The United States is rare among countries in that it has a worldwide tax systemA worldwide tax system for corporations, as opposed to a territorial tax system, includes foreign-earned income in the domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. . Under such a system, U.S. corporations are required to pay taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es to the United States on all their income, regardless of where it was earned. This contrasts with a territorial system, in which only income earned in the United States would be taxed.
One caveat in our worldwide system is if a company decides to reinvest overseas instead of bringing the money back to the United States, it can defer its taxes owed on foreign profits. This process of deferral helps keep U.S. companies internationally competitive, but heavily discourages the transfer of money back into the country, otherwise known as “repatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives. .”
There is $2 trillion or more kept deferred overseas by U.S. corporations, and there is an established consensus that something needs to change. Edward D. Kleinbard, the former chief of staff of the Joint Committee on Taxation, has said that “everyone agrees that something [has] to be done.” Additionally, President Trump made it one of his goals for tax reform during last year’s presidential campaign. Bringing money back to the United States seems to carry broad popular support, but the question remains: what will be done, and when?
In 2004, Congress passed the Homeland Investment Act (HIA) of 2004 which allowed corporations to repatriate foreign-source income at a reduced tax rate of 5.25 percent during 2005 and 2006. Additionally, corporations could qualify for the foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. on top of the reduced rate, causing the effective rates on these foreign profits to be even lower. In response, corporations brought back roughly $312 billion of deferred income and avoided an estimated $3.3 billion in taxation due to the lower rates. While the repatriation tax holiday did succeed in bringing billions of dollars of offshore cash back to the United States, it is generally seen as a policy failure, for many reasons.
First, even though Congress intended all the repatriated money be used directly for job creation, capital investment, and other growth-producing expenditures, it has been found that an approximate “$1 increase in repatriations under the HIA spurred a $0.92 increase in payouts to shareholders,” which was explicitly not permitted. Additionally, between 2004 and 2007 the top 15 repatriating corporations cut 20,931 jobs in the United States. These immediate effects seem bleak and aren’t particularly heartening; however, depending on what the shareholders did with the money, there could have been some unmeasured potential benefit.
Per a report published by the U.S. Senate Committee on Homeland Security and Governmental Affairs, this failing was partly due to a “major statutory failure.” The HIA did not require the tracking of any repatriated funds to ensure they were spent on permitted uses. While overcomplicated regulatory schemes can pile up and add to the cost of tax compliance overall, unenforceable regulation is simply bad policy.
Lastly, because the tax holiday was temporary, it directly encouraged more deferral in the future. Controlled foreign corporations now have an incentive to defer earnings even more than usual in the hopes of another potential repatriation tax holiday. Talk of another tax holiday in 2009 could have encouraged even more profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. . Planning around the uncertainty of intermittent tax holidays is costly and needlessly adds to the level of complexity surrounding financing foreign corporations.
Despite such explicit policy failings of the tax repatriation holiday, the economic effects of repatriation in some unique cases remain ambiguous. For example, 2005 was a period of “abundant credit,” which meant that businesses could satisfy their demand to finance projects easily through loans. This could have downplayed the importance of equity financing via cash gained though repatriation. During a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. or at times where credit is hard to come by, easier access to capital could have a potential stimulus-like effects.
In conclusion, comprehensive policy reform in regards to repatriation and international tax treatment is well warranted. A move to a territorial system or a reassessment of a destination-based cash-flow tax could significantly reduce the incentive for corporations to keep money overseas. Tax reform aimed at changing the treatment of future foreign earnings could also include a one-time transition tax on all previously earned foreign profits. However, much like the temporary tax holiday, it would offer no long-term revenue streams.
When weighing possible options going forward, policy makers should avoid repeating past policy failures such as the temporary tax repatriation holiday and instead look towards permanent solutions.Share