Free cash, corporate taxes, and the federal deficit

Abstract:

Over seventy years ago, Michal Kalecki noted that budget deficits would “permit profits to increase above the level determined by private investment and capitalists’ consumption.” Kalecki’s insight into the generation of “free cash” (cash in excess of new investment) was formulated at a time when consumer deficit spending and other private deficit spending was minuscule. But it can be shown that his insight can be extended not just to an expansion of public deficits but to private deficits as well. Over the past forty years, the rise of “free cash” and expanded deficits have allowed corporations to cut back on investment growth, funneling the excess cash into mergers, stock buybacks, and expanded dividends to the wealthy. In recent years, this outpouring of cash has accounted for well over fifty percent of corporate fixed investment. I run a simple “what if” exercise on U.S. corporate tax flows utilizing past U.S. tax rates to calculate the possible absorption of free cash and reduction of federal debt that would have been associated with such an exercise.

Key words::

• federal deficit
• free cash
• Michal Kalecki

Notes

¹Merger considerations from Mergerstat Review, various issues; Dividends, Table 1.14, Survey of Current Business, various issues; Stock buybacks, Wall Street Journal Almanac, 1999; Standard and Poor’s Press Release, September 15, 2009; Standard and Poor’s Index Services. Corporate fixed investment, Federal Reserve, Flow of Funds, Table F.6, addition of lines 10 and 12. Divestitures and foreign acquisitions are subtracted out of total merger considerations. Standard and Poor’s compilation of stock buybacks are minimum estimates of total buybacks given that Standard and Poor’s universe total is a subsector of all corporations.

²Free cash flow is generally defined as operating cash flow minus capital expenditures. Michael C. Jensen originally defined the term as “cash flow in excess of that required to fund all projects that have positive net values when discounted at the relevant cost of capital” (1986, p. 323). In confining capital expenditures to new investment (fixed business investment and inventory change), a free cash definition becomes amenable to calculation through the National Income and Product Accounts and the Flow of Funds Accounts of the Federal Reserve.

³In a survey of approximately 1,000 firms in which 186 firms responded, 111 indicated that the excess profits tax “had no effect upon the level of their investment expenditures on new plant and equipment” (Dugan and Zubrow, 1954, p. 245). Moreover, of those that depended on internal funds for expansion, “9 out of every 10 firms which relied solely upon funds from internal sources maintained that their decisions regarding the methods of financing were independent of EPT [excess profits tax] considerations.” (p. 248).

⁴There is, of course, no assurance that investment requirements surrounding socially beneficial projects would entail the same investment requirements as war. But the targeted expenditures enumerated above would certainly require high capital expenditures.

⁵Corresponding to the two measures of Free Cash there are two personal savings variables (“s”) one net of all savings derived from all corporate payouts, and the other net of dividends alone. The “s” in Figure 1 is calculated on the wide Free Cash measure.

⁶The exceptional years of 1974, 1979, 1980, 1981, and 2000 have been those few that have preceded or been part of sharp downturns in the economy.

⁷Residential construction in 1948 was $15.8 billion (NIPA accounts, table 5.3.5). Corporate fixed investment was $19.7 billion (Federal Reserve, Flow of Funds, table F.6, lines 10 and 12).

⁸The capacity utilization rate shows the same downward trend on normalized data. Corporate fixed investment: Federal Reserve, Flow of Funds, capacity utilization, table F.6, lines 10 and 12; Economic Report of the President, March 2013, p. 387.

⁹For official advocacy, see the Department of the Treasury Report, Tax Reform for Fairness, Simplicity, and Economic Growth, November 1984, vol. 1, p. 18, and vol. 3, p. 19. Robert Carroll et al. (2010, p. 1) note that in consideration of reducing recent federal deficits, prominent political personages such as Nancy Pelosi and Kent Conrad and former Federal Reserve chairmen, Paul Volcker and Alan Greenspan have indicated that a value-added tax should be considered.

¹⁰Interest rate estimates based on the ratio of federal net interest outlays applied to gross federal debt (Economic Report of the President, February 2013, tables B-78 and B-80). Gross and publicly held debt for 2013 is taken from the St. Louis Federal Reserve.

¹¹Laramie and Mair also take up the question of corporate tax shifting. They show that the effectiveness of government stimulus is diminished when the corporate tax is shifted onto workers. It should be noted that such corporate tax shifting is incompatible with a profit-maximizing postulate. Corporate taxes are levied as a percentage of profit.

¹²From 1970 to 2001, the top quintile gained income share from all sources from around 43–44 percent to 50 percent, with most of the relative income gains “concentrated within the top 1 percent—and especially the top 0.1 percent” (Piketty and Saez, 2007, p. 14). Corresponding to this increased income at the top, the share of taxes paid by the very top (0.1 percent) expanded, from a little over 40 percent around 1960 to over 55 percent in 2002. Yet over this same period, the rate of tax on this top group fell from around 60 percent to a little over 40 percent (p. 16).

¹³See www.forbes.com/sites/afontevecchia/2013/03/19/u-s-companies-stashing-more-cash

Additional information

Notes on contributors

Craig Medlen

Craig Medlen is Professor of Economics at Menlo College, Atherton, California.