March 28, 2024

DealBook: Reducing the Corporate Tax Rate Could Stabilize Banks

Republicans and Democrats in Congress have both expressed a desire to reduce the corporate tax rate.Jonathan Ernst for The New York TimesRepublicans and Democrats in Congress have both expressed a desire to reduce the corporate tax rate.

Republicans and Democrats have both expressed a desire to reduce the corporate tax rate from 35 percent to something in the neighborhood of 25 percent, which would be more in line with our major trading partners. The recent attention to the legal loopholes employed by Apple, Google, Starbucks and other multinational corporations to reduce their taxes could threaten the prospects of reducing the corporate rate.

While lowering the corporate rate remains good public policy, the optics have changed. It feels a bit like putting up a yield sign because cars keep running the stop sign.

But the importance of the corporate tax rate goes beyond offshore tax games. A draft paper by Thomas Hemmelgarn and Daniel Teichmann highlights the relationship between corporate tax rates and bank stability. Our tax code, like that of many countries, has a bias for debt over equity: interest payments to bondholders are deductible to the corporation, but dividend payments to shareholders are not.

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Corporations thus have an incentive to raise capital by selling bonds rather than equity. Debt payments reduce the amount of corporate tax that a company has to pay, leaving more left over for the shareholders.

Economists refer to this effect as the “debt tax shield.” Because the value of the tax shield is a function of the corporate tax rate, the value of the tax shield goes up as corporate tax rates go up.

The bias for debt over equity is especially troubling in the context of banks. Banks are distinctive because a bank failure, unlike an ordinary corporate bankruptcy, can cause other financial institutions to fail, creating social costs that go far beyond the banks’ shareholders, bondholders and employees. The less equity a bank has, the less stable it is, as it has less of a cushion to absorb losses.

Of course, bank executives also have nontax incentives to prefer debt to equity, as debt magnifies the upside for executives if the bank does well (and other parties, including the public, bear much of the downside risk if a bank fails).

In the paper, the authors look at statutory tax rate changes over a 12-year period in 87 countries to see how those rate changes affected banks’ capital structure. They find that a 10 percentage point increase (or decrease) in tax rates is associated with a 0.98 percentage point increase (or decrease) in the amount of debt in the capital structure. The authors control for a number of variables that would tend to affect capital structure, like bank size, regulatory requirements, overall economic environment, availability of deposit insurance, and so on. The authors also find that dividend payouts increase after a rate change, further reducing the equity on the balance sheet. Their findings are consistent with prior research, although the magnitude of the effect is a bit smaller.

But we should not scoff at the magnitude of the result. The implication is that reducing the United States corporate tax rate from 35 percent to 25 percent would lead to an average increase in bank equity of about 1 percentage point — to about 12 percent equity, from 11 percent.

One caveat is that the effect might be smaller for our largest and most systemically important banks, which tend to have other gimmicks available to reduce taxes. But considering the questionable track record of requiring responsible equity cushions through the multilateral Basel accords, reducing the corporate tax rate is a self-help technique Congress should consider, particularly if the revenue can be partly made up by reducing other corporate tax expenses.

If a corporate tax rate change is indeed on the horizon, analysts should watch banks’ balance sheets carefully. The paper confirms findings from previous research suggesting that banks will accelerate the recognition of tax losses before the rate change by increasing loan loss reserves before the change, effectively shifting corporate income forward to the lower-taxed period.

The aggressive gamesmanship by multinational corporations like Apple is disappointing, but it is not enough to simply say that we should close loopholes and keep the corporate rate high. The goal of bank stability should inform our decision-making about the design of the corporate tax, including the rate structure.

For further reading, see Thomas Hemmelgarn Daniel Teichmann, Tax Reforms and the Capital Structure of Banks (draft). On the social costs of excessive bank leverage, see Anat R. Admati et.al, Fallacies Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive (2011).


Victor Fleischer is a professor at the University of Colorado Law School, where he teaches partnership tax, tax policy and deals. Twitter: @vicfleischer

Article source: http://dealbook.nytimes.com/2013/05/30/reducing-the-corporate-tax-rate-could-stabilize-banks/?partner=rss&emc=rss

DealBook: Shipping Woes May Weigh on European Banks

FRANKFURT — Can a ship float and be underwater at the same time? If it has been financed by a European bank, the answer may be yes.

