Our 11/14/2012 E-mail Campaign Re Cause Of The 2008 Meltdown

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Introductory Comment

We often encounter books based on the false claim that the 2008 Economic Meltdown was caused by subprime mortgages and by old-fashioned insurance of the value of mortgage pools (called “credit-default swaps” in order to fool the NY Insurance Commissioner into believing that such insurance should not require adequate insurance reserves).

This forces us to explain why the $4 TRillion - $5 TRillion REDUCTIONS in American capital expenditures and payroll would have caused the 2008 Economic Meltdown whether or not there had ever been any sub-prime mortgages.

That explanation is contained in our 11/14/2012 E-mail Campaign to Paul Krugman that follows below.

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A reason for the E-mail campaign to Paul Krugman is contained in the sections of the e-mail entitled “THE REASONS FOR NEEDING YOUR HELP” =

“If you log onto http://www.ReadingLiberally-SaltLake.org and scroll down to the “Participants Comments” section for the 5/11/2011 meeting, you will see a long essay entitled “The Plausibility of John Karls’ Challenge to Conventional Wisdom” -- John Karls is the person described in the second paragraph of this e-mail as the former long-time Senior International Tax Partner (Technical) for Ernst & Young and the Chair of the ABA Tax Section’s International Tax Committee 1994-1996 who is spending his retirement skiing Utah and facilitating the book/discussion group there; John majored in economics at the University of Michigan before attending Harvard Law School; the author of the essay is his daughter, Hilary, who majored in economics (and double majored in electrical engineering) at M.I.T.

“Hilary posits that it is theoretically possible that the $4 TRillion - $5 TRillion reduction in American payroll and capital expenditures in order to repay the tax-haven subs of the US MNC’s so they could redeem stock might eventually have found its way back, probably through commercial banks, as replacement loans to the American companies that had not exported jobs -- FOR A BIG NOTHING (though not, of course, the “American Jobs Creation (sic)” advertised in the title of the 2004 Act).

”John counters that although it would be nice to have PhD students at one’s beck and call to examine the data, it probably isn’t necessary because of all the news-media headlines during the 2008-201? Economic Meltdown reporting how the Federal Reserve was lamenting that commercial banks were NOT making loans to the American companies that had NOT exported jobs and reporting that virtually-all such companies had an acute need for such loans!!!

”Could you please make the judgment whether it is necessary to examine the data or whether the news-media headlines are sufficient?

”And if you believe that it is necessary to examine the data, could you please assign some of your best students to do so?”

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The real but unstated reason for requesting Paul Krugman’s assistance was that he could trumpet in his regular NY Times OpEd column the results of the investigation by his PhD students.

Because, after all, John Karls is correct that the omnipresent laments of the U.S. Federal Reserve in news-media headlines about how the CHUMP American companies that had NOT exported American jobs COULD NOT BORROW during the 2008 Economic Meltdown -- demonstrate that the confirmation of Paul Krugman’s PhD students that the Economic Meltdown was caused by the American Jobs Creation (sic) Act of 2004 was/is really unnecessary.

For the curious, Paul Krugman was derelict in his patriotic fiduciary duty to protect the American Economy -- he never responded or, so far as can be ascertained, took any action.


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To = pkrugman@Princeton.EDU

Subj = Your Help Desperately Needed To Avert Another Economic Meltdown

Princeton Economics Nobel-Laureate Professor and New York Times OpEd Columnist Paul Krugman

Dear Prof. Krugman:

$4 TRillion - $5 TRillion is the amount by which American companies that did not export American jobs are about to be forced, once again, to reduce their payroll and capital expenditures within a 2-3 year time frame.

The former long-time Ernst & Young Senior International Tax Partner (Technical) facilitates a monthly politically-oriented book/study group which for 7 years has recommended policy positions to America’s decision makers and with which I am connected. [He also chaired 1994-1996 the American Bar Association’s International Tax Committee comprising the nation’s top 300 international tax lawyers and featuring 22 working sub-committees.]

He and Ernst & Young and the other “Big Four” CPA Firms designed the structure for U.S.-based multi-national companies (US-MNC’s) to export American jobs while capturing virtually all of their worldwide profits in tax-haven subsidiaries (principally non-resident Singapore subsidiaries) which contracted with factories in such low-wage countries as China to manufacture the US-MNC’s products using the US-MNC’s technology to the US-MNC’s specifications under the US-MNC’s supervision.

Accordingly, virtually all of the worldwide profits of such US-MNC’s were not, by virtue of being captured in a tax-haven subsidiary, subject to U.S. corporate income taxation until such time, if ever, that the profits are repatriated to the US parent corporation as a dividend or a “constructive dividend.” “Constructive dividends” are “investments in U.S. property” which are deemed by Sec. 956 of the Internal Revenue Code to be the functional equivalent of dividends, such as loans to the U.S. parent corporation or investments in U.S. property that is leased to the U.S. parent corporation.

