed $7.7 billion from Alphabet Inc. (Google’s parent company): a record-setting $5 billion fine last week, which topped the $2.7 billion record-setting fine slapped on Alphabet in June 2017.


What were Alphabet’s sins? The $5 billion fine was for creating the very successful Android operating system, which the company gives away to device manufacturers in exchange for the inclusion of profitable Google apps and services on devices. The $2.7 billion fine was for developing a great search engine and giving it away for free in exchange for users accepting the company giving priority placement to some of its profitable services.

There is a pattern here: First, US tech startups take large risks developing more new products than anyone bothers to count, of which only a small number succeed. Next, some of the successful companies expand into Europe using the same business strategy they use everywhere else: give services away for free in exchange for customers accepting marketing of profitable services. Lastly, the EU objects to European customers’ choosing to use these services and fines the US companies.

Why does this pattern exist? There are at least five reasons why the EU imposes record-breaking fines on US tech companies.

Reason 1: It’s good politics

Geopolitics matters. As Senator Orin Hatch (R-UT) tweeted: “The EU has a history of engaging in regulatory, tax & competition actions & proposals that disproportionately hit U.S. tech companies. This decision calls into question whether these actions are anything more than a series of discriminatory revenue grabs.”

There is evidence supporting the senator’s claim. Dating as far back as the WorldCom-MCI merger and the proposed GE-Honeywell merger, the EU went after US companies at least in part because they might outperform European companies.

But if the EU’s plan is to benefit European tech companies, it isn’t working out. As my AEI colleague James Pethokoukis showed last year, out of the 20 global leaders in tech, none are from Europe.

Reason 2: EU competition policies attack business models that make companies great

Europe’s competition policy places restrictions on what it defines as “dominant” companies. What does it take to be declared dominant? A market share greater than 40 percent held over a number of years, which, oddly enough, is also the definition of a successful company with large numbers of happy customers. And of course, there can be a bit of magic here since the antitrust authorities get to define the term “market,” which lacks a certain degree of coherence in tech. In the immediate case, the EU concluded that Apple’s app store and iOS are no competition for Android. That must be a shock to happy Apple customers.

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In Europe, once a company becomes successful, it has to stop some of the practices that customers like. This harms customers, but the EU is more concerned that standout companies distort competition by, well, standing out. In the immediate case, the EU considered it a problem that large number of Europeans bought Android phones rather than iPhones or Windows-based phones. Presumably Alphabet should have lowered the value of its offering once it proved popular.

Reason 3: The EU doesn’t like network effects

Google’s search engine is a two-sided market in that the users of search (one side of the market) attract advertisers (the second side), including Google. Google pays for its search engine from the money it makes from selling advertising or its own services that users find through the search engine. The more money Google makes from such advertising and services, the more it is willing to spend on making its search engine even more attractive to users. This benefits users, but the EU objects. An objection to network effects was central to the EU’s opposition to the Worldcom-MCI merger.

Reason 4: Bundled services also seem to bother the EU

Bundled services can be a win-win for customers and companies. Sometimes the bundle is more affordable for customers because bundling can increase sales, which allows a company to spread fixed costs over more customers. Other times the bundle prompts customers to use services that they value but wouldn’t otherwise choose if they had to pay separate prices.

The EU views bundling as a problem if a company is successful with some element of a bundle. This appears to be part of the problem that Google encountered in the most recent fine. Google gave away a lot of Android operating systems but did so bundled with profitable apps and other services, the revenues from which covered costs for the operating system. The potential value of a bundle was a central EU concern with the proposed GE-Honeywell merger.

Reason 5: The EU doesn’t like the messiness of tech innovation

Success in tech requires a willingness to destroy things by making them obsolete. According to a study by the EU, the majority of Europeans don’t like this idea very much, preferring to work in established institutions. Over half of Americans prefer to strike out on their own.

So it’s no surprise that European authorities would object to American entrepreneurs making headway in Europe by disrupting the established order.

What can be done? The community of antitrust professionals and academics should address this head-on by filling gaps in how antitrust should be applied in situations with network effects, clearly distinguish between business success and market power, and investigate the unique features of digital markets. This will pressure European professionals to modernize their approaches. Policy makers should also engage to ensure that antitrust enforcement is about customer harm and not used for other purposes.

(Disclosure statement: Mark Jamison provided consulting for Google in 2012 regarding whether Google should be considered a public utility.)

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AEI Political Report: Polls on Kavanaugh’s nomination, the Supreme Court, Roe v. Wade, and abortion - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

11 hours 53 min ago

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The July–August issue of AEI’s Political Report provides public opinion context for the hearings that will be held on Brett Kavanaugh’s nomination to the Supreme Court by looking at attitudes toward the Court and at views on Roe v. Wade and the legality of abortion.

In addition, we examine public views about democracy. Are Americans dissatisfied with democracy itself, or are they dissatisfied with the way our democratic government is performing?

The Supreme Court 

  • Support for Kavanaugh and past nominees: Data from several pollsters on past Supreme Court nominations show that initial support for confirmation usually outweighs opposition, although many people opt not to weigh in either way. Early polls about Brett Kavanaugh’s nomination show a slightly narrower division between support and opposition than there was in initial polls about recent past nominees (Gallup, Pew, Fox News, Huffington Post/YouGov).
  • Ideology of the Court and partisan approval: More people today think the current Supreme Court is too conservative (29 percent) than think it is too liberal (21 percent), a reversal from polls in 2009–16, although a plurality (44 percent) continue to say it is “just about right” (Gallup). Views of the Court have been divided by partisanship since Bush v. Gore. Approval of the Court rose among Republicans from 26 percent in September 2016 to 72 percent in July 2018, while it fell from 67 percent to 38 percent among Democrats over the same time period.
  • Confirmation factors: Pollsters have used different wording to understand what Americans think senators should consider in voting on a nominee. A majority of Americans in a recent Pew survey said Supreme Court nominees should be required to answer when senators ask them about issues such as abortion. At the same time, a recent Gallup poll found people are divided as to whether senators would be justified in voting against a qualified nominee if they disagree with the nominee’s stance on issues such as abortion, gun control, or affirmative action. A majority of registered voters in a recent Fox poll said it is unacceptable for a senator to base his or her vote on a nominee solely on the nominee’s position on abortion.

Roe v. Wade and abortion 

  • Roe: Most Americans do not want the Supreme Court to overturn Roe v. Wade. Three recent polls by Gallup, Fox News, and Kaiser Family Foundation all found that more than 6 in 10 said Roe should not be overturned.
  • Legality of abortion: Decades of polling has shown that pluralities to majorities think abortion should be legal in some circumstances or cases (Gallup, Pew). Most (60 percent in Gallup’s 2018 survey) say abortion should generally be legal during the first three months of pregnancy, but few (13 percent) say that it should during the last three months. In General Social Survey questions asked since 1972, majorities have consistently said it should be possible for a woman to obtain a legal abortion if her health is seriously endangered, if the pregnancy was a result of rape, or if there is a strong chance of a serious defect in the baby (NORC). Support for legal abortion “for any reason” is lower.
  • Deal breaker for voters? Surveys suggest people care about a candidate’s position on abortion, but most don’t see it as a deal breaker. Sixty-four percent of registered voters in a December 2017 Quinnipiac survey said they would still vote for a candidate with whom they did not agree on the issue of abortion. In a March 2018 Public Religion Research Institute poll, 18 percent of adults said they would only vote for a candidate who shares their views on abortion, a plurality (47 percent) said they would consider a candidate’s position on abortion as just one of many important factors, and 30 percent did not see abortion as a major issue.

