Barron's Cover

Get Yields Up to 9%

High-yield bonds and high-dividend stocks—Ford, Chevron—are the best bets for income this year. Not so, Treasuries. Steer clear of MLPs.

By Andrew Bary

There are still plenty of places to find decent income in stock and bond markets, even with many key interest rates at or near historically low levels. Investors can get yields of 4% to 9% on a range of investments, including junk bonds, utility stocks, telecom shares, and real estate investment trusts. These look appealing in an environment of sub-2% inflation, 1%-to-3% Treasury yields, and minuscule yields on bank deposits and money-market funds.

• Yield-oriented sectors of the stock market didn’t generate outsize returns in 2015 despite generally favorable earnings, as investors favored dividend-free or low-yielding growth stocks like Facebook,, and Alphabet. The result is that price/earnings ratios are lower now than they were 12 months ago in utilities, REITs, and telecoms. • A big issue is whether bonds and yield-oriented sectors of the stock market can do well in 2016, with the Federal Reserve likely to continue lifting short rates. The Fed may prove to be a head wind, but the central bank is expected to raise short rates to only about 1% by year-end 2016, and such an increase may be already partly discounted in the market.

This is the fourth straight year that Barron’s has sized up income-producing investments in both stock and bond markets. What looks best for 2016?

Topping our list are junk bonds, now yielding almost 9% on average after a weak year dominated by a crash in the energy and commodities sectors. Other areas that look good include dividend-paying stocks, with yields at 3% or more in a range of industries, as well as utilities and REITs. Municipal bonds, which are coming off a solid year in which they bested Treasuries, look good, not great, for the year ahead.

Pipeline master limited partnerships are on the minds of many individual investors following a 40% sector crash in 2015. Despite the losses, the sector doesn’t look like a bargain, given tougher business and financial conditions in an environment of low energy prices. What follows is our view of 10 income sectors in order of their appeal.

Junk Bonds

With yields averaging close to 9%, junk bonds look better than they have in several years. “A confluence of events suggests that you should be buying high-yield bonds now,” says Andrew Susser, manager of the MainStay High-Yield Corporate Bond fund (ticker: MHCAX). He argues that the junk market was an outlier in a year when U.S. stocks and interest rates were little changed and the U.S. economy advanced at a slow 2% pace.

Susser maintains that vulnerability of the $1.5 trillion junk market is overstated because buy-and-hold investors such as pension funds and insurance companies account for more than half of the investor base. Pension funds and endowments could see junk debt as an increasingly attractive asset class, as they seek to hit targeted annual returns of 7% or more.

One of the longtime knocks against junk debt is asymmetric risk—little upside and a lot of downside. The selloff has changed that equation, with most bonds trading at discounts to their face value, allowing for sizable capital gains. All of this suggests the possibility of double-digit returns in 2016.

The wild card is defaults, which probably will rise. Many energy and commodity bonds already discount bankruptcy and could be big winners if commodity prices rally in 2016. At a minimum, they offer a nice alternative to common shares.

Higher-quality junk from T-Mobile US yields about 6.5% and Charter Communications, 5.75%. Energy debt has been crushed, with that sector now trading for an average of about 50 cents on the dollar.

A good junk manager should be able to add value relative to an unmanaged ETF like the iShares iBoxx $ High Yield Corporate Bond (HYG). Investors need to look carefully at mutual funds, given the troubles at the Third Avenue Focused Credit fund (TFCVX), which was too heavily invested in risky, illiquid debt. Most junk funds are more prudent with risk. There are plenty of closed-end junk funds trading at roughly 10% discounts to net asset value, like the BlackRock Corporate High Yield (HYT). Another closed-end at a 12% discount, the AllianceBernstein Global High Income (AWF), holds junk and emerging market debt, which also is out of favor.

High-Dividend Stocks

There are plenty of stocks yielding 3% or more outside of traditional yield sectors like telecoms and utilities. Investors generally have to venture into out-of-favor industries like autos, retailing, and manufacturing to get those dividends.

General Motors (GM) and Ford Motor (F) both yield over 4% and are covering their dividends comfortably out of earnings. In technology, Qualcomm (QCOM) yields almost 4% and Seagate Technology (STX), almost 7%. Qualcomm has a large slug of cash on its balance sheet, while Seagate raised its payout in October in a sign of confidence.

Many traditional retailers facing competitive threats carry high yields, including Macy’s (M), at 4%; Gap (GPS), 3.6%; GameStop (GME), 5%; and Barnes & Noble (BKS), 7%. All are covering their payouts from earnings. Other notable high-yielders include Procter & Gamble (PG), the subject of a bullish Barron’s story last fall (“It’s Time for P&G to Split,” Nov. 23). P&G yields 3.3%; Merck (MRK), 3.4%; and Cummins (CMI), 4.3%.

With income-oriented funds, it pays to focus on expenses since high fees can eat up a good chunk of the dividends. Low-fee ETFs like the Vanguard High Dividend Yield (VYM) and Schwab U.S. Dividend Equity (SCHD) have annual expenses of about 0.10 percentage point and yields of about 3%.

Electric Utilities

The sector retreated after a strong 2014, as the Utilities Select Sector SPDR ETF (XLU) fell about 8% in 2015 and finished with a negative return of 4% after dividends. The ETF now yields 3.6%.

To enlarge graph click here

Many utilities, including American Electric Power (AEP), Southern Co. (SO), and Duke Energy (DUK), carry yields in the high-3%-to-mid-4% range. Valuations aren’t bad, as the group trades for an average of about 16 times projected 2016 earnings, in line with the Standard & Poor’s 500. The industry is expected to produce modest earnings and dividend growth in the low-to- mid-single-digit annual range over the next few years.

Edison International (EIX), the big Southern California utility, is favored by Bernstein analyst Hugh Wynne because he sees above-average profit and dividend growth in the coming years. Edison, at $60, yields 3.2% and trades for about 16 times projected 2016 earnings. One potential negative for the sector is the growth of rooftop-generated solar power, which cuts into demand.

