Feb 17, 2019

Axios Capital

By Felix Salmon
Felix Salmon

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1 big thing: Trump's invisible tax cut

Illustration: Sarah Grillo/Axios

The U.S. tax system does one thing right: It collects taxes in a very smart way.

  • Workers have taxes automatically withheld from every paycheck, and the withholdings are generally slightly higher than the expected tax owed. After the worker files her tax return, she receives a refund check for the amount that was overpaid in the previous year. About 75% of taxpayers receive a refund each year.
  • The system incentivizes workers to file their taxes and acts as a source of interest-free funding for Treasury. It's also a very effective hidden forced-savings mechanism for millions of Americans, who every year discover hundreds or thousands of dollars that they had been putting away every paycheck.
  • For most workers, the salient number when it comes to annual taxes is not the annual amount payable, but rather the difference between the tax due and the amount withheld. If you owe an unexpectedly large amount, that's a nasty hit; if you receive an unexpectedly large refund, that's a frabjous day.

The big picture: When Trump cut taxes in 2017, the White House also cut the amount that workers saw withheld from their paychecks. The result was an immediate pay hike — that went largely unnoticed.

  • The whole purpose of income tax withholding was to make taxes less salient — to make workers notice them less. According to a Harris poll for Axios,* less than half of American workers know exactly how much their take-home pay will be. When that pay went up at the beginning of 2018, they probably noticed for a week or two — and then forgot.
  • When Obama cut taxes for 95% of workers in the wake of the financial crisis, most of them didn't notice. It was implemented via the withholding system, by design, to ensure that the extra disposable income was spent immediately to boost the economy, rather than being saved.

This year, refunds are generally lower than they were previously. Increasingly they're zero; sometimes they're negative, and extra tax payments are owed.

  • The average refund was $1,865 as of Feb. 1 — down 8.4% from $2,035 a year ago.

The bottom line: Most of Trump's tax cut went to corporations rather than individuals, and many families, especially in coastal blue states, saw their total tax bill rise. By reducing withholding, the Trump administration probably thought it was making the tax cut immediate. Instead, that had the effect of making a tax cut feel more like a tax hike.

*The survey was conducted online within the U.S. by The Harris Poll on behalf of Axios from Feb. 14–15, 2019 among 2,042 U.S. adults ages 18 and older, among whom 945 were employed. This online survey is not based on a probability sample and therefore no estimate of theoretical sampling error can be calculated.

Bonus: Disappearing income in Finland

Illustration: Lazaro Gamio/Axios

It's not just the Trump administration that has problems with expectations management. A recent basic-income trial in Finland was cut short by the incoming conservative government, before preliminary results came out showing improved health and reduced stress among people receiving a no-strings €560 ($640) per month.

  • No one seems to have thought much about what would happen when the trial came to end end. One recipient told the Huffington Post: “We all are in big trouble now to be honest, because what would happen to you if your income decreased by €600?”
2. The anti-buyback groundswell
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Data: FactSet; Chart: Naema Ahmed/Axios

Stock buybacks have suddenly become a hot-button political issue on both sides of the aisle. A subject you might normally expect to occupy a breakout panel discussion in a CFO convention is now set to become central to the 2020 presidential campaign.

  • Senators Chuck Schumer (D-N.Y.) and Bernie Sanders (I-Vt.) are sponsoring a bill that would require companies to pay all their workers at least $15 an hour before being able to buy back their stock. Employees would also need to have health benefits and 7 days of paid sick leave.
  • Senator Marco Rubio (R-Fla.) says he's going to introduce a bill taxing buybacks as dividends. No one knows how this could possibly work in practice, especially in a world of mutual funds and ETFs. (The original idea surfaced in 1952, a much simpler world, and even then it was hard to work out how to levy income tax on shareholders who receive no cash distribution.)

The big picture: Buybacks are extremely popular in corporate America, which spent some $1 trillion on them last year.

  • Apple's share count has fallen from 6.6 billion to 4.7 billion since late 2012, an astonishing drop not only in terms of dollars spent but also in the percentage of outstanding shares bought back.
  • Other companies like Yum Brands, which owns Taco Bell, KFC and Pizza Hut, have seen their number of shares outstanding fall even more, albeit over a longer time horizon.
  • Most companies see their share count increase over time, as they issue new stock for compensation purposes and for acquisitions.

My thought bubble: Rubio is correct that since buybacks are economically equivalent to dividends, it makes sense that their tax treatment should be identical. What's more, buybacks are governed by federal law, unlike dividends, and are therefore easier to legislate against. But banning them outright would be easier than the contortions that Schumer, Sanders and Rubio are about to get themselves into.

Bonus: Adventures with GAAP accounting
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Data: FactSet; Chart: Harry Stevens/Axios

Many buybacks are funded with debt issuance. That increases a company's liabilities, and since the proceeds are used to buy stock that is then immediately canceled, it does nothing for the company's assets.

  • The result is that under generally accepted accounting principles, the company's liabilities can end up exceeding its assets. Technically, that's the definition of insolvency.

The other side: The companies with the largest negative shareholders' equity also tend to own extremely valuable brands. If you included a reasonable brand value on the asset side of Starbucks' balance sheet, then it would no longer look insolvent. The same goes for most of the other companies on this list.

One curiosity: The buyback-happy company at the top of this list, Philip Morris International, was spun out of Altria in 2008, around the same time that Kraft was also spun out. But Kraft, having merged with Heinz, now finds itself at the other end of the league table, with $65.4 billion in shareholders' equity.

