Recent weeks has brought much chatter — from both Republicans and Democrats — about offering companies a temporary tax holiday for repatriating foreign earnings. A typical proposal would effectively tax any repatriated earnings at 5.25% this year, rather than the usual rates which can be as a high as 35%.
Proponents tout this as a form of economic stimulus. But, as my Tax Policy Center colleagues Bill Gale and Ben Harris point out, that’s doubtful. In “Don’t Fall for Repatriation” at Politico, they say:
In addition, firms are unlikely to invest the repatriated funds. Congress passed a similar repatriation tax holiday in 2004 and required firms to create domestic jobs or make new domestic investments to get the tax break. Nonetheless, the firms, on average, used the tax break to repurchase shares or pay dividends — not to increase investment.
The holiday, instead, turned into a massive tax break for shareholders — resulting in little or no economic gain or job market expansion. Why? Because money is fungible, to satisfy the requirements of the law, corporations reported repatriated funds as the source of money for investments or jobs they would have created anyway — and used other funds to increase shareholder wealth.
Today, domestic firms are sitting on near-record levels of liquid assets. The reason they’re not investing or creating more jobs is not a cash shortage.
Bill and Ben also note the costs of a repatriation holiday:
First, allowing repatriation today means less taxable corporate profits in the future — which would translate into less government revenue.
Second, and perhaps even more costly than the lost revenue, would be the dangerous precedent that firms would expect regular repatriation holidays. This expectation may persuade firms to hoard profits overseas and perhaps even move production abroad, betting that Congress will eventually grant another “one-time” tax break.
Indeed, the prior tax holiday was supposed to discourage firms from holding profits overseas. But instead, firms stockpiled new reserves, presumably in anticipation of another holiday. The Joint Committee on Taxation estimates that these two factors would contribute to the $79 billion 10-year price tag on a second repatriation.
So I wonder what the shareholders are going to do with the extra income from dividends or stock buybacks funded from repatriated funds?
Eat the money for dessert?
Of course not. They are going to either consume it, which stimulates the economy, by increasing demand or they are going to reinvest it, which is the original reinvestment goal of the repatriation holiday in the first place, just done by the shareholders rather than the original company.
Apparently the authors of this article simply can’t understand that perhaps the reason these companies are sitting on the cash is *because* the 35% tax rate is simply too high.
Corporations stockpiled new reserves after the previous holiday for the same reason they did before the holiday–paying 35% in taxes is simply too much.
How about just cutting US corporate tax rates down to the international average? Won’t that improve US company competitiveness and increase hiring in the US? Isn’t that what so many people desire, after all?
“A typical proposal would effectively tax any repatriated earnings at 5.25% this year, rather than the usual rates which can be as a high as 35%.”
Marron largely parrots the language in the original Politico article:
“Repatriation could allow a large proportion of foreign profits — probably 85 percent — to be distributed tax-free to the U.S. This would essentially reduce the effective tax rate to just 5.25 percent from 35 percent”.
But, is that so? Both these statements are misleading and I think the issue deserves a closer examination.
It’s true that the statutory rate of US tax on repatriated dividends is the ordinary corporate rate of 35 percent. It is also true that the 2004 repatriation provision allowed (subject to numerous restrictions) 85 percent of such dividends to be excluded from the US tax base. Thus, in a sense it would be correct to say that the effective *statutory* rate of tax is 5.25 percent, but it would not be correct to simply say this is the “effective tax rate”.
When one speaks of the “effective rate of tax” one normally refers to the rate of tax on gross income after allowances for deductions and credits to determine that tax. Thus, in that sense and in this example, the US “effective rate of tax” would be anywhere from zero to 5.25 percent, depending on the foreign tax credit allowed.
But, in this context, this is also not the appropriate measurement. Dividends paid to a US parent from its foreign subsidiary are “grossed up” to an amount equal to the cash dividend received plus the foreign withholding tax, if any, and the underlying foreign income taxes paid with respect to the earnings that supported that dividend. Thus, if there is a cash dividend of $65 and the withholding tax and underlying foreign tax was $35, the US taxable income is $100, the tentative US tax is $35, the foreign tax credit is $35 and the “effective US tax” is zero.
The only sensible way to look at the issue is to compare the amount of US tax that would have been paid under normal US tax rules and the tax to be paid with the special repatriation rules. This is not the difference between 35 percent and 5.25 percent as both writers suggest. In most cases the difference will be much lower. Economists are not always prone to consulting the Code, Regulations or other IRS guidance before making their broad claims, but in this case they should have referred to IRS Notice 2005-64, which gives a comprehensive example of how the prior repatriation provision worked. Importantly, the cost of taking that 85 percent dividend received deduction is a permanent loss of foreign tax credits that would otherwise have been available with respect to those excluded dividends.
http://www.irs.gov/irb/2005-36_IRB/ar09.html#d0e1621
Arguably, the best way to look at this is that under current law the “effective US tax” is zero. That is because with respect to foreign earnings to low foreign taxes, the US tax take (and indirect economic benefit) is zero. US companies will never bring those earnings back because the disparity between the US statutory rate of 35 percent and the foreign effective rate is too high and the cost therefore too prohibitive. That’s why they don’t take a deferred tax liability on their financial statements for the potential costs of repatriation. Without reforming how we tax US companies on their foreign income, those earnings will just stay abroad. This does nothing to reduce the US deficit in terms of money—or jobs.
“The Joint Committee on Taxation estimates that these two factors would contribute to the $79 billion 10-year price tag on a second repatriation.”
I wonder if the authors could point us to the source of this claim?