A vast mass of U.S. corporate cash sits overseas, awaiting a tax cut that could bring it back to American shores. President Donald Trump wants to lure the cash to spur job creation. Trouble is, the money is unlikely to make that happen.
Why? The largest holders of foreign-based cash are tech titans, and they don’t use as much of their money on capital spending as other industries do. That spending goes for such things as plants, equipment, research -- and, presumably, more jobs.
Plus, many company executives (and not just in tech) think extra capital expenditures, a.k.a. capex, won’t boost their profits amid slow economic growth. Should they want to spend it on something, it would be to buy another company. Often, they would rather look like heroes and award the money to investors in the form of stock buybacks and fatter dividend payments.
The timing of getting this cash back is tricky, although Washington sentiment to do so, and get the taxes it would yield, is big. After the attempt to repeal and replace Obamacare failed, the White House and GOP congressional leadership vowed to pivot toward overhauling the tax code. This would include giving a special tax break for companies holding the $2 trillion in offshore cash to entice them to return it home, known in tax parlance as repatriation.
Lately, though, the politicians are saying a tax revamp will take a while -- the last major tax reform, in 1986, took more than a year. Mr. Trump now wants to make another stab at the health law first. And Treasury Secretary Steven Mnuchin told the Financial Times on Monday that the Trump administration’s deadline of August for passing a tax overhaul was “not realistic,” but he added that he expected it by year-end.
Regardless of when a tax-rewrite push happens, skepticism about the benign effect of luring back the cash is widespread on Wall Street. Lawrence Fink, head of BlackRock (BLK), the world’s biggest money manager, has said, “I don’t believe that repatriation is going to stimulate the economy.” That’s because the money would go to narrower goals, like pleasing stockholders with dividends and buybacks.
The reason all that cash is sitting outside the U.S. is the nation’s high statutory corporate tax rate, 35 percent. As long as money earned outside of America stays there, companies need only pay lower rates in their host countries. Ireland, for instance, charges just 12.5 percent.
True, due to loopholes, U.S. companies actually pay a lot less than 35 percent, as little as 14 percent from 2008 to 2012, according to a U.S. Government Accountability Office study. A large chunk of them pay nothing.
But to get there, the companies have to spend a lot on costly lawyers and accountants. They would rather minimize those expensive machinations and start from a lower tax rate level. Mr. Trump has talked about taxing the overseas cash at only 10 percent to entice it home, perhaps using the fresh tax revenue it would generate for infrastructure build-outs.
The record of bringing back the cash isn’t good when it comes to job creation. Look at what happened during the last such tax holiday, in 2004. The U.S. Senate Permanent Subcommittee on Investigations found that the 15 largest corporate beneficiaries trimmed 22,000 jobs, and the entire group of 840 companies that repatriated cash didn’t increase their headcounts overall.
And this was during a time of stronger economic growth: a 3.8 percent GDP increase in 2004 and 3.4 percent in 2005, far better than 2016’s anemic 1.6 percent rise. To be sure, the impact of the 2004 tax holiday may be distorted because it was a one-time event, focused only on overseas cash. Mr. Trump and House Speaker Paul Ryan (R-Wisconsin) seek a permanent tax cut affecting U.S. corporate earnings from all operations, whether domestic or international.
But if the objective is to give American workers a boost, these harsh realities stand in the way:
The biggest beneficiaries don’t need to do major capital spending. Historically, capex goes to upgrade factories or enhance a company’s other physical capabilities, like modernizing its truck fleet. But the companies with the most funds abroad are tech firms, which have nowhere near the need for such heavy infrastructure. According to Moody’s, five major tech companies hold the bulk of the offshore money: Apple (AAPL), Microsoft (MSFT), Google parent Alphabet (GOOG), Cisco (CSCO) and Oracle (ORCL). The second largest foreign-cash repositories are pharma outfits, also light on plants and equipment.
The Analyst’s Accounting Observer newsletter estimates that as of 2015, tech had $94.3 billion in foreign cash, health care $35.2 billion, financials $15.9 billion and industrials $8.1 billion.
“Companies need less capex these days,” said Doug Foreman, chief investment officer of Kayne Anderson Rudnik, a Los Angeles investment manager. “The U.S. is more based on intellectual capital. Facebook needs little capex.” Indeed, Facebook (FB) puts its money into data centers, offices and research, but its outlays were 15 percent of the $29 billion that General Motors (GM) spent last year
Tech simply needs fewer people than other lines of work. Facebook’s stock market value per employee is $21.8 million, but it’s only $248,000 for Ford Motor (F).
At the same time, factories aren’t gunning their production capabilities. A measure called capacity utilization shows that U.S. companies use less of their available facilities than they once did. This figure hit 85.2 percent in 1997 and was 81 percent at the end of 2007. After a recession plunge, it now sits at a blah 75.9 percent.
A lot of corporate managers don’t see the demand needed to rev up production. “Businesspeople are rational,” said economist Gary Shilling, whose eponymous investment and research firm is in Springfield, New Jersey. “If they need to increase production, they will do it. But they don’t.”
More capital spending doesn’t automatically translate into better productivity. And CEOs know it, giving them another reason to be leery of throwing good money into the capex maw. The classic formulation was that ever-greater employee producticity was good for the workforce’s wallets.
But with the advent of more and more automation on the factory floor, as well as other places like warehouses, layoffs and slower pay raises are the increasingly prevalent outcome. And despite the increased use of robots, productivity growth in recent years has been sluggish, and sometimes has slipped into negative territory.
Robert Gordon, a Northwestern University economics professor, believes this is the result of no big innovations that rival the automobile assembly line or the electric light bulb. A productivity spurt occurred with the large-scale adoption of the internet from 1995 to 2005, he said. But nothing since.
Economist Shilling has plotted the ebbs and flows of capital spending and productivity since 1948 and found they don’t jibe at all. “There’s zilch correlation,” he said. “Innovation comes in spurts,” and a lot of the spending is simply wasted. One example is the retail sector, where a lot of overbuilding took place to capture mall goers. But now many shopping malls are closing.
One counterpoint: The stock market seems to believe companies that already have high capital spending will do well up ahead. An exchange-traded fund that specializes in them, called Elkhorn S&P 500 Capital Expenditures, is up 11.6 percent since Election Day, beating the S&P 500’s 10.2 percent. Of course, the market has been wrong before.
If the money goes for anything, it’s mergers, buybacks or dividends. These days, mergers and acquisitions are down, which many attribute to uncertainty about the tax code. If a big dollop of overseas cash came sluicing into company coffers, though, the temptation would be strong to use it for empire building -- or if you wish, enhancing a product portfolio. Mergers tend to be popular with chief executives, often because they can buy a new business line cheaper than trying to build one from scratch.
By the same token, stock buybacks and higher dividends are popular with shareholders. Buybacks have the added boon of making earnings per share appear more valuable (because fewer shares exist) and offset large stock awards given to top executives.
Buybacks peaked in 2013 and really swooned in the last half of 2016. Chief reason: Stocks have gotten very expensive, with the S&P 500’s price/earnings ratio at 24, far above the historical average of 15. Meanwhile, dividends continue to grow as corporate profits have recovered from a slump.
Still, an infusion of millions into U.S. corporate headquarters would give CEOs a strong temptation to play Santa. “For many companies, returning money to shareholders is the right policy,” said Gene Neavin, a portfolio manager at Federated Investors, the mutual fund company. “It’s provided the best bang for the buck.”
What it hasn’t provided, however, is a rush of jobs.