Tematica’s Take on Mnuchin’s Reforms and Growth Prospects

Tematica’s Take on Mnuchin’s Reforms and Growth Prospects

There are several drivers of a company’s business as well as the price of its shares, assuming it is publicly traded. We described many of these in Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals for Better Returns, but a short list includes new technology, regulatory mandates, the overall speed of the global economy and new policies flowing out of Washington. From a business perspective, more regulations and taxes tend to drive costs higher, leaving companies with smaller profits to spread across developing new products and services, implementing new technologies and creating more jobs – in other words investing for the company’s future.


We’re seeing this today in the restaurant industry, which is struggling with the impact of higher minimum wages as companies like McDonald’s (MCD) and others look to bring mobile ordering, as well as in-store kiosks like those found at Panera Bread (PNRA), to market. There has been much made about the low to no growth in the US economy over the last several years, but headwinds, like our aging population that has people shifting from spenders to savers and rising consumer debt levels that weigh on disposable income levels and consumer spending, make prospect for growth challenging.


Last week Treasury Secretary Steve Mnuchin reiterated in his testimony in front of the Senate Banking, Housing, and Urban Affairs Committee that the Trump administration’s goal of 3 percent or better GDP is achievable provided, “we make historic reforms to both taxes and regulation.” Mnuchin went on to say, “he’s got 100 bodies working on tax system reform and that they’re working on far more than just undoing the Dodd-Frank Act” including overhauling housing finance reform.


Over the weekend in a radio interview, Mnuchin noted, “The good news is that [the administration and Congress] all agree on the fundamental principles: simplifying personal taxes, creating a middle-income tax cut and making our business taxes more competitive.” Mnuchin went on to acknowledge that over the past eight years, the US economy has had very low growth, but “tax and regulatory changes and better trade deals” can unleash more historically typically growth rates in this country,” with “sustainable levels of 3 percent growth.”


The key word employed by Mnuchin is “reform,” and no matter which definition of the word offered by Merriam Webster – “to amend or improve by change of form or removal of faults or abuses” or “to put an end to (an evil) by enforcing or introducing a better method or course of action” – it’s rather clear Mnuchin’s language suggests something far more historic than a temporary tax cut or other one-time band aids like we’ve seen in recent years. That resetting should help reduce regulatory and litigation costs, but also a lower corporate tax rate, which would benefit predominantly US based companies like Verizon Communications (VZ), CVS Health (CVS), Walt Disney (DIS), Norfolk Southern (NSC) and others as well as their shareholders.


With true regulatory and tax reform, there would be the added benefit of certainty or at least greater certainty that would allow for longer-term corporate planning. It’s rather well understood the stock market abhors uncertainty, but uncertainty in the form of short-term tax cuts and ones that are about to expire as well as a shifting regulatory environment wreak havoc on corporate planning and subsequently spending. One example is Research & Experimentation Tax Credit (better known as R&D Tax Credit) was originally introduced in the Economic Recovery Tax Act of 1981 with an original expiration date of December 31, 1985.


Flash forward a few years, and the credit has expired eight times and has been extended fifteen times with the last extension expired on December 31, 2014. Not exactly a boon to corporate planning, but in 2015, Congress made permanent the research and development tax credit, which now allows more consistent planning and product development at companies ranging from Apple (AAPL) and Facebook (FB) to II-VI (IIVI) and Oracle (ORCL), not to mention food and beverage companies like Coca-Cola (KO) and PepsiCo (PEP). Douglas L. Peterson, President and Chief Executive Officer of S&P Global Inc. summed it up well when he said, “If we knew where the cost was going…and we’re able to predict it over the long run, we could have a completely different planning cycle and invest in the long run.”


While these reforms are likely to help reignite growth in the US economy, the stark reality is between increased spending to rebuild US infrastructure as well as the US military and ensuring entitlement programs are in place for our aging population, there is a deficit funding gap at least in the short to medium term that will need to be addressed. While there are several mechanisms being bandied about, a recurring one is the Border Adjustment Tax. There are those that oppose it, particularly retailers that source heavily from outside the US, but the argument for the Border Adjustment Tax is that it would help level the playing field between imported goods and those crafted within the US as well as encourage companies to source within the US, thereby developing industries and creating jobs.


