September 2014 • Volume 3, Issue 9

INVESTMENT SOLUTIONS THAT FIT TODAY’S GLOBAL ECONOMY

THEARGENTUS OUTLOOK

The political class has been harrumphing and howling as companies contemplate moving out of the United States, supposedly to take advantage of lower corporate taxes in other countries. President Obama branded the companies unpatriotic.

It’s been a big year for these so-called “corporate inversions.” In late August, Florida-based Burger King Worldwide became the latest company to spurn the United States, proposing to take up Canadian residency as part of an $11.4 billion buyout of Tim Hortons, an iconic coffee and donuts chain.

Chiquita Brands International, America’s leading banana distributor, wants to abandon its Charlotte, N.C., headquarters for greener pastures in Ireland. The Emerald Isle also beckons Minnesota’s Medtronic, a producer of medical devices. Britain could be the new home for Chicago-based AbbVie, a pharmaceuticals researcher. Mylan, a Pennsylvania-based generic drug giant, is eying the Netherlands.

Tax-driven corporate flight isn’t a test of patriotism. Companies are responding to the perverse incentives built into a U.S. corporate tax system that’s increasingly burdensome and out of step with the rest of the world.

A reform that lowers corporate tax rates at least to the global norm—further, if politically feasible—would

benefit companies and investors. Moving the U.S. into the global mainstream on corporate taxes might even hold out a carrot for the political class—a jolt of corporate tax revenues.Stubbornly high rates

In the past two decades, countries all over the world have been cutting corporate tax rates. The average top rate for 34 non-U.S. countries went from 36.9 percent in 1993 to 25.1 percent in 2014 (see chart below ).

At 59.7 percent, Germany had the highest rate in 1993; now, it’s at 29.6 percent. Canada went from 44.3 percent to 26 percent, Ireland from 40 percent to 12.5 percent.

The United States has bucked the trend toward lower corporate rates, stubbornly clinging to top rate of slightly more than 39 percent—35 percent at the federal level, plus the average 4.1 percent for states. As a result, the U.S. rate now ranks as one of the world’s highest. The Tax Foundation scoured 163 countries, finding only two with corporate burdens higher than the United States—the United Arab Emirates and Chad.

To make matter worse, the United States is one of a handful of countries that tax worldwide revenues, forcing American companies to pay high U.S. rates on their overseas earnings. Most other countries use a territorial approach, taxing only the profits earned

By W. Michael Cox and Richard AlmSmall Talk

Continued on page 2

Source: Tax Foundation

Note: The AVERAGE includes rates for 34 countries.

20%

50%

40%

30%

60%

10%1993 1999 2002 2005 2008 2011 20141996

Germany

Japan

Canada

U.S.

France

ItalySpainU.K.

Mexico

Switzerland

AVERAGE

Korea

Poland

Ireland

Other Countries Cut Corporate Rates, Leaving U.S. with World’s Highest

Cutting Corporate Tax Rates: Good for Investors … And Even Uncle Sam

• Back to normal. Uncertainty isn’t easily measured, but some economists have devised clever ways to pin a number on it—stock market volatility, forecasters’ accuracy and disagreements, mentions of “uncertainty” in news accounts and Federal Reserve reports. In the spring Journal of Economic Perspectives, Stanford University economist Nicholas Bloomshows that uncertainty spikes during recessions. Of course, all the gauges went haywire during the financial crisis and Great Recession of 2008-09. Despite a still-skittish recovery, uncertainty measures have calmed down. The S&P 500 volatility index, for example, was below 12 in the last week of August—a level not seen since early 2007.

• Retirement worries. Not all of the Great Recession’s financial wounds have healed. The latest Retirement Confidence Survey, conducted by the Employee Benefits Research Institute and Greenwald & Associates, finds that 43 percent of workers aren’t confident that they’ll have enough money for a comfortable retirement, an improvement of just a single

percentage point from 2009. Before the Great Recession, only 29 percent of respondents

worried about paying the bills in retirement. One glimmer of hope in the recent survey: Those “very confident” of their retirement rose to 18 percent, the best reading since the start of the recovery.

• Strong bottom line. A sizzling stock market normally would reflect a bustling economy—but the recovery that began in 2009 remains relatively weak, with real GDP rising by just 2.5 percent in the past year. For investors, soaring corporate profits have more than made up for the sluggish recovery. The brutal Great Recession cut after-tax corporate profits in half, with the low point at $671 billion in the fourth quarter 2008. Since then, the rebound has been rapid and strong. Corporate profits regained their pre-recession peak of $1.4 trillion in early 2011. They reached new highs six times over the next three years, culminating in a record $1.8 trillion in the second quarter 2014.

Fed Watch and Chart Topper: Page 3

within their country.Britain switched to a territorial system in 2009, so

its companies pay Ireland’s 12.5 percent—and that’s all. A U.S. multinational pays 12.5 percent in Ireland, but it still owes U.S. taxes on its Irish earnings—the difference between Ireland’s low rate and the much higher U.S. rate.

