Political Calculations
Unexpectedly Intriguing!
August 16, 2017

Every three months, we take a snapshot of the expectations for future earnings in the S&P 500 at approximately the midpoint of the current quarter, shortly after most U.S. firms have announced their previous quarter's earnings. Today's snapshot of the trailing year earnings per share for the S&P 500 confirms that the stock market's earnings have continued to rebound off their 2016-Q3 bottom, where they have now finally surpassed their pre-earnings recession levels.

Forecasts for S&P 500 Trailing Twelve Month Earnings per Share, 2014-2019, Snapshot on 10 August 2017

The recovery in the S&P 500's earnings has been a significant factor in boosting the value of the S&P 500 since the index bottomed at 1829.08 on 12 February 2017. The index has since gone on to set its all time record closing value of 2477.83 just three weeks ago (26 July 2017).

As a general rule, the picture of the S&P 500's forecast earnings per share provided by Standard and Poor snapped at any give time tends to be quite optimistic, where the earnings growth indicated by their future trajectory will most likely not be as robust as projected.

Data Source

Silverblatt, Howard. S&P Indices Market Attribute Series. S&P 500 Monthly Performance Data. S&P 500 Earnings and Estimate Report. [Excel Spreadsheet]. Last Updated 10 August 2017. Accessed 13 August 2017.

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August 15, 2017
Pennsylvania Supreme Court Room - Source: http://www.bop.pa.gov/PublishingImages/supreme-court-harrisburg-pennsylvania-usa.jpg

In Philadelphia, the city's controversial soda tax has reached the state of Pennsylvania's Supreme Court after being upheld in two lower state courts, but a new legal threat to the city's highly regressive tax may be gaining traction in an unlikely place: Chicago.

Like Philadelphia, the leaders of the city of Chicago have sought to impose a tax on the distribution of naturally and artificially-sweetened beverages within the city, regardless of their calorie content, which means that the tax applies to both regular and diet versions of sweetened beverages that are sold by local retailers, with the dedicated purpose of generating tax revenue for each city's coffers. While some soda tax supporters have claimed that imposing such a tax might produce public health benefits through reducing the consumption of calorie-laden sweetened beverages in favor of "healthier" drinks, and thus reducing the incidence of obesity-related conditions that are believed to be affected by soft drink consumption, the way that Philadelphia and Chicago have structured their sweetened beverage taxes to apply on the sales of both calorie-laden drinks and their closest low-and-no-calorie substitutes ensures that any such benefits will be minimal at best.

In addition, an early study has indicated that no statistically significant change in average individual caloric intake has been realized in Berkeley, the city that pioneered local soda taxes in the United States, which calls the claim of achievable health benefits through taxation into question, although additional studies will be needed to quantify what public health benefit, if any, might be realized from targeting taxes to this class of beverages and to determine if it in any way counteracts their additional economic negatives.

That discussion aside for now, Chicago's attempt to implement its soda tax has repeatedly run afoul of both Illinois' and federal law, for many of the same issues that have been raised in the challenge of the legality of Philadelphia's soda tax.

The rollout of a soda tax in Cook County, Illinois, has been a complete fiasco.

Much to the frustration of businesses and taxpayers in a county that includes Chicago, officials have repeatedly vacillated on applying the soda tax to purchases made with food stamps.

They haven't been able to decide how the tax will be administered or determine how much revenue the tax will generate....

County officials, however, had initially planned to tax distributors, who would pass along the cost in the final sale price of a sweetened beverage. Last Thursday they cancelled that plan when the Cook County Revenue Department pointed out the sales price would still be subject to a sales tax.

A tax on a tax is illegal in Illinois.

A tax on a tax is also illegal in Pennsylvania, which then leads to the legal question of why both courts and public officials in Illinois are making very different legal assessments of the legality of Chicago's soda tax that their peers in Pennsylvania making decisions about the legality of Philadelphia's beverage tax are not. The following excerpts following the first court decision on the legality of Philadelphia's soda tax indicates some of the judicial legal reasoning being applied in Pennsylvania.

Philadelphia Court of Commons Pleas Judge Gary S. Glazer dismissed a lawsuit the American Beverage Association and local retailers and distributors filed against the City of Philadelphia Monday. The soda tax levies a 1.5 cent per ounce tax on distributors of sodas, diet sodas, juices and other sugar-sweetened beverages and is being used to fund pre-K programs, the renovation of recreation centers and to fill in holes in the city's budget....

The ABA and others argued the tax was unconstitutional mostly for two reasons. First that it violated the state's uniformity clause by favoring distributors that sell high-priced lower-volume beverages (a $5 Starbucks drink) will owe less than those who sell low-priced higher-volume beverages (a two-liter bottle of soda). Glazer compared the soda tax to taxes on alcohol and fuel, which can also lead to an unequal tax burden depending on how much they are sold for.