Municipal Bonds

Tax-exempt debt starred in an otherwise lackluster U.S. bond market in 2015, generating 2%-to-4% returns depending on maturity, while Treasury returns were about flat. “Munis are likely to outperform again because demand remains strong and credit issues have receded,” says Alan Schankel, municipal analyst at Janney Montgomery Scott. He notes that muni mutual fund flows have been positive in recent months, in contrast with taxable bonds.

Munis, however, don’t yield much, with triple-A-rated 10-year debt now about 2% and 30-year bonds at about 3%. There are some pluses. Top-quality muni yields are comparable to Treasuries and offer clear tax advantages, especially for those in top brackets.

High-quality long-term revenue bonds from the likes of the Los Angeles Department of Water and Power and the Port Authority of New York and New Jersey yield about 3.25%. Investors should be aware that most long-term muni debt trades at a sizable premium to face value, meaning yields should be calculated to the shorter expected call date, not maturity.

The efforts to restructure Puerto Rico debt probably will dominate the headlines in 2016, as its government, Congress, and investors grapple with how to reduce the commonwealth’s debt burden while implementing fiscal and economic reforms to help revitalize a moribund economy. So far, there has been plenty of posturing and gamesmanship, but little progress outside of negotiations involving the island’s electric company, Puerto Rico Electric Power Authority. Puerto Rico’s benchmark long-term debt issue, the 8% bond due in 2035, was trading last week around 73 cents on the dollar, indicating that investors are banking on some restructuring that will result in less-than-full recovery.

Vanguard’s muni funds, including the big Vanguard Intermediate-Term Tax-Exempt (VWIUX), continue to outshine most rivals, thanks in part to low fees. Veteran muni manager Joe Deane and his partner David Hammer are generating nice returns with the Pimco Municipal Bond (PMLAX) and Pimco High-Yield Municipal Bond (PYMAX). Muni closed-end funds aren’t the bargains they were a year ago, but many still trade at close to double-digit discounts to net asset values. These include the BlackRock Municipal Target Term Trust (BTT), yielding 4.5%. Unlike nearly all closed-end muni funds, the BlackRock fund has an appealing built-in mechanism to close its discount to NAV with a scheduled maturity date in 2030.

Real Estate Investment Trust

The overall sector moved little in 2015, as measured by the big Vanguard REIT ETF (VNQ). Its 2015 return of 3.7% through the middle of last week was entirely due to dividends. Its current yield is 3.9%.

Michael Bilerman, the REIT analyst at Citigroup, projects a 5% to 10% total return for REITs in 2016, writing in his outlook report that “REITs are benefiting from solid operating fundamentals, healthy free-cash-flow growth, good dividend yields and coverage, and a meaningful amount of private capital still chasing real estate.” REITs are expected to generate mid-single-digit growth in operating profits in 2016.

It probably pays to stick with quality franchises like Boston Properties (BXP), Vornado Realty Trust (VNO)—both in the office sector—or AvalonBay Communities (AVB), in apartments.

There have been plenty of stories during the Christmas season about the “death of malls,” due to the growth of and online retailing. That isn’t apparent yet, however, in the share prices of two of the top mall REITs, Simon Property Group (SPG) and Taubman Centers (TCO). Shoppers at high-end malls often want to see clothing or luxury goods in person before buying. That may insulate them from the online threat.

Convertible Bonds

An often overlooked sector, convertibles have experienced similar selling pressure to the junk market in late 2015, as hedge funds and other investors dumped securities to meet expected investor redemptions or reduce risk.

David King, who co-manages the Columbia Convertible Securities fund (PACIX), says convertibles look statistically attractive. He points to Allergan ’s 5.5% preferred stock (AGN.PA) as a good way to play the shares of the drug maker, which has a merger deal with Pfizer. The Allergan preferred trades around $1,030, above its face value of $1,000.

The largest convertible ETF is the SPDR Barclays Convertible Securities (CWB), and there are several convertible closed-end funds that trade at double-digit discounts to their net asset values, including the Advent Claymore Convertible Securities & Income (AVK), which was changing hands last week at a 17% discount.

Amid little enthusiasm for the U.S. telecom sector, AT&T (T) and Verizon Communications (VZ) have long traded in narrow ranges, and both are valued at a modest 12 times projected 2016 earnings. Verizon, at about $47, yields 4.8%, and AT&T, at $35, 5.5%. Both are committed to their dividends.

The competitive pressures in the U.S. wireless market are well known, as are the high expense to improve cellular network quality and the erosion of wire-line operations. Dubious investors view AT&T’s purchase of DirecTV as a deal for a declining satellite-TV business.

Perhaps the best way to view the pair is as bond surrogates, with upside potential if wireless competition eases and investors accord them higher valuations.

Preferred Stock

Bank issuers dominate the market, and their improving profits and balance sheets since the financial crisis have made preferred stock a more secure investment. The bank preferred market has been strong lately, with many issues at or near 52-week highs. Yields, however, generally don’t look attractive, given the interest-rate risk.

Most bank preferred trades above face value—usually $25 a share—and the result is that those issues probably will be redeemed early, typically five or 10 years after the initial sale. This means investors should focus on the lower “yield to call,” based on the shorter expected maturity date rather than higher current yields. 

Callable bank preferred from big issuers such as JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC), have current yields of about 6%, but the yields to the shorter call dates are closer to 5%.

Preferreds are vulnerable if rates rise, since they have no maturity dates. “Preferreds are usually issued at $25 and callable in five years. The risk/reward isn’t skewed in favor of the investor,” says King, who also co-manages the Columbia Flexible Income fund (CFIAX).

He favors two unusual preferred issues from Bank of America (BAC) and Wells Fargo that technically are convertibles, but amount to regular or “straight” preferreds, because the conversion prices are far above the current common equity prices.

