Tax Planning -- Spin & Sensibility
July 30th 2010 13:05
It’s one thing to make a bad decision, and another to make a stupid one. Unfortunately, in the interests of partisan politics, the Republicans are accusing some of the most astute business people of being illogical, when in fact their reasoning is beyond reproach even when it’s not quite clear what their reasoning is.
The United States has come out of a serious recession, sort of. The economy is growing, which meets the technical definition, and corporate profits have done well. ExxonMobile’s profits jumped 85%, and IBM, after taking a $500 million loss on changes in currency values, still showed a gain of 13%. Ford reported its highest quarterly profit in six years. In spite of this, unemployment remained high, as did long term unemployment. Corporations have not been hiring, and it has been estimated that the 500 largest non-financial firms have $1.8 trillion in cash. Google alone is reported to have cash reserves of $30 billion. The Republican position, as reported by the web site The Hill is to describe the impending expiration of the Bush tax cuts, which were originally enacted with an expiration date, as a tax increase. The party position is that extension of the tax cuts would stimulate job growth. This is fine political reasoning, but it’s questionable economics.
Most likely, the reason so many companies are sitting on high cash reserves is simply that they have no reason to spend it. This is what John Maynard Keynes called “the paradox of thrift” – when there’s an economic downturn, and the nation would benefit from increased spending, the normal, rational reaction is to hoard cash. The companies are showing high profits, but they still have unused capacity and so have no reason to expand or hire. They’re, quite rationally, waiting for somebody else to go first. If other companies start hiring, that will indicate an increase in the number of potential customers, and so it would make sense to gear up for more production – but as long as nobody else is hiring, why should they? Since the behavior applies to so many companies, and this is the simplest explanation, it’s probably the right one.
If corporate officers are really expecting taxes to increase next year, one rational option would be to stop sitting on the cash and issue a special dividend. The advantage to this is that for investors, those who have been holding the stock at least for a couple of months, the dividend would be taxed at 15%, while after the new year, the dividends would be taxed as ordinary income. Another option would be a stock buyback, but there are no major buybacks in the offing.
It’s also possible that the corporations are anticipating an increase in taxes in order to expand. This is completely rational. By delaying expansion and hiring until taxes are higher, investing profits in expansion and salaries reduces tax liability to a greater extent than when taxes are low. Meanwhile, sequestering current profits in cash accounts leaves the companies in a relatively strong cash position for the future. Historically, companies have been more inclined to expand during period of high taxes, because, in effect, the government is paying a greater share of the costs. The only objection to this theory is that there are 500 companies involved, and it just seems improbable that they’re all thinking the same way. Only the claim that they’re not spending because of concern about a possible increase in the tax rate, seems improbable.
Politics is what it is, and spinning the news is a fully appropriate strategy. Both parties do it, with varying degrees of credibility and success. In this case, we, and the CEOs and CFOs who have had a decade to plan for this, deserve better.
The United States has come out of a serious recession, sort of. The economy is growing, which meets the technical definition, and corporate profits have done well. ExxonMobile’s profits jumped 85%, and IBM, after taking a $500 million loss on changes in currency values, still showed a gain of 13%. Ford reported its highest quarterly profit in six years. In spite of this, unemployment remained high, as did long term unemployment. Corporations have not been hiring, and it has been estimated that the 500 largest non-financial firms have $1.8 trillion in cash. Google alone is reported to have cash reserves of $30 billion. The Republican position, as reported by the web site The Hill is to describe the impending expiration of the Bush tax cuts, which were originally enacted with an expiration date, as a tax increase. The party position is that extension of the tax cuts would stimulate job growth. This is fine political reasoning, but it’s questionable economics.
Most likely, the reason so many companies are sitting on high cash reserves is simply that they have no reason to spend it. This is what John Maynard Keynes called “the paradox of thrift” – when there’s an economic downturn, and the nation would benefit from increased spending, the normal, rational reaction is to hoard cash. The companies are showing high profits, but they still have unused capacity and so have no reason to expand or hire. They’re, quite rationally, waiting for somebody else to go first. If other companies start hiring, that will indicate an increase in the number of potential customers, and so it would make sense to gear up for more production – but as long as nobody else is hiring, why should they? Since the behavior applies to so many companies, and this is the simplest explanation, it’s probably the right one.
If corporate officers are really expecting taxes to increase next year, one rational option would be to stop sitting on the cash and issue a special dividend. The advantage to this is that for investors, those who have been holding the stock at least for a couple of months, the dividend would be taxed at 15%, while after the new year, the dividends would be taxed as ordinary income. Another option would be a stock buyback, but there are no major buybacks in the offing.
It’s also possible that the corporations are anticipating an increase in taxes in order to expand. This is completely rational. By delaying expansion and hiring until taxes are higher, investing profits in expansion and salaries reduces tax liability to a greater extent than when taxes are low. Meanwhile, sequestering current profits in cash accounts leaves the companies in a relatively strong cash position for the future. Historically, companies have been more inclined to expand during period of high taxes, because, in effect, the government is paying a greater share of the costs. The only objection to this theory is that there are 500 companies involved, and it just seems improbable that they’re all thinking the same way. Only the claim that they’re not spending because of concern about a possible increase in the tax rate, seems improbable.
Politics is what it is, and spinning the news is a fully appropriate strategy. Both parties do it, with varying degrees of credibility and success. In this case, we, and the CEOs and CFOs who have had a decade to plan for this, deserve better.
| 150 |
| Vote |
subscribe to this blog
