How $AAPL's Cash is Key to Turning the Economy Around

It’s 2015, and the government is mess. Getting budgets passed is next to impossible. Real investment back into the most critical parts of our infrastructure is nearly non-existent. Providing quality options for infrastructure like good schools, health care especially for women and family planning, safety, child care, and transportation is foundational to creating opportunities for the majority of society to participate in building wealth.

Today, participation is not equal and based on education, wealth, and status. Poverty has become institutionalized within a stratum of our society due to broken and inadequate access to basic infrastructure. The ability for government to fix this in the next few years is minimal because these issues generate deep political differences on what the root of the problem is, how to correct it, and who should pay for it. But while government does little to rectify this obvious gap, Rome burns.   Double digit unemployment, high incarceration rates, drug addictions, and low college graduation rates prevent the majority of our society from participating in the American Dream and contributing fully to society.

The biggest stick the government has used in the past few years to stimulate the economy has been Monetary Policy. The Fed has been engaged in managing the Fed Rate, which impacts overall interest rates. In addition, the Fed impacts market liquidity or the money supply by its activities of buying and selling bonds. As interest rates hit historic lows, the Fed ran out of runway to positively impact the economy. As the current rate has been steady now for some time, it does not appear to be driving consumption. But it has been driving Wall Street to rack up cheap debt at record low rates, to fund shareholder buybacks.   These buybacks concentrate the company ownership, and large shareholders end up with a relatively larger share of the company at no cost to them. The problem in economic terms is that this transaction of borrowing, buybacks, and concentration of wealth, does very little to stimulate consumption in the broader economy. The Fed’s current stance of holding down rates is actually accelerating borrowing and 2015 is expected to be the largest buyback year in history.

The other option to stimulate consumption is Fiscal Policy. This could include things like tax cuts and infrastructure spending. Tax cuts for the middle class could provide more disposable income to stimulate spend but most likely it would be a near term impact and not impact a change in behavior over the long run, unless the tax cut was significant. The poor would most likely not benefit since they pay so little in taxes and the benefit may not be material enough to stimulate consumption. Government spend on the other hand could be a way to stimulate business activity while also increasing jobs in areas like construction and services. There are still segments of our society with very high even double digit unemployment rates that could greatly benefit from this type of work especially if coupled with training and education. This type of action could therefore be very effective in stimulating long term consumption and enabling a transformation in the poor and middle class. This transformation takes the form of higher income earners, more college educated, higher home ownership, and a greater participation in The American Dream.

It just so happens that we are at the precipice of one of the most extraordinary opportunities to reallocate great sums of capital, that could be used to fund the type of infrastructure programs that would increase access and opportunity for greater parts of the society. This in turn would ultimately drive consumption as more segments of society participate in building personal wealth.

For many years, companies have been leaving stockpiles of cash outside of US because of the taxes they would be forced to pay if it was used to fund US based activities including buybacks and dividends. This factor is driving many companies, therefore, to borrow rather than use their stockpiles of overseas cash. This wasted use of capital could instead be unleashed on infrastructure programs designed to rebuild, reinvigorate, and reinvest in the US economy.

To close this gap, companies would have to be motivated not by altruism but by financial incentives. As I said there is a disincentive to touch this money today because of the tax implications. I would like to explain how a shift in thinking about Corporation Taxation could change how companies allocate this cash.

The current tax code provides many ways for companies to deduct and capitalize expenses. There are essentially two types of expenses companies incur in operations. The first is Operating Expenses. These are expensed in the period they are earned. There is an equal cash impact. Example: The cost of electricity during the year was $1M, the company paid the utility company $1M, and when they do their taxes at the end of the year, they can deduct $1M from the taxable income since this is a cost of doing business.

These type of expenses help the company stay in business and also contribute consumption to the overall economy since the company is using these resources in the year.

The second type of expense is a Capital Expenditure. CapEx is big outlay for hard assets that have a depreciable life. IRS doesn’t typically allow a CapEx to be expensed in a single year but rather the asset would be expensed as depreciation over multiple years. An example would be if a company purchased a very expensive enterprise software for $50M. The IRS would only allow the company to depreciate $10M each year for 5 years since the software is expected to have a five-year usable life before another substantial investment would be required.

CapEx investment is real consumption from the economy’s perspective. A company sold something, payment was made, and ultimately the employees got paid and maybe the sales people who sold the deal got a big fat bonus. When people get paid, it can drive real consumption at the consumer level. And this can have a multiplier effect because the worker who got the bonus for selling the $10M software deal can now afford to go on a big vacation with his family, buy a new car, or help his son put a down payment on a house. So, CapEx has both a business consumption and a consumer consumption impact.

The stockpile of corporate cash off-shore could be used to make CapEx investments back into society to fund infrastructure projects that create access and opportunity for a greater segment of the poor and working class. Direct corporate investment bypasses the need for government spend and political support for Fiscal Policy. The key to making this happen would be to approach taxation in a new light. Instead of depreciating Capital Expenditures, Companies would be allowed to expense them in the current period. The incentive for business would be to spend and reinvest back into their business and society because CapEx has a multiplier effect on the economy by affecting both business investment and consumer consumption. In addition, the infrastructure programs I described would have a long term impact on consumer consumption as the poor and middle class have more opportunity to participate in building their wealth.

Rather than use the income statement to determine taxable income, companies would use Operating Cash flow less CapEx. This is also called Free Cash Flow. Free Cash Flow is what is left over after a company makes hefty investments into its employees, customers, and the sustainability of the business. On the other hand, Free Cash Flow does not include financial transactions like buy backs and dividends, which have little to no impact on consumption and business investment.

The other benefit of using Free Cash Flow to calculate business tax is to enable a simpler tax code that focuses on real economic benefit to society.

In conclusion, encouraging rich corporations to repatriate cash in a way that does not make them worse off financially and enhances the infrastructure of our economy to provide a stronger future for consumption and greater participation in the American Dream begins with a change in the tax law. Taxing the Free Cash Flow is better economic incentive for companies to figure out how to spend more on their people and sustain those businesses while also rebuilding the foundation for a strong economy.