– Wei Gu is a Reuters columnist. The opinions expressed are her own –

Everyone agrees that China’s economy must be rebalanced, but few have bothered to delve into the costs. Japan’s experience has shown that even well-meant changes could sow the seeds for a bubble.

China cannot stay with its current economic model forever. But as the economy has become extremely unbalanced, to some extent even more so than Japan’s in the 1980s, rocking the boat too much risks tipping it over. Instead of rushing into changes, it would be better to make reforms gradually.

Most observers believe an extremely loose monetary policy was the root cause of Japan’s bubble. But Tomo Kinoshita, an economist at Nomura, reckons that efforts to liberalise the economy, such as sharply revaluing the yen, developing a deeper bond market and deregulating interest rates were among the fundamental reasons behind the bubble.

The challenges facing China’s economy are similar to those seen in Japan in the 1980s. Foreigners are calling for a currency revaluation because the undervalued yuan gives China’s exports an extra boost. Capital markets need to play a bigger role because investment has been directed mostly by state-owned banks.

True, property price increases appear to be milder than in the Japan of the 1980s. Household loans only account for 30 percent of disposable incomes in China, versus about 90 percent in Japan in 1989, according to Nomura. But there are warning signs. New mortgages recently hit a record. And ratings agency Fitch has cited China’s property market as a cause for concern.

The Chinese stock market also looks less overvalued than Japan’s did. The ratio of Chinese stock prices to earnings is only a third of the peak levels reached in Japan. Stock market capitalization as a percentage of GDP is 62 percent, much lower than Japan’s 150 percent at end of 1989. But China is catching up fast, and the ChiNext market, China’s long-awaited Nasdaq-style market, debuted last week with a speculative surge.

Moreover, China has been more aggressive in terms of monetary easing as it tries to prop up the economy while waiting for exports to return. The broad money supply in China has been rising at almost 30 percent this year, twice as much as in Japan back in the 1980s. So if there is a bubble, it could grow bigger than the one in Japan.

Even much-needed efforts to liberalise and rebalance the economy may lead to asset price inflation. Similar to China, Japan’s banks were too big and small companies had trouble getting financing. So developing a corporate bond market and encouraging banks to lend more to small firms was seen as a healthy change.

But policymakers underestimated the negative impact on banks. After Japan developed a liquid corporate bond market, large corporations issued cheap equity-linked bonds to repay bank loans. Because Japanese financial institutions lacked other revenue sources, they targeted smaller corporations and consumers. Total bank loans made to small- and medium-sized companies and individuals rose to 71 percent of total loans in the late 1990s from 47 percent in the late 1980s.

Due to a lack of information on their new clients, the banks’ bad loans started to rise. Their lending standards deteriorated as they scrambled to make up for lost business. This could very well happen in China as the country encourages consumers to take on more debt to stimulate domestic demand.

Moreover, Kinoshita argues that in Japan interest rate deregulation “put a cat amongst the banking pigeons” because banks were forced to lend out more when their margins became compressed due to more competition. Pressure from the United States played a role, and the Japanese authorities were eager to internationalize the yen anyway. Letting banks set deposit and lending rates was one of the requirements for the yen’s internationalization.

The policy lesson for China is that when Beijing takes business away from banks, it needs to balance things out by allowing them to take on new business, such as securities underwriting and broking.

But that leads to the question of how to compensate securities firms for their lost business and prevent them from engaging in reckless behavior. This just underscores the complexity of China’s problems.

Most of the world believes that China risks moving too slowly, not too fast. President Barack Obama might give Chinese leaders another ear bashing during his upcoming trip to China. But without the right systems in place, big bang reforms could be disastrous. It is important that China, as well as the rest of the world, learns from Japan’s mistakes.

- Erik Kirschbaum is a Reuters correspondent in Berlin. -

Will the party that traces its roots to Communist East Germany's SED party that built the Berlin Wall soon be in power in a west German state?

Or is the rise of the far-left "Linke" (Left party) in western Germany to the brink of its first role as a coalition partner in a state government with the centre-left Social Democrats (SPD) simply a political fact-of-life now so many years after the Wall fell and the two Germanys were reunited?

Will a "red" government in Saarland scare away investors and doom the state, as its conservative state premier Peter Mueller argues in a desperate fight to his job?

Or will the new leftist alliance in Saarland be able to better tackle state's woes, as the SPD state premier candidate Heiko Maas insists?

Depending on your Weltanschauung, that's what Sunday's election in three German states boils down to -- an emotional debate about whether the ex "Communists" in the form of the Left party should be allowed to be part of the next Saarland government or not.

