If I had to make a short list of the dumbest policies that prevent the United States of America from reaching its full economic potential, one of the top spots would be dedicated to the self-destructive taxation on repatriated earnings that force wealth into the silos of other countries rather than permitting an efficient use of the capital back home here in America.
The New York Times points out the absurd games that companies play to avoid a 35% repatriation tax:
More than a trillion dollars in cash and short-term investments sits in offshore holding companies, awaiting a repatriation tax holiday. In the meantime, tax professionals spin out ways to manipulate the system.
The tax code provides multinationals based in the United States with many incentives to shift income to foreign low-tax jurisdictions. In theory, American corporations are taxed at 35 percent on their worldwide income. But income earned by an active controlled foreign corporation is not usually taxed until the cash is repatriated to the parent company in the United States as a dividend.
Many multinationals use transfer pricing (the pricing of goods and services sold between affiliates of a parent company) to minimize their global tax rate. After transferring intellectual property to low-tax jurisdictions like Puerto Rico, Ireland and Singapore, companies manipulate licensing and cost-sharing arrangements to avoid or reduce United States taxes. Cash from global operations is then parked offshore until the tax professionals can figure out how to get it home tax-free.
Microsoft, for example, now holds more than $50 billion in foreign cash, cash equivalents and short-term investments. Apple holds more than $100 billion in foreign cash and investments — an amount roughly equivalent to the gross domestic product of Vietnam.
It’s hard to fault companies for acting rationally; do you think you would get far as an executive if you suggested taking $10 billion in Ireland, and bringing it back to the United States as $6.5 billion to invest here? Even if that is what you would personally do, you can surely understand the perverse nature of our tax code’s incentive structures that discourages American multinational corporations from taking money that is made “over there” and bringing it back here. If you’re Johnson & Johnson, and you need to build a new facility to manufacture Tylenol, and you need to use your U.S. generated cash to make dividend payments, are you going to build that facility here or in Ireland where you got a couple billion dollars sitting in the bank?
The U.S. Treasury isn’t getting the money anyway; they might as well eliminate or sharply reduce the tax altogether so that way they can reap the benefit of money flowing back into the United States. The last time we did this was in 2004 with the “American Jobs Creation Act” that granted a repatriation tax holiday.
When that happened, Pfizer brought back $35 billion to make acquisitions of American firms. Merck brough back $15 billion, about 80% of which was used for acquisitions and 20% of which was used to invest in new labs for American research. Eli Lilly and Bristol Myers Squibb brought back $17 billion to reduce debt, make acquisitions, and add to new research facilities. Procter & Gamble brought back $6 billion to make a massive buyback that greatly increased earnings per share (as an aside, people critical of repatriation holidays criticize companies for this maneuver, saying it only “benefits shareholders.” That net effect does not bother me—what do you think causes your 401(k) balance to go up? Where do you think pensions get their money to pay out to retirees? And even if you don’t have a 401(k) with a standard mutual fund investment or a pension plan, you could get your hands on P&G stock for as little as $50 per month, with no fees attached at all at the time this went into effect in 2004. And, of course, that leads to higher spending in the U.S.: do you think people spend more with a $2 million 401(k) balance heading into retirement or a $700,000 balance? If you answer the former, then why ridicule the method (increasing earnings per share due to buybacks) that leads to the increased wealth that provides opportunities for greater spending here in the U.S.?)
Yes, all else equal, I’d like to see jobs created in factories, research facilities, and so on, compared to stock buybacks. But I would prefer stock buybacks to the creation of artificial, super short-term jobs that mislead folks into thinking that they have found permanent employment only to be let go during the next whiff of an economic decline or lower product demand. Jobs created with a charitable purpose have a tendency of not lasting, and I’m not convinced that job creation without a commensurate demand for the particular job leaves the civilization better off for the long-term than stock buybacks (on the other hand, jobs not created by management because growth is “risky” compared to the sure-thing of buybacks is a net detriment to the civilization).
It’s been ten years now since the last repatriation holiday, and it seems we should do it again (or better yet, reform the whole thing to properly align incentives in the tax structure to remove the 35% tax burden from discouraging capital flow to the United States). Some of it will be used for stock buybacks, which will increase earnings per share and allow stock prices to climb (so when you sell the stock, you can buy more American goods). Some of it will go towards dividends, which will either get spent here or used to buy more stocks (thus increasing the demand for particular stocks and increasing its prices). Some of it will be used for debt reduction, so companies will be more free to invest U.S. generated profits for growth rather than long-term debt payments. Some of it will be used for job growth, thus strengthening the United States economy in an organic way. A lot of good things start to happen when you get billions of dollars swirling back into the United States again.