G7 nations reached an agreement on a global minimum tax over the weekend after years of discussions at the OECD. At a basic level, the framework would prevent companies from shifting profits to low tax jurisdictions and ensure the biggest multinationals pay more tax in the countries in which they operate. In return, the U.S wants European nations and others to drop their Digital Service Taxes that target American Big Tech companies, but many negotiations still await.

Bigger picture: In its current form, the deal would require that companies pay at least a 15% tax on income, regardless of where they are based, making it less advantageous to relocate operations to countries with lower tax rates. The rules would apply to multinationals that have a profit margin of at least 10%, while governments would share the right to tax 20% of profits above that threshold. For example, an online company that has no physical presence in a country, but has significant sales there via digital advertising, would be obligated to pay some taxes to the government of that nation.

The debate touches on the ongoing friction in international taxation: whether to tax companies based on the location of their income or the location of their headquarters. While administration officials like Treasury Secretary Janet Yellen said the new framework will halt a global “race to the bottom” on corporate taxes, others feel that it could be hard to enact and enforce on an international scale. The fine print is also in question, such as accounting rules, subsidies and exemptions for R&D and capital investment.

More hurdles: The new tax rules would have to apply globally, meaning the support from other large economies like China and India. Treasury chiefs are hoping for breakthroughs at the G20 and OECD by mid-year, as well as the backing of over a hundred countries that have been negotiating the new rules as part of the so-called Inclusive Framework. Some big obstacles also lie ahead, like in Ireland, which has a low tax rate to encourage foreign investment, and in China, which wants to retain control over its tax policy, but if the effort picks up speed it may be hard not to bow to the pressure.

The new tax approach could run into opposition in the U.S., where Janet Yellen needs to sell the deal to Congress. The changes could require the U.S. Senate to alter existing tax treaties, which would take a two-thirds vote and at least some GOP support. Republicans have already expressed opposition to any rise in taxes, while some lawmakers have condemned the idea of ceding taxing authority to other governments. Business groups have also complained that higher taxes could threaten the economic recovery as American companies navigate their way out of the coronavirus pandemic.

 

President Biden’s Push to Raise Corporate Taxes and Unionize Jobs

 

Janet Yellen’s latest commitment to support the Biden progressive agenda from higher taxes to unionization, will not lead to increased economic prosperity. Instead, it will lead to more outsourcing and offshoring of U.S. Labor. Such was evident in two recent comments.

“With corporate taxes at a historical low of one percent of GDP, we believe the corporate sector can contribute to this effort by bearing its fair share: we propose simply to return the corporate tax toward historical norms.”

And;

“Workers, particularly lower-wage earners, have seen wage growth stagnate over several decades, despite overall rising productivity and national income. There are several contributors to this troubling trend, but one important factor is an erosion in labor’s bargaining power.”

In theory, there is nothing wrong with either of these two statements. Why not have corporations pay more in tax and push companies to unionize?

In reality, however, if Janet Yellen and Joe Biden get their wish, it would lead to a sharp increase in the offshoring of manufacturing and employment.

Let’s dig into both of these issues.

 

Increase Corporate Tax Rates

 

Increasing corporate tax rates certainly seems like an easy task. However, the negative impacts of increasing taxes on the primary suppliers of employment will likely outweigh the revenue increase. 

Let’s start by understanding some of the most basic facts.

In the U.S. there are roughly 30.7 million businesses. Of those, 81% have ZERO employees. Such is important to understand because many of these “businesses” are set up for tax shelters and estate planning purposes.

The remaining 19% employee 100% of all non-governmental workers.

 

 

Importantly, when Yellen suggests we raise taxes on corporations, she is primarily talking about the roughly 10,000 major corporations in the U.S. However, 50% of all jobs are created by firms with fewer than 500 employees, and almost 90% by firms with less than 1000.

 

 

While Yellen is suggesting we go after those “evil corporations,” she is only talking about a fraction of the businesses that employ workers. However, the impact of higher taxes, unionization, etc., impact all businesses and hurts the small business owners that employ the most workers the most. 

Such was a point made by the Chamber of Commerce in response to Janet Yellen’s statement:

“The data and the evidence are clear: the proposed tax increases would greatly disadvantage U.S. businesses and harm American workers, and now is certainly not the time to erect new barriers to economic recovery.” – Suzanne Clark, CEO/President US Chamber of Commerce.”

 

Unionization Is A Barrier To Employment

 

As we discussed recently, the cost of operating a business is increasing. For small businesses which already struggle to remain profitable, increasing the cost of “labor” is problematic. The cost of a “union shop” costs nearly 1/3rd more to operate than a “non-union” shop.

“Research indicates that the cost of running a unionized operation is 25% to 35% greater than for a non-unionized one, and this figure does not reflect any negotiated changes in unionized employee wages or benefits.

