Brookings: Topics - Corporations

Corporate Tax Reform Without Tears

Robert C. Pozen — Sun, 31 Mar 2013 00:00:00 -0400

Economists have long recognized the damaging effects of the high U.S. corporate tax—at 35%, the rate is the highest in the industrialized world. Over the past few years, politicians in both parties have come to understand that the corporate tax system itself is dysfunctional, causing resources to be misallocated and encouraging corporations to invest overseas.

In February 2012, President Obama proposed a substantial reduction in the corporate tax rate to 28% from 35%. This year, the president has spoken positively about corporate tax reform if it is revenue-neutral, meaning the rate cut should be paid for by broadening the corporate tax base.

This is progress toward a bipartisan solution. Lowering tax rates and broadening the tax base is a central tenet of conservative economic philosophy. High tax rates distort decisions on the margin, as do many specific deductions, exclusions and deferrals. Lower tax rates and a broader base allow the market to allocate resources with less interference from the government.

But what is the best way to meaningfully broaden the corporate tax base? Eliminating tax credits to specific industries, such as green energy, is a good place to start. Unfortunately, repealing these provisions wouldn't raise enough revenue to make a significant dent in the corporate tax rate. Larger corporate tax expenditures, such as the research and development credit, have strong political support on both sides of the aisle.

Congress could also raise revenue by requiring U.S. corporations to immediately pay tax on all of their foreign profits. Currently, corporations may defer taxation on their foreign profits until they bring them back into the U.S. However, almost all Republicans would prefer for the U.S. tax system to move in the other direction: taxing only those profits earned in the U.S. (with some exceptions to prevent such abuses as shifting profits abroad to take advantage of lower rates).

Given the importance of reducing the corporate rate—and the infeasability of the other options for paying for it—Rep. Kenny Marchant (R., Texas) and Rep. Jim McDermott (D., Wash.) are floating a proposal to modestly restrict the deductibility of gross interest expense for corporations. This change would meet two crucial criteria: It would raise a significant amount of revenue and significantly reduce economic distortions caused by the tax code.

Based on Internal Revenue Service data from 2000 to 2009 (the most recent available), I estimate that disallowing roughly 30% of interest deductions (that is, allowing for a 70% deduction for gross interest expense) would have fully paid for a reduction in the corporate tax rate to 25% from 35%.

Limiting interest deductions for corporations would also correct, to a degree, a serious imbalance. When a corporation finances an investment by issuing debt, the interest payments generate a stream of tax deductions. When a corporation finances an investment by using its cash on hand or by issuing new shares of stock, there are no analogous tax deductions.

Because of this difference, many corporations choose to maintain a debt-intensive capital structure—primarily for tax reasons instead of underlying economics. As a result, the economy will tend to be overly leveraged relative to a true free market. This makes corporations overly at risk of going bankrupt, increasing the fragility of the economy.

Some corporate officials have criticized such a limit on interest deductions based on the fear that it would increase their tax burden. This is false, on average, since the proposal would be structured to be revenue neutral.

Here's a simple example. Consider a corporation with taxable income of $100 million, calculated after deducting interest expense of $90 million. Currently, it would pay $35 million in corporate tax—35% of its $100 million taxable income. If interest deductions were capped at 70%, $27 million of interest expense would become nondeductible, increasing the corporation's taxable income to $127 million from $100 million. At a 25% tax rate, it would pay $31.75 million in corporate tax—slightly lower than under current law. In other words, because the proposal would be revenue-neutral, some corporations will pay a little more and others a little less.

A more legitimate concern is how existing debt would be treated under this proposal. Corporate executives have made financing decisions based on good-faith beliefs about the tax law going forward, so it might be unfair to deny a full deduction for interest payments on existing debt. Any restrictions to interest deductions should be phased in very slowly and should not apply to debt issued before some relevant date.

Congress need not finance the entire rate reduction by restricting interest deductions. For instance, Congress could cap interest deductions at a higher level—say, 80%—and finance the rest by limiting other deductions and credits now available to corporations.

But there's a particularly strong case in favor of restricting interest deductions: It could raise significant amounts of revenue while at the same time reducing economic distortions. This proposed change should be the core of any revenue-neutral legislation to reduce the corporate tax rate to 25% from 35%.

Authors

Robert C. Pozen

Publication: Wall Street Journal

Can Executive Compensation Reform Cure Short-Termism?

Andrew C.W. Lund and Gregg D. Polsky — Mon, 18 Mar 2013 00:00:00 -0400

There is an increasingly pervasive view among corporate governance observers that senior managers are too focused on short-term results at the expense of long-term interests. Concerns about “short-termism” have been expressed within the financial industry context and outside of it, but because of the recent financial crisis, much of the discussion has been directed at financial institutions. To combat short-termism, several commentators have advocated executive compensation reform to encourage senior managers to adopt a longer-term perspective. Yet these reforms will likely prove ineffective because of other significant pressures on managers to maintain current stock prices.

Paper highlights include:

A general overview short-termism and the causes and effect of overweighing short-term results relative to long-term consequences when making decisions.
Proposals to redesign compensation structures to combat short-termism.
Questioning the effectiveness of compensation proposals.
A look at the new corporate governance world.
An examination of changes to senior management job security.
Policy proposals for better options to mitigate short-termism.

Download and read the full paper » (PDF)

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Authors

Andrew C.W. Lund
Gregg D. Polsky

Image Source: © Lisi Niesner / Reuters

Business Advocacy in Asian PTAs: A Model of Selective Corporate Lobbying with Evidence from Japan

Mireya Solís — Fri, 15 Mar 2013 00:00:00 -0400

What explains the pattern of selective business interest in preferential trade agreements (PTAs) with active campaigning for and utilization of tariff preferences for some trade agreements, but not others? Under what conditions can business advocates of PTA policy mount an effective lobbying campaign to influence policy outcomes (i.e., shaping decisions on who to negotiate with and what to negotiate about)? These are important questions given that analyses of Asian PTAs frequently assign a negligible role to business interests either out of apathy or lobbying weakness. To understand the pattern of selective business lobbying for PTAs, I develop a theoretical model with three main independent variables: venue selection, preference intensity, and advocacy effectiveness, and apply it to the case of Japan to test its usefulness. My model shows that the conditions for effective business PTA campaigning are exacting: loss avoidance, high technical expertise, and influence-seeking strategies that maximize access opportunities given institutional constraints. And yet when these factors align, business interests do influence PTA outcomes. My research shows that the current trend to characterize the agency of PTA proliferation as either state-led or business-driven needs to be re-examined as it is more useful to think about state-society constellations in favor or against PTAs.

Read the article at degruyter.com » (Membership required to access the article)

Authors

Mireya Solís

Publication: Business and Politics

The Predator Comes Home: A Primer on Domestic Drones, their Huge Business Opportunities, and their Deep Political, Moral, and Legal Challenges

Peter W. Singer — Fri, 08 Mar 2013 15:09:00 -0500

At the turn of the last century, a strange new technology began to appear in America. As a January 4, 1900 article about one of the very first sightings in the state of Florida described, “The Locomobile resembles a rubber-tired driving buggy in its outward appearance, except that no allowance is made for attaching a horse…A brake is attached to the rear axle that will stop the machine in a much shorter space than a horse can be stopped.”[1]

The locomobile, or “horseless carriage,” caught people’s fancy and powered a huge new industry. Businesses opened up in places that ranged from Basic City, Virginia, home of the Dawson Steam Auto-Mobile, a two-cylinder runabout with single chain drive and tiller rather than a steering wheel, to the Southern Automobile Manufacturing Company of Jacksonville, which assembled five cars a day that sold for a princely sum of $400 each.

Soon, the industry rippled out into all sorts of directions. It was only two years after the first car hit the roads of Florida that the first car dealership was created. This led to new endeavors in areas like the logistics and support “garages,” which had ripple effects out into other areas. For instance, just three years after the first news article on the locomobile appeared in The Florida Times-Union & Citizen, the very first newspaper advertisement for one appeared.

But this new technology also brought strange new questions, such as how to protect people from them. The first fine for “speeding” came just a year later in 1904, when a man was arrested for endangering the lives and property of pedestrians in downtown Jacksonville. He had exceeded the 6 mile per hour speed limit

The new technology also created new demands on governments, like an entire new type of infrastructure. Staying in Florida for the moment, it was in 1907 when the first of what we now call “snow birds” arrived via horseless carriage. Mr. Ralph Owen “accomplished the amazing feat of driving an Oldsmobile motorcar from New York to Florida in only 15 days.”

The reason this took so long is that no one was ready for it, especially the government. There were no real roads, at least as we think about them now, and no truly reliable maps for the pathways that did exist. Indeed, as late as 1921 the Automobile Club of America recommended that motorists traveling from New England to Florida simply bypass the entire state of Virginia because of these problems.

It wasn’t just the poor state of transportation that required a network of roads and highways to be funded but also basic issues like what safety equipment the new technology required. For example, early horseless carriages often had headlights but no turn signals. Drivers had to use hand signals to indicate their intentions to turn or slow down. A new business started selling a seeming solution, Devilseye Reflector Rings.[2] Drivers would wear large red rings on their fingers at night so that when they held their hand outside the car the rings reflected other headlights and allowed other drivers to see the signal. Soon, this concept was replaced by the novel idea of requiring the reflector be embedded in the car rather than carried by the driver.

These stories of the early days of “horseless carriages” and “locomobiles” aren’t just fascinating but they should serve to help us frame the issues we face today in “unmanned systems” and robotics. They were a technology that once seemed alien but we figured it out.

Where are we now? Robots and War

While unmanned systems have a long history dating back to Da Vinci’s designs for a robotic knight, and first emerged in war with German remote-controlled torpedo boats in the First World War, it wasn’t until just a decade ago that they truly took off.[3] Advances in technology made unmanned systems more usable, especially through the incorporation of GPS technology that allowed such systems to locate themselves in the world. At the same time, the new conflicts that followed 9/11 drove demand. When U.S. forces first went into Afghanistan, the U.S. military had only a handful of unmanned aerial systems (UAS, also called “remotely piloted aircraft” or, more colloquially, “drones”) in the air, none of them armed, and zero on the ground. Now it has a force inventory of more than 8,000 in the air and more than 12,000 on the ground. Another example of how far the change has gone is that last year, the U.S. Air Force trained more unmanned systems operators than fighter and bomber pilots combined.

But when we think about technologies like the Predator or the PackBot, we need to remember that they are just the first generation, the Model T Fords and Wright Flyers compared to what is already in the prototype stage.[4] We are still at the “horseless” stage of this technology, describing these technologies by what they are not rather than wrestling with what they truly are. These technologies are “killer applications” in all the meanings of the term. They are technologies that advance the power of killing. They are also technologies that have a disruptive effect on existing structures and programs. That is, they are akin to advancements like the airplane or the steam engine in allowing greater power and reach in war, but they are also akin to what iPods did to the music industry, changing it forever.

What Next? The Robotics Revolution

While many are surprised by the existing use of robotics, the pace of change won’t stop. We may have thousands now, but as one three-star U.S. Air Force general noted in my book Wired for War, very soon it will be “tens of thousands.”[5]

But the numbers matter in another way. It won’t be tens of thousands of today’s robots, but tens of thousands of tomorrow’s robots, with far different capabilities.

One of the laws in action when it comes to technology is Moore’s Law, which states that the computing power that can fit on a microchip doubles just under every two years or so.[6] It has become an encapsulation of broader exponential trends in technology that have occurred throughout history, with technological power constantly doubling in everything from power to storage to broader innovation patterns.[7] If Moore’s Law holds true over the next 25 years the way it has held true over the last 40 years, then our chips, our computers, and, yes, our robots will be as much as a billion times more powerful than today. But Moore’s Law is not a law of physics. It doesn’t have to hold true. What if our technology moves at a pace just 1/1000^th slower than it has historically? In this slowed-down scenario, we’d only see a mere 1,000,000 times the change.

The bottom line is that what was once only fodder for science-fiction conventions like Comic-Con is now being talked about seriously in places like the Pentagon. A robotics revolution is at hand.

We should be crystal clear here. The robot revolution happening is not the Robopocalypse that Steven Spielberg was preparing to film.[8] It is not the type where you need to worry about the former governor of California showing up at your door, à la The Terminator.[9]

Instead, every so often, a technology comes along that changes the rules of the game. These technologies – be they fire, the printing press, gunpowder, the steam engine, the computer, etc. – are rare but truly consequential.

The key to making technology truly revolutionary is not merely its new capabilities but its questions. Revolutionary technologies force us to ask new questions about what is possible and consider things that weren’t conceivable a generation before. But they also force us to relook at what is proper. They raise issues of right and wrong that we didn’t have to wrestle with before.

The historical comparisons that people make to the robotics revolution illustrate this. When I conducted interviews for my book, I asked people to give historical parallels to where they think we stand now with robotics. As I noted earlier with the comparison to the “horseless carriage,” many of them, especially engineers, liken where we are now with robotics to the advent of the automobile.

