A Little Extortion Never Hurts the Bottom Line

Original published on The Agonist

It used to be if a corporation wanted to practice the dark art of extortion, it would do so well outside of the public eye. Not these days; company CEOs are out in the open and proud of it when they want to extract yet more money out of the taxpayers.

Take the case of Caterpillar CEO Douglas Oberhelman. He wrote a letter to Illinois state governor Pat Quinn, complaining about the state’s recent increase in the corporate tax rate from 4.8% to 7.0%. He said at least four other states have approached the company offering generous allowances if Caterpillar would move its headquarters out of Peoria, Illinois. Neighboring states of Indiana and Iowa have admitted to lobbying Caterpillar, as has the far-away state of Texas. The company said it wasn’t threatening Gov. Quinn over the tax increase, but it had “to do what’s right for Caterpillar.” That’s corporate-speak for “we’re threatening to leave the state if you don’t rescind this tax increase.”

Let’s All Pitch In to Help Corporations

Illinois is easy pickings in intra-state competition for jobs: it is the only state that has been able or willing to raise taxes to deal with its budget deficit. In percentage terms, it raised the personal income tax rate even more, from 3% to 5%. Douglas Oberhelman never complained in his letter that his 23,000 employees in Illinois are also going to have to pay higher taxes. Caterpillar is seemingly okay with this, because the Illinois state deficit is one of the largest in the nation, and the money necessary to plug the hole has to come from somewhere – just not from corporations.

In the business of “let someone else pay for government services”, corporations are the hands-down winners. Corporations use the same roads as everyone else, fly out of airports, enjoy the services of the water, electric, and gas utilities, clog up the courts, get police and fire protection, and if necessary have their overseas interests secured by the military and the diplomatic corps. They just don’t want to pay for it. Fifty years ago corporate income taxes at the federal level generated about 6% of GDP; today the amount is less than 2% of GDP. The difference has been made up in increased taxes on individuals, and dramatically increased federal government borrowing.

At the same time, corporate profits in relation to GDP have soared. In 2010, the ratio was 9.46%, and the last time the corporate take of national income was this high was in 1929, when corporations earned 9.9% of GDP (an all-time record). Back then, corporate profits were the result of a booming economy, and were matched by accelerating corporate revenues. That’s not the case today. Revenues have been relatively stagnant the past three years since the 2008 financial crash. But corporate profits have recovered nicely – they were up 36.8% in 2010 on a yearly basis according to the Bureau of Economic Analysis – because corporations have several things going for them at the same time.

For one, the Fed’s zero interest rate policy has dramatically reduced corporate borrowing costs, and corporations have loaded up on long term debt at exceptionally cheap rates to lock in these benefits for years to come. Second, corporations are making much more of their income in emerging markets, including China and India, than ever before. If you look at a subset of non-financial companies among the S&P 500, their US earnings as a percentage of national income in QIII last year were 7.0%. In 1949, this number was 15%, and throughout the 1950s and 1960s corporations generated profits at a rate in excess of 12% of national income. The steady decline in these earnings has been made up in money earned from overseas operations, which used to be a negligible part of US corporate activities.

Combine all this with aggressive efforts to cut the tax bill, and you can see how corporations can be earning record amounts of income. But the real kicker to the bottom line has been the reduction in labor costs. Last year alone, labor costs fell 1.5% for corporations, and nothing reaches the bottom line quicker than cutting the biggest expense corporations have. Not surprisingly, this has been reflected in the unemployment rate, which has been stuck in the 9% - 10% range for three years now.

It’s the theory of Ben Bernanke and the Fed that the zero interest rate policy, plus all the liquidity added from Quantitative Easing programs, will induce corporations to start hiring again, and all will be well. Maybe Bernanke should take a look at Europe, where unemployment in many countries has been stagnant for decades in the 10% to 20% range. While economists in the US are fretting how long it has taken for the unemployment rate to move down, they might be better off investigating the question whether chronic high unemployment is here to stay. There is a lot to indicate this might be the case, especially if you think employment arbitrage is here to stay.

