Tuesday, July 24, 2007

The Paulson Interview

The straight shooting, sound thinking, optimistic Treasury Secretary Henry Paulson offered his views on a variety of topics on Kudlow & Company last night. What a pleasure it was to interview a civilized man with a keen intellect who does his own thinking.

It’s a pity Mr. Paulson has been dealt such a difficult hand. He’s up against a highly partisan Democratic Congress attempting to block the Treasury man’s good ideas on broad based reform of taxes, trade and entitlements.

Incidentally, the former Goldman Sachs CEO would not have argued that the subprime mortgage problem is contained if he didn’t really believe it. And his comments about the greatest global economy in our lifetime echo my own thinking.

Here's a look at Mr. Paulson's thoughts on last night's show...

On U.S. & global economic health:

I don't think there's much argument that we are in a very strong global economy. Japan is on a sustained growth course. In Europe, their growth rate has just about doubled—unemployment is still high, but it's at a 15-year low. The developing countries, you know, are growing twice the rate they grew in the '90s, three times the level of the industrial companies.

So now let's get to what's going on in the US. I happen to believe that we are making a successful transition to an economy that was growing at a rate that wasn't sustainable to one that is sustainable.

There has been a very significant housing correction. I think we're at or near the bottom there. I don't deny there's a problem with subprime mortgages, but I really do believe that's containable.

We have, Larry, a very, very healthy economy. We have very strong employment. We're creating jobs here at very high levels. The consumer is strong.

When you look at what's happened with the equity market and S&P going up about 24 percent over the last 12 months, there's been about $3 1/2 trillion of wealth created in the marketplace. That doesn't hurt the consumer in the US. And again, the strong growth outside of the US helps the US economy. The fact that our trading partners are strong is a positive. So I believe we have a very healthy US economy.

On whether credit markets are freezing up, subprime, and a possible credit crunch:

Well, I would just simply say this: We have had, now, benign positive markets for a while. And there's always a temptation to give way to excesses, to have less discipline. And so I believe that some of the issues we've had recently are a wake-up call. And I do believe that borrowers need to be vigilant, lenders need to be vigilant. I'm not going to say it's without risk, but I'm going say we have a healthy financial sector in this country, record earnings. You know, non-performing loans are at low levels. We need to be mindful. We need to always be vigilant.

…When I came to Washington, one thing I knew we needed to focus on is how do we get ready for a financial shock? We weren't predicting a financial shock. I'm not predicting one, but they're not predictable. And it's been since 1998 since we've had a financial shock. So we need to be ready. And there have been a lot of changes in the markets since 1998. We're much more integrated into the global economy. Private pools of capital are playing a more important role. There is expanded use of financial derivatives. All of which, I think, have made the markets more efficient and more liquid. But again, the next time we have a financial shock, we'll be seeing how some of these things perform under stress for the first time. But again, I believe we fortunately have a very strong global economy and a very strong US economy.

…Let me say this, Larry. You're always going to see excesses when there are good times. And I don't deny that there are excesses. And I don't deny that there are certain loans when you look at them from afar or even at close, you say, `Why did they make those loans?' I don't deny that you're going to see money lost on subprime mortgages. You can't go through the kind of housing correction we've gone through without having some side effects that are going to go on for a good while. But do I think these risks are contained? Yes, I do.

On why the U.S. corporate tax system is broken:

The lens I'm looking through is global competitiveness. We went in the 1980s from a nation with a business tax system which was high relative to others to one that was low relative to others. And it made a very big difference in our competitiveness throughout the late '80s and the '90s. And now today, once again, we have business taxes in the United States that are high relative to others. Other nations have lowered their rates, have reformed their tax systems and are moving to continue to do so and bring rates down. We need to continually look at our system and say, `What tax system is going to do the most to bring investment, to add jobs and to increase wages for the American worker?'

…We need to step back and build awareness, first of all, on the competitiveness issue. And then we need to really ask the question, you know, the whole reason for having taxes is to raise revenue. So for any given level of revenue, what is the right system? What system will place as small a burden on our workers as possible and do as much as possible to encourage growth, jobs and competitiveness?

We need to look forward. We need to look a few years down the road, and we need to ask ourselves, are we well positioned to be competitive looking forward with a tax system that is as complex as ours is and as the rates are as high relative to our competitors around the world and our trading partners around the world.

