Thursday, November 29, 2012

Truth stranger than fiction?

From the New York Times. I checked, it really is not from the Onion
WASHINGTON — House Republicans said on Thursday that Treasury Secretary Timothy F. Geithner presented the House speaker, John A. Boehner, a detailed proposal to avert the year-end fiscal crisis with $1.6 trillion in tax increases over 10 years, an immediate new round of stimulus spending, home mortgage refinancing and a permanent end to Congressional control over statutory borrowing limits.

...In exchange for locking in the $1.6 trillion in added revenues, President Obama embraced $400 billion in savings from Medicare and other entitlements, to be worked out next year, with no guarantees.

The upfront tax increases in the proposal go beyond what Senate Democrats were able to pass earlier this year. Tax rates would go up for higher-income earners, as in the Senate bill, but Mr. Obama wants their dividends to be taxed as ordinary income, something the Senate did not approve. He also wants the estate tax to be levied at 45 percent on inheritances over $3.5 million, a step several Democratic senators balked at. The Senate bill made no changes to the estate tax, which currently taxes inheritances over $5 million at 35 percent.
Meanwhile, Costco is in the news, for borrowing $3 billion dollars, and paying it out as a special dividend before dividend taxes rise.  Stock rose 6%. Tax arbitrage is so cool.

29 comments:

  1. "Meanwhile, Costco is in the news, for borrowing $3 billion dollars, and paying it out as a special dividend before dividend taxes rise. Stock rose 6%. Tax arbitrage is so cool."

    Rather than maintaining a steady dividend payment to encourage long term investing, Costco decided to do exactly what Republicans have been deriding economists like Krugman and Geithner over - relying on stimulus.

    So stimulus is cool now huh?

    ReplyDelete
    Replies
    1. You completely missed the point. This has nothing to do with stimulus. Dividends next year will be taxed as ordinary income. Dividends this year are taxed much less. Costco simply changed "dividends next year" into "dividends this year" and let its shareholders escape a lot of taxation. This is one of a hundred reasons why tax revenue from higher tax rates will be disappointing -- like rich Brits moving abroad. "Steady dividend payments" have nothing to do with long term investing. Per Modigiani and Miller, firm value is completely unaffected by dividend policy except for taxes.

      Delete
    2. "Steady dividend payments have nothing to do with long term investing. Per Modigiani and Miller, firm value is completely unaffected by dividend policy except for taxes."

      http://en.wikipedia.org/wiki/Modigliani–Miller_theorem

      "The basic theorem states that, under a certain market price process (the classical random walk), in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed."

      First, Miller Modigliani specifically excludes tax effects. Second, the "value of the firm" would depend on whether you value the firm on a cash flow basis ( Price / Earnings ratio ) or a balance sheet basis ( Asset / Liability ratio ). Please remember there are two types of securities holders that do not always see eye to eye on the value of a company. And the relative values of securities are affected by dividend policies.

      "Dividends this year are taxed much less. Costco simply changed dividends next year into dividends this year and let its shareholders escape a lot of taxation."
      Maybe I misunderstood. So Costco plans to pay next year's anticipated dividend this year AND pay no dividend next year - yes?

      A special one time dividend is different than dividend tax arbitrage - yes?

      Delete
    3. Or,alternatively, there could be a lot of firms that wouldn't have paid much dividend for 3-4 years and due to the tax issue are going to pay it this year, so the total revenue over 3 year horizon would be BIGGER than otherwise, because of such firms

      When bush cut dividend taxes, what was the impact on the market? all the research I have seen says that it was essentially zero, because most people hold stocks in tax-deferred accounts anyway

      Delete
    4. A special one time dividend is different than dividend tax arbitrage - yes?

      No. Making arrangements to pull any kind of pay-out forward from a high tax period to a low tax period is pretty much the textbook definition of "tax arbitrage".

      ...so the total revenue over 3 year horizon would be BIGGER than otherwise, because of such firms

      The size of the dividend has absolutely nothing to do with a the size of a firm's revenue. Higher revenue may lead to a higher dividend, on the other hand, but it's not a direct relationship.