The challenge here is that with the gap between Job Openings and Hirings already well above historical norms as companies struggle to find the right talent for open positions as we sit at what has been the lower range of the unemployment rate over the past fifty years, who is going to take these jobs? Regular Tematica readers will quickly recognize how this pertains to our Tooling and Re-tooling investment theme.



We frequently discuss here at Tematica Research how economic growth requires that either the labor pool grows and/or productivity must rise. If companies are able to keep more of their income thanks to tax cuts, they can invest back into their own operations so that the productivity of their workforce improves. That being said, cutting corporate tax rates doesn’t guarantee that companies will do such reinvestment as they could also look to return the additional funds to investors through dividends, fund buyback programs or hold onto it if there is concern that times could get tough in the near to medium-term future. Investors need to assess the overall economic conditions and business drivers as well as other incentives facing companies when it comes to decided just what to do with those tax savings.


As Team Trump and his allies, including Mnuchin, look to reset the administration’s timetable for meaningful reform, investors should begin doing their homework on which companies stand to benefit. If we see lower corporate tax rates like those being discussed, we could see greater earnings falling to corporate bottom lines, which could spur shares in those companies higher, outside of any decision on just what to do with those newly saved funds. If we see infrastructure spending beginning, it offers another shot in the arm for companies like US Concrete (USCR), Granite Construction (GVA) and aggregates companies like Martin Marietta (MLM). Any boost in defense spending would likely bode well for companies such as General Dynamics (GD), Raytheon (RTN) and Northrop Grumman (NOC).


The key is for investors to develop their wish list today and be ready to strike once we know the particulars on the actual reforms. While that is likely a sound strategy, we would suggest investors go one step further and utilize our thematic perspective to identify those companies already benefiting from pronounced multi-year tailwinds that could also benefit from tax and regulatory reform, rather than being dependent solely on these reforms making it through the D.C. sausage factory.

Walgreens and the morality of taxes

Walgreens and the morality of taxes



There’s been quite a bit of chatter on Facebook and in the investment community concerning Walgreens’ (WAG) announcement that it does not intend to take advantage of the tax breaks its potential acquisition of Alliance Boots in the UK would allow under the tax code, a strategy which could save it and thus its shareholders hundreds of millions of dollars each year. The announcement has been met with much moral posturing from all sides and has subsequently sent shares tumbling, loosing as much as $5 billion in market capitalization.

Many on Facebook have professed support for this position. Walgreens has two options:

1)   Take advantage of the legal tax breaks afforded to it through this potential acquisition, retaining more income for its shareholder, which are primarily Americans. This would result in more money in the private sector.

2)   Take money away from their shareholders and give it to the federal government in the form of taxes.   This would result in more money in the public sector.

Which option is better, 1 or 2? Depends on what you are looking to achieve. If what you are looking to achieve is more growth in the economy, then you simply choose the option that generates greater growth. So far, the evidence is fairly clear that the private sector generates more growth per dollar spent than the public sector, you can read about this here, here, here and here, (there are countless more, but I think you get the point.)

This is fairly intuitive if you think about it.

In the private sector, a company has a finite amount of money to invest in order to generate growth. By definition, if a company wants to remain in business it has to generate more money that it uses to operate. If it fails to do so, it will go out of business, thus will no longer be able to siphon money away from those ventures that do generate more than they consume.

In the public sector there is no such feedback loop. Programs within the government grow by garnering themselves more and more attention and by convincing those who hold the purse strings that they need more funds. There is no weighing of value generated vs value consumed. In fact there is more of a negative feedback loop by which a program that is shown to be failing miserably is more likely to get significantly more funds if it projects the impression of impending doom than one that is showing efficacy with the funds it already has been allocated.

