“If you’re a teacher or a firefighter, you’re probably paying more in taxes than Amazon or Netflix.” – Joe Biden
In last week’s post I explained why Amazon pays little to no federal income tax even tough their profits have continued to rise. This has become a hot topic on both sides of the isle who have used Amazon as the poster child for why our current system of economics is so broken. But as I explained last week, nothing nefarious is going on here and Amazon is simply reducing its tax bill in accordance with the IRS tax code due to the tremendous amount of money (and in some cases stock) it plows back into its own business. So what are we to make of all this? First, I don’t believe Amazon is doing anything wrong or should be thrown under the bus. As they stated in response to Joe Biden’s tweet from last week’s post and restated above for reference:
We pay every penny we owe. Congress designed tax laws to encourage companies to reinvest in the American economy. We have. ... Assume VP Biden’s complaint is w/ the tax code, not Amazon.
The relevant conversation is really not about Amazon at all; it’s about the incentive structures currently embedded in our tax code and broader financial system. Only about 1% of the tax code, after all, is dedicated to collecting revenue. The balance is dedicated to deductions and credits, otherwise known by economists as “incentives.” Incentives in the tax code and elsewhere are the mechanism by which economic policy makers intend to encourage certain behaviors and discourage others. So it’s important to remember that the first order effect of taxes is to generate revenue for the government, but the second order effect is to generate economic growth through the utilization of deductions and credits as incentives.
The ability to carry losses forward and apply them against future profits is an incentive for struggling businesses to take risk, stay the course and continue working towards profitability. Allowing for accelerated depreciation is an incentive for business to allocate more money on the margin towards long term investments in fixed assets. Being able to expense stock-based compensation enables companies to tether their executive teams to the long-term performance of the share price. And awarding tax credits for certain research and development activities incentivizes businesses to innovate and push the boundaries of efficiency and productivity.
Amazon has done all these things, and in doing so has become the second largest employer in the country while revolutionizing many areas of our everyday lives. Whether or not you believe the impact Amazon has had on society is positive or negative is not necessarily the point here. What’s relevant is that our tax code is set up to incentivize certain economic behaviors, and by exhibiting those behaviors Amazon has reaped the benefits.*
That said, this conversation is also about unintended consequences (linked post about tax reform and stock options). We have to allow for the fact that every policy decision put into place will have a wide variety of direct and indirect knock on affects. For example, the prospect of bonus depreciation might cause managers to make unwise or untimely investments. Equity-based compensation can lead to short-termism and moral hazard for executives making strategic decisions. Research and development credits might simply act as a taxpayer subsidy on an activity that a company is already undertaking in order to make themselves more profitable. Ultimately, I think the source of the angst in this instance is that people are simply experiencing cognitive dissonance seeing these incentives utilized on such a massive scale by one of the largest companies in the world, founded and run by the wealthiest individual in the world. You might say the unintended consequence is that the incentives played a role in allowing someone to win a little too much. If the same aggregate amount of deductions and credits were still claimed, but spread out across many small and medium sized businesses across the country, I doubt anyone would have a problem with it.
Unfortunately data is all too often pulled out of context and used to spin narratives that should never see the light of day, let alone go viral and be so influential in forming public sentiment. The tax code’s utilization and impact as it relates to a company like Amazon is not necessarily reflective of its utilization and impact on the small software startup down the street or the mid-sized chemical engineering company across town. We have to take a broad view and realize the risk of potentially throwing the baby out with the bathwater by focusing too much on an isolated instance. That said, it’s undeniable that the rapid evolution of technology has changed the way companies innovate, grow and interact with their stakeholders and communities. Every policy decision is going to come with its fair share of upsides and downsides, and it is the difficult job of policy makers to monitor and weigh the pros and cons over time and to adjust accordingly in a way that makes the most sense for the current environment.
*As a side note, it’s also pertinent to remember that corporations are subject to “double taxation.” The corporation pays taxes on its profits, but the shareholders also pay taxes on their dividends and capital gains.
Disclosure: I/we have no positions in AMZN, and no plans to initiate any positions within the next 72 hours. I/we are not receiving compensation for this article.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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