U.S. Tax Competitiveness Stinks

Today the Tax Foundation released its 2014 index of International Tax Competitiveness. Of the 34 countries ranked on the basis of "more than forty variables across five categories: Corporate Taxes, Consumption Taxes, Property Taxes, Individual Taxes, and International Tax Rules," the U.S. came in #32, only a few points ahead of notoriously tax-loving France. 

The chart above shows my representative sampling of 20 of the countries included in the index.

Key findings:

Estonia has the most competitive tax system in the OECD. Estonia has a relatively low corporate tax rate at 21 percent, no double taxation on dividend income, a nearly flat 21 percent income tax rate, and a property tax that taxes only land (not buildings and structures). 

France has the least competitive tax system in the OECD. It has one of the highest corporate tax rates in the OECD at 34.4 percent, high property taxes that include an annual wealth tax, and high, progressive individual taxes that also apply to capital gains and dividend income. 

The ITCI finds that the United States has the 32nd most competitive tax system out of the 34 OECD member countries. 

The largest factors behind the United States’ score are that the U.S. has the highest corporate tax rate in the developed world and that it is one of the six remaining countries in the OECD with a worldwide system of taxation. 

The United States also scores poorly on property taxes due to its estate tax and poorly structured state and local property taxes. 

Other pitfalls for the United States are its individual taxes with a high top marginal tax rate and the double taxation of capital gains and dividend income.

As the study notes,

Taxes are a crucial component of a country’s international competitiveness. In today’s globalized economy, the structure of a country’s tax code is an important factor for businesses when they decide where to invest. No longer can a country tax business investment and activity at a high rate without adversely affecting its economic performance. In recent years, many countries have recognized this fact and have moved to reform their tax codes to be more competitive. However, others have failed to do so and are falling behind the global movement.

This goes a long way to explaining why the U.S. economy has been struggling in recent years.

Today's WSJ has an op-ed that sheds even more light on the issue.

To be sure, not all the countries that rank higher in the index have stronger economies. Indeed, the U.S. economy is doing better than most these days, although it is only managing to post annual growth of slightly more than 2%.'

If there's any surprise here, it's that the U.S. economy is not doing worse. We are still relatively prosperous in spite of our onerous and burdensome tax code. This speaks volumes to the inherent dynamism of the U.S. economy, which is rather adept at overcoming adversity. If we only freed the economy from its tax shackles, it's hard to imagine how much better we could be doing.

We need serious and far-ranging tax reform. Now.

Federal government finances continue to improve

The latest budget data through August continue to reflect ongoing, gradual improvement in the federal government's finances. Spending growth is very slow, revenue growth is healthy, and the deficit is a very manageable 3% of GDP. 

Fiscal policy has been a significant drag on growth for most of the current recovery—not because of a declining deficit, but because of excessive spending. Spending is taxation, as Milton Friedman taught us, because spending must eventually be paid for by higher taxes. Spending is also bad because government doesn't spend money with the same efficiency as the private sector; you surely spend your own money much more carefully and frugally than you would if you got to spend someone else's money.

The good news is that even though the federal government arguably is still spending way more money than it should (federal spending is running about $3.5 trillion per year), federal spending as a % of GDP has been declining steadily for the past five years, so the drag of fiscal policy today is much less than it was just a few years ago. It's also good because the big decline in the federal budget deficit has all but eliminated the need for higher tax rates. As the public sector shrinks relative to the private sector, the private sector has more room to grow, and it's the private sector that delivers prosperity. 

The following charts illustrate some of the points made above:

Federal spending has been effectively flat for the past five years, thanks mainly to congressional gridlock and an improving economy, which in turn has reduced the need for social safety net spending. Federal revenues have been rising steadily, thanks mainly to more jobs, rising incomes, capital gains, and rising profits, and only partly thanks to higher tax rates imposed beginning last year. In retrospect, we would have been much better off not raising tax rates on anybody.

Federal spending relative to the size of the economy has declined by almost one-fifth, from just under 25% of GDP to just over 20% of GDP. This has reduced expected future tax burdens enormously, and on the margin it has helped to boost the economy's overall efficiency. Revenues are now about 17.2% of GDP, which is only slightly less than the 17.4% they have averaged since 1968.

The result of flat spending and rising revenues has been a two-thirds reduction in the federal budget deficit (from $1.5 trillion to $0.5 trillion). Relative to GDP, the deficit has collapsed from a high of 10.2% to now only 3%. 

