Huge Disparity in Corporate Profits Hints at Something Amiss

Some worry that gap between weak profits in official U.S. government data and record earnings of S&P 500 repeats warnings of late 1990s

Are U.S. companies making more money than ever before, or are they mired in one of their longest profit slumps since World War II? Widely used measures have diverged in recent years, leaving many investors worrying that something is amiss.

Look at pretax domestic profits as measured by the Bureau of Economic Analysis, and it is easy to be bearish. Profits are down 13% in five years, the biggest drop outside a recession since World War II. President Trump’s tax cut has cushioned the blow to earnings, with after-tax corporate profits falling only a little. Profit margins also are down sharply, with the pretax margin for domestic business lower than the postwar average and below where it stood from World War II until 1970.

Falling domestic profits suggest companies are in deep trouble, avoiding an even deeper slump only thanks to tax cuts.

Earnings by S&P 500 companies tell the opposite story. Reported earnings per share were at a record in the 12 months to June, up 31% in five years and forecast to keep rising. The after-tax profit margin is slightly down from a record last year, but still higher than any time before that.

Some investors are worrying that the gap between the weak profits and the record per-share earnings of the S&P 500 is a repeat of the warning signs of the late 1990s, when listed companies exaggerated their figures. There is probably some of this. Some such excesses usually build up during long periods of economic growth.

Another factor: High S&P profits have led many to conclude that U.S. businesses are raking in money in a way more consistent with oligopoly than a free market.

A deep dive into the numbers suggests most or all of the gap is explained by other elements. Much of the gap between S&P earnings and the national figures appears to be due to tax dodging by multinationals, the troubles of smaller businesses and that the big-company index includes more successful companies than the wider economy.

Before taxes, S&P 500 profit margins aren’t at new highs, but are holding up far better thaneconomy-wide profitability.

Stripping out tax narrows the gap. That is because big companies benefited more from the tax cuts than small businesses. Goldman Sachs analysts point out that the tax rate on the S&P dropped by 8 percentage points, from 26% to 18%. The economywide corporate tax take dropped by a smaller 5 points from 16% of profits to 11%, partly because the economywide data includes nonprofits and corporate structures where the tax is paid by the shareholders, not the company.

The rising use of tax havens to shift offshore patents and other intellectual property rights—and their fat profits—probably makes up much of the remainder. Figures here are sketchy. Researchers at the Minneapolis Federal Reserve last year estimated that roughly $280 billion of profits had been shifted by U.S. companies offshore in 2012. That would equate to tax revenues of as much as $100 billion. Add that back in, and after-tax profits are at a record, as with the S&P.

S&P profit margins before tax fit this pattern, too. They peaked in 2014, and have come down a little since then, though by less than the fall in margins. This suggests in part that a pickup in wages has started to eat into margins in the past few years, rather than being about the internet giants creating new monopolies.

However, Jonathan Tepper, author of “The Myth of Capitalism” and founder of research house Variant Perception, says the drop in pretax margins is a result of being late in the economic cycle, and is compatible with reduced competition leading to a multidecade trend higher in profitability.

Internet giants, like other successful tech stocks, have distorted profitability numbers. PHOTO: DENIS CHARLET/AGENCE FRANCE-PRESSE/GETTY IMAGES

Internet giants such as Alphabet and Facebook have skewed the numbers, though, along with other successful technology stocks. S&P 500 companies are far more profitable than small and midsize listed companies, in part because of the much heavier weighting of the tech sector in the blue-chip index.

Accounting shenanigans might play a part. As independent economist and author Andrew Smithers points out, CEOs were given incentives by bonus structures to overstate public-company write-downs in 2008 and 2009. That likely boosted stated profits, and bonuses, in later years.

The next bust will probably reveal accounting misdeeds from the long stock market boom, if history is any guide. The profits disparity can mostly be explained with tax, size and sector differences. But we will only know for sure when the market next crashes.

Companies will Pursue Profit. It is up to Society to be a Countervailing Force

When Goldman Sachs went to their shareholders with the 10,000 women program ..

I actually think that it is there job to be companies and society’s job to look after the public good.

Companies will primarily act for profit so other countervailing forces must.

A little bit of demonization of people who are stealing the dream is fine.

Trump and plutocrats are demonizing immigrants (punching down) instead of doing something to address the problem.

Elizabeth Warren isn’t out to get capitalism. She’s out to save it.

The heart of the Accountable Capitalism Act is a requirement that companies with more than $1 billion in revenue obtain a corporate charter at the federal level, rather than basing themselves in the most loosely regulated state they can find. (Sorry, Delaware.)

This new charter is meant to address an epidemic of bad corporate behavior, especially the tendency of top executives to value profits over wider well-being. It would obligate executives to consider the interests of all corporate stakeholders — including employees, customers and communities — not just shareholders. It would require that at least 40 percent of company board members be elected by employees, an idea known as co-determination. The bill also contains provisions curbing stock buybacks, which tend to benefit only shareholders, and unilateral political expenditures.

.. it’s a distinct break from the neoliberal capitalism of the recent Democratic Party.