If the horseless carriage is the parallel, think of the ripple effects that cars had on everything from our geopolitics to our law enforcement. A group of people who were, at the time, desert nomads became crucial players in the global economy simply because they lived over a sticky black substance previously considered more of a nuisance than anything else. The greater use of that same – now crucial – resource has changed the global climate. The growing use of cars, in turn, led to new concepts that reshaped the landscape, whether through highways and suburbia, or through new social notions, like dating (teens previously could only court on parents’ front porches).

And of course a whole new world requires the establishment of rules of the game, or rather new rules of the road. It wasn’t just a matter of fines for “speeding,” but also changes to the very structure of American law enforcement. The rise of easy cross state crime enabled by the speed and reach of horseless carriages, such as the string of bank robberies by Bonnie Parker and Clyde Barrow, helped lead to the rise of the then Bureau of Investigation, now the modern FBI.[10]

Others, such as Bill Gates, make a different comparison to the computer in 1980.[11] Much like robots today, the computer back then was a big, bulky device for which we could only conceive a few functions. Importantly, the military was the main spender on computers’ research and development and a key client driving the marketplace, again comparable to the development of robots.

But soon, computers changed. They got smaller. We figured out more and more functions and applications that they could perform, both in war and in civilian life. And they proliferated. It has reached the point that we have stopped thinking of most of them as “computers.” I drive a car with more than 100 computers in it. No one calls it a “computerized car.” I have a number of computers in my kitchen. I call them things like “microwave” or “coffee maker.”

The same thing is happening with robotics – not just the changes in size and proliferation, but also the reconceptualization. Indeed, if you buy a new car today, it will come equipped with things like “parking assist” or “crash avoidance” technologies.[12] These are kind ways of saying that we stupid humans are not good at parallel parking and too often don’t look in our blind spots. So, the robotic systems in our car will handle these things for us.

But again, just as the story of the automobile reveals more than just the shift from owning horse stables to garages, so, too, was the computer about more than never having to remember long-division tables again. What were important were the ripple effects. The game-changing technology reshaped the modern information-rich economy, allowing billions of dollars to be made and lost in nanoseconds. It led to new concepts of social relations and even privacy. I can now “friend” someone in China I’ve never met. Of course, I may now be concerned about my niece social networking with people whom she’s never met. It became a tool of law enforcement (imagine the TV show CSI without computers) but also led to new types of crime (imagine explaining “identity theft” to J. Edgar Hoover).[13] And it may even be leading to a new domain of war, so-called “cyber-war.”

This comparison is a striking one because it illustrates how bureaucracies often have a hard time keeping up with revolutionary change. For example, the FBI director was so averse to computers that he didn’t have one in his office and never used email as late as 2001. Sound amazing? Well, the current Secretary of Homeland Security, the agency in charge of the civilian side of American cyber-security, doesn’t use email today.[14]

The final comparison that is made is perhaps a darker one: work on the atomic bomb in the 1940s. Scientists, in particular, talk about the field of robotics today in much the same way they talked about nuclear research back in the 1940s. If you are a young engineer or computer scientist, you will find yourself drawn towards it. It is the cutting edge. It is where the excitement is and where the research money is.

But many worry that their experience will turn out just like that of those amazing minds that were drawn towards the Manhattan Project, like a moth to an atomic flame.[15] They are concerned that the same mistakes could be repeated – of creating something and only after the fact worrying about the consequences. Will robotics, too, be a genie we one day wish we could put back in the bottle?

The underlying point here is that too often in discussions of technology we focus on the widget. We focus on how it works and its direct and obvious uses. But that is not what history cares about. The ripple effects are what make that technology revolutionary. Indeed, with robotics, issues on the technical side may ultimately be much easier to resolve than dilemmas that emerge from our human use of them.

How Our Robots Are Changing

The first generations of aerial robots were much like the manned systems they were replacing, even down to some of them having the cockpit where the pilot would sit looking like it’d been painted over. Now we are seeing an explosion of new types, ranging in size, shape, and form. With no human inside, they can stay in the air not just for hours, but for days, months, and even years, having wings the length of a football field.[16] Alternatively, they can be as small as an insect.[17] And, of course, they need not be modelled after our manned machines, but can instead take their design cues from nature, or even the bizarre.[18]

The other key change is their gain in intelligence and autonomy. This is a whole new frontier. Traditionally, we’ve compared weapons based on their lethality, range, or speed. Think about the comparison between a Second World War B-17 bomber plane and a B-24 bomber plane. The B-24 could be considered superior because it flew faster, further, and carried more bombs. The same could be said in comparing the MQ-9 Reaper UAS with its earlier version, the MQ-1 Predator. The Reaper is better because it flies faster and further and carries more bombs. But the Reaper is also something else, which we couldn’t say about previous generations of weapons: It is smarter, and more autonomous. We are not yet in the world of The Terminator, where weapons make their own decisions, but the Reaper can do things like take off and land on its own, fly mission waypoints on its own, and carry sensors that make sense of what they are seeing, such as identifying a disruption in the dirt from a mile overhead and recognizing it as something that we humans call a “footprint.”

From these changes comes a crucial opening up of the user base and the functionality of robotics. Much as you once could only use a computer if you first learned a new language like “Basic,” so, too, could you once only use robotic systems if you were highly trained. To fly an early version Predator drone, for instance, you had to be a rated pilot. Now, just as my three-year-old can navigate his iPad without even knowing how to spell, so, too, can you fly some drones with an iPhone app.

The Civilian Side Opens

This greater usability opens up the realm of possible users, lowering the costs and spreading the technology even further. So, we are seeing the range of uses expand not just in the military, but also, once proved on the military side, moving over to the civilian world. Take aerial surveillance with UAS. It’s gone from a military activity to border security to police to environmental monitoring.[19] Similarly, the notion of using a robotic helicopter to carry cargo to austere locations was first tested out in Afghanistan, but is now being looked at by logging companies.[20]

A key step in moving this forward in the U.S. will be the integration of unmanned aerial systems into the National Airspace System (NAS) and expanded civilian use. While there has been a huge amount of energy around the topic of domestic drones, such that many politicians speak about them as if they are already “watching everything from above,” the present laws restrict civilian use. An ever growing number of special permits, however, have been issued to domestic operators, now summing 1,428.[21] These early users range from small police departments like Mesa County in Colorado, which found they cost over 90% less to operate than police helicopters, to universities conducting environmental research in Alaska.[22]

Congress has set a deadline of September 2015 for the Federal Aviation Authority to figure out how to make this happen on a more regularized basis, in essence opening up the national airspace to the civilian public and private sector use.[23] As part of this process, there are to be six test sites created around the nation, which some twenty states are competing to be awarded. While it is unclear if the FAA will meet the deadline, the step is coming, and with it, the next ripple effect outwards in the market.

Indeed, what the opening of the civilian airspace will do to robotics is akin to what the Internet did to desktop computing. The field was there before, but then it boomed like never before. For instance, if you are a maker of small tactical surveillance drones in the U.S. right now, your client pool numbers effectively one: the U.S. military. But when the airspace opens up, you will have as many as 21,000 new clients – all the state and local police agencies that either have expensive manned aviation departments or can’t afford them.

The scale of this market is estimated to be in the tens of billions in its first years, but it is frankly too early to know where it will end up.[24] If history is any lesson, we shouldn’t just focus on the sale of drones in roles we already know but recognize that there are many more ways we don’t yet know of where robotics might be applied to other fields. Who saw agriculture as a field to be computerized? And yet the application of computers has led to massive efficiency gains. So, too, is agriculture appearing to be an area in which robotics will drive immense change. Agribusinesses nationwide such as Monsanto are lobbying for the use of domestic drones in roles that range from the monitoring and surveillance of the fields to the crop-dusting to the picking and harvesting.[25]

Impact on U.S. military

There are a huge set of ripple effects that will emerge from the opening up of the airspace to domestic drones. One is a potential role reversal. What will be the impact on the U.S. military as a technology area that it once led in, blossoms on the civilian side?

Take the areas of acquisitions. What happens when manufacturers have a wider set of clients than just the DoD and therefore become less responsive to its needs? If the parallel is computers, microchips and IT networks, the U.S. military once was in the lead in the research and development and then purchasing of computing. Now it is often behind the civilian side and, indeed, in areas like microchips can’t get makers to shift to its unique demands.

Beyond the obvious applications moved over from the military side, the real change occurs when imagination and innovation cross with profit-seeking. This is where parallels to computer or aviation history hold most, as the civilian side then starts to lead the way for the military. For instance, the idea of moving freight via airplanes was not originally a military role. It started out in 1919 with civilians. Today, it’s both a major military role (the U.S. military’s Air Mobility Command has some 134,000 members) and an industry that moves more than $10 trillion in global trade.[26] And, yes, a number of airfreight firms are starting to explore drone air cargo delivery, from large-scale trans-oceanic movement to small movement of medical supplies or even fast food.[27]

Similarly, what will it mean for training, when more and more young service men will come in with experience using the technology at home, or even when they see more advanced versions on the market than what they get from the Pentagon? The bottom line is that discussions of the civilian side also matter to the military.

Economic Winners and Losers: Nations and Communities

A new industry raises another ripple effect: Who will be the winners and losers?

One can certainly think about this issue on the global level. The U.S. faces a strange situation of trying to compete in a world economy, where technologic knowhow is a key differentiator, and yet has an education system that too often moves in an opposite direction. American high school students rank 23rd in science and 31st in math among wealthy nations, and 27th in college graduates with degrees in science and math. And the trends aren’t improving greatly. In 2004, the number of American computer science majors was 60,000. In 2013, it had shrunk to 38,000. (It is all not bad news, we are graduating twice as many journalists.) [28]

But the issue of winners and losers isn’t just a matter for Washington policymakers; it should have huge resonance for state and local leaders. That is, if what is playing out in the field of robotics is comparable to horseless carriage, who is Detroit, which became the epicenter of this industry for the 20^th century, and who are going to be like Basic City or Jacksonville that had early automobile companies around the same period? Or, if the comparison is to computers, who is going to be akin to Philadelphia, a key node in the early days of computing, and who is going to be the robotics version of Silicon Valley?

Answering this question turns on challenging a false notion that has taken hold, that in today’s world of globalization distance doesn’t matter. But despite our new technologies, we have repeatedly seen at the state and metropolitan level, success happens in clusters.[29]

As Maryann Feldman writes in her study Location, Location, Location: Creating Innovation Clusters, “Grounded in place, innovation and entrepreneurship rely on an ecosystem of firms (both suppliers and customers), universities and community colleges, government agencies, and trade associations, all systematically aligned to encourage creativity and experimentation. Once started, concentrations of industries within places become self-reinforcing as talent is attracted to opportunity, the flow of ideas increases, and their potential is understood and appreciated. With that dynamic, it becomes easier and less costly for entrepreneurs to realize their dreams.”[30]

The role of the government is central in developing these clusters. While entrepreneurship is a private-sector activity, it is public policy that sets the stage. For example, I am from North Carolina. Like that old Saturday Night Live joke, we were really happy there was a South Carolina and District of Columbia whenever the education rankings came out, as that meant we had someone to look down on from our lofty perch of 49^th in the nation.

Yet, when North Carolina’s textile manufacturing economy declined, the local government did something brilliant. It fostered a new “innovation cluster” centering around the Research Triangle Park that is now the home to more than 130 research facilities and helped North Carolina become one of the hubs of the biotech industry. This boom then benefited the rest of the state and made it one of fastest growing states in the nation during this period. The success didn’t happen overnight. As Feldman noted, the policy world can nurture these kinds of success stories via “…steady and consistent state policy, investment tax credits, and quasi-governmental, sector-specific agencies.”

Job Gain and Loss

The rise of domestic robotics use holds the potential to create a number of jobs. Indeed, the AUSVI industry trade group has claimed some 70,000 new jobs will be created in just the first few years once the airspace opens up, arguing (with an obvious self-interest) that the US loses some $27 million per day in economic activity the longer it waits to do so.[31]

This boom for the robotics industry, though, raises deep questions not just of which areas will win out, but also which individuals will win and lose.

Just as the horseless carriage made titans of Henry Ford and Alfred Sloan, computers created a whole new generation of billionaires and millionaires. But, of course, just like with the craftsmen before the first industrial age, there were also losers. For hundreds of years, there was a highly skilled profession of men who did mathematics for hire. They were well paid, many making the equivalent of $200,000 a year. They were called “calculators.” They have gone the way of so many other professions reshaped by new technology like the blacksmith making horseshoes or the elevator operator.

Indeed, robots have already and will continue to shape the economy both as an issue of growth and job loss. As a recent MIT study found, automation is "destroying jobs and creating prosperity," explaining both the gains in efficiency and the loss of as many as six million jobs over the last decade.[32] Robots are a large part of the reason the automobile companies of Detroit are back, but so many automobile workers are not back to work. (Already, one in ten has been replaced by a factory line robot, with many companies across a wide array of industries planning to fully automate their assembly lines.)[33]

Such trends mean that a part of our economy will make a great deal of money from robotics, which is why there is so much lobbying behind the area today. Last year, drone manufacturers gave $2.3 million in contributions to the House Unmanned Systems Caucus, while the industry’s trade group spent a quarter million lobbying for the FAA bill that opens up the airspace (the group proudly told donors that “Our suggestions were often taken word-for-word” in the language of the bill).[34] But these very same trends also mean the expansion of the industry will be seen as a threat to livelihoods, further stoking tensions and underlying suspicions of the technology.