A second argument stated Pennsylvania already taxed soft drinks 6 percent as part of a different tax and that this tax would illegally duplicate the state tax. Glazer wrote Philly's soda tax was not duplicative of the Pennsylvania Beverage Tax because Philly's tax is levied on the distributor and that it was irrelevant that the tax would likely get passed on to consumers, therefore taxing the same subjects — those who purchase beverages — as the state tax.

An argument that SNAP benefits would be used to pay a sales tax was also thrown out by Glazer for the same reason: because the tax is collected on distributors.

The difference in legal outcomes for these cases may be attributed to whether the courts are willing to recognize the economic concept of tax incidence, which recognizes the difference between who is required by legal statute to pay a tax and who is really bearing the cost of paying the tax, where the actual economic burden of paying the tax is shifted in full or in part from one party to another.

What you can see in the Philadelphia court's decision is the deliberate dismissal of the concept of tax incidence, where the legality of its soda tax depends almost entirely upon the arbitrary disregard of that real world factor.

That's not the case in Chicago, where authorities have confirmed that taxing the distributors of sweetened beverages results in part or all of the tax being passed through to retail customers through the prices they pay, which is then subject to sales taxes, rendering that approach to taxing sweetened beverages to be illegal under that state's constitutional prohibition against imposing taxes on taxes.

The difference extends also to the way that recipients of SNAP (food stamp) benefits are now being subjected to Chicago's soda tax, where the city's attempted workaround to impose the tax without being duplicative appears to be in violation of federal policy.

The U.S. Dept. of Agriculture has warned Illinois government if Cook County continues to collect sweetened beverage taxes from food stamp recipients, it could lose millions in funding.

USDA is taking a hard line when assessing what constitutes a violation.

Say you're a SNAP client, you buy a soda, you are charged the tax but you get an immediate refund. You may think no harm, no foul, but Illinois Retail Merchants Association Vice President and General Counsel Tanya Triche Dawood disagrees.

"It is absolutely a violation of our (Illinois) SNAP contract," she tells WBBM's Bob Roberts. "The USDA has been clear about that since Day 1. We've been clear about it since Day 1."

The rule in question forbids food stamp clients from being charged any form of tax on the sweetened beverages. The county has offered merchants the immediate refund as a workaround, but Dawood said the prohibition is absolute and not curable by an immediate refund.

The federal rules for exempting SNAP benefits from state and local taxes applies to all goods eligible to be purchased using the charitable welfare benefits provided by the U.S. government. It does not just apply to sweetened beverages.

Where the situation with Chicago's soda tax creates legal jeopardy for Philadelphia's legal tax lies in the almost opposite ways in which public officials and judges in each jurisdiction are assessing the legality of the tax, which would appear to be a direct outcome of one jurisdiction's arbitrary dismissal of the economic concept of tax incidence and the other jurisdiction's acceptance of its legal applicability. While Pennsylvania's seven Supreme Court judges have yet to weigh in on Philadelphia's soda tax at this writing, should they allow the tax to continue, the wildly different judicial assessments and implementation of similar taxes and provision of welfare benefits in different states will likely result in the legality of state and local soda taxes being decided in federal courts.

Seven Angry Jurists: Do any of these Pennsylvania Supreme Court judges believe in the concept of tax incidence?

The ball, as they say, is now in the hands of Pennsylvania's Supreme Court.

Previously on Political Calculations

Presented in chronological order....

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August 14, 2017

The U.S. stock market has been on what we've described as a boring trend over the last several weeks, even as it has hovered near records highs.

That chain of boredom was broken with the S&P 500 in Week 2 of August 2017, when stock prices hovered at its high level just a few days longer than our dividend futures-based model suggested it could, where it found itself in a scenario similar to that of Wile E Coyote after having run off the edge of a desert cliff, hanging in open space until he looks down....

Metaphorically speaking, and from a behavioral finance standpoint, that's pretty much exactly what happened on Thursday, 10 August 2017.

Alternative Futures - S&P 500 - 2017Q3 - Standard Model - Snapshot on 11 August 2017

Fortunately, stock prices didn't have far to fall. We can however confirm that investors would appear to have locked their focus upon the distant future quarter of 2018-Q2, which matches not only what our dividend futures model is telling us, it also matches what the CME Group's FedWatch tool is telling us. Mike Shedlock has snapshots of what the FedWatch tool is communicating, but here is the short summary of the probabilities for what investors are expecting for the timing of the Fed's next change in short term U.S. interest rates after last week.

