Time for a Permanent Holiday on Foreign Earnings

The Wall Street Journal has a story this morning on a blog posting written by Michael Mundaca, Assistant Secretary for Tax Policy at the Treasury, throwing cold water on the idea of a tax holiday for U.S. companies to repatriate an estimated $1 trillion in overseas profits.

We too are not big fans of tax holidays, but not for the reasons Mundaca points out. Stability and neutrality are a core principles of sound tax policy and holidays clearly violate those principles. We have been frequent (and often lonely) critics of back to school sales tax holidays and other temporary tax cuts politicians believe will “jump-start” sales or the economy.

Mundaca and others charge that the 2004 repatriation holiday – in which companies brought home roughly $380 billion in foreign earnings – failed to create jobs or spur new investment. Why should that be a surprise? Jobs are created when companies foresee a stream of earnings that justifies new hires, not because of a one-time influx of cash. This is no different than why the ill-conceived “Cash for Clunkers” program failed to stimulate any net new sales of cars.

That said, the motivations of those who support the repatriation holiday are correct – the high U.S. corporate tax rate and our world-wide tax system have erected an economic Berlin Wall around the country, discouraging companies from reinvesting their foreign earnings back home. For most companies, the 35 percent toll charge for bringing that money home is too stiff.

What is also very troubling about this debate is the deceptive language used by critics of deferral and the repatriation holiday (this includes President Obama) that such policies allow companies to “avoid paying taxes” on that income. They know this is misleading and should be called out on it. (See too a recent piece on the issue of deferral by Seth Hanlon at the Center for American Progress.)

The truth is U.S. companies pay plenty of income taxes on those earnings – they pay them to the host countries where that income is earned and where the benefits of those taxes are received. Washington simply wants another bite at the apple with our worldwide tax system. IRS data for 2007 – the most recent available – shows that U.S. companies paid nearly $100 billion in income taxes to foreign governments on taxable income of $392 billion.

The table below shows the amount of income and income taxes paid by geographic region. Overall, companies are paying an effective tax rate of 25 percent on that income. Bringing that money back to America would subject it to a 10 percent toll charge to bring the total tax up to the U.S. corporate tax rate of 35 percent. No one should be surprised that businesses are keeping $1 trillion working abroad and not bringing it home.

The solution is not a one-time tax holiday but a swift and permanent move to a territorial system, as Japan and Great Britain recently did.