Politics & Policy

Gaming the Fiscal Cliff

Politics, profit, and pageantry

The so-called fiscal cliff is one installment in a series of manufactured crises, the purpose of which is to provide the political establishment with small problems it can solve or pretend to solve while steadfastly refusing to address the much thornier problem of the long-term non-sustainability of U.S. public finances. Watching the melodrama unfold, I sometimes think I should be reviewing it in my theater column over at The New Criterion rather than analyzing it for National Review.

The fundamental unseriousness of the fiscal-cliff debate can be appreciated by examining the Corker plan (as my colleague Dan Foster does here), which probably is very close to the best that deficit hawks could hope for in terms of a bipartisan compromise — which is to say, precious little. At best, the Corker plan would reduce the growth of U.S. federal debt by about $4.5 trillion over the next decade, but it would not eliminate the deficit or reduce the debt, and it would allow for trillions of dollars to be added to the wrong side of the national ledger.

The Democrats give every indication of being interested in using fiscal-cliff hysteria to achieve nothing but a modest, almost symbolic increase in federal income-tax rates for taxpayers earning $250,000 or more, which would do very little to reduce the deficit but would confer a measure of emotional satisfaction on the Left. A fair number of small-business owners, managers, and professionals would see their taxes go up, but the actual rich — the Wall Street types, CEOs, Silicon Valley princelings, etc. — would continue to have the bulk of their income taxed at the lower capital-gains rate. That rate will go up (from 15 percent to 20 percent) absent a fiscal-cliff deal, but the hedge-funders and such still will be paying a rate about half the top income-tax rate. President Obama wants that tax increase to happen, but only for taxpayers earning $250,000 or more.

If the president gets his way on investment income, that will produce at best about $240 billion over a ten-year period: chump change when compared with deficits running $1 trillion or more every year. It would take a decade to offset the debt run up in just one of President Obama’s many recovery summers. And that assumes that the economy does not slip back into recession and that investors do not change their behavior very much in response to the new tax regime. The latter of course is unlikely — and if the president doubts that, he should have a conversation with Democrats’ new favorite tycoon, Jim Sinegal of Costco.

Democrats suddenly are in love with Costco. Mr. Sinegal, founder of the company, spoke at the Democratic National Convention, and current CEO Craig Jelinek has been an ally of the president during the fiscal-cliff debate. On Thursday, Mr. Sinegal and Mr. Jelinek were visited by Joe Biden, who came by to commemorate the opening of the chain’s first Washington, D.C., store. That is a remarkable thing: The country is on the edge of a fiscal crisis, war is burbling in the Middle East, the president’s hometown is in the grip of a horrific wave of violent crime — and the vice president of these United States is going to Costco ribbon-cuttings.

Beyond getting the Biden treatment, Mr. Sinegal was the subject of a fawning New York Times profile and now has his very own Internet meme, which features his beaming face above the caption: “Costco CEO pays his employees $17/hr on average, plus benefits, earns less than $500K, refuses Wall Street demands to cut employee salaries and benefits.” Almost none of that is true, of course, but it hasn’t stopped the Left from holding up Costco as the ideal progressive alternative to Walmart.

Mr. Sinegal, like many corporate executives, took a relatively small salary, true enough, but received the majority of his multimillion-dollar annual income in equity-based compensation, meaning that he, like Mitt Romney and many a hedge-fund guru, paid 15 percent on most of his money. And while at least one Wall Street analyst has been critical of the firm’s generous compensation for its employees, Wall Street has hardly demanded anything of Costco other than continuation of its very profitable operations. This is partly out of appreciation for the fact that Costco’s customers are relatively wealthy — many are small businesses, and their average income is more than $80,000 a year — and that affluent shoppers have different expectations than do the relatively poor people who shop at Walmart. That’s Costco’s interesting niche: It’s a discount store for rich people, Starbucks to Walmart’s Dunkin Donuts. That strategy has been paying off: Institutional investors such as Warren Buffett’s Berkshire Hathaway are among Costco’s top shareholders, and Buffett has never been shy about making his demands known to management.

In fact, Buffett’s company, along with Mr. Sinegal, Mr. Jelinek, and other shareholders such as the Bill and Melinda Gates Foundation, are about to see a big payday from Costco — courtesy of Democrats and the fiscal cliff. As noted before, if the president gets his way, the capital-gains tax rate will go up to 20 percent for investors earning $250,000 or more. If nothing is done, the rate will go up to 20 percent for most investors — and more important, income from dividends will be taxed like ordinary income, meaning a top rate of 39.6 percent. That’s a big hit, so Costco is paying a big dividend — right now, before the new rates kick in.

In fact, Costco is set to pay out some $3 billion in a special year-end dividend this year to evade a January tax hike. The biggest single beneficiary will be Mr. Sinegal, the firm’s largest individual shareholder. He stands to gain $14 million. Institutional investors such as Berkshire Hathaway and the Gates Foundation will bring in many millions. That dividend will be made possible in part by a special debt offering. When a firm run by Mitt Romney does this, Democrats call it “vulture capitalists loading up companies with debt in order to write themselves big paychecks.” When companies that make friendly noises about Barack Obama do it, they get a personal visit from the vice president.

There is nothing unethical or illegal about what Costco is doing. In fact, there is a very good argument that this probably is the right thing to do: There is no need to inflict unnecessary costs on shareholders, the company is superbly managed, and its strong financials mean that it can borrow money at very low cost. It is taking a bet that the Obama administration and its friends in the Fed will be keeping borrowing costs low, but that is a fairly safe bet. Other companies offering unusual year-end dividends to beat the taxman include Las Vegas Sands, Movado, and Sturm Ruger. It is widely assumed that George Lucas had the fiscal cliff in mind when he sold Lucasfilm to Disney — by closing the deal this year, he’ll save some $400 million in taxes.

When conservatives talk about “uncertainty,” this is precisely what we mean. We have Costco and Warren Buffett and George Lucas jumping through all sorts of hoops because nobody knows what exactly is going to happen with taxes in the next month or two. They are dedicating their energy to anticipating and reacting to politics, rather than to improving their retail operations, seeking out new opportunities, or destroying beloved cinematic trilogies, respectively. In a stable, predictable environment, Costco might have found a more productive use for that $3 billion. Or it might not — but politics, not production, is in the driver’s seat here. Washington gets to have its little opera, and businesses have to react or try to influence the process. And what about Costco’s small-fry competitors, the ones without the scale to tap the credit markets on easy terms in order to cash out ahead of the tax hike? The political churn just gives them that much more of a disadvantage in the marketplace, without even the cold comfort of a visit from Joe Biden.

Meanwhile, the debt piles up. Washington kicks the can down the road, oblivious to the fact that the road has an end.

— Kevin D. Williamson is a roving correspondent for National Review.


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