It’s All About the Bottom Line

Douglas Oberhelman of Caterpillar is engaged in the game of employment arbitrage. He is placing the livelihoods of 23,000 Illinois workers in jeopardy so he can get a better tax deal elsewhere. This is the last large multinational company in America to be located in such a small town as Peoria, Illinois, which would have nothing much going for it if Caterpillar were to leave. The company has stayed in Peoria, where it was founded, because it makes farming equipment and has wanted to stay close to its agricultural roots. For most of the company’s history, this mattered, and the company identified in a positive way with its position in the heartland of America. Apparently that identification has been shattered, if the tax position and the bottom line now matter more.

It may be hard to believe, but there was a time in America when corporate identity wasn’t so fixated on revenue and earnings. Reading through corporate annual reports from 1940 through 1970, much of the management discussion focused on customers and employees, and the communities the company served. There was no need for quarterly earnings statements, and the stock price was mentioned in passing. No one expected 15% earnings growth rates per annum except for clever start-up companies, like IBM. There was no such thing as executive options or deferred share grants, and executive salaries were shockingly low by today’s standards.

The change came in the early 1980s, when Ronald Reagan ushered in an era of low corporate tax rates and a reduced regulatory environment. This was timed perfectly with the baby boomer generation coming into their peak earning years, and the result was a stock market which took off and never looked back (the Dow was at 1,000 when Reagan took office, and by 2000 was over 14,000 with hardly any corrections along the way). In such a market, it was quite possible for corporations to earn 15% on their equity year after year, double what had been the case in the previous decades. It was also possible for executives to earn unthinkable fortunes, for the stock market to turn into a casino, and for national income to shift away from the middle class and average worker, towards a select fortunate few.

Money Talks, But Threats Talk Louder

The corporate world has long forgotten about the old days when an 8% ROE would be considered respectable, and when customers and employees mattered more than the stockholders. Corporations think they are entitled to record high earnings and the resulting record high bonuses, and even if this practice over so many decades has nearly wiped out the middle class in the US and expanded greatly the number of people living in poverty, corporations have no intention of changing their expectations nor their behavior.

After all, they have the politicians on their side. It’s not just that corporate money buys votes in Congress. Fixing the campaign financing problem is only a part of the solution to reducing corporate influence in government. Something also needs to be done about corporate extortion, and this problem is much harder to eradicate.

Part of the dispute underway between the European Union and Ireland is on this issue of corporate extortion, aka tax arbitrage. Ireland has a very low tax rate on corporate earnings – 15% - and Germany and France have made it a condition of granting loans to Ireland in its current budgetary crisis that the country increase its corporate tax rate to EU levels, thus eliminating the arbitrage possibility. Ireland has refused – the low taxes after all are deemed to be the source of the “Irish Miracle” of the last decade, when the country achieved envious growth rates by attracting new companies from abroad. Never mind that the Irish Miracle blew up under a mountain of unsupportable debt, and that many of the new companies packed up and moved away. The ones that stayed fired most of their Irish work force.

Here you see the problem. Despite the obvious evidence that corporations are very fickle employers, politicians cling eternally to the myth that government must attract corporations in order to generate jobs. The Republican Party in the US has bought into this myth so thoroughly that even the Tea Party activists who are suspicious of corporations nonetheless, the minute they get into office, suck up to the corporate lobbyists. Money talks, and threats talk even louder. Time and again corporations will stage competitions among states and cities eager to be the home of a proposed new company plant, and the winner will be that government body which offers the largest tax breaks as bribes. Once the company decides, within a few years it will threaten to leave again, renege on its tax obligations, and move all its employees elsewhere. Yet there are no politicians to be found anywhere who stand up to these extortionist tactics.

