Good News! The Tax Cuts Are 'Trickling Down' - To Corporate Bottom Lines, That Is

Who could have seen this coming (besides everyone)?
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To be clear, no one could have predicted that massive tax cuts for corporations wouldn't immediately "trickle down" and manifest themselves in robust wage growth and other capital-to-labor transfers.

And when I say "no one", I mean "everybody".

Prior to the passage of the tax cuts, a veritable chorus of economists, analysts, politicians and pundits predicted corporate America would be predisposed to spending their tax windfall on buybacks. Because you know, when you consider that corporate compensation is in some cases equity-linked and then you account for the tyranny of next quarter's earnings guidance, you come away thinking there's a powerful incentive to employ financial engineering in all its various manifestations in the service of pleasing shareholders.

Sure, the passage of the tax bill triggered a slew of one-off bonuses for workers that ranged from well-meaning attempts to bestow rounding errors on C-Suite paychecks upon America's long-suffering working class, to comical "gifts" including free HoHos and Ding Dongs, but most of that was for show. That is, if you (corporate management) are under pressure to prove something about your commitment to sharing your windfall, you can create some friendly press by giving away token amounts upfront, before going right back to caring first and foremost about yourself and shareholders once the media frenzy around the passage of the tax bill dies down.

That's exactly what happened. I'd quote a bunch of Wall Street research here, but in this case, it's more amusing to simply cite CNN Money because the fact that they've picked up the story underscores the extent to which the mainstream media is hell-bent on letting American workers know that trickle down economics is yet again failing to trickle down. To wit, from an article published earlier this week:

Corporate America threw Wall Street a record-shattering party last quarter. Flooded with cash from the Republican tax cut, US public companies announced a whopping $436.6 billion worth of stock buybacks, according to research firm TrimTabs.

Not only is that most ever, it nearly doubles the previous record of $242.1 billion, which was set during the first three months of the year.

[...]

Of course, anything that helps the stock market can help the many American households that own shares directly or indirectly through retirement plans.

However, critics of buybacks argue they disproportionately benefit the rich. That's because the top 10% of households owned 84% of all stocks in 2016, according to research from NYU professor Edward Wolff.

Right. That last point is critical. Back in early December, I wrote something called "Who Benefits Most From Rising Stock Prices? Spoiler Alert: It’s Not You". That post featured the following chart and accompanying color from Credit Suisse:

Only higher net worth households tend to own appreciating financial assets. Figure 10 shows the share of families at different net worth quantiles which own equities (either directly or through mutual funds).

Households2

In case that wasn't enough to drive the point home, I featured the following visual from Deutsche Bank prominently in a number of followup articles:

Households

The bottom line: corporations used the tax windfall to boost the value of an asset that is disproportionately concentrated in the hands of America's wealthiest families.

On the employee compensation front, the picture is improving, but only gradually. Wage growth is still rising at a relatively subdued pace (average hourly earnings missed estimates in June), especially considering where we are in the cycle. If history is any guide, the Phillips curve will reassert itself at some point, but for the time being, the relationship between unemployment and wage inflation remains some semblance of broken.

Meanwhile, corporate profitability has virtually never been stronger. As Goldman writes, in a note dated Friday, "ROE ex-Financials rose by 44 bp to 19.9% [in Q1], the highest level on record except for 4Q 1997."

You'll never guess what you discover when you decompose that. Here's Goldman:

Lower corporate taxes was the largest tailwind to S&P 500 profitability following the enactment of tax reform in December (Exhibit 2). A lower tax rate accounted for 25 bp of the total 36 bp increase in ROE in the quarter.

ROE

Imagine that, right?

Finally, guess which sector's profitability was crimped by margin pressure? If you said "Consumer Discretionary", you win a free Ho Ho. Any guess why margins were under pressure there? Let's go to Goldman one more time:

... this in part reflects the sector’s susceptibility to growing wage pressures.

Nothing further.

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