The Bank of America Series L issue has a 7.25% dividend rate, $1,000 par value, and recent price of $1,100 for a current yield of 6.64%. Bank of America can redeem the issue only if its share price, now $17, hits $65. In that scenario, investors would be paid a premium above the current share price. The Wells Fargo 7.5% issue has a similar structure, with a $1,000 par value, price of $1,155, and yield of 6.5%. Wells Fargo can call the issue if its stock, now about $55, hits $203. “If you’re going to play bank preferred, this is the way to do it,” King says.

“They’re misunderstood.” The Wells Fargo 7.5% issue yields a percentage point more than the bank’s regular preferred.

There are several preferred-focused closed-end funds trading at discounts to net asset value, including Nuveen Preferred Income Opportunities (JPC).


It’s hard to get excited about government bonds, with yields ranging from 1% on two-year notes to 3% on 30-year bonds. Probably the best thing that can be said for Treasuries is that they could be a good hedge for stocks in a bear market.

Low-fee ETFs may be the best way for individuals to buy Treasuries. Large ETFs include the iShares 20+Year Treasury Bond (TLT), now yielding 2.5%, and the iShares 7-10 Year Treasury Bond (IEF), yielding 1.9%. Treasury inflation-protected securities, or TIPS, offer a good alternative to regular Treasuries. TIPS trailed Treasuries in 2015 as inflation expectations declined. The so-called break-even inflation rate at which 10-year TIPS return more than ordinary Treasuries is now 1.5%, down from more than 2% in late 2014.

Kenneth Taubes, U.S. chief investment officer at Pioneer Investments, likes TIPS. “They are imputing very low inflation rates for a long time,” he says. Once energy prices stabilize, U.S. inflation readings, now about zero, should rise. TIPS, moreover, offer a hedge against what many bond investors fear: inflation. The most liquid ETF is the iShares TIPS Bond (TIP).

Master Limited Partnerships

Bulls argue that pipeline MLPs, down an average of 40% last year based on the Alerian MLP index, are bargains. On a recent investor conference call, Kevin McCarthy, co-founder and managing partner at MLP specialist Kayne Anderson Fund Advisors, said that the “MLP sector is oversold, and commodity prices will recover.” Fans say the sector was depressed by late-year tax-loss selling and could rally in early 2016.

While MLP prices are down and the average yield on the Alerian index is almost 9%, the sector doesn’t look cheap based on traditional financial measures, and most companies still need to finance much of their capital spending in the now-unfriendly capital markets if they plan to continue their generous distributions.

Kinder Morgan (KMI) rattled the sector with a 75% reduction in its dividend last month, and its shares, at about $15, were off 65% in 2015. The Street is betting that big MLPs won’t follow Kinder’s lead. That could reassure investors, but the industry’s business model, which relies on outside funding, is under threat and may have to change.

Based on traditional valuation measures, MLPs aren’t cheap, with major companies trading for 10 to 12 times projected 2016 cash flow, or earnings before interest, taxes, depreciation, and amortization. That’s slightly higher than electric-utility valuations, and above those of the major telecoms and cable companies. Given financial and business pressures, MLPs don’t look like bargains now.

Economic sweet spot of 2016 before the reflation storm

China, Europe, and the US are picking up speed but the credit cycle is ageing, and treacherous waters lie just beyond the horizon

By Ambrose Evans-Pritchard

US car sales are booming on pent-up demand 
Sunlit uplands beckon. Almost $2 trillion of annual stimulus from cheap oil has been accumulating for months, pent up and waiting to be spent. It will soon come flooding through in a burst, catching the world by surprise.

But beware: the more beguiling it is over coming months, the more traumatic it will be later as the reflation scare comes alive.
Since the rite of New Year predictions is to stick one's neck out, let me hazard hopefully that this treacherous moment can be deferred until 2017.
The positive oil shock will hit just as austerity ends in the US, and big-spending states and cities ice the cake with a fiscal boost worth 0.5pc of GDP. Americans broke records with the purchase 1.7m new cars and trucks in December, a foretaste of blistering sales to come. There is a ‘deficit’ of 20m cars left from the Long Slump yet to be plugged.

The eurozone is nearing the sweet spot, a fleeting nirvana of 2pc growth, conjured by the trifecta of a cheap euro, budgetary break-out, and the end of bank deleveraging.

Mario Draghi’s printing presses are firing on all cylinders. The 'broad' M3 money supply is growing at turbo-charged rates of 5pc in real terms. This is a 12-month leading indicator for the economy, so enjoy the ride, at least until the demonic Fiscal Compact returns at the dead of night to smother Europe once again.

In China, the dogs bark, the caravan moves on. There will be no devaluation of the yuan this year, because there is no urgent need for it. Premier Li Keqiang has vowed to keep the new exchange basket stable. Armed with a current account surplus of $600bn, $3.5 trillion of reserves, and capital controls, that is exactly what he will do.

The lingering hangover from the Great Chinese Recession of early 2015 has faded. The PMI services gauge has just jumped to a 15-month high of 54.4, and this is now the relevant index since the Communist Party is systematically winding down chunks of the steel, shipbuilding, and chemical industries.

China's money supply is also catching fire. Growth of 'real true M1' has spiked to 10pc, a giddy shot of caffeine not seen since the post-Lehman spree. Combined credit and local government bond issuance is surging at a rate of 14pc. The Communist Party cranked up fiscal spending by 18.9pc in November.

Henderson Global Investors

Whether or not you think this recidivist stimulus is wise - given that the law of diminishing returns set in long ago for debt-driven growth - it will paper over a lot of cracks for the time being.

One thing that will not happen is a housing revival in the mid-sized T3 and T4 cities of the hinterland. It will be a long time before the latest reform of the medieval Hukou system unleashes enough rural migrants to fill the ghost towns. The stock of 4.5m unsold homes on the books of developers is frightening to behold.

