A Repatriation Holiday to Fund the Highway Trust Fund is Not Only a Bad Idea but a Costly One
In politics, bad ideas never go away, even after being shown to be bad. A repatriation tax holiday is a case in point. Senators of both parties have suggested using revenue generated from a repatriation holiday to plug near-term shortfalls in the Highway Trust Fund, which will be depleted within a couple of months. The problem, of course, is that revenues are only generated in the short-run, and revenue losses in out-years dominate the overall budget impact of a repatriation holiday.
Under its baseline budget, the Congressional Budget Office projects a fiscal year 2015 Highway Trust Fund shortfall of about $12 billion. The Joint Tax Committee projects that a repatriation holiday enacted this year would bring in about $13 billion in additional revenue in fiscal year 2015. Sounds like a great fix for a budget problem. What is not mentioned is cumulative Highway Trust Fund shortfalls between 2016 and 2024 total $824 billion and that the repatriation holiday will reduce federal tax revenues by $115 billion over the same period. Consequently, using a repatriation holiday as a short-term fix would increase longer-term federal budget problems associated with underfunding the Highway Trust Fund—increasing projected deficits from $824 billion to almost $1 trillion over the next 10 years. Surely, a repatriation holiday is a bad and costly idea.
But there are also other problems with a repatriation holiday, which requires a brief and, admittedly, wonkish review of the 2004 repatriation holiday.
The American Jobs Creation Act of 2004 (AJCA) was enacted as a response to worries about a sluggish recovery from the 2001 recession. One of the provisions of the AJCA was a repatriation holiday or, more formally, “incentives to reinvest foreign earnings in the United States.” The provision was explicitly labeled an economic stimulus and Congress emphasized “that this is a temporary economic stimulus measure, and the there is no intent to make this measure permanent, or to ‘extend’ or enact it again in the future.”
The basic idea behind the repatriation holiday was that it would require the reinvestment of repatriated foreign-sourced income in the United States that would have otherwise remained abroad. The legislation specifically stated that the repatriated earnings eligible for the lower tax rates should only be those designated as “permanently reinvested outside of the United States” on the firm’s financial statement. (Permanently reinvested means the firm has stated that it does not plan to repatriate the foreign earnings in the foreseeable future.) The theory for how this would boost recovery was that these monies would be a “source for funding of worker hiring and training, infrastructure, research and development, capital investments, and the financial stabilization of the corporation for purposes of job retention or creation.”
The intention of the supporters of the repatriation holiday was to provide a tax incentive for multinational corporations to bring foreign-sourced earnings to the United States. Specifically, the temporary provision (section 965 of the Internal Revenue Code) allowed for an 85 percent deduction of dividends received by a U.S. corporation from their controlled foreign corporations. The resulting tax rate on these repatriated earnings was 5.25 percent—far less than the 35 percent statutory corporate income tax rate. The dividends received were required to be invested in the United States, and only dividends exceeding those received in the (pre-holiday) base period were eligible for the preferential tax treatment.
The effect on the economy and job creation of a repatriation holiday depends on how much is repatriated and how the multinational corporations use the repatriated dividends. In an analysis of tax records, Melissa Redmiles showed that the repatriation holiday generated about $300 billion in additional repatriated dividends by multinational corporations.
Several studies examined various aspects of the 2004 repatriation holiday. Dhammika Dharmapala, Fritz Foley and Kristin Forbes found that for each $1 increase in repatriations, multinational firms increased shareholder payouts by 60 to 92 cents, rather than increasing investment by $1. They argue that the fungibility of money undermined the legal provisions that restricted the use of repatriated earnings.
Others, however, dispute this finding. Thomas Brennan found that most of the repatriated monies were spent on permissible uses, with cash acquisitions of other firms accounting for the largest share but little new investment. Michael Faulkender and Mitchell Petersen found that capital constrained firms tended to increase permissible domestic investments while unconstrained firms did not increase investment. The Permanent Subcommittee on Investigations found that the firms with the largest repatriations under the AJCA did not increase research and development spending and actually reduced the number of U.S. jobs. While the repatriated earnings may have generally been used for permissible purposes, the goals of increasing employment and investment were not achieved.
The earnings that were repatriated under the AJCA, while designated as permanently reinvested overseas, were not really permanently invested in physical foreign assets such as buildings or machinery. Marty Sullivan (pay website), in a 2004 article, shows that U.S. multinational firms dramatically shifted their profits to tax havens between 1999 and 2002. Tax havens are countries with very low corporate tax rates and in which the U.S. firm has little physical capital (often no more than a mailbox). Data contained in Redmiles study shows that over 75 percent of the repatriated earnings under AJCA came from controlled foreign corporations (i.e., subsidiaries of U.S. multinational corporations) in 12 tax haven countries.
The sad truth of a repatriation holiday is it encourages multinational corporations to shift profits to tax havens and then allows them to bring those profits back to the U.S. virtually tax-free without creating jobs or increasing investment. So, this is one of those cases where careful economic research confirms the most common-sense view of the world: governments cannot finance spending by giving corporations tax-breaks.