Penny sucking and corporate tax reform

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When I purchase some stock online, I never try to nail my “limit price” down to the penny. I do not believe that ordinary people can do market timing that well. But that penny means a lot to the high-frequency traders and their AI computer algorithms.

In a story that you might not see as connected, Amazon has had to apologize for its earlier dismissal of delivery driver complaints that they must resort to urinating in bottles on their routes if they are to meet productivity demands.

Both of these stories are examples of what I call “penny sucking” as a corporate strategy. The companies do it because it works to generate huge amounts of wealth flowing upward to stockholders. And “successful” penny sucking is a major reason why the move by President Biden to reverse the 2017 corporate tax cuts is so necessary and justified.

What is penny sucking?

I wrote a two-part series on “penny-sucking economics” over two years ago, but the concept is worth revisiting in this current corporate tax debate. Economist Paul Krugman recently wrote an excellent analysis of why the 2017 corporate tax cut legislation failed to generate the promised new business investment and net new tax revenues. I will add penny sucking to his list.

The idea of penny sucking is that very small amounts of money, multiplied by millions of transactions, and compounded over decades through the “time value of money,” generate many billions of dollars in transferred, and often untaxed, wealth.

The master of this strategy was Sam Walton, who realized that by holding his net profit margin to about three cents on the sales dollar, and by diligently penny-scrimping with both employees and suppliers at every turn, he could accomplish two things. First, he could keep his prices to Walmart customers so low that he could turn dominant competitors like Kmart and Sears into minor has-beens. [1] Second, Walton could generate family wealth over multiple decades by accumulating those pennies extracted out of every labor, purchase, and sale transaction. The Walton family is now America’s largest family wealth holding.

As an old camp song says, “two and two and fifty make a million.” High-frequency stock traders use complex artificial intelligence algorithms and special trading platforms to generate an estimated (per NASDAQ) 50% of all daily trades in U.S. stocks. At that volume, clearing just a few cents per buy-sell order through arbitrage, multiplied by millions of shares, extracts pennies-turned-into-dollars from thousands of slower investors like me, for whom that amount is seen as an unavoidable cost of trading on a much smaller portfolio. In effect, the “friction” created from a fast-churning stock market throws off billions of dollars of wealth in tiny bits annually, captured by a relative handful of high-frequency investors.

Where there once might have been one big brown UPS truck per day lumbering into my neighborhood, carrying Amazon products among a truckful of other sellers’ packages, I now might see several Amazon-branded vans cruise by daily. One of those vans is carrying the $5.00 do-hickey computer connector that I would once have purchased at a now-defunct RadioShack store. [2] That do-hickey must now be purchased through Amazon, but in exchange it is delivered right to my door.  My math-brain tries in vain to figure out the logistics of this distribution strategy, but clearly it has to do with a massive quantity of orders, multiplied by computer-monitored “driver productivity” pushed to a very high, “no pee break” level.

And back to Sam Walton, Walmart employees still regularly complain about being required to clock out before mandatory end-of-shift anti-theft inspections, as well as many other small labor cost “efficiencies” which squeeze “sweat-of-the-brow” pennies from each worker daily, multiplied by 2.3 million employees.

There are numerous other examples of corporate penny sucking in lots of industries. Good business management has always been about making labor more efficient, even in small increments. Especially in the case of Walmart, this is long-time corporate frugality at work. The difficult questions come when looking at “Who benefits?” from the swept-up pennies.

Good economists disagree

My observation is that when you put five economists into a room to talk about labor productivity and wages, you get six different answers. [3] The main difference I read in these disputes comes from the weakness of traditional methods in defining aggregate labor productivity, versus the reality of on-the-ground labor management. Regardless of what the aggregate numbers say, Amazon drivers see peeing into bottles, and Walmart workers see unclocked minutes at shift changes, as “more work for less money.”

When we get to taxation issues, however, this is “transferred wealth,” which you can see as either realized labor efficiencies or, alternatively, as an extraction of higher labor productivity without compensation. The income inequality gap over the last thirty years clearly favors the latter interpretation. Bottom rung employees have seen very little added cash compensation while the benefits have historically accrued primarily to top managers and shareholders. The decline of union bargaining has shifted the power structure in determining who gets the benefits of the squeezed-out labor pennies.

Magnification of the penny hordes

Obviously the accumulation of daily pennies does not account for the whole accumulation of one-quarter of a trillion dollars of Walton wealth, or the over-$200 billion held by Amazon’s Jeff Bezos and his ex-wife MacKenzie Scott. That is where the time value of money and tax avoidance come in.

