Friday, November 28, 2014

Gray Matter and the US Current Account

After increasing steadily from the mid-1990s through the mid-2000s, the rate at which the US is borrowing from the rest of the world - our current account deficit - has come down considerably.
The current account deficit peaked at around 6% of GDP in 2006 and has hovered around 2.5-3% over the past several years.

During the period when it looked like the US current account deficit was growing inexorably, there was quite a bit of discussion of "global imbalances" and whether or not the US' borrowing was sustainable.

Despite years of borrowing, the US tends to earn a positive balance on income - i.e., the US receives more in payments on assets it owns abroad than it makes to foreign owners of US assets.  Ricardo Hausmann and Federico Sturzenegger argued that national accounts understate the true value of US foreign assets.  They called the gap between the accounting value and the true value "dark matter", which they largely attributed to the know-how exported (but not properly measured) with US FDI.  (I revisited this idea in a previous post).

Writing at Project Syndicate, Jeffrey Frankel offers another idea on why our balance of payments accounts may make the US deficit look worse than it really is:
Every year, US residents take some of what they earn in overseas investment income – interest on bonds, dividends on equities, and repatriated profits on direct investment – and reinvest it then and there. For example, corporations plow overseas profits back into their operations, often to avoid paying the high US corporate income tax implied by repatriating those earnings. Technically, this should be recorded as a bigger surplus on the investment-income account, matched by greater acquisition of assets overseas. Often it is counted correctly. But there is reason to think that this is not always the case...

...For example, US multinational corporations sometimes over-invoice import bills or under-report export earnings to reduce their tax obligations. Again, this would work to overstate the recorded current-account deficit.
While the efforts that US multinationals make to evade their tax obligations are probably technically legal in most cases, they go against the spirit of the US tax law, which taxes US corporations based on their global earnings (whether it should be this way is another matter).  Since it arises from a gray area in our tax code, perhaps the we should call the resulting gap between our measured and true foreign assets "gray matter."

Update: Empirical evidence from Gabriel Zucman (QJE, 2013) that some of the "dark matter" is in tax havens...

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