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William H. Gross
With the budget and debt ceiling crises temporarily averted, perhaps a future economic priority will be to promote economic growth; one way to do that may be via tax reform. How to proceed depends as always on the view of the observer and whether the glasses are worn by capital, labor or government interests. Having benefited enormously via the leveraging of capital since the beginning of my career and having shared a decreasing percentage of my income thanks to Presidents Reagan and Bush 43 via lower government taxes, I now find my intellectual leanings shifting to the plight of labor. I often tell my wife Sue it’s probably a Kennedy-esque type of phenomenon. Having gotten rich at the expense of labor, the guilt sets in and I begin to feel sorry for the less well-off, writing very public Investment Outlooks that “dis” the success that provided me the soapbox in the first place. If your immediate reaction is to nod up and down, then give yourself some points in this intellectual tête-à-tête. Still, I would ask the Scrooge McDucks of the world who so vehemently criticize what they consider to be counterproductive, even crippling taxation of the wealthy in the midst of historically high corporate profits and personal income, to consider this: Instead of approaching the tax reform argument from the standpoint of what an enormous percentage of the overall income taxes the top 1% pay, consider how much of the national income you’ve been privileged to make. In the United States, the share of total pre-tax income accruing to the top 1% has more than doubled from 10% in the 1970s to 20% today. Admit that you, and I and others in the magnificent “1%” grew up in a gilded age of credit, where those who borrowed money or charged fees on expanding financial assets had a much better chance of making it to the big tent than those who used their hands for a living. Yes I know many of you money people worked hard as did I, and you survived and prospered where others did not. A fair economic system should always allow for an opportunity to succeed. Congratulations. Smoke that cigar, enjoy that Chateau Lafite 1989. But (mostly you guys) acknowledge your good fortune at having been born in the ‘40s, ‘50s or ‘60s, entering the male-dominated workforce 25 years later, and having had the privilege of riding a credit wave and a credit boom for the past three decades. You did not, as President Obama averred, “build that,” you did not create that wave. You rode it. And now it’s time to kick out and share some of your good fortune by paying higher taxes or reforming them to favor economic growth and labor, as opposed to corporate profits and individual gazillions. You’ll still be able to attend those charity galas and demonstrate your benevolence and philanthropic character to your admiring public. You’ll just have to write a little bit smaller check. Scrooge McDuck would complain but then he’s swimming in it, and can afford to duck paddle to a shallower end for a while. If you’re in the privileged 1%, you should be paddling right alongside and willing to support higher taxes on carried interest, and certainly capital gains readjusted to existing marginal income tax rates. Stanley Druckenmiller and Warren Buffett have recently advocated similar proposals. The era of taxing “capital” at lower rates than “labor” should now end.
There was a time in Pimcoland long, long ago; so long ago that it now seems like a fairytale – except it wasn’t. I had criticized a large Fortune 500 company about its balance sheet and use of commercial paper. It wasn’t really meant to be company-specific but more indicative of the growing amount of leverage that our credit system was accommodating. The company took it personally. Sorry about that. I mention it now in the age of the golden Scrooge McDuck because another large company – I shall name it Company X to be safe – is again representative of an excess that may haunt America’s future. X is a well-known corporation that, to put it simply, has grown earnings and earnings per share accompanied by nearly flatline revenues. This troubling trend began nearly a decade ago – sales having increased by only 9% since 2003 – barely a percentage point a year. Its most recent quarter in 2013, as a matter of fact, showed no improvement, with revenues actually declining by 1% instead of moving up.
Profits, however, increased because the company cut expenses along the way. Earnings per share (EPS) did even better, because X used some of its cash flow to buy back stock instead of reinvesting much of it in new plant and equipment. What struck me was not this unmasking of company X’s secret sauce to elevate its stock price, but the similarity of this corporation to the plight of the broader U.S. and even global economy. Never have American companies sent a greater share of their sales to the bottom line. Even when S&P 500 companies have witnessed a decline in corporate earnings, as shown in Chart 1, they have still experienced EPS gains. X and many companies in the S&P 500 are remarkably similar.
