Earlier this week, House Democrats proposed an increase in the top corporate tax rate from the current 21% to 26.5%, along with a sharp increase in the ‘minimum tax’ on foreign income from 10.5% to 16.6%. According to Kate Davidson and Richard Rubin in the Wall Street Journal on September 14th:
“Under the proposal, which would replace the flat corporate rate with a graduated rate structure, firms would face an 18% rate on income up to $400,000, 21% on income up to $5 million and a 26.5% rate on any income above that. The benefits of the graduated rate would phase out for firms earning more than $10 million a year.”
Apologists have been quick to point out this is still well below the 35% level prior to the ‘Tax Cuts and Jobs Act’ which took effect on January 1, 2018. However, that piece of legislation eliminated some loopholes, and the like, in exchange for the lower rate. Unfortunately, the proposed increase doesn’t put them back; it just jacks up the highest marginal tax rate.
Obviously, the argument for it is the Congress will need the additional revenue to pay for all of the money it has spent and intends to continue to spend moving forward, much of it in restructuring the US economy in some form or fashion.
As with just about anything in life, someone will get stuck with the bill
Earlier today, I addressed this topic in a presentation I made in Montgomery: who pays for this tax increase? The staff in the philosophy department at Brown University might think big, bad corporations will, but that isn’t the case. After all, are company owners, investors, going to simply shrug their proverbial shoulders and accept a lower return? Just grin and bear a sharp decrease in earnings per share? You got us Washington! Here take this money, and we will continue on the same as we were!
Of course not.
Let me ask a question: which can companies control more than the other? Revenues or expenses? There is only one possible answer: expenses. After all, if companies could control their revenue, they would simply grow their top line faster than the bottom…not some of the time, but all of the time. How much more simple could it be? Right? Um, wrong, as companies post losses, declare bankruptcy, and even go out of business all of the time.
Therefore, if the proposed changes to corporate taxes take effect, corporations will simply cinch their belts a little tighter. This isn’t a guess. It is a promise. Businesses aren’t any different than individuals in this regard: the more the government takes, the less they have to spend on or for themselves. It isn’t terribly complicated.
With this in mind, what might be the easiest, variable expense lever the CFO’s office can pull if and when it needs to do so in order to achieve the company’s profit target? That is right, employee related expenditures. That is the low-hanging fruit.
However, none of this means HR departments are automatically going to start slashing headcount should the legislation pass. They likely won’t, at least not a first. However, something has to get a haircut. So, what will it be?
Every company is different. However, here are some probable candidates. A reduction in or elimination of: 1) quarter-end and year-end payout incentive programs; 2) annual ‘merit’ or ‘cost of living adjustment’ raises; 3) overtime; 4) shifts for hourly employees; 5) associate training and/or continuing education; 6) profit-sharing bonuses; 7) company match in retirement programs; 8) company contribution to healthcare, AD&D, voluntary life, etc.; 9) new hires; 10) office supplies, and; 11) associate events like holiday parties, etc.
Clearly, that list is far from exhaustive. However, again, the money has to come from somewhere, and it will. It just won’t be out of the pockets of the shareholders over time. If they need to have, say, a 10% rate of return, they need to have a 10% rate of return. That doesn’t mean a 10% return less the variable increase in Federal income taxes.
You can call this greedy if you want, and a lot of people will. However, that doesn’t make it any less true. If Company A doesn’t generate the necessary earnings but B does, guess where the money will go? I will give you a hint, it isn’t A, all other things being equal. If you are being honest, do YOU want to earn less on your investments? Makes less because the Federal government, who has managed to amass a mountain of debt $28.4 trillion high with a myriad of different tax schemes over the years, wants more?
As for the concept of greedy, riddle me this: which is more greedy? Wanting to keep what you have earned OR wanting to take what others have earned? Hmm. Greed is an interesting concept, as is the government’s role in economics. Ultimately, that is what I think all of this discussion about higher taxes, and the desire to ‘tax the rich’ and ‘corporate America,’ is really all about.
As for that, I can think of no better way to end this week’s missive than with a partial transcript of an interview Milton Friedman did on Phil Donahue’s talk show all the way back in 1979.
“When you see around the globe the mal-distribution of wealth, the desperate plight of millions of people in underdeveloped countries, when you see so few haves and so many have-nots, when you see the greed and the concentration of power, did you ever have a moment of doubt about capitalism and whether greed’s a good idea to run on?”
“Well, first of all, tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fellow who’s greedy.
The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way.
In the only cases in which the masses have escaped from the kind of grinding poverty you’re talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kinds of societies that depart from that.
So that the record of history is absolutely crystal clear that there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.”
“But it seems to reward not virtue as much as ability to manipulate the system.”
“And what does reward virtue?
Do you think the communist commissar rewards virtue? Do you think Hitler rewards virtue? Do you think American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of their political clout? Is it really true that political self-interest is nobler somehow than economic self-interest?
You know, I think you’re taking a lot of things for granted. Just tell me where in the world you find these angels who are going to organize society for us.”
“I don’t even trust you to do that.”
Interesting, isn’t it? 40 years later, we are still having the same debate. Unfortunately, there aren’t a lot of unrepentant capitalists like Milton Friedman getting a lot of airtime these days. Hmm. I think that is a good way to end it this week.
Take care, have a great long weekend, and be sure to listen to our Trading Perspectives podcast.
As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself. Finally, we do NOT make a market in any of the companies listed in this newsletter, and I do not own them personally.