Tag Archives: corporate finance

Tax Cuts, Wages, and Promises, Promises, Promises

GD income wages salaries tax cuts 1980 2017

That Blue Line on the chart is FRED’s report of gross domestic income, in terms of compensation for employees (wages and salaries) from 1980 to the present.  One of the things to notice is that it keeps rising.  We can explain part of this by taking inflation into account, and some of the bumps and blips by noting that the shaded gray sections represent recessions.  But, it just keeps going up except for the Great Recession brought to us in the wake of the Housing Bubble/Wall Street Casino Crash, compliments of the Wall Street Casino.

Indeed, notice that increase in employees wages and salaries between 1990 and 2000, when the top marginal tax rate increased from 31% to 39.6%, the blue line keeps going upward.   If nothing else, the graphic above illustrates that anyone trying to convince us that increases or decreases in the top marginal rate for income tax payers correlate to increases or decreases in wage and salary compensation trends hasn’t been paying attention.

The Corporate Tax Wrinkle 

Okay, if one can’t make the case that tax cuts for the wealthy won’t “increase” the money in the pockets of middle income Americans, then there’s the Corporate Tax Wrinkle.  Thus, the White House is trying this line:

“The Council of Economic Advisers report argues that high corporate taxes hurt workers in the form of smaller paychecks and that worker incomes rise sharply when corporate rates fall. It points to “the deteriorating relationship between wages of American workers and U.S. corporate profits” and says, essentially, that high corporate taxes have encouraged companies to shift capital abroad rather than flow profits to workers through pay increases.”

Here’s the first problem — this statement assumes that high corporate taxes cause companies to “shift capital abroad.”  This conveniently ignores some other reasons corporations seek to invest overseas.  Let’s make a quick list: (1) There’s good old fashioned market seeking.  In this case the company is looking for new customers for its goods or services, and it may be that the domestic market is fairly well saturated so looking abroad makes perfect sense.  This is especially true for technology firms which often find that the smallest market needed to drive development is larger than some of the largest national markets.  (2)  Resource seeking.  Labor costs may be cheaper in another foreign market, or there may be quicker access to natural resources in a foreign location.  (3) Strategy.  Imagine that a corporation is looking to improve its distribution network, or to take advantage of new technologies; a company might decide to partner with a foreign corporation which specializes in some specific phase of production.  And then there are (4) Efficiency elements.  We can insert some common elements into this category like trade agreements which give an advantage to plant or service locations because of tariff agreements, or there could be currency exchange rate considerations involved.

Therefore, we can quickly see that the corporate tax environment is a part of the decision making process about shifting capital overseas, but it certainly isn’t the only factor, and it may not even be the most important one.  What the White House Wrinkle demands is that we believe if Congress reduces corporate taxes this will offset all the other other reasons a corporation may want to shift some of its operations overseas.  Frankly, this really isn’t rational.

And, then there’s the second problem —  hoarding.

“The cash held overseas by US firms has continued to grow at a rapid pace, rising to almost $2.5tn in 2015. The substantial tax bill most firms would face if they attempted to bring this cash home, however, means that it is still very unlikely to ever be repatriated under the current system.”

Gee, if we could “repatriate” all this money imagine the increase in wages!  Not. So. Fast. The firms stashing the most cash overseas are Apple, Microsoft, Cisco, Alphabet (Google), and Oracle. [MW]  Right off the bat we notice that these are all tech firms, and as mentioned above tech firms are constantly market and resource seeking — while a repatriation scheme may bring some of the cash home, there’s still a reason the firms may want to keep capital available for foreign operations; it wouldn’t matter what domestic tax system was in place.

Another point that should be made more often is that this money isn’t “trapped” overseas.   Where are these “deferred profits?

“A 2010 survey of 27 large U.S. multinationals found nearly half of their “overseas” tax-deferred profits were invested in U.S. assets, including U.S. dollars deposited in U.S. banks or invested in U.S. Treasury bonds or other U.S. government securities, securities and bonds issued by U.S. corporations, and U.S. mutual funds and stocks.”