A glut of ships, along with slack demand for shipping in the weak global economy, has slashed the value of cargo ships. According to some estimates, as many as half the cargo carriers on the high seas today may no longer be worth as much as the debt they carry — putting them underwater, in financial jargon. Their resale value is typically lower than the amount borrowed and spent to build them.

Large vessels that might have sold for about $150 million new in 2008 today fetch about $40 million, according to Nicholas Tsevdos, a shipping specialist at CR Investment Management, which helps banks deal with distressed assets. And with cargo fees near record lows, many vessels are not earning enough to make debt payments, either.

As European leaders agonize about how to rescue Cyprus banks, the formerly obscure world of ship finance is a reminder of how much cleanup work still lies ahead for European banks. The growing fear is that some lenders, almost all of them in Europe, have yet to confront the scale of potential losses from an estimated $350 billion in loans made to the shipping industry.

“Many banks are still shackled by the leftover effects of the crisis,” Christine Lagarde, the managing director of the International Monetary Fund, told an audience in Frankfurt in the past week, without singling out any specific assets. “This is the weak link in the chain of recovery.” She urged banks to take a harder look at their problem loans.

Whether the risk from shipping loans is serious enough to put another torpedo into the euro zone financial system is hard to say because of a glaring lack of detailed information about banks’ portfolios of shipping loans.

Andreas R. Dombret, a member of the executive board of the German Bundesbank who is responsible for monitoring financial stability, said he thought the shipping crisis, while serious, did not pose a broad threat to the euro zone. “It’s not a concern for the stability of the financial system,” he said during an interview. “It’s not systemic.”

But he and other bank overseers are stepping up pressure on financial institutions to address their problems. Shipping is “a substantial regional and sectoral risk in the banking industry,” Mr. Dombret warned an industry gathering in Hamburg last month. It was one of the first expressions of concern about the shipping problem by a bank overseer of his stature.

Under pressure from regulators, local governments that own most of HSH Nordbank in Hamburg said last Tuesday that they would raise their guarantees for the bank to 10 billion euros, or $13 billion, from 7 billion euros. Though only a midsize bank, HSH is the biggest lender to the shipping industry, with more than 30 billion euros in outstanding loans. The announcement, by the City of Hamburg and State of Schleswig-Holstein, amounted to an admission that losses from shipping were greater than earlier estimates and an example of the cost to taxpayers already built in to the shipping crisis.

The shipping downturn, which began in 2008, has already driven several large fleet operators into bankruptcy. The Overseas Shipholding Group, the largest American tanker operator, filed for bankruptcy in November. The fear is that some of the banks most active in ship finance, which are concentrated in Germany, Scandinavia and Britain, are in denial about their potential losses.

“It’s probably the most serious commercial problem that the banks have,” said Paul Slater, chairman of the First International Corporation, a consulting firm in Naples, Fla., that specializes in shipping. Banks with large portfolios of shipping loans “are just not taking the hits,” he said. “They are saying, ‘Give it time and it will work out,’ and it’s just not going to do that.”

For weak banks, the temptation to play down potential losses may be great. A frank appraisal of their losses would force some to raise billions in new capital or even to declare insolvency. That is true not only of shipping loans but also of other categories like commercial real estate, and remains a fundamental problem for the euro zone economy.

The uncertainty about banks’ true financial health fosters mistrust among institutions, makes them reluctant to lend to each other and is partly responsible for a shortage of credit for businesses and consumers.

As toxic assets go, ships are particularly troublesome. Unlike a plot of land, they require costly maintenance. They lose value over time from wear and tear or because more modern, fuel-efficient vessels make them obsolete. It even costs money to take an underused ship out of service and park it somewhere. The waters off Falmouth in Britain and Elefsina in Greece are popular anchoring spots for idle ships.

Investment funds that specialize in buying distressed debt have been wary about putting money into ships. That makes it hard for banks to unload unwanted shipping assets.

