Economic Recovery and the Tax-Fueled Exodus

by: Wall Street Strategies

As investors fretted over the myriad of economic data yesterday and watched paint dry in the form of an indecisive market, I think that the best story of the day was overlooked. Apparently, the canton of Zug Switzerland offered Diageo (NYSE:DEO) a seductive deal to move its corporate headquarters out of the UK. The deal would have exempted the top 200 executives at the company from paying income taxes, and given the company a sweet corporate tax rate. Maybe the guys and gals running the show at Diageo were sipping their own products -- which include Captain Morgan, Johnnie Walker, Smirnoff vodka and Guinness among others -- because the offer was turned down. Granted, when you have 25,000 employees around the world it doesn't help the esprit de corps if the guys at the top aren't paying any taxes. However, the deal underscores one thing leaders in the West are missing: the idea of taxing a nation to health is preposterous. Yet it's the game plan of choice in the United States, U.K., France and, to a lesser extent, other nations of the West.

These nations have been slipping for a long time as arrogance and cozy afternoons sipping cappuccino have left their flanks wide open. Centuries of dominance, first by the British Empire then by the United States, have left the impression that the rest of the world would never catch up. Now, it is scramble time on both sides of the Atlantic; but it's also panic time. The knee-jerk reaction to current economic woes is to blame the system and punish the most successful individuals. In others words, blame the player and the game. Oh well, it's going to backfire immensely -- it always does, and always will -- which is why it's such a head scratcher. You know, last week after the results of Oregon's vote to hike taxes on individuals and corporations were passed (individuals at $125,000 will see hikes up to 11% and corporations with sales above $250,000 will be taxed at higher rates as well) Chicago's mayor, Richard Daley, made no secret of his goal of taking advantage.

When asked about the vote the Mayor replied: "It will help our economic development immediately. You'd better believe it. We'll be out in Oregon enticing corporations to relocate to Chicago." Then he further added: "Businesses can go to Wisconsin. They can go Indiana. They can go to India. They can go to China. So if you want to beat up businesses, go beat them up and when they leave, just wave to them, and they're going to wave back to you."

It is amazing that a Democratic politician from the President's home state would utter such words, even though what he said is obvious. Still, it's the reaction and game plan of choice. Some think that it's only right and fair, and some kind of way of righting wrongs. Some see it as punitive, and really believe that as they punish their most important businesses there will be no lingering consequences. That is the sad irony of it all. When the rich catch a cold the general populace catches pneumonia, and when rich individuals and successful businesses catch punitive punishment the general populace catches hell.

High taxes are already taking a toll on New York.

Migration patterns in New York State show households moving out have average incomes 13% higher than those people moving into the state. From 2006 to 2007, migration flows resulted in $4.3 billion drained out of the state in the form of less taxpayer income. In fact, from 2000 to 2008 1.5 million more Americans left New York than moved to the state. There has been a massive exodus out of California, Michigan and New Jersey as people move to low/no tax states like Florida and Texas.

According to a research report by Art Laffer and Stephen Moore, from 1997 to 2007 1,100 people moved every day from nine states with the highest taxes. States with serious unemployment levels also sport really high tax obligations. Consider what has happened in California. The state, whose name is synonymous with wealth, glamour, and success, has become a revolving door with rich folks rushing to get out while much poorer immigrants rush to get in. California has a 10.55% income tax. Texas has no earned income tax and saw more than 700,000 people move into the state.

Back to Switzerland and its offer to Diageo. In Switzerland, each canton can set its own tax rate. Zug has been very aggressive, with rates starting at 16% but moving as low as 9.5% for businesses operating outside the country. Last year more than 1,200 companies moved their headquarters to Switzerland, including Noble Corp (NYSE:NE), Transocean (NYSE:RIG), Weatherford (NYSE:WFT), Tyco International (NYSE:TYC), and Foster Wheeler (FWLT). U.S. companies including Yahoo (NASDAQ:YHOO), Kraft (KFT), and McDonalds (NYSE:MCD) operating in Europe have been bolting the U.K. for Switzerland.

Still, the White House is going after multinationals to help pay for its runaway budget. I think that it would work best the other way around. I don't see this latest plan sparking people to spend or businesses to hire. It's doomed to backfire, and will put up a roadblock to a recovery that is in the cards as part of this odd thing we call the business cycle. If we let the nation be itself rather than hijacking the moment to move away from capitalism there will be much less pain. (Click to enlarge)

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The Market

The market marked time this week but fended off a few big pullback attempts, peaking into the plus column a couple of times. This morning could be about corporate earnings, which for the most part continue to impress.

Cisco (NASDAQ:CSCO) traded 79.9 million shares versus the daily average of 41.6 million in anticipation of a strong number, which was posted. Earnings were up 23% to $1.85 billion or $0.40 per share, beating the Street by a nickel. CEO John Chambers made several positive comments, including "entering second phase of economic recovery" and "saw dramatic across the board acceleration and sequential improvements in almost all areas of business." The $9.8 billion in revenue beat the company's expectations, and the consensus of $9.4 billion.

Yum Brands (NYSE:YUM) posted earnings of $0.50 per share against estimates of $0.48 per share, but the stock moved lower on same-store sales results. International same-store sales were -2%, China -3%, and the U.S. -8% (where individual franchises saw same-store sales down). Taco Bell was -5%, KFC -8%, and Pizza Hut -12%. The company opened 509 stores in China and 898 internationally outside China.

Visa (NYSE:V) traded 8.0 million shares against the average daily volume of 6.0 million before posting earnings of $1.02 per share on revenue of $1.96 billion after the closing bell. The Street was looking for $0.91 per share and $1.74 billion in revenue. The difference was debit cards, where payment volume surged 8% to $268.0 billion.

Economic Data

Initial Claims

For the fourth time in the past five weeks, initial jobless claims increased despite all the talk of improving economic trends. For the week, 8,000 more people filed jobless benefits, while the Street was expecting a 10,000 person decline. The average jobless claim for the month of January of 468.8K was much higher than the 455K average for the month of December. This does not bode well for the jobs report tomorrow.

What do we Make of Little Ole January?

Should we become excited by all the positive January comps? Or how about the swath of raised EPS outlooks for the now completed 4Q; are they worth breaking out the pom poms? With the book officially closed on the 2009 holiday season, it's safe to say that the retail sector got back to basics, managing inventory and margins, and basking in the slight ray of hope that was the reemergence of the U.S. consumer to the malls, outlets, and discount centers. Sector inventory levels entering the new fiscal year are rather lean as January clearance events, and a little extra money in the wallets of consumers that temped some to buy non-essentials, did the trick.

Disclosure: None