Tax Cuts Cure Cancer

Posted: Tuesday, August 03, 2010 | Posted by Jaba |

Over the last couple of years, there’s been a lot of debate on how best to stimulate the economy. Obama and the Dems have pushed for increased government spending to coax the economy along. Republicans have pushed for more tax cuts to stimulate the economy. And the Tea Baggers have pushed for, as best as I can understand, no taxes and no government spending of any kind.

So let’s set aside the Tea Bagger constituency as nothing but a hodge-bodge group of uneducated, unemployed, racist, ignorant monkeys who really shouldn’t have a voice in a civilized democracy. And for purposes of this email, let’s set aside the Dem’s position and focus on Republicans and their view that tax cuts are the cure for all things including fixing the economy (I’m sure if you place enough Republicans in a room, they’ll figure out a way on how tax cuts would cure cancer).

Republicans argue that if you cut taxes, businesses and individuals would have more money to spend and invest their capital, which in turn, would stimulate the economy. I’ll leave individuals for another discussion and focus more on businesses. Their argument seems to make sense: if a company didn’t have to spend its cash paying Uncle Sam, they’d have more capital to invest in R&D, B&P, and improve/increase their workforce.

But something always bothered me about this argument. Take the company I work for. We’ve weathered the poor economy better than most. We are a healthy large business with significant revenues and profits. We’re not exactly what you would call cash-strapped. We generate tons of cash every year and have billions of capital that we could easily deploy. You would think that we would take our cash and invest it in our future growth, that our R&D budget would grow, our B&P spend would increase, that we would be hiring the best talent to take advantage of our strong market position. We are not doing any of those things. Instead, we’re sitting on our cash. Sure, we’ll buy a company here and there, but that really doesn’t help the economy in any material way. Yeah, we’ll make a handful of dudes rich, but it’s not like they’ll go and spend all that cash buying stuff. All those greenbacks will probably be sitting in mutual funds or money market accounts somewhere.

My company pays about $300M in taxes annually. Let’s say Obama had listened to Republicans on this whole stimulus thing. Screw the poor and middle-class people, screw investments in infrastructure, all we’re going to do is give tax cuts, especially to businesses. Let’s say we cut taxes by half. My company would save about $150M. What do you think we’re going to do with that cash? Invest in our research, our marketing, our people? Hell effing no. It’s going to go in the piggy bank with the rest of our capital, sitting there, doing nothing.

You may then argue: “Well, maybe that’s just your company, it may help others”. Fair point. So I went and pulled up all the companies in the S&P 500 representing over $10 trillion of market cap, $8 trillion in revenue, and 22 million employees. Here’s what I found out:

Median figures
Revenue: $9.4 billion
EBITDA: $1.2 billion
Tax expense: $200 million
Operating capital (working capital + CapEx, ie amount of capital to sustain business): $540 million
Cash: $800 million
Debt: $2.8 billion

What does all this mean? It means that chances are, your average large company is going to be in the same position my company. Your average S&P 500 company currently has more than 1.5x the cash required to sustain operating capital (above and beyond the operating capital they currently have), $800 million of cash, and assuming max Debt/EBITDA levels of 4, over $2 billion of deployable capital. In other words, they’re not hurting for cash and any tax cut isn’t going to impact their decision on how to deploy capital. For avoidance of doubt (as those lawyers like to say), it means that if you have $2 billion, another $100 million isn’t going to mean squat.

So if you want tax cuts simply based on the principle that what you what you make you should keep, I guess I understand. Myopic sure, but I understand. However arguing that giving large businesses tax cuts will somehow stimulate the economy better than putting actual dollars into the hands of consumers doesn’t seem to hold water.

If this is the case, then why do so many supposedly smart Wall Street types, like my banker friend Sunny, push fanatically for corporate tax cuts? Simple, because it’s in their best personal interest to do so. Think about it: who is likely to have sizeable next eggs invested in equities? Rich banker types like Sunny. If you cut the taxes of large companies, theoretically their valuation will go up. Simple example: If the average Price:Earnings of the S&P 500 is 20, cutting taxes will increase Earnings and assuming a fixed P/E of 20, that means Price will have to go up. So your average Sunny will see his already sizable nest egg increase in value. But this is good for the economy right? Sunny will take that increased wealth and spend on consumer goods or start a business which will be good for the economy, right? Wrong. What Sunny will do is buy a beige Mazda minivan, last year’s model, on sale, and keep the rest in his eTrade account sitting idle.

At the end of the day, just like everything else, the solution to our economic troubles is a combination of things. When no one is spending, business or consumers, we unfortunately need the government to spend to prevent a real Depression. We also do need tax cuts, but smart tax cuts, those that will actually spur economy activity. Personally, I think this is all a moot point. Despite what the Fox News contingent want you to believe, all indications are that we are in an economic recovery. So go out there and spend some of that money. Who knows, in a couple of years, Palin could be President. Then we’d all be screwed anyways.