U.S. taxes on foreign earnings aren’t due until the company brings the money home, creating a strong incentive to park money overseas. Earlier this year, a Bloomberg News study put U.S. companies’ stockpile of untaxed foreign profits at $1.95 trillion. President Obama considers this as unpatriotic as corporate inversions.Investors’ gains

The Office of Management and Budget estimates corporate taxes will bring in $332.7 billion this fiscal year, or 11.1 percent of all receipts. Opposition to lower corporate tax rates rests largely on this money—with deficits still big, the federal government needs it.

But the United States doesn’t necessarily have to choose between fixing a flawed tax system and larger budget deficits. Art Laffer famously raised the idea that high tax rates choke off economic activity and actually reduce revenue. If so, lower rates will raise tax receipts.

This could very well be the case for U.S. corporate taxes. In 2007, American Enterprise Institute economists Kevin Hassett and Alex Brill determined that the revenue-maximizing U.S. corporate tax rate went from 34 percent in the late 1980s to 26.7 percent in 2005. The number went down because of increasing capital mobility and other countries’ cuts in corporate tax rates.

After all the rate cutting of the past decade, it’s probably a few percentage points lower now—but

we’ll stick with Hassett and Brill’s 26.7 percent and see where it takes us.

For the United States, moving down to the revenue maximizing rate would add about a third to corporate tax receipts (see chart below ). Why? Lower taxes reduce the incentives for moving abroad and stashing profits overseas. More important, it would encourage both American and foreign companies to expand and invest in the United States, raising overall economic growth, corporate earnings and tax receipts.

Investors focus on their portfolios, of course. Cutting U.S. corporate tax rates would raise both before- and after-tax earnings. The before-tax kick comes from faster economic growth and higher corporate revenues. After-tax gains are more direct: For every $100 in profits, firms would now keep $73 rather than $61.

Higher earnings lead to higher stock prices. The size of the gains will depend on a number of factors—for example, how much actual tax relief U.S. companies get, whether other countries respond with new tax cuts. Our calculations suggest a substantial boost for stock prices if the United States were to cut rates to 26.7 percent and even lower.

A final thought. The Tax Foundation uses an average state corporate tax rate—but there’s a wide disparity. Iowa imposts the highest top rate at 12 percent—so some of its companies could pay a combined state and federal rate of 47 percent.

Next comes Pennsylvania at 9.99 percent. Other states above 9 percent are Minnesota, the District of Columbia, Alaska, Connecticut, New Jersey and Rhode Island. Six states don’t tax corporate profits—Nevada, Ohio, South Dakota, Texas, Washington and Wyoming.

Continued from page 1

THE ARGENTUS OUTLOOK

About Michael Cox W. Michael Cox is director of the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business. He is chief economic advisor to Argentus Partners, LLC.

What It Meansfor Your Clients

Richard AlmRichard Alm is writer in residence at the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business

Investors shouldn’t care all that much

about what country a company calls

home—as long as its revenue, earnings

and other financials are promising and its

strategy makes sense. Your clients should

focus on these fundamentals and not get

distracted by the catcalls about patriotism.

The tax aspects of inversions stir up a

fuss, but these mergers and acquisitions

almost always have broad business goals

—expanding markets, reducing costs,

acquiring key assets, developing untapped

synergies. Burger King spent $11.4 billion

for Tim Hortons with an eye toward

accelerating both brands’ global expansion.

However, your clients can’t ignore

corporate taxes. As other countries reduce

their rates, the U.S. corporate tax system

becomes an increasingly heavy burden on

American companies—especially under

the country’s worldwide tax system.

In general, investors should cheer when

companies reduce their tax liabilities—if

done legally, of course. Indeed, some

American companies have become quite

skilled at maneuvering around the high

U.S. tax rates.

Your clients can’t count on that to

continue. Even perfectly legal tax avoidance

generates public resentment, fanned by

political posturing. Congress could outlaw

inversions or other maneuvers, effectively

raising U.S. corporate taxes.

As Dr. Cox points out, a large cut in

U.S. corporate rates would likely drive

up earnings and stock prices. In recent

years, both Democrats and Republicans

have come out in favor of lowering rates;

however, prospects are iffy. Your clients

should expect the status quo to remain in

place—but they should stay alert for any

signs that might herald favorable changes

in U.S. corporate tax laws.