What’s “trapped” are the tax payments due on the funds — not the funds themselves, 50% of which are already happily running along in the corporate revenue streams or “reinvested” in U.S. assets.   And if we could “bring home”  (or get out of the bank) the other half would this mean higher wages?  Remember, we tried this once before:

“In 2004, lawmakers allowed multinationals to repatriate more than $300 billion in profits at a greatly reduced tax rate. But independent studies largely conclude that firms used those profits to pay cash to shareholders, not to invest or create U.S. jobs. In fact, many firms laid off large numbers of U.S. workers even while reaping multi-billion-dollar tax cuts. Today, offshore profits are concentrated in a few large multinationals that have recently made record cash payouts to shareholders by buying back stock, showing that they already have enough cash on hand to make whatever investments they project would be profitable. Repatriated profits would likely similarly be paid out to shareholders, not invested.”

Who are those “buyback monsters” who’ve been demonstrating they already have enough cash on hand to make any investments they think might create even more profits?   Apple is one, then there’s Exxon Mobil, IBM, General Electric, Pfizer, and McDonald’s. [CNBC]  If Apple is one of the ‘monsters,’ then why would anyone believe that allowing the tech giant to “repatriate” more money at reduced tax rates would make them do anything other than what they’ve been doing — using the capital to buyback stock?  McDonald’s?  If they have enough cash on hand to indulge in financial engineering to increase their stock prices, what would make anyone believe they’d change midstream and start advocating for raising the minimum wage?

Mythological Means

It’s really hard to imagine where that $4,000 pay raise is supposed to come from if corporations are given more tax breaks.  There’s a question of the provenance of that $4,000 number in the first place, and in the second place it’s a dubious estimate at best.  We should also notice that the claim isn’t being framed in context; there may be some gains for employees BUT they are long term, certainly not short-term or annual gains. [FC]

“It’s important to note that any gain to workers would only come in the long term — over several years. Furthermore, most households would not see a gain as large as the “average” or mean figure, which is pulled up by very high incomes of a relative few. In 2016, the average household income was $83,143 as we’ve already noted, but the median or midpoint for household income was $59,039, meaning that half of all households received less.”  [FC]

This is another version of the old story:  The Sultan of Brunei walks into a room with nine members of the Little Sisters of the Poor and the average (mean) wage skyrockets.  Take that $4,000 figure with a couple of boxes of Morton’s Salt.

The Bottom Line 

So, what do we know?  We know that there’s no direct correlation between low top marginal rates for individual filers and wage increases.  We know that corporations make decisions about off shore operations for a variety of reasons, taxes being only part of the equation.  We know that corporations have several options for investing cash (foreign or domestic) only one of which — seemingly the least likely — is to pay increased wages and salaries.  We know that corporations use “financial engineering” to increase their stock value, or increase dividends to their shareholders.  We know that even accepting the 20-25% labor liability for corporate taxation the returns to labor are long (not short or annual) term benefits of little value in terms of household budgeting; it’s NOT like having any useful amount of “cash in your pocket.”

In short, we probably know what we’ve suspected all along.  The current Republican version of “tax reform” is simply a gift to corporations, extremely wealthy persons, and a nice gesture from the Haves to the Have Mores.

And for this we are to accept cuts in Medicare to the tune of $472.9 billion over the next ten years, between $1 and $1.5 trillion in cuts to Medicaid, cuts to food assistance programs, cuts to low income heating assistance programs, cuts to children’s health insurance, cuts to education, small business support, and Meals on Wheels….

Comments Off on Tax Cuts, Wages, and Promises, Promises, Promises

Filed under Economy, income tax, Politics, tax revenue, Taxation

The Warning Flags are Up: Trumpsterism and Corporate Debt

Corporate Debt Chart 2016

No, you don’t need to get out the magnifier to get the gist of this chart, but if you’d like to see the original click here.  Simply consider the trajectory of the blue line indicating the level of non-financial corporate business debt – as in UP.  Nevadans may want to gaze at this with some caution, because (to borrow and vandalize a fine old saying) the last time the national economy caught a cold, Nevada got pneumonia.  We can, and should, look at the comparison in the trends of corporate debt, government debt, and household debt:

Corporate Government Debt Levels

In the last five years government debt has dropped precipitously, (don’t show this chart to Uncle Fustian at your holiday dinner it’s likely to jolt his fact free universe) household debt has declined, and “business debt” is way up.  There are all manner of reasons for an increase in corporate debt, and some of them are very productive – such as expansion of plants and factories – others not so much.  We’re in “maybe not so much” territory.