      I don't know anything about the research you're talking about and, anecdotally, I saw a lot of increases in dividends in response to the tax cut, but the decision to pay a dividend or not is by far not solely a function of the dividend tax rate. A decision to bring planned dividends forward from a high tax period to a low tax period is completely a function of tax rates, thus it's hard to swallow your claim that tax rates don't matter.

      There seems to be a lot of desperation on the part of a lot of people to convince everyone that supply and demand curves don't slope the way they do and that people magically don't respond to incentives when it comes to taxes. There's just a lot of magical thinking out there. There's very good reason to think the government won't collect more revenue if it raises taxes, but that's precisely because people do respond to incentives.

      Delete
    5. Methinks,

      "No. Making arrangements to pull any kind of pay-out forward from a high tax period to a low tax period is pretty much the textbook definition of tax arbitrage."

      But did Costco pull a payout from one time period to add to another or did they offer a one time payout that was unrelated to either past or future payouts?

      Delete
    6. Methinks: In theory, there is no difference between theory and practice but in practice there is.

      so it's perfectly reasonable to ask, does what actually happen confirm your theory? that is the definition of scientific vs religious analysis

      http://www.federalreserve.gov/pubs/feds/2005/200557/200557pap.pdf

      Delete
    7. Frank,

      Here's what Costco did: It estimated the amount it will pay in dividends next year when taxes will be higher. It got a loan for that amount and used the loan to pay those estimated future dividends in a single payment this year, when taxes are lower. Next year, instead of using cash flow to pay dividends, Costco will pay off the loan instead. This is not a random one-time dividend.

      Anonymous,

      Incentives don't matter. Of course. How silly of me. Perhaps you can explain this from the linked article:

      "Tax revenue from capital gains in 1986 soared to $52.9 billion, then dropped to $33.7 billion in 1987 and stayed largely flat for nearly a decade. It boomed again after Bill Clinton and Newt Gingrich agreed to return the rate to 20% in 1997." And, of course, you'll have to explain all these companies pulling their estimated future dividends into this lower tax period.

      Now, as I said, many considerations are factored into dividend policy. It's not solely a function of the dividend tax rate. I am not familiar with the paper you link to and I'm not going to be able to familiarize myself with it in time to have a blog discussion. So, perhaps you can point to the part that convinced you that tax rates don't matter for dividend policy. Because, you see, a higher tax rate effectively reduces the dividend for and investor, making it less valuable.

      Since the price of the stock includes the cash used to pay the dividend and the price of the stock drops by the amount of the dividend when it is paid out (on ex-date, but I only clarify that in anticipation of someone coming along to split that hair). The tax rate matters. If, ceteris parabus, cash accumulates, the stock price will rise by the amount of the additional cash. A company can pay out that additional cash in the form of a highly taxed dividend or it can allow people to sell the stock and effectively pay a much lower cap gains tax on that cash.

      Delete
    8. Methinks:

      "..Summarizing our conclusion, we fail to find much, if any, imprint of the dividend
      tax cut news on the value of the aggregate stock market..."

      I never said that "Taxes don't matter". the issue is do they matter enough to make a difference or is there some other factor(s) that matter much more? if it's the second, then we should worry about those factors

      Delete
    9. Here's a little more insight on the dividend tax cliff and who actually pays the additional tax:

      http://politicalcalculations.blogspot.com/2012/11/racing-to-beat-clock-on-dividend-cliff.html#.ULjkp4ZYRqM

      Delete
    10. Anonymous,

      Regarding your quote: Well, of course not. And the reason is much the same as why the government can't collect more tax revenue by raising tax rates: people change their behaviour.

      Taxes on dividends have absolutely no effect on the profitability of the company. Dividends are not free money. They come from earnings and those earnings, as I pointed out above, can just be retained and not paid out in dividends. They would still be factored into the price of the stock.

      I thought your claim was that dividend policies are unaffected by tax rates. Your quote doesn't support that assertion.

      Delete
    11. When bush cut dividend taxes, what was the impact on the market? all the research I have seen says that it was essentially zero, because most people hold stocks in tax-deferred accounts anyway

      If most equity is held in tax-deferred accounts, why bother raise the taxes on dividends (and capital gains)? An increase in the tax rates would not raise much revenue since the accounts are tax-deferred.

