With the U.S. economic recovery stuck in low gear and traditional monetary and fiscal policy options seemingly exhausted, now is a good time to consider more novel approaches to stimulating growth. In particular, Congress should consider tax policy changes to prod corporations to put some of their remarkable cash hoards to productive use.

Estimates of the cash held by U.S. public corporations easily exceed $1 trillion; several technology companies alone are sitting on cash balances in excess of $20 billion. These balances are thought to result from the absence of investment opportunities or from indecision among corporate executives. Once such indecision becomes widespread, it can quickly become self-reinforcing. Recent record corporate profits will only exacerbate this situation. If chief executives and chief financial officers are goaded into spending that cash, the economy could benefit from a significant stimulus that, unlike stimulus measures relating to government spending, would stem from decentralized actors responding to private information and incentives.

Consider the potential effects of a temporary 2 percent tax on corporations’ “excess” cash holdings. The definition of excess cash holdings will be critical. But such levels easily could be defined relative to industry benchmarks from periods that featured more standard corporate savings behavior.

Implementing a temporary 2 percent tax on corporate cash would require measures to prevent some unintended consequences. A large fraction of corporations’ excess cash — as much as two-thirds, according to some estimates — is held outside the United States to avoid the “repatriation taxes” that occur under the U.S. system of worldwide taxation. Simply put, multinational firms currently have an incentive to keep money abroad.

A temporary holiday of the repatriation tax coupled with the tax on excess cash holdings would help ensure that the disgorged cash would be used productively in the United States. Coupling these policies provides a carrot and stick for managers to begin to repatriate cash and use it productively at home. The combined revenue effect is likely to be relatively small.

Ideally, firms would invest their excess cash funds in new projects in the United States and avoid the 2 percent tax. President Obama’s proposal to allow for immediate expensing of investments could help ensure that firms were tilted toward spending that excess cash on new projects within the United States. A reduction in the corporate tax rate that would bring the U.S. rate in line with worldwide norms would also help enormously in directing these cash hoards toward investment. But even cash disgorged through dividends, share repurchases, or mergers would have a potentially stimulative effect compared with corporations banking the funds.

It is tempting to pin hopes of an economic recovery on a centralized effort or another significant program by the Federal Reserve. But a remarkably large pool of unmobilized capital is sitting within our firms, and managers appear frozen in their decision-making. A gentle nudge to break this coordination failure — through the combination of the fiscal carrot and stick described above — could shake managers out of their indecision and provide a privately directed, revenue-neutral stimulus that could eclipse the effects of any potential stimulus that could emerge from Washington today.

— Mihir A. Desai, the Mizuho Financial Group Professor of Finance and senior associate dean for Planning and University Affairs, teaches financial management at HBS. Reprinted with permission from the Washington Post, December 10, 2010. All rights reserved. Edited for space.

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