End of Week Notes
Sustainable investors shouldn’t cheer a corporate tax cut
Investors in general have been cheering the prospect of a corporate tax cut. It’s one of the reasons for the stock market’s continued climb into record territory. As investors, we get it that, while claims of economic growth, increases in jobs and higher wages may be dubious, shareholders are almost certain to benefit, if they haven’t already. As sustainable investors, we can be happy for ourselves and for our clients for our good fortune, but we should also recognize the proposed corporate tax cut for what it mainly is: a short-term boon for mostly wealthy investors at the expense of the long-term sustainability of the U.S. economy.
While tax “reform” has quickly morphed into tax “cuts”, this is the one agenda item that the market and many other observers still believe Trump and the Republican Congress can deliver. At this point, I’m not convinced they can accomplish anything of the sort. Remember, these are the same people who were totally and rabidly opposed to Obamacare repeal, but couldn’t pull it off in multiple tries. And now, who’s to say the “Bannon wing” of the party isn’t positioning itself to sabotage tax cuts so as not to hand an accomplishment to the “swamp wing” of the party to run on in 2018, helping smooth the path for Bannon-wing primary challengers? We’ll see about that.
But I digress.
Lower corporate rates are almost certain to be a near-term boon to investors, sustainable investors of course included. Lower taxes will increase after-tax corporate profits, which will be passed along to shareholders. Warren Buffett, who otherwise is dubious of its broader benefits, says a corporate tax cut “would be good for a million shareholders of Berkshire in terms of their returns.” Eaton Vance portfolio manager Michael Allison told CNBC yesterday that tax “reform” (his word) could help lift stocks 5% to 10% higher from their current all-time highs. Others suggest the impact may already be priced in, making it likely that stocks would fall if a tax-cut package fails. In any event it’s hard to imagine anything but a burst of market euphoria accompanying passage of a tax bill — not only for its substance but for renewed hope that Republican governance will approach normalcy.
While those of us who are sustainable investors will benefit short-term from tax cuts along with investors overall, we should bear in mind that the likely long-term economic effects will be anything but sustainable.
First of all, there is little evidence that corporate tax cuts will have a positive direct impact on economic growth, jobs, and wages. Proponents contend that corporate tax cuts will lead businesses to invest and expand, and also will spur new business formation. But Warren Buffett says he has never seen anyone “shy away from a sensible investment because of the tax rate on the potential gain”. And here is Marcus Ryu, co-founder and CEO of GuideWire Software, in a recent op-ed piece in the New York Times:
As an entrepreneur myself and a friend to many others, I know that lower tax rates will not motivate more people to start companies. People start companies for many reasons: a compelling idea, ambition for fame and fortune, a desire to be one’s own boss, frustration with one’s employer. I have never heard someone say, “I would have started a company, but tax rates were too high” or “I wouldn’t have started this company, but then George W. Bush cut tax rates, so I did.”
There is little evidence that established companies have been holding back on investing in their businesses in the aftermath of the Great Recession because of high corporate tax rates. Corporate profits have been at or near record highs. Interest rates have been ultra-low. Businesses have had plenty of ways to raise capital for investment and ample means to raise wages. That they haven’t done so has to do with things like post-recession psychology, lower productivity, and a shrinking labor force lacking relevant skills. The latter problem, incidentally, is why we need more immigrants, not fewer.
Tax cuts not only are unlikely to boost long-term economic growth, jobs, and wages, they almost assuredly will come at the expense of increased federal deficits, adding to the overall federal debt at a time when the number of entitlement beneficiaries is also growing significantly. Here we’re not only talking about the impact of corporate cuts but of the entire tax package (such as it is — to this day, there still is no specific package on the table).
Early estimates are that the tax cuts would add $1.5 trillion to the deficit over the next decade. There isn’t much evidence that tax cuts will spur economic growth, but there is no evidence at all that they will unleash enough growth to generate additional tax revenue to cover an increased deficit. That didn’t happen after the Reagan tax cut in 1981; it didn’t happen after the Bush tax cut in 2001; and it certainly didn’t happen in the state of Kansas after it slashed taxes in 2012.
A deficit-exploding tax cut comes with enormous opportunity costs, even as it makes it more expensive to pay for existing obligations. Republicans are often accused of hypocrisy for acting like deficit hawks when Democrats are in power and then ignoring deficits when they have the power to pass tax cuts. There is a logic to their position, though. Today’s Republican Party is not a fiscally conservative party; it’s an anti-government party. More than anything, Republicans want to de-fund government. That means when Democrats are in power and seeking to expand government programs and services, Republicans rely on the deficit-hawk argument, warning of the dire consequences of growing the long-term federal debt. And when they are in power, Republicans tout tax cuts and ignore deficits because tax cuts are popular and they know that the larger the annual deficit gets and the more the overall debt grows, the more pressure they can ultimately exert to de-fund government.
For long-term economic growth that results in a more sustainable and more equitable economy, however, we need to invest in our economy and our people. That means investing in our infrastructure, which is not only aging, it is increasingly stressed by the impacts of climate change. To make sure our labor force is better matched with employment opportunities, we need to invest in education and job training. To make sure we remain innovative and competitive in the development of the industries that will lead a low-carbon economy, we need to invest in science and research. And to care for all of our citizens, we need to provide healthcare while continuing to provide for retirement security and for those in need. These are things that won’t happen, or their implementation will be significantly delayed, if another round of tax cuts blows up the deficit.
For all investors, tax cuts may enhance returns over the short run, but if they don’t spur economic growth, drive up government debt, and stand in the way of needed long-term investment, they will be destructive to long-term value creation for investors. Same can be said for our economy, climate, and society.
