Friday, July 28, 2017


Have you ever wondered whether the massive “new start-ups” in the digital tech field are actually good for the U.S. economy, creating and sustaining good jobs or that they just might somehow create some powerful overall negative consequences? After all, Facebook allows a seller to market to a highly targeted and infinitely available audience. Amazon enables smaller retailers and manufacturers to access a potentially “uuuge” marketplace. And Google opens the door for companies to be “found” in ways that never existed before. All good? Depends on your perspective.
The European Union has come down hard on Google, recently levying a $2.7 billion fine for violating its antitrust laws, while the United States – facing the same kinds of market restraints that angered the EU – has done nothing. The United States, recently pretty lax in addressing antitrust issues at any level, has mostly applied its laws in this space to address market distortions resulting from mergers and acquisition or situations where collusion results in price-fixing. Today mere “bigness” – which is more than enough to ignite EU antitrust violations – doesn’t seem to be much of a consideration to U.S. federal antitrust regulators at either the Federal Trade Commission or the Department of Justice. If companies merge and acquire to get too big: bad. If they just grow to be big: not bad. But it wasn’t always this way. The U.S. has not always allowed organic-growth bigness to pass without serious antitrust consequences.
Back in 1956, the Justice Department began a long and hard look over the monopolistic hold the organically-big Bell System held over virtually all of America’s telephone operations. Bell literally controlled all of what today are known as its fractured descendants, RBOCs (Regional Bell Operating Companies), which have since fractured even further with Internet, wireless, etc. spin-offs and now face competition from cable, Internet and satellite carriers as well. That break-up of the Bell System was hardly voluntary. But the actual break-up (“divestiture”) began in 1974 when the DOJ sued Bell under antitrust laws. In 1982, under a consent decree, that Bell monopoly was broken into little pieces.
But today’s tech biggies are pretty close to the same levels of that monopolistic market domination, and although they are heavily in the acquisition business (mostly smaller tech companies that have technology they want – see below), mostly they got really big simply by growing. Former investment banker and author (Move Fast and Break Things: How Facebook, Google and Amazon Cornered Culture and Undermined Democracy – Little, Brown & Company, April 2017) Jonathan Taplin tells us that these three corporations aren’t too far from the bigness that led to the divestiture of the Bell System.
He reminds us that Google controls 77% of the US ad-search business, and together with Facebook, about 56% of the mobile ad market. Amazon is the eBook giant (70% market share) and accounts for almost a third of all U.S. e-commerce. If you aggregate Facebook and its operating subsidiaries (Instagram, WhatsApp and Messenger), they account for about 75% of US social media traffic. That’s big, but what are the impacts on “the rest of us”?
Writing for the July 24th Bloomberg Businessweek, Paula Dwyer explains: “Economists have noticed these monopoly-size numbers and drawn even bigger conclusions: They see market concentration as the culprit behind some of the U.S. economy’s most persistent ailments—the decline of workers’ share of national income, the rise of inequality, the decrease in business startups, the dearth of job creation, and the fall in research and development spending.
“Can Big Tech really be behind all that? Economists are starting to provide the evidence. David Autor, the MIT economics professor who famously showed the pernicious effects of free-trade deals on Midwestern communities, is one. A recent paper he co-wrote argues that prestigious technology brands, using the internet’s global reach, are able to push out rivals and become winner-take-all ‘superstar’ companies. They’re highly profitable, and their lucky employees generally earn higher salaries to boot.
“They don’t engage in the predatory behavior of yore, such as selling goods below the cost of production to steal market share and cripple competitors. After all, the services that Facebook and Google offer are free (if you don’t consider giving up your personal data and privacy rights to be a cost). However, academics have documented how these companies employ far fewer people than the largest companies of decades past while taking a disproportionate share of national profits. As they grow and occupy a bigger part of the economy, median wages stagnate and labor’s share of gross domestic product declines. Labor’s shrinking share of output is widely implicated in the broader economic growth slowdown.
“Still others have shown that, as markets become more concentrated and established companies more powerful, the ability of startups to succeed declines. Since half of all new jobs spring from successful startups, this dampens job creation… Peter Orszag [Bloomberg View] He Jason Furman, chairman of President Barack Obama’s Council of Economic Advisers, point out that higher returns on capital [inherent in some of these behemoths] haven’t resulted in increases in business investment—yet another manifestation of monopoly power.
Some members of the Chicago School, the wellspring of modern antitrust theory, agree. In the 1970s and ’80s, a group of University of Chicago scholars upended antitrust law by arguing that the benefits of economic efficiency created by mergers outweighed any concerns over company size. The test was one of consumer welfare: Does a merger give the combined company the power to raise consumer prices, and are barriers to entry so high that new players can’t easily jump in? U.S. antitrust enforcers were swayed. From 1970 to 1999, the U.S. brought an average of 15.7 monopoly cases a year. That number has since fallen—to fewer than three a year from 2000 to 2014.” Time to revisit these assumptions? Yup! 0ld theories don’t always hold water in changed times.
