Why are American companies hoarding so much money?


A common explanation for the increase in cash holdings has been the growing importance of bad weather funds, particularly for companies with subjective valuations that may find it difficult to access capital quickly when the need or demand arises. opportunity presents itself. But there is also another possibility: a desire to minimize taxes.

So in a new study, researchers set out to determine to what extent the tendency to hoard could be explained by these two competing theories. Their analysis reveals that most of the increase comes down to taxes.

Mitchell Petersen, a Kellogg finance professor, and his co-authors found that foreign cash holdings grew faster than domestic holdings, especially in countries with the lowest tax rates. They also determined that a particular sector of American companies is driving the hoarding: multinationals whose value is primarily generated by their intellectual property, which tends to be much easier than physical assets to move around the world. world for tax reasons. These companies, including Alphabet, Apple and Microsoft, produced 92% of the increase in cash that the research team was able to document.

Many economists have long suspected that tax evasion plays a role in hoarding, says Petersen. But the extent to which the increase in this behavior can be explained by tax strategy was unexpected.

“I was a little surprised that so much of the upside was due to taxes,” Petersen says.

Corporate efforts to minimize taxes suggest a recent agreement among 196 countries – representing 90% of the global economy – to create a global minimum corporate tax rate of 15% could have a deep and far-reaching impact on how multinationals are structured. their operations.

The importance of cash in hand

There are many reasons companies might prefer to keep large cash reserves that are unrelated to taxes. On the one hand, cash is incredibly useful when it comes to weathering uncertainty, which the global economy has seen a lot of lately.

Cash reserves also make it easier for businesses to fund new initiatives or, at a minimum, secure better terms from lenders or investors. This is especially important for IP-focused businesses whose values ​​tend to be more subjective, which can complicate the lending process. Additionally, these companies often need to invest heavily in R&D and would prefer to act quickly – and quietly – on new opportunities.

“Let’s say you were at Google and you had a great idea about search. And because you didn’t have the money to act at the time, say ‘let’s wait three years, raise the money and see if the research is a thing.’ Petersen postulates. “You would be dead in six months.”

Given these benefits, it’s perhaps unsurprising that companies, especially those focused on IP, prefer to hold on to ever-increasing cash. But Petersen wondered how much of the increase in cash holdings could be explained by precautionary reasons, and how much could be attributed to a desire to shift and keep profits in low-tax regions.

Foreign liquidity is growing faster

Together with colleagues Michael Faulkender of the University of Maryland and Kristine Hankins of the University of Kentucky, Petersen first sought to find out where, geographically, the company’s money was hidden.

In the past, this has not been possible using publicly available data. But the researchers were able to tap into nonpublic data from the Bureau of Economic Analysis, which asked US multinationals about their foreign subsidiaries, including the amount of cash held in each subsidiary. This allowed them to estimate a company’s domestic and foreign cash holdings.

The researchers determined that between 1998 and 2008, while domestic and foreign cash holdings increased, the rise in foreign cash was much larger. Domestic cash held by multinational corporations increased by 90%, but foreign cash increased by 440%.

Additionally, the researchers also observed a sea change in the foreign countries in which companies held their money. In 1998, much of the cash was held in large economies such as the UK, Germany and Canada, and the amount of cash was roughly equal to the fraction of sales coming from these countries. But in 2008 the picture was quite different: smaller economies like Ireland, Bermuda, the Netherlands, Belgium and Luxembourg now housed an inordinate share of the silver. For example, Irish subsidiaries held 13.1% of cash, but generated only 4% of sales, while Luxembourg subsidiaries held 5.5% of cash, but generated only 0.5% of sales abroad.

What do these nations have in common? Lower and falling tax rates.

Taxing the intangible

The researchers also found that multinational corporations that invest in intellectual property-based intangible assets had the largest increase in foreign cash holdings.

This is telling, says Petersen, because the essentially non-physical structure of intellectual property assets makes it easier for financial executives to move their operations around the world to countries with the lowest tax rates.

