Back in the 1970s during the heyday of General Motors, they released an iconic add, with the tag line – Baseball, hotdogs, apple pie, and Chevrolet...
While hotdogs and Chevrolet may no longer be quite as popular, baseball, at least, remains our national pastime. What is more a part of our natural fabric than taking a child to a baseball game, arriving early to watch batting practice, or sitting in the leftfield bleachers hoping to catch a homerun ball? One of my fondest memories with my grandfather was playing catch with him, marvelling how he could actually catch the ball with his ancient glove that resembled a burnt piece of steak more than a modern day mitt. I still have autographs he collected of stars like Ted Williams and Yogi Berra.
After the horrific bombing of the Boston Marathon, the country rallied behind the Red Sox and no small sense of patriotism spurred the team on to the World Series championship. I dare say, baseball and patriotism are forever intertwined in our country.
Which brings me to the comment made recently by Treasury Secretary Jack Lew, "What we need as a nation is a new sense of economic patriotism, where we all rise or fall together." Lew made this remark in the context of the controversial debate about an accelerating trend in corporate America called inversion. Essentially, in an inversion, a U.S. company merges or acquires a foreign firm thereby benefiting from a lower tax rate on profits earned outside the U.S. Lew's comment left me a bit perplexed. I devote a fair amount of my time analysing and writing about the economy. I also enjoy discussions about patriotism and what that means for our country. But what really is, or perhaps isn't, economic patriotism?
The U.S. corporate tax rate is 35%, which is the highest of any developed country, and about twice the average rate of countries in Europe. While, some companies receive subsidies resulting in lower corporate taxes, most corporations pay taxes at rates well above global averages, hence the drive toward inversion. Moreover, the U.S. is one of the taxes copy copyfew developed countries that taxes foreign earnings at the U.S. rate, not at the lower rate of the country in which profits are generated. Corporations have long sought structural tax reform that would not only lower corporate tax rates but reduce the rate on foreign earnings. Due to the polarization in Washington, meaningful tax reform seems unlikely.
The economic consequences of tax reform, or lack thereof, are far-reaching. Global competitiveness of U.S. corporations is significantly impacted by high corporate tax rates, as are job creation and overall domestic economic growth. Higher taxes make U.S. corporations more likely to move operations overseas, or even be acquired by foreign companies, resulting in lost U.S. jobs. In fact, global business takeovers have soared over 50% in 2014 compared to the previous year. In the absence of meaningful tax reform, this trend is likely to continue.
Back to baseball... But, are there patriotic implications related to this as well?
All of us have an individual responsibility to be patriotic. To some degree the vast majority of citizens are, but we also recognize the right to dissent. This is one of the pillars of democracy in America. But corporate entities, be they fortune 500 companies or Major League Baseball teams, have no responsibility to be patriotic. They do have rules to follow, a code of ethics to uphold, but they are not governed by anybody's notion of patriotic duty. Is it any more "unpatriotic" for the pharmaceutical company, Pfizer, to merge with a U. K company to save billions in taxes than it is for the New York Yankees to draft players from Latin America? I've never heard anyone complain that the New York Yankees are unpatriotic for having foreign born players on their roster. For the record, approximately 28% of Major League Baseball players come from outside the U.S.
For-profit corporations must balance the needs and goals of shareholders, employees, customers, and business partners. The more successful they can be maintaining this balance the more people they can hire and the more money they can make for shareholders. This is their corporate duty and it involves short-run as well as long-term economic decisions.
More on M&A activity... There are multiple drivers of the increased Merger & Acquisition activity we are now seeing in the market. One is in fact a search for lower taxes. But another is the strength in the U.S. stock market which gives domestic companies a more valuable currency with which to pursue international expansion. While our country struggles to grow around 2%, many other regions of the world are showing significantly higher economic growth. With stock prices near all-time highs, corporations are more able to afford international acquisitions and investments. As the pace of deals accelerates, the motivation for further activity increases, as companies become fearful of missing out on opportunities. This herd instinct, while boosting share prices in the short run, can lead to ill-timed, or over-valued transactions negatively impacting shareholder value in the long run.
Global M&A, tax reform, and potential legislative changes are all areas to monitor closely going forward as critical drivers of the economy and markets. Next month we will turn our focus to corporate earnings, and what we can discern from 2nd quarter earnings reports. Stay tuned.
Michael Kayes, CFA
© Willingdon Wealth Management
