The $40 billion question

Barack Obama (and various other politicians) have often cited ExxonMobil's $40 billion in profits earned in 2007 as a bad thing. For instance, after winning one of his primaries, Barack Obama said, "I know that it won't be easy to change our energy policy. Exxon Mobil made $11 billion last quarter. They don't want to give those profits up easily."

Now, a few bloggers have remarked that Exxon actually paid taxes of 41%, and over the past few years, Exxon has paid an average of $27 billion per year in taxes.

However, I'd like to explore a different question: is Exxon Mobile really making huge profits? Now granted, the numbers are huge, but Exxon Mobil has to sell a lot to make that profit. Therefore, it's better to look at the percentage profit than the actual figure.

But in finance, it's not just the net after-tax profit figure that you should look at, but you should examine other indicators of profitablity as well. First, there's the issue of taxes. Corporations deploy legions of accountants, lawyers, etc. to delay paying taxes, and to shift money around to avoid certain taxes. So companies may pay high taxes one year and low taxes another year, so when comparing firms to each other, it's sometimes best to use pre-tax profits.

But there's another wrinkle: interest. Suppose you had two firms that were exactly the same, except the first paid dividends of its excess cash each year and the other one did not. The second firm would earn interest on its cash balance. Alternatively, one firm could have sold shares to the public to get its start up funds, while the second could have taken on debt, which comes with interest. So taking interest out of the equation also helps compare firms' profits to each other.

Finally, there's depreciation and amortization. When a firm buys equipment, it has to expense that over several years -- this is called depreciation. When a firm buys another firm, it has to amortize part of the cost of buying that firm over several years (namely, the amount that it paid above and beyond the net value of the assets acquired).

If you exclude amortization, depreciation, interest and taxes you get what's termed in the financial world as "EBITDA": Earnings before interest, taxes, depreciation and amortization.

It's also best to look not just at a single quarter, but a full year. This avoids the problem of one firm having a really good quarter or really bad quarter.

Here is a brief summary of how various other international oil companies have performed during the past 12 months, according to Yahoo finance:

Company	Sales ($B)	EBITDA ($B)	EBITDA %	Net Income	Net Income %
Exxon Mobil	$361.71	$73.01	20.18%	$40.61	11.23%
BP PLC	$284.37	$36.74	12.92%	$20.84	7.33%
Chevron Corp	$208.11	$38.48	18.49%	$18.69	8.98%
Conoco Phillips	$171.50	$35.17	20.51%	$11.89	6.93%
Eni SpA	$139.76	$41.06	29.38%	$15.91	11.38%
Hess Corp	$31.65	$5.30	16.75%	$1.83	5.78%
Marathon	$59.39	$7.60	12.80%	$3.95	6.65%
Respol YPF	$82.81	$8.14	9.83%	$5.07	6.12%
Royal Dutch Shell	$355.78	$53.77	15.11%	$31.33	8.81%
Total SA	$217.94	$49.67	22.79%	$20.95	9.61%

By examining the above, it's clear that versus other large, integrated oil companies, Exxon Mobil's after tax profits and its EBITDA are a little higher than other companies. However, this is due to it having a more efficient cost structure: if it charged much more than its competitors for oil, people would purchase oil from the competitors. Also note that the above revenue figures do not include sales taxes collected. Since sales taxes are included in the price of gasoline, they are sometimes included in companies' reported revenues.

Now, let's take a closer look at Exxon Mobil's profits:

Exxon Mobil splits its net income across three segments: upstream, downstream and chemicals, and it separates each of these according to US and non-US. Here is how Exxon Mobil's profits break out:

Division	US	Non-US	Total
Upstream	$4,870	$21,627	$26,497
Downstream	$4,120	$5,453	$9,573
Chemical	$1,181	$3,382	$4,563
Total	$10,171	$30,462	$40,633
Upstream	12.0%	53.2%	65.2%
Downstream	10.1%	13.4%	23.6%
Chemical	2.9%	8.3%	11.2%
Total	25.0%	75.0%	100.0%

(The above excludes a cost of $0.23 billion used for corporate overhead purposes)

Thus, 75% of Exxon Mobil's profits were earned outside of the United States, and only 25% -- $10.2 billion -- were earned in the United States. Now, Exxon Mobil is a huge company, and its lawyers and accountants almost certainly devise methods to shift taxes from high tax jurisdictions to low tax jurisdictions. For instance, if Exxon pumps crude out of the ground in Saudi Arabia, ships it to a refinery in the Caribbean and then sells the refined gasoline in the United States, how do you allocate the profits across the various countries?