Before cheering on Walgreens for taking money out of the pockets of its shareholders, think about whether you or Congress make better decisions with the money in your pocket. Given that according to a recent NBC/WSJ poll, Congressional approval rating is down to a staggering 14%, I’m guessing most believe that the money is best served in your pocket.

That being said, the main problem here is the ludicrously complicated tax code and excessively high tax rates which incentivize the private sector to seek out ways to minimize taxes. The Laffer Curve illustrates how lower tax rates, (and a simple tax code) would ultimately result in higher tax receipts and less money wasted in utterly non-productive pursuit of means to minimize taxes. Money spent on lawyers and accountants could instead be spent in ways that would productively grow the economy.

Foreign Account Compliance Tax Act

Foreign Account Compliance Tax Act

I spoke at FreedomFest in Las Vegas… in July… yes, know my pain.  On my way out from my talk my dear friend Richard Rahn, (the infamous one-eyed economist) grabbed me and introduced me to the lovely Emerald Robinson so that we could talk about the recently enacted Foreign Account Compliance Tax Act aka FATCA and its impact on expats as I split my time between the U.S. and Europe.

Michael Jordan and the B-Ball Inequality

Michael Jordan and the B-Ball Inequality

MKI know that this may come as a surprise to many of my regular readers, but I have a confession to make.  Michael Jordan is a better basketball player than I.  This basketball skill spread needs to be addressed. He shouldn’t be that much better than I. It isn’t fair.  No matter how much I practice, no matter what coaching I get, no matter how hard I train in the gym and follow a strictly regimented diet, he will always be better than I.  Unfortunately for Mike, the only way to address this issue, (given that there is a clear cap to my potential at 5’8″ with a proportional wingspan and at best, only slightly better than average springs) is to handicap him.  Now wouldn’t the world be a better place if the difference in our abilities were materially reduced?

You probably get where I’m going with this.  Before anyone gets into a tizzy and starts making all kinds of accusations about how mean and uncaring I am.  There is a serious problem today with respect to income, but the problem, thus the cure, isn’t what is preached in the popular media.

The billionaires at Davos, in what can only be described as irony of epic proportions, all agreed that “Severe income inequality” is one of the top 10 global risks of greatest concern for 2014.  You can read the report here.

So let’s break this problem down.  When people talk about income inequality there is a knee-jerk assumption that by definition, income inequality is bad, which in reality is quite destructive to society as a whole.  It intuitively doesn’t make sense that as a society we should strive to have income equality where regardless of what value an individual generates, income ought to be equal.  The guy who chooses to work 3 days a week sweeping floors at the local Walmart clearly should not enjoy the same income as Steve Jobs! So some degree of income inequality is Ok, right?  But not too much?  Hmmm, ok, then how much?  Who gets to decide how much is too much and how do they make that determination?  Then how do they enforce it? How do we trust that the person we give such enormous power to won’t abuse that power?  For argument’s sake let’s say they don’t.  What about their successor?  How likely is it that we continue to have only angelic geniuses that are able to manipulate society into a Utopian income spread without ever falling prey to corruption and graft?  So far the record throughout history doesn’t lead one to believe that is it all likely.

I spend a great deal of my time in Italy, where I sadly witness first-hand the awful consequences of this sort of societal structure.  If I get paid roughly the same amount whether I work my tail off and take risks trying to improve my performance or if I put in essentially the bare minimum level of effort, why try?  I see this everywhere.  Incredibly bright people who could be innovating like crazy, coming up with all kinds of solutions that would benefit their companies and eventually their nation are beaten down by a system that provides no incentive for those who really try to do something great.  Those who are naturally innovators want desperately to try new things, take risks, but for them there is only downside risk.  They can’t improve their income level through hard work and risk taking.  They only risk annoying their colleagues and supervisors by trying to improve things.  Status quo is the rational choice.  Notice the level of innovation coming out of Italy and its rate of growth!?

