Repatriated Foreign Earnings Do Not Mainly Go To Shareholder Payouts

August 23, 2013

The American Jobs Creation Act (AJCA) of 2004 allowed U.S. companies a one-time holiday to bring home foreign earnings at a reduced rate, and they did to the tune of $312 billion. However, many researchers concluded the money was spent largely on shareholder payouts, opposite of the law’s intent. Turns out that research is bunk, according to Thomas Brennan of Northwestern University:

International tax policy debate has been informed by a belief based on prior research that, notwithstanding legal prohibitions, shareholder payouts in 2005 accounted for $0.60-$0.92 per dollar repatriated under the AJCA tax holiday. I analyze total payouts that year and prove that this belief is actually false. I use constrained regressions to determine what spending really occurred. Legal restrictions mattered. Twenty firms represented 56% of repatriated cash and spent heterogeneously during 2005-2009, with $0.78 per repatriated dollar going to AJCA-permissible uses, including cash acquisitions ($0.54) and debt reductions ($0.16). Smaller repatriators spent at least $0.61 per dollar on AJCA-permissible uses.

Brennan reasons that companies avoided shareholder payouts not because the law was well crafted (it wasn’t), but because companies cared about their reputation and did not want to be seen as flagrantly violating the law. Makes sense, except that’s exactly how companies have been seen ever since!

Instead, I believe a) money is fungible, and b) companies for the most part spend money where they think it leads to the highest return. That includes cash acquisitions, debt reductions, R&D, capital expenditures, hiring and labor compensation, and shareholder payouts. Every company is different, but it is simply unbelievable that the average company would spend the money mainly on shareholder payouts rather than reinvesting it in the company. These are not fly by night operations, but companies that stick around for decades. To keep the lights on, companies must reinvest a large chunk of their earnings. An even larger chunk is required to grow and prosper. If a company fails to do this, the stock price collapses and the shareholders rebel. No one except bankruptcy lawyers have an interest in this dead-end strategy.

Certainly, the 2004 repatriation holiday was not ideal policy. Because it was temporary, it forced the companies to engage in more short-term investments, such as acquisitions and debt reductions – things they could back out of relatively easily if need be, i.e. by taking on debt again or selling a chunk of the enterprise. In contrast, capital expenditures and hiring and increasing salaries are longer term commitments and they require permanent policy incentives. This is why the U.S. should adopt permanently a territorial tax system that largely exempts foreign earnings from domestic taxation.

The rest of the world has already figured this out. While we’ve been arguing over how money was spent from the 2004 repatriation holiday, 12 OECD countries have switched to a territorial tax system, leaving only us, Mexico, Chile, Ireland, Korea and Israel with antiquated worldwide tax systems.

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