Democracy’s discontents 

  • Americans view democracy positively but are deeply dissatisfied with the US democratic government’s current performance. For example, 86 percent told Pew pollsters in early 2017 they thought “a democratic system where representatives elected by citizens decide what becomes law” is a good way of governing this country, compared to 46 percent who said they were satisfied with the way democracy was working in our country.

To view past issues of AEI’s Political Report, visit our archive here.

Trump can shut down his Russia critics with one bold move - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Sat, 07/21/2018 - 12:00

If President Trump wants to shut down the critics of his performance this week in Helsinki and strengthen U.S. national security, he can do so with one bold move: Announce he is moving out most U.S. forces currently stationed in Germany and sending them to Poland.

The Polish government recently presented Trump with a formal proposal to move U.S. troops from Stuttgart, Germany, to a new permanent U.S. military base in Poland. Trump should take up Warsaw on this offer.

Moving U.S. troops to Poland would be a bold, historic decision on par with Trump’s decision to move the U.S. Embassy to Jerusalem. Not only would it better position American forces, it also would completely flummox Trump’s critics in the U.S. foreign policy establishment. After spending the past week accusing him of being Putin’s puppet, they would look foolish if they turned around and criticized him for antagonizing Russia. And after attacking him for undermining NATO, they could hardly complain that he is taking unprecedented action to shore up the alliance’s Eastern flank.

Such a move would reinforce the tough line the president took on defense spending at last week’s NATO summit, by punishing a deadbeat ally that does not meet its NATO commitments and rewarding a steadfast ally that does. Why should Germany — a country that spends just 1.24 percent of its gross domestic product on defense — continue to be rewarded with the economic benefit of U.S. bases? Better to station U.S. forces in a country such as Poland that is providing what Trump has called a “truly magnificent” example as “one of the NATO countries that has actually achieved the benchmark for investment in our common defense.”

Trump can further argue that Germany’s actions beyond its inadequate defense spending have necessitated this move. At NATO, Trump blasted the Germany-to-Russia Nord Stream 2 gas pipeline, declaring “it’s a very bad thing for NATO.” He’s right. The pipeline not only makes Germany more dependent on Moscow for energy, it also risks the security of Poland and other Eastern European allies. Right now, all Russian gas exports to Western Europe go through pipelines that cross Poland and Slovakia — which means Russia cannot cut off gas to NATO allies in the East without also cutting off its lucrative exports to the West. But once the new pipeline is built, sending gas directly to Germany under the Baltic Sea, Russia will be able to shut off energy supplies to Eastern Europe far more easily. Trump can correctly say that he needs to shore up the security of NATO’s East European allies because of the German government’s sign-off on the pipeline.

The move would also address a major U.S. strategic concern about its ability to deter Russia. The Post recently reported that U.S. military commanders are worried that if they had to quickly move U.S. troops east to head off a military conflict with Moscow, “the most powerful military in the world could get stuck in a traffic jam” as “Humvees . . . snarl behind plodding semis on narrow roads” and “U.S. tanks . . . crush rusting bridges too weak to hold their weight.” Stationing American forces in Poland would alleviate that problem. As the Polish government points out in its proposal, “a U.S. permanent presence in Poland [offers] a more forward operating location than Stuttgart provides, would greatly alleviate well founded fears that fellow Eastern European and Baltic governments have that Moscow would be able to overtake defending forces prior to the support of U.S. and NATO forces in Stuttgart could provide.”

The move would also benefit U.S. taxpayers. The Polish government has offered up to $2 billion to cover most of the costs of building such a base and supporting U.S. troops in Poland, declaring it is committed “to share the burden of defense spending [and] make the decision more cost-effective for the U.S. government.” This should be attractive to Trump, who has criticized other allies for not paying enough for the cost of stationing U.S. forces on their territory.

And there is one last good reason to do it: Poland loves Trump. When Trump spoke in Warsaw last year, his speech was repeatedly interrupted by chants of “Donald Trump! Donald Trump!” Such a response would be unimaginable in Berlin.

The U.S. military presence in Germany is a legacy of the Cold War, when we positioned our forces to deter a Soviet invasion from East Germany. Today the need for deterrence is undiminished, but the potential line of contact has moved east. So should the U.S. military.

De-industrialization? Well, America’s thriving manufacturing sector just produced a record level of output in Q1 - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 21:09

The Bureau of Economic Analysis released data today on America’s GDP by industry for the first quarter of this year, and those BEA data show that real US manufacturing value added was more $2 trillion (in inflation-adjusted 2009 dollars) during the first three months of this year, setting a new all-time record high for America’s manufacturing output (see chart above). And yet we continue to hear all the time about how America doesn’t produce anything anymore, how all of our factory output has moved overseas, and how America’s manufacturing sector has been hollowed out and decimated, etc.

For example, here’s what presidential candidate Donald Trump wrote in USAToday in March of 2016:

Throughout history, at the center of any thriving country has been a thriving manufacturing sector. But under decades of failed leadership, the United States has gone from being the globe’s manufacturing powerhouse — the envy of the world — through a rapid deindustrialization that has evaporated entire communities.

US factory jobs have declined by almost 7 million since peak manufacturing employment in 1979 of 19.5 million, but largely because of advances in technology and significant increases in worker productivity. Just since 2006, the amount of manufacturing output per US factory worker has increased by more than 22%, as we are able to produce increasing, record-setting levels of output with the same or fewer number of factory workers.

Bottom Line: In terms of factory output, the US manufacturing sector is thriving and is still a global manufacturing powerhouse that produced more factory output during the first quarter of this year than any quarter in US history. In contrast to Trump’s rhetoric and public opinion, there has been no de-industrialization or hollowing out of American manufacturing, and that thriving sector of the US economy is actually “alive and well,” depsite rumors of its demise.

Reining in the administrative state | In 60 Seconds - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 14:33

The administrative agencies of the United States executive branch are gradually taking over the legislative role of Congress, adding thousands of laws each year outside the purview of Congress. AEI’s Peter Wallison argues that Americans can reign in this legislative overreach by selecting the right judges at all levels of government.

Drug importation should lower prices, but the FDA can do more - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 13:43

The Washington Post ran a story yesterday about the Trump administration contemplating allowing limited drug importation to address shortages and high prices.

The FDA is to put a group together to discuss options. I suspect this will go nowhere because the drug industry doesn’t want it to. Not that FDA requires a group. Foreign web pharmacies credentialed by pharmacychecker.com already encourage importation for those in the know. As I found when I tested them, they sell good quality medicines at roughly half the price of US-based pharmacies.