I sit at dinner and hear the agony in my friend’s voices as they vent their frustrations and their anger at how a colleague who does very little gets paid roughly the same as they do.  This type of structure infects relationships because it forces people to live in a lie, a lie which is painfully obvious to everyone. The guy who barely shows up to the office and only does the bare minimum knows that the guy who’s working his tail off, (he can’t help but try as innovation is in his DNA) is angry that they both get paid roughly the same.  They both are aware of the resentments, but are powerless to do anything about it because society tells them that this is a far better way to live.  It is more fair. What the hell?  More fair that those who are willing to sacrifice and take risks are basically barred from enjoying any benefit from doing so?  My Italian friends all talk wistfully about how great it would be to work in the U.S. where at least there they can hope to get rewarded for accomplishing something great.

As for the U.S., I struggle to see where this horrific trend we keep hearing about is evidenced.  The table below is from an excellent study by Alan Reynolds of the Cato Institute.  You can read the entire report here. The data does not prove out the claims, at least in the U.S..  The bottom two quartiles and the top quartile enjoyed nearly the same increase in income on a percentage basis from 1989 – 2007.  From 2007 – 2010, the bottom quartile experienced a rise in income, while all others experienced a decline.

Now where is inequality a problem?  Barriers and disincentives to improve one’s lot in life ARE problems.  Subsidies such as those in the Affordable Care Act put the poor in a veritable poverty trap in that as they work to improve their situation, the subsidies are taken away at such a pace as to make them far better off overall working less.  That is both demeaning to the individual and immoral in that it forces others to eternally be enslaved to subsidize their fellow citizen, despite the reality that the guy being subsidized may desperately want to get out of his situation, but is faced with overwhelming incentives that keep him dependent, resentful and demoralized.

There is also something horribly wrong with a system in which savers are punished through financial repression.  The Federal Reserve, by keeping interest rates low, forces savers to go into inappropriately risky investments just to try and get a reasonable return.  Those who are already wealthy and are able to invest heavily in the stock market enjoy out-sized returns courtesy of the Fed’s QEInfinity as evidenced by the 90% correlation between the Fed’s balance sheet and the stock market starting in 2008.  Previously the correlation was essentially 0!

The free market system is far from perfect, full of all kinds of flaws, but it is infinitely better than anything else out there.  There are no angelic, omniscient bureaucrats that can manipulate our world into a more Utopian state.  Be wary of any who claim they can.

That there is a Pavlovian dog: Obamacare and mismatched incentives

That there is a Pavlovian dog: Obamacare and mismatched incentives

This one ought to go down in the annals of “You just can’t make this stuff up,” but sadly when it comes to the twisted rewards system innate in government, this is more the rule than the exception.

Recently the Daily Caller reported that the very firm responsible for the disastrous roll out of Obamacare was awarded six more contracts by the administration’s Centers for Medicare and Medicaid Services AFTER the massive flop of a launch!  Yes, you read that right… AFTER!

In the private sector, businesses and individuals are rewarded for doing more with less.  The company that is able to provide a better product that costs them less to make will be able to charge less than the competition and will sell more.  Win!

Individuals that are able to accomplish more in less time or with fewer resources tend to get promoted, get raises, bonuses, more responsibilities.  Win!  Their behavior gets rewarded, so they do more of it.  The incentive system focuses them on being more efficient, accomplishing more with less.

The company that is able to generate greater returns for investors with fewer resources is rewarded with increased investor interest, lower borrowing costs, (as they’ve shown they are less risky) and better talent shows up on their doorstep, wanting to be associated with such a successful organization, (think Google).

These normal human desires, when expressed in the public sector, get seriously wonky.  Bureaucrats publicly state with great pride that some societal ill is a serious problem and they are going to marshal their resources to address it.  Fantastic.  We’d all like to see a lot less of whatever ill is the flavor of the week.  Who could possibly be against that?  So now all these well meaning sorts get together to work on the problem.  They come up with a budget to address the issue over the next few years and off we go.

Except unexpected things happen along the way, as they always do, and we can’t quite get this addressed the way we originally planned.  The easiest solution would to just get more money.  In the private sector, getting additional funds takes a lot of work, is time consuming and in the end may be impossible.  In the public sector, just whip up some stories that pull at the heart-strings and what politician can risk appearing heartless?  More funds are granted and government spending goes up.  If the plan actually starts to work, now we have to worry, as how do we justify our salaries?  The budget we control?  Ah ha, scope creep!  Now we need to expand into yet another area that is in “crisis” and probably need a bigger budget too while we are at it.

