The Two Economies

(warning: salty language will be used at the end of this column)

During this election cycle there’s been a lot of talk about what bad shape the economy is in.  Most of what they are referring to is the high unemployment rate.  It’s not historically high – that happened during the Great Depression when levels topped 25% of the work force looking for jobs.  But at a little less than 8%, it is still pretty uncomfortable.  There are other statistics that indicate that the problem might be worse than that because that only measures the number of people who are actively looking for work.  A segment of the population has lost hope and is no longer looking.  Of course, some of those who are no longer looking are people who have retired and some are going back to school, etc.  But by no stretch of the imagination am I going to suggest that times are good.

However, they aren’t bad for everyone.

Corporate profits have been setting records every quarter since the winter of 2009.  Corporate cash on hand has topped more than $2 trillion, a record both in total dollars and dollars adjusted for inflation.  To put this into some perspective, during the Great Depression, there were two years in which corporate profits were actually zero, and from 1929 to 1940, the total amount of corporate profits in the US never exceeded $10 billion a year.  Adjusted for inflation that amount would be roughly $129 billion in today's dollars.  That's total profits from all companies combined over an entire year.  Compare that to the corporate profits from the first quarter of 2010: $1.56 trillion.  One quarter, $1.56 trillion dollars.  That's eight and a half times the cost (inflation adjusted) for the entire Apollo program (1961-1975) to put a man on the moon... plus give you smoke detectors, microwave ovens, mylar packaging for your Doritos and the MTV award.   In one quarter.  If there was a critical problem with the economy, corporate profits would reflect it.  They don't.  In fact for more than two years they’ve pocketed trillions of dollars in profit, and were for nearly a decade before the Wall Street meltdown in 2008. 

A big reason this has happened was because large corporations and multinationals have been taking advantage of the tax code.  They use armies of tax attorneys to file returns thousands of pages long to exploit a wide variety of deductions that aren’t available to smaller businesses.  GE’s tax division, which numbers close to a thousand attorneys, made news in 2010 when they filed their famous 24,000 page return to net a $3 billion refund after earning more than $14 billion.  One deduction exploit that has garnered a lot of media attention is the creation of jobs overseas instead of here.  Corporations cite high labor costs in the US, then create thousands of jobs for abusively cheap labor in third world countries and then not pay taxes on the income because the money was “generated” overseas.  This exploit has a number of forms, many of which were outlined in a recent memo by Senator Carl Levin.  One example he cited:

“Another maneuver by Microsoft deserves attention: its transfer pricing agreement with a subsidiary in Puerto Rico. Generally, transfer pricing agreements involve the rights of offshore subsidiaries to sell the assets in foreign countries. The U.S. parent generally continues to own the economic rights for the United States, sell the related products here, collect the income here, and pay taxes here. However, in the case of Microsoft, it has devised a way to avoid U.S. taxes even on a large portion of the profit it makes from sales here in the United States. Microsoft sells the rights to market its intellectual property in the Americas (which includes the U.S.) to Microsoft Puerto Rico. Microsoft in the U.S. then buys back from Microsoft Puerto Rico the distribution rights for the United States. The U.S. parent buys back a portion of the rights it just sold.”

He continues:

“On January 1, 1997, the Treasury Department implemented the so-called “check-the-box” regulations, which allow a business enterprise to declare what type of legal entity it wanted to be considered for federal tax purposes by simply checking a box. This opened the floodgates for the U.S.multinational corporations trying to get around the taxation of passive income under Subpart F. They could set up their offshore operations so that an offshore subsidiary which holds the company’s valuable assets could receive passive income  such as royalty payments and dividends from other subsidiaries and still defer the U.S. taxes owed on them.”

Microsoft engaged in another exploit when it shifted income offshore (even when some of their offshore offices have zero employees, like its Bermuda subsidiary) and then loaned a portion of that cash back to the domestic business to comply with letter of the law tax rules that allow short-term loans.  Hewlett Packard took it a step further and paid domestic operating costs from their foreign subsidiary accounts.  Essentially, what they are actually doing as far as the IRS is concerned is turning income into a debt on paper.  They can then deduct the interest on the loan they pay themselves from the total income.  So even though they make the same amount of money, on paper they are making it look considerably less when it comes time to pay the taxes on it.  How many small businesses can do that?  The more important question is why aren’t our legislators doing more to change that?  The US Treasury estimates it lost more than $80 billion in tax revenue over the last three years from Microsoft, Google and Apple alone due to these exploits.   $80 billion.

Very similar to the picture of the top individual earners paying a lower tax rate than the vast majority of middle income earners, the top earning corporations are enjoying profit margins that small companies can only dream about.   Interestingly enough the global economy is slowing and the opportunities for foreign expansion slowing along with it.  Those corporate profits are beginning to slow as well.  Still, corporate profits will still top a trillion dollars this quarter.

