Thursday, February 2, 2017

Economists' Fantastic Vision, or Shallow Thinking and Analysis

Visionary economists Alan Auerbach and Douglas Holtz-Eakin ASSURE us that we need not worry, little darlings, because when the Border Adjustment Tax becomes law, the dollar will immediately skyrocket by 25% and our costs will plunge sufficiently to pay our enormous new tax bills.  Hence, presto chango, no prices will rise and no American company will be out a penny. Okay, screw companies in other countries, but no Americans will suffer. 

The theory makes no mention of pigs learning to fly but I think it's also assumed.

Some people, like me in this space, have openly scorned this fantastic vision, both for the low likelihood that it will actually come true, and for the "wisdom" of basing a new Federal tax regime on what amounts to a speculation.  Who on Earth bets a tax system on somebody's stupid guess?

Kevin Brady and Paul Ryan, by all appearances.

Anyhow, I happen to be at the Nuremberg Toy Fair right now and have asked a few vendors to share a little intel.  I asked them to break down their revenue dollars into two parts:  (a) local content plus profit, and (b) imported content.  Local content is largely labor in most cases. Vendors in some countries are able to buy some locally processed content (such as plastic stock), and vendors in other countries are largely dependent on foreign supply chains for high quality inputs.  Item (a) is denominated in local currency and would float down in dollar-based cost as the dollar rises.  Item (b) would float up in dollar-based cost as the dollar rises.  Thus, the sum of these effects is the actual cost change experienced by one of vendors as the dollar rises.

Our vendors cite a range of 30% - 60% for imported or foreign content (i.e., oil, plastic, paper, etc.).

Using the projected 25% Federal tax rate for "S" Corps and assuming a 25% increase in the value of the dollar (as predicted by Frick and Frack), please consider the following examples per dollar of vendor cost:

Vendor with 30% foreign content:

Local content:                     $0.70/1.25    = $0.56
Foreign content                   $0.30 x 1.25 = $0.375

Total new cost                     $0.56 + $0,375 = $0,935 (down 6.5%)

Vendor with 60% foreign content:

Local content                      $.0.40/1.25     = $0.32
Foreign content                   $0.60 x 1.25   = $0.75

Total new cost                     $0.32 + $0.75 + $1.07 (up by 7%)

The average is no savings. 

You can make up your own examples to see a further range of outcomes. The only scenario Auerback and Holtz-Eakin seem to consider is where all content is local.  This would even include oil, gasoline, you name it.  And if EVERYTHING that goes into the product has nary a direct or indirect trace of foreign content, yessiree, the cost for our vendors goes down 25%. Okay but that is never going to be the case.  So what then?

I have previously disclosed that I must recover 16-19% of my COGS (depending on the assumptions made about exports after BAT and the promised sharp rise in the dollar) to net out the same cash flow after BAT as the cash flow under current law.  I have also disclosed several different reasons, including our historical achievements through various business cycles, to be skeptical that anything near 16-19% can be achieved.  Frankly, we think 16-19% is a (bad) joke.

So this analysis suggests YET ANOTHER reason to doubt Frick and Frack.  The cost of foreign content in our vendors' supply chains will rise with the dollar and will negate the cost reductions experienced in the local content.  They are basically offsets.

Add the fantasy of exchange rate-driven cost savings to the list of BAT untruths.  You can decide if the people telling the untruths just don't know what they're saying, are mistaken, can't do math, have never run a business . . . or something worse. None of the choices make feel good about the planning and administration of this country.  In any way, shape or form.

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