Excessive Corporate Profiteering from the COVID-19 Pandemic - A Potential Solution

While it got almost no traction in what passes for the media today, a recent House Resolution introduced by Representative Tulsi Gabbard (HI-02) looks to punish large corporations (i.e Amazon, Walmart, Zoom etcetera) that gleaned excessive profits from sales during the pandemic.  

  

Here is the text from H.Res. 1267 "Expressing the sense of the House of Representatives that Congress must pass a pandemic excess profits tax on large corporations who have achieved windfall profits due to the COVID-19 public health crisis":

 

Here is a screen capture from Ms. Gabbard's website outlining her reasons for introducing the excess profits tax:

 

Here is the key paragraph:

 

"Big tech corporations and big box retailers are among those who have made excessive profits during the COVID-19 pandemic, while mom and pop shops are being forced to close their doors due to government-mandated restrictions. Because of this, these large corporations will be better positioned with a competitive advantage over small businesses in a post-pandemic economy. Congress must reinstate the WWII-era excess profit tax used at that time to prevent war-time profiteering, and dedicate the funds collected to helping small businesses recover. Small businesses are the backbone of our economy and have borne the brunt of this crisis. We need to support our small businesses and make sure that they are able to thrive and compete."

  

Recent research by Robin Greenwood et al at the National Bureau of Economic Research found that small firms were particularly at risk thanks to the COVID-19-related shutdowns.  Here is a quote (my bolds):

 

“Small firms are especially vulnerable to the crisis, not not because the pandemic has especially affected industries dominated by small firms, but instead because small firms􏰃 balance sheets are more vulnerable to losses in revenues.

 

Figure 6 confirms that large firms in need of restructuring have multiple options available, while small firms have no other option but to liquidate. Above $500m of liabilities, close to 80% of the bankruptcy filings end up as a Chapter 11-backed reorganization. The contrast with small businesses is striking: Below $1m of liabilities, 90% of the filings are straight-out liquidations, while less than 5% of bankruptcies end- up as re-emergence from a Chapter 11 filing. For a small firm, failure typically means liquidation....

 

Frictions to restructuring small firms are substantially larger. Even small disruptions to cash flow can trigger restructuring as many of these firms maintain low cash buffers and lack access to lines of credit (Bartik et al 2020). Based on the June 27 Census Pulse Survey, including financial assistance and loans, only 30% of small businesses reported having enough cash to maintain operations for another three months....

 

Chapter 11 bankruptcy imposes costs that can be as high as 30% of a small businesses, making it close to prohibitive for many small businesses even if they wish to continue. Consistent with this, small firms are more likely to simply shut down."

 

Here is a graphic from the paper showing the percentage of small businesses in various sectors of the American economy that have experienced a severe negative impact thanks to the COVID-19 response:

 

Here is a graphic from the paper showing the year-over-year change in revenues across the same industries:

 

 

In sharp contrast, let's look at one of the leading contenders for excessive profiteering, Amazon. Here are a selection of graphics showing key metrics from the company's Q3 report:

As you can see, on a year-over-year basis, Amazon's net sales are up 37 percent and net income is up 197 percent despite the fact that the economy was in a recession and that many consumers saw their household incomes slashed.

 

While it is unlikely that Representative Gabbard's proposal will ever see the light of day as it winds its way through Congress, it is quite clear that Amazon is one of the bill's prime targets.  Given that Amazon appears to have been guilty of price-gouging during the pandemic as you can see here, unless we all want to shop at the world's largest online emporium and make Jeff Bezos even wealthier, something will have to be done to ensure that Main Street American businesses have an opportunity to sell their goods on a level playing field.

Corporate America's Debt Problem

Updated October 2018

History shows us that economic contractions are never predicted, particularly by central bankers.  One aspect of the economy is growing worrisome and could prove to be extremely problematic during the next recession.

Here is a graph from FRED showing the growth in seasonally adjusted GDP going back to 1947:

Here is a graph showing the growth in non-financial corporate debt going back to 1945:

Now, let's combine the two and look at non-financial corporate debt as a percentage of GDP:

Over the six and a half decades since 1951, corporate debt as a percentage of GDP averaged 18.09 percent.  In sharp contrast, during the second quarter of 2018, corporate debt was 30.44 percent of GDP, just below its all-time high of 31.31 percent in the third quarter of 2017.  Prior to the Great Recession, corporate debt was only 22.2 percent of GDP during 2006; since then, corporate debt as a percentage of the economy has grown by 9.11 percentage points or 41 percent.

Let's look at another aspect of the corporate world, after tax profits, and compare this metric to corporate debt.  Here is a graph showing the growth in profits since 1947:

While that metric of corporate health looks quite good, let's go on to add corporate debt (in red) to the graph showing corporate profits (in blue):

You will observe that there is a substantial and growing divergence between the two key measures of corporate health.