It doesn't matter that the Left has already been in eastern state governments and will probably also be part of the next state government in the eastern state of Thuringia, which also elects a new state assembly on Sunday.

The "Cold War" has flared up again in Germany ahead of Sunday's elections in three German states, a closely watched warm-up for the national election on Sept. 27 when Chancellor Angela Merkel will be seeking a second term.

It's hard to explain to anyone outside Germany why the Left party has been seated in state and local governments throughout eastern Germany for the last 15 years with hardly a murmur while it was until recently an absolute taboo in western Germany. It's also not easy to explain to some Germans, especially those born after the Cold War.

But here goes: Many western voters have until now had a knee-jerk reaction to the Left party -- as well as its predecessor the Party of Democratic Socialism (PDS), which is the direct descendent of Erich Honecker's SED. Westerners remember the Wall, the shoot-to-kill orders, the barbed wire and the Iron Curtain that divided post-war Germany.

"It's not a big deal in Saarland anymore," Maas, the SPD candidate in Saarland, told me in an interview on the campaign trail in Saarbruecken this week. "The CDU is trying to make a scandal out of it.

They've been trying to whip up fears about 'red-red' for months but there hasn't been any movement in the opinion polls. I think that shows people aren't interested in the parties mud-slinging about coalitions. They're tired of those games. They want political leaders to resolve their problems."

Many eastern voters long ago realised the Left party is not the SED that built the Wall. In the east, the Left  has become the most powerful party in many regions partly due to nostalgia for East Germany but mainly due to its fighting for leftist ideals as well as standing up for the so-called "losers" of unification.

"A 'red-red' government would send Saarland down the tubes," said CDU leader Mueller.  And Merkel added at a rally in Saarbruecken: "This state cannot be allowed to fall into the hands of 'red-red'." She does not use that line in her campaign speeches in the former Communist east, where she was raised, because she knows it would sound ridiculous to eastern ears.

The SPD rules out a "red-red" coalition with the Left party at the national level because of deep differences over foreign and economic policy. But it now says it is ready to open the door to such alliances in western states -- after some painful experiences in the last few years. And Maas in Saarland could be the first to go through. The SPD will probably drop that ban on "red-red" coalitions at the national level someday as well after having abandoned it for eastern Germany in 1994.

So is it "The Commies are at the Gate in Saarland?"  Or is it just part of a democratic evolution that the renamed, reborn East German Communists are about to gain a small but important foothold in western Germany?
-
Tune into the Global News blog on Sunday evening for live blog coverage on the elections in the three German states.

Related Story: Merkel faces left threat in German state votes

– James Saft is a Reuters columnist. The opinions expressed are his own –

Rising pay in the finance sector in the wake of the global financial crisis is no surprise and is driven partly by the government’s bailout itself and the underwriting of banks that are too big to fail.

News that some financial firms benefitting from government largesse actually increased the share of revenue they pay their employees sparked a lot of outrage but more heat than light.

The good news is this new bulge in pay may not be sustainable.

The bad news is it will probably only be stopped by further regulation, regulation which may never come.

To understand what is going on you need to understand the economic concept of “rents”, essentially the extra money a given individual or industry is able to extract from its clients above what it would be able to if there was perfect competition.

A monopoly will charge a very high price for goods or services because, well, they can. Needless to say economic rents are not a good thing, unless of course you are in receipt of them.

Workers in financial services have been huge beneficiaries of economic rents in recent years. They sell products which are complex and poorly understood by clients. They have been very lightly regulated, and it has been hard in many areas for start ups to compete with large firms and drive down prices.

A study by economists Thomas Philippon of New York University and Ariell Reshef of the University of Virginia found that about 30-50 percent of the extra pay bankers get as compared to similar professionals is attributable to rents. <http://people.virginia.edu/~ar7kf/papers/pr_rev15_submitted.pdf>

In other words, banking is able to overcharge its customers and bankers are able to capture a huge portion of that for themselves. Why? Because they don’t face enough competition, their products are too complex for clients to be able to understand and bargain effectively, and crucially because regulation allows for this state of affairs.

Rising complexity, in my view, has probably been fuelled at least in part because it drives margins and tilts power away from bank clients and shareholders and to employees.

“The more complicated the product the easier it is for people to hide the risks,” Reshef said in an interview.

The study shows that excess pay in banking is very closely linked to lax regulation, as opposed to higher productivity or early adoption of technology.

Relative compensation in finance in the early part of the last century peaked not in 1929 before the crash but several years later just before the more stringent regulations kicked in. Relative compensation began to climb again in the 1980s as deregulation happened and rose like a rocket since 1990.

