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Starbucks in Hot Water Over British Tax

 by Kenneth Thomas

Starbucks in Hot Water Over British Tax

Reuters (via Tax Research UK) reported on October 15 the results of an extensive investigation into the British unit of coffee giant Starbucks, the second largest restaurant firm in the world after McDonald’s. It turns out that the company has reported losing money in every one of the 14 years it has operated in the country, even as it tells investors that the unit is profitable. Reuters documented this latter fact by getting the transcripts of 46 investor conference calls Starbucks has made over the last 12 years.
For the last three years, Starbucks has paid no income tax at all in the United Kingdom. This is a textbook case of using transfer pricing to hide your profits from the taxman and make them show up in tax havens instead.

According to the Reuters report, there are three potential routes the company has to make its profitable British subsidiary legally have no tax liability.

1) The British subsidiary pays a Dutch subsidiary for the use of trademarks and other intellectual property of Starbucks, at a cost of 6% of sales as royalties. An undisclosed amount of this barely profitable unit’s revenue is paid to another Starbucks subsidiary in Switzerland. Where the money goes from there only Starbucks and its accountants, Deloitte, know for sure.

2) Starbucks UK buys its beans through another Swiss subsidiary and they are roasted at a second Dutch subsidiary (this may be a pattern: pay a Dutch subsidiary, which pays a Swiss subsidiary). This gives a second opportunity for transfer pricing, although a transfer pricing investigation by Her Majesty’s Revenue and Customs (HMRC) in 2009-10 resulted in no penalties, the company told Reuters (HMRC would not comment). However, Richard Murphy reports that HMRC has been cutting audit staff and been subject to regulatory capture by the companies it is supposed to be regulating.

3) Finally, the British subsidiary’s operations are financed entirely through debt, for which it pays interest to other Starbucks subsidiaries. The interest is deductible from income in the UK and can accumulate in tax havens as income there. Reuters found that Starbucks UK pays at least 4 percentage points more in interest than McDonald’s UK does.

Paying zero corporate income tax (or corporation tax, as they call it in the UK) gives Starbucks a competitive advantage over other coffee companies that are purely domestic and can’t get out of the tax. Not surprisingly, this has ignited a firestorm of controversy in the United Kingdom. In the last 6 days, HMRC officials have been summoned for testimony before Parliament, probably in November. The Irish Congress of Trade Unions (which represents unions in Northern Ireland/UK as well as in the Irish Republic) has called for a boycott of Starbucks. And the company’s reputation has been simply hammered in the social media there, with studies by YouGov and Buzz showing sharp dips into negative territory on their measures of brand perception.

Of course, if Starbucks goes to all this effort to avoid British taxes, you’ve got to wonder what strategies it’s using to avoid taxes in the United States. Any reporters out there up for the challenge?

Middle Class Political Economist

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If They’re All Young Hooligans, Why Are Four of Eleven Over 35?

With a hat tip to Tim Harford, The General Manchester Police are reporting their already-public-record convictions via Twitter (@gmpolice).

On a quick check, four of the eleven so far convicted (including the one woman), are over 35. So far:

It appears that legendary “moral decay” began under Margaret Thatcher. Whodathunkit? Well, maybe David Cameron in 2007:

Sometimes a piece of research is published which goes straight to the heart of the national debate – it holds up a mirror to the whole of society and makes us see ourselves as we really are.

That happened this week. On Wednesday, Unicef published a report entitled “An overview of child well-being in rich countries.” It brings together comparative research on the material, educational and emotional state of childhood in 21 developed nations.

Britain comes bottom of the list….

Ten years after the current [Blair] Government was elected on the promise to end child poverty and make education its number one priority, Britain comes 18th out of 21 rich countries on material wellbeing, and 19th out of 21 on educational wellbeing. According to the report, British children are among the poorest and least educated in the developed world….

On the radio yesterday morning two local residents were interviewed about the spate of killings in their area….One said, “the children don’t seem to have anything to do. They just roam the street.” When she was asked who she blamed for that, she said “the Government, really. They’re closing down all the community centres.”

Now I like to agree when people blame the Government for things that go wrong. And, more seriously, I also agree that there is a problem with the lack of community facilities in our big cities….

Ultimately, we didn’t need the Unicef report – pages of statistical analysis – to tell us there is a problem with the emotional wellbeing of Britain’s children….

We need common sense in schools. It is madness for the authority of teachers and heads to be second-guessed by outside evaluators when they want to impose simple discipline in their own classrooms. It is madness for a teacher to fear that if he restrains a child who is violently bullying another child, he will end up in court on charges of abuse. It is madness for schools to have to cancel outdoor trips because their insurance policies won’t cover them in case of mishap.

Indeed, it is grimly instructive that the only measure in the Unicef report where Britain does not come at or near the bottom – where we come a respectable 12th out of 21 – is (you guessed it) health and safety. Our children might be the loneliest, worst behaved, unhappiest children in the developed world– but at least they are protected from sprains and bruises….

And I hope they illustrate something of what the Conservative Party under my leadership stands for. When we were last in government, in another political era, we stood for economic revival. We now stand for social revival. We used to stand for the individual. Now we stand for the family, for the neighbourhood – in a word, for society.

How’s that working out?

(cross-posted from a personal blog)

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The UK faces a serious inflation issue if oil pops!

Bond markets are pricing in rate hikes this year by the ECB and the BoE. Both are inflation targeters, so which one should react first to a possible spike in oil prices? What’s your answer?

(1) Neither. As FX appreciation and fiscal austerity pass through to domestic prices, the core will drag down the headline. If they hike, stagflation will result.

