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Is Heritage Right About Repatriation?
This week, JD Foster and Curtis Dubay from the Heritage Foundation wrote an article arguing that repatriation was a bad idea right now. ATR disagrees with this (and this seems to be a departure from prior Heritage Foundation policy on this, as well). Below are our reasons why:
What Is Repatriation? Under U.S. tax law, a company that earns a profit overseas must, in general, pay income tax to the overseas government AND to the IRS if they bring the remaining profit back to the U.S. The company gets a credit for the foreign income tax paid, but the difference between the foreign tax and the U.S. 35 percent rate must be paid to the IRS. In practice, deferrals and other tax rules allow companies to keep foreign after-tax earnings locked overseas, but that money generally remains unavailable to be used in the United States.
This is known as a "worldwide" tax system. All conservatives agree that we should move toward a "territorial" tax system, which most of the developed world already uses. Under a territorial system, the IRS would only seek to tax those profits earned in the United States. U.S. companies with foreign-source profits would be free to leave those profits overseas or bring them home without any further tax consequences.
The U.S. tried repatriation recently. In 2005, companies were allowed to bring back foreign source profits at a tax discount. Rather than having to pay the difference between the foreign tax rate and the U.S. tax rate of 35 percent (tied for highest in the developed world), the companies instead could pay a de facto repatriation tax rate of 5.25% to the IRS--a bargain in most cases. Over $300 billion was repatriated that year under this arrangement. Given the relative size of overseas profits accumulated today, it's reasonable that this number could be twice as high this time.
Foster and Dubay are probably correct about the cost of capital issue. In their article, Foster and Dubay point out that U.S. companies already have trillions of dollars in cash sitting on their balance sheets, ready to be deployed at no additional tax cost. Even companies that don't have this liquidity could borrow at rates approaching 0 percent after inflation. It's unlikely that repatriation will be just what companies have been waiting for on the margin to build that next factory or invest in that new technology. They can today, and they are not.
However, as I will argue below, repatriation is still very much worth doing for the following reasons:
Opposing repatriation because it isn't territoriality is making the perfect the enemy of the good. Foster and Dubay point out that a repatriation holiday only affects yesterday's risk decisions, represented by the after-tax earnings sitting overseas. They argue that since economic growth going forward happens on the margin (in the future), that territoriality won't help.
That's only true if repatriation happens once and never again, and comes as a bit of a surprise when it does. If businesses are expecting a repatriation opportunity at regular intervals (say, if repatriation becomes an extender, which is a goal of repatriation advocates), the de facto permanence of it will begin to affect economic decisions on the margin. Certainly, this is less ideal than a permanent repatriation law, or permanent territoriality. But it's a lot better than simply perpetuating worldwide taxation hoping for international tax reform to ripen one year.
A good analogy to this might be opposing a one-year 100% bonus expensing because you're in favor of permanent full business expensing. While the analogy isn't perfect because both of those impact investment at the margin, the political realities are similar. Take an imperfect half a loaf.
Companies will want to remain as capital-rich as before. Foster and Dubay point out repeatedly that companies have the capital to do mergers and acquisitions, capital investment, etc. today. The reason these companies have so much cash on the books today is likely the uncertain environment policymakers have put them in. They have no idea what Obamacare, Obama's regulatory efforts, trade bills, or even tax law will be. As such, they are doing what any confused and rational actor would do--sit it out and wait. Capital is on strike.
This won't change because of repatriation. They will still want to keep a lot of cash on the sidelines. However, the repatriated funds will be in addition to this cash, meaning that companies will be able to take risks with capital without changing their pre-repatriation cushions of security. It's certainly possible that companies could pad their cash on hand with the repatriated money, but it's equally likely that they will use the windfall to deploy investments. We simply don't know, but why not give companies that chance?
What's wrong with increasing shareholder value? Foster and Dubay point out that in the 2005 round, much of the repatriated funds found their way into stock buybacks (which increase the price per share and give investors unrealized capital gains) and dividends (which are direct cash payments to shareholders).
As if this is not a very, very good thing.
A shareholder invests in a company because he wants to make money. We as a country want shareholders to do this, since their delayed consumption means that the seedcorn of future investment is grown. The more we save and invest, the wealthier we will be over the long run. When the rate of return on an investment grows (by capital gains building up or the dividend yield rising), this incentivizes more people to invest rather than consume. The same is true when reductions in the capital gains and dividends rate increase the after-tax rate of return on stocks. Even if every penny of repatriation went to shareholders, that would be a huge net benefit for the U.S. economy.
The worldwide regime is simply unfair, and anything done to improve it is better than doing nothing at all. This is the key point of difference between ATR's position on repatriation and Foster/Dubay. We would argue that the worldwide double taxation regime is horrible, and so would they. Where we depart is in determining what is an acceptable solution.
We all agree that this problem is created by a vise-affect of two things--the U.S. marginal tax rate on corporate income is tied for highest in the developed world, and we make companies "plus up" to our rate when they bring foreign profits home. We would each agree that direct improvements to each side of this vise is ideal.
For the rate, it should come down to a level of about 20 percent, which would put us at the Eurozone average (when state corporate rates are factored in, as they must be in international comparisons).
For the international tax treatment, we should either have perpetual repatriation, or a switch to territorial taxation.
Where we disagree is that ATR believes that a less attractive solution to the international tax treatment--a one year repatriation holiday--is also worth doing. It would give companies something close to the tax treatment this money should have. Furthermore, there is every reason to believe that policymakers would continue the practice in extender bills (just as President Obama has endorsed a continuance of 100 percent "bonus depreciation," and just as Congress routinely increases Section 179 expensing for small businesses.)
In short, why not? What's the downside? If this is what is achievable, let's go for it. We can continue trying to lower the rate and improve the international tax treatment on a more permanent basis at the same time.
To use another issue area, expanding IRAs is not the enemy of lowering the capital gains rate. Both are aiming at the same thing--ending the double taxation of shareholder investment. But you can work on both projects at the same time, sometimes pushing one, sometimes pushing the other. Repatriation is to IRA expansion as territoriality is to eliminating the capital gains tax.
UPDATE: JD Foster from Heritage wanted to clarify that Heritage is not actively opposed to a repatriation holiday. However, their belief is that it would be an ineffective tax cut for the creation of jobs or to provide incentives for future economic growth.