Walmart - Winners and Losers in the U.S.-China Trade War

The Trump Administration's trade scuffle with China has now reached the hallowed halls of Walmart.  In a recent letter to Robert Lighthizer, the United States chief Trade Representative, Walmart weighs in on the "Proposed Modification of Action Pursuant to Section 301: China's Acts, Policies and Practices Related to Technology Transfer, Intellectual Property and Innovation", a rather wordy way to say "The U.S. - China Trade War".

Let's take a brief look at Section 301 and what it does.  Under Sections 301 to 310 of the Trade Act of 1974, the President is authorized to take actions including retaliation, against any policy, act or practice of a foreign government that violates an international trade agreement.  Concerns by the Trump Administration regarding China's policies on intellectual property, forced technology transfer and innovation policies and the impact of these policies on the United States economy has led to the launching of a Section 301 investigation of the aforementioned policies.  Once the United States Trade Representative (USTR) begins a Section 301 investigation, it must seek a negotiated settlement with the foreign country concerned, either through compensation or through the elimination of a barrier or practice.  The Trump Administration began its actions on March 22, 2018 targeting economic aggression by China and outlined four policies that justified U.S. actions against China under Section 301 as follows:

1.) China uses joint venture requirements, foreign investment restrictions, and administrative review and licensing processes to force or pressure technology transfers from U.S. companies to a Chinese entity;

2.) China maintains unfair licensing practices that prevent U.S. firms from getting market-based returns for their IP;

3.) China directs and facilitates investments and acquisitions which generate large-scale technology and IP transfer to support China’s industrial policy goals (such as the Made in China 2025 initiative); and

4.) China conducts and supports cyber intrusions into U.S. computer networks to gain access to valuable business information.

Here is a list of tariff increases that have resulted from this spat and their effective date:

1.) July 6, 2018 - 25 percent tariff increase on $34 billion worth of imports from China

2.) August 23, 2018 - 25 percent tariff increases on $16 billion worth of imports from China

3.) September 24, 2018 - 10 percent tariff increase on $200 billion worth of imports from China, increasing to 25 percent on January 1, 2019

As well, the USTR warned of additional tariffs on $267 billion worth of Chinese goods if China retaliated (which they did).

Here is a graphic showing the three rounds of implemented tariff increases:

The first two tariff increases covered a total of 1102 tariff lines with an estimated total value of $50 billion.  You can find the list of products for the first list here and the second list here.  Here is a sampling of the two lists:

Obviously, these increased tariffs on goods imported from China will have a significant impact on U.S. consumers.  One need look no further than the labels on items that Americans purchase at their local Walmart to see how many of the items stocked by America's largest retailer are made in China.

As I noted at the beginning of this posting, Walmart has entered the trade battle as part of the consultation process that takes place during a Section 301 trade dispute.  Here is a letter from Sarah Thorn, Walmart's Senior Director of Global Government Affairs to Robert Lighthizer, the current United States Trade Representative:

The letter outlines Walmart's concerns about the disruptive impact of the Trump trade war with China on its customers and suppliers, although my suspicion is that they are more concerned about the impact on Walmart's profits which have an ultimate impact on the compensation of its Named Executive Officers.

The letter notes that the latest tariffs on $200 billion worth of Chinese imports will impact households who consume a myriad of products that Walmart carries and that there simply is no viable alternative source for these products.  Not only will the tariffs impact Walmart's domestic operations, there is an impact on Walmart's operations in China where the retailer sells many U.S. products to Chinese consumers (i.e. American pork, beef, cherries, nuts, wine, apple, cheese and milk) which are now subject to a retaliatory duty imposed by China, a tariff that could end up hurting American producers of these goods.

Obviously, Walmart has some difficult decisions to make; they can either raise prices to consumers or they can absorb the cost of the tariffs and watch their profits (and stock price) drop.

While Donald Trump has proclaimed that trade wars are easy to win, it's pretty clear that someone has to lose and, in this case, it looks like it will be the consumers of Main Street America unless, of course, Walmart decides to absorb all of the costs of increased tariffs on its retail products.  As always, there is one thing that we can count on; there is an unintended consequence to government decisions.  

The Tangled Web of Walmart and its Subsidiaries

A recent report by Americans For Tax Fairness looks at how Walmart, the world's largest corporation, uses a vast network of subsidiaries and branches in overseas tax havens with two purposes:

1.) to minimize taxes owed on its foreign operations.

2.) most importantly, to avoid United States taxes on those foreign earnings.