The epic dollar rally has come and gone. The world's currency will drift down over coming months, and that will be a reprieve for the likes of Brazil, Turkey, South Africa, Indonesia, and Colombia.

Those at the wrong end of $9 trillion of off-shore debt in US dollars may breath easier: they will not escape. The MSCI index of emerging market stocks will return from the dead, clawing back most of the 28pc in losses since last April, but only to lurch into a greater storm.

Capital Economics

Dr Copper will recover. Inventories are down to 13-days supply in Chinese warehouses, and African supplies are dwindling. Forced liquidation of base metals by exchange trade funds - with a final killer twist from hedge funds - has distorted the market. Finance has decoupled from physical demand. The springs are coiled for a short-squeeze.

Oil may take longer as Saudi Arabia and Russia slug it out. The Saudis think they have deep enough pockets to outlast the Russians, and the Russians think they have the greater strategic depth to survive a long siege.

Both are courting fate. Russia's reserve fund will be depleted before the end of this year if oil stays anywhere near $40, and there is no other viable way to fund the Kremlin's budget deficit. Pressure on the Saudi riyal will keep building despite the latest austerity package, and capital flight will turn virulent.

Behind the bluster, both are looking for a way out. We will know if they reach a secret truce, and by implication take the first step toward 'super-OPEC'. Excess production will stop. Crude will be nursed back up to $60. So watch what they drill, not what they say.
It is not bad a outlook for the world, but economic recovery contains the seeds of its own demise at this late, stretched, phase of the cycle. Inflation lurks. Core CPI for services in the US is already creeping up to 3pc and the jobs market is tightening hard.

Base effects will lift the headline inflation in the US and Europe by mechanical effect as the commodity slump bottoms out, and it will not be long before we are all chattering about ‘secular stagflation’.

This is where the danger lies. $6 trillion of global government debt trades at interest rates below zero, and $17 trillion below 1pc. The bond market is priced for deflation as far as the eye can see, yet deflation is yesterday’s story.

Let us hope the lull before the storm is long enough to enjoy. The world is not prepared for the inevitable pivot when the Fed suddenly finds itself behind the curve and switches to rapid fire rate rises, sending 10-year US Treasuries screaming back towards 4pc, and lifting German Bunds with them. The global cost of borrowing will go up whether or not debt is in dollars.

Nobody knows where the pain threshold lies for a global system leveraged as never before.

Public and private debt ratios are hovering at all-time records of 265pc of GDP in the OECD club and 185pc in emerging markets, 35 percentage points higher than at the top of the pre-Lehman credit bubble.

But that is a bedtime horror story for 2017.

Happy New Year.

$250,000 a Year Is Not Middle Class


HILLARY CLINTON has vowed not to raise taxes on the middle class.

It’s a pledge that has worked well for others on the campaign trail before her, a resonant assurance to voters who saw themselves as middle class or aspired to be. But it’s a bad promise.

Mrs. Clinton is using a definition of middle class that has long been popular among Democratic policy makers, from her husband to Barack Obama when he was a candidate: any household that makes $250,000 or less a year. Yet this definition is completely out of touch with reality. It also boxes her in.
The most recent Census Bureau data showed that median household income — what people in the exact middle of the American spectrum earn — is $53,657.

Those families who make $250,000 a year, on the other hand, belong to an elite group: Americans who earn enough to be in the highest 5 percent of the income distribution. That top stratum captures anyone who makes $206,568 or more — not everyone in the so-called middle class that Mrs. Clinton says she is dedicated to protecting, but too large a chunk of it.

People waited in line at the post office to file their taxes before the April 15 deadline. Credit Spencer Platt/Getty Images    

This doesn’t matter just because the math is so off. In an era of deepening income inequality, those people in the top 5 percent who are being classified as middle class are pulling further away from the rest of us. Americans at the bottom or in the middle have experienced five years of falling or stagnating income; those in the top 5 percent have generally seen their incomes increase. Between 1967 and 2014, median household income went up by $9,400 while those 5 percenters are now making $88,800 more, all adjusted for inflation.
A policy response should give those who are sliding backward a hand up, most likely funded by the people who are doing so well. But under Mrs. Clinton’s pledge, some of the well off won’t be called on to help out, and are in fact lumped in for receiving a boost. (I should note that my spouse works on the technology team for the Clinton campaign, but is not involved in policy.)
Mrs. Clinton’s pledge also blocks her from backing policies that would almost certainly benefit middle-class Americans, even if it raised their taxes slightly.
Take paid family leave. As things stand, Americans are not legally guaranteed any pay when they take time away from work for the arrival of a new baby or to care for a sick family member.
According to a 2012 survey, about a third of people who get no or partial pay when they take time off for a new child end up doing things like borrowing money, dipping into savings or putting off paying bills. Fifteen percent enroll in public benefits.
Senator Bernie Sanders also wants to help the middle class, but he wants to do it in a way that could mean raising its taxes, even if he promises that most of an increased burden will fall on the wealthy.
This has made him a target of the Clinton camp, which is telling voters that Mrs. Clinton is the only candidate pledging to shield the middle class.

Mr. Sanders, as well as Martin O’Malley, who is also running for the Democratic nomination, have avoided any pledge against middle-class tax increases. The paid family leave program both support is designed as social insurance much like Social Security, funded by a 0.2 percent payroll tax increase.
Yet Mrs. Clinton’s pledge rules out supporting such a proposal. While she has frequently talked about paid family leave, she says her plan will call on only the wealthiest to pay for it.
Mr. Obama, who also made a pledge not to raise middle-class taxes, has seen how limiting it can be. 
It was a doomed idea. Some families with closer to median income do use 529 accounts. So adding a tax would, technically, increase some middle-class people’s burden, thus violating Mr. Obama’s promise. Backlash erupted not just from Republicans, but fellow Democrats, and he dropped the idea less than a week after floating it.
Even Mr. Sanders, who often talks about income inequality, isn’t entirely immune from the allure of the $250,000 threshold. He’s ruled out middle-class tax increases except to fund paid family leave, promising to somehow get the needed revenue for his platform from banks and the very rich. And in other areas — top tax rates, Social Security payroll taxes — he adopts the $250,000 cap for no clear reason related to the policies themselves. That speaks to the spell this arbitrary limit has cast over the Democratic Party. 