Trivia: Which company has the most shareholders' equity? That would be Berkshire Hathaway, on $375.6 billion.

3. AirPod World

Illustration: Rebecca Zisser/Axios

For two years, Apple's AirPods were a bizarre curiosity. They were clever, but they looked odd and didn't sell very well. Then, they exploded, and according to one source, they have sold more units than even the iPhone at the same age.

  • This will come as no surprise to anybody who has walked down the street or taken the subway in New York of late.
  • AirPods had limited availability when they were first released, but as they became more common, they also started to look less weird. With broad adoption, Apple has managed to re-architect what is socially acceptable and even desirable.

The rise of AirPods has also followed the iPhone upgrade cycle. When people get a new iPhone without a headphone jack, that's often their impetus to buy headphones they can use across all of their devices.

  • AirPods are also an elegant solution to a core problem with all smartphones, which is that they're clunky and generally hard to use as a phone.

Our thought bubble, from Axios' Courtenay Brown, who got a pair of AirPods for Christmas: "One day without AirPods taught me that I've forgotten how to talk on the phone and basically do my job without them. Ordinary bluetooth headphones — which squeeze my ears, make them sweat and are just a way less seamless experience — are not an adequate replacement."

4. Delinquent car loans hit record highs
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Data: New York Fed Consumer Credit Panel, Equifax; Chart: Andrew Witherspoon/Axios 

This is a picture of distress. Car loans are the last debt that Americans generally default on, since a car is in most cases necessary to get to work.

  • The number of Americans in default on their car loans is hitting record highs, but the default rate is not: Auto lenders have been issuing many more loans in recent years.
  • "The overall performance of auto loans has been slowly worsening, despite an increasing share of prime loans in the stock," write New York Fed analysts.
  • Whom you borrow from makes a huge difference. 6.5% of loans from auto finance companies are 90+ days past due, compared with only 0.7% of loans from credit unions.

Why you’ll hear about this again: This degree of woe is happening despite a growing economy and record-low unemployment. If and when a recession hits, expect these numbers to get a lot worse.

5. Labor resurgent
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Data: BLS; Chart: Andrew Witherspoon/Axios

Workers are finding their voice, whether it's through formal work stoppages (a lot of teachers went on strike in 2018) or through other means.

6. Uncorrelated metals
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Data: FactSet; Chart: Chris Canipe/Axios

Platinum and palladium are two very similar metals — they sit right above each other on the periodic table, are found in the same mines, and are both used primarily in catalytic converters for automobiles. Up until 2016, their prices tended to rise and fall in unison.

What’s happening: Since Volkswagen’s diesel-gate, demand for platinum — used in diesel-fueled cars — has waned. Palladium, which is used for catalytic converters in gasoline-fueled cars, has benefited.

  • The price differential between palladium and platinum is historically unprecedented,” David Holmes, head of trading at Heraeus Precious Metals, tells Axios.

Fun fact: An ounce of palladium now costs more than an ounce of gold, for the first time since 2002.

7. When tax evaders are jailed
Mary Boone's booth at Art Basel Miami Beach, featuring work by Barbara Kruger. Photo: John Parra/Getty Images

Art dealer Mary Boone was sentenced to 30 months in prison this week, despite receiving support from a wide range of art-world boldface names. She evaded more than $3 million in taxes between 2009 and 2011.

  • 584 people were sentenced to prison for tax evasion in 2017, the most recent year for which statistics are available. That's 0.9% of all sentences.
  • 52.4% were white, and 69.4% were men. The median tax loss was $277,576, and the average sentence length was 17 months.

My thought bubble: 30 months is a harsh sentence, but prosecutions for tax evasion are very rare. If sentences were short and uncommon, they would have negligible deterrent effect.

8. This week: Nigeria votes

Illustration: Rebecca Zisser/Axios

U.S. stock and bond markets are closed for Presidents Day tomorrow. 49 S&P 500 companies, including Walmart, will report earnings this week, writes Courtenay. Berkshire Hathaway’s earnings on Saturday will be accompanied, as ever, by Warren Buffett’s much-read annual letter to shareholders.

The Commerce Department will release a report to the White House today that could give President Trump the “authority to impose tariffs on foreign cars and car parts on the basis of national security,” per the New York Times.

  • The president has 90 days to decide what he’ll do. The range of possible actions includes tariffs on autos imported from allies in Europe.

Yet another round of U.S.-China talks kicks off in Washington this week.

The delayed Nigerian presidential election will take place on Saturday.

Fitch will review Italy’s credit rating on Friday, and the country might see its BBB rating downgraded.

9. Building of the week: Make It Right

Photo by Julie Dermansky/Corbis via Getty Images

After Hurricane Katrina, Brad Pitt founded Make It Right to rehouse residents of New Orleans's mostly destroyed Lower 9th Ward.

Frank Gehry designed this 1,780-square-foot duplex, built to LEED Platinum certification standards. It was one of 109 homes ultimately built by Make It Right.

Defective design work on the homes is alleged to have caused more than $20 million in damages; at least one of them has had to be demolished by the nonprofit.

  • Less flashy homes funded by Len Riggio, the Barnes & Noble founder, have fared better.

"We went into it incredibly naive," Pitt told the New Orleans Times-Picayune newspaper in August 2015. Today, neither he nor the nonprofit are returning reporters' calls.

Felix Salmon