Now, one more thing I want to do. I want to compare Exxon's EBITDA and Net Income to other large companies in the United States, just to give an idea that its profits are not outrageous. All dollar figures are in billions:

Company	Sales ($B)	EBITDA ($B)	EBITDA %	Net Income	Net Income %
Exxon Mobil	$361.71	$73.01	20.18%	$40.61	11.23%
Apple Computer	$26.50	$5.56	20.98%	$4.07	15.36%
AT&T	$120.70	$42.38	35.11%	$12.56	10.41%
Boeing	$66.39	$7.09	10.68%	$4.06	6.12%
Coca Cola	$30.13	$8.99	29.84%	$6.22	20.64%
Costco	$67.91	$2.39	3.52%	$1.19	1.75%
Ford	$172.46	$13.84	8.03%	$(2.76)	-1.60%
G.E.	$172.95	$37.69	21.79%	$21.90	12.66%
Google	$18.12	$6.51	35.93%	$4.51	24.89%
H.P.	$107.67	$12.25	11.38%	$7.85	7.29%
IBM	$101.26	$20.83	20.57%	$10.89	10.75%
Procter & Gamble	$79.74	$19.32	24.23%	$10.96	13.74%
Starbucks	$9.82	$1.47	14.97%	$0.68	6.87%

So when you look at a smattering of other companies, you see that Exxon Mobil's profits as a percentage of revenue are not that outrageous. They'll beat most pure retail operations: pure retail companies are very competitive, and they are just selling what others make, so they rely on volume. Automobile producers have low profits these days as they cope with legacy costs.

So, overall, while Exxon Mobil has high dollar figures for its profits, it does not have really excessive profits. How could it? It competes with other firms seeking to make a profit: if Exxon charged a lot more for gasoline than Shell, very few people would patronize Exxon instead of Shell. The oil industry is highly competitive.

So what does Barack Obama think could be gained by taking more of Exxon Mobil's profits? Well, presumably, votes. However, taxing oil companies more would almost certainly lead to higher prices, not lower prices, as they'd pass their costs on to consumers. They'd also be more likely to shift profits out of the United States, which already has a higher tax rate than most other industrialized nations. It certainly wouldn't lead to cheaper gas at the pump.

The Great Pumpkin Tax

Recently, Iowa became the brunt of many jokes when it attempted to implement a sales tax on pumpkins. In Iowa, groceries are exempt from sales tax, but the Iowa government decided that most people used pumpkins for decorations and not for food. However, some specific variety of pumpkins used for pies was exempt from the tax, and you could also fill out a form if you were going to eat a pumpkin and not carve it. Seriously.

What's the real problem here? It's that the Iowa government has arbitrarily decided to tax one class of good but not another. If it had simply decided to tax everything at the same rate, this issue would never have come up. Many states exempt certain items from sales tax: in Connecticut, all groceries and any article of clothing under $50 are exempt from sales tax.

I'd rather have everything taxed, but then have the rate lower. Right now, if one class of good is taxed but another isn't, the people buying the taxed good are in effect subsidizing those who buy the untaxed good. Sure, everyone buys groceries, but not everyone spends the same ratio on groceries and taxed items. And please don't talk about helping the poor. There are many more efficient ways of helping the poor than not having a tax on groceries but having a tax on gasoline or having a tax on furniture or having a tax on cars.