Now, let's subtract corporate profits from corporate debt to show how quickly corporate debt is growing when compared to corporate profits, a phenomenon that I term "the corporate profit-to-debt gap":

In the first quarter of 2018, the corporate profit-to-debt gap reached $4.251 trillion, slightly below its all-time high of $4.452 trillion which was reached in the fourth quarter of 2017.  As well, the corporate debt-to-profit gap has risen by $1.999 trillion or 88.8 percent since its post-Great Recession low.

There is one factor that has created this unsustainable situation for Corporate America as you can see here:

...and here showing the ICE BofAML US High Yield CCC or below effective yield, in other words, the yield on the junkiest of what Corporate America has to offer as debt instruments:

Given the desperate search for yield following the Fed's near-zero interest rate policies of the post-Great Recession period, investors have pushed the yield on even the riskiest of corporate debt to extremely low levels that do not reflect the risk involved.

Thanks to the Federal Reserve, Corporate America has been able to accumulate unprecedented levels of debt that, at least in some cases, will prove to be difficult to service during the upcoming recession when the growth in the profit-to-debt gap and the high level of corporate debt as a percentage of GDP come home to roost.  Unfortunately, investors (and central bankers) won't see the crisis until it's already upon us.

Corporate Financial Strip Mining - The Plague of Stock Buybacks

A paper by William Laconic entitled "Profits Without Prosperity" looks at the main reason why high levels of corporate profitability after the Great Recession have not translated into economic prosperity for Main Street, USA.

Here is a graph from FRED showing what has happened to after tax corporate profits since 2000:

While the growth in corporate profits has levelled somewhat since 2012, at $1.679 trillion in the third quarter of 2016, profits have grown by $270 billion since their pre-Great Recession peak in 2006.  With that in mind, why has it seemed like Corporate America appears to be suffering from lethargy?  According to the author of the paper, the blame can be laid at the feet of corporate stock buybacks.  Let's look at a bit of corporate history to help explain the current situation.

From the end of the Second World War until the 1970s, Corporate America took a "retain and reinvest" approach to business; they retained their earnings and reinvested them in both human and mechanical capital.  Companies used their profits to train their workforces and purchase additional machinery (among other things) to improve their competitiveness, ultimately leading to higher but sustainable levels of both profitability for companies and prosperity for workers.  This approach can be considered value creation.  In the late 1970s, things began to change; companies changed their operating philosophy and took a "downsize and distribute" approach; they reduced costs and distributed the increased cash to shareholders.  Companies reduced investments in both human and mechanical capital and used the freed up cash to enrich both employee and non-employee shareholders which led to increased income inequality and higher base levels of unemployment.  This approach can be considered value extraction.

It should not be surprising to anyone who has been paying attention over the past few years, but the value that Corporate America has extracted from itself has been used to enrich company executives at the same time as the growth in wages for "working stiffs" have done this since 1978:

Over the past 15 years, real wages have increased by a paltry 12.8 percent while CEO compensation has done this (again, compared to 1978 compensation):

With stock-based compensation forming a larger and large part of overall executive salaries, its pretty obvious who benefits from the "downsize and distribute" approach to doing business.

One of the key ways that Corporate America has implemented the "downsize and distribute" model is through the use of stock repurchases.  By repurchasing its own stock, a company removes those shares from its overall outstanding share inventory and can then provide Wall Street with higher per share earnings numbers, the key metric to maintaining the appearance of business success.  This is often touted as a way of returning value to a company's shareholders including even the smallest of shareholders.  

All of this stock repurchasing began in 1982 when the SEC instituted Rule 10b-18 of the Securities Exchange Act which redefined how equities could be purchased by the issuer of those equities  This rule provided a "safe harbour" for companies when that company wishes to repurchase its own shares; in other words, companies would not be deemed to have violated the anti-fraud portions of the Securities Exchange Act of 1934.  Purchases had to meet the following criteria:

1.) Manner of purchase: The issuer or affiliate must purchase all shares from a single broker or deal during a single day.

2.) Timing: An issuer with an average trading volume less than $1 million per day or a public float value below $150 million is unable to trade within the last 30 minutes of trading. Companies with higher average-trading-volume or public float value can trade up until the last 10 minutes.

3.) Price: The issuer must repurchase at a price that does not exceed the highest independent bid or the last transaction price quoted.

4.) Volume: The issuer can't purchase more than 25% of the average daily volume.


This change to the Securities Exchange Act opened the proverbial can of worms.  The SEC only requires companies to report total quarterly purchases rather than daily purchases, meaning that it cannot determine whether a company has actually breached the 25 percent limit on any given day.  Even with the 25 percent limit, companies with very high market capitalization can purchase hundreds of millions or even billions of dollars worth of their own stock on a given day.  Basically, Rule 10b-18 legalized stock market manipulation through open market stock repurchases.

