SHI Update 2/22/17: ODD man OUT

SHI Update 2/15/17: Economic Soup

February 15, 2017

SHI Update 3/1/17: Broken China?

March 1, 2017

Published by llterry5 at February 22, 2017

The US is unique.

For many reasons. Lately, one of the more glaring reasons has been in the news: TAXES.

Consider this graphic, courtesy of the OECD and their publication, ‘OECD Revenue Statistics 2016′:

Not only are total US tax collections – as a percentage of total country GDP – one of the lowest in the 35 member international organization, we also have the distinction of being unique for another reason: We are the only member of the OECD without any form of a national consumption-type VAT, or ‘value-added tax’.

W e are the odd man out.

On the other hand, we already have a form of VAT or consumption tax: State sales taxes. Tennessee tops the list with a 9.45% levy, but some states like Oregon have no state sales tax.

But on the other hand (it’s good I have two hands!), the US corporate tax rate is the highest in the OECD. At 35% (before adjustments), our top corporate tax rate is significantly higher than Switzerland (8.5%); Ireland (12%); Canada (15%); and, Germany (15.83%). Only 4 other countries have corporate tax rates at 30% or higher – and in second place is France at 34.43%. (And we all know how poor the business climate is in France.) If you’d like to see the corporate tax rates within the developed nations of the OECD, click the link: http://stats.oecd.org/Index.aspx?QueryId=58204

You may be asking what all this has to do with the Steak House Index? Simple. The SHI is intended to measure the ebbs and flows of US GDP thru its largest single component: Consumption. So if the Trump Administration and Congress pass a new consumption-focused tax plan, it could have a huge effect on both consumer consumption and the GDP.

Welcome to this week’s Steak House Index update.

Remember: The Steak House Index BLOG has its own URL – https://www.steakhouseindex.com/ The reading experience on the site is much better than in the email form. I suggest you click the link and give it a try!

As always, if you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://terryliebman.wordpress.com/2016/03/02/move-over-big-mac-index-here-comes-the-steak-house-index/)

Why You Should Care: The US economy and US dollar are the foundation of global economics: our nominal GDP is over $18.8 trillion a year. Is it growing or shrinking? Is it possible to know – before the quarterly GDP releases from the BEA?

The objective of the SHI is simple: To predict the direction of this behemoth ahead of official economic releases. But while the objective is simple, the task is not.

BEA publishes GDP figures the instant they’re available. Unfortunately, it is a trailing index. The data is old news; it’s a lagging indicator.

‘Personal consumption expenditures,’ or PCE, is the single largest component of the GDP. In fact, the majority of all GDP increases (or declines) usually result from (increases or decreases in) consumer spending. Thus, this is clearly an important metric to track.

I intend the SHI is to be predictive, anticipating where the economy is going – not where it’s been. Thereby giving us the ability to take action early. Not when it’s too late.

Taking action: Keep up with this weekly BLOG update. If the SHI index moves appreciably – either showing massive improvement or significant declines – indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.

The BLOG: Everyone seems to agree: the current US corporate tax system is a mess. They don’t yet agree on the solution, but they seem to agree it needs to be “fixed.” I believe a new tax law will pass. Probably before the end of the current fiscal year, September 30th. We’re seeing tremendous desire – both in Trump’s administration and in Congress – to pass new tax legislation.

The current tax law, they will tell you, creates two large problems:

Tax Inversions
Trade Deficits

Tax inversions result from the combination of fluid international trade and developed countries (like Switzerland and Ireland) sporting significantly lower corporate tax rates.

Many US companies, seeking to increase their ‘bottom line’ (after-tax) profit, have moved their headquarters to a low-corporate tax country. Our 35% tax rate motivates this behavior. This is a problem for a number of reasons. First, such a move eliminates much (if not all) the US taxes paid by that company. And second, once that company is domiciled in another country, what was previously a US manufactured, and US consumed product is now a foreign manufactured product and a US import. Which increases our trade deficit.

A trade deficit results from the US importing more than we export.

The math is simple. Let’s look at December of 2016. In that month, the US exported $190.7 billion of goods and services; at the same time, we imported $235.0 billion. Resulting in a December trade deficit of $44.3 billion. To get a handle on the ‘big picture,’ take a look at the following chart, courtesy of the BEA:

In 2016, the trade deficit was $502.3 billion. And each of the past 5 years has been about the same.

Which has Congress thinking: The US is buying about 1/2 a trillion dollars of “stuff” – each year – more than we’re selling. Shouldn’t those countries selling us this stuff pay a tax for the privilege of accessing our market? The math is certainly compelling: If the US was able to charge a “border adjustment tax” – or BAT – on $2.7 trillion of imports, at a 20% tax rate we would generate $520 billion of new tax revenue!

Hmmm…there’s gold in them thar’ hills!

But there’s a catch. A big one. Who, precisely, will pay the BAT? The exporter to the US? The US company? The consumer? Hmmm …. clearly, this is a bit more complex than at first glance.

In fact, it’s far more complex than anyone can possibly imagine. The potential for unintended consequences is staggering. Which is why I wanted to start this dialog with you.

You will see and hear a LOT about this topic in the next few months. Pay attention. And I’ll chime in from time to time. But economic theory aside … taxation reform aside … the greatest impact of this type of new tax approach will be on consumption – and consumers. Ultimately, consumption taxes are paid by the consumer. I suspect we will see the same result here. Oh, sure, economic experts will assure us that market forces will adjust the relationship between the US Dollar and the currency of the exporting country – effectively rendering the BAT meaningless. Perhaps. I don’t think so. But possibly. Regardless, even IF this is the result, it will take a long, long time. And during that adjustment period – IF it happens – we will see a lot of winners … and a lot of LOSERS.

