By Mihir A. Desai
Friday, December 10, 2010;
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 U.S. 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 U.S. 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 U.S. 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.
The writer is a professor of finance at Harvard Business School.