On Loews CEO James Tisch’s campaign to reduce the corporate capital gains tax and set up a differential between corporate income and corporate capital gains:

…I'm very familiar with that idea. That's a very good idea. I, for years, have worked with corporations in my previous job when I was an investment banker who wanted to do things to make their companies more efficient—which would have actually added to jobs and made our country more competitive. But they were impeded by the high levels of corporate capital gains tax. So that's a very good idea.

We are going to look at a number of things. We're going to look at idea to simplify our tax system and do things to broaden the base. Right now we have a good number of special preferences for one industry or another, many of which make great sense if you look at them individually. But if we didn't have them, we could have tax rates which are 25 percent lower.

We're going to look at reducing the tax on investment …the way I think about it is investment is necessary to create jobs and raise wages. And, depending on how you tax investment, you're going to have less of it. We're going to look at a number of ideas.

On former Clinton Treasury secretary Robert Rubin’s recent statement that the capital gains tax cut didn't help the American economy one “iota” and Mr. Rubin’s desire to raise taxes on hedge funds and buyout funds:

Well, let me say to begin with, like just about everyone else, I have a very high regard for Bob Rubin. So I'll start there. But again, the way we are looking at it is—and I would be very surprised if Bob Rubin doesn't agree with this—that we are in a world that's continually changing. And it's increasingly easy for someone to start up a business and operate from many parts of the world.

So we need to continue to say, `What tax system is going to let us be competitive with the rest of the world? Which tax system is going to let us—for any given amount of revenue raised—add more jobs, and pay higher wages?'

Now, my own view is investment is key to jobs, and is key to innovation, and is key to R & D. And productivity is key to higher wages. And the way you get greater productivity is with more investment, and I think the way you get more investment is tax it less.

On raising taxes on buyout funds, hedge funds and the other private partnerships:

What our view is, very simply is, it doesn't make sense to single out one industry. And part of the reason why we have such a complex tax system is there's too many provisions that are aimed at one industry, reacting to the headlines of the moment.

We need to take a step back and look more broadly at our tax system. Now, there's a lot of thought in Congress and a lot of rhetoric and thought being given to looking at the partnership structure. And all I would say is the principles that have governed partnership taxation have existed in this country for a long time. And, you know, we tax partnerships, we tax corporations. And the partnership structure, which is available for real estate, for energy, for investment partnerships, has been very, very effective at--again, at promoting risk taking and driving efficiency in the economy.

But again, I think the way to look at it is look at our tax code comprehensively and look at it and say, `What's the right way to tax our businesses in order to increase the prosperity of American people and American workers?'

On free trade, and whether House Democrats reneged on a promise to deliver a trade agreement with Peru, Panama and Colombia:

Larry, what I would say is we've worked very, very, hard with the House Democrats to get these free trade agreements done. We are not where we want to be yet.

…I need to take the perspective that we are going to have a deal and we're going to get this done. And I'm new to working in Washington. I'm going to give everyone the benefit of the doubt and give people in both parties the benefit of the doubt that we got to work together to do what we say we're going to do.

And, you know, I know how much Charlie Rangel, in particular, would like to see these deals get done. And we in the administration are going to work hard to get them done. But again, I would like to see Congress begin holding hearings and moving forward on these because they're very important.

On class warfare and the backlash in rich nations against globalization:

This is the head wind we're fighting, and this is going to be a head wind we are fighting, and we're fighting in virtually every other developed country and many developing countries. And, in many ways, it's a paradox. Because the lesson of the last 20 or 30 years is that those countries that have reformed, opened themselves up to competition, free trade, and free capital flows, have benefited. The rest have been left behind.

And as I made the point earlier, we reformed our business tax system [back in the 1980s with] the Ronald Reagan tax reform of '86. The rest of the world watched what happened here. They marveled. They've learned from what we've done. They've reduced their taxes. They've simplified it. But I think we're going to need to, now, take a very, very careful look at competitiveness.

We all have to do a better job of communicating. Because what I believe is that some of the down sides of globalization and trade, the obvious dislocations, job losses are very visible. And the benefits are not quite as transparent. They reflect themselves through the overall health of an economy, through greater prosperity, and we have an economy that benefits greatly from competition. We don't need to be afraid of competition. But we need to tell that story better.