“Every hedge fund in the world is trolling Europe, but they are bidding on a small percentage of relatively good assets,” said Jacob Lyons, managing director of CR Investment Management in London, which helps banks manage shipping loans and other damaged assets.

Mr. Dombret of the Bundesbank pointed out that the banks that had made the most loans to the shipping industry were in nations like Germany or the Scandinavian countries whose governments had the least debt and were best able to cope with a banking crisis.

Mr. Dombret did not single out individual banks, but German banks like HSH Nordbank and Commerzbank in Frankfurt were among the top shipping lenders because German tax breaks favored ship finance. German banks’ exposure to shipping has been estimated at about 100 billion euros, more than double the value of their holdings of government debt from Greece, Ireland, Italy, Portugal and Spain. Aside from German banks, the DNB Group in Norway and Nordea in Sweden are big players in ship finance, as are Lloyds Banking Group and the Royal Bank of Scotland in Britain.

It does not necessarily follow that these banks will face losses on their shipping portfolios. Some of the savviest lenders probably still make money, or at least have made an honest appraisal of the value of their portfolios and set aside enough money to cover possible losses.

“We are very happy with our shipping business,” said Rodney Alfven, head of investor relations at Nordea. The bank, which is listed in Stockholm, increased the amount of money it set aside for potential bad loans in shipping to 63 million euros in the final three months of 2013 from 54 million euros the previous quarter. Over all, Nordea, the largest Swedish bank, has consistently made a profit from its shipping business, Mr. Alfven said. Shipping loans account for only 2 percent of Nordea’s lending, according to the bank.

The sorry state of global shipping stems from a shipbuilding boom that peaked in 2008, just before the global financial crisis, and created a glut in cargo capacity. Rates for nonliquid cargo are half or less of the level needed for shipowners to break even, according an estimate by the consultant KPMG. That means that ships are doubly damaged. They do not earn enough to cover interest on their debt, nor can they be sold for the value of the loan.

Nordea has told investors it expects shipping to begin to recover in 2014, as the world economy rebounds. But others are more skeptical.

“By any kind of measure, this is a deeper and more difficult downturn than we’ve had in the last decade or two,” Mr. Tsevdos at CR Investment said.

Except for some specialized categories of ship, like liquid natural gas carriers, Mr. Tsevdos said, “I don’t think there is a lot of indication for a lot of sectors that rates are going to turn around soon.”

Article source: http://dealbook.nytimes.com/2013/03/22/shipping-woes-may-weigh-on-european-banks/?partner=rss&emc=rss

Your Money: For Student Borrowers, a Tax Time Bomb

This potential tax bill is a byproduct of federal efforts, including the newly expanded income-based repayment program, that allow you to limit the monthly payments on most federal loans to what you can afford to pay. There’s a formula that uses your income to determine your payment. Then, the federal government forgives any remaining balance, usually after 10 to 25 years.

The catch comes with the forgiveness, since you generally have to pay income taxes on any forgiven debt (unless you were in a program for teachers or worked in a public service job, in which case the taxes go away). For many people, especially those who finished graduate or professional school with six figures of debt, the tax bill could be well into the five figures. And when it comes, you are supposed to pay in full, immediately.

Figuring out just how many people will be in this situation — and just how high the tax bill could be — is a tough task, and not many experts have tried it.

Sorting it all out begins with the repayment programs themselves. Some people signed up for income-contingent payments back in the 1990s. The income-based program came along more recently, and the Obama administration then tweaked it to make it more generous by shortening repayment periods and adjusting the formula used in figuring out the monthly bill.

As of Oct. 31, about two million people had applied for income-based repayment, according to Education Department figures. About 1.3 million had low enough income and high enough debt payments under standard repayment plans to qualify for reduced payment under the terms of the program. Another 440,000 applications were still pending.

In the 2011-12 school year alone, more than 10 million people took out the popular federal Stafford student loans, according to the College Board’s Trends in Student Aid report. Cooper Howes, a Barclays analyst, estimated in a report earlier this month that more than half of all borrowers would be eligible for payment reductions because of their incomes.