Law and Privacy

One profession that will be busy, though, is the lawyers.

While some say drones are no different than manned planes or fixed surveillance cameras on the street, and so raise no new privacy issues, this is incorrect at face value. There are similarities but also fundamental differences.

To operate, a robot is always gathering and storing information about the world around it. Always. This is different from a regular plane, for example, where the human operator is gathering most of this information but cannot store it for playback. A robot’s operating requirements mean that even in the course of regular operations, it is gathering and storing information about everything that crosses its path. This gives robots an advantage over human operated planes, where a conscious decision to acquire and store data must be made. The other main advantage of unmanned systems is their ability to loiter for long periods of time, which again allows them to draw in more information, and as the ACLU's Jay Stanley and Catherine Crump have written, also allows them to “...pose a more serious threat to privacy than do manned flights."[35]

Taking in vast quantities of information even unintentionally is a key part of the concern. For example, a robot on a “Where’s Waldo?” mission to hunt down one person in a city will still be gathering data on the entirety of the city throughout the search process.

Visual information is not the only type of data being gathered. Unmanned systems also carry out electronic surveillance. A drone unveiled at the DefCon hacking conference in 2011 can crack Wi-Fi networks and intercept text messages and cell phone conversations – without the knowledge or help of either the communications provider or the customer.[36] This type of drone draws in electronic information on a wide group of people beyond the intended target – and, different from a computer, includes those who have not signed a user agreement or otherwise signaled they accept this intrusion upon their privacy.

Finally, the size and mobility of robotic systems is fundamentally different – many are being designed in increasingly smaller sizes, and they are able to move and track targets covertly when required. A robotic system can watch from above, but can also get up close and personal, unlike a fixed security camera or a high altitude spy plane.

These differences lie at the heart of a lot of the worries over domestic use of unmanned systems. Such suspicion has mobilized left wing groups like the ACLU, but also those on the right, such as the Tea Party movement, perhaps best illustrated by the speeches and legislation of Senator Rand Paul, who has attempted in the words of one article to launch “a Preemptive Strike Against Domestic Drone Use.”[37] While some 20 states from Nevada to North Carolina are competing to be the home of the six FAA drone test sites, the anti-drone movement has crystallized into efforts to ban the use of drones in at least ten state legislatures, ranging from Virginia to Oregon. Indeed, Charles Krauthammer, a right wing commentator on Fox News, even urged Americans to use their Second Amendment powers to shoot down drones (something already done by a group of hunters in Pennsylvania, who shot down a drone doing environmental monitoring).[38]

Building Code

With these concerns brewing, we are starting to see some steps forward to respond. For instance, an industry “code of conduct” has been put forward by the same trade group that prompted the current controversy over domestic drones with its successful lobby to open the airspace. The AUVSI code took on many of the concerns circulating, grouping them into three core themes of Safety, Professionalism, and Respect.[39] It laid out how the industry and users would "commit" to not operating drones "in a manner that presents undue risk to persons or property;" to planning for "all anticipated off-nominal events;" and to share such contingency plans with "all appropriate authorities." It made great sense and was reported widely.

The challenge for the robotics code of conduct, however, is much the same as other industries' attempts at self-regulation, ranging from banking to the private military industry. It's a laudable start, but it doesn't change the underlying issues and concerns. Like such other would-be "codes of conduct," it lacks a key ingredient: consequences.

It is a voluntary code with no results if one violates it. Indeed, much of what is laid out is actually restatements of responsibilities the firms and users already should abide by, regardless of any code. For example, the code says that the firms "will comply with all federal, state and local laws." So, before the code, they could violate the law at will? Of course not.

But more importantly, the code is not able to deal effectively with all the areas where the law is absent or vague. It says that "We will ensure that UAS are piloted by individuals who are properly trained and competent to operate the vehicle or its systems." Who will determine this, and what does "trained and competent" mean in a world where some believe drones should only be operated by rated pilots, even though new versions can be flown by teens using iPhone apps?

Likewise, the code pledges to "respect the privacy of individuals," which is a bold statement. But "Respect" could be anything from avoiding the monitoring of individuals without their express permission to showing them "respect" only in the public-relations sense.

Of course, these are thorny issues. Indeed, it's their very thorniness that is why an industry self-regulatory code is the beginning of the discussion, not the final answer

The Police Weigh In

The same could be said of a push by police chiefs, who have offered a code of conduct for their use of drones.[40] This effort asserted that police wouldn’t let any images captured by unmanned aerial vehicles be open to inspection by the public, and that the images would not be stored, unless they are evidence of a potential crime or part of an ongoing investigation. Of course, that’s a pretty large out clause.

More importantly, the police chiefs’ effort is a proposal, not yet policy, with some huge gaps. Even worse, it has a big dose of unrealism. For instance, it suggests that police would use a “Reverse 911 telephone system to alert those living and working in the vicinity of aircraft operations. If such a system is not available, the use of patrol car public address systems should be considered.”

In reality, such a system would be unworkable and even laughable. Each and every time a UAS flies, the police are going to call all of an area’s residents’ home phone (setting aside the growing number who only have mobile phones)? Or, alternatively, the police are planning to ensure public awareness of potential privacy losses by recreating the scene from the movie The Blue Brothers, driving through the streets yelling out on a car’s bullhorn?

Similarly, we have next order questions, like whether drones should be armed. This is cast aside quickly in the proposed codes, but again definition and context matters. Law enforcement in Texas has shown interest in unmanned aerial systems armed with a shotgun that shoots “less than lethal” rounds.[41] One person’s shotgun or taser is another person’s unarmed drone.

The bottom line is that, as with revolutionary inventions of the past, no amount of handwringing by pundits late to the game will see a technology of such great promise banned.

Instead, a revolutionized world requires the establishment of new rules, which in turn requires an understanding of the new technology. Much of the substance of these rules will likely come from both public discourse and the private sector. For example, the origins of the modern way we drive can be found in Rules of the Road, published in 1903 by William P. Eno. Known as "the father of traffic safety,” Eno’s book contained such revolutionary ideas as cars only passing on the left, stop-lights and one-way streets. (Ironically he never drove himself; he was always chauffeured).[42]

We are seeing a similar evolution now, whether in the development of industry codes of conduct or guidelines for university research groups. But much like the early “rules of the road,” these will need enforceable laws to make them real. Early cars and planes, for instance, needed more than Eno’s book – mainstream use of these inventions demanded the drafting of traffic laws and the creation of regulatory institutions like the Federal Aviation Administration. Similarly, the increasing use of unmanned systems has highlighted a gap at the state and federal level that demands action.

Where the Law Goes Next

As these laws are hopefully built by Congress, we need to recognize that much of what is written in the law is just the first draft. For instance, federal district court judges have spoken about how, much like with computers and the privacy questions they created, questions over the proper use of drones by law enforcement will end up as Supreme Court cases.

But even then what will the Court decide? A case that is frequently spoken about as a potential precedent is 2001's Kyllo vs. U.S.[43] In this instance, a federal government agent used a "thermal imaging device" to scan a home in Florence, Oregon. They did not have a warrant, but it allowed them to learn that marijuana was being grown.

When the case made its way up to the Supreme Court, the majority opinion, written by Judge Scalia, was that when the "government uses a device that is not in general public use, to explore details of a private home that would previously have been unknowable without physical intrusion, the surveillance is a Fourth Amendment 'search,' and is presumptively unreasonable without a warrant."

Many point to this as evidence that the Supreme Court will be less likely to approve domestic use of drones in an intrusive way by police. But they ignore the caveat. What about when a technology becomes in “general public use,” as drones are evolving to?

Similarly, last January in the U.S. v. Jones case, the Supreme Court ruled that placing a GPS tracking device on a vehicle is considered a search under the Constitution and required a warrant. Notably, though, it was the physical placement of the GPS on the vehicle that mattered most.[44] The Court said other evidence obtained without using the GPS device was admissible because the suspect had no "reasonable expectation of privacy" for a vehicle on the public streets. One way to read it is that your car can’t be tracked without a warrant; another is that your car can be tracked without a warrant, just as long as the police don’t place anything on the vehicle, which is no longer required with our current technology.

The underlying point is that the precedents cited with certainty by analysts and lawyers are often not as clear as they might be. And, when there are questions, or even potential abuses, it will be years before the legal system resolves them. The GPS case happened in 2005, but didn’t get resolved until 2012, well after the technology of a physical tracker was no longer needed. Moreover, just because the Supreme Court ruled one way, doesn’t mean it won’t rule differently on very similar issues, just at a different time. As everything from voting rights to abortion rulings demonstrates, all it takes to reorder the law is just a few seats changed on the court. Neither technology nor laws are written in stone, and justices don’t live forever.

User Questions

The innovation spread of robotics represents another trend of opportunity and peril. An ever-wider set of users is innovating for all sorts of positive purposes with robotics, from the great work being done by young students at robotics labs at McGill University to the team in Australia that built an autonomous drone to help find lost hikers.[45]

But not all of the people behind machines have only the best in mind. Take the traditional notion of using a robotic drone for surveillance. The new users have not just been militaries or police, but have also been civilians. These include news journalists who have reported on natural disasters with drones, as well as parents who want new ways to watch their kids.[46] A father in the U.S. gave new meaning to the term “helicopter parent,” using an automated quadcopter drone to escort his child to the school bus stop.[47]

The problem is that each and every technology has its darker side. The technology is enabling a new field of drone journalism (already taught at University of Nebraska and University of Missouri) that reports important stories with a whole new level of fidelity.[48] But the same phenomenon also advances the field of paparazzi. For instance, Gary Morgan, chief executive officer of Splash News, a celebrity-photo agency, has already said he’d like to be buzzing his quarry soon with silent, miniature drones mounted with tiny cameras: “It would strike fear in the hearts of every celebrity having a birthday party.”[49] And, one has the sense that the child may end up telling a therapist one day about his father loving him a bit too much, to the extent of following him with a drone.

Open Source

More seriously, just as software has gone “open source,” so has warfare. Robotics is not a technology like the atomic bomb or aircraft carrier, where only the great powers can build and use it effectively. Instead, just like with the “app” in the field of software, it is not just the big boys who control the field. The barriers to entry are not exceptionally high, and that means that bad actors will be able to gain and use this advanced technology.

If history is any guide, the repurposing of a low-entry revolutionary technology tends to happen fairly quickly. The first car bomb was set off as early as 1905, used in an assassination attempt on the Ottoman sultan. Similarly, the first hijacking of a plane took place in 1931, very early in civilian air travel.

A particular area of concern, then, is the use of robotic systems by terrorists and other non-state actors. Israel as a state has long used drones, and now so does its non-state opposition. Hezbollah, for example, is not a major state military, but it has already operated UAVs, as too has Hamas.[50]

The impact of this trend is twofold. The first is that it reinforces the empowerment of individuals and small groups against the power of the state. During the Second World War, for example, Hitler’s entire Luftwaffe could not manage to reach across the Atlantic to strike at Canada or the U.S. Just a few years ago, a blind 77-year-old man managed to build his own drone that flew itself across the Atlantic.[51]

And one man’s hobby may be another man’s plot. In 2011, the FBI arrested Rezwan Ferdaus, a man who wanted to recreate the 9/11 attacks (not so ironically, he had been angered by drone attacks in the Mideast intended to stop terrorism).[52] Unable to hijack planes, he instead obtained a large drone and planned to fly it into the Pentagon. Fortunately, he made the mistake of asking an FBI informant where he could obtain C-4 explosives. The plot was averted, but it showed we are now in a world where it is easier to get the drone than the bomb.

This greater reach and power may also see a lowering of the bar. One does not have to be suicidal to carry out attacks that previously might have required one to be so. This allows new players into the game, making al-Qaeda 2.0 and the next-generation version of the Unabomber or Timothy McVeigh far more lethal.

Just as car bombs are not the only way automobile technology has been misused, we should not make the mistake of only focusing on terrorism when it comes to the potential criminals uses of robotics. The early horseless carriage may have been reworked into a car bomb by turn-of-the-century terrorists, but the main illegal use was as a getaway device for criminals. Similarly, the best example of innovation in the field of robotics last year might be the team of thieves in Taiwan, who used tiny helicopters equipped with pinhole cameras to carry out a jewellery heist. They made away with $4 million worth of loot before being caught.

Accountability

The challenge for the law is not just how to prevent bad guys from doing bad things, but what to do when things go wrong without someone having bad intent, such as when the Google car was in a wreck in August 2011. Like most wrecks, the various sides involved blamed each other, just now they did it via online social networks.

Now take these issues and move them into the air. Congressional investigators report that there were over 200 drone accidents in Iraq and Afghanistan over the course of four years. This doesn’t include the many that happened in the not so covert world of strikes in Pakistan and Somalia. Perhaps the most amusing, but also maybe scary case took place at a base in Djibouti in March 2011.