Part of the pile of current corporate debt is the result of stock buy backs, a boomlet of sorts in recent times:

“Over the first six months of the year (2016) S&P 500 companies paid out 112 percent of their earnings in the form of either dividends or share buybacks. That, Damodaran argues, is the kind of figure you might expect to see when a recession had suddenly crimped company cashflows, not during a very long-running, if tepid, expansion.

The last time companies were paying out this much more than they are taking in was in 2008, when the financial crisis hammered revenues faster than companies could cut buybacks and dividends.”

… Certainly the very idea of buybacks has come under increasing scrutiny. While a share buyback improves per share earnings performance, it is a piece of financial engineering which increases leverage but does nothing to improve a company’s product offerings or market position, much less its long-term prospects. Indeed, the vogue for buybacks has happened at the same time as an otherwise puzzling lack of corporate investment, especially given that corporate profit margins are still high by historic standards.” [Time] (emphasis added)

There’s nothing too terribly “puzzling” about this state of affairs.   Why would companies indulge in “financial engineering” while profits are high?  Could it be that the “wealth” of the company is financially anchored rather than structurally? Consider this Household debt service as a percentage of disposable personal income  chart from FRED:

Household Debt trends 2016

Superficially, we could argue that the American consumer has done some belt tightening since the Recession of 2007-08 and there’s less money being paid out in debt service from the family coffers – but, we’d also have to be realistic and see that the debt levels are already too high.

Yes, household debt levels relative to the GDP have been declining, but it remains higher than it’s been for almost all of post-war history, and by post-war we mean World War II. [Slate]  

What else could be depressing loans? Other loans – such as Student Debts. Again, we have a picture of that from the Federal Reserve:

Student Loan Trends FRED

What we see here is an increase in student loans owned and securitized, which are outstanding: from Q1 2006 at $480.9670 to Q3 2016 at $1,396.3355.  Student loan indebtedness now exceeds credit card debt, auto loans, and other non-mortgage debt. [Slate] What’s happening here?  Perhaps those corporate profits aren’t predicated on the increasing number of consumers flocking to their doors?  Perhaps not when consumers have an annual household credit card debt of $16,000; a $27,000 average of auto loans; and $169,000 in mortgages? [Slate]

Then, there’s the matter of real household income in the US.  In the first quarter of 1999 it hit a high of $57,909 and hasn’t been back since. The current figure is $56,516. [FRED]   Little wonder there’s some “financial engineering” going on in the corporate world.   That “financial engineering” especially in terms of stock buybacks simply doesn’t make any long term sense:

“No matter how low-interest rates get, it is hard to justify the raising of corporate debt to purchase outstanding stock. Longer-term debt should be used for longer-term needs, e.g. capital expenditures. But from a macroeconomic view, raising stock prices does not figure in promoting economic growth or general well-being—it is simply financial engineering serving the interest of only shareholders and management. No new jobs are created and no new capital investment is undertaken in a world of corporate buybacks. Investors are simply bribed with their own money.” [FinSen] (emphasis added)

So, where does Trumpsterism come into play?  First, let’s assume, given the preliminary appointments to Commerce and Treasury, that the emphasis in this administration won’t be on reducing student debt and regulating the securitization of corporate debt.  Let’s also assume that a Corporate Tax Holiday in the form of “re-patriated” corporate earnings will be a feature.  How is that likely to be spent?

The Financial Times reports: “Much of the debt sold by companies in recent years has been used to buy back their own shares, pay out higher dividends or finance big mergers and acquisitions. While these buybacks funded by cheap borrowing have boosted earnings, a missing ingredient has been spending on investment to build their businesses.”