  • 2017-Q3 (20 September 2017)
    • Decrease to 75-100 bps: 4.1%
    • Unchanged at 100-125 bps: 95.9%
  • 2017-Q4 (13 December 2017)
    • Decrease to 75-100 bps: 2.6%
    • Unchanged at 100-125 bps: 61.5%
    • Increase to 125-150 bps: 35.2%
    • Increase to 150-175 bps: 0.7%
  • 2018-Q1 (21 March 2018)
    • Decrease to 75-100 bps: 2.2%
    • Unchanged at 100-125 bps: 52.7%
    • Increase to 125-150 bps: 39.1%
    • Increase to 150-175 bps: 5.9%
    • Increase to 175-200 bps: 0.2%
  • 2018-Q2 (13 June 2018) (Now Most Likely Quarter for Change in Federal Funds Rate)
    • Decrease to 75-100 bps: 1.7%
    • Unchanged at 100-125 bps: 41.3%
    • Increase to 125-150 bps: 41.8%
    • Increase to 150-175 bps: 13.5%
    • Increase to 175-200 bps: 1.7%
    • Increase to 200-225 bps: 0.1%

2018-Q2 is when the combined odds of the Fed hiking its Federal Funds Rate above its current range of 100-125 basis points (1.00 to 1.25%) finally exceeds 50%, where that action is not expected until the Fed's 13 June 2018 meeting.

The headlines for the week in the markets had a good amount of noise in them, particularly related to North Korea, which really says more about the media's interests than what's motivating the markets.

Monday, 7 August 2017
Tuesday, 8 August 2017
Wednesday, 9 August 2017
Thursday, 10 August 2017
Friday, 11 August 2017

Elsewhere, Barry Ritholtz summarized the positives and negatives for the U.S. economy and markets for the week that was.

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August 11, 2017

Can you tell that we're getting closer to the first day of school?

Real analysis is way realer than I expected.

Via XKCD: Existence Proof

Wait until they get past composition of functions and enter into the realm of convolution!

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August 10, 2017

Let's analyze some of the news coming out from Philadelphia regarding its poorly performing tax that the city's leaders imposed upon naturally and artificially sweetened beverages distributed to be sold by retailers in the city.

The Current Challenge to the Soda Tax in Court

Source: ZeroHedge

The City of Philadelphia is facing lawsuits from beverage manufacturers and distributors regarding the constitutionality of its Sweetened Beverage Tax (SBT), one of which has already reached the state of Pennsylvania's highest court. The plaintiff in the case, the American Beverage Association (ABA), has argued that the tax isn't legal under the state's constitution, which prohibits municipalities from applying local taxes on top of items that have already been taxed at the state level.

Two lower courts have ruled in favor of the City of Philadelphia already, finding that since the tax is assessed against beverage distributors rather than beverage consumers, the tax is not duplicative, which would be directly prohibited by Pennsylvania's state constitution.

The judicial findings in these two lower court decisions are largely based on the letter of the law, by which we mean that that they have not considered the real world issue of tax incidence, where the people and businesses who might be mandated by legal statutes to pay a tax are not necessarily the ones whose money is being collected by the government. Most often, they will pass as much of the cost of the tax as they can onto their customers through increasing the prices of the goods and services they might sell to them, so that in effect, their customers become the ones who are really paying the cost of the tax.

For the Philadelphia Beverage Tax (PBT), we've found examples where the city's beverage consumers are paying anywhere from two-thirds to nearly all of the the city's new soda tax, where much of the difference from one store to the next might really be attributable to the extent that the retailers or beverage manufacturers are willing to subsidize the cost of the tax to consumers through their advertising and marketing budgets to generate discounted sale prices.

Some retailers have made it clear on their receipts how much of the cost of the beverages they sell is being passed through to their customers (Image Credit: ZeroHedge). As we're about to see, the higher costs being passed on to them are, particularly for small retailers, having a negative effect on their businesses.

A Family-Owned Bakery Goes Under

In Philadelphia, the Orlando family has owned and operated a bakery since 1948 in the Overbrook neighborhood at the intersection of Lebanon Ave. and Kenmore Rd. Sunday, 6 August 2017 was its last day in business, and the last day of work for its five employees.

Over the years, it survived every economic challenge that came its way, but one.

"The soda tax was the kill shot," said Anthony Voci Jr., a grandson of Christopher Columbus "Chick" Orlando and now a lawyer in Philadelphia.

Chick Orlando started in the baking business with his father in the 1930s with a shop in West Philadelphia, and ran several shops in the city and Delaware County until he was killed by a drunken driver while making a delivery shortly before Christmas 1971. His sons David and Robert took over Orlando's.