As The Washington Post reported, a Predator parked at the Camp Lemonnier started its engine without any human direction, even though the ignition had been turned off and the fuel lines closed. “Technicians concluded that a software bug had infected the “brains” of the drone, but never pinpointed the problem…“After that whole starting-itself incident, we were fairly wary of the aircraft and watched it pretty closely,” the Air Force squadron commander testified to an investigative board.”[53]

The issue here isn’t that Predators are poised to take over the homeland, but rather another vexing question of law, politics, and ethics. Robotics has a long history of what one Vice President of a technology firm described to me as “oops moments.” These are when things don’t work out with your machine as planned and you have to take it back from the field. With military robotics, the examples range from the machine gun armed UGV that went “squirrelly” and started spinning around during a demonstration to the automated anti-aircraft system in South Africa that had what investigators thought was a “software glitch” during a training exercise. It shot nine soldiers by accident in a real world version of the famous scene from Robocop.[54]

Today, these oops moments might even be intentionally caused by hostile man-made threats, including criminal or adversarial efforts at UAS communications interference or hacking. Here again, this scenario is not science fiction, but was recently demonstrated in a test in Texas, where a university team hacked the navigation system of a drone.[55]

The issues this phenomenon presents are not just how to avoid them through technology improvements and deconfliction protocols, but also more vexing questions of process, policy, and even philosophy. How do we investigate and apportion out accountability in a realm where more and more is happening outside our old concepts of control and responsibility?

For instance, aviation law and insurance right now focuses on determining if the problem was a hardware error (a widget broke), wetware error (the human pilot made an error), or spiritual (an “Act of God” caused the loss). Now we have much in between, the role that software plays. And in the software field, responsibility and accountability is not something easily assigned. It can be stretched over the long periods of time between design and use, over the large numbers of people involved in writing and selling and buying and upkeeping software, by a business approach that often intends to let the customer find the errors, and by the fact that software will repeatedly be put in real world circumstances for which it wasn’t originally designed. In short, we have to figure out how to catch up our 20^th century laws, with our 21^st century technologies.

The Psychology Side

The irony in all this is that while the future may involve more and more machines watching us, whether it is police watching city streets from above, or the NSA reading your email, or your phone letting Starbucks know you are walking nearby, how we react to it will still be driven by the very fuzzy combination of our human programming, our identity and emotions – our chemical makeup that drives human psychology.

So what then will be the reaction to this next level step in the surveillance state? Will we redefine our notions of privacy, reacting like how teenagers have handled their online behavior on Facebook and Twitter? Who cares if all my behavior is shared with the world? Instead, I’ll embrace a loss of privacy that would have shocked my parents generation, and even mock it. One can already see this in the new offerings of anti-drone “stealth clothing” for any “style-conscious” terrorists the U.S. seeks, as well as “fashionistas who value their privacy.” As its designer told the media, it also doesn’t fall along clear partisan lines, making it the “Project Runway” version of Rand Paul’s filibuster. “It interests people on the far right as much as it interests people on the far left. Ultra-conservatives see it as anti-government and ultra-liberals see it as anti-military.”[56]

Or will we fear it? And is this a good or bad thing? Some, such as one senior State Department official, believe that our unmanning of war “…Plays to our strength. The thing that scares people is our technology.”[57] The carryover of this belief to the domestic side is the belief that a world of more drones will be a safer world, via a deterrent value. Where’s Waldo won’t mug me if he knows he’ll be caught on screen,

But the psychology of scaring people with technology is a tricky business. It’s the domestic version of the problem we face in our counterterrorism today. Abroad the U.S. government is wrestling with the robot’s impact on our very human “war of ideas” that we are fighting against radical movements. U.S. troops in Afghanistan describe having drones overhead as reassuring, saying they can sleep better as they feel like someone is always above, watching out for them. On the other hand, many civilians there say it’s intrusive, and creates a climate of fear and distrust. That is, on the domestic side, the risk is that robotic surveillance will instead be perceived as an intrusive “Big Brother” figure, as the Russian police who have already used drones to monitor protesters have been called.

The broader issue might not be one of fear, however, but a redefinition of how those who are watched look at the watchers. There is the potential that the drone could become emblematic of those trying to police people they don’t know, on the cheap, from afar. The drone becomes like the cameras favored by the disconnected Baltimore police force of the TV show The Wire, who watch a world of crime play out that they don’t understand.[58]

Conclusions

The ripple effects of robotics will continue to push out into all sorts of domains, in ways both expected and unexpected. Through it all, though, one fundamental principle will hold true as it has in the past: There are always two sides to technologic revolutions. From our new technologies we gain amazing capabilities that seem like they are straight from science-fiction. But from our new technologies we also gain new human dilemmas that seem like they are straight from science-fiction. Moore’s Law is operative, but so is Murphy’s Law.[59]

The issues of domestic “drones” all seem futuristic, but notice how none of the examples that were explored in this article were from the distant future. The questions they raise are fundamental policy questions of today. We can ignore them, or we can embrace and engage in the opportunities and dilemmas of these exciting times.

The above paper includes sections explored in the article The Robotics Revolution, for the Canadian International Council. The author would also like to thank the Christopher Newport University Center for American Studies.

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[50] Zeina Karam, “Hezbollah says it sent drone over Israel,” USA Today, October 11, 2012, http://www.usatoday.com/story/news/world/2012/10/11/israeli-leader-accuses-hezbollah-of-drone-launch/1627315/.

[51] Chris Anderson, “The patron saint of DIY drones,” Geekdad (blog), Wired, April 3, 2007, http://www.wired.com/geekdad/2007/04/the_patron_sain/.

[52] Peter Finn, “Mass. man accused of plotting to hit Pentagon and Capitol with drone aircraft,” The Washington Post, September 28, 2011, http://articles.washingtonpost.com/2011-09-28/national/35274975_1_rezwan-ferdaus-undercover-agents-fbi.

[53] Craig Whitlock, “Remote U.S. base at core of secret operations,” The Washington Post, October 25, 2012, http://www.washingtonpost.com/world/national-security/remote-us-base-at-core-of-secret-operations/2012/10/25/a26a9392-197a-11e2-bd10-5ff056538b7c_story.html.

[54] Robocop, directed by Paul Verhoeven (Orion Pictures Corporation, 1987), http://www.imdb.com/title/tt0093870/.

[55] “Drone Hacked By University Of Texas At Austin Research Group,” The Huffington Post, June 29, 2012, http://www.huffingtonpost.com/2012/06/29/drone-hacked-by-universit_n_1638100.html.

[56] Claire Stern, “Adam Harvey Launches Stealth Wear, an Anti-Drone Clothing Line,” The Daily Beast, March 5, 2013, http://www.thedailybeast.com/articles/2013/03/05/adam-harvey-launches-stealth-wear-an-anti-drone-clothing-line.html.

[57] P. W. Singer, Wired for War.

[58] The Wire, created by David Simon (Blown Deadline Productions/Home Box Office, 2002-2008), http://www.imdb.com/title/tt0306414/?ref_=fn_al_tt_1.

[59] Ranaan Avidor, Murphy’s laws site, http://www.murphys-laws.com/.

Authors

Peter W. Singer

Image Source: © Reuters Staff / Reuters

Countering Corruption: 2012 Conference Report from the World Forum on Governance

Stephen M. Davis, Thomas E. Mann and Norman J. Ornstein — Mon, 04 Mar 2013 00:00:00 -0500

EXECUTIVE SUMMARY

Reformers, businesspeople, investors and citizens alike are grappling with a common issue around the world: Good governance. How can each nation secure government that is honest and not corrupt, that serves the public interest and not special interests, and that aims to deliver practical solutions to today’s most pressing problems? How can corporations and institutional investors achieve good governance of their own, that protects and promotes long term value while complying with legal norms, ethical standards and customer expectations? What is the relationship between good corporate and democratic governance? Indeed, is either possible without the other?

In December 2012, Brookings convened the second World Forum on Governance, which has unique capacity to join thought leaders from the public and private sectors together. The objective was to identify means to leverage the collective power of capital, media, public policy and social organization behind the movement against global corruption.

Conference participants included a rich mix of leaders, experts and grassroots innovators from Latin America, Africa, the Middle East, Europe, North America, the corporate and investment worlds, traditional and new media and faith-based organizations. Delegates revisited the Ten Principles outlined in the Prague Declaration, which was formulated during the 2011 World Forum on Governance, reviewed reports on initiatives raised at the 2011 meeting, and discussed next steps to address governance and integrity.

Most importantly, breakout sessions trained attention on four policy action areas critical to the fight against corruption:

Crafting effective law, regulation and enforcement within and across borders;
Strengthening the business and investment case for managing corruption risk;
Linking a wider group of civil society organizations, including faith groups, behind the push for integrity in the public and private sectors; and
Enhancing the capacity of traditional and social media to serve as watchdogs against corruption.

One plenary session concentrated debate on the experience of financial institutions; a second addressed how the strengths and weaknesses of democracy affect corruption. By the end of the 2012 WFG, conference organizers gained enough feedback and useful ideas from the participants to decide upon an agenda of next steps. These policy action ideas are clustered around five themes. Organizers can steer follow-up on each to specific conference participants or relevant organizations; other actions can be taken forward by the Brookings Institution.

Establishing a framework for an investor road show, to bring the voice of capital directly to political leaders on the business value of fighting corruption.
Encouraging greater collaboration among policymakers around the world to incubate legislative and policy action to improve anti-corruption efforts.
Increasing the capacity for the media to report on and be educated about corruption and increasing accountability for media companies themselves.
Engaging with the faith community to identify a role for this critical voice in the fight against corruption.
Raising the profile of firms considered leaders in the field for business integrity, transparency, and corporate governance.

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Authors

Stephen M. Davis
Thomas E. Mann
Norman J. Ornstein

U.S. Tax Reform: Reducing the Tax Code’s Bias for Debt

Robert C. Pozen — Mon, 18 Feb 2013 00:00:00 -0500

To begin with, let me summarize the specifics of my proposal, which I detailed in Tax Notes. My proposal would reduce the U.S. corporate tax rate from 35% to 25%. I would finance such a rate reduction by limiting deductions for the gross interest expense of corporations (I call this provision the “interest cap”). Non-financial corporations would be allowed to deduct 65% of their gross interest expense, while financial corporations would be allowed to deduct 79% of their gross interest expense. There would also be special rules for corporations that would have reported a loss for tax purposes, but for these restrictions on interest deductions.

My piece in Tax Notes was not intended to set a specific proposal in stone, but rather to illustrate the general strategy: reducing the corporate tax rate while limiting interest deductions. I believe that such a combination would reduce the tax code’s bias in favor of debt, while making the U.S. a more attractive location for discrete, profitable investment projects.

With that said, let me address the main objections to my proposal.

Winners and losers

The most common objection to my proposal is that it would create winners and losers. While that objection is true, it is true because my proposal would substantially correct a significant distortion within the tax code in favor of debt finance. As a result, some corporations that are taking advantage of this bias in the tax code might see a higher tax burden under my proposal.

However, any revenue-neutral tax reform is mathematically guaranteed to create winners and losers. So, in my view, the primary criterion for evaluating a tax reform proposal should be whether it would reduce economic distortions.

I believe that my proposal would meet this criterion by moving the tax code closer to a neutral position between debt- and equity-finance. Under my proposal, corporations would no longer issue debt mainly because interest payments are deductible and returns to equity (dividends or share appreciation) are not. This means that corporations would make financing decisions for economic reasons rather than tax reasons—leading to a more efficient allocation of resources.

Transition relief

Other commentators in the International Tax Review article objected to the idea of applying the interest cap to pre-existing debt. I share this concern: corporations have made decisions about issuing debt based on good faith beliefs that the current treatment would continue.

I had been hesitant to allow for a broad grandfathering of existing debt. If the tax reform legislation allowed such grandfathering—effective on the enactment of the legislation—then corporations could rush to issue long-maturity debt shortly before the enactment of the legislation. In my piece, I proposed instead a 10-year, linear phase-in of rate reductions and restrictions to interest deductions.

However, I would accept an alternative approach: grandfathering existing debt effective as of January 1 of the year in which the legislation was first introduced (rather than at the date of enactment). That could substantially reduce any rush to issue debt shortly before the enactment of the legislation. The corporate tax rate could then be gradually reduced in a revenue-neutral manner.

Net interest versus gross interest

Observers frequently argue that my interest cap should apply solely to net interest expense, rather than gross interest expense. I disagree for two reasons.

First, applying the interest cap to net interest expense would raise only a small amount of revenue—enough to finance a reduction in the corporate tax rate by about 1.5 percentage points, based on estimates by the Congressional Research Service. As a result, the U.S. corporate tax rate could not be reduced to a level competitive with most industrialized countries.

Second, restricting net interest deductions would (by itself) increase effective marginal tax rates (EMTRs) on debt-financed investment to nearly the same extent as restricting gross interest deductions (though average tax rates on debt-financed investment would be substantially different).