Let's look at the top ten repurchasers for the period between 2003 and 2012 and how much of each company's net income went into repurchasing their own stock:

These 10 companies spent a combined $859 billion on stock buybacks between 2003 and 2012.  During that same ten year period, the CEOs of these same companies received, on average, total compensation of $168 million each with 34% of that compensation in stock options and 24% in stock awards.  As well, the data shows that, in seven out of the ten companies, the combination of dividends paid to shareholders and funds spent on repurchasing stocks consumes more than 100 percent of net income over the ten year timeframe.

What we see from this report is that Corporate America is far more interested in enriching itself through stock repurchasing than it is in investing in innovation and human and mechanical capital.  This could easily be termed corporate financial strip mining; companies strip their own livelihood and future potential to benefit their own insiders and those on Wall Street over the short-term.  This has led to a situation where employment is far less secure than it was in the decades immediately after the Second World War and where those who dwell in the upper floor corner offices get wealthier and wealthier while their workforce falls further and further behind. 

Corporate America - Profits and Taxes

I have posted on the subject of corporate profits and taxes before, however, in light of the changes in the corporate tax regime proposed by the Obama Administration, the subject is worth revisiting.

Let's open with a graph that shows both after-tax corporate profits (in blue) and corporate federal taxes paid (in red) since 1990:

Between the fourth quarter of 2007 and the first quarter of 2013, corporate profits rose from $1.314 trillion to $1.694 trillion, an increase of $380 billion.  Between the first quarter of 2008 and the first quarter of 2013, corporate tax remissions to Washington rose from $233.7 billion to $384.9 billion, an increase of $151.2 billion.

Here is a graph showing now the difference between after-tax profits and corporate federal taxes remitted has grown since 1990:

In 1990, the difference between after-tax profits and corporate federal taxes was $140.5 billion.  This rose to $1.376 trillion in 2013, an increase of $1.236 trillion or 879 percent.

Here is a graph that shows how Federal tax revenues as a percentage of total receipts has varied over the decades since 1950:

Corporate taxes (in black) declined from nearly 30 percent of total federal tax revenues in the 1950s to as little as 6 percent since the 1980s.

Here is another interesting graph that shows how federal tax revenues as a percentage of GDP has changed since the 1950s:

Corporate taxes (in black) have declined from over 6 percent of GDP in the 1950s to 1 percent in 2010.

In its 2016 budget, the Obama Administration is targeting what are termed "indefinitely reinvested earnings or IRE", those earnings by American corporations that are held overseas to avoid paying United States corporate taxes.  In case you wondered how much money is held overseas by Corporate America, here is a table from Audit Analytics data that shows how the IRE balances have grown since 2008:

By the end of 2013, U.S. companies in the Russell 1000 (the large capital segment of the U.S. equity market) held a total of $2.119 trillion in overseas earnings, up by 93 percent from $1.098 trillion in 2008.  It is also interesting to note that the number of companies using this tax strategy grew from 472 in 2009 to 547 in 2013.  As well, as a percentage of total assets, IRE balances have risen from 5.8 percent in 2008 to 8.71 percent in 2013.  It is these earnings that the Obama Administration is targeting with its"transition toll charge".   The administration has proposed a one-time toll charge of 14 percent on untaxed foreign retained overseas earnings, regardless of whether or not the earnings are repatriated, which would bring in an estimated $238 billion that would be allocated directly to the Highway Trust Fund to be used to repair the badly decaying national transportation infrastructure.

Let's look at a table that shows specific company data on the ten companies with the highest foreign IRE balances for the 2013 tax year and their effective tax rates:

Of course, in all cases, these corporations are functioning wholly within all foreign and United States tax laws.  What I found interesting was the fact that, in some cases, foreign retained earnings make up a very substantial part of a company's total assets, as high as 54 percent in the case of Merck and 53.6 percent in the case of Microsoft.

According to the Government Accountability Office, for the 2010 tax year, profitable U.S. corporations paid U.S. federal income taxes (i.e the effective tax rate or ETR) amounting to 12.6 percent of their worldwide pre-tax profits as reported on their financial statements.  When foreign, state and local taxes are included, their tax burden rose to an effective tax rate of around 17 percent, less than half the headline federal corporate tax rate.  This shows us that the effective corporate tax rate can vary significantly to the downside from the statutory tax rate.  As well, according to the Congressional Research Service, while Corporate America likes to complain that the top statutory corporate tax rate of 35 percent is highest in the world, the effective tax rate of only 23 percent is below the weighted average effective tax rate of the six largest OECD economies.

There is a strong corporate lobby in Washington that has the goal of shifting the tax burden away from Corporate American and placing it firmly into the hands (and wallets) of consumers.  Unfortunately for voters, it is these same corporations that donate billions of dollars to the campaigns of the politicians who have the power to reduce corporate taxes.