© 2017 Farok J. Contractor, Rutgers Business School
Republicans want a one-time tax of the money currently stashed overseas at a “tax holiday” rate of 8.75 percent, according to the House blueprint, while Trump has called for 10 percent. (Reuters, January 25, 2017)
As a professor of International Business I am in favor of ethical business, economic progress, and jobs. But in President Trump’s latest announcements of both a “tax holiday” for multinational companies and a border wall with Mexico, I could not fail to notice the contrast between proposals to forgive (past due) tax on US companies and an unforgiving attitude toward illegals in the US.
What are the amounts in question?
Between $2.1 and 3 trillion of US multinational company foreign profits have been bottled up overseas, and not brought home, because of a longstanding tax provision whereby the additional US tax liability on foreign source income has been deferred indefinitely by the simple expedient of not remitting foreign affiliate profits back to the US. Apple, Inc. alone is said to have between $181 and 200 billion in foreign profits not brought back to the US.
If and when the foreign profits do get remitted back to the US, they are subject to US corporate tax—which can range up to 35 percent. However, with innumerable deductions and double-tax-avoidance treaties, the percentage could be less than half that. (For details, see my earlier comprehensive review Tax Avoidance by Multinational Companies.
This gigantic loophole, created by Congress, has understandably been used by many US-based multinationals to defer additional US tax, and to reinvest those profits outside the US where economies and markets grow faster.
But first, we’ll look at some definitions and quibbles. I used the word “amnesty” in my title, which suggests complete forgiveness or absolution. But this is not quite true. Instead of the supposed maximum 35 percent US corporate tax rate, the US Congress proposes a low 8.75 percent, and Trump proposes a 10 percent tax—within a yet-to-be-defined “tax holiday” of six months or so. Hence, it is not quite an “amnesty,” but a very much lower rate than what many firms would have paid.
In the opening paragraph, I used the expression “past due.” This is only literally correct, in the sense that for some US multinationals, profits going as far back as 2004 have been legally tax-deferred because of the existing deferral provision. Company accountants would remonstrate that their firms are only taking advantage of a provision legally provided by Congress.
In the above sentence, why did I invoke the year 2004? Because George W. Bush gave a similar tax holiday to US multinationals in 2004, when billions flowed back to the US with very low tax liability. Thus, the “tax holiday” Trump proposes has been done at least once before. Yet, the same proponents bristle at the idea of giving illegal immigrants amnesty on the grounds that that would attract even more illegals that would wait and hope for future amnesty.
Will it work? What will it do to US tax revenues and US jobs?
$2.1 to 3 trillion does sound like a lot of money to tax, even at a low rate of 8.75—10 percent. The 2017 fiscal year budget would certainly benefit a tad. As political theater, it would make for a satisfying spectacle if congresspersons and Trump claimed they were “bringing money back home.” Corporations and their shareholders could benefit somewhat from companies that have a lot of foreign profits bottled up abroad.
However, I would not give too much credence to any significant economic impact for these reasons:
- Only a fraction of the $2.1 to 3 trillion will actually be repatriated.
– Much of it has already been reinvested in factories and assets in foreign subsidiaries. Those assets cannot be easily liquidated and converted to cash to be brought home.
– Even though the US economy grows at 2.5 to 3.5 percent annually—a healthy rate for a mature economy—many other countries in emerging nations such as India grow considerably faster, and the reinvestment opportunities there remain more attractive.
– How much of the $2.1 to 3 trillion is actually repatriated also depends on the retroactive provisions applicable to this income beyond the six months or so tax-holiday window. In short, while Congress wants to completely revamp the US tax code, no one knows what the end result will look like.
– Multinationals can use, or have already used, at least six other tax-avoidance methods (legal loopholes) to shelter foreign income (which I outline in my primer Tax Avoidance by Multinational Companies).
- The effect on US jobs will be minimal or even negative.