WHAT JUST HAPPENED??

The economic crisis, far from undermining circumstances that allow for rents and excess pay, has in some ways cemented them.

One area of complexity, asset backed finance, has been eviscerated but many others still sail on relatively unaffected.

Most importantly, the doctrine of too big to fail has confirmed and reinforced the superior market position of those banks and investment banks which still survive.

The U.S. has essentially made it known that the current players will not be allowed to fail. These banks had an advantage already based on their size, that advantage is now greater and carries an implied government guarantee.

Ladies and gentleman, this is your banking recapitalization program: an unfair playing field. I might be able to swallow that as the economy needs a banking system. But, if you believe Reshef and Philippon’s data, a goodly part of the essentially unearned money that should be going to recapitalize the banks is ending up instead overpaying the bankers.

It is true that part of the reason banks are paying their best people so much is that a tectonic shift in banking will place a higher premia on the most talented. Fair enough, but only if we see a shrinking pool of compensation money being tilted towards a smaller elite.

The rise and rise of the rents extracted by bankers from the economy will only really be stopped by government intervention, since, given we have a system of bank insurance, it only really can exist with government connivance.

You could make good progress controlling excess compensation and banking rents by placing limits on size, by taxing complexity (which after all hasn’t really served us well), and by limiting the use of leverage within the parts of the system that can make a call on the taxpayer.

If you look at the Great Depression, this process will take about four years. We’ve not made a very encouraging start.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

– Christopher Swann is a Reuters columnist. The views expressed are his own –

Recession historians on Wall Street often consider a downturn over when job declines fall to half their peak.

The July employment report, with its revisions, takes us past this milestone. The numbers were better than expected in almost every respect. There was even a tick up in hours worked, especially in manufacturing. The output component of the recession has probably already ended.

Even so, the labor market is likely to remain grim for a very long time. That a decline in payrolls of 247,000 should be taken as good news is an indication of how bad things have become. Such falls were close to the average in most postwar recessions, not an indication that the worst was over.

In the recession of the early 1980s, the peak job loss was 389,000. In this recession it has been around 740,000. So we are still on a different trajectory. The United States may continue to bleed jobs at a fast pace for some time to come.

There has seldom been more slack in the labor market. Businesses have plenty of room to increase the working hours of existing employees — which have declined far faster than in previous downturns.

Part-time workers can be brought fully on board. Only then might companies add to payrolls.

After the end of the 2001 recession, it took 21 months for the labor market to fully turn around. Even the White House, which is becoming much better at managing expectations, is saying that it still expects the unemployment rate to reach 10 percent.

Once people lose their jobs, they are also spending longer out of work than in previous downturns. In the recession of the early 1980s the average spell of unemployment reached a peak of 20 weeks. Now it is at 25 weeks. A third of the jobless have now been without work for more than six months, up from 29 percent in June — both post-war records.

This is bad news for consumption, since state payouts typically cover less than half of a previous salary.

For America’s hobbled banking system the ever growing duration of unemployment is almost as ominous as job destruction itself. Few consumers have sufficient precautionary savings to continue to service debt for such extended periods once their income is halved.

Under an optimistic scenario, in which job creation rebounds to about 100,000 a month, it will still take five years to recover the more than 6.6 million jobs lost during the recession. This should keep consumer spending weak and means that the United States will remain vulnerable.

Over coming months the temptation to ease off the monetary and fiscal pedals will increase. It should be resisted. Policy makers should get used to looking at economic data in absolute as well as relative terms.

– James Saft is a Reuters columnist. The opinions expressed are his own –

The explosion in company pension fund shortfalls in Britain nicely illustrates issues which will dominate economics and investment in coming years: the re-pricing of risk, a disillusionment with equity markets, and the boom in savings these shortfalls will help to drive.

Under current accounting rules, the pension funds of companies in Britain’s FTSE 100 index are together 96 billion pounds ($170 billion) underfunded, more than double the deficit of a year ago and an all-time record, according to a report from pension fund consultants Lane, Clark & Peacock.

This is partly for the very positive reason that people are living longer but principally because of the dire performance of financial markets, especially equities, over the past year.

To make matters worse, the surge in corporate bond spreads, which are used to calculate the current value of pension plans’ future liabilities to retirees, has actually minimised how underfunded British pension plans look when accounting measures are applied. Minimised how underfunded they look, but not how underfunded they are.

One of the net results of all this is that companies are getting out of the pension providing business as fast as they can, pushing employees into plans where the saver takes all of the investment risk and the company is purely a contributor and a facilitator.