When you tax people or items differently, you create many distortions. This ncludes the creation of silly government forms that make you declare you shall eat a pumpkin and not merely carve it. I'm all for low taxes. However, they need to be low on everything. Having taxes removed from one particular good, or for one preferred group of people, isn't really a tax cut. In the end, it's just a transfer payment. If the government taxed everything equally, but then gave checks for the amount of tax you paid for one particular good, that'd be a subsidy, and no one would argue with you on this fact. But that would have the same exact effect as what the situation currently is. In finance, if two financial scenarios have the exact same cash flows under all circumstances, they are deemed equivalent and would have the same price applied, and would be considered interchangeable.

For now, however, we'll be faced with the fact that we'll have to prove were eating a pumpkin pie or pumpkin bread, and not making a jack-o-lantern that is a tax dodger.

Don't Cross that Line!

In the United States, many people live in one state but work in another. In some states, like Colorado, this number is quite small since a small portion of the population lives near the state line. In other states, like Connecticut, this number can be quite substantial.

This has an impact on local tax policy. In Connecticut, various politicians talk about the rich paying their "fair share", which always seems to be more. The problem for Connecticut is that many of the wealthiest residents pay no income taxes on wages ot the state of Connecticut, since they work in New York state, and pay income taxes to New York instead. Raising the top bracket of Connecticut's income tax won't have an impact on these people until the Connecticut top bracket surpasses New York's top bracket, since you don't have to pay income taxes twice if you cross state lines on the way to your job.

Connecticut has about 3.5 million people. About 38% of these are either under 18 or over 65, so are not likely to be in the work force. According to Metro North, the commuter railroad that takes people to New York City and intermediate points, about 80,000 commuters get on the trains every day in Connecticut. A few more Connecticut residents probably board at Port Chester (the first train station in New York, right over the Greenwich border), and there are also some that drive their cars or take a bus over the Hudson line in New York state and take the train into the city from there (indeed, my town, Ridgefield, has the shuttle bus which runs 8 times per day to the Katonah train station in New York).

There are some commuters -- not many -- who take the train to other Connecticut towns, and there are some New Yorkers who commute outwards to Connecticut. But I would estimate that conservatively, there are 50,000 net train commuters from Connecticut into New York.

Some people drive from Fairfield county to Westchester county, but I would imagine that these people cancel each other out. The Massachusetts/Connecticut people probably also cancel each other out. There may be more Rhode Islanders coming in than Connecticut residents heading into Rhode Island, since Connecticut has two large casinos (Foxwoods and Mohegan Sun) located near the Rhode Island border. However, these are mainly low wage jobs, and thus don't generate much in the way of income taxes for the state.

These 50,000 or however many commuters into New York are mainly high wage earners. Monthly tickets from Greenwich to Grand Central station in New York City cost $237, and they get more expensive as you go further out. So the salary has to be worth the cost and approximate hour of commuting time.

New York has a graduated income tax that hits 7.7% after $500,000 (7.375% after $100,000). Connecticut reaches 5% at $10,000 and stays there. So for the top rate, Connecticut would not receive any income taxes from cross-border commuters until it topped the 7.7% level.

I don't have any statistics available, but I would imagine that as a percentage of income earned, Connecticut probably has the highest percentage being earned out of state. New Hampshire has a lot of commuters going into Boston, but since New Hampshire doesn't have income tax, this becomes irrelevant. New Jersey of course is also a commuter heavy state, both in the north (to New York) and south (to Philadelphia), but it's a much bigger state than Connecticut. Maryland has a decent percentage that commute into D.C., but it appears that there is some sort of agreement in place that means those residents pay taxes to Maryland and not DC (however, Maryland commuters to Delaware don't seem to have this agreement.

In any event, when a large portion of your biggest income producers commute out of state, and are thus not subject to your taxes, it's difficult to promise that raising taxes on the rich is going to bring in lots of new revenue.

One Conencticut state senator, Ed Meyer, said he would favor raising the top rate to 18.97%, which would make Connecticut the highest taxed state by far. This would of course pull in some money (18.97% minus 7.7% paid to New York) from the wealthy cross-border commuters, at least until they moved closer to their jobs, in the low tax jurisdiction of Westchester County, New York.