Why not? If the consumers (read the other 99% of the US population) aren’t clamoring to spend more (read creating demand) then the “financial engineers” will boost themselves by … buybacks, higher dividends, and mergers and acquisitions.  Or…

“A tax holiday that prompts repatriation of cash held overseas by global US companies, a move investors expect during the Trump administration, could help boost investment. Mr Milligan says it is unclear whether companies will plough any repatriated profits into capital investment or simply boost buybacks.“Repatriation could flow through fairly quickly and lead to a noticeable rise in share buybacks.” [FinT]

In less diplomatic terms – here we go again.  Corporations, getting tax breaks and subsidies, faced with a market in which there is declining or stagnating consumer capacity, find ways to engineer their financial statements.  Nevada has seen this movie before, and it didn’t end well for us.

Comments Off on The Warning Flags are Up: Trumpsterism and Corporate Debt

Filed under Economy, financial regulation, Nevada economy

The Great Balancing Act: US on the high wire

High Wire ActThe previous post was, in essence, a set up for this one.  Those looking for illustrative examples of radical economic philosophy will find none better than the musings of Nevada Representatives Amodei (R-NV2) and Heck (R-NV3).   When radical economics combine with radical politics the resulting admixture is toxic, and dysfunctional.  Witness the 12% approval rating for the Congress. [HuffPo]

So, why is the economic theorizing beloved by our two Tea Party darlings from the Silver State to be categorized as “radical?”

#1. It turns classical economic theory on its head.  Traditional economic theory asserts that an equilibrium price, and optimal market function,  can be determined when supply and demand for goods or services converge.  To give undue attention to one side or the other of the equation is asking for trouble.  Since the perpetration of the Supply Side Hoax, the “job creators” (corporate executives) have been attended to like medieval monarchs, with the Congress bowing, scraping, and otherwise engaging in obsequious behavior before members of the CEO class.   In sum, the Supply Side economics offered by the radical Republicans of the 21st century is little more than a political agenda masquerading as an economic theory. (1)

#2.  It eviscerates the guiding principal set forth in the founding documents of this nation which contends that we do better as a country when we take an interest in our communal welfare, and economic interests.  The preamble to the U.S. constitution notes that one of our foundational principles is the notion we should “promote the general welfare,” not that we should promote the interests of the rentier class, or any other specific class for that matter.  One of the first charges leveled at King George III was that he had “refused his asset to laws, the most wholesome and necessary for the public good.”  (Declaration of Independence) Note that the criticism wasn’t that the monarch had not attended to the good of “some” but of “all.”

In order to make this country work politically, as well as economically, we need to balance the needs and interests of business and labor.  Capital and commerce. Consumers and manufacturers.  When things get out of balance, things go wrong.  Achieving a balance between competing interest demands compromise.  However, when the Republicans in Congress assert their demand that they will not enact any modifications to the debt limit until the President and the Democrats in the Senate agree to repeal the Affordable Care Act and Patients Bill of Rights, accept the Ryan Budget, and privatize Medicare — the unwillingness to compromise produces nothing but manufactured gridlock.  Those who advocate no comprise in the face of opposition to their own exclusive agenda are functioning as anarchists — promoting no government as a solution to any governance.  (2)

Radical Theory Applied to Practical Reality Yields Poor Results

I’ve lost count of the number of times I’ve used the term “aggregate demand” in economic related posts.  However, when the situation becomes unbalanced and the needs of the top 1% of the American public are given greater consideration than those of the other 99% we have a situation in which there are few positive long term results.

Unalleviated promotion of the demands of the 1%, especially in the financial sector, helps to create economic consequences such as an increase in income disparity.  This is NOT to argue for some scheme of income re-distribution imposed by the federal government, but for a market based re-distribution based on the traditionally accepted principles of standard economics — including attention to the necessity of increasing our aggregate demand.