The trend now is to take these tactics global, by moving the entire company to a different country. George Buckley, the CEO of 3M Corporation, said recently that he’s sees his company moving either to Canada or Mexico altogether if the business climate in US does not prove more amenable to corporate interests. How much more amenable does Mr. Buckley want the climate to be? Does he want no corporate taxes whatever – a free ride paid entirely by individual taxpayers? Should he be able to operate without any regulations? Should the 15% capital gains tax payable largely by corporate executives be abolished entirely? Maybe corporate executives should be exempt altogether from personal income taxes, the way the French nobility avoided taxes before the French Revolution.

Multinationals as Sovereign Powers in Their Own Right

We are already operating in a world where corporations float around from country to country, impervious to control by any one nation. The US had a hard enough time last year during the Gulf of Mexico oil spill to get British Petroleum to pay any attention to the federal government. BP had outsourced a lot of its offshore drilling operations to an American company called Transocean, but when it came time to get this company to cooperate, the US found out that the year before Transocean had shifted its headquarters to Zug, Switzerland. It was essentially out of reach of the US government.

Zug is a town of 26,000 people, but it is home to over 30,000 corporate headquarters. It offers one thing: a 15% corporate tax rate (just like Ireland). Transocean is typical of the companies that have headquarters in Zug; the company has no more than 15 employees in its headquarters, while it has 1,300 employees in Houston, Texas. Its headquarters is a corporate shell, yet it is a strong enough shell to avoid oversight or the reach of the taxman from the US. The Swiss government, of course, doesn’t care what the company does outside of Switzerland.

In order to do something about corporate extortion, you have to eliminate the corporate tax havens in places like Zug, the Bahamas, and the Cayman Islands. You have to convince states and provinces and nations to stop offering tax breaks and other incentives in order to garner precious corporate jobs. You need, in short, one world government to enforce rigid tax codes that wipe out arbitrage possibilities.

We are a long way away from one world government. The closest thing we have to one world government are the multinational corporations that operate in the global economy independent of any government control, and unmoored to any particular community. The closest thing we have to a global parliament are the expensive restaurants and resorts where corporate executives meet to discuss tax strategy and the excessive burden of government regulations.

The CEO of JP Morgan Chase, Jamie Dimon, was recently speaking at one such resort. He warned the US government about the “absurd” idea of restricting derivatives, and the “terrible shame” that is the Dodd-Frank Act, designed to prevent yet another financial collapse. “If America adopts a lot of things very different from the rest of the world”, said Dimon, the US will be hurt competitively, and he noted that Singapore, China, India and South Korea don’t have these sort of restrictions.

Addressing the US Chamber of Commerce, President Obama said “I understand that you’re under incredible pressure to cut costs and keep your margins up. I understand the significance of your obligations to your shareholders. I get it.”

President Obama gets it, alright. He understands the explicit threats involved, and he “gets it” in his pocketbook in the form of campaign contributions. The rest of us get it too – we just get it in a different part of the anatomy.



there was a "hit piece" on 60 minutes

with their latest "tax holiday" demand, which is to bring their parked offshore profits back, tax free...

and the Cisco CEO was claiming this would "help the economy and create jobs". He's so full of shit! They simply want to bring back the profits in order to distribute them to shareholders and bump up their stocks, dividends.

Cisco has literally demanded employees move to India, move to China AND take pay on the pay scales of China and India. Cisco at one point proclaimed they wanted to be a Chinese company.

IBM has gotten tax breaks, routinely from local, state and federal governments, subsidies, gifts, all the promise of creating jobs....so what does IBM do? Fires Americans and offshore outsources the jobs or brings in foreign guest workers to displace Americans....
amazingly enough local governments, state have not demanded the subsidies back that I am aware of.

Quick to take Govt funds tho

Great writeup. Amazing how fast these amoral multi-nationals are to take
stimulus funds (Caterpillar, GE), TARP (eg GE taking FDIC funds STILL), government guarantees of the commercial paper market at the height of the crisis (GE, Caterpillar, Chase) ad nauseum.