      From the linked Federal Reserve paper:
      Overall, the analysis of payout behavior indicates that the dividend tax cut did prompt a substitution from repurchases to dividends, but the effect on total payouts was much more muted. Apparently, firms for which the higher tax burden on dividends was an impinging factor had used share repurchases as tax-advantaged alternative. With an
      equalization of statutory rates, such firms became more willing to substitute towards dividends and scale back repurchases, leaving total payouts little changed.


      So cash payments to shareholders was unchanged but the form of payments did change. Wouldn't the form switch back to less in dividends and more in share repurchases if taxes on dividends are raised?

      Delete
  2. What makes it even better is that Costco's CEO is a big Obama supporter and donor. He'll personally make about $7 million on a lower tax rate via this move and be able to "launder" back some of it to the DNC. So the rich get richer, the Dems make money and the Rs get to take credit for protecting the rich. Seems like it works out for everyone.

    ReplyDelete
  3. 1) Why is the treasury secretary involved? I can complain all I want about my disagreements with fed policy but at least Bernanke has a resume backing him.

    2) This reminds me of TG going to China and getting laughed at with his "your money's safe because we fixed health care spending."

    http://www.reuters.com/article/2009/06/01/usa-china-idUSPEK14475620090601

    3) "The president has already signed into law over $1 trillion in spending cuts." Well that's comforting. Anyone want to show me a spending projection that has Federal government spending going down?

    4) TG "Proposed permanently ending Congressional purview over the federal borrowing limit." Sounds a lot like the "oh just trust the executive branch to make all the big decisions" logic that got us into Iraq

    5) Do people in Washington really not understand dividends are from after corporate tax dollars and taxing them higher than the top marginal rate on income (see the ACA tax provisions) is ludicrous and won't raise any money because companies will retain earnings?

    6) Isn't the issue we're upset about private equity folks getting a carried interest exemption ... did everyone just forget Romney's tax rate or is that not an issue anymore.

    7) Is the capping itemized deduction thing off the table because it harms high tax states more than low tax states and is actually a reasonablish form of raising revenue?

    8) Did someone really try to give Professor Cochrane a lesson on MM?

    Head hurts, hate politics. Time to get back to Tirole.

    Thanks for the post, Professor. Would love to see a response to Diamond's 70+% marginal rate paper.

    Parth

    ReplyDelete
    Replies
    1. 6) Isn't the issue we're upset about private equity folks getting a carried interest exemption ... did everyone just forget Romney's tax rate or is that not an issue anymore.

      It's not an exemption. The source income is long-term cap gains and the partners agree to give up some of their allocation to the managing partners. That's all. "Sweat equity" exactly the same thing.

      While everyone is screaming about a non-loophole in PE and VC, nobody says anything about the mixed-straddle; which is an actual loophole, an honest to goodness rent. Nobody says anything about it because nobody knows what it is.

      And the whole debate is kind of funny because these people will adjust their behaviour to any changes in the tax code and the government will not collect more taxes from them. Incentives matter. So, it's just a lot of finger pointing and screaming "NO FAAAIR!" - usually by people whose own effective tax rate is much lower than the people they're complaining about. It's like watching a bad sitcom.

      Delete
    2. ParthVenkat: 4) TG "Proposed permanently ending Congressional purview over the federal borrowing limit." Sounds a lot like the "oh just trust the executive branch to make all the big decisions" logic that got us into Iraq.

      Did you mean to say Libya? I recall at least a couple of Congressional votes to approve action in Iraq over the decades.

      Delete
    3. I definitely agree with you Methinks. I was only putting it out there as a pot shot to the media and group think.

      If I were to play devil's advocate to CI (and trust me, I have no idea why in a recession or ever you'd want to tax investment), when you run an S-corp you are required to pay yourself a salary commensurate of the size of your firm and the work that you do. It's loose language but most S-corps hire accountants to tell them how much they have to pay themselves in salary as their preference would be 0 (I think the issue is salary you pay the employer and your own part of the payroll tax whereas if you pass it through as earnings, it's just your own share of the payroll tax). CI allows PE managers who are doing work to "pass through" all their earnings as Lt Cap gains and none of it as income where arguably, if they're managing the firm, part of that should be salary and taxed as income.

      On a related note, Is Obama interested in returning the cap gains rate for rich people to 20% at the end of Clinton's time or to the income tax rate or his even higher dividend rate? And while using logic to figure out the tax code is a hopeless exercise, why are dividends treated differently than capital gains again?

