Study Calls into Question Impact of Tax Holidays

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The allure of some sort of tax holiday on repatriated earnings, which I covered in this blog back in June 2011, remains strong. In October, members of the House of Representatives' Democratic Blue Dog Coalition, a group of fiscal conservatives, added their support behind H.R. 1834, or the “Freedom to Invest Act of 2011,” as this article from the Win America Campaign describes. The legislation would, among other things, extend the election allowed to a U.S. corporation to deduct dividends received from a controlled foreign corporation.

In a letter to the members of the Joint Select Committee on Deficit Reduction – the now defunct “Super Committee” – the Blue Dogs also stated, “As you consider tax reform, we urge you to include a temporary change to the tax code that allows businesses to repatriate money trapped overseas as part of reform or as a bridge to comprehensive reform.” The letter went on to say that “experts agree that temporarily lowering tax barriers will bring earnings back home, and therefore strengthen our economy.”

However, some experts are reaching different conclusions. New research by Lillian F. Mills, professor at the University of Texas at Austin, Susan M. Albring, assistant professor at Syracuse University, and Kaye J. Newberry, a professor at the University of Houston, casts doubt on the ability of tax holidays to affect significant change to many companies' repatriation plans. Their study, “Do Debt Constraints Influence Firms' Sensitivity to a Temporary Tax Holiday on Repatriations?” appears in The Journal of the American Taxation Association.

The professors examined the actions of 421 U.S. multinationals with permanently reinvested earnings after the passage of the American Jobs Creation Act of 2004 (AJCA). The AJCA temporarily reduced taxes owed by American multinational corporations on foreign earnings from 35% to 5.5%. The change resulted in the repatriation of an estimated $312 billion, according to the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research and practice.

However, the researchers found, perhaps not surprisingly, that firms with fewer financial covenants in their debt agreements, as well as those with greater access to the public bond markets, repatriated significantly more of their eligible funds. “Our results suggest that U.S. multinationals with greater access to external debt markets have more flexibility to time their repatriations around a tax holiday and, as such, they are the primary beneficiaries of any tax savings,” they write. In other words, “the average repatriating firm in our sample is a firm with few debt constraints.” Many simply were more credit-worthy: 25% of the tax holiday repatriators had bond ratings of A+, A or A-, compared to only 7% of the firms that didn't repatriate earnings.

That's not to suggest that the firms that did repatriate their funds did anything wrong. However, as the professors note, it's “unlikely that these firms were the intended target of the AJCA 2004, given the stated legislative goals of directing repatriated funds towards financial stabilization and previously unfunded positive return investments.” Instead, mature firms – many of which would have had the means to invest and create jobs even without the legislation – were more likely to be the primary benefactors of the legislation.

To be sure, the corporate tax code needs significant reform – it's needlessly complex and filled with loopholes. Rather than spend time and energy implementing a tax holiday geared to a relatively small subset of companies, and whose benefits are questionable, better to work on more permanent, broader-based simplification.

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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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