Why cut taxes?

[Uncle Ted]

On the corporate taxes... Apple would rather borrow billions rather than pay corporate taxes:

Apple borrowing billions while sitting on huge overseas cash pile

Apple has fat stacks of cash stashed overseas, but that hasn’t stopped the company from borrowing billions to give money back to shareholders.


Why borrow when sitting on $240 billion in cash?


“One five-letter word: taxes,” said Steven Rosenthal, a senior fellow at the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution. Apple has $240 billion in cash held overseas, out of total cash reserves of $256.8 billion, according to Securities and Exchange Commission filings.


So far in 2017, the Cupertino tech giant has issued unsecured notes three times: on May 5 for $7 billion; on Feb. 15 for $1 billion; and on Feb. 3 for $10 billion, according to company filings with the SEC, for a total of $18 billion.


The money, in all three cases, would be used for “general corporate purposes, including repurchases of our common stock and payment of dividends under our program to return capital to shareholders, funding for working capital, capital expenditures, acquisitions and repayment of debt,” Apple said in its filings.


That borrowing followed $23.9 billion in unsecured debt raised last year.
[...]
Apple’s borrowing this year carries interest rates of 1.6 to 4.3 percent, a fraction of the cost of repatriating hoarded funds.


Apple appears to be waiting on a one-time tax holiday widely expected from Congress, which would let companies bring overseas money home at a far lower rate than 35 percent, Rosenthal said.


“They’re betting that they’ll get tax relief in the near term, and rather than incur the expense of repatriating their offshore earnings, they’d like to defer and hope for another holiday,” he said.
[...]

http://www.mercurynews.com/2017/05/0...eas-cash-pile/

[pelagius]

What do you believe if the lowering of the corporate rate were tied to reinvestment in certain sectors or a requirement for employment in the US? Would that increase the probability of some success? I haven't refined how to make the ties but hopefully you get the idea.

In general, I think doing that is a bad idea because it would likely force companies to invest in negative NPV projects (you likely haven't lowered the cost of capital or you wouldn't have to make the reinvestment mandatory). These distortions in investment can lead to big costs of adjustment in the long run.

[old_gregg]

On the corporate taxes... Apple would rather borrow billions rather than pay corporate taxes:


http://www.mercurynews.com/2017/05/0...eas-cash-pile/

unless repatriation is tax free, the usfg ain’t going to beat the real cost to apple of debt

[cowboy]

That said, one mechanism I think is plausible is something like the following: Lowering the corporate tax rate shifts the optimal capital structure for most firms to a smaller leverage ratio (less debt). This would be a prediction of capital structure models that highlight the trade-off between the tax advantage of debt over equity and the costs of financial distress as first order effects on capital structure (we teach basic forms of these models to MBAs). They are not as strongly supported by the data as one would like, but there's probably something to them. If optimal capital structure shifts to less debt -> lower probability of default -> less employment disruption and layoff -> higher real wages. I doubt this is a very big effect, but channels like this and a few other could lead to some positive effect with respect to wages and employment.

I've thought about this post for several days. I think what you are saying is that it would be good to structure tax laws to provide incentives for companies to borrow less, thereby making them more stable and making layoffs less likely. I don't think I agree.

First, reducing debt would have a huge braking effect on the economy. The fed uses interest rates to encourage or discourage borrowing as a way to speed up or slow down economic growth and inflation, so a widespread deleveraging would be equivalent to an enormous interest rate increase. The end result would be a massive economic slowdown. This actually brings up another point, which is the ability of the Fed to regulate economic growth if we change incentives to borrow. They could still use interest rates, but there would be a painful learning curve to adjust to new borrowing habits.

Second, reducing risk by reducing leverage would also imply reduced returns. Greater risk requires higher returns, so an economy full of de-levered businesses would presumably grow slower due to the lower returns these businesses are realizing as they assume less debt.

Maybe I'm thinking about this wrong, so please tell me what I'm missing. In a broader sense, the question is really about who allocates capital more effectively. Money saved from tax cuts doesn't disappear. It is spent on either consumption or investment. Thus , when considering who to tax and who to give a tax break to, the question is more than one of fairness. It's also one of who will spend money that would otherwise be taxed in a way that has the greatest turnover and grows the economy the most

[pelagius]

Maybe I'm thinking about this wrong, so please tell me what I'm missing.