The business' last owner, Tyler Orlando, 32, also a grandson, said business was off 60 percent since the soda tax went into effect Jan. 1 – a difficult situation for a low-margin business. Orlando said his customers simply crossed the nearby city line to avoid the higher prices for juices, milk and other sweetened drinks typically purchased with doughnuts and pastries. "I'd see my customers in there," he said. "I don't blame them."

The actions of consumers to avoid the burden imposed by the true tax incidence of Philadelphia's soda tax is not surprising. It is human nature to want to get the most for one's money, so we should expect that people will change their long-established shopping patterns to avoid having to pay an outlandish increase in prices, when they can easily buy exactly the same product just a little way down the road for a lot less.

Nor is it surprising that Philadelphia is experiencing the rise of an organized black market that is thriving on exploiting the differences in the prices for soft drinks in Philadelphia and its surrounding suburbs.

A Boom in Bootlegging

When we've talked about bootlegging in the past, it has typically been in the context of cigarette and other kinds of so-called "sin taxes" that are supposed to produce positive benefits by reducing consumption. But that only matters to the extent that consumption is actually reduced, where the business of bootlegging both allows the "undesired" consumption to remain higher than it might otherwise be while it also damages the expected tax collections that would be realized if the sin tax was achieving its desired results.

On 23 June 2017, Danny Grace, the Secretary-Treasurer of the Teamsters Local 830 union, testified before a Pennsylvania Senate committee on the direct negative impact of Philadelphia's soda tax on the members of the union, where he counts 155 lost jobs (10 more than we tallied back in May 2017). In doing so, he also shown a light on a negative externality being experienced by members of the union because of the increased profits for bootleggers whose profits are made possible because of the tax and their ability to avoid paying it, and also the impact to the city's poorest residents because of the soda tax' highly regressive nature (emphasis ours).

The definition of a regressive tax is one that disproportionately affects the very people who can least afford to pay it. The city's poor don't have the financial means to absorb a tax that has more than doubled the costs of their favorite sodas, juices, iced teas, sports drinks, flavored milks and countless other beverages. The tax has been applied to virtually every beverage sold in the city. The working poor also don’t have the ability to drive to the nearby suburbs or South Jersey to buy their beverages and avoid the outrageous tax, like many other city residents are doing. This situation – which the Teamsters predicted – has forced many low income Philadelphians to forego sweetened drinks altogether or purchase them through the many illegal black market operations that have sprung up across the city. We have seen evidence of people purchasing hundreds of cases of sweetened drinks in nearby suburban areas such as Upper Darby in Delaware County, loading them in unmarked vans, and driving them into Philadelphia to be sold out of nondescript warehouses or right out of the vans.

The Kenney administration's stated assumption that lost sweetened beverage sales would simply be filled in with increased sales of water and other non-sweetened drinks has been proven false. Consumers don't behave that way. Consumers can make the choice today to abandon sweetened beverages for water and other non-sweetened drinks, but they haven't done so nor will they.

As a direct result of the beverage tax, there has been a huge drop-off in sales of sweetened beverages in the city, just as we predicted. The damage the tax has already done to our union has been significant. As of this moment, 155 of our union brothers and sisters have been laid-off - 80 members at Pepsi, 40 at Coke and 35 at Canada Dry. And these are family-sustaining jobs we’re talking about.

The beverage tax has caused a disastrous domino effect within Teamsters Local 830. The tax has resulted in drastically fewer products being sold in the city, which means less trucks needed for deliveries, which means less Teamsters drivers needed. Fewer delivery trucks on the roads means less need for Teamsters' mechanics to maintain and repair the trucks. Less products being sold also means less need for Teamsters' production and warehouse personnel. And decreased sales of beverages means less need for Teamsters' merchandisers in corner convenience stores and supermarkets.

That's more practical insight into the nature of externalities than one may ever find in the lecture halls of today's universities. We will point out that when Grace refers to a "huge drop-off in sales of sweetened beverages in the city", he's referring to the sales of sweetened beverages to which Philadelphia's beverage tax has been applied, where bootlegging operations and the actions of Philadelphia's consumers to shift their purchases of these products outside of the city's limits to legally avoid having to pay for the highly taxed products are sustaining a far higher level of consumption within the city than the amount of taxed sales would suggest.

Additional Notes

  1. There are several acronyms that we've used in this post that apply to Philadelphia's soda tax, which are really all referring to the same thing, but which appear in different reports. These acronyms include PBT (Philadelphia Beverage Tax), SBT (Sweetened Beverage Tax, Sugary Beverage Tax).
  2. There's an as-yet little noticed legal argument that might severely dent the administration of Philadelphia's soda tax, which could effectively crash both its revenues and the city's plans for what it would do with that money if it proves to have any traction. We'll explore that idea sometime next week, but will be drawing on the information presented here!

Previously on Political Calculations

Presented in chronological order....

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