Dr. Scott Gottlieb testifies before a Senate Health Education Labor and Pension Committee confirmation hearing on his nomination to be commissioner of the Food and Drug Administration on Capitol Hill in Washington, DC, US April 5, 2017. REUTERS/Aaron P. Bernstein

The Post makes a point that I’ve heard repeatedly from those who oppose importation on practical grounds. Basically the argument is that if you allow importation from country X (Canada is usually the prime example), the drug industry will simply cut off supply to that country, thus nullifying the practice.

This is ridiculous for several reasons. Most importantly, Pharmacy Checker credentials pharmacies in Europe and Europe allows for redistribution of drugs throughout its systems. Therefore the drug industry would have to boycott the whole of Europe. Ignoring the loss of revenue, can you imagine the publicity (to say nothing of lawsuits) the second a grandmother in Paris or London or Berlin dies because she couldn’t get a drug in question?

As soon as President Trump mentions prices are high, Pfizer backtracks on increases, and Novartis and Merck say they won’t raise them.

But actually access to cheaper medicines is likely to diminish, thanks to the opioid crisis. Industry-backed pressure groups have been pushing the FDA to clamp down on internet sales of opioids. Part of the policy will be stopping all technically illegal mail order activities, and this means your Lipitor from Canada.

All the FDA has to do is allow Pharmacy Checker to do its job and tell the American people about it.

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The US counterpunch to the OECD BEPS Project - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 13:13

The OECD’s Base Erosion and Profit Shifting (BEPS) project is aimed at reducing the ability of multinationals to shift profits out of high-tax countries to low-tax ones and to avoid double non-taxation. It does so by tying reported profits more closely to ‘economic substance’, meaning that companies can only claim profits where real economic activity — such as jobs, assets and sales — is actually located.

When the OECD first announced its 15 step action plan to go after tax planning and double non-taxation by multinationals, I wrote about why the BEPS Project should be a source of concern for the US. At that time, the US had the highest statutory corporate tax rate in the OECD and there was a real risk that the country would lose economic activity — jobs, research activity and actual production — to other low-tax jurisdictions.

Since that time, much has changed. In December 2017, the US passed an historic corporate tax rate cut as part of the Tax Cuts and Jobs Act (TCJA), lowering its headline corporate rate from 35 per cent to 21 per cent, less than the OECD average. It also made significant changes to the international taxation of US multinationals.

The US Response to BEPS: What do These Changes Signify?

A big takeaway is that, post-tax reform, the US has unilaterally taken steps to address profit shifting, base erosion and non-taxation of multinational income. In addition, it has created strong incentives for companies to relocate investment, economic activity and profits in the US through a more competitive tax code. If I were to rewrite my op-ed referenced earlier, I would title it ‘The OECD is right to worry about the US BEPS project’, instead of the reverse.

A prominent agenda item of the OECD BEPS project is the taxation of digital companies. Many countries in the European Union have expressed frustration with the fact that tech companies, such as Apple, Google, Facebook and Amazon, are able to operate and sell within their jurisdictions, but pay little or no corporate income tax. Some countries have tried to unilaterally implement measures such as a diverted profits tax, or equalization levies to tax digital activities. The US tax reform effort has put in place a provision that would provide US multinationals a lower tax rate on ‘intangible income’ – in reality, high profits not tied to tangible forms of capital – earned from foreign sources. Broadly speaking, the Foreign-Derived Intangible Income (FDII) rule provides a deduction of 37.5 per cent to intangible income derived by domestic companies from their overseas operations, lowering a domestic corporation’s effective tax rate to 13.125 per cent. If this works effectively, digital companies should find it in their interest to move, not just their profits to the US, but their intellectual property as well. In addition, the TCJA now imposes a minimum tax on excess foreign earnings of US multinationals. Hence, if the aim of the BEPS project was to capture more of this intangible income in the European Union, the new US tax law will likely interfere with their efforts.

FDII is also a reaction to BEPS Action 5, which is aimed at developing new substance rules for patent boxes. Patent boxes are essentially means by which companies can get preferential tax treatment for certain intellectual property such as patents. The BEPS project tries to tie these kinds of preferential tax treatments to real activity, so as to discourage companies from merely shifting profits to low tax jurisdictions that offer such benefits. While FDII does provide a deduction on this kind of intangible activity, it does not take into account the substantial nexus (economic activity) requirement. However, given that substance requirements are becoming more important under BEPS, non-US companies should still have an incentive to meet substance requirements for any excess income claimed in the US.

BEPS Action 2 aims to neutralize the effects of hybrid mismatch arrangements. In effect, the aim of this action item is to prevent companies from being able to get multiple deductions for a single expense, deductions in one country without corresponding taxation in another, or the generation of multiple foreign tax credits for one foreign tax payment. Similar to BEPS Action 2, the TCJA also adopts an anti-hybrid rule. Under it, a US company is no longer allowed a deduction for an interest or royalty payment to a non-US related entity if the local tax rules in the jurisdiction of that entity exempt such a royalty or interest payment from tax. This new rule would reduce the ability of firms to lower their tax bill by showing higher interest or debt payments for US tax purposes when such payments would otherwise go untaxed on the other side. In addition, US shareholders will not be allowed to avail of tax-free repatriations of ‘hybrid dividends’. A hybrid dividend is an amount otherwise eligible for the dividends-received deduction for which the distributing controlled foreign corporation (CFC) received a deduction with respect to income taxes imposed by a foreign country.

The BEPS CFC recommendations are designed to ensure that tax jurisdictions have rules that prevent taxpayers from shifting certain kinds of passive income into foreign low-taxed subsidiaries in which they have a controlling interest. This is something that the US had pushed for, but which did not receive much support from other countries. As a result, these are not adopted as minimum standards in BEPS, but are recommendations for best practices gathered from other countries’ experiences. Accordingly, the TCJA has broadened the scope of CFC rules to include the case where a non-US parent owns both US and non- US subsidiaries. In this case, non-US subsidiaries, which are sister companies to the US subsidiaries are now going to be treated as CFCs. These CFCs will be required to make detailed annual filings with the IRS regarding the activities of non-US subsidiaries. In addition, if a US subsidiary owns 10 per cent or more of the shares of a non-US sister company, then the US subsidiary must generally include in income its share of passive-type income, such as dividends, interest and royalties and certain other income received by the non-US sister company.

Action 4 of the BEPS project is an attempt to reduce base erosion through limitations on interest deductibility and other financial payments. The problem here is that since interest payments are tax deductible, intra-group financing within a company can lead to high levels of debt and total interest deductions that could exceed their unrelated third party interest expense. Along the same lines, the TCJA limits interest deductions for a US company to the sum of a US company’s business interest income for the taxable year plus 30 per cent of the company’s adjusted taxable income for the year.

Another BEPS recommendation that has been adopted by the US includes country-by-country reporting standards. The BEPS project requires participants to report country-specific information on a common template about income, employment, and taxes paid, and to exchange that information with other countries. In the TCJA, the base erosion and anti-abuse tax (BEAT) would further allow the Treasury to obtain information on reporting companies such as the name, place of business, countries in which related parties are resident and any base erosion payments made. The BEAT is a 10 per cent minimum tax on the amount of any base-erosion tax benefits that US companies derive from transactions with non-US affiliates. It relates to any deduction that results from a payment by a US company to a related party, such as interest or royalty payments.

