Professor Robert Reich’s New Tune? “Corporate Tax Cuts Are Absurd.”
Risaburo Nezu
Senior Executive Fellow, Economic Research Center
April 21, 2010 (Tuesday)
Japan and the US in similar situations
Robert Reich, the University of California at Berkeley professor well-known in Japan, offers interesting comments in the March 24th, 2010, edition of the Financial Times. A political commentator and author of “The Work of Nations” and “Supercapitalism,” Professor Reich was formerly the US labor secretary under the Clinton Administration, and is said to hold sway in the current Obama Administration as well. Professor Reich notes that big US companies have increased their cash on hand, but, unsure of how to use it, are buying back their own stock or pursuing M&As instead of putting the money into new job-creating projects. Arguing for tax cuts on big corporations in this context, he asserts, is absurd.
Professor Reich has previously argued for eliminating corporate tax; his recent comments suggest he has changed his tune. Regardless, his opinion is worth considering from a Japanese perspective. US and Japanese corporate tax is high among developed countries at nearly 40%, compared to around 30% in Europe and around 25% among Japan’s Asian neighbors such as South Korea and Taiwan. Japan’s business community has for some time demanded corporate tax cuts, and Prime Minister Hatoyama recently stated that the possibility for such cuts will be examined. I opined in a November 12th, 2009, article that it is dubious that corporate tax cuts will really stimulate growth in Japan, and am again surprised by the resemblance to the situation in the US. I also commented on how Japanese companies are retaining profits and strengthening their capital bases in a recent FRI column (“Current Topics,” April 15, 2010). The following is a more detailed explanation in response to several questions I have received regarding the facts.
Over half of profits used to repay loans
A look at the “Financial Statement Statistics of Companies” (houjin kigyou toukei of the Ministry of Finance) shows that cash and account balances have basically remained unchanged; there is no proof that Japanese companies are hoarding piles of money. Instead of keeping all retained earnings in cash, companies are more likely putting money into stocks and securities of other companies or in business investment. The more striking change is that corporations are borrowing considerably less and rapidly reducing their outstanding bonds. A majority of retained earnings are used to pay off debt, a trend evident in the change in net assets (subtract debt from total company assets: “Financial Structure of Japanese companies” below).
The net assets of corporations alone increased JPY 224 trillion from 1998, equivalent to about 60% of the amount of increased government bonds in the same period. In other words, this large sum of money released by the corporate sector was eventually used to purchase government bonds via financial institutions. The reason companies refrained from business investment was therefore not for lack of money, but rather for lack of promising investment opportunities. As Professor Reich notes, if cutting corporate tax to increase investment and stimulate growth by ensuring adequate investment capital for companies is the goal, the move is likely to fail.
Surging buy-backs
Buy-backs, or companies acting in the interest of shareholders and buying their own shares from the market with cash, are recently on the rise in the US. Slashing the number of shares in the market increases earning per share and appreciates the stock price. Buy-back totals reached 5.7% of GDP in 2007, indicating companies supplied vast sums of money. Even in Japan, buy-backs totaled JPY 20 trillion in 2008, or 4% of GDP. Companies are increasingly employing this method to return excess funds to shareholders; as a result, companies where the largest shareholder is the company itself are even emerging.
Companies becoming a savings sector: a global trend
The trend of companies turning into a “savings sector” isn’t unique to Japan and the US: investment levels have started to drop below cash flows in companies globally. Using pre-2006 data, the OECD also analyzes in its 2007 economic outlook that the corporate sector is becoming a savings sector. The US raised the policy interest rate to cool economic overheating well before the onset of the subprime problem, but this move was ineffective in driving up long-term interest rates. What was the reason for this? Some claim that “China and other developing countries pumped current-account surpluses back in to the US.” Though this theory, which places responsibility on Asia’s excess savings, has gained some traction, it only paints half the picture. Another major factor is that companies in developed countries have become savings sectors. This trend, the OECD suggests, is rooted in the cyclical “decline in investment with the global economic recession.” Other structural factors include lower business investment costs from cheaper IT devices as well as pressure from shareholders to enhance profitability. The trend of companies becoming a savings sector is therefore likely to continue over the long term. More fundamentally, companies have been unable to unearth promising investment opportunities since the IT bubble collapsed in 2001 and new large-scale IT innovation disappeared. It will take time until healthcare and the environment and can become the new frontiers.
Beyond the common sense of economists
The potential for financial collapse in Greece and Portugal is currently the subject of serious discussion. They are not the only countries facing unprecedented fiscal imbalances: excluding Northern Europe, EU countries are disregarding their own agreement to keep cumulative government debt under 60% and single-year budget deficits under 3% of GDP. Yet, concrete exit strategies such as spending cuts and tax increases are absent in these countries, suggesting high budget deficits will continue. With a few exceptions, however, interest on government bonds has stabilized and there are no signs of inflation in these countries, defying the common sense of economists. The reason lies in companies becoming a savings sector. If this trend is deemed as correct, it would represent a departure from the traditional structure of “households save money; companies spend it,” and leave no choice but to fundamentally reexamine the management of the economy including the financial system.
