U.S. companies will soon experience a tsunami of free cash flow. Because of the new Trump-GOP tax plan—the Tax Cuts and Jobs Act—we estimate American companies will have over $2.6 trillion of additional cash over the next five years. This will come from three sources: repatriated overseas cash, future foreign earnings, and lower corporate taxes on domestic profits. The critical question is: What will companies do with this inpouring of cash?
For years, many CEOs of public companies have complained of pressure by analysts and activists to focus on short-term profits rather than long-term growth. Now each CEO has a great chance to put their money where their mouth is.
CEOs have two main alternatives for this incremental cash flow; they can boost short-term returns to shareholders through higher dividends and share repurchases, or they can augment long-term growth by investing in plants, people, research, and technology acquisitions.
For the sake of their credibility and the American economy, we urge CEOs to invest in long-term growth, and not in share buybacks as they did in 2004.
In 2004, Congress passed a tax holiday for the repatriation of foreign profits of U.S. companies then held abroad—at a 5.25% rate. As a result, nearly 1,000 eligible American companies decided to bring back to the U.S. $362 billion in foreign profits then held abroad. They then mostly spent that money on share buybacks, which decrease the outstanding number of a company’s shares and thereby increase earnings per share.
Under the new tax act, the incremental cash flow from repatriating past foreign profits is likely to be much higher—above $1 trillion over the next five years. The foreign profits of U.S. companies held abroad have increased dramatically—from approximately $600 billion in 2004 to over $2.5 trillion in 2017. In 2004, companies paid a repatriation tax on foreign profits only if they were brought back to the U.S. By contrast, the new tax plan assesses a repatriation tax on all foreign profits held abroad, so there is no extra tax cost for bringing them back to the U.S.
The future foreign profits of U.S. companies will total over $2 trillion during the next five years. Under the new tax act, these future profits may be repatriated to the U.S. without paying any additional U.S. corporate taxes. We estimate that American companies could reasonably allocate half of this total, or $1 trillion, to capital investments in the U.S.
Read the full post at Fortune.
Robert C. Pozen is a Senior Lecturer at MIT Sloan School of Management and a Senior Fellow at the Brookings Institution.
Robert K. Steel is the CEO of Perella Weinberg Partners and a former undersecretary of the U.S. Treasury Department.