If you or your children are borrowers and the income-based repayment program is new to you, you should consult the Project on Student Debt’s ibrinfo.org site, which is about as clear as this complicated topic can get. The Education Department’s site is worth a thorough look, too, as is the New America Foundation’s income-based repayment calculator. I’ve stuffed the Web version of this column with links to these and other pertinent information sources.

Trying to pinpoint the scope of the looming tax issue starts to get more complicated pretty quickly. Not all eligible students will sign up for income-based repayment, since some will not hear about it, will ignore it when they do, will assume or be told (incorrectly) that they can’t qualify or will worry that there is some kind of catch. For those who sign up, it’s awfully hard to predict how many will eventually have some debt forgiven a couple of decades from now.

But Jason Delisle, who has written extensively about the income-linked repayment programs as director of the federal education budget project at the New America Foundation, points to an Office of Management and Budget effort that took a stab at it. The O.M.B. assumed that 400,000 borrowers from 2012 through 2021, each with a beginning average loan balance of about $39,500, would each eventually receive loan forgiveness of about $41,000. Yes, you read that right. The forgiven debt will be more than the original balance, albeit many years later.

At $41,000 of loan forgiveness, the federal tax bill could easily be over $10,000 depending on your tax bracket. There are also state income taxes to contend with, depending on where you live.

But the numbers can go much higher. Stephanie Day earned her bachelor’s degree in her 40s after a divorce, intending to enter the field of social work. She finished in the depths of the recession and could not find work, so she returned to school to get a master’s in psychology to bolster her credentials.

Even then, the jobs available near her home in Seattle were slim, so she moved to a town on the border of New Mexico and Texas for a position there. One home invasion and 12 months of misery at being apart from her children later, she’s now back in Seattle and paying just $30 each month on her $80,000 or so in debt via the income-based repayment plan.

Ms. Day has run the numbers and can foresee a situation where the government will forgive more than $100,000 of her debt, given that her unpaid balance keeps growing thanks to the low payments. And while she expressed dismay that so few people were aware of the tax bill in their future, she does not necessarily mind paying it. “I think it’s perfectly fair,” she said. “I guess I’m old school.”

Article source: http://www.nytimes.com/2012/12/15/your-money/for-student-borrowers-a-tax-time-bomb.html?partner=rss&emc=rss

Economix: The Debt Downgrade and Stock Prices

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Casey B. Mulligan is an economics professor at the University of Chicago.

The big financial story in the last few days has been the declaration by Standard Poor’s that United States government bonds were no longer worthy of its AAA rating. The agency, in a nutshell, thinks there is some chance that the government will default or be delinquent on its debt payments.

Today’s Economist

Perspectives from expert contributors.

The announcement was followed by a wild ride in the stock market in the last two days — a plunge of almost 7 percent in the Standard Poor’s 500-stock index on Monday, followed by a surge of almost 5 percent on Tuesday.

But with the index down almost 18 percent from its April peak, it is clear that investors’ concerns long predated the downgrade.

The real news is how poorly the economy is doing, and how poor its prospects seem. The chart below shows the changes in several indicators of economic activity over the last nine months. The blue series is an inflation-adjusted stock price index, which (even with Tuesday’s big gain) is lower than it was nine months ago. Through May 2011, real housing prices (black series) were down 7 percent. Real consumer spending (red series) has failed to increase, and inflation-adjusted spending on consumer durables has fallen four months in a row.

All of these indicators are forward-looking in the sense that they depend on what people expect to happen to incomes and profits in the future. These indicators had been looking better during much of 2010 but now it seems that consumers and investors are not optimistic about what is ahead (are they worried about riots like in London? higher taxes? government program cuts?).

In my view, a rating agency does not move the market but rather reacts to some of the same prospects that are reflected in the decisions of consumers and investors. For example, to the degree that incomes continue to remain low, tax collections will also remain low, making it that much more difficult for governments to pay their obligations.

Recovery for the stock market, and the wider economy, needs a lot more than an agency to change its mind about government bond ratings.

Article source: http://feeds.nytimes.com/click.phdo?i=81c3a75304e91c199aa556849e48228f