In Canada, corporate income tax makes up a falling share of all government revenues thanks to tax breaks given when the recession hit. The general federal corporate income tax rate stood at 28% in 2000. Since then it has been whittled down, from 21% to the most recent cut from 16.5% to 15%, effective January 1, 2012. The corporate tax rate remains the same in 2013, at 15%.
In the U.S., in the final quarter of fiscal year 2012, corporate income taxes amounted to 1.7 percent of GDP. The effective tax rate, which is defined as the share of corporate profits actually paid in taxes, averaged 19% over the previous three decades, much lower than the top corporate statutory rate, currently 35%, because of the various deductions and exclusions that corporations claim.
However, over the past few years, this effective tax rate has plunged. It was only 13% in the final quarter of fiscal year 2012. The argument to cut corporate income tax has been that increased, after-tax, corporate profits would be re-invested in company operations, boosting economic growth, productivity, and jobs.
Studies have shown that rising corporate after-tax profits have not resulted in increased investment. Instead, corporate cut backs in hiring and investment, added to cuts in corporate income tax, have contributed to a significant increase in cash reserves held by corporations. The largest companies have not used that money to invest in the economic recovery. Instead, they are holding onto the cash, claiming that growth has not justified spending.
The biggest companies seem to be the worst – holding onto much more of their profits than small and medium sized companies, who are doing more to invest in the economy. This dead money is not at work increasing productivity, creating more jobs or opportunities. This exacerbates the uncertainty in the economy.
David Seaton, chief executive of Fluor Corp., a large engineering and construction firm, said that, if uncertainty isn't removed, "People will sit on their war chests of cash and return it to shareholders. You'll have a retarded growth trajectory."
This is not a tenable situation. As long as huge amounts of money are being kept out of circulation, the economy will continue to be stagnant … or worse. We could be plunged back into a recession, which would result in more cash hoarding, which would … well, you get the picture. It’s a vicious cycle.
A friend of mine had this suggestion to spur investment and spending “Tell these corporations that, unless they start spending, they lose their tax savings. See how soon they’ll start investing if their tax rate goes back to where it should be, on par with our personal rate.”
That idea is probably not going to gain many fans in the Fortune 500 boardrooms, but there has to be some way out of this hole.
From where will meaningful investment to spur the economy come, if not from the biggest corporations? Have you seen any effects of this in your business? What might cash hoarding mean to the valve industry?