The regular 35% income tax on the profits of the tax-haven subsidiary are not recorded as a “deferred tax liability” under “generally-accepted accounting principles” so long as they are “permanently reinvested” outside the U.S. This test is satisfied with a few brief “boiler plate” paragraphs comprising “pipe dreams” about such things as possible acquisitions and locked away for safekeeping in case an auditor should bother to inquire.

As a practical matter, Sec. 956 of the Internal Revenue Code restricts the US MNC’s that have exported American jobs to have their tax-haven subs loan their accumulated profits from exporting American jobs to UNRELATED American companies that did not export American jobs or, in some cases, invest the profits in U.S. government T-bills.

[US-MNC auditors dutifully recorded that the tax-haven profits were “permanently reinvested” in loans to the US companies that had not exported American jobs and/or in US Government T-bills.]

By 2004, these tax-haven profits had reached the level of $4 TRillion - $5 TRillion. Microsoft alone had more than $1 TRillion in its tax-haven subs, causing its stock analysts, as reported prominently and often in the financial press, to analyze Microsoft as a bank rather than as a software company.

Both the amounts and the character of such investments “stuck out like sore thumbs” in the US MNC’s Form 10-K’s filed each year with the US Securities and Exchange Commission.

At the end of 2004, Congress enacted the so-called American Jobs Creation (sic) Act which permitted the US MNC’s to have their tax-haven subs pay “cash dividends” during the next 12 months of the profits that had piled up over a decade or so from exporting American jobs subject to a special one-time 5.25% corporate income tax rate rather than the normal 35% rate.

As you can appreciate, the American companies that had NOT exported American jobs were not in a position to repay the loans from the tax-haven subs of the US MNC’s within the typically 90-day loan terms.

However, virtually all of the US MNC’s that had exported American jobs decided that it was unwise to involve a Bankruptcy Court and instead dictated stiff terms based on how quickly the American companies that had not exported jobs could reduce their payroll and capital expenditures. The $4 TRillion - $5 TRillion of reductions in American payroll and American capital expenditures largely occurred during 2005-2007.

The requirement in the American Jobs Creation (sic) Act to pay $4 TRillion - $5 TRillion in “cash dividends” during 2005 was satisfied by having the banks of the US MNC’s, for a small fee, book a loan to the tax-haven subs equal to the portion of their loans to the American companies that had not exported jobs that could not be repaid immediately and then book an off-setting loan from the US MNC’s after they had immediately received those same amounts as “cash dividends” from the tax-haven subs. “Cash”, of course, in a modern economy is nothing more than a wire transfer and has no more tangibility than a book entry for a “loan.”

The only other significant requirement in the American Jobs Creation (sic) Act was for the dividends from the tax-haven subsidiaries to be invested in American payroll or capital expenditures. This, of course, did not produce an increase in American payroll or capital expenditures because the dividends were “traced to” or “matched with” the normal level payroll and capital expenditures that the US MNC’s have. And the normal cash flow that would normally have funded the normal level of payroll and capital expenditures was now “freed up” on a tracing/matching basis to redeem stock of the US MNC’s.

The American Jobs Creation (sic) Act of 2004 was the result of lobbying by Price Waterhouse (another of the “Big Four” CPA firms) on behalf, initially, of their US MNC’s, though many non-client US MNC’s joined the group. Price Waterhouse hired Bill Archer, the recently-retired Chairman of the House Ways & Means Committee, to do the actual lobbying.

Bill Archer “sold” the key decision makers in Congress on the argument that earnings in the tax-haven subs would be “brought home” to create American jobs, that the earnings would otherwise remain “offshore,” and that tax revenue (albeit at only a 5.25% rate) could be generated but 5.25% is better than nothing.

The “elephant in the room” that nobody in Congress investigated was whether the $4 TRillion - $5 TRillion was really “offshore” or whether it had already been loaned to the American companies that had not exported jobs to pay for payroll and “bricks and mortar.” And whether “round tripping” the $4 TRillion - $5 TRillion from the American companies that had not exported jobs to the US MNC’s to redeem their stock would actually result in a NET REDUCTION in American payroll and capital expenditures of $4 TRillion - $5 TRillion.

[Cynics might suggest that nobody in Congress wanted to ask the obvious question of whether the $4 TRillion - $5 TRillion was “stuffed in mattresses” located in Singapore because they were more interested in receiving “campaign contributions” from Bill Archer’s clients but it is possible that none of them was smart enough to think of the obvious question.]

The rest is history.