It’s one it needs to break. The middle-class pledge has not just been outpaced by Democrats’ policy ambition. It’s been outpaced by voters’ reality.
Over the last decade and a half, fewer and fewer Americans are identifying as middle class, and a growing share says it is working or lower class. Income inequality compresses many downward and lifts up the sliver already at the top.
That shifting identity should relieve candidates of the sense that there is a political urgency in spouting the phrase “middle class,” and it demands a new framework — one that is honest about the class divisions in the country.
Bryce Covert­ is the economic policy editor at ThinkProgress and a contributor to The Nation.

Republican tax plans

Indecent disclosure

The Republican candidates’ tax proposals are exorbitant

ASK Republicans how best to reform taxes, and they will inevitably mention Ronald Reagan.

In 1986 the Gipper slashed levies on earnings; the highest income-tax rate tumbled from 50% to 28%. At the same time, Reagan simplified taxes by closing loopholes and killing off exemptions. Today’s Republican presidential contenders would dearly love to repeat the trick.

But they have given up a key ingredient in the recipe. The 1986 reform cost nothing, mainly because taxes on businesses went up. In stark contrast, today’s Republican tax plans are jaw-droppingly expensive.

American taxes are a mess. There are seven different rates of federal income tax, up from three after Reagan’s reform (in Canada there are four; in Britain, three). Endless exemptions and deductions cost just over 7% of GDP. These distort incentives and benefit mainly richer folk, but are hard to keep track of because their cost stays off the government’s books. Filling in tax returns takes the average non-business filer eight hours and costs $110 every year. By one recent estimate, the inconvenience costs of filing add up to 1.3% of GDP.

Business taxes are no better. At 39%, the tax on corporate profits is the highest in the OECD. In reality, businesses pay less because of a whirlwind of incentive-distorting exemptions. Want to invest in America? Issue shares to finance your project, and your marginal tax rate ends up at 38%. Load up on risky debt and the rate plummets—in fact, you will benefit from a 6% subsidy. Across industries, average tax rates range from 40% for making software to 15% for building mineshafts. The World Bank and PricewaterhouseCoopers, an accounting firm, ranks America’s tax system 53rd in the world, wedged between Jordan and Vanuatu. It takes American businesses 87 hours, on average, to pay their taxes; in France it takes just 26 hours.

Tax reform, then, is essential, and Republicans have embraced the cause. Among the presidential candidates, Jeb Bush has proposed the most detailed plan, and is cheered on by a crew of right-leaning economists. One thing keeping the plan on the shelf is that Mr Bush lags behind in the polls.

But thanks to its detail—and the scrutiny poured on it as a result—it is a useful benchmark.

Mr Bush rightly wants to reduce the number of income tax bands, to three. In doing so, though, he calls for a whopping reduction in the top rate of income tax to 28%, from 39.6% today. Mr Bush would slash the corporate tax rate to 20% and all but abolish the tax incentive to borrow.

Today, if a firm buys a new computer or piece of machinery, it can knock the cost off its tax bill only incrementally as the new equipment loses value; but under Mr Bush’s plan it could deduct the full cost up-front. That should encourage investment.

The plan is hugely expensive. Before accounting for its economic effects, it would cost $6.8 trillion, or 2.6% of GDP, over a decade, according to the Urban-Brookings Tax Policy Centre, a think-tank. About two-thirds of the bill comes from income-tax cuts. Cuts for high-earners are costly, because the highest-earning 1%—who would see a 12% increase in after-tax income under the plan—produce almost half of income-tax revenues. By 2026 the $715 billion annual cost of the plan exceeds the projected budget for national defence.

The plan would wrench on purse-strings that are already stretched. By 2025 government health-care and pensions programmes will have nearly 60% more beneficiaries than in 2007. Mr Bush, like most Republicans, wants to increase rather than cut defence spending. And non-defence day-to-day spending has already been slashed by 22% in real terms since 2010.

Mr Bush’s plan, then, looks unachievable. Incredibly, though, it is one of the most modest in the pack. Donald Trump, who tops opinion polls, wants to cut income taxes still further; under his plan, the top rate of tax falls to 25%. Whereas Mr Bush would nearly double the standard deduction, the amount that can be earned before paying income tax Mr Trump would quadruple it. The Donald would cut business taxes more aggressively, too. Though he talks about raising taxes on hedge-fund managers by removing the “carried interest” provision, Mr Trump’s cuts to income tax are so deep that the provision barely matters. In all, reckons the Tax Policy Centre, Mr Trump’s plan is almost 40% more expensive than Mr Bush’s.

Must be funny
Where to look for realism? Marco Rubio offers more modest income-tax cuts, but would eliminate most taxes on capital gains and company dividend payments. Many economists view these taxes as inefficient. Yet capital is mostly the preserve of the well-off: only a fifth of adults who earn less than $30,000 tell pollsters they have stockmarket investments, compared with nearly nine in ten who earn more than $75,000. Citizens for Tax Justice, an advocacy group, reckons Mr Rubio’s plan would make the pockets of the top 1% of earners bulge more than Mr Bush’s would.

Ted Cruz has the boldest plan. The Texan senator promises to replace all income taxes—including payroll taxes which fund Social Security and Medicare payments—with a 10% flat tax. Business taxes would be replaced with a value-added tax of 16%. This plan is roughly as expensive as the Bush plan, before accounting for its economic effects, according to the Tax Foundation, a right-leaning think tank. But it would be still more generous to the highest earners, as value-added taxes are less progressive than income tax.

