The Tax “Jubilee” of 2016–17

  • How corporate income taxes got so screwed up…
  • … and what “reform” will probably look like
  • Why Stockman anticipates a lousy earnings season
  • The tech company that “mines” more gold than many gold juniors… what to think about when gold suddenly zooms up… revisiting the basics of bond prices and rates… and more!

Beware politicos promising “reform.” That’s all we can say about the chatter in Washington surrounding the corporate income tax.
There’s been no shortage of hand-wringing recently about the corporate income tax — coinciding, no doubt, with the release of the “Panama papers” two weeks ago and the run-up to Tax Day yesterday.
The “anti-poverty charity” Oxfam released a report saying giant U.S. firms like Apple, Wal-Mart and General Electric have “hidden” $1.4 trillion in offshore tax havens — an amount “larger than the economic output of Russia, South Korea and Spain,” says The Guardian.
Elsewhere, the Government Accountability Office found about 20% of large U.S. firms that turned a profit in 2012 paid no corporate income tax.
The GAO issued the report at the behest of Sen. Bernie Sanders. “Large corporations,” he predictably huffed, “cannot continue to get more tax breaks when children in America go hungry.” [False-choice fallacy for $200, Alex.]
If Sanders and his fellow politicians are looking for someone to “blame,” they need only look in the mirror.
Start with the fact that America’s corporate tax rate — the nominal one, on paper, anyway — is the highest in the developed world. There’s a 35% federal rate, and an average 4.1% state rate on top of that.

Click to Enlarge.

As a practical matter, however, few companies pay 39.1%. Among all those aforementioned large firms that are profitable, the average rate is about 14%.
How did the system become so godawful complicated? Consider the case of Boeing and its French peer in aircraft manufacturing, Airbus.
“Airbus faces lower rates than Boeing,” writes economist Veronique de Rugy from the Mercatus Center, “and is taxed on a territorial basis (at the rate in place in the country where the income is earned). Good for Airbus if it earns income in a country that has a lower corporate tax rate than France.
“More importantly, Airbus faces a lower rate than Boeing no matter where Boeing sells its planes, if the U.S. firm decides to bring its foreign income back home.”
Yep. All the outrage over U.S. firms “hiding” their profits overseas? “Years ago,” explains Ms. de Rugy in her syndicated column, “lawmakers answered the call for reform by instead designing a loophole that helps companies avoid the heat of the U.S. rate by keeping their foreign income abroad, which is what many companies do.
“But sometimes that’s not enough, and they simply renounce being American companies by incorporating abroad.”
That’s what the whole kerfuffle about “inversions” — mergers that end up with a U.S. company moving its headquarters overseas — is all about.
The good news, if that’s what you can call it: Many people in Washington recognize the system is a joke.
President Obama, whose administration cracked down on inversion deals earlier this month, proposes to lower the top federal rate from 35% to 28%. Sen. Chuck Schumer, who will likely be the top Senate Democrat next year, wants to slash taxation of corporate income overseas. Republican presidential contenders Ted Cruz and Donald Trump have their own proposals, too.
[Ed. note: For the moment, we’ll leave aside the common-sense recognition that any amount corporations pay in taxes is a cost that’s borne by their customers — or, as recent research shows, by their workers, who end up with lower wages.]
“It may be the one bipartisan issue out there,” de Rugy writes. “All we need is leadership.”
We don’t share Ms. de Rugy’s faith in the political process. Rather, we suspect that the various and sundry calls for “corporate tax reform” in Washington will turn into a massive bait-and-switch.
There’s precedent with what happened to individual income taxes when Reagan and Tip O’Neill came to terms on “tax reform” in 1986. It involved a trade-off of sorts: A bunch of deductions, exemptions and credits went bye-bye. (Remember when credit card interest was deductible?) But in exchange, the top tax rate fell from 50% in 1986 to 28% by 1988.
Here’s why it was a bait-and-switch. That 28% top rate lasted all of three years. Poppy Bush and his lyin’ lips brought the top rate up to 31% in 1991 and Bubba raised it to 39.6% in 1993.
The deductions that went away under the 1986 law? Those never came back.
We can only imagine corporate “tax reform” will work out much the same way. We’ll get some form of Sen. Schumer’s proposal — maybe this year, maybe next. It’ll be hailed as a corporate tax “jubilee” — encouraging American firms to “bring home” some of that $1.4 trillion to “reinvest in America.”
Then, maybe three years later, everyone in D.C. will start squawking about the need for more revenue. They’ll find some way to muck up whatever reform had been previously enacted.
Besides, those corporations won’t “reinvest in America” anyway. Why should they?
The economy will probably still be in stall speed. The mighty American consumer will still be feeling stretched. (The savings from low gas prices? As we noted in February, it’s all gone toward rising health insurance premiums.) Why invest in the future growth of their companies under those circumstances?
The proceeds from the “jubilee” will instead be handed out to shareholders. Just imagine all the share buybacks and special dividends! Whee!
It would make for one hell of a last stock market hurrah before everything goes kerflooey, eh?
If it doesn’t go to hell before corporate “tax reform” is passed, that is…
To the markets today, where the major U.S. stock indexes are notching — say it loud, say it proud — “new 2016 highs.”
Yesterday, the Dow closed above 18,000 for the first time since last July. Today the S&P 500 is flirting with the 2,100 level, last seen oh so briefly in mid-November.
But if it’s real excitement you’re looking for, it’s in gold — up $22 at last check, to $1,254. And crude is recovering smartly from yesterday’s “summit letdown,” a barrel of West Texas Intermediate at $41.25.
The big economic number of the day stunk up the joint. Housing starts for March came in way below expectations. Worse, so did building permits — which are a better indicator of future activity.
The big earnings number of the day is Goldman Sachs. Like Morgan Stanley yesterday and the Big Four commercial banks last week, the vampire squid’s profits are way down, but better than expected. Buy!
With the big financial stocks now out of the way, the “meat” of earnings season is setting up to be yet another disappointment, says David Stockman.
“Corporate earnings have been slipping for five quarters now,” he reminds us. The peak came in the third quarter of 2014; earnings for the S&P 500 companies rang in at $106 per share for the previous 12 months. For the most recent four quarters — that is, calendar year 2015 — it’s only $86.44 per share.
“That means profits per share are down 18.5% from the peak,” says David; without record stock buybacks and shrinkage of the S&P 500 float, the drop would have been even steeper during the last five quarters. Yet while earnings are heading even lower in the current period and the quarters ahead, the implied S&P valuation multiple has risen to the nosebleed section of history.
“At the current S&P 500 index level, the market is trading at 23.8 times reported earnings per share. And that’s based on honest GAAP earnings — the kind CEOs and CFOs report to the SEC on penalty of jail. It is only a matter of time, therefore, before this deepening slump in GAAP earnings unexpectedly ‘shocks’ the casino when shortfalls from the estimates of ‘adjusted’ 2016 earnings materialize, too.
“Analysts have been furiously marking down their estimates for Q1 for weeks now,” he goes on. “At the latest reading, profits are projected to fall by 10%, marking the fifth straight quarter of decline.


