Recent tax deal-making has relied on conventional instruments of fiscal stimulus. Yet, we live in unconventional times, and more novel approaches suited to the peculiarities of our current economy are required. In particular, the remarkable cash hoards that American corporations have amassed have been a saving grace in ensuring that the financial crisis did not cause further damage to the economy. With traditional monetary and fiscal policy instruments seemingly exhausted, the mobilization of that cash hoard can prove critical to reviving the economy.
The historically exceptional cash holdings--estimates of the amount held by US public corporations easily exceed $1 trillion; several technology companies alone are sitting on cash balances in excess of $20 billion--are thought to result from the absence of investment opportunities or from indecision among corporate executives. Once such indecision becomes widespread, it can quickly become self-reinforcing. Recent record corporate profits will only exacerbate this situation. If chief executives and chief financial officers are goaded into spending that cash, the economy could benefit from a significant stimulus that, unlike stimulus measures relating to government spending, would stem from decentralized actors responding to private information and incentives.
Consider the potential effects of a temporary 2 percent tax on corporations' "excess" cash holdings. With the returns on their cash holdings approximating zero, managers would have to explain to their investors why earning a negative 2 percent return would make sense as opposed to either investing or disgorging that cash to shareholders.
The definition of "excess cash holdings" will be critical. But such levels easily could be defined relative to industry benchmarks from periods that featured more standard corporate savings behavior. Alternatively, a measure of accumulated nondistributed earnings could also serve as the basis for the tax. Accumulated earnings taxes have been used in the past, although sparingly, with particular reference to individuals who incorporate for business purposes.
Implementing such a tax would require measures to prevent some unintended consequences. A large fraction of corporations' excess cash--as much as two-thirds, according to some estimates--is held outside of the United States to avoid the "repatriation taxes" that occur under the US system of worldwide taxation. Simply put, multinational firms currently have an incentive to keep money abroad.
A temporary holiday of the repatriation tax coupled with the tax on excess cash holdings could help ensure that the disgorged cash would be used productively in the United States. A previous repatriation tax holiday in 2004 induced the return of more than $300 billion to this country, and commentators across the political spectrum, including Andy Stern, formerly of the Service Employees International Union, have already begun to call for another repatriation tax holiday.
Coupling these policies provides a carrot and stick for managers to begin to repatriate cash and use it productively at home. The combined revenue effects is likely to be relatively small, given how little revenue is currently collected on unrepatriated earnings and how sensitive corporations are likely to be to facing a negative rate of return on their cash holdings. But the goal would be more to trigger behavior that feeds that economy rather than raising revenue for the government.
Ideally, firms would invest their excess cash funds in new projects in the United States. President Obama's proposal to allow for immediate expensing of investments could help ensure that firms were tilted toward spending that excess cash on new projects within the United States. A reduction in the corporate tax rate that would bring the US rate in line with worldwide norms would also help enormously in directing these cash hoards toward investment. But even cash disgorged through dividends, share repurchases or mergers would have a potentially stimulative effect compared with corporations banking the funds.
It is tempting to pin hopes of an economic recovery on a centralized effort or another significant program by the Federal Reserve. But a remarkably large pool of unmobilized capital is sitting within our firms and managers appear frozen in their decision-making. A gentle nudge to break this coordination failure--through the combination of the fiscal carrot and stick described above--could shake managers out of their indecision and provide a privately-directed, revenue-neutral stimulus that could eclipse the effects of any potential stimulus that could emerge from Washington today.
This article originally appeared in The Washington Post on December 10, 2010.
- Anonymous
Typical Orwellian solution from the ivory towers of academia. The very idea of government (or universities, for that matter) determining what constitutes "excess cash holdings" in order to tax that money is nothing short of imbecilic. To begin with, these august entities anointed with this power are, by their own abysmal records, arguably the worst choices for making any judgment as to prudent fiscal policy. Add to that the glaring conflict of interest inherent in the fact that government (and the universities who rely on money distributed from government seizures) would directly benefit from these "repatriation taxes", and any sensible person can recognize the true motives of such a transparently abusive scheme or pity the staggering naiveté of its proponents who might actually see any productive - or even benign - outcomes from its implementation.- Jim Briggs
- Managing Director, Freestone Partners, LLC
Desai's recommendation of a 2% tax on corporations' "excess" cash is a classic example of government overreach. Does Mr. Desai really think that: 1) corporations are asleep at the switch, not looking for investment opportunities; and 2) companies will make dumb investment decisions to avoid a 2% tax?The liberal prescription is consistent: If we get enough smart people together in Washington and give them vast authority to regulate, tax and spend, they can solve any problem facing the nation.
