12/29/17…time to think about taxes…

Right on the cusp of a new year I have decided to do a special Trader Bill. He had no choice thanks to a government controlled by one party. That is never a good thing whether they be Republicans or Democrats and this year should have proved it beyond any doubt. When this happens and especially with the simple majority rule in the Senate, there is no need to negotiate, reach across the aisle, etc. In fairness, due to the do-nothing GOP, the Dems enacted the 51 vote rule which may be okay for appointments but should never be used for anything as complex as a tax bill…or health care. Worse, no one had any way to protect themselves before this took effect and the IRS had just five days to prepare for 2017 and total changes in payroll taxes. What can go wrong? Nothing, or so the GOP says. So here are my thoughts on the tax bill and its implications:

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”  – Benjamin Franklin

Acting in a totally partisan manner, the GOP-led Congress has just passed a tax bill that will hurt Americans. They did this after months of intra-party meetings without the recommendations of any tax experts, and in fact opposed by all tax policy groups except the Tax Policy Institute, which used dated, incorrect information. There were no hearings, open meetings, or floor discussion of any part of this act which ended with a seriously flawed act, which should be renamed the 2017 Tax Preparers and Accountants Full Employment Act! Meanwhile, they did not appropriate funds for more agents to audit returns which will likely result in instances of tax fraud. Were the Democrats complicit in this? Yes and no. The GOP claims that they refused to participate, but that is because all of the main details had already been set even before members of their own party knew what was in it, and then additions were made to elicit the votes of Senators Collins, Rubio and others.

Despite claims by Trump and his party (even though he never was a Republican), this is not the biggest tax cut in history, David Stockman in an article posted on Seeking Alpha, https://seekingalpha.com/article/4133728-hysteresis-c-suite-gop-tax-bill-stimulate-growth-part-3  points out that it is “one-tenth of the size of the 1981 Reagan tax cut”. That tax cut had to be reversed as the positive supply-side effects promised did not materialize and the deficit increased until if forced Reagan to raise taxes. It well may prove to be the second largest transfer of wealth in our history, the first being the Bush 43 tax cuts which were enacted after we started two wars, which continue to this day, making them the longest in our nation’s history. History also shows the ‘guns and butter’ tax cuts of Johnson, increased inflation and of course the federal deficit.

The purpose of tax cuts, other than for the lower income classes it to encourage economic growth. This falls way short of doing that. First, corporations received a tax cut which is good for smaller companies but not enough to do much for the overall economy, while the Fortune 250 corporations who were already paying an average 19% will get little benefit from this act. Furthermore, at least ten of the largest corporations, including GE, paid no tax, while some like XCEL Energy, had a negative tax rate due to subsidies…ah the subsidies. Not addressed here.

Fifteen years ago, I was at a conference in London where the keynote speaker was Nobel laureate Dr. Franco Modigliani. His speech was excellent and centered on eliminating the corporate income tax…that’s right, he said the correct rate was zero! Why? Because they don’t pay taxes or at least nowhere near the rate set by law. I didn’t quite get how it could possibly work.

That evening, as my wife and I were going to dinner we stepped on the elevator, the only other person inside was Dr. Modigliani, who I had studied in Economics and Finance. I told him how much I enjoyed his speech but didn’t see how his proposal was fiscally feasible. When we reached the lobby he spent ten minutes talking to us and here it is in a nutshell:

First, since they don’t pay the full tax rate, the correct tax is zero. I asked what the offset was and he said that ALL subsidies had to be eliminated, and ALL dividends taxed at the full rate by shareholders. There are two benefits to this: first, a company could not argue that stock buybacks are better because effectively dividends are double-taxed, and secondly, all projects being considered would no longer have the benefit of the tax saving effect. Thus the argument to not increase dividends, the only consistent returns on capital. Also note that stock bubyacks no longer ‘retire’ the stock, and haven’t for years, so they could easily be reissued. The main benefit is to offset stock options while making shareholder equity look higher. Despite years of trying to convince Congress, it was a non-starter for self-serving reasons, not because it was the right thing to do.

This brings up another flaw in the act: there is no reason for corporations to do anything other than business as usual. Is a company that has moved its ‘tax headquarters’ (which should have been disallowed years ago), going to move it back and pay a higher rate? Take the case of Ireland with a 12% rate. Not only would that double their tax but Ireland as a member of the EU has access to the labor pool of the entire EU, at a time when our government is trying to make it more difficult to ‘import’ skilled employees. This flaw is in addition to the CEO meeting where Cohn asked them if they planned to raise salaries for their employees. Out of more than 100, perhaps five hands went up. You can bet however, that the CEO and other top officers will get increases, and possibly overpaid board members who are already beholding to the CEO. Don’t take my word for this. In a 1991 book, In Search of Excellence, Graef S. (Bud) Crystal, former senior compensation analyst for Towers, Perrin, had no limits on CEO compensation…only that they earned it. Performance measurement has been ‘gamed’ so that no CEO looks bad. Crystal also said that in all the time he was doing this he never saw any CEO who was in the bottom 50%! In fact, the only thing that has changed since he wrote the book is that the CEO no longer chooses the analyst or sets the parameters, now the board does both. Could that be the reason that directors pay has risen so sharply? Crystal says the worst form of compensation to hand out is restricted stock. Why?

Let’s say the top officers (and sometimes even the board members), are granted shares of restricted stock with a market value of $50 a share and a five year vesting period. In the interim, they receive all the dividends, but let’s say the stock declines to $25 at the end. On 1,000 shares it is still worth $25,000, and that is what the tax liability is based on. Compare and contrast to you, the individual who bought it at the same time but instead of a gain now have a $25,000 loss (think GE). Incentive, or rip-off?

The reason they get away with this is simple: most shares of major corporations are held by institutional shareholders who get analysis from SEI or other proxy analyzing firms. With few exceptions, they vote with management. If things go wrong, they vote with their feet. This is especially true of hedge funds (whatever happened to Trump’s pledge to eliminate the carried interest provision that only pertains to them?). There are a few activist pension fund shareholders like Cal Pers, but they are in the minority.

In conclusion, don’t fool yourself into thinking of this as tax reform, it is just the special interest groups, which now include major donors to politicians who shall remain nameless. This will not and cannot change unless Citizens United is repealed by the Supreme Court who incorrectly counts a corporation as an individual. Retired Justice Sandra Day O’Conner summed it up best, after hearing of the decision, “where in the Constitution does it say that a corporation is an individual.” For legal purposes they are considered ‘one’ but since they cannot vote, they should not be able to affect the outcome of our elections. More importantly, it is the CEO who determines where the funds go and that can be vastly different than the goals of the shareholders, certainly not all the shareholders.

Happy New Year to all of you and to those non-believers like TB, we will just have to muddle through, won’t we?



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