Finally, in order to reduce multinationals’ ability to avoid US taxes, the TCJA has put forward mandatory repatriation and GILTI (global intangible low-taxed income) provisions. As the US has now moved to a territorial system, it is possible, in practice, for companies to pay dividends to their US parent without facing any taxes. This could potentially result in a loss in revenues since companies have built up more than US$2 trillion in untaxed offshore earnings over the last several decades. Instead, the TCJA imposes a one-time tax on such foreign held earnings. The tax rate is 15.5 per cent for earnings held as cash or cash equivalents, and 8 per cent for reinvested earnings. A second provision, termed GILTI, imposes a tax of 10.5 per cent on certain amounts of profits (in excess of 10 per cent of depreciable tangible property) earned by non-US subsidiaries, irrespective of whether those profits are repatriated, unless the non- US subsidiaries have paid a significant amount of taxes on these profits already.

One contentious area where the US has co-operated with the OECD, but as yet has refused to sign on to, is in the area of multilateral treaties under BEPS. The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) provides ways by which governments can close the gaps in international tax rules so as to avoid double taxation, battle tax treaty abuse and improve dispute resolution mechanisms. BEPS participants have generally agreed to revise their bilateral tax treaties to incorporate BEPS measures to go after tax avoidance and treaty abuse. All signatories are required to commit to BEPS mandatory standards. The US has not signed on to this and insists that its own treaty framework already meets BEPS minimum standards. The new treaty model that it released in 2016 includes provisions that further reduce companies’ ability to use the treaty for tax avoidance. Some of these new provisions have been adopted in the TCJA as well, such as the denial of the participation exemption for payments made from inverted companies.

As is clear from the review above, the TCJA has dramatically changed the landscape for US multinational firms. It has pushed the US forward in terms of tackling profit-shifting, non-taxation and base erosion. While the US has not adopted BEPS wholeheartedly, it has adopted several unilateral measures that would reduce base erosion and profit shifting. At the same time, with a more competitive corporate tax code, the hope is that there are now strong incentives for firms to locate real economic activity in the US, as well as profits and intangible incomes. In effect, the US has now beaten the OECD BEPS Project to the punch.


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Which countries win and lose if the EU’s digital taxation plans are adopted? - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 11:00

The European Commission recently released two proposed directives that relate to the taxation of the digital economy. Adoption of these directives requires consensus among the member states, which does not seem particularly likely in their current form. That said, the proposals are important indicators, both of where the Commission stands, and where some of the countries that have been supportive of the proposal, such as France, may choose to go by themselves. Both proposals would shift tax revenue from the United States to Europe – and would potentially invite retaliation – by taxing activities dominated by American firms where their customers are located. This shift toward destination-based taxation would also reduce the scope for tax competition both within the European Union and between the European Union and countries outside it.

The first proposed directive[1] is meant to provide a definitive, permanent answer to the question of how to tax firms that operate online as opposed to only through traditional physical establishments. This question is an important one both within and across countries. In the United States, for example, the Supreme Court is in the midst of deciding whether South Dakota is allowed to collect sales tax from online retailers without a physical presence in the state, in South Dakota v. Wayfair, Inc. The disputed South Dakota law would subject online sellers with annual sales over US$100,000 or more than 200 transactions to South Dakota’s sales tax regime and all the compliance and enforcement burdens that accompany it.

In this proposal, the Commission applies a similar criterion at the national level to determine whether firms are deemed to have a significant digital presence in a member state, in which case they are allowed to tax profits deemed to have been generated within their borders. A firm would be considered to have a significant digital presence – ‘a virtual nexus’ – in a member state if its annual revenue there exceeds €7 million (US$8,289,144), or if it has more than 100,000 users in the member state, or it has over 3,000 contracts for digital services with businesses in the member state.

The second proposed directive[2] is presented as a temporary solution that allows countries to collect taxes on certain digital activities while negotiations regarding the permanent fix take place. This interim tax – though what is temporary today can of course become permanent tomorrow – is more narrowly targeted. It would apply only to social media operations and online ad sales, and only to certain large companies – those with worldwide revenue of at least €750 million (US$886 million) and revenue within the European Union of at least €50 million (US$59 million). Those activities, if carried out by such firms, would be hit with a gross-proceeds tax of 3 per cent.

The central justification offered by the Commission for these two proposals is that digital activities escape traditional taxation. The implicit contrast here is with brick-and-mortar establishments that add value and sell products in a single location, which is also where its employees and consumers live. These various elements have of course come unbundled before, in all types of industries, and it is hard to believe that it was through purely deductive conceptual reasoning that the Commission arrived at these proposals. Instead, it is unlikely to be a coincidence that the economic activities at issue here – especially those affected by the interim proposal – are ones where the European Union is a net importer, not a net exporter. While the Commission argues, for example, that only about half of the firms that would owe the 3 per cent gross-proceeds tax are American, the share of actual payments owed would surely be larger. (Note that even a 50 per cent share is quite large, of course.)

But, back to the idea that digital activities escape traditional taxation in a unique manner. There are three different elements at work here. One is that, as discussed, non-European firms are dominant in this industry. Their intellectual property is often located outside the European Union, and most of the value added is created there as well. These companies’ income is therefore mostly not taxed in the European Union, but that certainly does not mean that they are not taxed, especially now that the United States has adopted what, for all intents and purposes, is a global minimum tax. The Commission responds to this by arguing that value in this industry is actually created through “user engagement”, and that the location of such engagement should determine where profits are taxed, which is not currently the case. Most economists would probably dispute that this is a unique feature of social media: the food I buy is also useless if I don’t eat it, where eating is a traditional form of user engagement.

This takes us to our second consideration. One can easily envision a system of corporate taxation that is destination-based, i.e. that taxes profits where consumers are located. In fact, Republicans in the US House of Representatives proposed precisely such a scheme just last year. What does not necessarily seem reasonable is to apply this type of system, as the Commission proposals do, only to industries where consumers are disproportionately domestic.

The third consideration, and one that has led to significant opposition to the Commission’s proposals within the European Union, is that a destination-based tax system, whether organised on the basis of ‘significant digital presence’ rules or not, automatically reduces tax competition. If companies owe taxes strictly based on where their consumers are, they can no longer choose to locate where the tax environment is friendliest unless they manage also to organise massive migration flows. This ought to be concerning to low-tax countries, which would lose some of their attractiveness. The specific criteria proposed to detect a significant digital presence are, in addition, absolute numbers that do not vary with country or population size. This reduces the taxation powers of small EU nations relative to larger ones, which should concern said small nations. (There are countries, of course, that are both small and of the low-tax variety!)

Perhaps then this debate is not solely about new challenges posed by new technology. Perhaps the allocation of resources and the power to extract them are, in fact, as controversial as they have always been.

