It would only hurt business activity

Yon Kang-heum

The economic team is considering a penalty tax on companies’ excess cash reserves at the suggestion of the new deputy prime minister, who has promised “uncharted” stimulus to revive the economy. The idea is to redirect corporate earnings to households and stimulate domestic demand. It is not entirely a brainchild of the new finance minister. The opposition party last year introduced a bill to tax corporate reserves to promote capital investment. Despite the urgency to boost corporate investment and domestic demand, it is not wise to tax retained corporate earnings.

In principle, the earnings left after expenses - production and labor costs, supply purchases, depreciation, interest payment and taxes - should be returned to shareholders. The funds after dividend payments are assets for corporate growth. Companies can raise financing for machinery and facility investment through loans or bond and equity issues. But profitable companies stack away funds for future investment. Its own money is cheaper and safer than outside financing. Those with sufficient cash reserves can grab investment chances when they come along. Solid liquidity also helps protect management integrity. It could be used later to compensate shareholders when companies incur losses and run into problems.

It is naive to believe that a tax on companies’ cash reserves would improve household income and stimulate consumption. Forced dividend payouts can only weaken the capital base and investment affordability, and weigh on stock prices. Corporate share prices gain only when investors have faith in the business prospects of a company and see greater dividends from corporate growth. Moreover, institutional investors such as the national pension fund, insurers and mutual funds make up the bulk of corporate ownership and do not increase spending because dividends increase. Instead, foreign investors - another group of major stakeholders - will likely take their extra cash back home or elsewhere.

Tax revenues could increase from the new levy, but nevertheless at a cost. The tax would be levied on cash reserves of a certain level if they are not returned to shareholders. If dividends are paid out, a tax would be levied on them. Whether they pay taxes or shareholders, companies lose some ability to invest in the future. Future growth and profits would be at risk. Competitiveness could weaken if they have to finance through debt or new share issues to make new investments because they are short of their own funds. Worse, they could pack up and move abroad.

Companies are double-taxed because they pay twice on their earnings - in corporate taxes and in dividend payouts. To tax cash reserves that could be used to pay shareholders is also a tax on future payouts. In the end, companies would be paying multiple taxes on same earnings. Increased taxes only dampen the corporate and consumer spending appetite.

The government also cannot be the judge in deciding how much cash a company needs. Companies must have cash available for not only business operations such as cash settlements and wages, but also to buffer unpredictable business challenges or opportunities. Companies all have different reasons to retain different amounts of cash.

Cash reserves are the result of hard corporate work. It is unfair to force companies to reduce them for the sake of plans to help improve the household economy. At the end of the day, both companies and consumers will feel constrained to spend as they wish. What is needed is incentives and deregulation to encourage corporate investment. Companies should be willing and eager to open their bankbooks to invest because they see opportunities and promising business prospects. Only in this way can employment and domestic demand grow in a healthy and productive way.

Translation by the Korea JoongAng Daily staff.

*The author is a professor of business administration at Yonsei University.

BY Yon Kang-heum