Gasoline Taxes and Road Building

While I'm all for low taxes, I believe that gasoline taxes and tolls on highways can be perfectly reasonable, provided, however, that there are some constraints to them.

Roads cost money to build and maintain, and therefore, I think it's fair that the people that actually use the roads pay for their use. If someone has managed to position their life so they can walk to work and walk to the stores they need, why should they have to pay taxes so I can drive a car? However, the collary should also be true: if I drive, why should the gas taxes and tolls go to items other than those that are necessary to maintain the road?

I favor congestion-based tolls. These would be tolls that would be charged only during peak periods: by peak periods, I mean only those times when traffic moves less than the speed limit. As I wrote in a previous blog entry, these tolls would be set at such a rate so that enough people were deterred from using the road until the speed limit could then be attained. I believe this would be a more sensible allocation of a limited resource than to force everyone to sit in a traffic jam.

Now, if the congestion-based tolls are throwing out so much money that no other funding for roads is needed, this would tell me that the road infrastructure is woefully inadequate. The excess funds should be used to build more roads. The objective with congestion-based tolls isn't to raise revenue, it's simply to reallocate resources to those willing to pay for them.

Regular tolls are fine, as long as the toll can be collected efficiently. I hate having to wait 20 minutes to pay $1 for a toll. Gasoline taxes and various property taxes on cars are also acceptable, so long as these funds are not diverted to other sources.

So whatever gasoline taxes and tolls would have to be to maintain the road system is where I think the taxes should be set. However, there's one slight problem here. If a small state, such as Rhode Island, needed to have higher taxes than the neighboring states (perhaps because of more miles driven by its residents, more miles per car, or whatever), this could cause locals to cross state lines when making purchases. Taxes need to be high enough to cover costs, but not so high that people start finding alternative fuel sources in other states. States like these would probably have to revert to more tolls. Traffic fines should also be used solely for the road system.

The cost of the road system are construction costs, repair, snowplowing, traffic police salaries, and the cost for emergency rescue personnel for the portion that they deal with automobile accidents.

So would this make gas taxes higher or lower?

Currently, gasoline is taxed at $0.184 per gallon by the federal government, and then the states add their own taxes. This brings in about $30 billion to $40 billion per year, according to various estimates. The most recent highway bill signed by Bush had $286.4 billion in spending over six years, which right there is more than the gas taxes collected. This would indicate that the gas taxes aren't enough to fund federal transportation spending. Add to the fact that much of the $0.184 collected is block granted back to the states, and it looks like the federal gas tax is woefully short of where it should be. The highway bill was also filled with lots of local projects, not for the interstate highway system. The bridge to nowhere in Alaska is only the most ridiculous example.

Republicans and Democrats alike call for tax holidays of the gas tax. I guess my question would be: during this time, would you still build and repair roads, have police and fire units, etc? If so, then who's going to pay for it all if not the drivers. If I set up my life so that I don't need to drive, why should my income taxes go up to pay so people can drive?

At the same time, gas taxes shouldn't be thought of as a piggy bank to fund other non-road related projects.

There's a few other things I haven't mentioned. Pollution. In my above proposal, there's no allocation for pollution. I would definitely favor some sort of duty on pollution to encourage people to reduce their own. Charge each car based on the amount of particulates per mile times the number of miles driven; this will encourage people to get cars that pollute less. I don't really care if the car is a hybrid or runs on ehanol. Base it on the output. I never understood why there should be tax breaks for hybrids. Why not tax breaks for really fuel efficient cars, most of which happen to be hybrids. But what if someone else came up with a different way? Like reducing the number of cylinders in use when on a highway.