Individuals are less able to take the long view and hold riskier assets like equities during downturns, meaning they are more likely to hold more in cash and bonds than are company pension plans.

Individuals are also going to be increasingly aware of the shortfalls of the pensions they have coming, which will push the savings rate still higher.

A growing awareness that we are going to live a very long while will also support this. It’s nice to live to 90, but it takes savings to fund that old age, even if you plan to work until you are 70.

Put simply financial markets have been fantastically volatile during the past two years, making it difficult to figure out how much to save and even tougher to figure out how much those savings might earn over the longer term.

Amazingly, more companies in the Lane, Clark survey raised their estimates of long-term returns from equities than cut them in the past year. But even after a huge rally in recent months, five and ten year returns in many of the world’s equity markets look pretty uninspiring, especially if you apply any kind of penalty for the very extreme level of volatility.

Assumptions about equity market returns will likely fall in coming years and more pension funds and individual retirement savers will ease up on the percentage of their portfolios they allot to shares.

SAVINGS UP, CONSUMPTION DOWN

One of the key false assumptions of the pre-credit crisis age was that we lived in a newly tame economic era. This conditioned people to save less and take on more risks, as borrowers, lenders or investors. This leveraged economy grew more quickly than a more conservative one, and we rationalised away the risk by saying that better macro-economic policies meant we were in a new era where rainy days were fewer and less severe.

That obviously has been proved wrong, and the results are written in the pension plans deficits. We live in a more volatile, riskier world than we believed. As that realisation spreads, and as many retirees find they have too little in savings, behaviour will change in important ways.

A growing awareness of the fragility of growth and the volatility of markets will not just change the behaviour of investors but also others.

Banks, as we’ve already seen, are going to want more security and a better margin. That will crimp growth. Companies will be more cautious in how they borrow, invest and expand. That too will crimp growth. This is not a bad thing, but it is bad if you have a business or personal plan that is predicated on very high growth.

All investors will be less comfortable with equity risk, and as individuals will bear more of those risks alone, they will accentuate a trend away from equity investment.

But more powerfully, the fact that there is no benevolent company or government which can fund our 25 year retirements will push all of us to save more, as well as to be more cautious with how we invest the money we do save.

This will have a big dampening effect on economic growth, especially in the ageing West, and isn’t likely to be very helpful to long term equity valuations either.

Monetary and fiscal policy can work against these forces, as we’ve seen, and can ease the transition, but they can’t do it by themselves forever.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

– John Kemp is a Reuters columnist. The views expressed are his own –

The Bank of England’s decision to continue with its asset purchase programme, or quantitative easing (QE), at the rate of 50 billion pounds per quarter in Oct-Dec, unchanged from Jul-Sep, shows bank officials are more worried about ending support for the recovery too soon than about risking inflation by leaving it too late.

The problem with QE is that you have to keep buying the same amount of assets each month to maintain the same monetary stance. With interest rates, the Bank can cut them and they stay cut. If asset prices drop with QE, it represents a tightening of monetary policy.

The Bank initially bought 75 billion pounds in the first 3 months (Apr-Jun) and then tapered this to 50 billion in the second three months (Jul-Sep) as the crisis engulfing the banking system and the rest of the economy eased. A cautious approach might have tapered the QE programme again to 25 billion in the final three months of the year before ending it entirely at the start of 2010. But the Bank opted to stick at 50 billion.

Critics point out that the programme has not achieved its announced objective of increasing bank credit and the amount of money in circulation. The rate of growth in M4, the broadest money supply measure, has risen only marginally. But that ignores the counterfactual of what would have happened to M4 in the absence of the programme — it might have fallen sharply.

Growth in the monetary aggregates is, in any event, mostly endogenous. It depends on demand for credit. In the current environment, where many households and businesses have little or no collateral, credit is impaired, and most are focused on paying down debt rather than adding to it, limited growth in M4 is not surprising. Trying to make it grow faster is like force feeding a duck to make foie gras — possible but unnatural.

QE has always been as much about restoring confidence, dispelling fears about deflation and ensuring a ready market for the safer securities banks hold as much as growing the money supply. On most of these measures it must be considered a qualified, if expensive, success. A full judgement will only be possible when the Bank has proved it can withdraw the excess liquidity in a timely manner to prevent an upsurge in inflation.

In the end, the decision to press on is driven by fears about the fragility of the current recovery, and the risk that if QE ends too soon, effectively tightening policy, whatever green shoots have emerged over the summer will be killed off by an autumn frost.

