Accounting Versus Economics, and Their Incentives

The uncertainly over tax increases has been moved out until 2012.  Individuals and companies get a two year reprieve.  Politicians get an election issue.   My bet is that America is not stupid enough to take the bait that rich people don’t pay enough.  Eventually maybe we will get a flat tax with no write offs.  That’s economic efficiency.

That water that is still in the well.  The real worry for 2011 is how did the delay of passing the extension of current tax policy (except for the unlucky folks that were snared by the “new and improved” estate tax) affected the behavior of companies.  No doubt, as the year wore on, Finance departments made accounting judgements that they normally wouldn’t have made.  They recognized revenue in 2010 that they might have wanted to recognize in 2011, and other out years.  Additionally, they may have recognized corresponding expenses to decrease their tax liability.  The risk that the Democrats would be inactive on taxes was too great.  Along with that, the outcome of the November election was a last quarter event.  Recall, earnings in the third quarter were pretty good.  How much did political behavior artificially skew company behavior?

Why is this important?

Companies that made the decision to recognize revenue early have to jump over a higher artificial revenue hurdle caused by the Democrats delay.  2011 revenues and expenses might confound analysts.  This will cause earnings fluctuations that are unexpected, adding volatility to the stock market.  Even if a company is actually doing pretty well economically, on paper the accounting numbers might not add up.

The actions of government have consequences.  In this case, Democrats delaying altered behavior-which might have aftershocks a year or two after they occurred.

Hope the new cadre of politicos keeps that in mind as they debate bills.

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