How to Boost the Economy and Give Shareholders a $500 Billion Dividend

Congress has until Dec. 13 to come up with a budget; both parties want the U.S. economy to grow, while Democrats want increased revenue.

There is an untapped resource many aren't considering: the foreign earnings stockpiled on U.S. companies' balance sheets. While the last repatriation-tax holiday failed to stimulate the economy or generate much revenue, there's a better way to achieve both: Give the money directly to shareholders.

I propose a tax holiday that would lower the tax rate on repatriated earnings -- if and only if the repatriated earnings are paid out as dividends to shareholders before Dec. 31, 2014. That could easily put as much as $500 billion in shareholders' pockets. Read on to find out more.

Offshore earnings
The U.S. tax system creates incentives for companies to move their profits offshore and keep them there. Apple (AAPL 0.51%), Google (GOOGL 1.42%), Microsoft (MSFT 0.46%), and countless others use strategies with names like the "Double Irish" and the "Dutch Sandwich" to pay minimal taxes on their earnings. While many people don't like this, as a recent Senate investigation of Apple and Microsoft found, it's perfectly legal.

Companies have been sitting on cash from their foreign profits for years, because to bring it back to the U.S., they would have to pay a tax rate of 40% -- the second-highest corporate tax rate in the world. This cash would be repatriated into the U.S. if there was a repatriation tax holiday. The last one failed, but we can learn from it to stimulate the economy.

Repatriation tax holiday failure
The American Jobs Creation Act of 2004 produced the last repatriation-tax holiday in the U.S. Companies brought home $312 billion, with the top 15 companies making up 52% of that amount. However, the tax holiday did not stimulate investments and jobs.

The top paper on the effects of the American Jobs Creation Act, the National Bureau of Economic Research's "Watch What I Do, Not What I Say," found that "a $1 increase in repatriations was associated with a $0.79 increase in share repurchases and a $0.15 increase in dividends."

The majority of companies used the funds for share buybacks, rather than for investment, even though this was not allowed under the American Jobs Creation Act. Companies got around lawmakers' intent by using the repatriated money for investments they would have made anyway and using their U.S. cash for share repurchases. As tax experts at the Heritage Foundation wrote, "The evidence is clear that these repatriations did not produce the hoped-for subsequent surge in domestic investment."

A new repatriation-tax holiday that closed this loophole so that cash went to its intended target of dividends for shareholders (i.e., only dividends above 2013 levels would get the repatriation-tax holiday rate) would give a significant boost to the economy, as those investors are likely to spend their windfall.

Why dividends and not share buybacks?
While traditional economists treat special dividends and stock buybacks as the same thing, they are not.

As every investor knows, the price you pay is key. A McKinsey study found that companies typically buy back shares at high valuations and stop buybacks as prices drop. Valuations currently look stretched, so this is the wrong time for buybacks.

Millions of shareholders can better allocate money to its most efficient uses. Those who want to reinvest the cash can, while others could pursue more productive uses of the funds.

Second, buybacks are not stimulative to the economy. Financial economists and MBAs argue that buybacks are more efficient than dividends and that shareholders can create their own dividends by selling shares. In practice this doesn't happen as people have been taught to live off interest and to not consume principal.

While all money is money, mental accounting treats dividends as spending money while stock sales do not lead to more spending. A 2007 study on The Effects of Dividends on Consumption found that on average, households withdraw from investment accounts 33% of large special dividends and 77% of ordinary dividends, while capital gains are not associated with any withdrawals. Just ask yourself: When was the last time you spent a stock buyback?

Top 10
While excess cash is not the same as foreign earnings, the top 10 public companies, excluding financials, are sitting on roughly $290 billion of it.

Source: S&P CapitalIQ.

Looking at the top three, if Apple, Microsoft, and Google distributed all their excess cash to shareholders, for every share they owned, they would get one-time yields of 21%, 21%, and 11%, respectively. Instead of paying special dividends, what have these three done with their cash? Not much.

Apple has historically just sat on its cash, earning nothing. Last year the company initiated a dividend for the first time and now yields 2.4%. While activist investor Carl Icahn wants the company to initiate a $150 billion stock buyback, the stock looks highly valued, and a dividend would be a better way to distribute the cash to shareholders. Microsoft has also been sitting on cash for years, though it has also used its cash to make the questionable acquisitions of Skype and Nokia. Nearly 10 years ago, however, Microsoft entrusted its shareholders with a $3 special dividend for a one-time yield of 11% when the company was sitting on $50 billion. Now that the company has $59 billion, it would be great to see Microsoft's management return cash to shareholders again. Finally, Google saves its cash to spend on its moonshot projects. It's probably the least likely of the three to distribute cash: Although its founders only own 14% of the stock, they hold more than 60% of the voting rights in the stock and have publicly stated they want to use their cash for ambitious new initiatives.

How big could it be?
The total level of foreign earnings by U.S. companies, both public and private, is impossible to know exactly. However, a 2011 report from the Congressional Research Service put the level of all foreign earnings at nearly $1 trillion. Two years later, the actual number is now certainly higher. Giving even half that amount to shareholders as dividends would be a boon to the economy.

Now what
A repatriation-tax holiday for dividends to shareholders would stimulate the economy and generate an increase in tax revenue for the government through the tax on the distributions. Spread the news, everyone wins.