[1] European Commission, ‘Proposal for a Council Directive – laying down the rules relating to the corporate taxation of a significant digital presence’ Brussels, European Commission, 2018, https://ec.europa.eu/taxation_customs/sites/taxation/files/proposal_significant_digital_presence_21032018_en.pdf (Accessed 16 May 2018)

[2] European Commission, ‘Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services, Brussels, European Commission, 2018, https://ec.europa.eu/taxation_customs/sites/taxation/files/proposal_significant_digital_presence_21032018_en.pdf (Accessed 16 May 2018)

Conservatives should welcome Obama’s belated rejection of identity politics - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Fri, 07/20/2018 - 10:30

‘Democracy demands that we’re able to also get inside the reality of people who are different than us, so we can understand their point of view. Maybe we can change their minds, maybe they’ll change ours.”

That was Barack Obama speaking in South Africa on the 100th anniversary of Nelson Mandela’s birth.

South African President Cyril Ramaphosa talks to former President Barack Obama at the 16th Nelson Mandela annual lecture, marking the centenary of the anti-apartheid leader’s birth, in Johannesburg, South Africa July 17, 2018. Reuters.

The former president went on to say that you can’t change people’s minds “if you just out of hand disregard what your opponent has to say from the start. And you can’t do it if you insist that those who aren’t like you, because they are white or they are male, somehow there is no way they can understand what I’m feeling, that somehow they lack standing to speak on certain matters.”

Now, I am biased. I recently wrote a book making many of these and other points Obama made. But I also understand why many conservatives are dyspeptic about Obama pushing this message.

As president, and on his path to the presidency, Obama often exploited identity politics for partisan advantage. He called on Hispanic voters to “punish our enemies.” He appointed to the Supreme Court Sonia Sotomayor, who famously suggested that a “wise Latina” on the bench would come to better conclusions than a white male would.

Obama also had an annoying tendency to ascribe bad faith to anyone who didn’t share his opinions or conclusions.

Nevertheless, Obama is right. Identity politics is a fundamentally undemocratic phenomenon. It assumes that vast numbers of individual human beings can be reduced to the color of their skin, their gender, or their sexual orientation. Diversity among different “kinds” of people is celebrated everywhere, but intellectual, ideological, and political diversity among those groups is demonized. The idea that all I need to know about someone is the color of their skin — white or black — strips individuals of their individuality and their agency.

Obama is also right when he says that “strongman politics are ascendant suddenly, whereby elections and some pretense of democracy are maintained — the form of it — but those in power seek to undermine every institution or norm that gives democracy meaning.”

Obama implied that this is only a phenomenon of the Right, and was almost surely taking a veiled shot at Donald Trump.

But this is a problem of the Left, too. The right-wing populism galloping across Europe is in no small part a response to the undemocratic tactics of the European Union, which looks at democratic accountability with a sovereign disdain.

More importantly, many nationalist-populist voters backed Trump in part out of their understandable frustration with the way “the establishment” ignored the will of voters and even constitutional prohibitions. Obama, for example, said he couldn’t award amnesty to the children of illegal immigrants because the Constitution prevented him. Then he did it anyway.

But here’s the thing: I’m still glad Obama is saying these things because, again, he’s mostly right.

Americans have always detested hypocrisy, in part because this country was founded on the idea that monarchs and aristocrats were no better than anyone else. A king can be a hypocrite because kings aren’t subject to the laws governing their subjects. In America, the dogma of “Who are you to judge me?” and “You’re not the boss of me” lives loudly in us. And I love that.

But everything good can become toxic if you increase the dosage too much. Our political culture has become poisonously obsessed with hypocrisy.

We act as if basic truths are untrue if the wrong messenger gives them voice. Former adulterers must not speak against adultery. Parents shrink from lecturing their children about, say, smoking pot or underage drinking for fear of feeling like hypocrites because they did those things when they were young. Never mind that good parenting requires giving your kids the benefit of lessons you’ve learned, not encouraging them to make the same mistakes you did.

I understand why some conservatives want to dismiss Obama’s statements. They only see the hypocrisy. But there’s a reason we say hypocrisy is the tribute vice pays to virtue. Hypocrisy is a good gauge of a person’s sincerity in defense of an ideal. It’s near-useless in gauging the merits of the ideal.

Would it be better if Obama endorsed tribalism and identity politics? Obviously not. Would it be better if he’d lived up to and defended these ideals better when he was president? Yes.

But outside of Jesus, I’m unaware of anyone who lived up to their ideals all of the time. Meanwhile, let’s celebrate when our political opponents agree with us.

Discussing NATO and the EU: Thiessen on Fox News’ ‘The Story With Martha MacCallum’ - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 23:20
Resident Fellow Marc Thiessen discusses the latest foreign policy headlines involving NATO and Montenegro on Fox News' 'The Story with Martha MacCallum.'

Discussing the socialist movement: Goldberg of Fox News’ ‘Special Report with Bret Baier’ - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 22:00
Fellow Jonah Goldberg says the Democrats are hellbent on unlearning all the lessons of the past, specifically regarding appealing to the center and super delegate reform on Fox News' 'Special Report with Bret Baier.'

Discussing the Helsinki Summit: Goldberg on Fox News’ ‘Special Report with Bret Baier’ - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 22:00
Fellow Jonah Goldberg discusses President Trump's comments regarding Russia and NATO and their implications on Fox News' 'Special Report with Bret Baier.'

Banter #323: Ed DeMarco on reforming Fannie Mae and Freddie Mac - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 16:24

This week on Banter, we’re joined by Ed DeMarco to discuss the history of Fannie Mae and Freddie Mac, these entities’ role in the 2008 housing market crash, and how (and if) Fannie and Freddie could be reformed. From September 2009 to January 2014, Dr. DeMarco served as acting director of the Federal Housing Finance Agency, conservator for Fannie Mae and Freddie Mac, and regulator of those companies and the Federal Home Loan Banks. Today, he serves as the president of the Financial Services Roundtable’s Housing Policy Council and a senior fellow in residence at the Milken Institute’s Center for Financial Markets. He participated in an AEI public event hosted by AEI Resident Fellow Ed Pinto on whether Fannie and Freddie should be expanding or shrinking their activities. You can watch the full event video at the link below.

Learn More:

Should Fannie Mae and Freddie Mac be shrinking or expanding their activities? | Ed Pinto | AEI public event video | July 12, 2018

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Europe’s idiotic war on Google - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 15:41

Not every trade war involves tariffs. The European Union’s record $5 billion fine against Google for antitrust violations involving its Android operating system is protectionism masquerading as consumerism. And the risk for America isn’t that the penalty will sink the U.S.-based technology titan — parent Alphabet makes that much dough every couple of weeks in revenue — but that anti-tech activists here will be encouraged to ramp up their attacks against the country’s most innovative companies.

European Competition Commissioner Margrethe Vestager addresses a news conference on Google in Brussels, Belgium, July 18, 2018 Reuters

Coming just days after President Trump slammed NATO for skimping on defense, it might look like Europe quickly found a clever way to finance some additional military spending. But the EU’s actions against Google began with a wide-ranging investigation back in 2010 that previously led to a $2.7 billion fine against the company for using its market share to unfairly benefit its comparison shopping service.

The core of the EU’s complaint this time around is that Google used restrictions on the use of Android — which runs more than 80 percent of the world’s smartphones — to unfairly favor its own search, browser, and other services. A mobile phone company that wants to offer the Google Play app store must also preload a suite of other Google applications. In addition, it must make Google search the default search application. These and other “illegal practices,” according to EU antitrust boss Margrethe Vestager, “denied rivals the chance to innovate and compete on the merits.”