Increasing income disparity means that fewer households control more wealth, and hence have more spending “power.”  It is possible to have a warehouse load of vehicles, BUT the U.S. annually  manufactures some 15,797,864 cars and trucks (as of 2012) [WardsAuto  XL download] and 1% of the population obviously isn’t going to make a dent in this inventory without some significant assistance from the middle class.   The American middle class is less able to contribute to the aggregate demand than it was prior to the last Recession:

“Median household income in the country is nearly $4,000 less than what is was back in 1999. Things have gone from great to terrible since then, and this change has certainly played out in the nation’s median household income number. In September of 1999, the national unemployment rate was 4.2%; in September of 2011, the national unemployment rate was 9.1%.” [Manuel.com]

There are all manner of explanations for this situation, from various positions on the political spectrum.  For the radical right the explanation is to be found in the “high” corporate tax rates and regulation of financial transactions (the politics of prosperity for some and austerity for all).  For the left the explanation often incorporates the nefarious influence of the 1%.  Easy rationalizations miss an essential question.

What does our allocation of interest, energy, and resources tell us about our attention to our economic health?

There is one sector of our economy which has experienced significant growth — finance.  The NBER published a paper in 2007 offering an explanation for this increase:

“The share of finance in U.S. GDP has been multiplied by more than three over the postwar period. I argue, using evidence and theory, that corporate finance is a key factor behind this evolution. Inside the finance industry, credit intermediation and corporate finance are more important than globalization, increased trading, or the development of mutual funds for explaining the trend. In the non financial sector, firms with low cash flows account for a growing share of total investment. […] I find that corporate demand is the main contributor to the growth of the finance industry, but also that efficiency gains in finance have been important to limit credit rationing. Overall, the model can account for a bit more than half of the financial sector’s growth.”  (emphasis added)

Some definitions are in order, for example what’s “credit intermediation?”   The simplest way to describe this is to say that intermediation is the transfer of funds from the ultimate source to the ultimate user.   Our banks “intermediate credit” when they borrow from depositors to make loans to creditors.

Corporate finance runs a gamut of fiscal operations.  However, the standard expression relates to how does a corporation manage its capital investment decisions?  Decisions would be made such as should the company raise funds by the equities route, by issuing debt (bonds), and so forth.

If the NBER report is essentially correct, then the increasing transfers of funds, and the increasing role of corporate finance transactions are driving the increase in the growth of the financial sector.  So what?

The “so what” question may be answered, at least in part, by observing the increasing role of securitization of assets (Remember: One man’s debt is another man’s asset), and manufacturing of financial products in the “intermediation” process.   There’s a cautionary note from a 2009 IMF report (pdf)

“Mobilizing illiquid assets and transferring credit risk away from the banking system to a more diversified set of holders continues to be an important objective of securitization, and the structuring technology in which different tranches are sold to various investors is meant to help to more finely tailor the distribution of risks and returns to potential end investors. However, this “originate-and-distribute” securitization model failed to adequately redistribute credit risks, in part due to misdirected incentives. Hence, it is important in restart ing securitization to strike the right balance between allowing financial intermediaries to benefit from securitization and protecting the financial system from instability that may arise if the origination and monitoring of loans is not based on sound principles.”

What the polite phrasing of the IMF document is trying to say may very well be — “all the fancy ways the investment houses tried to reduce the risk to investors in various schemes aren’t going to be much help IF the underlying assets aren’t very good in the first place.” So, why did the system freeze up in 2007-2008?  Insert “avarice,” or good old fashioned “greed” in the place of “misdirected incentives,” and we have a situation in which all the financial products dreamed up by the “market makers” couldn’t erase the hard cold fact that many of the mortgages and other credit instruments which were securitized into ever more elaborate packages weren’t any good in the first place.

If we’re spending too much of our attention, energy, and finances on manufacturing financial products which are supposed to spin dross into gold for investment houses and major banks,  then we’re not paying attention to the sectors of our economy which need more attention, more energy, and more financing.