In the 1980s, Milton Friedman enshrined the idea of shareholder value maximization, which told businesses that their sole purpose was to maximize profit for their owners. Rather than pushing back against this obviously selfish, wealth-favoring theory, Democrats got on board. Sure, this framing might need a tweak here, a bit of regulation there, or the carrot of a tax break or two. But super-efficient big businesses would keep the broader economy chugging along for everyone — self-interest would mean we’d all win.

.. some 80 percent of stock market value is owned by 10 percent of the population, little of that benefit trickles down to the rest.

.. All that said, the Accountable Capitalism Act still relies on a fundamental belief that capitalism is good, even as a new generation of Democrats wants to upend that system altogether. On the left, winner-take-all competition — which Warren professes to “love,” by the way — is more and more seen as the root of our country’s ills, not something to preserve. A new wave of socialist candidates are loudly making that case.

.. But Warren isn’t out to get capitalism. She’s out to save it. The senator clearly believes that markets can create wealth.

Crushing it for whom, Mr. Kudlow?

Last week, one of President Trump’s top economic advisers, Larry Kudlow, argued the U.S. economy is “crushing it,” posting boom-like numbers in key areas, all thanks to the leadership of the president.

Evaluating such claims usually begins with assessing whether the president should get credit for an economy he inherited in year eight of a solid expansion. But the fact that Trump is claiming credit for trends that were largely ongoing before he took office is one of the few ways in which he is not much different from former presidents.

.. Who is actually getting ahead in the Trump economy?

.. . In contrast, corporate profits and equity markets truly are crushing it, both on a pre- and especially, given the large business tax cuts, a post-tax basis.

.. There is also no evidence of an investment boom, suggesting the recent, above-trend growth in GDP is Keynes, not Laffer — meaning the deficit spending is providing a temporary boost but will not have lasting, positive impacts for long-term economic growth.

.. Starting with wages, since Trump took office, the real hourly wage for the 82 percent of the workforce that is blue collar in factories and non-managers in services is up half-a-percent, an extra 11 cents per hour.

.. the growth of mid-level pay has picked up a bit, as we’d expect with such low unemployment. But inflation, largely driven by higher energy costs, has also sped up, canceling out any real gains.

.. If energy prices come down and unemployment continues to fall, real wage growth for mid-wage workers will improve. But the magnitude of their gains will likely be nothing close to the administration’s claim that the tax cut would add at least $4,000 to annual earnings within a few years of the legislation.

.. In President Barack Obama’s second term, real annual wage growth for mid-wage workers was about 1 percent, so call that the baseline.

.. Sticking with the tax cut, its proponents main claim was the big corporate cuts would generate more business investment, which would lead to faster productivity growth, which would position us for higher paying jobs. So far, every link in that chain is broken.

.. Business investment is growing, as we’d expect in an economy operating close to full capacity. But its growth rate is not faster now than at various points earlier in the expansion.

.. There has been a modest uptick in investment in structures (such as plants, offices, wells, mine shafts, warehouses) in the first half of 2018, but, as economist Dean Baker has shown, the growth in such investment was due to higher energy prices generating increased investment in mining for oil and natural gas.

.. While mining investment has increased by 36.7 percent over the last year, it rose by 47.3 percent from the second quarter of 2009 to the second quarter of 2010, when the Obama administration was still enforcing environmental laws. In both cases, the key factor was rising world oil prices.

.. It takes time to plan investments, so it is too soon to conclude the tax cuts have not made a difference. But none of the surveys of companies’ investment plans show any plans to ratchet up capital spending

.. What is clear is firms are using their tax windfalls to boost share prices through buybacks, which, along with strong corporate profits, are fueling a historical bull market for stocks.

.. instead of borrowing $2 trillion to finance the regressive tax cut, Congress could have put more money in the pockets of working Americans and made investments for our economic future.

.. First, we should have expanded the Earned Income Tax Credit to compensate for decades of stagnant wage growth. The Brown-Khanna plan, calling for a $1.4 trillion EITC expansion, would have provided working families making up to $75,000 with up to $8,000 more in take home pay.

.. the best way to raise pay for ordinary Americans is to do so directly as opposed to pretending it will come through the largesse of executives and shareholders.

.. Second, we should have put billions to expand the National Science Foundation’s Advanced Technological Education program, linking employers to technical schools to develop credentials that respond to the needs of our cutting-edge industries.

.. Third, we should have provided hiring incentives for anchor companies to create jobs in places left behind such as Paintsville, Ky., or Flint, Mich. If a company is willing to hire in places where people do not have enough access to high-wage jobs, then they should get support for doing so.

.. Fourth, we should have invested in bringing high speed Internet to every corner of America. Providing fiber broadband to every corner of the United States is the modern equivalent of rural electrification.

.. Larry Kudlow’s right: The Trump administration is crushing it for its donor base, which is in turn handsomely rewarding them.

.. But it has done nothing for the forgotten Americans and nothing to make sure America is a winner in the 21st century. We do not need more sugar highs for those already doing well. We need to give lasting pay raises to those struggling to pay the bills and then focus on the forward-looking investments that will finally reconnect GDP growth to broadly shared prosperity.