Consider a hypothetical non-financial corporation that has $300 million in gross interest income and $500 million in gross interest expense. Imagine it is considering a marginal investment that would cause it to incur an additional dollar in interest expense. Under my proposal, that corporation could deduct 65 cents of that additional dollar. If I instead applied the restrictions to net interest expense, that corporation could still deduct 65 cents of that additional dollar. This corporation’s incentives—on the margin—essentially do not depend on whether the interest cap applies to net or gross interest expense.

Yet, as mentioned above, applying the interest cap to gross interest raises much more revenue, and thus can finance a much more significant reduction in the corporate tax rate. The reduced corporate tax rate mitigates the increase of EMTR on debt-financed investment and sharply reduces the EMTR on equity-financed investment. According to the model developed by the Congressional Budget Office, the average EMTR facing non-financial corporations would be roughly unchanged under my proposal.

By contrast, applying the interest cap to net interest expense could not finance a reduction in the corporate tax rate sufficient to offset the increase in EMTR associated with the interest cap. Thus, financing a corporate tax rate reduction by restricting net interest expense would cause the average EMTR facing corporate investment to increase.

Alternative approaches

Lastly, some commentators argue that we should reduce the distortions to financing decisions by cutting shareholder-level taxes on dividends and capital gains, rather than imposing an interest cap. While there are many good reasons to support lower dividend and capital gains taxes, such tax relief would in fact work against the goal of raising revenue to reduce the corporate tax rate. If corporate executives wish to reduce shareholder-level taxation, then they must put forward specific revenue or spending proposals to offset the revenue loss.

In fact, though most corporate executives want a 25% corporate tax rate, they have not been willing to eliminate or restrict the large tax preferences built into the tax code—such as the deduction for domestic production activities and the research and development credit. The items usually identified for repeal—such as accelerated depreciation for corporate jets or credits for green energy—are too small to finance any meaningful reduction of the corporate tax rate.

In these times of tight budgets, any proposal for tax reform must be at least revenue-neutral. And while I support “comprehensive” tax reform, this seems to be a long-shot.

A continuing process

I want to thank International Tax Review for giving me the opportunity to respond to the earlier article. But it is equally important to thank all those who commented on my proposal for that article. The thoughtful comments will help me refine the proposal—both to bolster the U.S.’s global competitiveness and to reduce the distortive effects of the tax code.

Authors

Robert C. Pozen

Publication: International Tax Review

Image Source: © Jessica Rinaldi / Reuters

A Win-Win: Compromise on Foreign Profits

Robert C. Pozen — Thu, 07 Feb 2013 00:00:00 -0500

In last year’s State of the Union, President Obama argued in favor of reforming how the U.S. taxes the foreign profits of U.S. corporations: “From now on, every multinational company should have to pay a basic minimum tax.” While an international minimum tax is a sound idea, it should be part of a broader effort to fix our dysfunctional system for taxing foreign profits.

Currently, foreign profits of U.S. corporations are subject to a Hobson’s choice. Such profits are subject to a 35 percent tax rate if repatriated to the U.S. parent company. But if a corporation keeps that money permanently outside of the U.S., it typically owes no U.S. tax on those profits.

This bifurcated tax treatment leads to two related economic problems. First, corporations can reduce their tax burden by artificially shifting their profits from the U.S. to a tax haven, such as Bermuda or the Cayman Islands. Because highly mobile intellectual property (such as patents, brand names, and the like) has become an increasingly important driver of corporate profits, corporations have been able to shift more and more of their profits to tax havens. In 2008, U.S. corporations reported profits in Bermuda over 1000% of that island’s GDP.

Second, U.S. corporations have a huge disincentive to bring any profits earned in a foreign country back to the U.S. If a corporation did repatriate those profits, it would owe the difference between the 35 percent U.S. corporate tax rate and the local corporate tax rate. As a result, trillions of dollars in cash is currently being held by overseas affiliates of U.S. corporations—cash that cannot be invested in the U.S. by the parent company.

An international minimum tax, as President Obama has proposed, is a smart way to reduce profit-shifting—the first problem. Such a minimum tax should allow a credit for foreign taxes paid (as allowed under the current system); if the minimum tax were 17 percent and the local tax rate were 5 percent, the U.S. would impose an immediate tax equal to the difference between the two rates (12 percent in this case).

However, the international minimum tax would not address the second problem of today’s system: the incentive for U.S. corporations to keep their cash in the hands of their foreign affiliates. The U.S. could fix this second problem if it taxed foreign profits at 35 percent regardless of whether they were repatriated. But such a “worldwide system” of taxation would put U.S. corporations at a significant disadvantage to their foreign competitors. For instance, McDonald’s would face a 35 percent tax rate on the profits they earn in their restaurants in the United Kingdom, while a U.K.-based competitor (say, Harry Ramsden’s) would pay the U.K. rate of 24 percent.

Most jurisdictions take the opposite approach, taxing only those profits earned within their borders (with limited modifications to try to prevent egregious forms of profit-shifting). This system, known as the “territorial system” of taxation, is also the proposed solution of the GOP. If Congress enacted a territorial system, it would essentially remove the tax-related barriers blocking corporations from using foreign profits to invest in the United States. However, it would also strongly encourage the transfer of corporate profits to tax havens—especially income attributable to intellectual property or mobile investments.

Fortunately, there is a sensible compromise in the offing: policymakers could combine President Obama’s proposed international minimum tax with the GOP’s proposed territorial system. Here’s how this combination could work:

First, there would be an international minimum tax rate equal to, say, 17 percent. If a corporation paid less than 17 percent to a foreign government, it would immediately owe the difference to the U.S.—reducing the incentive to artificially shift profits to tax havens.

Second, if a corporation paid more than 17 percent in taxes to a foreign country, it would be allowed to repatriate that income freely to the United States and owe no (or minimal) taxes. This would substantially reduce the incentive to keep cash in the hands of overseas affiliates.

By imposing an international minimum tax, this combination would ensure that all corporate profits were taxed at some reasonable rate by some government. And by allowing corporations to easily repatriate profits earned in most foreign countries, this combination would strengthen the competitive position of multinational corporations based in the United States. President Obama proposed the first half of this combination in last year’s State of the Union; I hope he finishes the job in this year’s speech.

Authors

Robert C. Pozen

Image Source: © Darley Shen / Reuters

Reimagining a Corporation’s Purpose in the Great Recession Era and Meeting Threats to Free Enterprise

Wed, 30 Jan 2013 14:00:00 -0500

Event Information

January 30, 2013
2:00 PM - 3:30 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue, N.W.
Washington, DC 20036

Register for the Event
The current economic climate is obviously a difficult one for U.S. corporations: the economy is sluggish, the housing market has yet to fully rebound, consumer demand is down, and Wall Street’s relationship with Washington appears to have hit an all-time low. To add to these mounting difficulties, corporate America’s current focus appears to have shifted heavily toward maximizing shareholder profits and executive compensation at the expense of long-term corporate growth and business stakeholders, including employees, investors and communities. “Corporate short-termism” and profit by any means necessary are veritable threats to free enterprise and the health of the U.S. capital markets.

On January 30, as part of a series on corporate purpose, Brookings hosted a discussion on the substantial challenges modern-day corporations face as they struggle to rebound in an historically difficult economic environment, which is seemingly bound by different ethics than eras past. Moderated by Governance Studies Vice President Darrell West, a panel of experts explored how the short-term focus of shareholders and investors affects corporate behavior and government policy; how to encourage longer time horizons among shareholders and executives; how companies can best serve the interests of its stakeholders; and how corporate America can best meet the challenges presented by the Great Recession.

35 Percent Is Way Too High For Corporate Taxes

Robert C. Pozen — Tue, 29 Jan 2013 10:53:00 -0500

If there's one policy agreement between Republicans and Democrats, it's that the 35% corporate tax rate in the United States should be reduced to 28% or 25%. The current rate, highest in the advanced industrial world, disincentivizes investment and encourages corporations to relocate overseas.

Unfortunately, the deficit is a major hurdle facing any proposal to reduce the corporate tax rate. Because of the fiscal pressures facing the government, most politicians recognize that any corporate tax rate cut must be paid for by eliminating tax preferences and "loopholes." But few politicians have identified enough revenue-raising measures to offset the cost of a significant reduction of the corporate tax rate-cutting the rate from 35% to 25% would cost roughly $1.2 trillion over ten years.

I believe that there is a sensible answer: a modest limit to the deductions that corporations claim for the interest they pay on their bonds and other debt.

Admittedly, interest deductions probably won't be the first target for politicians. Most likely, politicians will first take a close look at the myriad of provisions designed to benefit specific industries. For instance, the fiscal cliff deal extended tax benefits for car racing facilities, railroads, mining companies, and various alternative energy companies. Indeed, many of these preferences have highly suspect economic justifications; unfortunately, these special deals are too small for their repeal to raise a significant amount of revenue.

Politicians might then turn to some of the larger tax preferences that corporations enjoy, collectively known as "tax expenditures." However, they will likely find it unwise, or politically infeasible, to repeal any of these large tax expenditures, such as accelerated depreciation or the research and development credit. Most Democrats and Republicans view these policies as being essential to economic growth. In any case, the bipartisan Joint Committee on Taxation has estimated that the elimination of virtually all corporate tax expenditures would not be sufficient to reduce the corporate tax rate to 25%.

Another approach would be to change how the U.S. taxes the foreign profits of U.S. corporations. Currently, U.S. corporations can avoid paying U.S. tax on foreign profits so long as they keep those profits overseas. Congress could raise a significant amount of revenue if it required U.S. corporations to immediately pay U.S. taxes on their foreign profits-beyond the foreign taxes that they already pay. However, this change would make our corporate tax system even more out of step with the rest of the world; most foreign countries require corporations to pay tax only on profits that were earned in that country (with exceptions designed to prevent abusive tax-shifting).

Thus, if policymakers are serious about reducing the corporate tax rate, they will need to consider other revenue-raising measures. To merit serious consideration, such reforms should offer the potential for meaningful new revenue, and they should also make sense from a policy standpoint.

My proposed limits to interest deductions (which I call the "interest cap") would meet both criteria. Currently, corporations may fully deduct the interest they pay on their bonds and other forms of debt. This deduction costs the Treasury a significant amount of money, and encourages corporations to take on too much debt, increasing the fragility of the economy.

Using data from 2000 to 2009 (the most recent available), I estimate that a 65% cap on deductions for gross interest would have paid for a reduction in the corporate tax rate from 35% to 25% over those ten years. In other words, corporations would be able to deduct 65% of their gross interest expense, rather than 100%; from 2000 to 2009, this modest restriction would have been enough to finance the entire rate reduction to 25%.

My proposed "interest cap" would also reduce a significant distortion in the tax code. Currently, if a corporation finances an investment with debt, it can deduct the interest that it pays on that debt. If a corporation finances an investment by issuing new shares of stock, or by using money in the bank, there is no equivalent deduction. As a result, the tax code effectively encourages corporations to load up on debt. This makes companies more vulnerable to downturns-exposing their employees to a greater risk of layoffs and prolonging recessions in the broader economy.

I acknowledge that the treatment of financial institutions under my proposal is a tricky issue. Financial institutions typically borrow significant amounts of money in their daily operations. On the one hand, a vibrant financial sector is a critical component of a healthy, growing economy, and the "interest cap" could constrain these daily operations. On the other hand, excess debt within the financial sector can be especially damaging, as it has the potential to increase the severity of financial crises.

To balance these competing demands, my proposal would apply the interest cap to financial institutions, but at a lower rate. They would be allowed to deduct 79% of their interest expense-less than the 100% that they may deduct currently, but more than the 65% that nonfinancial corporations could deduct.

Undoubtedly, certain debt-intensive industries will lobby against my proposed cap on interest deductions. But policymakers should resist such pressure: any revenue-neutral tax reform must necessarily create winners and losers. Instead, policymakers should focus on setting the stage for broad-based economic growth by reducing the distortions in favor of debt-finance, and by bringing our corporate tax rate in line with the rest of the world.

Authors

Robert C. Pozen

Publication: Real Clear Markets

Image Source: © Robert Galbraith / Reuters

There's a Civil War in America's Business Community, But Will Obama Notice?

William A. Galston — Tue, 22 Jan 2013 00:00:00 -0500

The chief business of the American people is business,” Calvin Coolidge famously said. But not all business is the same: The policies that assist some may injure others, and the organizations that represent different kinds of business often work at cross-purposes. This reality, which the Republican mantra of “job creators” obscures, could be the key to determining the success of President Obama's second term. The Obama administration will need to recognize the fervent opposition of small businesses to its priorities, while taking advantage of large corporations' willingness to cooperate.

There are deep and strucutral differences between these two sectors. Most small businesses pay taxes through the individual code, while big businesses pay corporate rates. Small businesses typically hire through family and local networks, while big businesses draw from a national labor pool. Small businesses focus mainly on the domestic market, while big businesses are just as concerned about overseas sales. Corporations have sizeable cash flows and access to credit markets, which gives them a cushion against adversity and added costs; small businesses often operate much closer to the margin and are acutely sensitive to policies that threaten to drive up costs. Corporate CEOs can hire experts to help them cope with added regulatory burdens and can spread the costs over a large workforce; small business owners must deal with these burdens by themselves and have few ways dilute their impact.