(2) The ECB, because it is the most hawkish of all central banks, in my view. The ECB mandates a rigid targeting scheme compared to that of the BoE. Since the January 2005, the BoE has successfully targeted inflation slightly under 2% just 27% of the time, while ECB has done so 61% of the time.

(3) The UK. The January 2011 UK inflation rate was 4% Y/Y (3.2% in November on a harmonized basis) and near-double that in the Eurozone, 2.4% according to the flash estimate.

Furthermore, the UK story is not one of just energy and food. The chart below illustrates the diffusion of price inflation across the components of the harmonized HICP (data at Eurostat), and the legend lists the period average for each economy. Diffusion levels above 50 indicate that a larger share of component prices are growing at an annual rate above 2% that below 2%. The diffusion a measure of the breadth of price pressures…

…and is UK inflation broad-based! In contrast, inflation in the Eurozone is focused in the commodity and energy space. Now, I’m not suggesting that the BoE hike – in fact I would recommend the opposite, or at least stay on hold – but I’m sure that the BoE has its vision acutely focused on developments in the Middle East.

If I had to choose an economy that would be derailed by the price spikes in the commodity space, it would be the UK. But I choose (1).

Rebecca Wilder

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Capital, Labor, and Modernization

Many years ago, I had a Cultural Anthropology professor who discussed the glories of the mechanical cherry-picker. The only catch was that (1) it had upfront and maintenance costs and (2) it performs less well than experienced cherry-pickers. In short, it would be useful if you have a shortage of labor and an excess of capital, but not—as is common in cherry-picking areas—the reverse.

Roy Mayall at The London Review of Books blog notes that the same type of conceit is being used by the Royal Mail:

Walk-sequencing machines sort the letters into the order that they are going to be delivered in. The old walk-sorting machines only organised the post into rounds: postal workers had to do the final sorting. Under the old system, all the post was in the delivery office by 7.15 and we were usually out on our rounds by 9.00. Under the new system, the last lorry arrives at 9.15 and sometimes we don’t get out until after 11.00. It’s quite normal for a postal worker to finish work at 3.30 these days, and for posties doing rural rounds still to be delivering letters as late as four in the afternoon. The machines also have a tendency to break down, as we’ve just discovered, so on some days no post is delivered at all. But they are central to the Royal Mail’s ‘modernisation’ programme. [italics mine]

And, as with newspaper deliveries in the United States, the emphasis on capital over labor has collateral costs to both:

The Royal Mail have scrapped all the bikes in Milton Keynes and replaced them with vans. Vans are obviously much more modern than bikes. They are also more expensive. Not only do they cost several thousand pounds to buy, they cost several hundred pounds a year to tax and insure….

Vans are also slower and less versatile than bikes. They are quicker along the road, but once on your round you have to get out and walk, pulling the post behind you on a trolley. It’s awkward. After a while it puts a strain on your back. And you can’t read the envelopes as you’re walking, which slows things down even more. Rounds that used to take three and a half hours to complete are now taking up to five. Whoever devised this method has obviously never delivered a letter in their life.

There’s a possibility that the shift to cars allows you to downsize labor. (It also means you cannot deliver the post without a driver’s licence.) But the cost of labor is virtually never the primary cost in a service industry, and it is unlikely to be cost-saving when you go from spending nothing on petrol to buying a commodity whose cost increased 9.9% in the past year, and which is currently running about 1.30 per litre. When your Fixed Cost of “0” becomes a Variable Cost much larger than zero, those “savings” disappear rather quickly.

As Mr. Mayall summarizes:

‘Modernising’ the Royal Mail means replacing a tried and tested method that’s been good for more than a hundred years with one that is more tiring, more polluting, slower and more expensive.

If the goal were optimal processing, he would be correct. If, instead, the idea is to exploit a difference in net pricing between capital and labor and leave the consequences and externalities to the future, then the Royal Mail becomes just a contemporary example of bad economic policies leading to poor social outcomes.

In that context, it’s not even especially noteworthy. Just ask, say, Jaime Dimon.

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Household leverage: what does the US have that the UK does not?

Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:

So generally, this simple analysis would suggest that Menzie Chinn’s skepticism of a “status quo” of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture – certainly for the Eurozone, but possibly for the global economy as well.

The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the “household”) as a share of personal disposable income.

In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).

Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.

The problem is: that according to the sectoral balances approach, it’s impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it’s not). Therefore, the £6.2billion in public “savings” may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.

The punchline: the US household has something that the UK household does not: (still) expansionary fiscal policy ($26 billion in state aid and extending unemployment benefits, for example).

Rebecca Wilder

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Household leverage: US vs. UK

Households in the US and the UK are members of the “most levered club”. But put their balance sheets side-by-side, and the outlook for the US economy looks a little brighter than that for the UK. Why? Both are dropping debt burden, but a qualitative analysis suggests that the UK household leverage (probably) should be falling at a more accelerated pace.

The chart illustrates leverage in the US and UK, or household debt (loans) as a percentage of disposable income (DPI) through Q3 2009 and Q2 2009, respectively (the UK releases Q3 Economic Accounts at the end of December). By Q2 2009, UK and US households dropped leverage rather coincidentally, -4.8% and -4.4%, respectively. However, the debt bubble was bigger in the UK than in the US, peaking at 160% of DPI compared to 131% in the US. Why isn’t leverage falling more quickly? Spending.

To be fair, UK Q3 statistics may paint a very different picture. However, that is unlikely, given that real retail sales continue to grow, 3.2% at an annualized rate in the three months ending in October.

Oh, it all makes sense now: UK retail sales remained firm in 2009, and real home values hit a (probably local rather than global) cyclical low much earlier than in the US.

This is an ominous sign for the UK economy. Households are kicking the can down the road: de-leveraging – paying down debt by dropping consumption and saving a relatively higher share of income – is inevitable.


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