“If you’re producing concrete for highways in Ohio, you’re not going to make the concrete in Ireland and ship it across the Atlantic just because the tax rate is lower,” he says. “But if you’re selling software in Ohio, you could design it in Ireland because shipping software, shipping ideas, shipping design around the world, is really cheap.

In addition, unlike raw materials or other commodities purchased on a market, it is difficult to assign an exact value to intellectual property. This means that even though the engineers, product designers, and marketers responsible for creating this software are spread across several countries, it is often relatively easy to inflate the costs of services provided by the lowest-taxed foreign affiliate. So, for example, a foreign subsidiary in low-tax Ireland might charge a higher-tax subsidiary a very high rate for its design services, in order to capture as much profit as possible.

“In the old world, where you sold copper, the government could say, ‘Wait, copper is about $400 a ton. You can’t charge them $5,000 a ton. But today, if you want to transfer IP, and you’re literally the only one who has it, is it worth a million dollars? Is it worth a hundred million dollars? said Petersen.

Driven by tax strategies

Finally, the researchers analyzed the factors that would best explain companies’ foreign and domestic holdings. They found that for domestic holdings, variables such as access to capital markets or R&D and capital expenditure were good predictors of the amount of cash a company would accumulate. For example, firms with less access to capital markets can be expected to retain more cash, while firms with lower R&D costs might expect to retain less.

But for foreign currencies, the story is quite different. The same factors did not have much predictive power. But lower effective tax rates did.

Taken as a whole, the study paints a picture of a cash-holding trend that is primarily driven by the growing value of IP in the global economy and the desire of IP-driven multinationals to avoid taxes.

Compete beyond taxes

It would therefore be a big problem if the recent agreement around a global minimum tax materializes. Currently, the vastly different corporate tax rates between, say, Bermuda (7%) and France (26.5%) provide multinationals with a good reason to keep as much of their profits as possible in low-rate jurisdictions. of taxation. This in turn encourages countries to undermine each other, depriving governments of essential resources. “Now you’re starting to have a competition where we’re going to keep lowering tax rates,” says Petersen.

An overall minimum tax rate of 15% would effectively narrow the gap between the highest and lowest taxed jurisdictions and temper this race to the bottom.

“If you had asked me four years ago how likely this is to happen, I would have said ‘zero’,” says Petersen. But amid the pandemic, as cash-strapped governments struggled to serve their populations, the political calculus seemed to be shifting. “All of a sudden there’s this discussion, and some people think it could actually happen,” he says.

Even though the United States will likely maintain its tax rate above 15% if this agreement is signed, a lower gap between the US corporate tax rate and this global minimum will reduce the incentive to shift profits abroad. ‘foreign.

Petersen likens it to how states compete in the United States Yes, some states have lower corporate tax rates than others, which gives those states an advantage in the race to attract business , but everyone pays the same federal rate, which limits their advantage. This allows companies to consider other factors when deciding where to base their operations. “It means I can start thinking about: where do I want my employees to be? Where can I find the best employees? What is the most efficient way to structure my supply chain? said Petersen.

Other policies also have the potential to change the holding of cash offshore, but not always in the way that policymakers want. For example, in 2017 the Trump administration did two things to reverse the trend of offshore stockpiling. The first was to lower the corporate tax rate, which effectively reduced incentives to shift profits offshore. But the second was to eliminate the repatriation tax on income (and therefore cash held offshore), which would make it less costly from a tax perspective to repatriate that income. This particular decision, says Petersen , probably has increased the amount of profit (and therefore money) earned overseas, as it removed a major barrier to doing so.

“Well, wait a minute. So I can go earn money there, and when I want, bring it back, at zero additional tax? This has accelerated the incentive to move income overseas,” he says.

It is still too early to predict the net impact of the 2017 tax policy on corporate cash flow or whether the global community will ever agree on a minimum tax. Yet Petersen predicts that at least some profits will flow back to the United States for another reason: the pandemic. “There’s this preference to move those supply chains home: not where you make the money, but where you produce it,” he says. “Because it is a physically identifiable activity, it will tend to generate revenue.”


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