To accept the EU’s case, however, one has to ignore the reality of the modern internet, where users easily and frequently download millions of apps some 100 billion times a year. Indeed, even though developers must preload Search, Chrome, and some other Google services as a condition of licensing the app store, the arrangement is not exclusive. A device maker could also preload rival app stores and other apps. As it is, the Firefox browser, for instance, has been downloaded more than 100 million times on Play. And consider this: One thing that really bugged the EU was that the Android home screen displayed a Google Play icon and a folder of 10 other Google apps vs. the myriad of preloaded apps on the Apple home screen.

Such preloading has long been a part of Google’s phone business. It’s one thing that allows Google-developed Android to remain free, which has subsequently drastically lowered the cost and availability of smartphones. This has increased the number of people who own them. Developers in Europe and elsewhere are thus able to distribute their apps to over a billion people around the world. If Google couldn’t preload its money-making apps onto Android phones, it probably wouldn’t give Android away for free.

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Another reality: Google has a powerful app store competitor — Apple, which rakes in a whopping 87 percent of smartphone profits.

But maybe this isn’t just about competition. Amazon, Apple, and Facebook have also been the target of legal or regulatory actions lately, after all.

Yet you won’t find the U.S. suing Europe’s super-successful platform companies because, well, there aren’t any. Likewise, Europe has generated only a tenth of the fast-growing tech startups, or unicorns, found in the U.S. Instead of company creation, Europe seems to be specializing in regulation and investigation. The whole thing stinks of platform envy.

Then again, Europe’s gonna Europe. Perhaps more important for Big Tech is to what extent activists and policymakers here — both on the left and right — view Europe as a model for what they should be doing. While still more an issue for Washington and Wall Street than Main Street, the anti-tech movement isn’t going away. Progressives view it as an important front in their battle against inequality and oppressive corporate power. And many conservatives see left-leaning Silicon Valley as a political foe.

At a House hearing on Tuesday, Republican lawmakers pressed executives from Facebook, Twitter, and Google-owned YouTube over supposed bias against conservative views. Rep. Steve King (R-Iowa) even mused about the idea “of converting the large behemoth organizations that we’re talking about here into public utilities.” Whoa. Even Europe isn’t going that far, though some tech critics there think governments should develop public versions of Facebook and Google.

Lawmakers and regulatory agencies should be careful. Big Tech is where the fast productivity growth can be found in the U.S. economy right now. And rather than stagnant monopolies, they are in sharp competition with each other across a variety of businesses. If Washington is going to do nothing about these unceasing attacks against America’s tech giants, maybe they could at least avoid launching their own.

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The foolish court-packing craze - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 14:44

In their desperation over the prospect of losing the “swing” seat on the Supreme Court, some Democrats are considering a political and constitutional Armageddon if Judge Brett Kavanaugh — a well-qualified, intelligent, and mainstream conservative choice — replaces Justice Anthony Kennedy on the Supreme Court. These Democrats have begun to float the idea of packing the Court should Democrats win the White House and both houses of Congress in the future.

@IndypendenZ via Twenty20

Berkeley Law dean Erwin Chemerinsky recently told the Los Angeles Times, “The idea of expanding the size of the Supreme Court will get traction IF the Democrats take the White House and Congress in 2020. . . . It is the only way to keep there from being a very conservative Court for the next 10–20 years.” Another law professor recently wrote in The Atlantic, “On the day the Democrats hold power to alter the makeup of the court by bare-knuckle means, they will do it. And they should.”

A spate of recent articles in the Washington Post, the Los Angeles Times, and Slate, among others, show where the winds are blowing in the liberal punditocracy. Liberals are offering a variety of plans to expand the number of Supreme Court seats and fill them with liberal or progressive justices, thus guaranteeing that the Court will rubber-stamp the Left’s agenda. One proposal, by a political-science professor writing for the Washington Post earlier this month, calls for the resignation of the “illegitimate” Justice Neal Gorsuch; if that doesn’t happen, Court-packing should ensue. The above-mentioned law professor writing in The Atlantic claimed that Gorsuch’s appointment itself was an act of “packing” the Court.

None of this will prevent a shift to the right on the current Supreme Court. Democrats may resort to scorched-earth tactics to stop Kavanaugh, but President Trump has a deep bench of lower-court judges — the other two dozen on the White House’s list of candidates, to be precise. One of them will eventually get through. With a fifth conservative justice joining Chief Justice John Roberts and Justices Clarence Thomas, Samuel Alito, and Neil Gorsuch, the last remaining branch of the federal government will have slipped away from liberal hands. And two of the four liberal justices on the Court are in their eighties. For the first time in about eight decades, the country may have a truly conservative Supreme Court.

Under President Obama, power began slipping away from the Democrats, who currently control neither of the elected branches of the federal government nor the majority of the States. But rather than seek to reform themselves, Democrats have been attempting to discredit the institutions that they cannot control. They have attacked the Electoral College — a constitutional fixture since 1788 — ever since George W. Bush defeated Al Gore in 2000 and Trump defeated Hillary Clinton in 2016. Their attacks on Trump have passed beyond political criticism of an incumbent president and become an onslaught on the institution of the presidency. A Harvard law professor, for instance, has just told Newsweek that Trump’s conduct of diplomacy “could reasonably be defined as treason.” And, on Monday, a House Democrat from Tennessee tweeted. “Where are our military folks? The Commander in Chief is in the hands of our enemy!”

Now the Supreme Court is in the cross-hairs.

Court-packing would destroy the Court’s independence. Indeed, that is the very purpose of such proposals. But in a republic such as ours, judicial independence is essential if constitutional rights are to be protected. In the Federalist Papers, Alexander Hamilton explained that “the complete independence of the courts of justice is peculiarly essential in a limited Constitution.” Limitations on government “can be preserved in practice no other way than through the medium of courts of justice, whose duty it must be to declare all acts contrary to the manifest tenor of the Constitution void,” he argued. “Without this, all the reservations of particular rights or privileges would amount to nothing.”

Of course, the Constitution does not require that the Supreme Court have exactly nine members. It leaves Congress the discretion to fix the number of seats. Early in the Republic, when our population was vastly smaller, the number was normally six. In the Civil War period, it briefly reached ten. The number varied partly because of Court-packing schemes by the party holding, or leaving, power. But since the administration of President Ulysses S. Grant, in 1869, the number of Supreme Court seats has been nine.

The only serious effort since then to manipulate the number of justices — that of Franklin Roosevelt in the depths of the Depression, when his popularity and power were at their zenith — decisively failed. Both Republican and Democratic senators rightly viewed FDR’s court-packing plan as an attempt to neuter the Court because it had tried to impose constitutional limits on one of FDR’s signature achievements, the New Deal.

Court-packing is the kind of thing that leaders like Hugo Chávez in Venezuela or Viktor Oban in Hungary do.

From time to time, fair and thoughtful commentators have put forward various reform proposals to phase in new Court seats over a series of different administrations. Those gradual changes would eventually raise the number of Justices to, say, 15. We are not concerned here with such reform proposals. Nor are these Democrats. Instead, they are promoting a naked, unapologetic power grab.