And Robert gets it exactly right re the 60-minutes BS piece on corporate efforts to get a tax holiday on repatriation. At one time I respected 60 Minutes but that piece with Leslie Stahl could have just as easily been written by the Koch Brothers

I gather it is over $1 trillion at stake

That is the minimum amount being reported on corporate balance sheets in offshore accounts. See further comments below on this tax scheme.

I was thinking of adding a few paragraphs on the tax holiday

The article was getting lengthy enough however. There have been several news reports on this tax gimmick granted corporations by Congress. They get to keep their earnings offshore and "defer" taxes until they repatriate the earnings back to the US. The problem is, they never repatriate the earnings. Rather than pay US taxes, companies go to great lengths to manage their cash flow by taking on debt. Microsoft last year came to the debt markets for the first time ever, precisely to raise the cash that they could have just as easily repatriated.

What companies are gambling on is Congress granting a tax holiday so that this money can be repatriated tax free; it has happened at least once before. The behavior is exactly the same as illegal immigrants who stay below the radar in the US until the government grants an immigration holiday; that too has happened before, so both illegal immigrants and multinational corporations are governed by the same behavior.

It is estimated the tax break costs the US Treasury $60 billion a year in lost revenue. Interestingly, the Treasury has resisted the current pleas by corporations to grant a tax holiday; they don't want to encourage bad behavior. Good luck to them, especially since the matter is really up to a spineless Congress (which will of course be completely opposed to an illegal immigrant amnesty).

go for it, lots of space on EP!

I haven't written about the "tax loophole to offshore outsource your job" in a while, but if you have something to say that's good, unique and you're on a roll, it's perfectly cool to write a separate piece.

It seems we're about to get hit with two things, one is yet another corporate lobbyist wish list even on the corporate tax code and another is an unlimited importing of their "offshore outsourcing the jobs" trick of importing foreign labor through various means to manipulate the U.S. immigration system,, completely ignoring the statistics on U.S. citizens being displaced by this.



Freeze their assets, pull their passports

3M was once a fine company of engineers, problem solvers, and innovators. Now this CEO feels free to make such statements. The first time a corporation leaves the USA for real, workers as well as legal address, there should be a special tax, "the 3M tax," that adds 100% to any imports from 3M or anyone else that pulls this stunt.

As for Zug, Switzerland and the Bahamas, I'm sure that Gates might offer a few ideas ... Robert, not Bill;)

I wonder if the German people hear this type of nonsense out of their CEO's. If they don't, I wonder why?

This article flows nicely and then, all of a sudden, crashes you to shore with a big thud. It's hard to imagine the entitlement that these "leaders" posses.

Caterpillar vs Chicago

We are not tax serfs. The govt is ours, we do not belong to the govt. Illinois and especially Chicago have driven most of their large corporations out of state or out of business. "Only" 7% corporate tax, along with fees, fines, rules and regulations, have made Illinois the #1 most expensive state to do business in. Meanwhile Chicago has about bankrupted itself with it's populist gimmies, and has famously run out of "other peoples money," which they have given to their friends in return for votes and campaign donation kickbacks.

It is Chicago that needs to find another way of doing business, not Caterpillar.

Catepillar is offshore outsourcing

and that would do that regardless of the taxes in a particular state.

That said, it sure seems the illegal immigrant lobby gets special favors carte blanche, such as Chicago, LA, is where the taxes are also going through the roof. I'm sorry folks, but this really does drive a lot of social underclass costs and is another example of lobbying vs. common sense practicality.

The large corporations are a

The large corporations are a different matter but many small manufacturers want to stay and produce in the US. Before thinking about increasing taxes on companies that produce in the the US, taxes should be imposed on imports from countries that manipulate their currencies and are protectionist like requiring technology to be transferred overseas to sell there. Does it make sense to be taxed to produce and create jobs in the US when products from protectionist countries come in for free?