A glance at the websites of two leading business organizations—the National Federation of Independent Business (the “voice of small business”) and the Business Roundtable (CEOs of leading companies with a collective $6 trillion in annual revenues) underscores these differences. While the NFIB continues to call for the repeal of Obamacare, the BR seeks only modest fixes. The NFIB denounces “overzealous regulation” and advocates a national drive to protect small businesses from regulations recently proposed by the Obama administration. For its part, the BR calls for “smarter regulation” and criticizes eight proposed or pending regulations but also “applaud[s] President Obama’s initiative to streamline the federal regulatory apparatus.” Many corporate CEOs supported the fiscal cliff agreement, which small business people opposed because it increased top marginal rates for high-income taxpayers.

The NFIB stance toward government is almost entirely negative: Most of what government does makes the lives of small businessmen and women harder, and it should just stop doing it. By contrast, last year the Business Roundtable issued “Taking Action for America,” a comprehensive plan for jobs and economic growth that called on the government to act on numerous fronts, from education and immigration to energy and trade. While it is easy to discern the thread of self-interest woven through its agenda, the BR at least acknowledges that well-judged government action can contribute to a more robust economy and a healthier labor market.

For the foreseeable future, the NFIB will remain a building-block of the Republican base and a charter member of the “leave us alone” coalition. Corporate American finds itself in a more ambiguous situation. On fiscal policy, the pantheon of gods to whom they bow includes Simpson and Bowles, Domenici and Rivlin. The Republican Party’s tax rejectionism leaves them cold, but so does what they see as the Democrats’ refusal to take entitlement reform seriously. They favor immigration reform, which most Republicans have not, at least until the recent election, but tilted toward higher skilled workers and away from family reunification—the reverse of most Democrats’ priorities. While they are willing to make their peace with the architecture of the Affordable Care Act, they push for changes such as medical liability reform that are anathema to the Democratic base. The Republicans’ populist, nationalist impulses worry corporate leaders, but so does the Democrats’ heightened emphasis on fairness and redistribution. Neither party is focused on what the CEOs believe is the central challenge we face—sustainable economic growth in a hyper-competitive global economy.

On balance, corporate America remains right of center. But that does not make its leaders comfortable in today’s Republican Party, dominated by a hard-bitten, quasi-libertarian stance toward the public sector. CEOs are closer to being politically homeless than they have been since the waning decades of the nineteenth century, when the pettiness and corruption of both parties drove business leaders to the sidelines. The right kind of Democratic agenda might cement a new alliance with at least a portion of corporate America. Gene Sperling, the author of a notable book entitled The Pro-Growth Progressive and the director of Obama’s National Economic Council, would seem ideally placed to lead the conversation.

But it’s not clear that his boss is interested. President Obama’s second inaugural address was notable for the relatively short shrift it gave to fiscal issues, tax reform, and pro-growth public investments. He spent much more time on climate change and on the social equality agenda, which was clearly the thematic and emotional heart of the speech. And while he spoke in passing of “hard choices to reduce the cost of health care and the size of our deficit,” he spoke much more forcefully about the need the preserve programs for the elderly, raising the moral stakes by calling them the “commitments we make to each other. If economic growth rests in part on expanded public investment—in research and development, education and training, transportation and communication—where is the money to come from? With an agenda dominated by a new emphasis on guns and immigration, and a renewed focus on climate change, where is the energy and political capital that would be needed to put growth first?

It was never exactly true that (in the words of Secretary of Defense and former GM head Charlie Wilson) that “what was good for our country was good for General Motors, and vice versa". Still, there is a substantial overlap between the agenda of responsible corporate leaders and the well-being of average Americans. Our country would be stronger if the Democratic Party could find a way of linking the long-term self-interest of corporate America to a progressive pro-growth agenda. But we seem to be headed in another direction altogether, and CEOs are likely to remain without a home in either party.

Authors

William A. Galston

Publication: The New Republic

Image Source: © Larry Downing / Reuters

How to Slash the U.S. Corporate Tax Rate

Robert C. Pozen — Sun, 20 Jan 2013 11:47:00 -0500

Both Republicans and Democrats agree that the 35 per cent corporate tax rate in the US is too high. Yet discussions over the corporate tax fizzled out during the recent fiscal cliff negotiations, partially because of the budgetary maths. Neither party has identified enough revenue increases to offset the $1.2tn cost over 10 years of lowering the corporate tax rate to a more reasonable 25 per cent.

We would like to offer a proposal: limiting the tax deductions for the interest that corporations pay on their bonds and other debt they issue. This change alone could raise the required revenue for a 10 percentage point reduction in the corporate tax rate. And this change would also improve the allocation of capital and deter excessive leverage.

Although there are three alternative approaches to financing a corporate rate deduction, none of them are large enough or politically feasible.

Read the full op-ed at FT.com »

Authors

Robert C. Pozen

Publication: Financial Times

What’s the Answer for Corporate Taxes?

Robert C. Pozen — Tue, 23 Oct 2012 10:37:00 -0400

President Obama and Governor Romney may have their differences on tax policy, but both candidates agree that the United States needs to cut its corporate tax rate. Including federal, state, and local taxes, corporate profits are currently taxed at 39.1 percent, the highest rate in the industrial world. This high corporate tax rate distorts investment decisions and encourages corporations to relocate overseas.

However, given the federal government's large deficits, any reductions in corporate tax rates should be paid for by broadening the tax base. In February, President Obama released a corporate tax reform framework that endeavored to do just that. Although Governor Romney is less specific, he has suggested a willingness to broaden the corporate tax base to pay for rate reduction.

An Imperfect Solution

Unfortunately, revenue-neutral corporate tax reform will prove very difficult for either candidate. Oft-mentioned tax breaks, such as those favoring hedge fund managers or green energy firms, are simply too small for their repeal to have a substantial effect on tax revenues. And both President Obama and Governor Romney have called for the expansion of other, larger corporate tax breaks, such as the credit for increasing spending on research and development. Thus, if either candidate wants to reduce the corporate tax rate, he will likely have to search for other revenue-raising measures.

One particular reform should get a close look: limiting the deductibility of corporate interest expense. Such a reform could raise a large amount of revenue and would improve economic efficiency by treating different investments more equally. President Obama has suggested this approach be "considered," as has Congressman Dave Camp (R-MI), the Chairman of the House Committee on Ways & Means.

Significant New Revenue

According to the IRS, corporations with net income paid $2.1 trillion in corporate tax between 2000 and 2009 (the most recent years with available data). During this same period, these corporations claimed over $8.5 trillion in gross interest deductions—at a 35 percent tax rate, those deductions were worth almost $3 trillion.

Based on an analysis of data like these, I calculate that the corporate tax rate could have been reduced from 35 to 25 percent from 2000 to 2009, financed solely by disallowing roughly 30 percent of gross interest deductions. In other words, corporations would have been able to deduct nearly 70 percent of their gross interest expense, instead of 100 percent as under current law. The revenue raised from this limitation (at a 25 percent tax rate) would have been roughly equal to the revenue loss resulting from the rate cut.

Of course, this simple estimate misses some key factors. First, interest rates and corporate leverage will likely be lower over the next 10 years than over the past 10 years, reducing the value of interest deductions. Second, such a reform would need to give special treatment to the financial sector, which would face a large burden under this proposal. Nevertheless, this back-of-the-envelope calculation shows that limiting the deductibility of corporate interest expense could play a large role in rate-reducing corporate tax reform.

Reducing the Bias Toward Debt

Disallowing a modest portion of the interest deduction would also improve economic efficiency by reducing the tax code's large bias toward debt-financed investment. Currently, corporations can deduct the returns to a debt-financed investment (interest expense), but not the returns to an equity-financed investment (dividends or stock appreciation). This differential treatment leads some corporate managers to make financing and investment decisions for tax reasons, instead of economics.

Even worse, when a corporation takes on too much debt, it increases its risk of bankruptcy—an event which imposes significant costs on the corporation's employees, customers, and suppliers. Because these costs affect external parties, corporate managers won't be sufficiently motivated to take these costs into account when deciding how much debt to take on. Thus, these managers are likely to choose a level of debt that is too high from the standpoint of society as a whole.

Banks will argue that limits on interest deductions should not apply to them because borrowing money is the "raw material" in the lending process. However, as recent history has demonstrated, the demise of one large bank can trigger a cycle of panic, fire sales, and more bank failures. So, while the financial sector should be given special treatment under this type of reform, it should not be exempted entirely.

In short, the U.S. urgently needs a reduction in the corporate tax rate implemented on a revenue neutral basis. As part of the tax package to achieve this goal, Congress should include some limits on the deductibility of corporate interest expense. Such a limitation would raise enough revenue to allow a substantial reduction in the corporate tax rate, increasing the global competitiveness of the U.S. Such a limit would also reduce the tax bias in favor of debt by decreasing the effective tax rate on equity—without raising the average cost of capital in the U.S.

Authors

Robert C. Pozen

Publication: Yahoo! Finance

Do Performance Reforms Change How Federal Managers Manage?

Donald Moynihan and Stéphane Lavertu — Fri, 12 Oct 2012 13:22:00 -0400

Policymakers on both sides of the aisle say they want government programs to perform better. A central strategy to achieve that goal at the federal level has been the creation of a performance management system, the latest iteration of which was shaped by the GPRA Modernization Act of 2010. This system promotes the collection of information on the performance of federal programs. The expectation is that agency personnel will use this information when managing federal programs, but do such reforms actually make a difference? To address this question, we look at the impact of past reforms: the Government Performance and Results Act (GPRA) of 1993 and the Bush administration’s Program Assessment Rating Tool (PART). Both reforms established new routines intended to encourage federal agency personnel to take a performance-oriented approach in managing their programs.

Using data from two surveys, we found that the involvement of federal managers with GPRA processes and PART reviews generally had little direct effect on purposeful performance information use, i.e., using data to improve management and allocation decisions. These reforms were more strongly associated with passive use, i.e. using measures to further modify goals and measures in accordance with the procedural requirements of the law.

The findings reflect the limits of government-wide reform efforts that depend upon bureaucratic behavior that is difficult for reformers to control and observe. But the findings also offer some insight for the implementation of the Modernization Act.

The Act has sought to institutionalize leadership commitment to performance by requiring leaders to publicly commit to a handful of high-priority goals. Our findings support this approach, as we find that perceived leadership commitment is associated with higher performance information use.

We found that the existence of a dialogue between employees about performance was associated with performance information use. If such dialogues can be institutionalized through the quarterly reviews of performance goals required by the Modernization Act, this will facilitate greater use.

Our results suggest that quarterly reviews can also play an instrumental role in fostering performance information use if such reviews focus on the motivational nature of the task (“why are these goals important?”) and developing actionable knowledge (“what do the measures tell us about how to manage?”).

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Donald Moynihan
Stéphane Lavertu

A Recipe for Cutting Corporate Taxes

Robert C. Pozen — Thu, 04 Oct 2012 00:00:00 -0400

Amid all the division on Capitol Hill, both parties generally agree that the corporate tax rate, which at 35 percent is among the highest in the world, needs to be cut. During Wednesday’s presidential debate, both candidates advocated a significant reduction in the corporate tax rate.

Yet the federal budget’s unsustainable fiscal path should preclude a large unfunded tax cut. Given these competing demands, policymakers have been searching for revenue-neutral reforms that reduce the corporate tax rate and broaden the corporate tax base.

Few politicians have offered sufficient details about how they would pay for a reduction in the corporate tax rate. Politically vulnerable tax breaks, such as special treatment of corporate jets and “green” energy, are small relative to total corporate tax receipts. And large tax breaks, such as those for research and development, are considered essential to economic growth.

So if Congress wants to finance a meaningful reduction of the corporate tax rate, it will need to find other base-broadening measures that meet two criteria: a solid policy rationale, and the potential for significant new revenue. Fortunately, there is a base-broadening reform that fits both: limiting corporate interest deductions. Democrats, including President Obama, and Republicans, including House Ways and Means Committee Chairman Dave Camp (R-Mich.), have suggested that Congress seriously consider such an approach.

Currently, when a corporation pays interest, it may deduct that interest on its tax return. By contrast, a corporation may not deduct its dividend payments to shareholders. This bias distorts the financing decisions of corporate managers, who might choose, solely for tax reasons, to finance a certain project with debt instead of equity. This bias also distorts investment decisions in favor of easily collateralized equipment suitable for debt finance, at the expense of investments better suited for equity finance, such as capital-raising by small business.

The tax code’s bias for debt is even more worrying, because excess leverage often imposes costs on external parties other than the debt issuer. For instance, a highly indebted company is more likely to go bankrupt, which can seriously harm its employees, customers and suppliers. Companies are unlikely to fully consider those external costs when deciding how much debt to take on.

Furthermore, reforming the treatment of interest expenses can raise a large amount of revenue and thus pay for a significant reduction of the corporate tax rate. In 2007, corporations with net income paid $294 billion in corporate taxes and claimed $1.37 trillion in gross interest deductions, according to the Internal Revenue Service.

I estimate that from 2000 to 2009 — the most recent years with relevant data — a reduction of the corporate tax rate from 35 percent to 25 percent could have been financed solely by disallowing the deductibility of roughly 30 percent of corporations’ gross interest expenses — that is, by allowing corporations to deduct only 70 percent of their gross interest expenses, rather than 100 percent, as they can now. Although this would increase the effective tax rate on debt-financed investment, the overall cost of capital would remain roughly the same because equity returns would be taxed at 25 percent instead of 35 percent.

Looking forward, our revenue estimates would have to take into account the lower interest rates and lower corporate leverage expected over the next decade. Also, debt issued by the financial sector is likely to need special treatment, because the profits of a financial institution depend largely on the spread between the interest rates at which they borrow and the rates at which they lend.

That is not to say that the financial sector should be exempt from this reform. Excess leverage increases the odds that a financial institution can fail. And as the 2008 financial crisis vividly demonstrated, the failure of one financial firm can damage other firms, governmental entities and the economy as a whole. While regulators are trying to adopt measures to make the financial system more stable, tax subsidies for leverage in the financial sector have the opposite effect.

In short, modifications to the treatment of corporate interest expense should be a key component of bipartisan corporate tax reform. Such a restriction could finance a significant reduction in the corporate tax rate and greatly reduce the tax code’s implicit subsidy to debt-financed investment. This would make the United States a more competitive place to do business, reduce distortions in corporate decision-making and help foster a more stable financial system.

Authors

Robert C. Pozen

Publication: Washington Post

The Underfunding of Corporate Pension Plans

Robert C. Pozen — Tue, 04 Sep 2012 10:09:00 -0400

The current low level of interest rates poses a big challenge to pension plans with benefits guaranteed by their corporate sponsors. These pension plans have a difficult time earning a decent return from high-quality bonds with relatively low risk.

In response, Congress has recently revised the rules for calculating the obligations of corporate pension plans. But these revised rules allow corporate pension plans to assume that they will earn unrealistically high returns. As a result, many corporate sponsors will not contribute enough to meet their likely benefit obligations to retirees.

The key to calculating a pension plan's obligations is the "discount rate." Actuaries estimate a plan's long-term benefit obligations by studying its benefit schedule and projecting the life span of its workforce. Then they reduce this amount by the discount rate -- the returns that the plan can reliably earn on its investments from the present to the times at which it must pay out benefits to retirees.

Therefore, the lower the discount rate, the higher the plan's estimated obligations. The higher the discount rate, the lower the plan's estimated obligations. If a plan's estimated obligations exceed its assets on hand, the plan's corporate sponsor must make contributions to the plan.

In the past, the accounting regulator required corporate pension plans to utilize a discount rate based on the two-year average of interest rates on top-quality bonds. In July, however, Congress passed legislation allowing corporate pension plans to use a discount rate based on average interest rates over the last 25 years. Since interest rates were quite high during the 1980's, the discount rate for most plans will increase by over one percentage point.

Although a one percentage point increase in the discount rate may seem like a technical matter, the change will lead to much lower required contributions by companies with substantially underfunded pension plans. For example, the required 2013 pension contribution for UPS will drop from $1.62 billion to $47 million, according to David Zion at Credit Suisse. Similarly, he calculates that the required 2013 pension contribution by Lockheed Martin will drop from $2.35 billion to $1.4 billion.

Fortunately, the legislation effectively phases out by 2016 – by then, the discount rate will likely revert to the two-year average for top-quality bonds. But I have a sneaking suspicion that if interest rates are still very low in 2016, corporate sponsors of pension plans will again lobby Congress for a higher discount rate.

Another positive aspect of the legislation is that it raises insurance premiums paid by corporate sponsors to the Pension Benefit Guaranty Corporation (PBGC) -- a government entity that guarantees up to $56,000 per year in benefits for participants in bankrupt companies with underfunded plans. In 2011, the PBGC reported a deficit of $26 billion. The new legislation would increase premiums paid to the PBGC by $9.6 billion over the next decade.

Unfortunately, the combined effect of both aspects of the new legislation is to penalize corporations that have well-funded pension plans at the expense of corporations whose pension plans are severely underfunded. The former corporations will have to pay higher PBGC premiums although the chances of their using PBGC insurance are minimal. The latter corporations will be able to make much lower contributions to their pension plans although they present a significant default risk to the PBGC.

The supporters of this legislation argued that current interest rates are "artificially" low because of policy actions taken by the Federal Reserve under Chairman Bernanke. While there is some validity to this argument, the average interest rate over the last 25 years is a poor indicator of low-risk returns in corporate bonds over the next decade. During the 1980s, the Federal Reserve under Chairman Volcker "artificially" kept interest rates high.

What is the correct "discount rate" that should be used to estimate the long-term obligations of a pension plan?

The answer depends on the timing of its obligations to pay retirement benefits, as under current accounting rules. Consider a pension plan that must pay out 20% of its benefits over the next 2 years, 50% around 10 years from the present, and 30% around 20 years from the present. The discount rate of such a plan should be divided into 3 parts -- with 20% discounted at the interest rate on two-year bonds, 50% at the interest rate on 10-year bonds and 30% at the interest rate on 20-year bonds.

In my view, pension plans should look to the average interest rate over the last five years in determining these discount rates. To illustrate, for the discount rate on 10-year benefit obligations, corporations would use the average interest rate during the last five years on AA-rated corporate bonds with maturities of 10 years. This approach would represent a simple and more accurate way of choosing discount rates, though far from perfect.

In short, the new legislation temporarily reduces the contributions by corporations with substantially underfunded pension plans by using an unrealistically high discount rate. However, this legislation will not improve the financial condition of these plans; in a few years, the corporate sponsors of these plans will have to make even higher contributions to their underfunded plans.

Authors

Robert C. Pozen

Publication: Real Clear Markets

Image Source: JOHN SOMMERS II

Pension ‘Savings’ in Transportation Bill May Be Costly

Robert C. Pozen — Thu, 02 Aug 2012 00:00:00 -0400

The transportation bill that Congress passed this summer is financed, in part, with a budget gimmick: Lawmakers changed the funding rules for corporate pension plans. These changes help the federal budget in the short term by reducing the tax deductions that corporations take for contributing to these plans — thereby reportedly increasing their taxable income.

These changes, however, encourage companies to contribute less to pensions, which raises the long-term risk that a governmental insurer will need to step in to pay benefits. Under the new funding rules, the required pension contributions for public U.S. companies could drop in one year from $58 billion to approximately $33 billion, says accounting expert Chris Senyek.

To understand these accounting changes, consider how corporate pension plans calculate their future obligations to plan beneficiaries. Actuaries begin by projecting the number of current and future employees and their life expectancy to estimate a total plan obligation. The actuaries then reduce this total by applying a “discount rate,” which should represent the risk-free return that plans could be certain of earning on their investments.

The lower the discount rate, the higher the estimated pension obligation. And if the plan has a gap between this amount and its current assets, the company must make up the difference through regular contributions.

The discount rate, then, is an important factor to businesses. Under the old funding rules, companies used a discount rate based on the interest rate for high-quality bonds, averaged over the past two years. Under the new rules, companies may use an alternative discount rate, based on the interest rate for the same bonds but averaged over the past 25 years. Because interest rates today are near historic lows, this new alternative discount rate is likely to be at least 1 percentage point higher than the prior discount rate and, therefore, to lead to much lower required contributions by companies with underfunded pension plans.

Estimates by David Zion of Credit Suisse show that a 1 percentage-point increase in the discount rate would require Lockheed Martin to contribute $1.4 billion to its pension fund in 2013, instead of $2.4 billion under the old rules. According to the same estimates, UPS’s required contributions would drop to $47 million in 2013, compared with $1.6 billion under the old rules.

Unfortunately, these substantial “savings” to companies pose a substantial risk to the Pension Benefit Guaranty Corp. (PBGC), the federal agency that guarantees up to $56,000 per year in benefits for each pension participant. The PBGC would assume the obligations of a pension plan if participating companies filed for bankruptcy or their plans otherwise became insolvent.

These companies pay annual premiums to the PBGC, but what is paid in is insufficient to finance the agency’s ongoing obligations. In 2011, it reported a deficit of $26 billion. Although the new legislation would also increase corporate premiums paid to the PBGC by $9.6 billion over the next decade, this increase would be grossly inadequate to pay for the agency’s overall exposure to risk from underfunded pension plans.

Some argue that the “artificially” low interest rates engineered by the Federal Reserve in the past two years do not accurately reflect expected risk-free returns over the long term. While there is some validity to these arguments, using the 25-year average is similarly unrealistic, since it includes the high interest rates of the early 1980s that were “artificially” engineered by then-Federal Reserve Chairman Paul Volcker.

Fortunately, this reform effectively phases out in a few years. By 2016, the alternative discount rate is scheduled to drop to 70 percent of the 25-year average rate (down from 90 percent in 2012). Moreover, the high rates of the late 1980s will fall out of the 25-year average by 2016, further reducing that alternative discount rate. Since lower discount rates result in larger calculated funding gaps, the supposed “pension relief” produced by this legislation will quickly disappear.

The transportation legislation is, in short, another example of Congress kicking the can down the road. The esoteric changes in funding rules will not actually improve the financial condition of corporate pension plans; instead, the new rules will allow companies with deeply underfunded plans to avoid the day of reckoning when they must deliver on their promises to plan beneficiaries.

Authors

Robert C. Pozen

Publication: The Washington Post

Image Source: Joshua Lott / Reuters

Are China’s Multinational Corporations Really Multinational?

David Shambaugh — Tue, 10 Jul 2012 17:21:00 -0400

Editor's Note: This article originally appeared in East Asia Quarterly's Volume IV/Number II, April-June 2012 issue.

Following the Chinese government’s mandate that companies should "go out" (走出去) or "go global" (走向世界), many observers anticipate that Chinese multinational corporations (MNCs) will secure a growing share of the international consumer market around the world. This may eventually occur, but for the time being China’s multinational corporations remain a very long way from playing in the premier leagues of international commerce.

How many Chinese corporations can you name? Most likely fewer than 10, or even five. We are all familiar with Tsingtao beer, Air China, Bank of China and Lenovo computers—and some may know names like Huawei Technologies, Haier appliances or China Mobile. But not a single one of these firms made the 2011 ‘Top 100 Global Brands’ list compiled annually by BusinessWeek and Interbrand. The global brand presence of China’s best-known multinationals is nowhere near the likes of Coca-Cola, GE, Intel, McDonald’s, Google, Disney, Honda, Sony, Volkswagen and similar global giants.

Yet when measured in terms of total revenue, it is clear that Chinese companies have steadily climbed up the global rankings. Twelve Chinese companies were included in Fortune’s Global 500 list in 2001. And only a decade later, in 2011, that number rose to 61 (including four with headquarters in Hong Kong). China now ranks third on the global list, only slightly behind Japan but well behind American firms. In 2010 these 61 Chinese enterprises had a combined annual revenue of US$2.89 trillion and an estimated overall profit of US$176.1 billion. Of the 57 mainland companies, 49 are state-owned enterprises (SOEs).

While ranking on the Fortune Global 500 list indicates the growing clout of Chinese corporations, it does not mean that a company is internationally active or even that it is a real multinational. When these companies are ranked by foreign assets and sales, it becomes clear that, with few exceptions, they all operate predominantly within China. In other words, despite the government’s directives and financial incentives to ‘go global’, many leading Chinese corporations have yet to do so.

So why have Chinese multinational corporations encountered difficulties in going global? Ten possible factors may explain it.

First, very few Chinese firms can operate truly globally. Haier, Huawei and the national oil companies Sinopec, CNOOC and CNPC are often the only ones that have capital, operations and sales on a global scale. Many of China’s other multinationals (banks, auto companies, natural resource companies or IT) really only invest in and operate on some continents; most are far from possessing global production, marketing, distribution, logistics, supply, research and development, and human resource networks.

Second, the Achilles heel of Chinese multinationals is human resources—particularly management. Multilingual and multicultural managers are few and far between, and all assessments of Chinese corporations note this to be a fundamental weakness. A 2005 study by the global multinational consulting firm McKinsey & Company estimated that Chinese multinationals will require 75,000 global managers by 2020. As a result, Chinese students are flooding into foreign MBA programs as well as business schools in China. Distance-learning MBAs tailored to the Chinese market are also taking off. But classroom training alone will not suffice because there is no substitute for extensive international experience. Some Chinese companies have taken advantage of the global financial downturn by hiring (preferably young) laid-off staff in New York, London, Hong Kong and elsewhere. In 2010, for example, the China Daily reported that Chinese companies operating overseas had hired a total of 800,000 foreign employees.

