Taxation Tuesday: Repatriation Games

Or, “Incorporate in Anguilla!” 

The United States doesn’t have a territorial tax system, meaning federal tax is collected on American income throughout the world, not just income earned within its borders.

There is one notable exception to that: corporate income earned overseas, as long as that money stays overseas. Here’s how it works mechanically: A U.S. corporation forms a foreign subsidiary. That subsidiary pays income taxes in that foreign country. (This is why lots of American companies have Irish subsidiaries, as Ireland has super low taxes.) The remaining profits are either reinvested in the subsidiary, or taxed when they arrive back in the United States. The thing is, there’s no deadline on when that money has to come back. This is called deferral. Passive income—dividends, interest, etc—is not deferrable, but regular corporate profits are.

Deferral has existed since 1909, when the corporate income tax was created. It’s also expensive, with trillions in American profits parked overseas. The criticism is basically that these corporations are stealing, because if they dumped that money back in the United States it would get smacked with at 35% rate (now bumped down to 21%). That being said, deferral as a general concept isn’t going away. Its main justification is competitiveness: foreign corporations who didn’t pay domestic taxes in the same way would be able to dunk on American companies. It’s thematically in line with why Middle Eastern airlines are so much better than American ones—they are paying way less to play in the same sandbox, because of the level of government support. Not everyone agrees with this. Arguments about the value of deferral tend to devolve into arguments about outsourcing, because any normative discussion about what giant companies should and shouldn’t be doing is focused on jobs, and because deferral is a necessarily foreign-focused concept. The ideas are related, but distinct.

A lot of economic policy is focused on connecting the dots about what companies could and should do down the line, but deferral is the first step: one plan involves paying no taxes; one plan involves paying taxes. So. There’s a lot of corporate money that isn’t being washed through American systems, but policymakers have so far been disinclined to hamstring the multinational corporations that prop up the worldwide economy. This is where the idea of repatriation holiday comes in.

The recent history of the “repatriation holiday” has three chapters: first, the total mess of 2004. Second, President Obama’s failed attempt. Third, the version contained in the current tax reform.

The Homeland Investment Act

In 2004, Congress passed the Homeland Investment Act, which gave a one-time break on deferred profits, lowering the tax rate to 5.25%.  It purported to restrict what that money could be used on once it arrived back in the United States—for example, no stock buybacks or increased dividends. Instead, the money was supposed to fund R&D and job creation. Well. Companies brought about $300 billion dollars back to the U.S., but none of that happened. Without accusing them of violating the law, the comprehensive study linked above, by Dhammika Dharmapala, C. Fritz Foley, and Kristin Forbes found that companies that repatriated engaged in big stock buybacks and distributed increased dividends. Other companies engaged in a shell game: investing money that year in foreign subsidiaries that subject to American taxes, so the money stayed foreign but they got the cut in the tax rate. So of the $300 billion that came back, about $100 billion turned around and left. The HIA is widely criticized but has some defenders.   

The 2010s

Under the Obama administration, several attempts to deal with offshore profits were bandied around, but never got off the ground. One idea was ending eliminating the repatriation tax and eliminating total deferral, instead having a low rate on annual overseas income. That would have been paired with ‘deemed repatriation,’ which would tax overseas profits as if they’d been repatriated, regardless of whether that actually happened. The rates varied: 14%; 8.75%.

The idea, which landed politically but never moved, was to earmark these funds for infrastructure spending, specifically the Highway Trust Fund. This maintained the theme of the corporate money in question being for something.

Now

Things are moving very fast right now. The most recent text of the current tax reform bill was released on Friday. But here’s where things stand this minute: the current tax sets a mandatory one-time repatriation rate to 15% for cash and 8% for non-cash. Proponents say this cash infusion into the economy will result in investment and have positive effects; detractors say it’s just going to stock buybacks and is a holiday for multinational corporations.

There’s a framing problem here, which results in a lot of people talking past each other. Let’s take one example: Under the Senate version of repatriation, Apple is going to save $47 billion dollars, news reports said. Well, sort of, in that Apple could repatriate every dollar of their offshore money at a 35% rate, which would be a $78.6 billion tax rate, and so with the Senate rate, they would pay somewhere between $29.3 billion and $31.4 billion (also, by the way, this is all based on the report of one guy, a Villanova tax professor). But there is just no universe in which that would happen, and it’s disingenuous to suggest that it would. This argument doesn’t accurately confront that there are other countries in the world, an unavoidable fact.

The consequences of corporations, which benefit from their American bona fides in every other way, keeping a significant amount of money out of the American system, are profound and can be negative. That’s where the argument for a limited tax rate comes in: this money would be better here, so let’s bring it here. It’s a difference of philosophy: is having this money back an a priori good, or does the fact that it aids these big companies make it bad, such that it could only be justifiable if  that money was tied mandatorily to infrastructure spending or other public benefits.

I think it’s a bad idea to describe any corporation as a moral actor in this context, in either direction. I’m not sure stock buybacks actually have a moral valence. Like many technical elements of economic policy, what people see in it reflects what they bring to it.

 

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