All recoveries are fragile and weak early on. While the rebuilding of inventories along the supply chain, often provides the initial boost, this must eventually be replaced by a more sustained increase in household and business expenditure.

But with their new focus on the experience of the 1930s, central bank officials worldwide are more worried than normal about doing anything to stall the recovery.

Looming over the debate is the experience of 1937, when the Federal Reserve responded to concerns about the amount of “excess liquidity” in the banking system and sharp rises in the price of some commodities, especially steel, by doubling reserve requirements on banks in the space of nine months. It effectively converted previously “excess” reserves against which the banks could lend into “required” reserves against which they could not.

The four-year old recovery (1933-1937) promptly collapsed amid tightening bank credit, and the United States suffered the second deep recession in a decade, with output not fully recovering until the onset of war in 1940-41 (https://customers.reuters.com/d/graphics/DSTMIRROR.pdf).

Anxious to avoid a repeat, it is no wonder that the Bank of England is in no hurry to tighten policy. While this level of QE must eventually generate inflationary pressures, the Bank judges, probably correctly, that it still has some time before policy needs to move to a more restrictive setting.

– Bernd Debusmann is a Reuters columnist. The views expressed are his own. –
Nobody ever landed on the moon, the televised images are a hoax. John F. Kennedy was murdered in a complex plot involving the Mafia and the CIA. Elvis Presley lives. Barack Obama was born outside the United States and therefore is ineligible to be president.

All these claims stem from conspiracy theories and myths born in the U.S. and they throw a question mark over the long-held view of experts that such ideas flourish most in societies where news is controlled, access to information difficult and barriers to independent inquiry difficult to overcome.

This kind of restrictive environment  applies to many Third World countries - conspiracy theories are particularly abundant in the Middle East and Africa — but not to the technologically and economically advanced United States. Yet there is a parallel universe inhabited by millions and millions of Americans immune to facts, logic and common sense.

Some of the myths are harmless, such as the notion that rock-and-roll king Elvis Presley did not die in 1977 and instead went into hiding. (The reasons vary depending on who tells the tale).

There have been thousands of supposed Elvis sightings and a 2005 book says there’s DNA evidence that he is still alive. While the Elvis-in-hiding theory appears to fading (though it is far from dead), the hoaxed moon landing continues to run long enough to prompt a Newsweek magazine article that debunked the story on the 40th anniversary of the Apollo mission to the moon in July. Perhaps not surprisingly, early skepticism about the moon landing came from the Flat Earth Society, based in California.

The Flat Earthers have their own website, unlike the latest addition to America’s wide variety of conspiracy cults, the “birthers.”

They insist that President Barrack Obama was born in Kenya and that the certificate attesting to his birth in Hawaii is a forgery. Unlike the Flat Earthers, the birthers managed to find Congressional sponsors, all Republicans, to introduce a bill meant to block non-eligible Americans from becoming president in future.

H.R. 1503, introduced by Florida Republican Bill Posey, wants to “To amend the Federal Election Campaign Act of 1971 to require the principal campaign committee of a candidate for election to the office of President to include with the committee’s statement of organization a copy of the candidate’s birth certificate, together with such other documentation as may be necessary to establish that the candidate meets the qualifications for eligibility to the Office of President under the Constitution.”

TALK RADIO BOOSTS BIRTHERS

Weighty language for a weighty cause. First voiced during the presidential election campaign (when Obama opponents also aired suspicions that he is a Muslim), the birther conspiracy gained currency when a right-wing talk radio host, Rush Limbaugh, expounded on it and entertained his audience with the following line: “What do Obama and God have in common? Neither has a birth certificate. How do they differ? God does not think he’s Obama. And there’s another difference between God and Obama, and that is that liberals love Obama.”

This from a man with a reputation as the loudest and perhaps most influential conservative voice in American politics. Asked a few weeks ago whom he would chose as a political leader if the choice were between Limbaugh and former Secretary of State Colin Powell, former Vice President Dick Cheney opted for Limbaugh.

A conservative cable TV show host, Lou Dobbs of CNN, also boosted the birth certificate tale, inviting proponents of the theory on his program and raising questions over the authenticity of the certificate Obama’s campaign team produced before the elections.

Air time for the birthers, whose natural habitat is the Internet, clearly helped spread their claims. There are no reliable statistics on the number of American Flat Earthers, Moon Walk deniers or Elvis spotters but a poll in late July showed considerable Republican support for the birthers’ assertions and their conclusion that Obama is an illegitimate president.