US headquarters executives will be elated, in several firms, by seeing a sudden injection of millions in usable cash that had hitherto been kept overseas. But what will they do with the windfall? Will it be wisely spent on adding jobs or furthering long-term shareholder interests? In a US firm, claimants to extra after-tax profits include (a) shareholders, but also (b) top management, (c) labor and salaried workers, and (d) “the community,” in a corporate social responsibility sense.
From a strategy point of view, claims should also be wisely distributed over two temporal categories: (i) short-term payouts versus (ii) long-term investments in research and development (R&D), skilled jobs, and worker development, which pay off in future years. But in US companies, how benefits have been distributed over the four claimants (a) through (d), or via short- versus long-term strategies (i) and (ii), has had a mixed record.
With windfall money, it is very tempting to
– Show it as additional profit for one year, or to buy back company stock, which can boost share prices, stock options, and bonuses (for top management)
– Spend it on more automation and robotics, which in turn can reduce job growth, or even induce layoffs in the future
The mere fact that extra money has been injected into a firm in one fiscal year is unlikely to alter the company’s strategy, or the proclivities and temptations besetting its top executives. In the ultimate analysis, jobs in the US depend on fundamentals such as domestic market growth, worker skills, and training, which affect the productivity of the US worker compared with that of foreign workers (in what, despite Trump, is an increasingly globalized labor market).
The US does desperately need to revamp its tax code for three intimately related reasons:
(1) The maximum 35 percent corporate tax rate is high by the standards of advanced nations.
(2) However, only a minority of firms pay that much—the effective tax (after innumerable loopholes) amounts to between 19 and 27 percent.
(3) The number of loopholes, or special provisions written by lobbyists, has made the US tax code a bloated mess of thousands of arcane page, resulting in a distribution of tax burden that is blatantly unfair:
(a) Large firms that can afford sharp lawyers and accountants effectively pay below the advanced nations’ average.
(b) Small and medium-sized companies pay a disproportionate share of tax (as a percentage of their sales or profits) because they cannot hire the tax advisors that big firms can to shelter income. (Unsurprisingly, the “Tea Party” wing of the Republican Party was made up of mostly small business representatives.)
(c) The US is an outlier (unusual) country in the share of the overall tax burden borne by individuals, who in 2015 paid 80 percent (toward the total US government budget in income and social contribution taxes), while corporations paid only 13.8 percent.
Can Congress and Trump deliver a tax revamp that is both simple and fair?
Reuters. COMMENTARY: Corporate inversions in a new regulatory environment. FRB | Wed Jan 25, 2017.
Tim Higgins. Tim Cook’s $181 billion headache: Apple’s cash held overseas. Bloomberg, July 22, 2015.
Contractor, Farok J. Tax avoidance by multinational companies: methods, policies, and ethics. Rutgers Business Review, Vol. 1, No. 1, pp. 27–43 (2016).
A little-realized fact is that for every one job “lost” in the US because of international trade, three to four jobs have been lost through automation, information technology, robotics, and artificial intelligence. Knowledge at Wharton. Can Trump–or anyone–bring back American manufacturing? November 30, 2016.
Critics assert that the much-trumpeted US corporate tax rate actually is not 35 percent—that it is only the marginal rate on the last slab of income, with average effective rates variously estimated to be not more than 19.4 percent (according to Citizens for Tax Justice: The Sorry State of Corporate Taxes: What Fortune 500 Firms Pay (or Don’t Pay) in the USA and What they Pay Abroad—2008 to 2012 ) or 27 percent (according to Price Waterhouse: Paying Taxes 2014: The Global Picture—A Comparison of Tax Systems in 189 Economies Worldwide). This would put the US tax burden in the middle of the Organisation for Economic Co-operation and Development (OECD) advanced-nation group.
Farok J. Contractor. Happy Tax Day, USA (April 18, 2016): How are corporations and individuals footing the tax bill? and Heather Long. U.S. tax revenues at record high. Who’s paying? August 14, 2015. CNN-Money.