“Always and everywhere,” David concludes, “such persistent profit collapses have signaled recession just around the corner.”
Whaddya know? One of the most productive junior gold miners on the planet is… Apple.
“In 2015,” says Apple’s annual “environmental responsibility” report, “we collected nearly 90 million pounds of e-waste through our recycling programs.”
That includes 2,204 pounds of gold worth an estimated $40 million… and 6,612 pounds of silver.
Don’t try this at home with your dying iPhone: In 2013, an outfit called 911 Metallurgist measured a mere $1.58 of gold in an iPhone 5. And that was at a time gold prices were $300 an ounce higher than they are now.
“I think those who are concerned about what they will do with their gold when the price does go up are looking at the trade from the wrong side,” a reader writes in response to yesterday’s mailbag.

“It would be better to ask, ‘What do I take as payment for my goods or services I want to sell?’ If the value of the dollar is declining rapidly, the choice seems fairly obvious. I don’t foresee being able to trade either gold or silver being a big problem if or when the time comes.”
The 5: Indeed. On the other hand, if you’re selling goods and services and your customer base doesn’t have any precious metals with which to buy them, then what?
“Thanks for the latest run-through of the ‘Shanghai Accord,’” a reader writes after we explored it anew last Friday.
“There are lots of things I find confusing about trading and finance, but the interrelationships between currencies is definitely one of them.
“As for bond yield versus price, I still find that makes my brain stall for a few seconds. Maybe you could have two versions of the newsletter. One for the smart folks and one for the rest of us… 😉
“Also, I found the caption of that bear photo on Friday interesting. I don’t see how two countries trading with each other in their national currencies is somehow unsavory! Being forced to trade in U.S dollars is what I would call unsavory.”
The 5: Well said, sir.
As for the relationship between price and yield on a bond, just remember both of them are functions of perceived risk. If the market perceives the issuer of a certain bond is a poor risk, buyers will demand a higher yield in exchange for that risk. By the same token, demand for that bond will be lower than for another bond that’s thought to be safer, and lower demand tends to dictate a lower price.
Of course, that’s just a general principle. As we check our screens this morning, we see that 10-year debt issued by the Spanish government yields 1.53%, and equivalent Italian debt yields 1.4%. Meanwhile, a 10-year U.S. Treasury note yields 1.78%. Does anyone think Spain or Italy is a better credit risk than Uncle Sam? But the post-2008 world in which we live is a crazy one!
We don’t know about two versions of The 5, but we’ll do our level best to remember we have readers at all levels of investing experience… and one of our missions is to help newbies like you gain a clearer understanding of the world without insulting the intelligence of someone who’s an “old hand.” We welcome the challenge!
Best Regards,
Dave Gonigam
The 5 Min. Forecast
P.S. Congratulations to readers of Agora Financial’s Catalyst Trader. Editor Rick Pearson urged them this morning to take profits on a position in Amazon for a 41% gain in only five weeks.
With Rick’s guidance, they applied what he calls “the most powerful trading strategy on the market today.” It’s a strategy that works whether the Dow keeps rising past 18,000… or if it tumbles to 13,000 in the next six months.
Discounted access to Catalyst Trader is available only through midnight this Thursday. Check it out here.

Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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