In this week’s shoot-the-shit, we’d like to provide some clarity to why businesses are leaving the country. This will be our last topic related to the 2016 election cycle. We think it’s important because there a lot of ideas being floated that are simply acoustic noise.

Business typically works with two sets of financials, the first is their Generally Accepted Accounting Principles (GAAP) financial statements; the other is their tax returns. Income as stated in the company’s financial statement is not the same as taxable income. We’re going to answer the question of why business is leaving the country by taking you through a very simple and condensed financial statement, specifically the profit and loss statement.

  1. Total Revenue…                             $1,000,000
  2. Cost of Revenue…                                600,000
  3. Gross Profit….                                  $ 400,000
  4. Selling and Administration…                150,000
  5. Income Before Taxes…                                        $ 250,000
  6. Taxes…                                                                       35,000
  7. After Tax Income…                                               $ 215,000

Let’s say that our fictitious company manufactures shoelaces and in the current year they sold one million dollars worth of shoelaces. However, to make shoelaces, the company had to incur $600,000 worth of expenses. These expenses include direct labor, which is the salary and benefits of employees used in the production of shoelaces. It also includes the supplies, machinery, rent and utilities for the factory, repair of plant equipment, insurance on the shoelace plant and any other cost directly associated with the manufacture of shoelaces.

Line item 4, Selling and Administration captures the costs associated with marketing, advertising, sales and general business management – the C.E.O. salary and benefits is included in Selling and Administration.

Line item 5, 6, and 7 are self explanatory.

Businesses leave the country to influence their highest cost component which is the Cost of Revenue

  1. Cheaper direct labor reduces cost of revenue.
  2. Cheaper cost of land and plant rents reduce cost of revenues.
  3. Government regulations  requiring that defective shoelaces be melted instead of thrown in the garbage increases cost or revenue, requiring that factory workers be paid overtime pay and receive specific levels of medical benefits will increase the cost of revenue; by leaving the country, this shoelace manufacturer gets out from under government regulations and higher cost labor, thus reducing its cost of revenues.

Reducing the cost of revenue provides a higher gross profit and a subsequent higher income before taxes. They will have a higher tax liability but that is dependent on what deductions and credits are available to the business under current tax code.

Reducing tax rates is highly desirable but it is not the principal driver for business leaving the country. In fact, if Congress reduced the business marginal tax rate to just 5%,  business would still leave the country as long as they could reduce Cost of Revenue and bring back their product tax or tariff free. Business’ objective is to reduce Cost of Revenues and if our theoretical shoelace manufacturer is a public corporation they would be rewarded by a higher stock price.

Nowhere in this process is consideration given to the intangible costs from the decision. Some of the many intangibles include…

  • sacrificing intellectual property rights.
  • quality control issues from lower cost labor.
  • social impact created by unemployment.
  • reduction of the tax base for local governments.
  • the economic impact to affected communities.

So who benefits?

  1. The new host country
  2. The stockholders

What you as a voter need to weigh is the validity of a candidate’s argument who propose to help American workers by imposing more regulations or promote strategies that add to Cost of Revenues for businesses.

Have a great weekend! We hope you had a great Memorial Day!

This entry was posted in Shoot-the-shit and tagged , , . Bookmark the permalink.