According to the survey, by the polling institute Research 2000, there is a huge gap between Republicans and Democrats on the issue: 93 percent of Democrats believed that Obama was born in the U.S. while only 42 percent of Republicans thought so. Of the rest, 28 percent thought he wasn’t born in the U.S. and 30 percent were not sure.

“Far from being an isolated, on the edge movement, the birthers have planted deep a paranoid conspiracy seed about Obama’s legitimate right to sit in the White House among a wide body of Americans,” lamented Earl Ofari Hutchinson, a political analyst.

The debate, he says, has bestowed a kind of perverse legitimacy on the birthers. “They won’t quietly go away.”

Probably not. Conspiracy theories come in many forms but they have one thing in common: they survive against overwhelming factual evidence.

– Christopher Swann is a Reuters columnist. The views expressed are his own –

Cash-strapped politicians are more willing to play Robin Hood than at any time in a generation. Tax rates on the rich may soon hit levels not seen since the 1980s.
The wealthy, alas, are not easy prey. Backed by highly paid lawyers and accountants, no other group is better able to run circles around the taxman. As a result, America’s politicians may get less cash than they bargained for and more economic distortions.

There are many easier and less disruptive ways to get the cash.

Of course, the temptation to launch a direct strike on the rich is understandable. The past three decades have been very good to the affluent. The top 1 percent of earners now account for 19 percent of America’s income, up from 9 percent in 1980. This elite group has also been quiescent, dutifully paying 40 percent of all income tax, according to the non-partisan Congressional Budget Office.

It has been many years since the rich had a powerful incentive to test the limits of the tax code. The top rate of income tax has fallen with only minor interruptions since its vertiginous peak of 92 percent in 1953. But a foretaste of what might be expected was offered by Maryland’s ill-fated creation of a millionaires-tax bracket in 2008.

A year later 1,000 millionaires had disappeared — a third of the total — and revenues from this group had fallen by $100 million. Some may have left the state while others may have found ingenious ways to reduce their reported income.

The U.S. tax code is replete with legal dodges for the wealthy, whether you are a top executive, independent business owner or the lucky recipient of inherited wealth.

Well-paid salaried employees often have considerable leverage over how they are paid. For this group, tax-efficient fringe benefits — including lavish health plans, and use of the corporate jets and other perks — may increase. Stock options may become more popular still, enabling employees to defer tax until they retire and have lower incomes.

Business owners have even more flexibility and can deliberately muddle personal and business consumption. And as income tax surges above corporation tax, business owners may choose to pay themselves risible salaries, locking up their wealth in their companies.

The wealthy may also choose investment strategies that avoid income and maximize capital gains, further reducing potential tax revenues. The capital gains tax is preferable because there is flexibility in when gains can be taken. Tax-exempt municipal bonds could also become more popular.

Significantly higher taxes on the wealthy, then, could reduce tax reduces while encouraging businesses to waste more money on executive perks. Such unintended consequences could undermine efforts to stabilize the financial system. Politicians should avoid this lazy and wasteful solution.

Tidying up the fabulously complex tax system and closing loopholes could raise just as much money and be easier to market politically. Many of these measures have the advantage of extracting cash from the rich in ways they will find harder to avoid.

Scrapping the tax exemption of municipal bonds would eliminate a favorite haven for the wealthy.

Reducing or eliminating the gulf between income and capital gains — as Ronald Reagan’s 1986 tax reform did — reduces sharply the opportunity for hiding money.

A number of other quirks in the code also primarily benefit upper-income groups — including breaks on employer-provided healthcare, mortgage interest and state and local tax.

For the less progressively minded, the gradual imposition of value-added tax, as proposed by Bill Gale at Brookings, could raise a great deal of cash in the future while actually encouraging people to spend now.

A clumsy increase in top rate taxes, by contrast, will mainly be a bonanza for tax accountants and lawyers.

– This article by Paul Smalera originally appeared in The Big Money. The views expressed are his own. –

Indulge me in a thought experiment. Pretend that drinking something called “lethalcoffee” has been found to cause cancer. There are five or six kinds of gross-flavored lethalcoffees that hardly anyone drinks, like chocolate, cherry, banana, and vanilla. But there’s one flavor, mint, that 30 percent of all lethalcoffee drinkers are hooked on. And there’s one particular group of lethalcoffee drinkers—let’s call them investment bankers—who drink mint lethalcoffee like there’s no tomorrow.