      Delete
    4. Methinks,

      "The source income is long-term cap gains and the partners agree to give up some of their allocation to the managing partners."

      Do the limited partners have a choice to give up their allocation to the managing partner? The managing parter is collecting a fee for their efforts in managing the assets of the partnership. It is earned income.

      Delete
    5. ParthVenkat,

      Aha, you sneaky devil! I'm not certain, but I think all of those firms are LLC's and so a disregarded entities for the purposes of taxation which cannot engage in the arrangement you describe. They do pay the ordinary income tax rate on the 2% management fee.

      Obama is interested in whacking the high earners, not necessarily the rich. If you've ever tried to work and raise a family in Manhattan on $360K per year, you'd realize just how little you'll be able to save to ever become comfortable, let alone rich. Obama wants to raise the LT cap gains tax rate to 20%, but people earning over $250K will also have to pay a nearly 4% surcharge. The 4% is part of Obamacare, so LT cap gains have already gone up to 19%. He wants to add another 5 percentage points.

      Frankly, I don't understand why investment income is taxed at all (except that it's politically popular. There's my answer). It's double taxation of the worst kinds (first you pay income tax on your wages, then you pay taxes on your deferred consumption) and discourages investment. The higher the rate, the more that's true.

      Delete
    6. Anonymous,

      Yes, the limited partners have a choice. They volunteer a portion of their positive returns in the contract they sign with the managing partners. The fee they collect to manage the money is called a "management fee" and they do pay regular income taxes on that portion.

      You know who doesn't have a choice to withhold money they earned by their own sweat from a mafia they don't agree with? Taxpayers.

      Delete
    7. ""If you've ever tried to work and raise a family in Manhattan on $360K per year, you'd realize just how little you'll be able to save to ever become comfortable, let alone rich.""

      In Houston Texas, fourth largest Metropolitan center in the USA, you can live like a KING on 360k per year. And pay NO state or local income taxes.

      So maybe the big tax people have a point. Maybe people are not rational and do not respond to incentives, otherwise there would be much fewer upper middle class people living in New York, and a lot more living in Dallas or Houston.

      Delete
    8. They're not irrational, Kyle. There are a million rational reasons for staying in a high tax area like NYC. Had I not gone to NYC to start my career in finance, I wouldn't have had the exposure and made the connections I did. The moment I went out on my own and my firm did well, I moved out of NYC to Connecticut and eventually technology allowed me to move to a state with no income tax. Many of us do exactly that.

      However, that doesn't change the fact that the tax is on high earners, not the wealthy. You can earn a lot and not be able to accumulate wealth. That was my point.

      Delete
  4. What was the Republican counter proposal?

    ReplyDelete
    Replies
    1. Indeed. Given that the Republicans have been on the one hand demanding cuts to entitlements and on the other hand attacking Democrats for past proposals to cut spending on Medicare ("death panels" etc) no one should be surprised that the negotiations unfold like this. The Republicans have to go on the record with their proposals for cuts to entitlements and other spending if they want a deal.

      So far as dividends go - it will be a good thing for everyone if all the companies which have built up excess working capital (leading to excess bank reserves) stripped some of it out as special dividends.

      Delete
    2. They have had a proposal up for about three months now. But it does not really matter. In fact they can just sit on their ass and do nothing because the onus is entirely upon the winning party, you know, the guys who haven't been able to present a budget for three years.

      Delete
    3. Well, unless you count as a proposal the closing unspecified and ultimately irrelevant loopholes I don't know where else this proposal is clear.

      Delete
  5. people voted for obama, just let him get what he wants, thats what the people voted for. then in 4 years maybe we'll get some sanity.

    ReplyDelete
  6. I don't know, I think it's a trick.

    Has Costco promised to not pay next year's dividends? what's forcing them not to? I actually think the borrow and spend govt stimulus is not so bad an analogy here.

    Although it is interesting to see that the prices rise now, (just as we might see the price level rise now in response to borrowing and spending), why wouldn't it be ex-post optimal for the board of directors to issue the dividends anyway (or to keep inflating in the govt's case)?

    Then we are eventually in Lucas Critique area aren't we ? people should figure this out sooner or later...

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.