In most cases, American corporations set up subsidiaries in tax havens where they have little or no business operations and very few employees (if any at all).  These subsidiaries allow corporations to maintain financial secrecy and are typically used by both technology and pharmaceutical companies.

According to the report, Walmart has a vast and very complex network of 78 subsidiaries in 15 overseas tax havens as shown on this graphic:

Walmart has been able to keep the existence of these offshore tax havens relatively unknown to the general public; none of the 78 subsidiaries that go by such creative names as Azure Holdings, Bounteous Company Limited, Main Street 824 (Proprietary) Limited Sarl and MCLM III are disclosed in Walmart's annual 10-K filings with the United States Securities and Exchange Commission.  This means that these entities remain invisible to anyone seeking information on corporate tax avoidance.  It is interesting to see how large some of these subsidiaries are; MCLM III holds $31.6 billion in assets, 15 percent of Walmart's total assets.  The exact content of these assets is currently unknown but the company paid $1.8 billion in dividends to the parent company in fiscal year 2013 and 2014.

Here is a listing of the foreign tax havens used by Walmart, the number of Walmart subsidiaries in each, Walmart's total assets held in each jurisdiction (where available) and the number of Walmart stores in each:

You will notice that there is not a single Walmart store located in any of the nations on this list and that Walmart has $64.2 billion in assets held in Luxembourg where it has zero stores.  While Spain is not generally considered to be a tax haven, it appears that it was used by Walmart to avoid taxes on its operations in Argentina.

Here is a listing of some of the countries in which Walmart owns stores (outside of the United States) and the location of the tax haven parent company for each of the operating company location along with the name of the tax haven parent company:

What this is telling us is that Walmart has transferred ownership of these foreign operating companies to its subsidiaries located in tax havens.  It is important to note that publicly available information does not allow the authors of this report to determine whether or not Walmart's Canadian and Mexican operations are owned through subsidiaries located in tax havens.

As you can well imagine, Walmart's web of subsidiaries is very complex because the subsidiaries located in tax havens are integrated into the company through entities that are organized as limited liability companies (LLCs) or limited partnerships (LPs).  Both LLCs and LPs which can be either corporations or individuals located anywhere in the world are used as conduits for moving earnings from one country to another.  For example, an LLC that is located in the United States can receive dividend income from a foreign subsidiary and distribute those dividends to a foreign owner without incurring tax in the United States as long as the LLC's income is not gleaned from business activity that occurs in the U.S.  

Here is an example of how Walmart uses LLCs located in the United States, Canada and the United Kingdom and how they are integrated into the aforementioned tax havens:

As you may have noted, low-tax Luxembourg seems to be preferred tax haven for Walmart.  According to Deloitte, the headline corporate tax rates in Luxembourg range from 20 percent if taxable income is less than 15 million euros and rises to 21 percent if taxable income exceeds 15 million euros (plus an Employment Fund surcharge of 7 percent).  This is significantly lower than the American headline corporate tax rate of 35 percent that Corporate America likes to complain about endlessly.  Since 2009, Walmart has formed 20 new subsidiaries in Luxembourg including five in 2015 alone.  This has allowed Walmart to move in excess of $45 billion in assets into its Luxembourg subsidiaries since 2011.  

How does Walmart extract these funds from Luxembourg?  Documents suggest that Walmart is using short-term, low-interest loans from Luxembourg.  This is a similar tactic that was used by Hewlett-Packard.  The current Internal Revenue code allows these loans to take place as long as they are repaid within 30 days, otherwise they are deemed dividends that are subject to U.S. taxes.  During the first six months of 2014, Walmart took $2.4 billion in loans from its Luxembourg subsidiaries at interest rates of between 0.25 and 0.28 percent.  This allowed Walmart to borrow money (from itself) at ultra-low rates at the same time as it avoids paying U.S. taxes on the funds.  

Walmart is far from the only big American corporation availing themselves of this tax loophole.  The offshore profits of Corporate America has grown from $562 billion in 2004 to $2.1 trillion in 2015.  This offshore hoarding began in 2004 when Congress approved a tax break for repatriated earnings that allowed U.S. companies to bring home their accumulated earnings at a 5.6 percent tax rate.  The recent proposals from the Obama Administration that would see a one-time 14 percent tax on the trillions of dollars of unrepatriated foreign earnings of American multinationals suggest that Corporate America has been busy lobbying for changes that would allow them to bring their earnings back to the U.S. without significant penalty.  Just in case you wondered, here is how much Walmart has spent on lobbying in Washington since 1998:

Most of us have spent at least some of our hard-earned money at Walmart at one time or another whether we liked it or not.  Walmart's relatively slim profits of $16.18 billion on $485.7 billion in sales for the 2015 tax year show us that reducing its tax burden is an important part of its ongoing strategy.  Through the use of tax havens, the massive corporate behemoth take can advantage of options that are not available to its smaller, locally owned and operated competitors to improve its bottom line and further enrich its key shareholders who are already among America's wealthiest. 