“There is little debate that this cramped [Chicago School] view of antitrust law has resulted in an economy where two-thirds of all industries are more concentrated than they were 20 years ago, according to a study by President Barack Obama’s Council of Economic Advisers, and many are dominated by three or four firms. What’s now at issue is whether the outcome has benefited society.
“Research by John Kwoka of Northeastern University, for example, has found that three-quarters of mergers have resulted in price increases without any offsetting benefits. Kwoka cited industries such as airlines, hotels, car rentals, cable television and eyeglasses.
“And even former antitrust officials acknowledge that their approval of Google’s purchase of YouTube and ITA Software and Facebook’s acquisition of Instagram and WhatsApp look naive in hindsight, eliminating the kinds of companies that might have someday challenged the tech sector’s most dominant firms.” Steven Pearlstein writing for the July 28th Washington Post. But there are so many other ways to look at the world, where current US antitrust statutes simply no longer apply.
The elements that the EU has uses to justify its prosecution of these tech giants often include variables other than direct pricing costs imposed on consumers, issues that have not reached a parallel level of concern here in the United States. “Instead of applying conventional antitrust theory, such as the effect of a merger on consumer prices, enforcers may need to consider alternative tools. One is to equate antitrust with privacy, not a traditional concern of the competition police. Germany’s Federal Cartel Office, for example, is examining charges that Facebook bullies users into agreeing to terms and conditions that allow the company to gather data on their web-surfing activities in ways they might not understand. Users who don’t agree are locked out of Facebook’s 2 billion-strong social media network.
“Another avenue is to examine control over big data. Google collects web-surfing and online-purchasing data from more than a billion people. It uses that to send personalized ads, video recommendations, and search results. The monopoly control of consumer data by Facebook and Google on such a scale has raised antitrust questions in South Korea and Japan.
“[It’s not always a matter of simple dollar-analysis] For example, because what Facebook offers is free, regulators weren’t concerned that its $22 billion acquisition of WhatsApp in 2014 might result in higher consumer prices. In fact, because WhatsApp is in a different industry, it didn’t even increase Facebook’s market share in social media.
“The tech superstars insist they compete fiercely with each other and have lowered prices in many cases. They argue that their dominance is transitory because barriers to entry for would-be rivals are low. Google often says competition is ‘one click away.’ And since consumers prefer their platforms over others’, why punish success? But when a cool innovation pops up, the superstars either acquire it or clone it. According to data compiled by Bloomberg, Alphabet, Amazon, Apple, Facebook, and Microsoft made 436 acquisitions worth $131 billion over the last decade. Antitrust cops made nary a peep.” Dwyer.  
And it’s equally clear, these biggies use their power to impair nascent competition. Modern technology – particularly “reverse engineering” (reaching the same technological result with a different patent path) – has empowered the biggest to kill-off threats before they can really be competitive. “Snap Inc.’s experience with Facebook is instructive. Since Snap rebuffed Facebook’s $3 billion offer in 2013, Facebook has knocked off one Snapchat innovation after another. That includes Snapchat Stories, which lets users upload images and video for viewing by friends for 24 hours before self-destructing. Facebook added the feature—even calling it Stories—to its Instagram, WhatsApp, and Messenger services, and most recently to the regular Facebook product. Snap’s shares now trade at around $15, below the $17 initial offering price in March. By offering advertisers the same features but with 100 times the audience, ‘Facebook basically killed Snapchat,’ Taplin says.” Dwyer.
Earlier this year, the Yale Law Journal published a 24,000-word ‘note’ by [a 28-year-old law student named Lina Khan] titled ‘Amazon’s Antitrust Paradox.’ The article laid out with remarkable clarity and sophistication why American antitrust law has evolved to the point that it is no longer equipped to deal with tech giants such as, which has made itself as essential to commerce in the 21st century as the railroads, telephone systems and computer hardware makers were in the 20th.” Steven Pearlstein.  “Too big to regulate”? We seem to be living in a new evolving “winner-take-all” economy where smaller competitors just do not stand a chance against the biggest baddest boyz in those huge market silos.
While we have used existing required statutes to stop simple “bigness” – as the Bell System divestiture suggests – upgrades (statutory and regulatory) to our antitrust laws are needed to focus beyond simple consumer pricing variables. Think that’s going to happen within the Trump administration or with a Republican Congress? Yeah, right… even if some of the leaders of these companies aren’t exactly the President’s best friends. Weird to think that the American public has to rely on EU antitrust enforcement of big US companies “over there,” which leaks into the United States bit by bit, because its own government has little or no interest in helping the little guy. Maybe that’s why the Dems have just turned to look in this direction. But can they really stand to lose those big contributors? “Jobs, jobs, jobs”? Tired of winning yet?
I’m Peter Dekom, and progress and change requires statutes and regulations to adjust to modern realities… or just wither away into irrelevance like so many other political directives of the past.