By one common definition, the current stock price of Walmart, Amazon, or any other stock is the theoretical net present value of all expected future cashflows from those companies. In effect, the cashflow stream of future dividends, enhanced by all of those squeezed-out pennies stretching out every year into the future, is discounted by the company’s “cost of capital” to create one estimate of the current market value of a company’s stock shares.

Bottom rung, penny-squeezed employee real earnings have been growing at a measly 1.5% to 3% over the last several decades, while executive compensation and corporate owner income has grown between 6% and 10%. You can use the “Rule of 72,” to estimate the accumulated time effect of compounded rates of income growth, and see that bottom rung income has taken 24 to 36 years to double, while executive compensation has been doubling every 7 to 12 years. [4]

The wealth gap gets ever wider, and often this wealth transfer is in the form of unrealized capital gains, which never get taxed in many cases of multi-generational wealth. This is due to numerous special-interest tax preferences and complex quasi-legal tax avoidance schemes. Wealth and power beget more wealth and power.

The double taxation myth

While the 2017 tax cut took the top marginal corporate tax rate in the U.S. from 35% down to 21%, numerous special-interest tax preferences and “creative accounting” have resulted in 55 of the nation’s largest corporations paying zero dollars in federal income tax on more than $40 billion in profits in 2020. President Biden is attempting to take the nominal rate back up to 28%, still well below the pre-2018 rates, and trying to cast the collections net more broadly and equitably. Right now, the big guys often pay low taxes, while the small corporations get stuck paying “full freight.”

It has been Republican dogma in recent years that ALL taxes are bad, but especially corporate taxes. They often claim that there is “double taxation” going on here, where the corporation pays taxes on their profits (well, sometimes), but then the stockholders pay taxes again on distributed earnings (again, sometimes).

Three years ago, I looked at the “double taxation myth” in detail, but my main point still is that corporate owners want to have it both ways. On one hand, they have made increasing legal progress in determining that corporations are “legal persons,” separate from their owners, in terms of a host of constitutional and economic rights, from free speech to freedom to withhold services or employee benefits. When bankruptcy looms, this “legal person” status means that the government, vendors, and employees will bail them out no matter how badly they have mismanaged corporate assets, limiting the liability of often-irresponsible investors and managers.

On the other hand, when it comes to being taxed on that accumulated wealth, including all of those extracted billions of pennies, they then claim that the company is not a separate person from the owners, and that they should be taxed instead as one entity. Pick one, please.

I regularly joke that, if corporations want to be treated as legal persons, then the simplest tax reform solution is to tax corporations at personal tax rates. I know that it is more complicated than that. But I do think this needs to be the starting point for discussion. Instead, we get a host “special interest” reasons why that Amazon driver might get taxed in net at a higher rate than the corporation itself, or even many of the stockholders.


Notes:

  1. While the combined Sears/Kmart is technically still operating after their 2018 bankruptcy, most watchers see them primarily as a property holding company today rather than as a significant retail player.
  2. RadioShack also still exists, but with far fewer stores, now selling mostly phones, and no wall rack containing every possible combination of male and female electronics cable connectors that was once their staple.
  3. For example, this Iowa State University economist sees wages tracking productivity up while these European economists see the opposite.
  4. To quickly estimate the time it takes for an income stream to double in value, simply divide the annual percentage growth rate into 72. Thus a 10% growth rate doubles wealth in about 7.2 years, while a 3% growth rate requires 24 years to double.

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3 thoughts on “Penny sucking and corporate tax reform

  1. Bruce Lindgren

    A few years back, we spent Christmas in Branson with our children and their families. At Silver Dollar City, we had discussions with several employees about what was to happen to them at the beginning of the New Year: Virtually all of them would be laid off and would apply for unemployment. Similarly, employees at all the local tourist attractions, motels, restaurants, and music shows would do the same thing. In there words, the Branson business model is, “We will pay you for nine months of the year, and the state of Missouri will pay you for the other three.” So, the employment costs for a majority of local businesses for those three months were transferred to Missouri taxpayers (complicated by the fact that some of those taxes came from the employers). Undoubtedly, there are other industries where similar economics come into play. More than pennies are beings sucked here.

    Reply
  2. Lisa7

    Always learn something new from your blog. A question – when a corporation’s tax rate is increased, who “pays” for the increased expense – is this cost simply passed along to the consumers/purchasers of the company’s products/services in the form of higher prices, especially in industries dominated by a few large companies or a lack of price transparency?

    Reply
    1. @rklindgren Post author

      The market sets the price in the end. It is common in Europe to see McDonalds workers paid a living wage and with health benefits paid by higher personal & business taxes, yet adjusted for exchange rates the Big Mac costs about the same. Google “Big Mac Index.”

      Reply

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