All analogies break down at some point, but for illustrative purposes only contemplate what might happen to an individual who owns a home with a set of broken steps to the front porch.  These steps are a risk for the homeowner.  However, instead of fixing the broken stairs the homeowner buys an extra insurance policy to offset his risk, then the benefits of the policy may be securitized, the security may be further offset with hedges, bets, and other derivatives — and in all the revenues generated and all the fees and commissions collected everyone appears to forget that the entire financial contraption is built upon a set of broken stairs.   When the steps collapse, as they inevitably must, the policy must pay out, along with those who bet against the policy being paid out and those who bet on the policy in favor of the  benefits being paid…. and so it might go.

The moral of this hypothetical is that if we are paying more attention to devising ways to mitigate risk, and manufacturing more financial products to do so, and we are not attending to correcting the faulty underlying assets — then we ought not complain when the house of cards falls in a heap at our feet.

Further, if we are studiously attending to generating revenue from the transfer of risk among credit intermediaries and corporate finance offices, then we are consequently paying less attention to our education system, our infrastructure, our manufacturing and business lending operations, and our fundamental  banking soundness.  Further, as more finance is sucked into the Shadow Banking system, the very real one is in danger of being neglected.

Worse still, according to the Economic Policy Review, the emphasis on the shadow system isn’t leveling off:

“Looking ahead, the authors contend that despite efforts to address the excesses of credit bubbles, the shadow banking system will likely continue to play a significant role in the financial system for the foreseeable future. Furthermore, increased capital and liquidity standards for traditional banking entities are “likely to increase the returns to shadow banking activity” partially because reform efforts have done “little to address the tendency of large institutional cash pools to form outside the banking system.”

This really doesn’t give much hope that financial institutions and major corporations will be excited about investments in manufacturing, infrastructure, or work force concerns, at least not in the foreseeable future.

Increasing aggregate demand, and thereby increasing our GDP, requires more earning power in the wallets of more residents and citizens.  The shadow banking system is not designed to take into consideration the credit needs of American car buyers — only to securitize and minimize (and then bet on) the credit worthiness of the underlying loans.   If banks made “good” home and auto loans then there would be less need to offset risks — which need not stop the shadow system from continuing to bet on the prospects of default anyway.

Finance and The Family Wallet

Looking back at the mess created by the Mortgage Meltdown of ’08, several observers were wont to ask — Why did the banks make those shaky loans in the first place?  And, no, it wasn’t because they “had to” because of the consumer finance laws — they made them because the loans could be originated quickly then securitized even faster. Once securitized the financial sector could manufacture  products to paper over the risks to the bankers — here came the hedges, bets, derivatives, swaps, etc. — and if the revenue generated from the manufacturing of those paper products could be greater than the loss from the loan default — then where was the incentive to make good and proper loans?  Someone wasn’t looking at those faulty front porch steps?

That was then, this is now and those who are playing derivative games with the underlying assets originally residing the family wallet aren’t taking kindly to being regulated, to being required to be more transparent, to being litigated against because of their manipulations.  Some more attention needs to be paid to that crucial line from the IMF report: “Hence, it is important in restarting securitization to strike the right balance between allowing financial intermediaries to benefit from securitization and protecting the financial system from instability that may arise if the origination and monitoring of loans is not based on sound principles.”

Balance

There’s that word again — we need some balance between competing interests (capital and commerce, labor and ownership) and balance requires — demands — compromise.  Those standing on the ramparts of their own idiosyncratic battlements of ideological purity, refusing to compromise with the dreaded Other, are jeopardizing not only the political life of this nation but the economy of the country as well.

(1) For more on this topic see: The Trickle Down Hoax, AmericanThinker, July 15, 2012.  The Political Genius of Supply Side Economics, Financial Times, July 25, 2010. (registration required) Supply Side Economics Explained, Reign of Error, September 23, 2005.  The Six Biggest Hoaxes in History, Huffington Post, May 23, 2013.

(2)  See also: Gridlock and Harsh Consequences, New York Times, July 7, 2013.  Gridlock in Congress, CNN, May 21, 2012.  Five Reasons Gridlock Will Seize Congress Again, Washington Post, January 4, 2013.   Congress Shows Few Signs of Ending Gridlock, Bloomberg News, July 8, 2013.

Comments Off on The Great Balancing Act: US on the high wire

Filed under Economy, Politics