Public transportation. Many governments seem to think that drivers should pay for public transportation, because for every guy on the railroad, he's not on the road. However, if we were going to have a closed system, in which gas taxes and tolls and fines pay for roads and highways, then why should the drivers pay for the railroad riders? Yeah, they reduce congestion. So what. If a factory were to build worker housing next to the factory, should the owner get the same tax break because he's reducing congestion as well? Or if a company allows its employees to work from home or have flex commuting, should they get a tax break? Well, they sort of would, because under my proposal congestion wouldn't happen often: except when there was a wreck, there should be little congestion due to peak tolls.

So in any event, keep road taxes and tolls as high as necessary to maintain and build the roads. Don't expect subsidies, and don't expect to subsidize anyone else...

Conservatives and Property Taxes

What is it about conservatives that causes many of them to propose and embrace completely crazy property tax "reform"?

The latest is Ron Paul, a libertarian-Republican congressman from Texas who is often regarded as being the most free-market congressman, and who's revered by various free-market think tanks. He says that he wishes that in Texas, the state legislature would consider the following proposal:

Specifically, end the practice of annual assessments. Properties should be reassessed for tax purposes only when sold or ownership is otherwise transferred. The current system is terrifying for seniors forced to pay more and more each year, with no idea where they will find the money. And unlike other bills, property taxes must be paid or else one’s home can be taken away. My office hears from seniors who may have no choice but to leave Texas altogether because they cannot live with the uncertainty of arbitrary property tax increases. They literally fear losing their homes.

Now, I'm all for lower taxes, but they have to be lower for everyone. Ron Paul's proposal is simply crazy, and for several reasons.

First, it gives no incentive for people to elect conservatives who want to limit spending. Why? Because, under his proposal, their taxes cannot go up! Normally, when a community goes off and elects some liberals who want to spend a lot of money, they find that their taxes go up (and then as the tax base shrinks, their taxes go up some more). They start to question what value they're getting. However, Paul's proposal completely decouples these two things. The local populace can vote for all kinds of things, knowing that future home buyers are going to have to foot the bill.

Second, his proposal is simply unfair. It amounts to a subsidy from new homeowners to long-term homeowners. This is because without annual assessments, the increased tax burden will fall on the new homeowners. If you want lower taxes, fine. But if you don't apply the taxes uniformly, then you're not really having lower taxes, you have subsidizing by the unfavored group to the favored group. What about corporations or limited partnerships? The LP or LLC or whatever will own the property. Shares in that company can change hands, but without revaluation, the property taxes will be fixed in time.

Third, why should the government discourage mobility? Our economy is dynamic because people move to where the jobs are. (Compare this to a country like Germany, where people rarely move from one region to another). When the kids have left for college, the parents can buy a smaller house. But under this scenario of Paul's, there's a reward for not relocating, in lower property taxes. And downsizing to a smaller house may result in significantly higher property taxes. So people will be reluctant to relocate.

It also makes the cost of housing more expensive for younger people, who must buy a new house and therefore must shoulder a larger tax burden than older people who have lived in the same place.

Imagine the following quote:

Specifically, end the practice of annual rent increases. Rents should be raised only when the tenant ends the lease. The current system is terrifying for seniors forced to pay more and more each year, with no idea where they will find the money. And unlike other bills, rents must be paid or else one can be evicted. My office hears from seniors who may have no choice but to leave Texas altogether because they cannot live with the uncertainty of arbitrary rent increases. They literally fear losing their homes.

So how is a fixed property tax different from rent control? Now, you can say that you own the property and shouldn't be forced to pay taxes on it. Fine, but then do away with property taxes for everyone and find a different revenue stream, like the sales tax or income tax, to fund the government. The fact is, the government needs some money. Even the most die-hard libertarian realizes you need a court system, a law enforcement system, and some other items. You can debate how much government is ideal, but you need some. Therefore, you need some taxes. If you don't like property taxes, then abolish them for everyone. But if you are going to impose property taxes, impose them equitably.

Don't assess two identical houses at massively different rates. As for the argument that seniors cannot afford the increased taxes, there are sadly no guarantees in life. You buy an SUV and gas prices skyrocket, and you can't get gas at the old fixed price. Rents go up. When prices rise, you can either pay, or not purchase that product anymore. Not purchasing here implies that either you vote for conservatives who lower taxes, or you sell your house so you need not pay property taxes anymore.

