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How to Finance Infrastructure and Clean Energy Investments
Tuesday, September 06 2011 | 08:17 AM
|Investments in clean energy and infrastructure projects can help address the unemployment problem and make American business more competitive. The challenge is financing these investments in the current environment. There is a creative solution available that does not require new taxes, printing more money, or increasing the deficit.
The President is set to propose investments in infrastructure and clean energy in his jobs speech next week. There are several reasons that make spending on infrastructure and clean energy a good idea at this time: the jobs created are local and cannot be exported, the jobs created are in sectors like construction that are facing higher unemployment, it generates demand for products and services from a variety of industries creating more jobs, deteriorating US infrastructure is sorely in need of maintenance, and now is a good time to make these investments as raw materials and labor are cheap (maintenance is necessary and overdue - not doing it now just means that it will have to be done at a later time when it will likely cost more).
Even though infrastructure investment is a good idea, it faces two big problems.
First is the need to finance these investments. With the focus on reducing deficit, it will be difficult to get everyone to agree on spending money on these projects. The President has made similar proposals in the past. Republicans are almost certain to oppose more spending and any taxes to pay for it this time too. The bankruptcy filing this week by the solar power panel maker Solyndra, which had $527 million in loans from Federal government, and had been praised by the President, will be held up as an example by many of a poor government investment that put public money at risk, and a reason why government should not get involved.
The second problem is picking projects that are productive and not just a waste of money. Government may not be the best judge for picking the best projects.
The solution to both problems is increased involvement of private sector.
However, to get the private sector to invest in infrastructure projects, the government has to provide incentives, but in a way that does not increase deficit or taxes. One creative possibility for doing this may be by using the estimated $1 trillion of unrepatriated profits US companies hold in foreign subsidiaries.
American companies can generally defer paying taxes on foreign profits as long as they keep the money outside US. When they bring the money back to US, they have to pay the top corporate tax rate of 35%. To defer taxes, US companies generally have left large sums of profits in their foreign subsidiaries. These untaxed profits are part of the reason large multinationals have lower overall tax rates for which they have been criticized at times.
The administration has proposed taxing worldwide income of US companies, but faced strong opposition since that would put the US companies at a competitive disadvantage.
On the other end, US companies are arguing that they could bring back the earnings in their foreign operations if the US government offered a tax amnesty and permitted them to repatriate foreign earnings at a low rate of around 5% instead of the 35% federal tax they face at present. They argue that 5% tax could bring $1 trillion back to US for increased economic activity and could generate additional $50 billion in federal tax revenue.
The tax amnesty will not result in an increase in deficit or taxes, as government is giving up what it is not getting anyway - without it, these funds will not come back into the US economy, and the Treasury will not get the additional tax revenue.
However, the tax holiday idea has been opposed by many as the funds brought back will not necessarily be used to generate jobs. The companies could use the money for M&A activity, stock buybacks, and paying out dividends. A similar tax-amnesty program was implemented in 2004. However, of the $362 billion that was repatriated, very little was used for actual investments to create jobs.
A better idea, one that addresses this concern, will be to offer the tax amnesty only to the funds brought back that are actually invested in infrastructure and clean energy projects in the US. However, money is fungible, and it can be easily moved from one bucket to another. To ensure that the tax break really results in investments that create jobs, the repatriated money has to be separated from the other funds of the repatriating company. Hence, for this idea to be effective, the funds brought back must be invested with third-party private fund managers for a minimum number of years to qualify for the tax break.
A limited time tax amnesty will encourage US companies to repatriate earnings back to US quickly. A requirement to invest in infrastructure projects for a minimum fixed number of years (say something between 3 to 5 years) will ensure that the funds brought back create jobs. Companies will be allowed to invest in either debt or equity depending on their risk-reward preferences. Government will not be involved in making investment decisions. All investments will be chosen and managed by private fund managers, who will pick projects and investments based on sound economic calculations of cost-benefit and expected returns. The companies will be free to pick any fund manager based on their judgment of managerís capabilities and investment strategy.
