Just Who Do You Think You Are?
The following commentary was originally posted on FoolFunds.com, the website of Motley Fool Asset Management, LLC, on March 12. With permission, we're reproducing it here in slightly edited form.
I don't want the world. I just want your half. -- They Might Be Giants
Honest, I'm not going out of my way to make fun of the French. And it should be noted that France is far from alone in its conflicted philosophy toward capital. On certain levels, every country on Earth has policies in place that punish the very capital that makes their countries' economies tick. It's just that the French are just so ... French about it.
Dang it! I did it again.
There are people who believe that labor makes the world go round, that it has primacy over capital. It's compelling, and perhaps slightly more romantic, to have this view of the world. But let's do a little thought test. There are countries that have plenty of labor and very little capital. Others have the opposite condition, of plenty of capital and scarce labor. In the first group are places like North Korea, Sudan, and Venezuela. In the latter are Qatar, Singapore, and Norway. So I'm not saying that labor is worthless -- far, far from it -- but capital is the primary driver of economic development.
Ultimately, economics don't operate based upon the beliefs of the majority, or of those in power. Economics operate on inputs and incentives, and at the center of the economic world is capital.
Politics vs. capital
Politics is the opposite, which is bad news for capital in places where its primacy isn't necessarily appreciated. Unfortunately, economics also isn't a very good science, because it's impossible to generate precise repetition of results. Which means that it is really, really easy to do things like compare economic outputs between different presidential terms, but just as easy for many people to forget that most of those comparisons don't mean a blessed thing, because so many of the inputting factors were entirely different. Political expediency demands that such subtleties be ignored, which is why it ought to be perfectly acceptable to stick your fingers in your ears and scream "LALALALALALA!" whenever a politician attempts to discuss economics.
Here's the thing about the conflict between capital and politics. Politics wins nearly every single battle between the two. Yet because capital is fungible, capital always wins the war. When capital isn't respected, it leaves. That which cannot leave, molders.
It's a simple matter. Mistreat capital and it will go elsewhere. And "elsewhere capital" means that your assets will command lower multiples. You can see this principle in action every time a CEO of a public company steps down or gets the boot and the company's stock skyrockets. (See McLendon, Aubrey.)
It doesn't matter if you are among the most powerful people on Earth. Capital is much more powerful than you.
Which brings me back to France.
The French fiscal situation is fairly grim, with the national government looking for more and more places to tap revenue sources. Several French citizens, including Bernard Arnault, France's wealthiest man, have sought Belgian nationality after the government pressed forward with a plan to tax ordinary income above 1 million euros (US$1.32 million) at a rate of 75%.
Introducing the financial transactions tax!
More importantly to us, France has recently instituted a tax upon financial transactions of 0.2%. There are some expansive projections of how much revenue such a tax will generate for the country's coffers, but the reality is that this financial tax probably will do substantial harm to the French economy without hitting the government's revenue goal.
That 0.2% figure may not sound like a big tax burden, but it is notable because it is payable at the time of the purchase transaction. Let's just suppose that one of our portfolios was going to invest 2% of its overall funds into a French company. Since that portfolio has about $250 million in assets, that would be a $5 million investment, triggering a tax payable of $10,000.
Our entire trading budget for the portfolio in 2012 was about $130,000. We don't trade much because we believe that excessive trading costs are a real drag on performance. After all, if you take $10,000 and begin compounding it at a market return, eventually you end up with a much larger number. And that's only if you buy once! Every purchase transaction triggers a new tax payment.
Now, to be clear, if a 0.2% tax is the deciding factor preventing you from buying a security, then the market probably isn't giving you a large enough margin of safety in the first place. If we find bargain companies in France, we're going to buy them, tax or no.
Worth a look?
Whether we will spend as much time looking for French companies in the first place is a more pertinent question. Don't you think such a tax demonstrates a certain lack of self-awareness on behalf of the French government? It's not as if France has a massive growth rate and is blessed with compelling demographic trends. Why would the government want to make its financial markets less attractive by socking investors with a tax that gets paid no matter how well or how badly the investment ends up doing? Even if we're willing to consider French investments, we have to take the algebraic multiplier of the transaction costs into account.
Statistics suggest that this is already happening across the marketplace. France applies the tax only on companies valued greater than 1 billion euros (about US$1.3 billion). According to a recent Credit Suisse study, trading volumes in companies subject to the tax decreased through December 2012 by 16%, while French companies not subject to the tax saw volumes rise by 19%. I doubt this is wholly attributable, but it certainly is interesting.
And France is not alone. Eleven EU countries are planning on launching a similar harmonized transaction tax of 0.1% by 2014. One country deeply opposed to the tax is Sweden. In 1984, Sweden initiated its own financial transaction tax on the purchase and sale of securities. By 1990, beset by lower share prices and paltry trading volumes, the country scrapped the tax.
I bring this up because it is unlikely that many investors pay attention to foreign transaction taxes. I actually support the concept of small taxes on high-frequency trades, which are positions that are held in increments that many times measure in milliseconds and are more of a hack on the markets than a measure of providing liquidity to profit-making enterprises. But countries that attempt to "punish" capital, in many cases, find that much of that capital simply builds their actions into its required rate of return, and in many situations that's enough to make capital go elsewhere.
Well, if France can do it ...
There is only so much fun we can make of France, though. The power of self-preservation of capital is more than apparent right here in the USA. Like me, you are likely to be in the process of preparing your tax statements. If so, you might have noted that your taxable-dividend line item on your brokerage statement is much larger than in years past. There's a good reason for this: Companies were doing a Hail Mary to pay out big dividends ahead of the rise in capital-gains tax rates. Hundreds of companies paid special dividends in November and December 2012, returning tens of billions of dollars to shareholders (and insiders, natch) at the former dividend tax rate of 15%.
Two of the largest special dividend payers were Costco and Las Vegas Sands, which paid out one-time dividends of $3 billion and $2.3 billion, respectively.
Costco's payout was particularly noteworthy, as its former CEO and board member, James Sinegal, spoke of the need for shared sacrifice when he addressed the Democratic National Convention just a few months before. Based on his personal ownership of Costco shares, Sinegal's potential tax savings from the big payout runs into the millions of dollars. I have great admiration for Mr. Sinegal, but I cannot help pointing out the conflict between what he believes and this financial decision. It is nearly irresistible to call this conflict hypocritical, but I prefer to think of it in a slightly different vector. At the end of the day, Costco's board of directors and its management are basically rational allocators of capital. And what was rational for a company like Costco with excess capital was to return it to shareholders in as efficient a manner as possible.
Put another way, it reminds me of St. Augustine's prayer: "Lord, make me pure. But not yet."
Editor's note: Bill Mann is not able to engage in discussion on the boards or in the comments section below. Bill owns shares of Costco.
The article Just Who Do You Think You Are? originally appeared on Fool.com.The Motley Fool recommends and owns shares of Costco Wholesale and has a disclosure policy.