The administrative budgets of the unionized plants were 30% higher. In addition to obvious increased costs, there are those that affect morale, creativity, and resiliency. Ultimately, an organization’s profit margin can decline. Productivity appears to be lower in unionized environments.” – Adams, Nash, Haskell & Sheridan

 

 

Increased costs of labor are the primary reason why companies look to “offshore.”  To wit:

“The two main reasons that organizations decide to outsource are to reduce costs and to have the ability to focus on core business goals and planning. But the research shows a shift in industry thinking. Outsourcing is not just about saving money anymore. It’s seen as a critical tool in innovation.” – Deloitte

 

 

Of course, the companies that are outsourcing labor are the industries with the highest wage-paying jobs.

“The primary industries for outsourcing are Consumer & Industrial Products, Financial Services, Life Sciences & Healthcare, and Technology, Media & Telecomm. There has also been a growing increase in outsourcing from industries such as Real Estate, Facilities Management and Procurement.”

That leaves the lower-wage paying jobs in the U.S. which are being automated to further save costs.

 

The Carrier Reality

 

A great example of trying to “onshore” jobs came with the Carrier company.

Pay attention to the details.

The deal made with Carrier Industries, which makes heating, air conditioning, and refrigerator parts, meant roughly 1,000 workers would keep their jobs in Indiana. However, in exchange for keeping those jobs in Indiana, Carrier received $7 million in tax credits and other incentives which fell to the taxpayers of Indiana. Carrier also invested $16 million in its Indianapolis plant.

According to Carrier, they would have saved $65 million a year by moving operations to Mexico. 

So, how do tax credits and company investment of $16 million equalize the disparity of costs?

For that answer let’s go to an interview with Greg Hayes, the CEO of Carrier: (Transcript courtesy of Business Insider)

JIM CRAMER: What’s good about Mexico? What’s good about going there? And obviously what’s good about staying here?

GREG HAYES: So what’s good about Mexico? We have a very talented workforce in Mexico. Wages are obviously significantly lower. About 80% lower on average. But absenteeism runs about 1%. Turnover runs about 2%. Very, very dedicated workforce.

JIM CRAMER: Versus America? Much higher.

GREG HAYES: Much higher. And I think that’s just part of these — the jobs, again, are not jobs on an assembly line that people really find all that attractive over the long term. Now I’ve got some very long service employees who do a wonderful job for us. And we like the fact that they’re dedicated to UTC, but I would tell you the key here, Jim, is not to be trained for the job today. Our focus is how do you train people for the jobs of tomorrow?

 

Entitlement Is A Problem

 

While foreign countries have cheaper labor (not demanding $15/hr) they also have a more dedicated workforce. To wit:

GREG HAYES: The assembly lines in Indiana — I mean, great people, great people. But the skill set to do those jobs is very different than what it takes to assemble a jet engine.

There are several problems that should be readily evident with American workers:

  • We believe we are entitled to higher wages, benefits, time off, support, bonuses, health care, etc. 
  • Our skill set, and dedication to the job, lags that of other countries. 
  • We now believe “blue-collar” work is degrading. 

As we discussed in “The Adverse Consequences Of $15/min Wage:”

“Increasing the cost of employing low-wage workers generally leads employers to reduce the size of their workforce. The effects on employment cause changes in prices and different labor and capital types.

By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers.

Higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices. Those higher prices, in turn, lead consumers to purchase fewer goods and services. The employers consequently produce fewer goods and services, reducing their employment of low-wage and higher-wage workers.”

Here is the most important point:

“When the cost of employing low-wage workers goes up, the relative cost of hiring higher-wage workers or investing in machines and technology goes down.”

While U.S. workers believe they are entitled to higher wages, employment is ultimately driven by competition, costs, and relative skills.

 

Yellen’s Prescription Won’t Work

 

So, as I asked earlier, how do you equalize the cost of saving $65 million annually by moving a plant to Mexico in exchange for $7 million in one-time tax credit and incentives?

That is where the $16 million investment came in.

In order to justify keeping the Indiana plant open, the company injected $16 million to drive down the cost of production and reduce the operating gap between the US and Mexico.

GREG HAYES: Right. Well, and again, if you think about what we talked about last week, we’re going to make a $16 million investment in that factory in Indianapolis to automate to drive the cost down so that we can continue to be competitive. Now is it as cheap as moving to Mexico with a lower cost of labor? No. But we will make that plant competitive just because we’ll make the capital investments there.

JIM CRAMER: Right.

GREG HAYES: But what that ultimately means is there will be fewer jobs.

While the idea of higher corporate taxes and unionization sounds great in theory, businesses operate from a position of profitability.