Walmart, Tax Fairness and How to Exploit Tax Loopholes

Now that we're getting into the major shopping weeks of the retail year, I thought that this posting was particularly pertinent, given that it's about the world's largest retailer.

Walmart is the largest corporation in the United States with domestic net sales of $279 billion  during fiscal 2014 and corporate-wide net profits of $15.918 billion. Worldwide revenues in 2014 were $476.294 billion with a gross profit margin of 24.3 percent.  In the United States, the company has 1.2 million "associates" or employees as the rest of the world knows them.  This makes Walmart the biggest single private employer in the United States.  According to Forbes, it also happens to have the wealthiest family in America as its owners with Christy Walton having $41.1 billion in assets putting her in sixth place in the U.S. pantheon of the most wealthy, Jim Walton, the youngest son of Walmart founder Sam Walton having $40 billion in assets, putting him in seventh place, Christy's sister-in-law and Sam Walton's daughter, Alice Walton, having $38.5 billion in assets, putting her in eighth place and S. Robson Walton, Sam Walton's oldest son, and Walmart's current Chairman of the Board having a mere $38 billion in assets in 2014, putting him in ninth place.  Not only is Christy Walton one of the richest people in the United States, she is the wealthiest woman in the world.  While all of this information may seem like an unnecessary aside, Walmart, like many of its corporate peers, prides itself on its ability to pay higher and higher levels of dividends to its shareholders.  Walmart proudly announced that it had increased its dividend for the 41st consecutive year to $1.92 per share.  Here is a look at how many shares Walmart's key Walton insiders control from the company's 2014 Proxy Statement:

As you can imagine, by controlling millions of Walmart shares, every time Walmart raises its dividend, the Walton family gets substantially richer.

With that as background, let's look at a report by Americans for Tax Fairness that gives us an idea of how much Walmart pays in taxes and what accounting maneuvers it makes to avoid paying more than it already pays.

As we know, the headline corporate tax rate in the United States is 35 percent.  While they like to complain, most companies pay nothing that even approaches this rate.  Walmart is no exception.  Over the period from 2008 to 2012, Walmart's effective tax rate was 29.1 percent, with loopholes allowing the company to reduce its tax bill by $5.1 billion over the five year period.  Walmart accomplished this by using "accelerated depreciation" which allows companies to write-off any capital investments that they make faster than those capital goods wear out.  In straight-line depreciation, an asset depreciates at the same rate throughout its useful life.  When companies use accelerated depreciation, as time passes, the effect reverses and there is less depreciation available to shelter income.  Accelerated depreciation is a means of deferring taxes into the future but as long as a company continues to make new capital investments, the tax deferral mechanism becomes more or less indefinite.

As a company that operates outside of the United States, Walmart is also able to avoid paying taxes on its ample offshore profits.  In 2008, Walmart's offshore entities earned net profits of $10.5 billion.  This rose to $21.4 billion in 2013 as shown on this graph which also shows how Walmart's capital expenditures on its international operations have not risen since 2008:

Walmart will pay $0 in taxes on these offshore profits as long as they are not returned to the United States.  Under a territorial tax system, all U.S. taxation of Walmart's overseas profits would be eliminated and Walmart would pay taxes solely in the country in which they are earned.  Countries with lower corporate tax rates than the United States will then become particularly appealing targets for operational expansions as shown on this chart which shows the top ten nations receiving additional profits under a territorial system and their effective tax rates on United States affiliates:

  

This means that Walmart would be creating jobs outside of the United States rather than at home, in fact, this commentary shows that a territorial tax system would created 800,000 jobs in low-tax nations.  

As I am prone to do, let's see how busy Walmart has been in Washington.  Here is a screen capture showing how much Walmart has contributed to political candidates in the 2014 cycle:

Walmart's 2014 cycle contributions of $2,403,466 puts the company in 88th place overall among 16,411 donors.

Here is a chart showing the actual size of the overall contributions made to Democrats and Republicans:

It is quite clear that Walmart/the Walton family have a strong preference for donations to the Republicans over the Democrats.  It's also interesting to see how the level of their donations rose markedly during the 1990s and how the level has pretty much flatlined since the 2004 Presidential cycle.