The U.S. economy and Company X are lookalikes as well, perhaps even twins. Revenue growth in the U.S., for instance, can best be shown by national income or its proxy, more commonly known as nominal GDP. While our annualized nominal GDP growth rate has been a tad better than the 1% that Corporation X has shown over the past 10 years, our five year moving average has slowed from nearly 7% to just above 3% in recent years and struggled to do just that, as shown in Chart 2. “Expenses” have been cut significantly as the share of wages to GDP has declined from 47% to 43% during the past decade. Before-tax profits as a percentage of GDP on the other hand have increased from 10% to 14% over the same period, mimicking what has happened with Company X. And here’s a rather incredible kicker to this theoretical comparison. The U.S. economy – thanks to the Fed – has been operating a 1 trillion dollar share buyback program nearly every year since late 2008, buying Treasuries but watching much of that money flow straight into risk assets and common stocks instead of productive plant and equipment. My goodness! If X can’t grow revenues any more, if X company’s stock has only gone up because of expense cutting and stock buybacks, what does that say about the U.S. or many other global economies? Has our prosperity been based on money printing, credit expansion and cost cutting, instead of honest-to-goodness investment in the real economy?
The simple answer is that long-term growth for each company, and for all countries, depends not on balance sheet alchemy and financial wizardry, but investment and the ultimate demand for a company or a country’s “products.” In the U.S. we have had little of that, watching our investment (ex housing) as a percentage of GDP decline from 14.6% to 12.2% over the past 13 years. Similarly, our net national savings rate (total savings after depreciation) has sunk below ground zero over the past few years before rebounding recently, as shown in Chart 3. Without savings there can be no investment. Without investment there can be little growth.
President Obama just this past week finally sounded a faint alarm, mounting a campaign to bolster foreign investment in the U.S. – amidst evidence like that presented in Chart 3 that the U.S. is falling far behind less developed nations such as Mexico in the race for investment and future productivity. “It’s time for folks to…focus on doing everything we can to spur growth and create new, high-quality jobs,” he said last Friday. Folks? Ordinary folks, the 99%, don’t have money anymore, Mr. President. The rich 1% and corporations do. Perhaps your Administration could focus some attention these next few weeks and months on an effort to engage foreign investors, corporate America and the 1% in investing in the U.S. If there’s not a profitable new “iGIZMO” or a dynamic biotechnological breakthrough worthy of investment, how about simply a joint effort between government and private enterprise in an infrastructure bank where our third world airports, third world city streets and third world water systems are modernized?
And back to my original point. Developed economies work best when inequality of incomes are at a minimum. Right now, the U.S. ranks 16th on a Gini coefficient for developed countries, barely ahead of Spain and Greece. By reducing the 20% of national income that “golden scrooges” now earn, by implementing more equitable tax reform that equalizes capital gains, carried interest and nominal income tax rates, we might move up the list to challenge more productive economies such as Germany and Canada.
Our problems are significant, Mr. President, and “Obamacare” and the signing up for it is far down the list of what we need to correct in order to move in the direction of “old normal” growth rates. Surely a few astute observers in Congress know that as well. Until we can more equitably balance “Scrooge McDuck” tax rates to rebalance wealth and “GINI coefficients,” while at the same time focusing on investment in the real as opposed to the financial economy, then the prospects for markets – whatever the asset class – are anything but “golden.”
Scrooge McDucks Speed Read
1) Growth depends on investment and investment in part depends on an equitable rebalancing of personal income taxes, capital gains and carried interest.
2) The era of taxing “capital” at lower rates than “labor” should end.
3) Investors in the U.S. and elsewhere must look for investment in the real economy, not share buy-back maneuvers that artificially elevate stock prices.
William H. Gross Managing Director
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2015, PIMCO.
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