However, Yellen’s prescription of unionization and taxes won’t reduce the employment, wage, or wealth gap. Instead, those policies will only create incentives for businesses to fight back by passing on costs, reducing labor, increasing automation, and offshoring labor.

 

Truth About Inflation

 

70% of the increased price inflation comes from 5 items, all of which jumped due to unusual pandemic-related factors. There’s little reason to expect persistent inflation from here

  • Higher inflation readings were a given. The critical question is whether they are truly “transitory” or not.
  • Five items account for 70% of headline inflation pressure: Energy commodities, used vehicles, restaurant meals, auto rental and airline fares.
  • All these represent oddities of today’s economy compared to nationwide business closures a year ago. There is no reason to think they will persist.
  • Long-term Treasury yields are most sensitive to inflation pressure. If bond traders truly expect 5% sustained inflation, yields should be much higher.

Next week’s Fed policy meeting will be a juggling act. They will no doubt talk about tapering stimulus while also continuing to call inflation transitory. Everybody wants to know what’s next, but the truth is even the Fed doesn’t know.

 

Market Data

 

  • In recent weeks, there has been a surge in global equity indexes hitting 52-week highs. At the same time, there are fewer U.S. industries also reaching 52-week highs. When there are spreads like this, it has been a good sign for the MSCI World Index relative to the S&P 500.
  • It’s been a tough couple of days for inflation-sensitive stocks as the market comes to terms with the Fed’s “transient” inflation narrative.
  • Inflation-adjusted earnings and dividend yields are at multi-decade lows.
  • Ford has outperformed Tesla year to date.
  • VIX hit the lowest level since the start of the pandemic.
  • Last week we saw a return to the options market among speculative traders, with bets on call options picking up once again.
  • The S&P 500 has been stagnating while other indexes like the Russell 2000 have been picking up the slack.
  • Overseas markets are showing some thrusts, too. Bonds and oil are both showing signs of extreme optimism.

 

US Economy

 

  • The May jobs report came in below economists’ forecasts.
  • As we saw last month, there is no shortage of demand for labor. Instead, job growth is constrained by supply, which is pushing wages higher in some sectors
  • Nonetheless, bond yields and the dollar reversed Thursday’s gains.
  • The unemployment rate dipped below 6%.
  • Cornerstone Macro expects the labor market to keep tightening, with the unemployment rate hitting 2.9% by the end of next year.
  • The labor force participation rate remains depressed
  • Consumer spending is still near 20% higher than 2019 levels.
  • The partisan gap in consumer confidence remains wide.

 

 

  • Home price appreciation by state

 

 

  • The moratorium on student debt payments ends in October. Many borrowers have stopped paying and are hoping for debt forgiveness. Absent such a policy change, we are likely to see delinquencies climbing back to pre-COVID highs and perhaps even higher.
  • The U. Michigan real household income expectations have rolled over as inflation expectations climb.
  • Nomura expects the May core CPI to moderate from April but remain above trend.
  • The labor market continues to tighten, with the latest job openings indicators hitting record highs (well above consensus forecasts). Note that both the absolute number and the openings rate have been surging.
  • Manufacturing (factory jobs are here; workers are not)
  • The rate of voluntary resignations (quits rate) hit a record high, pointing to confidence in the job market and rising competition for workers.
  • The spike in resignations points to higher wage inflation.
  • The May NFIB Small Business Optimism Index was below expectations.
  • The NFIB report points to acute labor shortages.
  • Inventories are extremely tight due to supply constraints.
  • Businesses now have pricing power. They are raising prices and plan to keep doing so in the months ahead.
  • Markets are pricing cyclical (temporary) rather than structural (long term) inflation pressures.
  • Airline fares are rebounding.
  • Which sectors benefitted the most from COVID?

 

 

  • Another below-expectations payroll report suggests the Fed will have to wait longer to see the “substantial further progress” it wants.
  • At the same time, hourly earnings gains were much stronger than expected, especially in the low-wage leisure and hospitality sector.
  • Restaurant traffic is almost back to the pre-pandemic level, but restaurant employment remains 12% lower.
  • Construction employment fell, indicating materials shortages may be hindering building activity.
  • Looking at the labor force participation rate by age reveals growing permanent retirements in the 55+ group.
  • The Labor Force Participation Rate is now a key indicator for Fed policy, and thus almost everything else. The Fed is unlikely to start tapering until LFPR improves substantially.
  • Worker shortages in manufacturing are becoming acute.
  • The hires-to-openings ratio in the sector is lower than the overall US labor force.
  • Restaurants are having trouble hiring as they reopen.
  • When will the emergency programs expire?

 

 

  • Rising prices in consumer durables and rapid home price appreciation are becoming a drag on consumer confidence.
  • Year over year population growth

 

 

Thought of the Week

 

“If your primary mission in life can be accomplished in your lifetime, then your mission is much too small.”

-Unknown

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker