April 17, 2002
How many corporate decision makers are aware that an economic stimulus package recently was signed into law that provides substantial benefits for investment expenditures and aids the cash flow of corporations? Indeed, how many investors are reacting to the benefits provided by this package?
I raise these issues because of a discussion I had with a tax advisor who is finding blank stares when he discusses the change in tax law with corporate decision makers. To be sure, they want the most tax efficient accounting practices.
But little thought has been given to changing investment decisions as a result of the tax changes.
If the accelerated depreciation and the recapture of previously paid taxes against current losses in that law were permanent, such reluctance to consider the law would be understandable. Investments must have an economic purpose, not just a tax advantage. Empty buildings will not be filled just because depreciation charges can be written off rapidly.
However, the investment incentives soon disappear. Therefore, if investment makes economic sense soon, it makes tax sense now.
Perhaps, few are considering the significance of the tax stimulus package because most economists, including myself, feel that tax stimulus legislation no longer is needed. An economic recovery is underway. Inventory liquidations went too far during the fall, causing the warehouses to become depleted at too rapid a rate.
At current sales levels, inventories remain excessive. However, just as a space ship must slow long before reaching its destination if it is to dock safely, this economy needs to reduce the rate of liquidations or we will soon have too few inventories.
By making some sales from current production instead of meeting all orders out of existing stock, production must rise. The extension of the manufacturing workweek last month, increases in railroad activity, more truck traffic, and the rebound in industrial production all indicate that more goods are being produced.
Normally, such activity should soon lead to more pay checks, or at least fatter ones because of increased overtime hours. This, in turn, will aid consumer spending.
As factories slowly become more active, there will be increased demand for lower cost production capability. Investments will slowly rise. Thus, the economic recovery will provide enough incentive to stimulate investment spending.
Nevertheless, the $30 billion in reduced tax liabilities for companies making those investments soon should not be ignored. After all, the purpose of the stimulus package was to change investment behavior, not just reward those who would invest anyway.
To be sure, the package only changes after tax profits by about 7 percent and only for a limited time. That 7 percent reduced tax burden may not be large enough to offset the risks faced in a weak economy. However, it is more than ample to encourage investment decisions to be made sooner rather than later.
Not only are investment committees ignoring the impact of the stimulus package on their investment decisions, but investors also appear to be less than enthusiastic about the impact of the tax package on corporate valuations.
Certainly, a temporary tax change should have only limited impact upon the valuation of future income streams. However, greater capital accumulation, especially if that capital is providing low cost opportunities, should have some long term impact upon company values.
As far as I can see, stock values have not reflected any of the potential gains that the tax stimulus package will deliver. Of course, if corporate America takes the tax reductions but does not add the cost efficient capital, then such stock market behavior is appropriate.
If investment activity rebounds sooner than normally expected in a recovery because of the stimulus package, then stronger gains than currently reflected in stock values should develop in the next few months.
Hopefully, corporate decision makers will begin to realize that these tax benefits lead the way to economic benefits. When they do, and I expect they will, then higher stock market valuations may become a safe bet.