Sorry, you are. Riskiness of an economy's real assets (the projects firms invest in) determines the overall risk in the economy. firm level investment (e.g., investing in new banana stands) -> creates assets and determines risk level. Financing (mix of debt/equity) simply splits the risk between different claim holders. The preceding is basically the core theorem of corporate financial economics. All your points hinge on that not being true. I don't mean this to be harsh. I hope it doesn't come across that way.

[old_gregg]

miller modigliani dawg

[pelagius]

miller modigliani dawg

Yeah, MM was the first to really show it, and it's usually thought of as part of MM but it holds much more generally (as opposed to capital structure irrelevance which only holds given a set of very restrictive assumptions).

[BlueK]

The Senate version appears to be less rough on the middle class in general, than the House version.

[BlueK]

One disturbing issue with the tax "reform" ideas is the plausible theory that it's the super-rich donors of Republicans in Congress who are really driving this: give us a massive tax cut or we stop giving you money! I don't care what you have to do to soak the middle class to get it done!

[wuapinmon]

Sorry, you are. Riskiness of an economy's real assets (the projects firms invest in) determines the overall risk in the economy. firm level investment (e.g., investing in new banana stands) -> creates assets and determines risk level. Financing (mix of debt/equity) simply splits the risk between different claim holders. The preceding is basically the core theorem of corporate financial economics. All your points hinge on that not being true. I don't mean this to be harsh. I hope it doesn't come across that way.

I'm interested in how a multi-national like Apple, with more cash on hand than many national economies, employs that capital. From what I understand, they aren't investing in new banana stands as much as they are derivatives. If we cut taxes and they repatriate the funds they've been pooling....the borrowing to pay dividends to shareholders will likely cease, as they won't have the incentive to hold back anymore...so what then? Will Apple's stock become a dividend king and that money flow into shareholders' pockets and the economy? That'd be great, but it seems unlikely to me (I'm becoming a bitter skeptic instead of an optimistic skeptic). Apple is basically a tech company and a financial management company now...probably getting up there in size with the 2big2fail banks in terms of assets under management, only all the assets are theirs.

I like low corporate taxes, but where's the incentive now to take big risks? Are low taxes a guarantee of bigger risk taking? Do we really expect Apple, to build more banana stands, or, if they do, will they build more banana stands in the USA?

I wish this tax cut had some mechanism to encourage--but not compel--investment in domestic entrepreneurship, research, development, urban/rural renewal, employment, and education. Also, importantly, corporate conservation and land stewardship--good stewardship, should be rewarded with tax breaks. If we want to protect the environment from over-development, the only way to get the GOP on-board is to incentivize conservation, maybe some kind of tax amortization scheme against the developed value/capitalization vs. the undeveloped value, probably something the economists should figure out.

[Bo Diddley]

One disturbing issue with the tax "reform" ideas is the plausible theory that it's the super-rich donors of Republicans in Congress who are really driving this: give us a massive tax cut or we stop giving you money! I don't care what you have to do to soak the middle class to get it done!

That makes no sense--stop giving them money so the democrats can win and raise their taxes?

[cowboy]

miller modigliani dawg

You are right to bust me on this. I mean this as a compliment when I say your posts in this thread indicate that you clearly have more knowledge than you're drive-by posting style suggests. I would be interested in knowing the reasons behind your opinions more often.

Sorry, you are. Riskiness of an economy's real assets (the projects firms invest in) determines the overall risk in the economy. firm level investment (e.g., investing in new banana stands) -> creates assets and determines risk level. Financing (mix of debt/equity) simply splits the risk between different claim holders. The preceding is basically the core theorem of corporate financial economics. All your points hinge on that not being true. I don't mean this to be harsh. I hope it doesn't come across that way.