By Argentus Partners, LLC

Cutting Corporate Rates Benefits Investors, Sometimes Raise Revenue

Source: Authors’ calculations

P

510152025303540

50

25

200

100

Higher Government Revenue (T) and Higher Stock Prices (P)

75

41

84

61

Corporate Income Tax Rate (t)

136

167

Revenue-maximizing corporateincome tax rate, t=26.7%

199 Index:100 at

t=26.7%

Higher Stock Prices (P) but Lower Government Revenue (T)

T

P

W. Michael Cox’s Fed Watch:

Started more than 30 years ago, the Jackson Hole, Wyo., symposium has become a Woodstock of sorts for central banking. All of the big names come to the Grand Tetons just before Labor Day to relax and swap ideas about monetary policy.

Federal Reserve chairwoman Janet Yellen was there, of course. So was Mario Draghi, president of the European Central Bank—and the top central bankers from England, Japan and Brazil.

If nothing else, this year’s symposium confirmed how far monetary policy has shifted toward labor markets and away f rom t rad i t iona l concerns for price stabil i ty. The tit les of the academic presentations and panel discussions are telling: “Churn and the Functioning of Labor Markets,” “Job Polarization,” “Demographics,” “Wage Dynamics”

and “Labor Markets and Monetary Policy.”And then there was Yellen’s speech—a

justification for keeping the federal funds rate near zero. She said labor markets have improved faster than the Fed anticipated, but the central bank’s objectives for maximum employment haven’t yet been met. Unemployment of 6.5 percent, the only goal on record, has been achieved—so we don’t know what numbers will tell the Fed that labor markets are fully recovered.

In addition, Yellen explained that labor market complexities and crosscurrents make it difficult to separate the cyclical from the structural in declining labor-force participation, rising part-time work and retirements, falling quit rates and sluggish wage growth. The Fed now looks at a collage of 19 labor

market indicators, Yellen said. Divining the Fed has rarely been easy. The focus

on labor markets just makes it harder. We can only guess at the Fed’s objectives for jobs and unemployment. We can only speculate about the market indicators and models the central bank will use in setting policy.

Monetary policy is turning murky. Yet, investors still have to make judgments about the timing and pace of changes in Fed policies. Good luck.

In 25 years at the Federal Reserve Bank of Dallas, Dr. Cox rose to chief economist and senior vice president, advising the bank’s president on monetary policy and other economic issues.

Chart Topper

About The Argentus OutlookA monthly publication of Argentus Partners, LLC, the newsletter strives to deliver current economic information relevant to investing and operating in today’s complex global economy.

Chief Executive Officer: Douglas Gill, CFP®Publisher: Susanna Joiner, Chief Marketing OfficerEditor: Richard AlmContact: marketing@argentuspartners.com

THE ARGENTUS OUTLOOK

State of the Welfare State: Social Spending on the Rise in Europe, Rest of the WorldMargaret Thatcher became Britain’s prime minister in

1979. The next year, Americans elected Ronald Reagan. Both leaders won on the same message: The welfare state had gotten too big and government needed to be cut back.

In both countries, social spending fell a bit by the mid-1980s—then resumed its rise. As a share of GDP, Britain’s social spending increased from 13.2 percent in 1980 to 23.7 percent in 2013. The United States went from 13.2 percent to 20 percent.

Social spending has been rising worldwide. The European countries are the most profligate, led by France at 33 percent of GDP in 2013 (left panel ). Portugal and Greece trailed the European norm in 1980, but they’ve borrowed to expand social spending quickly, saddling them with excessive debt.

Outside of Europe, social spending is lower (right panel ). However, the same upward trend persists. In two decades of economic malaise, Japan has increased social spending from 11 percent of GDP in 1980 to 22.4 percent in 2013. An exception is Canada, which went from 20.9 percent of GDP in 1993 to 18.2 percent in 2013.

South Korea and Mexico suggest that developing nations are also increasing their social spending.

Source: World Development Indicators

30

35

20

15

10

25

51980 1988 1996 2004 2012

Germany

Percent of GDP

Belgium

Portugal

Greece

France

Italy

Spain

U.K.

30

35

20

15

10

25

51980 1988 1996 2004 2012

Percent of GDP

Japan

Canada

U.S.N. Zealand

Australia

S. Korea

Mexico

Important Disclosures: Information herein in this newsletter and has been obtained from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. This newsletter is for informational purposes only, and should not be considered as an offer, invitation or solicitation to subscribe, purchase or sell or any securities, and is not intended to provide any specific investment advice or recommendation. You should review your personal financial situation, investment objectives, goals and risk tolerance prior to investing. All indices referenced are unmanaged and an investor cannot invest directly into any index. The economic forecasts and projections illustrated in the newsletter may not develop as predicted and there can be no guarantee or assurance that strategies promoted will be successful. All expressions of opinion reflect the judgment of Dr. Cox and his research conducted for Argentus Partners, LLC at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete.

This research material has been prepared by Argentus Partners, LLC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that Argentus Partners, LLC is not an affiliate of and makes no representation with respect to such entity.

THE ARGENTUS OUTLOOK

For additional information, or to subscribe to the monthly publication,please e-mail marketing@argentuspartners.com