Third, and related, Chinese companies and their management have displayed an inability to escape their own national corporate culture and business practices. Chinese business culture values interpersonal over institutional relationships, and business decisions are often oriented towards short-term profit. There is also a lack of transparency and oversight, which has been linked to a high degree of corruption. Moreover, Chinese companies are politicised: that is, many have Communist Party cells and members embedded within the firm. Most of China’s state-owned ‘national champion’ firms have CEOs appointed by the Organisation Department of the Chinese Communist Party, and this is also true of multinationals. Unlike their Chinese competitors, though, most Western multinationals are apolitical. And this is not where the differences end. Western business culture emphasises teamwork and cooperation between management and staff, detailed long-term planning, transparency and oversight, multiculturalism, prosecution of corruption, and the institutionalisation of relationships.

Fourth, as noted above, Chinese companies have a very poor global brand presence. Establishing this type of presence requires investing large and sustained resources into advertising and cultivating clientele. Having distinctive, non-Chinese names will also help in this endeavour.

Fifth, mergers and acquisitions have become the preferred modality for Chinese corporations to go global because they are a quick means of acquiring advanced technology, sales networks, established brand names and other strategic assets overseas. Precisely because Chinese corporations have very few multilingual staff who have experience working in cross-cultural environments, and many who are inexperienced in local business practices, it is much easier for Chinese multinationals to simply buy a share of an established foreign firm in order to gain these elements and offset their deficits in one stroke. Even though in recent years China’s mergers and acquisitions have spiked in number and sometimes in value, they have not been very successful so far. One report estimates that 90 per cent of China’s 300 overseas mergers and acquisitions conducted between 2008 and 2010 were unsuccessful, with Chinese companies losing 40–50 percent of their value after the acquisition. This has particularly been the case in the technology, communications and natural resource sectors.

Sixth, while some Chinese firms develop business plans and strategies to globalise, the majority do not. Instead, efforts to ‘go global’ tend to be driven by pent-up cash in search of a place to invest outside China’s saturated domestic market; a strong mandate by the government to ‘go out’, with incentives to do so and penalties for not doing so; naïveté about the complexities of foreign countries; a desire to maximise profits as quickly as possible, rather than produce steady revenue streams; and a fickle management tendency to frequently change decisions and directions.

Seventh, while Chinese firms do tend to have clear performance indicators and incentive programs and do provide job security, they do not score as well in other aspects of management. Big Chinese firms—and the Chinese government is no exception—are extremely hierarchical. Chinese organisational culture stresses discipline and conformity, which creates a climate of risk aversion and discourages initiative. Being entrepreneurial (which Chinese companies certainly are) is different from being innovative and creative. Moreover, the Chinese notion of teamwork is geared towards following leaders’ instructions, rather than the more egalitarian and collegial model prevalent in Western organisations. This preference for clearly defined workplace roles and hierarchies often means that Chinese do not adapt well to management structures that prize decentralisation and individual initiative—and this has resulted in repeated culture clashes in Chinese mergers with Western companies. The practice of mid-career (re)training is similarly alien to Chinese multinationals, while it is intrinsic to most Western corporations.

Chinese firms tend to train a worker for a precise skill and job, which they are expected to do indefinitely, whereas many Western firms adopt much more flexible personnel policies that emphasise self-improvement, retraining and job mobility within the firm, and generalisation over specialisation. Oftentimes this is done within the firm through training aimed at developing new job skills, but also via mid-career management training outside the firm—so-called executive education. A one-month stint in an ‘Executive Ed’ program at the Wharton School, the Kennedy School, INS EAD, London Business School or similar institutions offers an ‘escalator effect’ for corporate management. Chinese business schools—such as Shanghai’s China Europe International Business School, Hong Kong University of Science and Technology’s Business School, or Peking University’s Guanghua School of Management—are all seen to be improving, but are yet to enter the premier league internationally. Though mid-career training has become de rigueur in the Chinese Communist Party and government, this organisational culture is yet to become prevalent in the corporate world.

Eighth, Chinese companies have demonstrated difficulties in adapting to foreign legal, regulatory, tax and political environments. Transparency and corporate governance are not exactly attributes associated with Chinese companies, which have a reputation for opaque decision-making processes, frequently corrupt business practices, and often fraudulent accounting procedures. Few Chinese firms have in-house legal counsel who are knowledgeable about foreign legal and regulatory environments. This impatience with the regulatory environment of host countries has had a negative impact on business operations abroad, particularly when Chinese companies have tried to list on foreign stock markets: many Chinese companies have filed fraudulent information with securities regulators in the US before their initial public offerings. They also often run afoul of foreign politicians who are suspicious of Chinese investments on national security grounds.

Ninth, Chinese firms rarely apply due diligence when dealing with their competitors abroad, which often means they overlook both the strengths and weaknesses of their potential partners and competitors. As a result, they find it harder to exploit comparative advantages.

Finally, in looking for foreign partners, many Chinese multinationals run up against the ‘reciprocity problem’. Many foreign multinationals with whom Chinese corporations seek to partner have either been operating in China for many years or are seeking to enter the Chinese market. The former have most likely experienced years of Chinese red tape, investment obstacles, and have had very frustrating and costly experiences (even if they have become profitable), while the latter want an entrée. In both cases they look to the Chinese firm to make life easier for them inside China; for them, there is an informal quid pro quo: you help us in China, we help you abroad. The problem is that many Chinese multinationals have a bifurcated corporate structure, which means that domestic and international divisions often have a bureaucratic firewall between them and do not communicate well with each other. Moreover, the Chinese partner firm is not necessarily responsible for improving a foreign company’s situation or solving its problems in China—this is often the domain of domestic government authorities. These competing motivations often lead to a mismatch of expectations between Chinese and foreign multinationals.

For all these reasons, Chinese corporations face a number of impediments in going global. They have a steep learning curve ahead. Over time, they will no doubt learn and adapt—as Chinese in all professional pursuits seem so capable of doing—but these obstacles are not insignificant. China’s multinationals are still taking baby steps in global business.

Authors

David Shambaugh

Publication: East Asia Forum Quarterly

Image Source: Reuters

Whose Capital; What Gains?: Why the U.S. Economy Needs to Change Incentives

Lawrence E. Mitchell — Tue, 10 Jul 2012 00:00:00 -0400

If we fail to change the incentive structures of American management and financial markets, our nation’s long-term economic well-being and, with it, our national security, will suffer, writes Lawrence Mitchell. The crisis was decades, and perhaps more than a century, in the making, and is the result of many different factors that can be found in the historical record.

In this new paper, Mitchell argues that common stock has almost never been a source of permanent capital in American industry. And, he writes, the sources of capital gains has also dramatically shifted from the 1950s, when Merton Miller and Franco Modigliani, developed their famous dividend irrelevance theory, from corporate profits in the form of retained earnings to future profits in the form of velocity-induced trading gains. While both of these propositions may seem counterintuitive, the latter will seem plainly wrong, at least to devotees of efficient market theory. But the empirical correctness of the former proposition underlies the contemporary theoretical weakness of the latter.

The net results are that shareholders, or managers on their behalf, are gambling with debtholders’ money, and that the future profits of American industry are being spent today. Both call into question the sustainability of American industry and the future wealth of the United States.

Mitchell makes a number of recommendations in this paper, incuding:

Build long-term investing into the initial investment decision by developing a sliding scale capital gains tax, with highly punitive taxation for short-term trading, diminishing over time to tax forgiveness for long-term holding.
Include returning to largely insider boards (outside directors tend to manage by stock price) and making appropriate accounting changes to rely more heavily on cash flow than income statement accounting.

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What Businesses Can Do—Beyond Corporate Philanthropy—to Support Global Education

Justin W. van Fleet — Tue, 19 Jun 2012 13:45:00 -0400

The B-20, the private sector forum that feeds into to the G-20, has been quite active in developing thematic task forces and recommendations for government and business to contribute to global economic growth and social development. However, in the final set of top-line policy requests for the G-20, there is no serious inclusion of investments in education and learning to advance economic growth and social development. Given that quality education is a core component for sustained economic growth, I am surprised by the “light touch” attention it receives in the B-20’s recommendations.

Maybe businesses did not give these recommendations to the G-20 because they have a lot of work to do themselves. While evidence last year showed that corporate social investments and philanthropic contributions to education in developing countries are relatively small, short-term, uncoordinated and not directed to address the needs of the most marginalized, many companies are working to improve the effectiveness of these activities. In the past year alone, we have seen various efforts underway to improve business engagement in education, including a new Global Business Coalition for Education, incentives for corporate engagement in new bilateral donor agency initiatives, and a UNESCO task force on the issue.

At the same time, we cannot ignore the need to improve other corporate policies that have the potential for even greater systemic impact on global education. Inspired by the B-20 recommendations, I have five recommendations for what corporations can do beyond philanthropy to support education and therefore promote economic growth and social development.

Stop corporate tax evasion. Lost revenue in developing countries due to corporate tax evasion is estimated to be $160 billion per year. This excludes the hundreds of billions estimated to be lost through the offshore economy of high net worth individuals. In some Latin American countries, companies underreport by as much as 40 percent. While cracking down on tax evasion and instituting government anti-corruption and transparency measures must go hand in hand, directing just one-tenth of the estimated corporate tax evasion amount to education could fill the estimated financing gap and put every child in school.
Improve human resource policies to be pro-education and learning. With estimates showing that multinational corporations employ between 20-36 million employees in developing countries, pro-education human resource policies for employees and their families can have a huge impact. With adult illiteracy rates nearly at 775 million, companies could provide family literacy programs for employees and children. Early childhood centers for children of employees can also make a big impact on long-term learning in communities.
Be serious about combating child labor in supply chains. Child labor in supply chains in rampant, and the 2012 Child Labor Index indicated that 40 percent of countries are at extreme risk of including child laborers in supply chains, including fast-growing economies such as the Philippines, India, China, Vietnam, Indonesia and Brazil. Allowing children to engage in labor in the supply chain does not only have moral implications, but takes children away from learning foundational skills that can help promote social development and economic growth in the future.
Go beyond vocational training to support general education, starting early. Companies are quick to invest in vocational training to help bridge the talent gap and create a base of skilled labor. But firms actually project that soft skills — social skills such as communication, teamwork, problem solving and conflict management—will be in higher demand and harder to find than technical skills over the next three years. These skills are the basic values produced from a quality basic education system. If companies are serious about having these skills in a future workforce, the place to invest isn’t at age 18, but instead in early childhood and primary education when children acquire these non-cognitive abilities.
Put pressure on governments to meet basic education goals. Last week it was reported that the number of out-of-school young people in Africa actually increased by two million between 2008 and 2010. This is unacceptable for the global community and the business community should be equally outraged since these are their potential innovators, employees and consumers who, without going to school, will not be integrated into the social and economic sectors. Business leaders must remind governments to keep their commitments and go the last mile to get all children in school and learning.

Authors

Justin W. van Fleet

The Problem of Corporate Purpose

Lynn A. Stout — Mon, 18 Jun 2012 00:00:00 -0400

In a new paper, Lynn A. Stout, questions the purpose of the modern public corporation. Is it to maximize shareholders’ wealth? Or are other goals, like serving customers or providing innovative products, valued in their own right?

Stout looks at the history of corporations and their attitude towards shareholder wealth and outlines how this relatively new notion of shareholder value thinking gets the law, economics and evidence wrong.

Stout explains that the current predominant view is that the purpose of corporations is to increase stock price, despite the fact that this shareholder value ideology is a relatively new development in the business culture. It is not supported by the traditional rules of American corporate law; is not consistent with the real economic structure of business corporations; and is not supported by the bulk of the empirical evidence on what makes corporations and economies work.

Indeed, there is good reason to suspect that focusing on “shareholder value” may in fact be a mistake for most business firms. This is because there is no single shareholder value—different shareholders have different needs and interests depending on their investing time frame, degrees of diversification and interests in other assets, and perspectives on corporate ethics and social responsibility. This ultimately harms most shareholders themselves—along with employees, customers, and communities.

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Lynn A. Stout

Brookings: Topics - Corporations

Corporate Tax Reform Without Tears

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Can Executive Compensation Reform Cure Short-Termism?

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Business Advocacy in Asian PTAs: A Model of Selective Corporate Lobbying with Evidence from Japan

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The Predator Comes Home: A Primer on Domestic Drones, their Huge Business Opportunities, and their Deep Political, Moral, and Legal Challenges

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Countering Corruption: 2012 Conference Report from the World Forum on Governance

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U.S. Tax Reform: Reducing the Tax Code’s Bias for Debt

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A Win-Win: Compromise on Foreign Profits

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Reimagining a Corporation’s Purpose in the Great Recession Era and Meeting Threats to Free Enterprise

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35 Percent Is Way Too High For Corporate Taxes

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There's a Civil War in America's Business Community, But Will Obama Notice?

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How to Slash the U.S. Corporate Tax Rate

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What’s the Answer for Corporate Taxes?

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Do Performance Reforms Change How Federal Managers Manage?

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A Recipe for Cutting Corporate Taxes

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The Underfunding of Corporate Pension Plans

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Pension ‘Savings’ in Transportation Bill May Be Costly

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Are China’s Multinational Corporations Really Multinational?

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Whose Capital; What Gains?: Why the U.S. Economy Needs to Change Incentives

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What Businesses Can Do—Beyond Corporate Philanthropy—to Support Global Education

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The Problem of Corporate Purpose

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