Here is a graph showing how much Walmart has spent on the all important game of lobbying in Washington since 1998:

So far in 2014, Walmart has spent $5.22 million on lobbying.  In its peak year of 2011, Walmart spent  $7.84 million on lobbying.  As you can see on this chart, thus far in 2014, among its retail sector peers, Walmart has spent the second-most on lobbying after CVS Health:

In 2014, Walmart has 74 lobbyists with 81.1 percent being revolvers, that is, they have previous connections/employment in Washington.  

Here is a chart showing the issues that have been of most concern to Walmart in 2014:

Not surprisingly, Walmart is most concerned about taxes.

Now, let's travel to an imaginary world for a moment and pretend that America actually has a functional Congress.  If Congress were to sit down and agree to lower the headline corporate tax rate by 10 percentage points to 25 percent, based on the $87 billion in profits that Walmart earned over the five years from 2008 to 2012, they would have paid $3.6 billion less in taxes or $7 billion less over a ten year period.

Perhaps instead of its former "Always Low Prices" motto, Walmart's could recycle and revise its new motto to read "Always Low Taxes".

Walmart and its Impact on Housing Prices

In many communities, the building of a new Walmart is far from welcome.  Some of the complaints include increased traffic volumes, pricing that puts local merchants out of business, lower wages that push down wages for those working at competitors and downward pressure on the price of housing because of the visually unappealing prospect of having another big box store plus the accompanying retail outlets as a neighbour.  There has been substantial research regarding the labor-effects of Walmart but there has been little actual study on the impact of Walmart on local housing prices.  A study by Devon Pope at the University of Chicago and Jaren Pope at Brigham Young University looked at over a million housing transactions that took place near 159 new Walmart stores that opened between 2000 and 2006 to see if the opening of a Walmart really did have an impact on the price of nearby housing.    Here are their conclusions.

As background, according to Walmart's 2014 Annual Report, Walmart served nearly 140 million weekly shoppers to its fleet of 4203 American stores (excluding Sam's Club which adds another 632 stores) during fiscal 2014.  Walmart employs 1.2 million "associates" or nearly 0.8 percent of the U.S. workforce.  During fiscal 2015, Walmart plans to add between 21 and 23 million retail square feet or the equivalent of between 385 and 415 units.  ttle actual study on the impact of Walmart on local housing prices.

The authors first examined the history of Walmart openings to get a sense of Walmart's preferred demography.  They noted that during the 1970s, 1980s and 1990s, Walmart tended to build their stores in counties where median household incomes were $3000, $2000 and $1000 below the average for the state respectively.  This changed during the period of the study, between 2000 and 2006, Walmart built new stores in counties where the average median household income is approximately $2000 above the average for the state.  This means that Walmart is no longer tending to build in communities with lower incomes and is trying to appeal to a different demographic group.

The building of a Walmart store is often accompanied by an overall retail expansion in the nearby area.  Additional businesses will set up, using Walmart as the attraction for customers.  If households find it desirable having convenient access to additional goods and services nearby then having a new Walmart could have a positive impact on housing prices.  If, on the other hand, the building of a new Walmart leads to increased traffic, increased light and noise pollution and increased crime among other issues, there would be an adverse impact on housing prices.

As I noted above, the authors used two datasets:

1.) data showing where and when Walmart opened new stores in the period between 2000 and 2006 as shown here:

2.) data for more than one million real estate transactions that took place within four miles of one of the 159 new Walmarts that opened between 2000 and 2006 as shown here:

The authors used the dataset to compare the selling prices of homes before a Walmart opened and after it opened along with comparing prices for homes very close to a new Walmart to those somewhat further away. 

The authors conclusions suggest the following:

1.) the opening of a new Walmart store increases housing prices by between 2 and 3 percent for houses located within a half mile of the store.

2.) the opening of a new Walmart store increases housing prices by between 1 and 2 percent for houses located between one-half and one mile of the store.

This suggests that the average selling price of a home within one-half mile of a new Walmart would increase by approximately $7000 and by $4000 for homes located between one-half and one mile of the store.

The results also suggest that the positive impact on housing prices was slightly larger within a half mile of a new Walmart Supercenter than for a regular Walmart.  In the half to one mile radius, the impact of a Walmart Supercenter was even greater, increasing housing prices by approximately 2 percent. 

Overall, the benefits of easy and quick access to lower retail prices offered by Walmart is seen to outweigh the negative impacts of having a nearby Walmart.  This relationship holds for an average situation, however, their are other external factors that may, in some cases, cause real estate prices to decline when Walmart "comes to town".