Anonymous said...

Tech companies think inside the "patent box", incentive tax rates offered by countries for creating hardcore intellectual property there, aka research & development. If the US wants more tech jobs, create a "patent box" at a 10% rate, and significantly lower the corporate tax rate to make it competitive. Another corporate repatriation amnesty may help too (even though some argue it would only be used to increase shareholder dividend rather than US investment and jobs).

Not only does the US already have to play catch-up with other OECD nations on a lower corporate tax rate, but European competitors are becoming increasingly tax friendly. This July, Google won a 1.3 billion dollar tax case in France against the EU. The UK is desperate to stem the flow of investment running scared on Brexit fears. Even the EU is looking at a low harmonized rate to make the single market al the much more competitive.

Emily Graham

Anonymous said...

As I have blogged before, US corporations with $10M+ in annual gross income pay an effective “loophole-filled” federal corporate tax rate of 12.6%. Eliminate the loopholes – don’t forget the power of lobbyists and well-paid fleets of “tax avoidance” lawyers engaged by those with the largest taxable income – and have a more sane rate? It is an area of tax reform where Dem and the GOP could find common ground and pass tax reform, but beware.
In the Reagan era, the short-term moratorium reduced tax rate on off-shore corporate money brought tons of cash onshore. More jobs? Not exactly. With all that cash, the biggest companies bought back their own stock or engaged in a flurry of mergers and acquisitions. Result, M&A and buy-backs encouraged “efficiencies” to kick values higher… consolidation generated massive layoffs and unemployment soared.
Aside from the tax benefits accorded to patent holders, the recent US shift to a “first to file” priority in patents, and serious costs for those who do not file, the American patent system clear favors big companies able to afford the constant filing of patents (including refinements) – not cheap – over entrepreneurs struggling to find money just to stay in business. And without patents, the value of any IP company falls into “questionable” at best.
Finally, there is the harsh reality of big boyz’ stepping on patents without much care about the consequences, reverse engineering when they can, knowing that small patent-holders do not have the money to sustain the expensive American legal system… often folding like a house of cards. Peter Dekom

Anonymous said...

Apple is appealing from the EU ruling requiring it to pay Ireland 15.2 billion dollars, for what the EU court held was a reverse engineered and unfair Advance Pricing Agreement. For its part, Apple claims the EU kept changing the tax rules. Apple is placing the funds in escrow until the end of what is setting up to be a long appeals process.

But for US tax purposes, Apple won. Apple did even better than a 12.6% tax rate: winning for a long time at paying no corporate income tax, thanks to its "nowhere corporation". Apple "checked the box" in the US, and made the equivalent election in Ireland, to get treated as a pass through entity reflexively in both places. Apple could elect to be treated as an Irish corporation for US tax purposes because it was incorporated in Ireland, and could elect to be treated as a US corporation for Irish tax purposes because it was managed and controlled in the US. The management is in the US, there is a small manufacturing plant in Cork, Ireland, and most manufacturing is done by third-party contractors.

Yes, with all relevant statues applied, a lot of corporations pay rates much lower than the marginal corporate tax rate. Big issues there are 1) matching up "check the box" regimes that define permanent establishments differently, 2) cost sharing arrangements, 3) and digital permanent establishments. Since the EU is cracking down on Advanced Pricing Agreements and the OECD Base Erosion and Profit Sharing (BEPS) project is tightening definitions on permanent establishments, it may be more difficult for corporations to avoid a permanent establishment overseas.

However, the US remains committed to its permanent establishment definitions and "check the box" election option. Practically what this means is that tech companies are creating a permanent establishment elsewhere in search of tax deferral and lower tax rates, all while keeping overall manufacturing costs low by engaging US third-party manufacturers who employ workers at low wages and foreign manufacturers who pay even lower wages.

The US is closing many of the loopholes. For example, the US closed a loophole which previously didn't include goodwill and workforce-in-place as intangibles for purposes of migrating IP under IRC Section 367(d). This change was done to conform with OECD. However, the US still has the highest corporate tax rate of all OECD countries. US companies are still establishing R&D facilities abroad to take advantage of patent boxes and to avoid taxation of outbound IP issues. Deferral of taxes and lower rates elsewhere (among the other OECD nations, with comparative wages and living standards) apparently outweigh the benefits of the R&D tax deductions and tax credits offered for IP created in the US.

How can the US both close the loopholes and put a "cork" in the outbound flow of manufacturing and R&D jobs, thus making the US a better place to plant tax roots? It seems like the carrot is winning over the stick so far. Perhaps tech companies would find a lower starting tax rate here more appealing.

Emily Graham