Costco's Costly Contradiction

I love to shop at Costco despite the fact that the company's two principal founders, Jeffrey Brotman and Jim Sinegal, and I would probably agree on very little when it comes to politics.  I guess you would call me a little more sensible and reasonable than the nasty liberal politicians who tried to demonize Chick-fil-A because Dan Cathy, CFA's President, espoused his personal view that he was not in favor of gay marriage.

Brotman and Sinegal are staunch Democrats both of whom hosted $35,800 per couple fundraisers for Barack Obama during the recent campaign.  Sinegal also got a prime time spot to give a speech at the Democratic National Convention in support of Obama.

All of this is interesting in light of the news this week that Costco has declared a $7 per share special one-time dividend to its shareholders before the end of the year.  That's about $3 billion that the company will distribute to shareholders at the current 15% tax rate.  Of course, for shareholders like Brotman and Sinegal, the tax rate on dividends is scheduled to increase to 39.6% in 2013 if Barack Obama has his way.  On top of that, wealthly individuals like Brotman and Sinegal will also pay an additional 3.8% Obamacare tax on dividends received beginning January 1.

To put this in perspective, the regular quarterly dividend for Costco is currently set at 27.5 cents per share.  That's $1.10 per year.  Therefore, this special dividend is paying out what normally would be paid out over the next six years or so.  In effect, Costco is pulling dividends from future years to the current year.  You will see how they are doing that below.

It is difficult to understand that if people like Brotman and Sinegal think it is such great public policy to increase taxes in order to spread the wealth around why don't they think it is a great idea when it comes to their money? 

Why are they going to all of the extra trouble to declare this special dividend to avoid a little tax that could do so much good in the hands of the federal government?

It almost sounds as if they are greedy and unpatriotic. It seems that I have heard those terms thrown around once or twice before from Barack Obama's supporters.

By the way, Jim Sinegal is Costco's largest single individual shareholder with 2 million shares.  What is particularly interesting is that Costco is using the proceeds of a $3.5 billion debt offering to pay the special dividend.  That's right, Costco is going into debt to raise the cash to pay the dividend.  In effect, they are borrowing today against the future.  Now I understand why Brotman and Sinegal like Obama and the Democrats so much.  They have a similar view.  Borrow as much as you can now so you can  enjoy yourself today and pay for it later.  Costco should also send a nice thank you note to Ben Bernanke and the Federal Reserve for the low interest rates that also make that borrowing so attractive.

What is the benefit to Sinegal cost to the federal government of this planning scheme?  Mr. Sinegal The Treasury will save will lose about $4 million in taxes that would otherwise be owed by Sinegal.  In addition, since Costco has loaded itself up with $3.5 billion in debt, it will pay substantially lower corporate taxes in future years than it othewise would have because of the deduction of interest expense on that debt. This will further reduce future revenues to the U.S. Treasury.  Isn't this all working out just great?

Costco is not the only company declaring special dividends prior to year-end.  The Wall Street Journal had a recent op-ed that calls this "The Great 2012 Cashout".  The WSJ reports that as of November 28, 173 companies had already announced special dividends.  I would expect to see many more before year-end. It literally is unprecented in a couple of ways according to the Journal.

"I find no precedent like this (special dividends) at all going all the way back to the 1950's", Howard Silverblatt of S&P Dow Jones Indices told the Journal.  Then again, there is no precedent for the Obama Presidency.

I realized a long time ago that people usually will behave according to their self-interest.  Therefore, your best chance of altering behavior is by altering incentives so that they align with self-interest. 

Capitalism works because it recognizes that human beings are motivated primarily by self-interest.  In a capitalist system the incentives are aligned so that talented people are willing to be inspired and perspire for their own success and self-interest.   A critical element in this alignment is for government to respect and protect the right to aquire and possess private property so that self-interest and ambition (yes, even greed at times) can counter-balance other strong natural human traits such as laziness and a desire to get something for nothing.  History has shown that the results from capitalism provide the greatest benefits for the society as a whole.

Collectivism and socialism are great economic and political theories in a textbook.  However, the idealism of all for one and one for all breaks down when the theory meets the realities of human behavior.  The self-interest that controls in a socialist society is getting the largest share of the collective effort as possible with the least amount of individual effort.  Why put forth significant effort if everyone gets the same result?  It almost becomes a race for the bottom rather than a race for the top.  This inevitably leads to contempt and conflict and a dearth of overall benefits for the society as a whole. 

Costco and its owners are merely doing what is in their self-interest in paying this special dividend.  I get it.  What I don't get is how Jeff Brotman and Jim Sinegal cannot see how they expect the economy and country to prosper by supporting the liberal, progressive (and anti-capitalist) views of Barack Obama and the Democrats when their own actions say exactly the opposite.

Of course this is not new.  It is pretty common for liberals to say one thing and do another.  Peter Schweizer wrote an excellent book a few years ago "Do As I Say (Not As I Do): Profiles in Liberal Hypocrisy, that takes you through example after example of how liberal luminaries such as Michael Moore, Nancy Pelosi, Al Franken and Barbra Streisand want you to do one thing while they do another.  It all leads to a simple question that Schweizer poses in the book-"if these liberals ideas don't work for the very individuals who promote them, how can they work for the rest of us?"

Jeff Brotman, Jim Sinegal and the Costco dividend are just another example of why it does not work.

I will continue to shop at Costco. Why?  Self-interest.  I like their stuff and their prices.  What other reason is there?