Allow 40 years for several million lethalcoffee-related deaths to pile up before the pandemic is taken seriously by the government. (Try to put aside any negative feelings you harbor about investment bankers.) Finally, Congress introduces a Lethalcoffee Safety Act that has a chance of becoming law. Would you imagine that law would:

A) Order the FDA to regulate lethalcoffee but withhold from the agency the power to ban it?
B) Ban every flavor of lethalcoffee except mint, the one most people drink?
C) Make it really hard for people to sell badcoffee, a new but much less hazardous cousin of lethalcoffee?
D) Be co-authored by Starbucks (SBUX)?

How about “E,” all of the above? Because that’s what Congress is proposing to do in the Family Smoking Prevention and Tobacco Control Act, probably soon to head to President Obama’s desk for a signature. Mint-flavored lethalcoffees are menthol cigarettes. The 80 percent of investment bankers who prefer menthols are African-Americans. And the bill was largely shaped by Philip Morris (now called Altria), which sells more cigarettes than nearly every other American tobacco company combined.

“It is a dream come true for Philip Morris,” Michael Siegel, a professor at the Boston University School of Public Health, told me. “First, they make it look like they are a reformed company which really cares about reducing the toll of cigarettes and protecting the public’s health; and second, they protect their domination of the market and make it impossible for potentially competitive products to enter the market.” Other tobacco companies have taken to calling the bill the “Marlboro Monopoly Act of 2009.”

It’s hard to fathom where Congress is finding the political cover necessary to pass an industry-sponsored love letter like this one. But it’s coming from Philip Morris’ partner in crafting the legislation: a nonprofit anti-smoking organization called Campaign for Tobacco-Free Kids.

As early as 1998, Philip Morris executives were worried about the continued existence of their industry. Big Tobacco was locked in a battle with Congress over advertising and product regulations. And it was reeling from the $264 billion settlement in the lawsuit brought against it by 46 state attorneys general over Medicare costs for smokers. The future was hazy, and the tobacco companies’ ability to fight costly legal battles for the indefinite future was in doubt.

So, as Roll Call recounts, Philip Morris executives made a huge shift in tactics. Rather than beat back every attempt at industry regulation, they initiated the secret Project Sunrise, an effort to help craft those regulations. Part of the strategy was to work with the very anti-smoking groups they had fought for years. Big Tobacco decided to sue for peace in order to win at the negotiating table.

Philip Morris found a willing partner in the Campaign for Tobacco-Free Kids. It was among the more moderate anti-smoking groups, and some of its top staff had worked for Sen. Tom Daschle, so they were well-versed in the art of legislative compromise. The existence of an agreement between Philip Morris and the Campaign is how Rep. Henry Waxman, the bill’s main sponsor, has justified the perverseness of Philip Morris’ support for a supposed anti-smoking bill.

“Don’t let perfect be the enemy of good,” has been the old saw the administration uses to admonish interest groups dissatisfied with compromise legislation. But opponents of this bill on both sides are asking, What’s the enemy of terrible? Isn’t it this bill, which is racist, protectionist, cynical, and misguided? And barring an improbable veto, it will soon become law. Nowhere is the bill’s perfidy more obvious than in its failure to ban menthol cigarettes.

The National African American Tobacco Prevention Network released a statement on the bill last May that read, “Tobacco legislation that treats menthol differently from other flavoring additives is incomplete.” This is in response to studies showing that menthols are far more addictive then other cigarettes and far harder to quit, no matter what race the smoker is.

And last July, the Harvard School of Public Health released a study showing that tobacco manufacturers carefully controlled the menthol content of cigarettes to maximize its masking of harsh tobacco smoke, even creating new brands for longtime smokers who require increasing amounts of menthol to maintain its numbing, cooling effect.

Menthols accounted for a quarter of the roughly 370 billion cigarettes smoked domestically in 2006 and are more popular here than anywhere else in the world. So far, neither Waxman nor Sen. Ted Kennedy, who shepherded the Senate version through his Health, Education, Labor and Pensions Committee last week, has specifically defended the exclusion of a menthol ban. Waxman notes that after an FDA study, menthol could be banned as well but didn’t explain why menthol merited a study period and chocolate cigarettes did not.

By the numbers, the menthol exemption practically paints a bull’s-eye on the lungs of African-American smokers. So you might presume that African-American Congress members have an interest in exposing the bill’s shortcomings. But of the 42 voting members in the Congressional Black Caucus, 20 are co-sponsors of the bill. Philip Morris’ parent company has donated more than $1.5 million to the caucus since 2002 and thousands more to individual members, including James Clyburn, the House whip, and Edolphus Towns, chair of the House committee that favorably reported the smoking legislation. Towns has been dubbed the “Marlboro Man,” thanks to his long-standing relationship with Philip Morris. And donations must have been easy for Philip Morris to file; a CBC advisory board member, Shuanise Washington, was treasurer of the organization while she was also Altria’s (MO) vice president of government affairs. The tobacconist and the caucus even share a graphic designer.