To pack the Supreme Court would be to discredit it as a force in American political life. Court-packing is the kind of thing that leaders like Hugo Chávez in Venezuela or Viktor Oban in Hungary do. It makes the judiciary a tool of the political forces in power at a given moment. It is a policy for dictators or those with a dictatorial bent.

And it is a game that two can play. If a resurgent Democratic party packs the Supreme Court by giving its president the power to fill six new seats, then the next Republican cycle could put the Court’s membership at 27 — or 99. (The Polish Supreme Court has 110 members, the Chinese Supreme Court upwards of 300.) Or Republicans can do away with seats created by Democrats, or even try something truly radical, such as rotating lower-court judges through the Supreme Court for one- or two-year terms.

If Democrats threaten to use their future majorities to fight dirty, Trump, Majority Leader Mitch McConnell, and Speaker Paul Ryan could just as well start first and expand the Court right now.

If the Democrats want to break the Supreme Court utterly and irrevocably, packing it is exactly the way to do that. That Democrats are willing to destroy two centuries of constitutional tradition in order to protect Roe v. Wade and its progeny displays the nihilism at work in their midst.

The Supreme Court should halt, and even reverse, the spread of judicial activism into every social controversy.

Why does a party so closely associated with the idea of a “living Constitution” hold so tenaciously to Roe? If the Constitution is “living,” then any judicial precedent is up for grabs, including Roe and the 1992 Casey decision that preserved it. Neither Roe nor any precedent creates a super-rule that is embalmed in the Constitution in perpetuity.

There is a less destructive path to fixing the Court, for those critics who believe it is ailing. The emerging conservative majority on the Supreme Court should return power to the states and the people by continuing to resuscitate the basic constitutional principle of federalism. They should halt, and even reverse, the spread of judicial activism into every social controversy. When the states, rather than the federal government, decide questions about abortion, marriage, and religion, control of the Court will matter less. Each change in the Court’s majority will not have to be a crisis that shakes the Republic.

Political democracy depends on the existence of a responsible opposition that challenges the party in power vigorously while remaining loyal to our basic institutions. Those institutions depend on respecting certain norms and boundaries, and on a large degree of regard and toleration for political opponents. The politics of nihilism, however, will lead only to destruction.

Related reading:

John Yoo is the Emanuel S. Heller Professor of Law at the University of California at Berkeley and a visiting scholar at the American Enterprise Institute. Robert Delahunty is the Lejeune Professor of Law at St. Thomas School of Law. They both served in the Justice Department during the George W. Bush administration.

US debt ‘double whammy’ unsettles emerging markets - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 14:34

Writing in the Financial Times in June, India’s central bank governor Urjit Patel complained of the destabilizing effects of a U.S. debt “double whammy”: The Federal Reserve is ramping up its “balance sheet normalization” effort at just the moment when the U.S. budget deficit has been widening due to previously unanticipated tax cuts and higher levels of federal spending. The result, according to Patel, has been a diversion of significant amounts of available global capital away from emerging market economies and into the purchase of U.S. Treasury securities. This, in turn, pushes down the value of emerging market sovereign debt instruments and increases inflationary pressures. He urges the Fed to make a course correction.

@achirathep via Twenty20

Patel may have a point. Since election day in November 2017, the yield on 10-year Treasury bonds has risen from 2.307 percent to 2.862 percent, and the dollar has strengthened against many emerging market currencies. India’s rupee has fallen more than 6 percent relative to the dollar since October last year. The currencies of ArgentinaBrazil, and Turkey have each fallen by more than 20 percent relative to the dollar over the past six months.

It is possible to estimate the potential size of the double whammy from the Fed’s publicly released plans for downsizing its balance sheet and from budget projections issued by the Congressional Budget Office (CBO).

Between November 2008 and October 2014, the Fed engaged in a series of purchases, known as quantitative easing (QE), that expanded its balance sheet from $0.9 trillion in 2008 to $4.5 trillion in 2014. During this period, the Fed bought $2 trillion of U.S. Treasury securities, or roughly 35 percent of the cumulative federal budget deficit during this period. The Fed also purchased $1.8 trillion of mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac. The Fed halted QE at the end of 2014, but kept the aggregate value of its holdings steady by reinvesting the principal value of all of its maturing bonds. In October 2017, the Fed owned about 18 percent of all outstanding federal debt.

The Fed announced last year that it would begin reducing its holdings of Treasury and MBS securities over the next several years by not reinvesting a portion of the principal of maturing debt. Starting in October 2017, the Fed established caps limiting the amount of balance sheet “runoff” that would occur each month. To put it another way, only the principal amounts of maturing debt above the level of the monthly caps are reinvested in new purchases.

The monthly caps have been gradually increasing each quarter. From October 2017 to December 2017, the monthly caps were set at $6 billion and $4 billion for Treasury and MBS securities, respectively. The cap for Treasury securities was raised to $12 billion monthly beginning in January, to $18 billion in April, and to $24 billion in July. The last increase, to $30 billion monthly, is planned for September. The monthly cap for MBS securities is being raised in a similar fashion; it will reach $20 billion monthly in September. In some months, the amount of maturing debt will be less than the caps, which means the amount of balance sheet reduction that will occur in those months will be less than the cap would allow.

It is unlikely that the Fed will attempt to shrink its balance sheet all the way back to pre-financial crisis levels. Rather, the consensus among investors and others seems to be that the Fed’s goal is to reduce its assets to between $2.5 trillion and $3.5 trillion over several years.

In one bank’s model of how this might play out, the median scenario would have the Fed balance sheet falling to $2.9 trillion at the end of 2021 — a reduction of $1.6 trillion over four years. If the reduction in Fed ownership of Treasury securities is roughly in proportion to its current portfolio, then this model would imply the Fed would shed about $0.9 trillion in Treasury debt over this period.

The other half of the double whammy is the deteriorating budget outlook. In June 2017, before the tax cut and before Congress and the president agreed to large spending increases on appropriated accounts, CBO projected the cumulative deficit over the period 2018 to 2021 would be $2.9 trillion. CBO’s most recent forecast expects the deficit during these four years will reach $3.9 trillion, or $1 trillion more than was projected one year ago.

Taken together, then, the Fed is on course to reduce its holdings of Treasury securities by around $0.9 trillion over the next four years. Meanwhile, the federal government is expected to issue an additional $1 trillion in previously unanticipated federal debt over the same period. That’s a total of $1.9 trillion, or an average of $475 billion annually, in new Treasury securities above and beyond the baseline level of a $2.9 trillion federal deficit projected by CBO just last year. Flooding public markets with this much additional federal debt is bound to draw available capital away from other uses, including investments in emerging market economies. The drop in Fed holdings of MBS securities will compound the problem.

The irony, of course, is that the U.S. economy is stronger than it has been in some time, with low unemployment, low inflation, and improving prospects for workers who have not seen large wage gains in many years. This is the moment when the federal government should be restraining spending and reducing projected deficits, to free up resources for other, more productive uses. Instead, the federal government is now running large and widening deficits, with no end in sight, which only increases the pressure on the Fed to pursue an even tighter monetary policy.