This basic framework could be enhanced in several ways. Companies could be encouraged to invest for a longer period by offering to reduce any taxes on the earnings from the infrastructure investments, if the investments are held for say 7 to 10 years or more. Also, companies could be allowed to use part of funds brought back to build new plants for their own use, or setup funds that finance purchases of companyís products.
This proposal is a middle of the road approach which addresses the problems the US economy is facing in a productive way and should be acceptable to both sides. Even if there are plans to change rules to tax worldwide earnings of US companies in future, it still makes sense to address the past earnings that are held outside US.
Longer term, the US needs to develop regulations that clarify and encourage private sector investment and involvement in the clean-energy and infrastructure sectors, both of which are essential for the growth and competitiveness of the US economy in the longer term. The areas that need attention from lawmakers and regulators include Public-Private Partnerships, securitization of infrastructure financing, and eligibility rules for MLPs and REITs.
Note: I originally wrote about this idea in November 2010 and shared it with several policy-makers, elected officials, industry chieftains, think-tanks, and members of the media. Given the state of the economy, the idea is more timely and urgent now. The original, more detailed, article is at http://marketsandeconomy.wordpress.com/2010/11/23/tackling-the-us-unemployment-problem/.
A version of this article was published in Thoughts on Markets & Economy.
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Ok, But The Math Doesn't Work
Tuesday, March 08 2011 | 11:44 AM
Chief Investment Officer,
YOUR SOURCE FINANCIAL (RIA)
|A year or two ago I reconnected with a friend from highschool on Facebook. He has turned out to be extremely liberal in his political thinking and regularly posts links and status updates consistent with his beliefs. He has been very pro-union in some of his posts and has been keenly interested in the goings on in Wisconsin these days despite living in another state. He feels very strongly about his beliefs to the point I would say of being entrenched.
This week's John Mauldin post devoted some space to the various entitlement issues and the notion of congress figuring out how to cut $61 billion in expenses versus a $1.6 trillion problem. As I read this and thought about my friend's posts I had a moment of clarity or perhaps better stated as a moment of simplicity which is that for so many of the country's problems the math doesn't work.
All of the reasons that someone might be pro-union might be 100% correct but the math doesn't work. Cutting $61 billion is expenses might be a win of some sort but in the full context of the problem does not itself represent any progress toward a solution. The retirement savings quandary that now exists (referring to the ridiculously low average savings that people have) can be thought of in one way as not understanding the math needed to make it work.
To the union issue, that there is not enough money for workers to get everything they have previously bargained for, that return assumptions are way too high and that the unions have dirty hands (as well as management) in the failures that have occurred would, I believe, be a conversation that my friend could not hear. If union leaders negotiated some sort of dollar figure 15 years ago (making up an example) that has proven out to be wildly unsustainable what should happen? I am not intending to make a political argument here. I can't say that a union doesn't deserve something they successfully negotiated for but if the math doesn't work then that means the math doesn't work.
In simplistic terms the math appears to be breaking down with all sorts of different things which makes debating these things along political or ideological lines futile. An analogy that is related to our fire department; for several years the community has been having a heated debate about whether or not to become a fire district (an entity with taxing authority) or remain donation based. One bone of contention is how much of a tax would be imposed. Related to the potential tax is what sort of service the community wants. On bit of advice that has been pretty consistent along these lines has been not to ask what service is wanted but how much people want to pay. We can have everything but the more service (really I mean paid personnel and new equipment) the more we will all pay. It is quite simple in that regard.
Well, we can have all the medicare, social security and union benefits we want. It's just that the more we want the more we will have to pay. I'm not arguing for more taxes from a belief standpoint, simply pointing out that there is a deficiency that exists. We either pay more or we get less. To the extent this holds water for you it argues all the more for staying on your own mat (self sufficiency). For me this means saving a lot, living below my means and having a job that I want to keep well past typical retirement age. For you, self sufficient could mean something completely different but either way we cannot rely on other people to get the math right, we need make sure that if nothing else our own math works.
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