Ten of the remaining, nonsponsoring CBC members hail from tobacco-producing states that oppose the bill primarily because it puts their home-state tobacco companies at a huge disadvantage to Philip Morris. That leaves 12 African-American Members of Congress who withheld their names from the bill, despite menthol cigarettes’ being linked to 14.6 percent of all African-American deaths in 2006. And there are, of course, 217 other co-sponsors, mostly white, ignoring the fact that despite menthol’s cultural identification with 4 million African-Americans, double that number of white smokers also partake in the minty tobacco.

The next most popular flavored cigarette, clove, accounts for .09 percent of the market. Those cigarettes will be banned under the bill. Indonesia, which provides 99 percent of the clove cigarettes to the U.S. market, has complained to the U.S. trade representative about the disparity with menthol. If Indonesia brings a protectionist complaint to the World Trade Organization, it would compel our government to prove cloves were banned for health reasons. Namely, the United States would have to show that the flavor of cloves enhances cigarettes’ addictive properties. If it can’t, the ban could be considered a trade violation.

It’s a lose-lose proposition. If the United States proves it banned clove cigarettes strictly for health reasons, it would be admitting that menthol cigarettes, manufactured domestically, are getting a free pass despite their clovelike increased health risks. Which puts the FDA, as the tobacco regulator, in the position of justifying a ban on cloves but not menthols. This is the type of case Siegel refers to when he told me the bill lets “the tobacco companies produce and market the cigarettes and the FDA approve them. The ramifications of this bill go far beyond tobacco control. The bill completely undercuts and undermines the entire system of federal public health regulation in this country.”

In other words, the United States will have two choices in the above scenario, both hairy: protect the FDA’s independence by admitting it banned cloves but not menthols only to protect Philip Morris’ market share or let the FDA manufacture an explanation, contrary to recent studies, by which menthol cigarettes, which are used to lure children to smoke, are just as safe as unflavored cigarettes.

Click here for a longer version of this article.

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(Top right picture: Cigarettes are be seen in a tobacco shop in New York April 1, 2009.  REUTERS/Lucas Jackson.)

– Louis E. Lataif, a former president of Ford Motors of Europe, is dean of the Boston University School of Management. The views expressed are his own. —

Government ownership of General Motors (60% U.S. and 12% Canada) will be fraught with difficulties.

Given the large taxpayer stake in the company, it will be impossible for elected officials to stay out of the fray. Congress inevitably will interject itself in business decisions affecting employment, the kind of vehicles the company builds, or the company’s position on nationalizing health care – just as it is now asserting itself on the question of dealership closures.

Imagine the new General Motors (i.e., the government) attempting collective bargaining with the United Auto Workers’ union (on whose behalf the government stepped into the fray in the first place).

Consider the company lobbying Washington on an issue favored by the government (e.g., tax policy or the elimination of secret ballots for workers) but ill-suited for the company. And there there’s the matter of types of vehicles to be built.

With a strong environmental agenda, the government will understandably favor alternative fuel vehicles. Yet, there is no company in the world making any real money on such vehicles, given the current economics of alternative propulsion methods.

The government points to Toyota as a car company that has been responsive to the need for small, fuel-efficient cars, but Toyota reported a first quarter loss much worse than that of General Motors. That’s because the vehicles that keep these businesses viable — larger cars, SUV’s and trucks — are not selling in sufficient volume during this consumer credit crunch.

If GM’s new owner find that the company’s products are not selling well (while competitor vehicles are selling better) it may decide to institute expensive purchase-incentive programs. When those programs are matched by the competition (which is what happens in normal competitive marketing), thereby eroding the profitability of the healthier competitors, where do those stronger companies go to complain about predatory pricing practices by their government-owned competitor?

I think the current approach to “saving General Motors” will prove untenable.

If the government truly believed that America needed to save its domestic auto industry, it would have been far wiser if the U.S. Treasury served simply as a lender of last resort. It then could have granted the ailing automakers interest-bearing bridge loans with restrictive covenants requiring sacrifices from management, the union, the bond-holders, and suppliers — and then let professional managers run the private businesses.

Then when the demand for automobiles rebounds (as it always does following a recession), the taxpayers would be the first to be repaid.

But by becoming an owner, a role for which government is singularly ill-suited, the federal government has taken us into difficult, uncharted economic waters — a market-damaging move I suspect we will regret. Hopefully, the Treasury realizes this and will work to find a swift way out of its ownership position.