The candidates all say their plans will increase economic growth, boosting tax-revenues and dramatically bringing down costs. Mr Bush’s cheerleaders say his plan will add 0.5 percentage points to growth each year, knocking two-thirds off the so-called “static” cost. Mr Trump claims—with a straight face—that his plan is revenue-neutral.

Done right, reforming and simplifying taxes would boost growth. Yet the gargantuan cost of the plans comes from

Turkey’s Syrian Tangle

Javier Solana

 Turkish flag 
MADRID – As 2015 draws to a close, new steps – albeit small and tentative – have been taken toward ending the war in Syria. The United Nations Security Council has adopted Resolution 2254, expressing its backing for a transition out of the conflict, and the International Syria Support Group has set a date for its next meeting, to be held next month. But the ISSG comprises both allies and adversaries – for example, Saudi Arabia and Iran – meaning that continued progress will be a challenge.
Now, another pair of countries in the process, Turkey and Russia, appear headed down the road to mutual enmity. Turkey, whose proximity to Syria generates both challenges and opportunities, could play an especially significant role in shaping how the peace process plays out. But Turkey’s downing of a Russian warplane on its border with Syria last month has spurred a swift and sharp deterioration in bilateral relations, with the Kremlin imposing retaliatory economic sanctions.
Russia, for its part, is facing the tough reality of maintaining an active military presence in the Middle East. Its efforts to bolster President Bashar al-Assad’s regime (and thus to strengthen its own role at the negotiating table) places it at odds with the countries – including NATO member Turkey – that want Assad out.
The problem for Turkey is that its interests are not as straightforward as stopping the Islamic State (ISIS), or even driving Assad from power. It also aims to ensure that Kurdish groups – such as the Democratic Union Party (PYD) of Syria, which is closely affiliated with Turkey’s Kurdistan Workers’ Party (PKK) – do not consolidate control of territory in Syria, now or during the post-conflict reconstruction.
Since the summer, when several severe outbreaks of violence effectively ended a two-year old ceasefire between the PKK and the Turkish government, the Kurdish conflict in Turkey has once again been burning white-hot, raising fears about the impact of an empowered PYD. Ongoing domestic political upheaval, including two parliamentary elections in just six months, has complicated Turkey’s situation further.
Turkey’s opposition to empowering the Kurds has been a source of tension with its traditional ally, the United States, which believes the Kurds are the only force on the ground capable of fighting ISIS.
The rekindled hostility between Turkey’s government and the PKK is thus undermining Turkey’s interest in the success of the Syrian peace negotiations.
Amid these challenges, however, is a ray of hope: Turkey’s relations with the European Union have lately improved markedly. Europe’s desperation to resolve the refugee crisis has strengthened its incentive to cooperate with Turkey. This creates an important opportunity to restart negotiations for Turkish accession to the EU – a prospect that had been nearly extinguished.
To be sure, in its latest report on Turkey’s progress toward meeting the accession criteria, the European Commission noted “significant shortcomings” relating to the judiciary, freedom of expression, and freedom of assembly, and appealed for the resumption of efforts to resolve the Kurdish issue. But now the mood is significantly improved. Already, the EU and Turkey have agreed on a joint-action plan, which entails some visa liberalization, and there has been talk of a possible “privileged” bilateral relationship.
Moreover, there has been some promising forward movement on the Cyprus issue, a longstanding impediment to Turkey’s EU accession. With Greek Cypriot and Turkish Cypriot leaders having resumed talks in May, Turkey now has the opportunity to take decisive steps toward uniting the island.
In short, the refugee crisis has tilted the EU toward Turkey. But defeating ISIS remains a top priority.
This will require negotiating with Russia – something that EU members have recognized. Since the Paris attacks in November, efforts to strengthen cooperation against terrorism, including between France and Russia, have intensified. If Turkey wants its relationship with the EU to continue to improve, it will have to engage, too.
The tension between Turkey and Russia has also hurt Turkey’s own position in Syria. Beyond the economic sanctions, Russia has now equipped its warplanes with air-to-air missiles, making it more difficult for Turkey to defend its airspace and maintain its influence over the northeastern Syrian border, an area that it considers critical to prevent the PYD from crossing the Euphrates to the West.
Turkey should reflect on its position. It cannot risk being perceived as a country that jeopardizes basic freedoms, thereby widening the gap with the EU. Two factors will sustain its position as an essential ally of the US and the EU: improved relations with the Kurds and progress toward a settlement in Cyprus. In the Syrian peace process, the decisions Turkey makes can either drive or impede progress toward a settlement.
The myriad factors shaping Turkey’s position make decision-making very difficult. But there is a way out of the current tangle: a strategic approach that makes the most of rapprochement with the EU, recognizes the importance of stabilizing Syria as soon as possible, and clarifies, once and for all, Turkey’s role in the fight against the Islamic State.
Turkey recently demonstrated its ability to overcome complex challenges, wisely restoring full diplomatic relations with Israel after a five-year breach in ties. Given this, reconciliation with Russia cannot be ruled out. Such an approach would, no doubt, facilitate the management of a host of risks that have been exacerbated by the Syrian conflict.

Teach Your Children Well: Unhook Them From Technology

Teachers at Mountain Oak say they can immediately detect who has been using devices at home.

By Naomi Schaefer Riley

Photo: Getty Images/Ikon Images

In the far corner of the desolate looking yard outside Mountain Oak Charter School, a boy of 9 or 10 is digging a hole. A few other children are standing nearby, periodically checking his progress and taking a turn with the shovel.

Mountain Oak is a charter school that offers an education inspired by Waldorf, a progressive model that encourages exploration of the natural world and rejects the use of technology in the classroom and even in the home. When I ask later in the afternoon about the ditch digging, eighth-grade teacher Jeffrey Holmes smiles. “Oh, they’re playing Minecraft,” he says, referring to the popular online game. Last year “they had a whole system of ditches and they were bartering with rocks too.”

