Home » Money » Corporate Profits – A Bad Thing?

Corporate Profits – A Bad Thing?

Though the stock market is hitting new highs, many people are less than impressed. It’s commonly believed that the Federal Reserve’s $85B per month spending on mortgage backed bonds is all that is holding things up more than reality. That was backed by the big rally after Bernanke announced the program (aka QE3) would not “taper” in the near future, but continue.

But the truth is that corporate profits are at levels that they have never been before, meaning that there is underlying value in the stock market that is driving the rise. More importantly, corporate profit margins (profit over gross revenues) are also at unknown highs. It points to not only how we get out of the job shortage that is the reason the Fed keeps buying, but also the most obvious ways to close the budget deficit – and gives a little more definition to the boomtimes that probably like ahead in the 2020s.

Before we get into the details, the background is essential. The Bureau of Economic Analysis (BEA) has been keeping track of corporate profits since the 1930s. We’re not entirely sure how things went before that, and most people only use their data since WWII. The share of the total economy that appears as corporate profits (after taxes) is shown below in their data from 1947:

Corporate Profit as a share of GDP, data from BEA

Corporate Profit as a share of GDP, data from BEA

Corporate profits were never above 10% of the economy before 2006, and the current 10.8% is a record by a wide margin. Since WWII the average has only been 6.3%. But what does this mean?

stockCorporations can do several things with their money. They buy another business, give it to the shareholders as a dividend, or they can spend it on more employees and equipment to grow their existing business. All of those are legitimate, deductible expenses – “profits” are more or less money that they are sitting on as cash.  A lot of profits is actually a bad thing, in a way, because it means that businesses are slow to invest in what they do. If they prefer to realize it as profits, and subject it to corporate taxes, it’s a sign of a lack of faith in the economy or themselves.

Dividends are another matter, of course, and usually only happen when shareholders demand them. But it’s the other way that money stops being “corporate profits” and becomes “personal income”.

One of the things that Barataria has been watching for in 2013 is the wave of hiring by big corporations that will come once they start having faith in the economy and its potential for growth. As earnings from 3Q13 come in we’re seeing about 7.5% increase over 3Q12, which is huge. By just about any measure, corporations do have a lot of money. And as shown in this chart below, using data from Zacks Investment Research, margins are also at historic highs:

Corporate profit margins since 2000

Corporate profit margins since 2000

Typically, a high margin shows a business that is worth investing in. That means that people are hired, the business expands, and the margins gradually fall back down to a more normal level – but the overall income is higher. Not so right now. Net margins well over 8%, which used to be rare in the non-finance world, are now almost expected – and they are projected to keep climbing. Note also that finance, which was once much more profitable than anything else, is now much closer to “normal”.

moneyWhat will it take to restore confidence? Again, while this is hardly a time for austerity (just ask the Federal Reserve!) a reputable path towards a balanced budget in 2017 would help a lot. That would be about the time stimulus would not be as necessary, especially if corporate profits are unleashed into a wave of hiring and expansion. If this would be so good for business, it only makes sense that corporate taxes, now at a historic low as a share of revenue, would be the best place to look for balancing the budget in the first place.

Higher corporate taxes would discourage realizing profits and encourage spending them on expansion. While that may sound really difficult to get past Republicans, combining it with tax deductions for dividends (the other way money passes into income) and a dramatic simplification (reducing the cost of compliance with the tax code) could make it palatable.

No matter what, it is clear that we are in a very different era for corporate profits, and they should be treated differently than they have in the past. It’s very much worth thinking through as a matter of tax policy – and how the flow of that cash can become the logical replacement for the buying program that the Fed wants badly to start tapering off as soon as it can.

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24 thoughts on “Corporate Profits – A Bad Thing?

  1. If corporate profits are way up and taxes are way down I’d say that yes, let’s balance the budget that way. Your proposal to raise corporate taxes to the postwar average can’t be controversial and it would almost balance the budget right there. Good blog.

    • Hey, you followed the link! 🙂 Yes, raising corporate taxes to the average level they have been since WWII would just about eliminate the deficit today. I haven’t run the numbers in a while, but a year ago that raised $300B and it would be more with profits up. Against a deficit of about $465 it might also take a transaction tax of 0.2% on all stock trades (about $200B) to do it all the way, but it’s a good idea all around. Thanks!

  2. The sequester cuts were a good bloodletting for the deficit. Kinda like a leach on the budget. Sometimes you gotta just let go of spending.

    “It was the best of times. It was the worst of times….”

    • Sequester was part of it, and not the largest part. The truth is that the economy is recovering and the deficit has, so far, been fixing itself. Sequester cuts along with very real tax hikes in 2013 closed the gap even further.
      I only hope we can be more intelligent about it in the future. And I do think that corporate tax reform with an eye towards getting tax receipts up just to the postwar average is a very easy way to raise most of what we need to close the gap without serious “austerity” effects.
      Sometime around 2017-2020 a balanced budget will be very important, so we can move to close the last 4% of GDP over 4 years, IMHO. Or, we can make deep cuts in the military, tax corporations a bit more, and spend some on infrastructure now – which is what I prefer.
      No matter what, I think reform is the real answer.

  3. At 6 pm eastern time, President Mitt “47%” Romney will address a joint session of Congress. Majority Leader Erik Hare and Speaker of the House Norm Coleman will be attendance.

    • Haha! Actually, a Republican President and a Democratic Congress would be pretty interesting about now. It seemed to work pretty well in the 1980s 🙂

  4. AP Wire, 4:30 CST, breaking news

    NSA surveillance reveals that the children of Rick Santorum, Ted Cruz, Rand Paul, and John Boehner will be trick or treating tonight in the West 7th/ Fort Road neighborhood. The children will be offering all neighbors a 7 teabags, for good luck in the next 12 months. The children are hoping it will snow heavily in St. Paul after they trick or treat.

    Alan Greenspan is also heard to be inviting Fort Road federation board members out for a beer at midnight to discuss monetary policy. Location has not been determined.

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