Corporate Finance

Tax Reform’s Success Hangs On Capex, Expert Says

If the U.S. Tax Cuts and Job Act doesn’t push companies to invest more in capex, a “stagflation scenario” could ensue.
David KatzFebruary 2, 2018

The real test of whether the Tax Cuts and Jobs Act succeeds in its goal of driving economic growth will be whether U.S. companies step up their sluggish capital expenditures, according to a leading expert in cash-flow accounting.

Charles Mulford

Charles Mulford

“We need to have longer term investment in capex beyond the flashy, fiery announcements of bonuses and the like — that’s not what we want,” says Charles W. Mulford, a Georgia Tech accounting professor who directs the university’s financial analysis lab. “We want significant investment in capital assets. We need to see the capital assets that were used up during the recession replaced going forward.”

If companies don’t shift substantial amounts of their capital allocation from share buybacks and dividends to investments in plants and equipment, “then this whole big plan of what tax reform was supposed to do is not going to work,” Mulford said in an interview. The interview followed the release earlier this week of the lab’s report on cash-flow trends at 2,599 public non-financial companies during the third quarter of 2017. (The results don’t reflect company responses to the new tax law, which was enacted on December 22, 2017.)

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“If it doesn’t work, we will have higher deficits. We won’t have higher growth and higher productivity. We would then have a stagflation scenario,” he added.

But one aspect of the new law represents a policy that should boost capex, according to Mulford, who co-authored the cash-flow report with graduate research assistant Mark Jacobson. That’s the provision enabling many companies to boost the portion of the cost of certain kinds of business property that companies can immediately claim as an expense from the previous rate of 50% to 100%.

“The ability to expense fixed assets at purchase for tax purposes gives a big tax incentive to spend,” he says.

An intangible effect of the new law, the buildup of “animal spirits,” should have a marked effect on increasing capex, according to the professor. “I think we’re standing right at the edge of higher capital spending,” Mulford says.

Still, the lab’s research provides reason for skepticism.  Despite steadily rising corporate revenue, capital expenditures have declined from 3.96% of revenue in September 2016 to 3.70% in September 2017. During that period, median revenues rose 12.8%, to about $1.2 billion.

Companies’ also showed a pronounced tendency to sit on their liquid assets through the third quarter of last year. Median cash and short-term investments grew to $153 million, the highest total since at least 2000, according to the report.

During the 2008 recession, companies, strapped for revenues and earnings, understandably kept a close hold on their liquidity. “But we have yet to see companies replace the lower capital spending that occurred during the recession,” Mulford said. “And companies are carrying significantly high levels of cash and short-term investments on their balance sheets.”