Waldorf private schools have been around for almost 100 years—the first was launched by educator Rudolf Steiner in Germany. But they have been experiencing a resurgence in the U.S., where Waldorf has become popular with wealthy parents, including Silicon Valley types, who are attracted by the more simplified approach to learning.

In addition to eschewing technology, the schools tend to delay formal reading instruction—say, until the age of 7—and testing, and to reserve kindergarten entirely for imaginative play, especially with blocks and natural materials such as leaves and other things found outdoors. Students at all levels receive extensive instruction in music and art. They also do physical exercises in the classroom to break up their lessons.

But this model is no longer limited to private education. In recent years Waldorf-inspired charter schools have begun popping up—there are almost 50—especially in the West. Mountain Oak is one of the older ones, launched in 1999. It serves about 150 students in grades pre-K through 8, about half of whom receive a free or reduced-price lunch.

Mountain Oak students perform at the state average on tests, but the school has been given an A grade by Arizona’s state education department because of the academic improvement its students experience compared with their peers with similar backgrounds at public schools. Unlike parents at the private Waldorf schools, though, many Mountain Oak parents must be persuaded by teachers that the elimination of tablets, smartphones and even television at home is an important part of this success.

Sunshine Reilly, who lives on a farm near Mountain Oak and has a son in sixth grade there, recalls putting him in front of the television for hours a day when he was a toddler while she did chores. It wasn’t until he started kindergarten that she understood that the screen time was hurting his ability to entertain himself, to enjoy books and even to like playing outside.

Teachers at Mountain Oak say they can walk into a classroom and immediately tell who has been using devices at home. “We see it in their behavioral problems, their ability to reason, their cognitive skills, even their ability to communicate with other people,” one teacher tells me.

Jennifer McMillan, who teaches kindergarten, says she has to “have the conversation in a gentle way.” Many of these parents simply don’t understand the effects that staring at a screen can have on children’s behavior and their ability to learn.

Why would they? Most schools that cater to low-income children are trying to get them more technology, not less. Los Angeles spent $1.3 billion in 2013 to put an iPad in the hands of every child in the district. Schools show parents these shiny new toys as evidence that they are giving their children a leg up, helping to bridge the so-called digital divide.

While there’s evidence to suggest that poor children are slightly less likely to have access to laptops and tablets, those without are a pretty small slice of the population. According to a Pew report this year, “Fully 87% of American teens ages 13 to 17 have or have access to a desktop or laptop computer.”

For families earning less than $50,000 a year that number is 80%. As for a racial divide, Pew found that African-American teenagers are more likely to own a smartphone than any other group of teens in America.

What no one tells low-income families is this: The real digital divide is between parents who realize the harmful effects of technology on their children and try to limit them, and those who don’t. It’s the difference between parents buying wooden blocks this Christmas and those racking up more credit-card debt to buy a Leap Pad.

Research backs this up: In December the Journal of the American Medical Association, JAMA, published a study showing that electronic toys hinder verbal development. An article in the journal Mind, Brain and Education found that traditional toys “sparked higher quality conversations.”

The teachers at Mountain Oak say they have the toughest time trying to reduce media use among children in single-parent households. Typically these mothers tend to be younger and less educated, and it is very tempting after a long day at work to come home and turn on a screen to keep a child occupied. The teachers keep prodding anyway.

Felicia Fishback, who is recently divorced, has never liked videogames, but once she started sending her four children to Mountain Oak, she realized that these were making her oldest son’s behavior worse and hindering his academic performance. He had been diagnosed with ADHD and was gaining weight from a lack of physical activity.

Now her children are not allowed any screen time during the week and a little on weekends.

“Mountain Oak,” she says, “has made me a better parent.”

Ms. Riley is the author of “Got Religion: How Churches, Mosques and Synagogues Can Bring Young People Back” (Templeton Press, 2014).

Free exchange

Exit, pursued by bear

The Fed has at last raised rates. What happens next?

IT IS more than two weeks since the Federal Reserve raised interest rates for the first time in over nine years, and the world has not (yet) ended. But it is too soon to celebrate. Several central banks have tried to lift rates in recent years after long spells near zero, only to be forced to reverse course and cut them again (see chart). The outcome of America’s rate rise, whatever it may be, will help economists understand why zero exerts such a powerful gravitational pull.

Recessions strike when too many people wish to save and too few to spend. Central banks try to escape the doldrums by slashing interest rates, encouraging people to loosen their grip on their money. It is hard to lower rates much below zero, however, since people and businesses would begin to swap bank deposits for cash or other assets. So during a really nasty shock, economists agree, rates cannot go low enough to revive demand.

There is significant disagreement, however, on why economies become stuck in this quagmire for long periods. There are three main explanations. The Fed maintains that the problem stems from central-bank paralysis, either self-induced or politically imposed. That prevents the use of unconventional monetary policies such as quantitative easing—the printing of money to buy bonds.

The intention of QE is to buy enough long-dated debt to lower long-term borrowing rates, thereby getting around the interest-rate floor. Once QE has generated a speedy enough recovery, senior officials at the Fed argue, there is no reason not to raise rates as in normal times.

If the Fed is right, 2016 will be a rosy year for the American economy. The central bank expects growth to accelerate and unemployment to keep falling even as it lifts rates to 1.5% or so by the end of the year. Yet markets reckon that is wildly optimistic, and that rates will remain below 1%. That is where the other two explanations come in.

The first is the “liquidity trap”, an idea which dates back to the 1930s and was dusted off when Japan sank into deflation in the late 1990s. Its proponents argue that central banks are very nearly helpless once rates drop to zero. Not even QE is much use, since banks are not short of money to lend, but of sound borrowers to lend to.

