Why cut taxes?

[frank ryan]

Republicans can stop pretending they care about the deficit.

[Uncle Ted]

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[BlueK]

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

Ok, or fund a primary challenge. Since most of them live in gerrymandered districts, that's really what they're scared of.

[pelagius]

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.



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?

You deserve a better response but short on time (I'll try to come back to it). My very short answer is I agree with you that changes in the money multiplier represents a possible channel but I think it second order at best in the short run (and no effect in the long run). Additionally, I really wasn't suggesting the shift towards less debt by corps would be very big. Debt probably still remains tax advantaged overall, and it still helps mitigate some agency costs. Plus these changes only apply to corp debt.

[wuapinmon]

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.



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.

Thanks for the quality, educational reply.

[Lost Student]

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


Sent from my iPhone using Tapatalk

Dr. Kearl's (is that really how you spell his name?) was one of my favorite undergrad classes.

[Moliere]

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


Sent from my iPhone using Tapatalk

[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.

[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.

[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?

[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?

[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.

[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!

[BlueK]

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

[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).