Here's another approach: Reduce the size and cost of government at all levels in the U.S., lower the tax and regulatory impediments to doing business in this country, and watch companies invest, make money and create jobs.
- Suresh Masand
- Retired
Now this is innovative thinking.- Anonymous
Respectfully, I think your premise is incorrect. Government is playing a larger part in the problem. Businesses need certainty, especially around taxation. The current Bush-level tax rates for individuals, which LLCs members (small business owners) are taxed, is temporarily extended for 2 more years. It is difficult to make capital decisions when tax rates are uncertain.Additionally, there is considerable uncertainty around carbon taxation, health care implementation, and other potential government mandates that are preferred by the Obama administration and the Democrats.
Instead of new taxes, the government needs to control is grotesque levels of spending.
Aside reducing spending and creating a streamlined, efficient, and transparent tax regime, the government needs to reduce its role in commerce. In short, get out of the way.
Finally, I would recommend reading Ludwig von Mises's book, "Human Action." Mises is right, Keynes is wrong.
Merry Christmas!
- Kit
- adjunct, UConn
FDR tried this during the great depression. It was a miserable failure!- Jackie Bugnion
- Director, American Citizens Abroad
Professor Desai has provided an innovative approach. I would go further. In a tax reform package, why not simply adopt residency-based taxation for U.S. corportions while simultaneously eliminating any potential tax liabity on repatriaton of cash from past earnings abroad, lower U.S. corporate tax rates while eliminating all of the special credits to specific industries. This is in fact what the Bowles-Simpson commission has recommended. Coupled with a temporary, and I emphasize temporary, 2% tax on excessive cash reserves may provide a real jump-start to the economy.- Joydeb Chatterjee
- Sr General Manager F &A, Haldia Petrochemicals Ltd
While the suggestions made by Prof Desai are indeed novel, it may tantamount to taxing corporate earnings twice, since taxes would already have been paid when the cash (we presume that the cash balance has arisen out of the operating earnings ) accrued to the company . This may be challenged in the courts of law. As a way out, Government may think of a deferred tax credit to companies who are subjected to such cash holding tax .- J.J. Smith
- Owner, Judson Smith and Associates
Repatriation of cash from overseas with no tax consequences - great idea. There should be no barriers to the free flow of capital to legitimate enterprises.As to taxing so called "excess cash" it would be self defeating following the professor's reasoning. Less cash in the banks, less cash to lend, resulting in, higher interest rates putting a drag on bank financing and increasing interest costs to corporations.
- Kevin O'Meara
- Director, HBS GMP class of '08
Mihir offers a very innovative solution and I agree that companies today struggle with doing something with the money they have accumulated. I also agree that the only way to spur this economy is to either 1) have the Government spend it or 2) have the private industry spend it. Right now, the first is being done but, as the voters showed in November, it will not continue.However, I do question the efficacy of taxing money which is essentially sitting in the bank. Therefore, I have an alternative:
The Government should combine two efforts. First, give the repatriation holiday. That makes a lot of sense. However, rather than tax money on the balance sheets of companies, the Government should offer a two year "holiday" on dividend taxation. If money was not taxed when paid as dividends two things would happen:
1) The shareholders would DEMAND payment or reinvestment. They would never let it just sit there. Since there is no cost to paying it out, if the company did not reinvest they would be forced, by shareholders, to pay it out. This would have the effect of increasing wealth, increasing money in circulation and the demand side would kick in.
2) It would stop the crazy attempt to artificially inflate stock prices by companies buying back their own stock with my money (my being the investor). It would allow me, the investor, to decide what to do with the excess cash.
Finally, for the few rude people who feel a need to insult people on the internet I can tell you, having taken Mihir's classes, he is one of the smartest people in the world. I am sure he would make most look "sick" in a true debate on anything financial. He is a fantastic finance professor, teacher and thought leader.