The result of these exploits it that a number of Fortune 500 corporations (26 in 2011) are paying their CEOs more money than they pay in taxes on billions in profit.  In addition, many are lobbying for a tax holiday where they would have to pay no taxes for a full year, which would cost the government more than a trillion dollars in tax revenue.  George W. Bush gave them a tax holiday in 2004 in an effort to jump start a sluggish post-9/11 economy and the economy responded with an unimpressed yawn. 

The great discussion this election is what to do about this.  Those that claim that the problem is too much government spending often say that increasing taxes in a time like this would be disastrous.  And that might be true if everyone was struggling.  But any reasonable reading of the financial news over the last two years indicates that some are not enduring any hardship whatsoever, especially when it comes to paying taxes.  Despite record revenues, the total amount that corporations actually pay into the system is down from 30% of all federal revenues 50 years ago to 6.6% today, despite personal income taxes being the lowest they've been since the 1950s.  One would expect with personal income taxes being so low that corporate taxes would make up a greater portion of the federal revenue.  In fact, the opposite is true. 

Look, I'm all for equal opportunity in this country.  But equal opportunity is not what we have.  Corporations aren't going to leave the US if we fix the tax code so that they pay their fair share.  Just so I’m being clear, I’m not talking about small businesses that employee less than a hundred people; I’m focused on multinational corporations that employ thousands and pay millions to lobbyist and attorneys to bend government policy.  They won’t relocate.  There are simply too many positives for doing business in the US - established infrastructure, skilled workforce, robust higher education, and yes, the tax code.  If it was only about the tax code, they’d have all incorporated in Qatar, which has 0% income tax, 0% corporate tax and 0% payroll tax.  They do however still stone criminals there.  Maybe that’s why they haven’t relocated.  Regardless, there are too many people who want to work who aren't being given that opportunity because short-term corporate profits are taking precedence over the long-term health of the country. 

For those who argue labor costs are too high here, consider this: when Henry Ford introduced the first Model Ts in October of 1908, there were only 144 miles of paved road in the US.  He famously doubled his employees' salaries so they could afford to buy the car.  By 1918, half of all cars driven in the US were Model Ts (more than 2 million) and there were more than 300,000 miles of paved roads.  This is not coincidence.  They built quality cars that everyone could afford despite the fact that the people who assembled them were paid very well by industry standards.  Numerous studies have shown that manual labor employees who are compensated well tend to be more productive, both in quality and quantity.  That saves money on the back-end as there are fewer recalls and lawsuits, and it inspires greater customer loyalty.

Despite corporate profits growing like crazy since late 2009 and robust bonuses awarded for stock performance for their decision-makers, Wall Street firms cut more than 75,000 jobs in 2011, and between Bank of America, Nokia and Hewlett Packard alone those three firms will shed another 67,000 by themselves this year.   Now Wall Street has the temerity to complain there’s no more land to cultivate, no more room to cut costs other than through lower taxes.  And that’s the great disconnect.  Corporations had a chance to create jobs when they were raking in record profits (remember trickle down theory?) but instead they decided to pad their own wallets.  If they don’t help anyone but themselves when times are good, what evidence is there that they know how to help anyone but themselves when times are tough?     

President Obama needs to take a page out of Pulp Fiction, look directly into the camera during a televised address and tell the CEOs something like, ““Normally, your asses would be dead as fucking fried chicken, but you happen to pull this shit while I'm in a transitional period so I don'twanna kill you, I wanna help you. But I can't give you this economy, it don't belong to me; it belongs to all the American people.  Besides, I've been through too much shit this term over this economy to hand it over to your dumb asses. There's a passage I got memorized. Ezekiel 25:17. ‘The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men.  Blessed is he who, in the name of charity and good will, shepherds the weak through the valley of the darkness, for he is truly his brother's keeper and the finder of lost children.  And I will strike down upon thee with great vengeance and furious anger those who attempt to poison and destroy My brothers.  And you will know I am the Lord when I lay My vengeance upon you.’ Now... I been sayin' that shit for years.  And if you ever heard it, that meant your ass.  I never gave much thought to what it meant.  I just thought it was some cold-blooded shit to say to a motherfucker before I popped a cap in his ass.  But I’ve seen some shit these last three years that made me think twice.  See, now I'm thinking: maybe it means you're the evil men. And I'm the righteous man. And Mr. Tax-Hike-On-The-Wealthy here... he's the shepherd protecting my righteous ass in the valley of darkness.  Or it could mean you're the righteous men and I'm the shepherd and it's the world that's evil and selfish.  And I'd like that.  But that shit ain't the truth.  The truth is you're the weak.  And I'm the tyranny of evil men.  But I'm tryin', Ringo.  I'm tryin' real hard to be the shepherd.“  

That may seem a little harsh, but I am reminded of another Jules Winfield quote from Pulp Fiction: “If my answers frighten you then you should cease asking scary questions.“