Wednesday, April 26, 2017

Business Investment Spurred by Tax Cuts?

Either the investment makes sense or it doesn't. Either it--whatever it is be it an acquisition or product/service expansion, reinvestment in factories, etc.--returns more than other possible uses for the cash or it doesn't. Right now corporations are sitting on an ever-growing pile of cash. Granted, 5 firms, such as Google, account for nearly a third of all corporate cash but corporations have been 'hoarding' cash for over a decade. Even before the 2007-2008 financial crisis. Cash reserves have been said to be at a record $1.9 trillion as of last year--which is the amount of cash not needed to maintain current operations.
Source: St. Louis Federal Reserve Bank, Compucast

Why? There are a lot of theories, but one aspect is that there isn't anything else they can do with the cash that isn't a potential loss. So they leave the cash in places that earn "no" interest. Some have been using it to buy back their own stocks--to inflate their share price, make stockholders happy and improve their executive share-price-based bonuses. Otherwise, it hasn't been used to acquire more companies or develop new capacities, capabilities or technology at a rate that's stimulating the economy past 1-2%.

Some politicos and economic think-tanks like proposing a reduction in corporate tax to spur economic growth. My question: how will a tax cut do this? The immediate need for more cash to invest in new products or services, build more stores or factories isn't there. A tax cut reduces the burden on new opportunities and the level at which it breaks even. But the current 'savings' rate is near zero. It's not a very high threshold for any business-related investment to exceed. If the new opportunity could return 5%, even with a max corporate tax rate of 39%, it still returns more than what the cash is doing just sitting parked in a bank. (Of course the average effective tax rate for corporations, after all the credits and other deductions occur, has been below 13% according to the GAO.)

Instead of a tax cut, maybe the US Government could provide an investment stop-loss insurance policy for corporations' economic investments (and buying stocks doesn't qualify). Maybe then corporations will take the risk on new ventures that could create jobs within their organization or within the supply chain.

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