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September 5, 2005

Corporate Tax Increase an Option?

Kazuhito IKEO (Professor, Keio University)

Excess saving is a global phenomenon. It means there is shortage of investment opportunities on a worldwide scale.

Such propensity is not new. It began in the 1980s when economies of developed countries were in their maturation processes. The trend was somewhat obscured during the 1990s when investment opportunities emerged, especially in the U.S., because of the IT revolution. But as the initial upsurge in the economy due to the IT revolution subsided, global over-saving again became a focus of attention.

A distinctive characteristic of current over-saving is that the excess is building up mainly in the corporate sector. In the case of Japan, corporate sector has constantly been net saver in the aggregate during recent years. Now this has become a global trend. Excess saving by the corporate sector is observed in most developed countries.

Perhaps the shortage of investment opportunities is the underlying cause, but excess saving by corporations may mean there could be a problem with their payout policies. This is because in the case of incorporated companies, free cash flow--which is the remainder of profits after investments are made--should be returned to investors.

It would not have been possible for the corporate sector to save if corporations had stuck to the policy of returning their free cash flow to investors, be it in the form of dividends or repurchasing their own shares, Corporations were able to save by holding on to their free cash flow, neither investing it nor returning it to investors.

One aspect of recent discussions about corporate governance refers to such behavior of corporations. A company holding on to its free cash flow is clearly acting in conflict with the best interest of investors. As such, investors attempt to strengthen their governance and retrieve cash held by companies. Corporations with distinctively large free cash flow are therefore prone to become targets of hostile takeovers.

It must be noted here, however, that investors are not the only people who have the right of claim on the profits of corporations. The government, in the way of power to levy taxes, also has certain rights.

In other worlds, excess saving by the corporate sector poses an issue of corporate taxation policy. The notion of increasing corporate taxes has been strongly opposed for the reason that it would have detrimental effect on the international competitiveness of domestic companies. But it may be worth revisiting the issue under the circumstances when corporations are preserving significant amounts of free cash flow.

The international competitiveness of a company is not determined by the level of corporate tax alone. It may not be possible to reconcile on a dollar-to-dollar basis, but on the whole, tax payments can be considered a cost for receiving services provided by the government. Lower taxes would naturally be preferable if the quality and the volume of services provided by the government are the same, but if the substances of the services differ the comparison is not so straightforward.

In fact, it is quite possible that there are demands for better services at higher costs. The bottom line is whether the services received are worth the tax paid - whether there is value for money. Although the government must first thoroughly review the services it provides - i.e. the rationale of its expenditures, this means the possibility of raising corporate taxes should not be precluded from policy options. Indeed, corporations need to recognize the government as one of their stakeholders along with investors.

(The original Japanese article appeared in the August 27, 2003 issue of Weekly Toyo Keizai)

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