The decline in the unemployment rate has correlated very closely to the decline in government spending relative to GDP. A significant decline in government spending relative to the economy did not in anyway harm the economy by this measure. As the graph above suggests, further declines in spending relative to GDP are very likely to coincide with a healthier labor market.

All in all, lots of good news here, even though there is plenty of room for further improvement. Things could be a lot better, of course, but at least they are getting better. 

Apple still looks juicy

I've been a fan of AAPL for many years, and I see no reason to stop now. Apple continues to innovate, both on the hardware and software front, they are a recognized leader in their market, and they capture the lion's share of industry profits.

Although Apple was late to the game with a bigger smartphone, it's now once again the leader of the pack. No competitor can match Apple's design, quality, reliability, ease of use, and integration. I know quite a few people who are lusting for an iPhone 6, and I'll be getting one for sure (but I'll probably get the 6 because I think the 6 Plus is too big for my tastes). It's got great new features (e.g., a much better camera, incredible video capabilities, a better quality screen, NFC, faster WiFi, and VoLTE). And of course there is iOS 8, which will be released next week and will bring delightful new features to most of the iPhones already out there in the world. Similar software advances are on track for Apple's industry-leading laptops and desktops, due out next month. No other competitor makes it so easy to upgrade your smartphone or your computer with the latest and greatest version of its operating system.

I was immediately struck by the beauty of the new Apple Watch, which is not just an amazing gadget but also a piece of jewelry that will be coveted by many. I'm sure I'll get one myself when they come out next year.

Even though Apple is the most valuable company in the world, it has only recently eclipsed the record high valuation of MSFT set in early 2000—over 14 years ago—and only by about $15 billion or so. Like Microsoft, Apple sells products and services to the entire world. Unlike Microsoft, Apple's products and services are highly regarded in the biggest and fastest growing part of the world (e.g., China).

When Apple's PE ratio fell to 10 early last year, it was a clear sign that the market thought its best days were behind it. Backing out Apple's significant overseas cash hoard, its PE ratio was approaching a miserable 8. 

The only way to make sense of that was to figure the market expected no further increase in earnings going forward, and a strong likelihood that earnings would decline. And indeed, Apple's earnings have been essentially flat for the past 2 ½ years.

Today, however, Apple's PE ratio is back up to just over 16, so that implies that the market worries much less about declining earnings. But even at a PE of 16 the market is still looking at Apple with skeptical eyes. Back out the overseas cash (and assume Apple pays onerous taxes on it), and you get a cash-adjusted PE today of 13-14, which is substantially below the S&P 500's PE ratio of 18. So today's pricing only makes sense if you assume that at best Apple's earnings will never rise meaningfully and may well stagnate or decline in coming years.

While that may prove to be the case (it's always tough to argue that the market is wrong about the future), after yesterday's announcements it's clear that Apple has two new sources of revenues in the pipeline: the Apple Watch and Apple Pay. The Apple Watch is a handsome piece of jewelry that is also a watch and a high-powered computer, yet costs only half of what the average Swiss watch costs. (Perhaps Jony Ive wasn't exaggerating when he said "Switzerland is f*cked"). The Apple Watch is by far the best-designed and most functional of all the "smart watches" on the market. Fitness buffs could go crazy for its built-in sensors, and Apple's HealthKit could find lots of traction in the healthcare field. Why couldn't Apple sell tens of millions of watches per year? The Swiss sold over 20 million last year.

And then there's Apple Pay, which has the potential to revolutionize how the world buys things. If the service is successful, Apple could get a tiny piece of potentially tens of billions of credit and debit card transactions each year all over the world. Based on my understanding of how it works, it has all the ingredients for success: it's super-easy to use and it's far more secure and private than the current system, which we know is deeply flawed. There will be millions of iPhones that could start using the system beginning next month—as many as 80 million by year end—and Apple has already signed up the biggest players in the credit card industry.

There's still lots to like about Apple.

Full disclosure: I am long AAPL as of the time of this writing, and have been for many years.

UPDATE: Here's a terrific review of the Apple Watch by the watch pro Benjamin Clymer (HT: John Gruber). It helps you appreciate the tremendous amount of work and detail that Apple has put into this. The variety and beauty of the watch cases and straps is simply amazing. This is much more than just a digital watch.