If the turbulence that is hitting emerging markets is indeed related to a combination of a shifting Fed position on asset holdings and a deterioration in the U.S. fiscal outlook (which is not completely clear at this point, given the many complex factors involved), there may not be any easy answers. The Trump administration seems unaware and unconcerned about the risks its fiscal policy might create for the global economy, and the Fed wants to capitalize on a strong U.S. economy to turn the page on quantitative easing. Consequently, the pleas coming in from around the world are not likely to have much effect in Washington.


Related reading:

Episode 2: Sharing Your Stage - AEI - American Enterprise Institute: Freedom, Opportunity, Enterprise

Thu, 07/19/2018 - 14:10

The story of an unexpected moment of ‘bridging’ — two opponents share a stage. What happened when Hawk Newsome, leader of a small group of activists from Black Lives Matter of Greater New York showed up at a pro-Trump rally. Arthur talks to Hawk about how that played out, and also to john powell, Director of the Haas Institute for a Fair and Inclusive Society, about the challenges of sharing your stage (literally or metaphorically) with your ideological opponent.

References and further reading:

Empathize with your political foe | Arthur Brooks

America can’t fix poverty until it stops hating poor people | john a. powell & Arthur Brooks

E Pluribus Unum: Diversity and community in the twenty-first century | Robert Putnam

Sign up for Arthur’s bi-weekly newsletter.

Statement from the Black Lives Matter Global Network: “The Black Lives Matter Global Network is a leaderful movement and has grown to an organizing network of over 40 chapters across the world. Since 2013, we have organized under the banner of Black Lives Matter, connecting our work across borders, and fighting for our vision of a future that honors all Black lives. At the same time, some individuals and groups have worked using the name of Black Lives Matter and implied a relationship with our network, chapters, and members. But many of them are not in alignment with our guiding principles. Nor do they have any affiliation with the Black Lives Matter Global Network.

Hawk Newsome and the group known as BLM Greater NY have never been associated with the Black Lives Matter Global Network. They do not have the authority to speak on behalf of the Network or the work our activists are doing globally. And since the Black Lives Matter Global Network has not been contacted by Mr. Newsome or his associates, we believe that no funds raised by these individuals will benefit the Network or the work our chapters lead every day.

To see a full list of our chapters and to support their work, please visit us at www.blacklivesmatter.com.”

You can subscribe on Apple Podcasts, Google Play, Stitcher, Spotify, TuneIn, and ART19. The Arthur Brooks Show is published by The Vox Media Podcast Network.

Hello soft Brexit, goodbye US-UK trade agreement — and an American ally on digital trade rules? - Hello soft Brexit: Goodbye US-UK trade agreement — and an American ally on digital trade rules?

Thu, 07/19/2018 - 10:00

The saga of Brexit negotiations, Prime Minister Theresa May’s agony, and President Trump’s clumsy and destructive interventions changes daily. But the main focus of this blog is on the implications for a US-UK trade agreement. and more specifically for potential digital trade and internet issues in such an agreement.

US President Donald Trump and British Prime Minister Theresa May hold a press conference after their meeting at Chequers in Buckinghamshire, Britain, REUTERS.

To review: Last week, Prime Minister Theresa May’s Conservative government descended into chaos over the terms of the UK’s exit (Brexit) from the European Union. First, Foreign Secretary Boris Johnson and Brexit negotiator David Davis abruptly resigned from the cabinet, with scathing blasts at the PM. The direct cause of the resignations and turmoil stems from May’s decision — after months of internal Conservative party wrangling — to opt for a so-called soft Brexit.

Of course, in his continuing role as the Great Disrupter, President Donald Trump initially agreed with Johnson (“he would make a great Prime Minister”), after having scolded May for not following his (and Johnson’s) advice to hold out for a cleaner (hard) break with the EU. He warned that the soft Brexit course would “probably kill” a US-UK free trade agreement (FTA).

But 24 hours later, having gravely damaged May’s political authority within her own party, the president seemed to reverse course, stating on Brexit: “Whatever you do is OK with me,” and touting a future “great bilateral trade agreement with the United Kingdom.”

Still, as this is written, May is hanging on by her fingertips, forced to accept amendments to her original proposal. On Monday, she accepted four amendments from hard-line Brexit Conservatives, only to face a further revolt from a smaller group of pro-EU Conservatives. Whether May can continue to cobble tougher a fragile majority is increasingly an open question.

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But as noted in a previous blog, Trump was more nearly correct in his initial assessment: A soft Brexit will make it much more difficult to conclude a comprehensive US-UK FTA. And it would almost certainly represent a lost opportunity for the US to forge an important alliance with the UK on vital issues related to digital trade and policies regarding rules for the internet.

These issues had formed an important focus and defense of the proposed FTA when UK Trade Secretary Liam Fox spoke at AEI last year. As part of a larger defense of open markets and free trade under a “sovereign” Britain, Fox cited free data flows as an area where the UK has its “own differences” with the EU: “(On) some of the issues on data movement, we take the view that you can’t have a functioning global economy with free movement in goods and free movement in services, but not free movement in data.” He went on to criticize some European trading partners for pushing data localization measures, noting that in this area, the UK “may be closer to the US.”

Oversimplifying somewhat, there are three potential models for a future world digital trade and investment regime: A US model embodied in the Trans-Pacific Partnership agreement (which the Trump administration in foolhardy fashion repudiated), a Chinese authoritarian national sovereignty model, and a generally restrictive, regulated model being constructed by the EU. The EU’s division over digital trade is on display in the new EU-Japan FTA, in which the data flow provisions, according to the Financial Times, are “unacceptable” and constitute “one of the most important holes in the EU’s trade strategy.”

As an independent nation, the UK would become the world’s fifth largest economy, occupying a central position in services trade and the world services economy. Although its place in the world economic order is diminished, Britain still punches above its weight in trade and investment policy as well as in multilateral organizations. Should it join with the US (or the TPP-11, as it has also contemplated), it would give powerful impetus and authority to the US-TPP digital trade regime.

Trade independence and a soft Brexit

In a white paper published last week, the May government presented more details regarding its future economic relations with the EU. On manufactured goods and agricultural products, the UK will accept the “EU rulebook,” which means in effect that the UK is agreeing to a de facto customs union in these areas and will have little independence over issues such as food safety and GMO regulations. On services, the issues are less clear in that the UK is proposing “wide regulatory flexibility,” with the details to be filled in later.

Similarly, and most importantly for this blog, digital trade and e-commerce will involve a “new arrangement” (details unspecified) that will allow the EU and UK to “respond nimbly to new opportunities and challenges” and result in a future where the “UK and EU will not have current levels of access to each other’s markets.” This language portends two things: (1) a huge fight with EU trade negotiators over the exact terms of digital trade and Brexit, and (2) an almost certain refusal of the EU to back away from existing policies such as the court-mandated Privacy Shield for data protection and the EU’s new General Data Protection Regulation.

In sum, there are compelling economic and political reasons for the UK to hew close to the EU with a soft Brexit. But if that is the outcome, the US will lose an important partner in the competition for new rules for digital trade and the future of the global internet.

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