Advocates of this theory see only two routes out of the trap. The government can soak up excess savings by borrowing heavily itself and then spending to boost demand. Or the central bank can promise to tolerate much higher inflation when, in the distant future, the economy returns to health. The promise of higher-than-normal inflation in future, if believed, reduces the real, or inflation-adjusted, interest rate in the present, since money used to repay loans will be worth less than the money borrowed. Expectations of higher future inflation therefore provide the stuck economy with the sub-zero interest rates needed to escape the rut.

Governments pursued both these policies in the 1930s to escape the Depression. But when they reversed course prematurely, as America’s did in 1937, the economy suffered a nasty and immediate relapse. The liquidity-trap explanation suggests the Fed’s rate rise was ill-advised.

The American economy, after all, is far from perky: it is growing much more slowly than the pre-crisis trend; inflation is barely above zero; and expectations of inflation are close to their lowest levels of the recovery. If this view is correct, the Fed will be forced by tumbling growth and inflation to reverse course in short order, or face a new recession.

Stuck in a glut
There is a third version of events, however. This narrative, which counts Larry Summers, a former treasury secretary, among its main proponents, suggests that the problem is a global glut of savings relative to attractive investment options. This glut of capital has steadily and relentlessly pushed real interest rates around the world towards zero.

The savings-investment mismatch has several causes. Dampened expectations for long-run growth, thanks to everything from ageing to reductions in capital spending enabled by new technology, are squeezing investment. At the same time soaring inequality, which concentrates income in the hands of people who tend to save, along with a hunger for safe assets in a world of massive and volatile capital flows, boosts saving. The result is a shortfall in global demand that sucks ever more of the world economy into the zero-rate trap.

Economies with the biggest piles of savings relative to investment—such as China and the euro area—export their excess capital abroad, and as a consequence run large current-account surpluses.

Those surpluses drain demand from healthier economies, as consumers’ spending is redirected abroad. Low rates reduce central banks’ capacity to offset this drag, and the long-run nature of the problem means that promises to let inflation run wild in the future are less credible than ever.

This trap is an especially difficult one to escape. Fixing the global imbalance between savings and investment requires broad action right across the world economy: increased immigration to countries with ageing populations, dramatic reforms to stagnant economies and heavy borrowing by creditworthy governments. Short of that, the only options are sticking plasters, such as currency depreciation, which alleviates the domestic problem while worsening the pressure on other countries, or capital controls designed to restore monetary independence by keeping the tides of global capital at bay.

If this story is the right one, the outcome of the Fed’s first rises will seem unremarkable. Growth will weaken slightly and inflation will linger near zero, forcing the Fed to abandon plans for higher rates.

Yet the implications for the global economy will be grave. In the absence of radical, co-ordinated stimulus or restrictions on the free flow of capital, ever more of the world will be drawn, indefinitely, into the zero-rate trap.

Piketty vs. Piketty

J. Bradford DeLong
Thomas Piketty signing autographed copies of his bestseller.

BERKELEY – In Capital in the Twenty-First Century, the French economist Thomas Piketty highlights the striking contrasts in North America and Europe between the Gilded Age that preceded World War I and the decades following World War II. In the first period, economic growth was sluggish, wealth was predominantly inherited, the rich dominated politics, and economic (as well as race and gender) inequality was extreme.

But after the upheaval of WWII, everything changed. Income growth accelerated, wealth was predominantly earned (justly or unjustly), politics became dominated by the middle class, and economic inequality was modest (even if race and gender equality remained a long way off).

The West seemed to have entered a new era. But then, in the 1980s, these trends seemed to start shifting steadily back to the pre-WWI norm.

Piketty’s central thesis is that we shouldn’t be surprised by this. Our reversion to the economic and political patterns of the Gilded Age is to be expected as the economies of North America and Europe return to what is normal for a capitalist society.

In a capitalist economy, Piketty argues, it is normal for a large proportion of the wealth to be inherited. It is normal for its distribution to be highly unequal. It is normal for a plutocratic elite, once it has formed, to use its political power to shape the economy in a way that enables its members to capture a large chunk of a society’s income. And it is normal for economic growth to be slow; rapid growth, after all, requires creative destruction; and, because what would be destroyed would be the plutocrats’ wealth, they are unlikely to encourage it.

Since the publication of his book, Piketty’s argument has come under ferocious attack. Most of the critiques are at best mediocre; they strike me less as serious acts of engaged intellect than reflections of the political and economic power of a rising plutocracy.

Out of this cacophony, however, two lines of criticism suggest that Piketty may be wrong, both with respect to the normal characteristics of a capitalist economy and where we may be headed when it comes to inequality.

The modern champion of the first line of attack is Matthew Rognlie, a graduate student at MIT, though his argument has a long and impressive pedigree. It can be found in, among other places, John Maynard Keynes’s 1919 The Economic Consequences of the Peace and his 1936 The General Theory of Employment, Interest, and Money.

Rognlie agrees with Piketty (as Keynes would) that the normal operation of capitalism produces a class that accumulates wealth, which, as a result, takes on a sharp-peaked distribution. But he disagrees about what happens next. Rognlie argues that the rising concentration of capital is to some extent self-corrective, as it produces a proportionately larger fall in the rate of profit.

Unequal wealth distribution, in this view, produces what Keynes called “the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.” The result is an economy with relatively equal income distribution and a polity in which the wealthy have a relatively small voice. My response to this line of reasoning is an unequivocal “perhaps.”

The standard bearer for the second line of criticism is none other than Piketty himself – not in anything he has written, but in how he has behaved since becoming a celebrity and a public intellectual.

Piketty’s book encourages a passive response. It portrays the forces favoring the formation of a dominant plutocracy as being so strong that they can be countered only by world wars and global revolutions – and even then, the correction is only temporary.

But Piketty is not behaving like a passive chronicler of unavoidable destiny. He is acting as if he believes that the forces he describes in his book can be resisted. If we look at what Piketty does – rather than what he writes – it seems evident that he believes we can collectively make our own destiny, even if the circumstances are not what he, or we, would choose.