In the private sector, more funds are awarded when you prove you are able to accomplish your goals.  In the public sector, more funds are awarded when you can’t accomplish your goal as originally planned.  In the public sector, the greater the problem, the harder it becomes to solve, the larger your budget.

The private sector pressures individuals and organizations to be efficient with the resources, (money and time) that is invested in them.  The public sector rewards ineffectiveness with bigger budgets and greater scope … because clearly now that I look at it, this problem is just so much bigger than I originally thought!

Bottom Line:  In the private sector you always have to answer to someone for what you are doing with their money, which keeps the pressure on.  In the public sector, there is no such pressure, so the reward system is no longer tied to effectiveness and taxpayers in the end pay too much for too little.


Another unilateral change to Obamacare

Another unilateral change to Obamacare

Obama already pushed back the employer mandate to 2015 from 2014, conveniently after the mid-term elections. Now his administration is pushing back the mandate for businesses with 50-99 employees to 2016. For companies with over 99 employees, they must cover 70% of employees by 2015 vs. 95%.


This is now the 18th executive branch unilateral change to the Obamacare. Safe to say that at this point, the LAW now says whatever Obama wants it to say on any given day. So much for our Constitutional Republic form of government! Changing a statutory mandate requires the approval of Congress, yet Congress hasn’t done much to stop these dictatorial edicts.


We were told that ACA was going to solve a myriad of problems and that once we got it, those of us who were opposed, would understand the veritable utopia it created. If that’s the case, why keep delaying implementation? If this thing is so great, why wait at all? What is it that is going to happen in a year that will then make this legislation a net positive whereas apparently today even the White House thinks it is a net negative?


Let’s take a step back and look at the big picture. The administration claimed that the ACA would lower healthcare costs for the vast majority and would provide “affordable” insurance for significant portions of the population that were previously not covered, with the assumption that those without insurance were in need or desired it.


So where are we now? So far costs are going up and we have a net loss of coverage as more people have lost the coverage they had pre-ACA than are gaining coverage without having any previously. This is not at all surprising and some simple economics tells us that it’s likely to get worse. ACA increases the demand/use of healthcare while at the same time doing nothing to increase the supply, and in many instances actually reducing the supply of healthcare. How can the price not go up?


Now we’ve gotten an even more troubling dynamic going on with more artificially created warfare between various parts of society. The administration has been doing a bang-up job creating an irrational and self-destructive war between different income and wealth levels, now they are fostering a war between individuals and businesses, creating a lovely trap that the Republicans seem all too eager to fall into.


We’ve now got the Republicans ranting and raving about how it is unfair for businesses to get a break when “hard working families” aren’t. I suppose that makes for a compassionate sound bite, but talk about losing the forest for the trees. Healthcare isn’t a war between businesses and families. Hell, the two shouldn’t even be in the same sentence. Why is health care even remotely related to employment? I don’t get my car insurance or my home owner’s insurance through my employer. Why is my health insurance employment related?


Employers didn’t start offering health benefits roughly 60 years ago because they were experts in medical decisions. It was a way of circumventing the World War II wage and price controls. Barred from offering higher salaries to attract workers, employers offered health insurance instead. Aided by an IRS ruling that said workers who received health benefits did not have to pay income taxes on them, and by the fact that employers could write off the cost of the health benefits as a business related expense, this accidental arrangement became the primary way most Americans access health care and is now viewed as just the way it works.


The system worked at first, but a lot has changed in 60 years. Back then, the average soldier returning from World War II took a job with a local company where he would work for decades until he got a gold watch at a big retirement party. Today, lifetime employment is dead. By 42, the average American will change jobs 11 times.


Sixty years ago, most American companies competed only against neighboring companies for lucrative contracts. Today, most businesses are up against foreign companies that don’t foot the bill for their employees’ health-care costs.

