Whither the Consumer? Taxation Impacts

Over the past several quarters, much has been made over lackluster U.S. consumer spending. Excluding autos, retail sales growth has averaged 3.3% annually since 2012 but only 1.9% through late 2014. Over recent years, there have been sea changes in consumer behavior and store traffic trends, many of which are complicated and nuanced. Our focus is on understanding these trends and their implications for companies’ growth and profits.

Before we go any further, we believe the U.S. consumer is in a better position to spend this year. Our confidence reflects:

1. Recent non-farm employment numbers were near all-time highs
2. Home values have largely recovered to their pre-crisis highs
3. While volatility has been top of mind these past weeks, consumers have benefited from a five-and-a-half-year bull market
4. Consumer confidence, highly correlated to consumer spending, has been rising, steadily but choppily, since the 2009 bottom

So what gives? In a series of blog posts, I’ll be taking a look at the ranging influences shaping consumer activity and the implications for companies. In Part 1, I’ll focus on taxation.

Taxes Have Changed the Consumer Landscape
There’s a solid body of economic research that points to taxes as a primary driver of reduced consumer spending. Prior to 2010, the correlation between consumer spending and taxation was low or non-existent, but this relationship has become solidly inverse since 2010.

As the graphs below show, the decline in consumer spending is coincident with the new U.S. tax schedule. We believe the 460-basis point difference (from 35% to 39.6%) in the marginal tax rate for the upper-range of filers is having a real and measurable difference—$128 billion, in fact.

Decreased Spending Followed an Increase to the Top Marginal Tax Rate

Source: Piper Jaffray, “Multi-Brand Retail & Specialty Commerce: Conquer Mobile, Win the Consumer,” August 13, 2014, using data from Bureau of Labor Statistics Consumer Expenditure Survey and Piper Jaffray & Co. Research.

Taxes Have Taken a Toll on Retail Activity

Source: Piper Jaffray, “Multi-Brand Retail & Specialty Commerce: Conquer Mobile, Win the Consumer,” August 13, 2014, using data from Bureau of Labor Statistics Consumer Expenditure Survey and Piper Jaffray & Co. Research. TTM: Trailing 12 Month.

Lest readers believe the changes in tax rates only affect more affluent households, the increase in the Social Security portion of the payroll tax is two percentage points—from 4.2% to 6.2%. This affects everyone with a paycheck.

What does this mean for stocks of consumer companies? Few of us believe that higher taxation is a positive. While many companies will suffer from higher taxes, those that are secular growers may be better positioned to navigate the taxation headwind.

When consumers have less money to spend, a company must be that much more competitive in terms of its products, how it distributes them and how it engages with potential shoppers. We believe the stocks of companies with differentiated product offerings, brands that can be leveraged into new categories, and those that control their distribution will continue to win and are likely to be less hindered by the increased taxation burden on consumers. To wit, we believe we are now in a growth stock regime as we enter the late stage of the economic cycle (for more on this, see Global Co-CIO Gary Black’s recent posts).

While the reality is that there are many influences that are potentially impacting consumer spending, in my next post, I’ll focus on how the internet is transforming consumer activity and creating a new landscape for retailers.

Past performance is no guarantee of future results. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.