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A troubling change is taking place in American business, one that explains why nearly five years after the Great Recession officially ended so many people cannot find work and the economy remains frail.
The biggest American corporations are reporting record profits, official data shows. But the companies are not investing their windfalls in business expansion, which would mean jobs. Nor are they paying profits out to shareholders as dividends.
Instead, the biggest companies are putting profits into the corporate equivalent of a mattress. They are hoarding what just a few years ago would have been considered unimaginable pools of cash and buying risk-free securities that can be instantly converted to cash, which together are known in accounting parlance as liquid assets.
This is just one of many signs that America’s chief executive officers, chief financial officers and corporate boards are behaving fearfully. They are comparable to the slothful servant in the biblical parable of the talents who buries a fortune in the ground rather than invest it. Their caution, aided by government policy, costs all of us.
This rising sea of liquid assets holds back economic recovery in at least two ways.
First, the economic engine sputters when profits are not recycled through the economy — when they are not invested in new plant and equipment, not spent on research and development, not paid out as higher wages or larger dividends. The flow of funds between buyers and sellers, employers and workers, companies and their investors is the fuel required to rev up the economy.
Congress understood this in 1909, when the corporate income tax was adopted. Worried that companies would become bloated with cash, slowing the economy, Congress put a stiff 15 percent penalty tax on excessive pools of cash. Thousands of small business owners who have hoarded cash have had to pay that penalty over and above their taxes.
But in 1986 Congress changed the rules, retaining the penalty tax on domestic cash hoarding but allowing multinationals to hold unlimited amounts of cash so long as they sent the money offshore. This act incentivized the enormous world of offshore tax avoidance we see today, as chronicled in my book “Perfectly Legal” and other books such as Nicholas Shaxson’s excellent “Treasure Islands.”
Second, the accounting techniques American multinationals use to siphon profits out of the U.S. delay their taxes for as long as they wish, shifting tax burdens to everyone else, which thereby puts a damper on the overall economy.
This siphoning of profits out of the United States cost the Treasury between $57 billion and $90 billion in 2008, Kimberly Clausing, an economics professor at Reed College in Oregon, estimated after analyzing corporate disclosure statements.
Cash sent offshore cannot be invested in expanding American operations. However, Congress does permit the money to be used to buy federal debt — Treasury notes and bonds. More about that in a moment.
My analysis of the latest data from the Federal Reserve, the IRS and corporate reports shows that American businesses last year held almost $7.9 trillion of liquid assets worldwide.
Corporations hold liquid assets equal to all the money the federal government spent in 2013, 2012 and three months of 2011.
Those who follow the news may be surprised, because the figure that’s been mentioned lately has been just under $2 billion. That figure, which comes from the Federal Reserve, is only for domestic cash. The Fed makes its calculations (from the latest Flow of Funds report) using IRS worldwide data after subtracting offshore money.
My estimate is conservative. I did not count cash due to American companies from their offshore subsidiaries as accounts receivable because the IRS does not provide fine details on these additional trillions of dollars.
But even my $7.9 trillion estimate is so huge that it may be difficult to understand, so let’s review some ways to put it in perspective.
Consider the debate over federal spending. Uncle Sam spent $3.5 trillion in fiscal 2013. Corporations hold liquid assets equal to all the money the federal government spent that year plus 2012 and three months of 2011.
The cash hoard also equals all the sales rung up by all 6 million American businesses every three months. And four years of 2013 profits, which totaled $1.9 trillion.
Corporations now hold $2.30 for every dollar of cash they had in 1994, after adjusting for inflation.
The total corporate cash reserve also amounts to almost $25,000 per American, up from $13,000 per American in 1994 (again after adjusting for inflation). And this cash is highly concentrated, most of it held by the 2,800 biggest companies, IRS data shows.
Since 1994, liquid assets have grown at about six times sales, my analysis of the official data shows. When liquid assets grow six times faster than revenues, it tells you that companies are hoarding cash, not investing or spending.
Turning taxes into profit
These facts also demonstrate that America’s CEOs, chief financial officers and corporate boards fear the future because instead of investing their cash they hold onto it. But even if cash hoarding comforts weak-kneed executives, it makes no sense for investors, workers or taxpayers.
Investors do not need a company to hold their extra cash. That’s what savings accounts are for.
Workers need companies to invest in the future, replacing old factories, purchasing new equipment and engaging in other activities that employ people in pursuit of bigger future profits.
Taxpayers also get a terrible deal. When companies siphon cash out of the country it reduces their immediate federal income taxes. Congress spends the money anyway, which requires borrowing. Companies then loan Washington the money they did not pay in taxes, collecting interest.
This means companies that do this turn a profit on their taxes. Consider a company that defers a $1 billion tax for 30 years, using the cash to buy federal debt paying 4 percent interest in an era of 3 percent inflation. The company will collect more than $2.2 billion in interest, while inflation will erode the value of the tax to $401 million, a nearly 60 percent reduction. From the government’s point of view the tax is converted from a source of revenue into an expense.
In the parable of the talents (Matthew 25:14–30), the returning master praises two servants who invest the fortunes entrusted to them, earning big gains. But the servant who buries the gold and merely returns it is denounced as “wicked and slothful” and is cast out.
Corporate executives and directors who hoard cash are modern slothful servants. If we want jobs, wealth, lower taxes and a prosperous future, they should also be cast out.