Last month, Oxford University wrote a very, very detailed paper on this topic. Called “Destination-Based Cash Flow Taxation,” at 98 pages, it’s pretty dense. (You will see this name as an acronym in the text below.) So I’ve “cut” out a small piece that might help you understand the mechanisms and economics behind the change. It is directly below … is rather long … and, sorry, rather dense. Read it if you feel up to it and know, either way, there’s a beautiful steak dinner waiting for you at the end of this BLOG! 🙂

“A key element for understanding both the incentive effects of a DBCFT and the incidence of a DBCFT is the role played by border tax adjustment (BTA). By this is meant that exports would not be subject to the tax, but imports would be. The impact of BTA has been extensively studied in the literature on VAT, in analysing the effects of shifting from an origin-based system (export taxed, imports untaxed) to a destination-based system (exports untaxed, imports taxed); we draw on that literature here.

The adoption of border adjustments would appear initially to make a country more competitive in international trade. But any such effect is at most a temporary one.

To see this, consider first the case in which there is a single common currency, or a fixed exchange rate. Then consider a border adjustment by one country only; for the moment we consider only the impact of this border adjustment, abstracting from the other elements of the DBCFT.

Moving from an origin-based tax that included exports in the tax base, the border adjustment would make exports cheaper on the world market; this would create a stimulus to exports. By contrast, the domestic cost of imports would increase with the tax on imports; this would discourage imports. With a fixed exchange rate, and sticky wages, both effects would induce a stimulus to domestic activity.

This corresponds to the well-known effect of such border adjustments having the same impact as a currency devaluation – that is, in making exports cheaper to non-domestic consumers, and imports more expensive for domestic consumers. In the short run, this would generate a stimulus to domestic production relative to foreign production.

Over the longer run, however, we would expect prices to adjust. Expansion of domestic production would lead to an increase in the demand for labour.

This would in turn push up the wage rate, and in consequence, push up the price of domestically produced goods and services. The effect of this rise in prices and wages would be to begin to raise again the price of exports on the world market, and to raise the price of domestically-produced goods relative to imports.

When domestic prices and wages had risen far enough, the initial real equilibrium will be re-established. In this long run, there would be no overall impact on trade, due to the price adjustments. If instead the country had a flexible exchange rate, the same real long-run effect would occur naturally – and much more quickly, quite possibly indeed immediately (with some effect in advance if the change is pre-announced) – through an appreciation of the exchange rate, which would raise the (domestic currency) price of exports in the world market and reduce the price of imports. This would not require adjustment to the nominal price level in the domestic country.

In effect, the initial fiscal devaluation would immediately be offset by an appreciation of the currency – i.e. a revaluation; these two effects would cancel out, leaving trade unaffected. The nature of the adjustment — as between changes in domestic prices and wages, in the nominal exchange rate, and in the level of activity — will thus depend in practice on which of these can adjust more rapidly.”

🙂

The excerpt above suggests where countries have “flexible exchange rates” FX might immediately ‘re-balance’ pricing relationships. Maybe. But I’m not sold. FX doesn’t work that way … and certainly not that efficiently or effectively. So I’ll repeat: Even if the initial disruptions are “smoothed out” by market forces, I suspect it will take longer than economists suggest.

Further, once that adjustment occurs, all imports will probably cost more than they do today. But, you might argue, if the USD appreciates by, say 20%, wouldn’t that value increase offset any increased cost for the producer? Probably not. Let me give you an example: Today, you can buy a euro for about $1.06. From 2010 to 2014 a euro cost you about $1.28 – about 20% more. When the euro effectively “devalued” (in USD) by 20% in 2015, did European imports get 20% cheaper? If you bought a 2014 Porsche for $100,000, could you buy the same 2015 model for $80,00?

Nope.

OK … had enough? Shall we move on? How is the consumption of high-dollar steaks this week? Let’s take a look.

Well, this week the data is interesting. Remember that last week’s SHI was 41 – an extremely strong reading. Surprisingly strong. Perhaps Valentine’s Day impacted the results? (Remember we track Saturday reservations. VD was Tuesday.) This week, our SHI reading is a positive 1.

As usual, Mastros is fully booked between 5:45 and 9:00 pm – but we can get you in at 9:30! 🙂

But this week Filet Mignon’s are not flying off the grill at our 3 other pricey-eateries. On Saturday the 25th, The Capital Grill is wide open, there are plenty of tables at Ruths’ Chris, and even Morton’s has about 50% availability. This is a significant change from last week.

Here is this week’s chart:

It’s interesting to note today’s SHI reading is very much in line with the reading from 3/2/16 – almost a year ago. Almost identical. We almost have a full year of weekly data. Soon we’ll be able to see if 2016 fluctuations were possibly influenced more by holidays or special events than economics. And we’ll be able to better assess the macro-trends.

Here is the SHI trend chart since 3/2/2016:

My conclusion: It appears to me we’re very much in a “trading range.” Today’s data does not worry me; in fact, it validates my belief that the US economy continues on a solid, strong path. Assuming our theory is accurate, and the consumption behavior suggested in the SHI accurately reflects the consumption component of GDP, then it would appear the consumer continues to feel optimistic about the future – and is willing to buy expensive steak and ‘Lobster Mac And Cheese’ dinners in large numbers!

I’m more concerned about the possible tax law changes making their rounds in Congress. And their impact on GDP, inflation, etc. So stay tuned!

Terry Liebman

llterry5

Comments are closed.