President Obama recently gave a lengthy speech on inequality, poverty, and what to do about it. He claimed inequality is increasing, which is debatable, and then offered a few populist ways to reduce it, such as raising...
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Why a Permanent Repatriation Holiday, Rather Than a Temporary Fix, Is Prudent Policy
Surrounding discussion of corporate tax reform earlier this year was the idea of repeating a 2004 repatriation holiday.
Repatriation is the act of bringing profits made abroad back to the U.S. If a company decides to bring back profits made abroad, the money is currently taxed at the U.S. statutory rate of 35% less whatever percentage has already been paid to the foreign government. If a repatriation holiday is enacted, however, little or no domestic tax would be levied upon this cash, and companies could temporarily bring profits held overseas back to the U.S. at a discount.
The idea sounds enticing. The rationale behind the holiday is that if the U.S. government entices companies to bring funds back to the U.S. and determines what they must invest in to qualify for the tax reduction, the inflow of cash will be used to create domestic jobs and spur economic growth. Due to an anemic economy, this intuitive idea has gained traction in both parties of Congress as well as the business community.
However, experience shows that the holiday has been ineffective policy. In "Watch What I Do, Not What I Say" (Dharmapala, Foley, and Forbes, NBER, 2010), the authors conclude that the holiday did not improve domestic investment, employment, or research and development. Using instrumental variables to control for endogeneity (an econometric flaw that can yield highly misleading conclusions), the paper actually finds each repatriated dollar resulted in a payout to shareholders ranging from $0.60 to $0.92. While one could argue that this could increase employment by putting money in the hands of investors, the study does not bear this out.
Adding to the complexity of the analysis are the expectations such holidays build in the business community. Many argue that a firm is more likely to keep cash offshore now if it expects these holidays in the future. More important, however, is the uncertainty these holidays introduce into business decisions. Much research has been conducted on this topic, generally arriving at the same conclusion: Uncertainty is harmful to investment. (For more information on this topic, see Bloom, Bond, and Reenen, "Uncertainty and Investment Dynamics," Review of Economic Studies, 2007. 391-415.)
In contrast to a temporary holiday tied to federally mandated constraints on spending, a permanent repatriation holiday (however oxymoronic the phrase sounds) has great potential to make U.S.-based corporations more globally competitive. While U.S. corporations essentially operate under a worldwide taxation system (described in the first paragraph), corporations based abroad are not taxed at all on income made overseas and brought back to the home country. This lower tax rate results in an advantage that makes it easier for a foreign company to make a given return on investment than one incorporated in the U.S. In other words, it is more difficult for domestic corporations than foreign ones to meet a given hurdle rate. Our current system decreases U.S. corporations' competitiveness and makes them easier targets for foreign acquisition.
At a time the country is experiencing serious fiscal woes, our economy could use whatever policies the government can enact to responsibly promote growth, as long as they adhere to principles of sound tax policy, such as stability. A permanent repatriation holiday is certainly one such viable policy.
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