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Economic Stimulus, Tax Breaks, and Corporate Liquidity

June 25, 2009

DURHAM, N.C. - Corporate tax breaks included in the recent economic stimulus package, formally known as the American Recovery and Reinvestment Tax Act of 2009, could add an estimated $20 billion of liquidity to the corporate sector in 2009, according to analysis by Duke University Finance Professor John R. Graham. 

Graham and Duke Ph.D. student Hyenseob Kim analyzed the extent to which U.S. companies could benefit from a provision in the stimulus expanding the use of  net operating loss carrybacks. This provision allows a company that is losing money today to spread today's loss backwards in time to profitable years, ultimately allowing the firm to obtain a refund for taxes paid on those previous years' operating profits.

Under the stimulus package, companies with revenues under $15 million per year are allowed to carry back operating losses incurred in 2008 to receive tax refunds for taxes paid at any time during the past five years, instead of two years as normally allowed under tax law.

Graham and Kim estimate companies could receive $20 billion in additional refunds under an extended carryback provision that is proposed in the Obama Administration's budget blueprint.  Likewise, allowing companies to carry back 2009 operating losses (an option not included in the stimulus package) could net an additional $33 billion in refunds.

"Whether companies are allowed to carry back only 2008 losses, or those incurred in '08 and '09, there would be a significant injection of liquidity at a time when corporate America is suffering for cash," Graham said.  "Of course, this is paid for by reducing corporate tax collections, increasing the federal budget deficit."

The pair predicts that companies in the home-building industry and financial sector would benefit most from the extended carryback provisions.

Although firms that received funds through the Troubled Asset Relief Program (TARP) are ineligible for refunds related to the proposed carryback extension, Graham and Kim calculated the hypothetical refunds those firms could expect if they were eligible.  They found that, based on 2008 losses, firms that received TARP funding could receive refunds of $53 billion if they were able to carry losses back over 5 years.  Based on forecasted performance in 2009, TARP firms (if allowed to use the five-year carryback provision) would be eligible for an additional $30 billion in refunds if the carryback provision were extended to included 2009 losses.

"The companies that benefit the most from the proposed carryback extension are those that paid substantial taxes during the past five years, and now are losing money hand over fist," said Graham. "TARP firms fit this description perfectly. Allowing them to carry back their current losses five years would essentially refund all the taxes these companies have paid since 2002. Of course, including TARP firms would be controversial because some would argue they contributed to causing the worldwide recession, so would it be fair to forgive all of their tax payments from their go-go profitable years?"

Graham and Kim presented their research, which was funded by the National Tax Association, at the association's recent symposium, "Tax Policy and The Economic Recovery."   Their paper "The Effects of the Tax-Loss Carryback Period on Tax Receipts and Corporate Marginal Tax Rates," is available for download from the Social Science Research Network.