Is it Time for a Tax Repatriation Holiday?


A movement is underway to get corporate America to return the $1 trillion that some estimate U.S. companies have stashed overseas. Last month, representatives Kevin Brady, Texas Republican, and Jim Matheson, Utah Democrat, introduced The “Freedom to Invest Act of 2011.” The Act (H.R. 1834), which was referred to the House Committee on Ways and Means, would amend the Internal Revenue Code to allow U.S. corporations to deduct dividends received from a controlled foreign corporate from either the last tax year beginning before the Act is enacted, or the one-year period beginning once the bill is passed. However, companies would be fined $25,000 if they failed to maintain specified employment levels.

The legislation has garnered the backing of a group called Working to Invest Now (WIN) in America. Supporters of WIN America include both companies, such as Adobe, EMC Corporation, and Pfizer, as well as business groups like the Business Software Alliance and the Telecommunications Industry Association. “It is always a welcome sign when Democrats and Republicans come together to put forward ideas that strengthen our economy, support innovative American businesses, and put our country on sound financial footing,” said Karen Olick, campaign manager with WIN America, in a release.

“For U.S. companies, such repatriation of earnings carries a significant penalty: a federal tax of up to 35 percent,” wrote John Chambers, chair and CEO of Cisco Systems, and Safra Katz, president of Oracle, in an October 2010 op-ed in the Wall Street Journal. In contrast, almost every other developed country, including Germany, Japan and Canada, impose tax rates of just zero to two percent on repatriated earnings, they say.

As any taxpayer knows, the U.S. tax code is a mess: burdensome, convoluted, confusing, and too easily manipulated by those who have the means to do so. However, it's not clear that a tax repatriation holiday would provide the benefits to the economy that its supporters claim. A 2009 study by the National Bureau of Economic Research, “Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act,” looked at the results of a one-time tax holiday on the repatriation of foreign earnings, which was part of the Homeland Investment Act. The Act was intended to create more than 500,000 jobs over two years as a result of increased investment in the U.S. Indeed, U.S. multinationals repatriated about $300 billion in 2005, up from an average of about $60 billion over the previous five years. However, the researchers found that a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders.

Some supporters of another tax holiday, such as WIN American, point to other studies that show tax repatriation holidays do help create jobs. One is a 2008 study, “Macroeconomic Effects of Reducing the Effective Tax Rate on Repatriated Foreign Subsidiary Earnings in a Credit- and Liquidity-Constrained Environment,” by Allen Sinai at Decision Economics. This study looked at the funds repatriated as a result of the American Jobs Creation Act of 2004, which provided an effective tax rate of 5.25 percent, (versus the normal 35 percent) on repatriated funds. Companies used the funds for capital investment (24 percent), to hire and train U.S employees (23 percent) and for U.S. research and development (15 percent), the study found.

A footnote in Sinai's study addresses the findings of the NBER and other studies that showed the tax holiday resulting in large amounts of share repurchases. While acknowledging that share repurchases may have violated the intent of the Homeland Investment Act, as the NBER study itself states, “presumably these shareholders either reinvested these funds or used them for consumption. Either of these activities could have a substantial effect on growth, investment and employment.”

OK, so returning money to shareholders may boost their bank accounts or prompt them to go shopping. There's nothing wrong with that, but it's not going to provide the types of jobs that, say, expanding a factory might.

As the Sinai study also notes, if the companies didn't have decent investment opportunities here, returning the cash to shareholders made sense. At the same time, if the companies lacked investment opportunities, one might question the rationale of a policy intended to get them to invest.

There's also a concern that companies will grow to depend on tax holidays, and keep money overseas until the next one rolls around.

Rather than ride a roller coaster of high nominal corporate tax rates that then give way to tax holidays, why not a simpler tax code that works reasonably well for large companies and small firms, all the time? The National Commission on Fiscal Responsibility and Reform recommends a single corporate tax rate of between 23 and 29 percent, eliminating tax subsidies for specific industries and moving to a territorial tax system, in which income earned by foreign subsidiaries and branch operations would be exempt from domestic corporate income tax. These ideas deserve more attention than they're getting.

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Karen Kroll supplies the Business Finance community with reporting and commentary examining cash management and treasury-related topics.

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