November 18, 2017 dan@danherman.ca

Corporate cash – a public affair?

A growing debate has sprung in Canada relating to the growing pile of cash held by Canadian corporations. Investing that cash into employment or productive capital would, says one school, stimulate the economy and aggregate demand, leading to a virtuous cycle of growth. The list of commentators on the issue has grown to include Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty and has created a stark divide between those whose who see corporations as independent entities acting in their best interests versus those who see those very corporations as failing to properly compensate the societies they are embedded in.

Fundamentally it’s hard to disagree with those, like Carney, who have pointed out that large cash balances are a potentially massive stimulus to the economy. And he’s far from the first. Two years ago I attended a speech by FT columnist Martin Wolf at the International Economic Forum for the America’s where he stated that the solution to the US demand crisis was either increased corporate spending or the repatriation of corporate cash through increased taxation.  He too viewed them as a potential means of unlocking demand.  As he walked back to the head table someone (I think a Minister from a Caribbean country) called him irresponsible!

Yet regardless of one’s ideological position on the issue, there’s no easy fix to intervening in the bank accounts of corporations. The reason corporations hold cash is to prepare for unforeseen events, potential acquisitions, and future investments. They don’t (from my knowledge) do it to screw over the unemployed or the societies they’re located in.

Nonetheless, out of curiosity I decided to take a look at the case of one of Canada’s biggest cash hoarders : Power Financial Corporation which holds over $3 billion in cash (and little debt).

For the year ended Dec 31, 2011, Power Corporation made a profit (before taxes) of $3.61 billion. On that profit, they paid $706 million in corporate income taxes. This translates to an effective taxation rate of 19.5%. Let’s say that, as some such as Jim Stanford of the CAW have proposed, we were to claw back corporate income tax cuts on the basis of some definition of “holding too much cash.” If this clawback were based on the most recent tax cut, which is done (in theory) to incent investment, Power would return the 2011 tax cut (1.5% at the Federal Level) to the CRA. For 2011, the return of the 1.5% tax cut would equate to $52 million.

Now $52 million would certainly pave a lot of roads or perhaps purchase the left wing of an F35 jet. Looking more broadly than just Power Corp, Canadian corporations on a whole took home a profit (before taxes) of $207 billion in 2011. Applying the same marginal tax rate that Power Corp pays to this bigger grouping shows a tax bill of approximately $40.6 billion. Revising/clawing back the most recent corporate tax cut of 1.5% would raise an aggregate $3 billion. This represents a significant stimulus cheque.

Yet what are the drawbacks of threatening to re-tax corporations if tax cuts aren’t spent (as Stanford proposes)? Might such a threat simply incent inefficient spending, rash investment decisions, and possibly catalyze the leakage of dollars beyond our borders. For what if Power Corp decided that rather than lose $52 million off the balance sheet they’d rather invest in real estate in the United States or Mexico? Do Canadian tax payers win? Possibly thanks to profits from those investments but certainly not in the immediate employment and investment gains that those on the Left envision.  And what if instead of that acquisition they would have rather to amass a war chest for a large domestic investment in three years hence that led to increased productivity or employment?

Corporate investment decisions don’t get made along the calendar year that our taxes get paid to the CRA and by treating them as such we risk creating long-term net negatives for the Canadian economy.

That said, the fact that rising corporate profits have not coincided with increased employment or investment (though this is debatable) should give us pause as to the merits of continued tax cuts. As I wrote back in early 2011, while there is evidence (substantial) that moving from a high tax regime to a globally competitive one yields significant employment and investment benefits, we have no proof that continued cuts will yield the same benefit.

Rather if we’re going to provide tax credits and incentives to corporations, a near-necessity in a global economy where municipalities through to Federal governments are falling over themselves to provide incentives for job creation and retention, than we need to find a way to incent growth and employment rather than allowing simply for growing profits. However in so doing we need to acknowledge that investment decisions don’t get made on a clock, and that clawing them back when not spent is not an effective solution. Rather, if we’re confident that our tax regime is already competitive (as it is) than additional incentives should come after the fact rather than before (as many our boutique tax credits for new industry are already structured). Doing so would ensure that government intervention in the affairs of corporate balance sheets don’t distort the decision-making of private actors, but rather support the strategic investment decisions by private actors that lead to job creation that everyone, left or right, desperately wants.

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Showing 5 comments

  • Ian Crookshank
    Reply

    Interesting commentary Dan. This issue interests me as it has led some who would usually comment on the side of the free market/ purely capitalist economy to question the “hoarding” of cash. That being said, maybe some of these corporate entities are holding onto cash in preparation for its decreased value in the future. In fifty years the going rate for a small 3 bedroom home in Riverdale should be about $3 billion…sarcasm aside. You make a great point about investments not occurring on a clock or calendar and that an annual clawback might actually effectively defeat the very investments it is supposed to encourage.

  • Peter Griffiths
    Reply

    Dan, just a quick thought/FYI from the accountancy school which you probably know. If a corporation makes an investment, most typically a capital expenditure the financial impact of this won’t show up in the corporation’s profits, it’s pretty much a balance sheet transaction, in which the corporate has exchanged their cash for the asset into which they’ve invested (the labour etc. which goes into developing this asset is generally capitalised too). A lot of capital expenditure receives capital allowances at certain % which enables the capex to be deducted from a company’s taxable profits. Amending capital allowance %s to encourage the type of investment that you’re keen on should be a classic way of govt encouraging certain types of investment over others.

    If you look at ratios in a corporates balance sheet such as fixed assets/current assets – you’ll get a feel for its sentiment about the future.

    And don’t forget the other option that corporates have for their cash, if they’ve got no productive place into which to invest it they should pay it out as a dividend to their shareholders, who will be more objective in finding a productive place to invest it, or alternatively spend it.

    • Dan Herman
      Reply

      Hey Pete, good to hear from you. Yes, capital allowances and depreciation are another way of encouraging investment, and common across both federal and provincial tax regimes in Canada. The current debate, however, has been framed around our basic corporate tax rates, and recent reductions to it, versus the actual effects of those cuts. As for dividends, I’d be happiest if they gave me cash, but as one bank analyst recently noted, 85% of cash payouts get reinvested in stock, thus leaving only minimal input into demand. Have you taken over for Cameron yet?

      • Peter Griffiths
        Reply

        Sure understood Dan, specific tax allowances vs flat rate cuts is probably a different debate. But what it’s implying is that you want the government to have the “spare cash” and to spend it rather than the firms?

        I think I agree but firms can probably make more productive investments than government if incentivised properly – hence my love of capital allowances!

        But agreed firms in Canada and the UK are hoarding cash because of their negative macro sentiment. If they acted collectively their actions would improve the macro environment, but its not in firms make up to take action for the macro and that’s why you have government.

        It’s the same issue as the analogy they use in the UK to explain deficit reduction to the man in the street – that it’s about a household not spending more than it brings in. How does Krugman have any hair left?

        Lastly of those 85% of dividends reinvested, if the reinvestment isn’t going into the same stock(s) i.e. mature low growth [rent seekers] like the one you used in your example and were instead going into start-ups, in green tech or whatever we’d also get some of the investment boost that you’re looking for.

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