Congress was in such a panic that only days after the House of Representatives re-convened in January 2008, it passed the Economic Stimulus Act of 2008 providing most taxpayers with immediate $300 rebates ($600 for most married couples) and investment incentives for businesses. It passed the Senate a week later and was signed into law on 2/13/2008.

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THE REASONS FOR NEEDING YOUR HELP

If you log onto http://www.ReadingLiberally-SaltLake.org and scroll down to the “Participants Comments” section for the 5/11/2011 meeting, you will see a long essay entitled “The Plausibility of John Karls’ Challenge to Conventional Wisdom” -- John Karls is the person described in the second paragraph of this e-mail as the former long-time Senior International Tax Partner (Technical) for Ernst & Young and the Chair of the ABA Tax Section’s International Tax Committee 1994-1996 who is spending his retirement skiing Utah and facilitating the book/discussion group there; John majored in economics at the University of Michigan before attending Harvard Law School; the author of the essay is his daughter, Hilary, who majored in economics (and double majored in electrical engineering) at M.I.T.

Hilary posits that it is theoretically possible that the $4 TRillion - $5 TRillion reduction in American payroll and capital expenditures in order to repay the tax-haven subs of the US MNC’s so they could redeem stock might eventually have found its way back, probably through commercial banks, as replacement loans to the American companies that had not exported jobs -- FOR A BIG NOTHING (though not, of course, the “American Jobs Creation (sic)” advertised in the title of the 2004 Act).

John counters that although it would be nice to have PhD students at one’s beck and call to examine the data, it probably isn’t necessary because of all the news-media headlines during the 2008-201? Economic Meltdown reporting how the Federal Reserve was lamenting that commercial banks were NOT making loans to the American companies that had NOT exported jobs and reporting that virtually-all such companies had an acute need for such loans!!!

Could you please make the judgment whether it is necessary to examine the data or whether the news-media headlines are sufficient?

And if you believe that it is necessary to examine the data, could you please assign some of your best students to do so?

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THE REASON WHY YOUR HELP IS NEEDED URGENTLY

As you are probably aware, the news media constantly reports that corporations have another $4 TRillion - $5 TRillion that the media unquestioningly contends could be invested in the U.S. but on which the companies are sitting due to uncertainty.

What the news media fails to appreciate is that the $4 TRillion - $5 TRillion is what has piled up since the American Jobs Creation (sic) Act of 2004 in the tax-haven subs of the US MNC’s that have exported jobs.

And which Mitt Romney proposed constantly during the recent Presidential campaign should be exempt (or for which the normal 35% tax should be substantially reduced a la the 2004 legislation).

At the same time, President Obama’s Deficit Reduction (Simpson Bowles) Commission has included in its recommendations that US-based corporations should be taxed on a “territorial basis”!!!

Which means, of course, that since virtually all of the earnings of the US MNC’s that have exported American jobs are captured in off-shore tax haven subs, the profit from exporting jobs will escape US corporate income tax entirely.

But more importantly, for the near term, implies that the $4 TRillion - $5 TRillion that has piled up in the tax-haven subs since the 2004 legislation can also be dividended free of US corporate income tax.

Accordingly, it is important to determine whether the 2008-201? Economic Meltdown was really caused by the $4 TRillion - $5 TRillion of reductions in the payroll and capital expenditures of the American companies that did not export jobs. [And whether the Economic Meltdown would have resulted from those reductions in payroll and capital expenditures even if every American worker who lost a job had at least a 20% equity in her/his home.]

Because America is poised to do the same thing all over again!!!

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FOOTNOTE REGARDING INTERNATIONAL COMPETITION

When John Karls (described above) was active in the ABA Tax Section, he authored many articles for the ABA and for several publications on whose editorial boards he served, addressing whether multi-national companies had tax advantages over their competitors resulting from where the MNC and its competitors were headquartered.

It should be noted that European-based multi-national companies are typically exempt from home-country taxation on dividends from foreign subsidiaries.

Accordingly, European-based multi-national competitors of US-based MNC’s have exported European jobs and captured virtually all of their worldwide profits in tax-haven subsidiaries from which the profits can be brought home to the European parent companies immediately on a tax-free basis.

If you believe there is merit in preventing the $4 TRillion - $5 TRillion currently accumulated in the tax-haven subs of the US MNC’s from being dividended in the near future at a zero (or greatly-reduced) US corporate income tax rate (or, indeed, whether there is a lack of merit in the Simpson-Bowles proposal to completely exempt on a going-forward basis the profits from exporting jobs), it would be wise to note the competitive effects and strongly recommend that the US government pressure European governments to tax their MNC’s on their profits from exporting European jobs since they compete against US MNC’s in both American and European finished-goods markets.

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Thank you very much for your consideration.