Property taxes going up means that your house value is probably rising as well. This means that you could take out a Home Equity Line of Credit and pay the property taxes. Due to price appreciation, when you sell the house, you can pay the loan back.

Conservatives often propose similar schemes to Ron Paul's for property taxes. California has it in the form of Proposition 13. However, I think that conservatives would be better served if they proposed limits on increases in spending, or if they set a maximum tax rate on properties, but allowed those properties to be regularly reassessed. Taxes should be low, but they should also be fair.

Any tax cut that is not distributed among all people fairly is essentially a subsidy. Suppose that all houses in a neighborhood were regularly reassessed, and then were taxed at 1%. Everyone sent in their checks. Then the government figured out what the assessed rate was whenever you bought the house, and sent you a check for the difference. Some people would get nothing, some people would get a little and some people would get a lot.

Would you object to that? If not, why not? And if so, don't you also object to Ron Paul's proposal? Because in the end, it's the same thing. Everyone has the exact same cash flow under both my scenario and Ron Paul's proposal.

Keep this in mind during any property tax reform. Never altering the assessment creates massive distortions.

Property Tax Reform

In various states around the country, property tax reform seems to be creeping up as an issue. While I'm all for lower taxes, I'm skeptical of exactly how property tax reform might be implemented.

To me, the only fair property tax seems to be one that has the same rate for everyone in a given municipality (unless there is a legimitate reason not to, such as a special sewer district), and the assessments are based as closely as possible to actual market rates, which means if the owner sold it, what would he or she get for it? Any transfer of the property (besides those among family members, because those won't necessarily be at market rates) would automatically trigger a reassessment at the purchase price.

Any deviance from this system seems to me to end up in a complete distortion: some people will have lower rates because they're preferred, while the others will have to carry the burden.

Many people make the claim that they're on a fixed income, and by golly, since they bought the property 40 years ago, the assessment has gone way up and now they cannot afford property taxes. Well, I wouldn't be opposed if the town could put some sort of lien on the property so that when it was sold, the town would receive the extra property tax plus interest. This way, the town wouldn't be out money, and the only reason the homeowner was paying extra taxes is because the value of their house increased so much that the assessment went up, but when they sold the house, they'd presumambly be way ahead. If you buy a car and then the price of gas goes up, people don't expect the gas station to cut you a break. Why should the local government cut you a break?

Many of the property tax reforms floating around limit how much assessments can go up, and they limit the tax rate. California has a 2% maximum increase in assessments and a 1% tax rate. I'm ok with the latter, but the former doesn't seem fair. You can wind up with two identical houses next to each other, but they'll have massively different assessments and therefore property taxes, because when you sell your house in California, it's reassessed.

If you don't reassess houses when they are sold, then you are going to favor people who live in old houses versus people who live in new houses, because new houses built after the law goes into effect will have their initial assessment done at market rates. If you reassess houses when they are sold, then you'll end up favoring long-term homeowners over younger homeowners.

If you want to keep property taxes down, then limit spending. If you limit spending, then property taxes will be kept in check. But if you don't limit spending, but you limit property taxes, then either 1) other taxes will have to be raised, or 2) the municipality will go deeper into debt.

When two people are taxed differently for the exact same wage or exact same property, then you get massive distortions, with certain people benefiting for no reason.

Another thing that bugs me about property tax reform is that it can actually lead to higher spending. If you limit the amount that someone's property taxes can go up each year, but you reassess when the house is sold, this means that newer property owners will pay more due to their higher assessments. But for the older people, when there's an election, why would they vote for someone who wanted to not increase spending fast? Their property taxes can't go up more than x%. Think about it: if we had a guarantee that our taxes wouldn't rise, but someone else's would, do you think we'd vote for many candidates that promised to cut spending?

Property tax reform has to include market rates for assessments and a consistent tax rate. Anything else is just playing favoritism, in which one group gets to benefit at the expense of another.