Bottom Line: Obamacare cannot reduce the price of healthcare when it increases demand and at best keeps supply flat, at worst decreases it. What the legislation has done masterfully is show how poorly the public sector addresses pricing and availability problems in the private sector. Health insurance and employment should be separate. Individuals should be able to pick whatever type of insurance best suits their preferences and finances. One-size fits all solutions stifle innovation and in the end, satisfy no one.

Speaking with Wealth TV on the Apple Tax Charade

Speaking with Wealth TV on the Apple Tax Charade

On May 22nd, I spoke with Graham Ledger on Wealth TV about the horrific show the Senate put on in an attempt to shame Apple for not voluntarily paying more in taxes than it required by the tax code by implying inappropriate corporate behavior.

The Daily Ledger Chewing Up Apple from One America News Network on Vimeo.

The U.S. Senate has been hosting a sham of a hearing to try and publicly berate Apple for not paying “it’s fair share” of taxes despite the reality that Apple is in full compliance with tax law. The government has not even once suggested that Apple has in any way violated the tax code.  To try and publicly shame a company that is in full compliance with the law is an embarrassment and a blight on the legitimacy of our political system.

The supposed crime is that the company has not voluntarily paid more than required by law to pay and has taken advantage of the tax code, enacted by the very group hosting this charade, to the benefit of its shareholders, employees, suppliers, and all the ancillary individuals and organizations that benefit from such a successful company. The federal government apparently would prefer that Apple voluntarily take money away from American investors, retirement funds etc and give it to the government to spend. Apple does far more good for the American economy with every dollar it generates than the federal government ever could.

Apple should not pay taxes on income generated outside of the U.S. That income is already subject to foreign taxes. It is ridiculous that the U.S. would try to argue that another sovereign charges too little in taxes, thus Apple ought to pay more.

To the extent that Apple is using the tax code in order to minimize its taxes by shifting U.S. income into foreign income, the U.S. should be taking a long, hard look at how uncompetitive the U.S. corporate tax rate has become and review the Laffer curve. By lowering the U.S. corporate tax rate, multinationals would find less value in such techniques, which would likely raise the amount of taxes collected.

I was beyond thrilled to see Rand Paul call the Senate to the floor for the atrocious nature of this hearing.

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Americans renouncing citizenship over onerous tax code

On January 25th, Lenore Hawkins joined the Freedom Fighters to talk about Americans giving up their citizenship due to the onerous tax code.

  • The current tax code is outrageous.  In 1913 the Federal Tax code was 400 pages.  It is now over 72,000 pages!
  • Americans spend over 7.6 billion hours a year preparing their taxes which equates to about 3.8 million skilled workers, making the tax compliance industry SIX TIMES the size of the U.S. auto industry.
  • 82% of Americans need help preparing their taxes
  • 60% hire a professional tax preparer.
  • According to the IRS, “If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad. Your worldwide income is subject to U.S. income tax, regardless of where you reside.”  Thus you are subject to double taxation; tax for the country of residence and a second level of tax from the United States.
  • If you decided to give up your U.S. citizenship, you are taxed on all your assets using a mark-to-market regime, which generally means that all property is deemed sold for its “fair market value” on the day before the expatriation date.  You will be forced to then pay taxes on those assets as if you had sold them.

Rather than using a punitive tax code that attempts to bar people from leaving, how about building a legal code, regulations and tax code that attract wealth and high income earners from all over the world?  Their assets and innovation will help the economy grow, providing much needed jobs.


Bernanke is watching you

On September 27th, Freedom Fighters Chris Cotter, Nancy Skinner, and Lenore Hawkins discussed the Fed’s plans to monitor the Internet, and why Coca-Cola is choosing China.

What is the proper role for government?

Only July 21st, Lenore Hawkins joined the Freedom Fighters, (Charles Payne, Ellis Henican and Kmele Foster) and on Freedom Watch to discuss the economics of electric cars, Florida selling info on citizens obtained by the DMV, the federal government’s restriction of potatoes in school lunches and the impending FAA shut down.