Maybe old gregg is right and I am dumb. I read your post wrong, and should have spent more time reading and less time thinking. I was reading while driving across Oklahoma, saw you agreeing with og about the lack of empirical evidence that tax cuts help the economy, and then the last part about less debt being a stabilizing factor and assumed you were against tax cuts and instead in favor of eliminating deductions for mortgage interest as a way to encourage less borrowing. Doing that would seem to result in all betas being essentially unlevered, hence the risk discussion. I know, dumb. Please don't tell Hal Heaton.

But I will argue that all my points did not hinge on the cost of capital. My primary concerns were with money supply. It may not be relevant to the discussion, but that's never stopped us on this board so I'll ask my questions and maybe you can help me. First off, is a money supply question: If debt is reduced in the economy, would that decrease money supply and have a deflationary effect? I'm trying to wrap my brain around the interaction between capital allocation vs the multiplying effect that borrowing and lending the same dollar has on supply. Second is a debt market question: Given that the Fed uses interest rates to control money supply, if reducing leverage reduces the money supply is there any way that tax rates would impact aggregate debt without the Fed stepping in and making debt more attractive to maintain debt levels?

[cowboy]

One disturbing issue with the tax "reform" ideas is the plausible theory that it's the super-rich donors of Republicans in Congress who are really driving this: give us a massive tax cut or we stop giving you money! I don't care what you have to do to soak the middle class to get it done!

This is an area where Democrats have won the spin game. They have as much big money behind them, and as many rich donors, as Republicans. I haven't researched the site, but assuming their information is correct, here are the breakdowns of donor demographics.

[pelagius]

I'm interested in how a multi-national like Apple, with more cash on hand than many national economies, employs that capital. From what I understand, they aren't investing in new banana stands as much as they are derivatives. If we cut taxes and they repatriate the funds they've been pooling....the borrowing to pay dividends to shareholders will likely cease, as they won't have the incentive to hold back anymore...so what then? Will Apple's stock become a dividend king and that money flow into shareholders' pockets and the economy? That'd be great, but it seems unlikely to me (I'm becoming a bitter skeptic instead of an optimistic skeptic). Apple is basically a tech company and a financial management company now...probably getting up there in size with the 2big2fail banks in terms of assets under management, only all the assets are theirs.

Probably way too much here for me to try to answer in a helpful way, but I will try do say something useful. Apple does hold onto a lot of cash. As you note, it's not really cash. I don't think it's primarily derivatives. I believe they end up investing a lot in corporate bonds with the money (I think primarily US corp bonds too). It's on odd equilibrium (as you note). On the hand, it is leading to investment; it's just not Apple directly investing in banana stands. They are buying the bonds of companies that want to invest in banana stands.

Could the corp tax cut (or more likely repatriation) change that? Yes, at least a little (maybe only a little); it should lead to more disbursement of money directly to claim holders. Would this have a big effect on overall investment in the economy? I think there could be some benefit, but I tend to think it's small. The marginal propensity to invest in real assets or the efficiency at which that happens could increase (apple's incentives are leading to distortions). That said, I tend to think it's a smallish effect because Apple is mostly already investing it back into the economy.

I like low corporate taxes, but where's the incentive now to take big risks? Are low taxes a guarantee of bigger risk taking? Do we really expect Apple, to build more banana stands, or, if they do, will they build more banana stands in the USA?

So lower corporate taxes should provide some incentive to increase investment. If you want to build a banana stand, you might not pull the trigger because your projected average rate of return is lower than the cost of capital (which is determined by the risk of project). In other words, the project is slightly negative NPV. Lower corp taxes will increase the average rate of return some. Future cash flows get bigger because less go to the government. That could shift your project from negative to positive NPV (but likely only for projects that were slightly negative NPV).

On the other hand, it's an expensive approach to get this incentive because you are also lowering taxes on current cash flows where real investments have already been made. It would be more bang for the tax cut buck to do a more targeted approach. For example, you can accelerate depreciation schedules (I believe the gop plan does this but the provision only lasts a few years). That gives you bigger tax shields earlier in the life of a project which helps given time value of money. It also wouldn't reward past investment.

[Moliere]

I feel like I’m in some melange of Dr Kearl and Dr Pinegars classes, which is a good thing.


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