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What Would A 'Tax Holiday' Of Multinationals' Foreign Earnings Do?

by: Gene Balas, CFA

One proposal would allow U.S. multinationals to repatriate profits earned abroad to the parent company without income taxes (this is not the same as a reduction in the tax rate).

The thesis is that these funds could be used to invest in the U.S., whether in U.S. financial markets or in companies' facilities or equipment.

But would this have any economic impact? Are those foreign profits sitting in a pile of uninvested cash waiting to be put to work?

The answer is that many of those foreign subsidiaries already invest in U.S. facilities or securities. Some U.S. companies' foreign subsidiaries already have 100% of their cash denominated in dollars.

Thus, any economic benefit may be muted, as some of those funds are already here and already being put to work.

When examining policy proposals, it pays to understand certain ramifications beyond the simple premise of an idea. More specifically, consider the repatriation of funds from the foreign subsidiaries of U.S. corporations. (This is not a discussion of lowering the corporate tax rate; rather, this discussion only pertains to the ability of corporations to allow their foreign subsidiaries to repatriate foreign profits to the parent company without tax.) According to a November 25, 2016 Wall Street Journal article, over the past decade, total undistributed foreign earnings of U.S. companies have risen from about $500 billion to more than $2.5 trillion, a sum equal to nearly 14 percent of U.S. gross domestic product.

Now, just what exactly is that pot of money actually doing, when it is held by foreign subsidiaries? Would it boost economic activity if the U.S. had a tax "holiday" to allow repatriation of those funds here? Well, it turns out that it isn't some unused mountain of cash that is sitting idly by, stockpiled in some warehouse. Instead, those funds are often already here in the U.S., already invested and at work, though they are owned by the foreign subsidiary, per recent research from the Atlanta Fed.

In 2011, the Senate Permanent Subcommittee on Investigations conducted a survey of 27 large U.S. multinationals. Survey results showed that those companies' foreign subsidiaries held nearly half of their earnings in U.S. dollars, including U.S. bank deposits and Treasury and corporate securities. Consider the table provided by the Atlanta Fed on just how much of those funds are already denominated in dollars and invested in the U.S.:

Those investments may be in the form of securities or bank accounts, of course, but they may also be invested in the physical equipment and structures of operations here in the U.S. A report from the Joint Committee on Taxation notes these earnings "may include more than just cash holdings as corporations may have reinvested their earnings in their business operations, such as by building or improving a factory, by purchasing equipment, or by making expenditures on research and experimentation."

In other words, a foreign subsidiary of a company domiciled overseas may invest in (and own) those facilities here. To put it a different way, those funds are often already put to work here or are invested in U.S. securities, having bolstered share or bond prices long ago. Offering a tax holiday, then, would simply mean that companies wouldn't have to pay income taxes on profits they've earned and already invested in the U.S. Reading between the lines of the Atlanta Fed's research, it amounts to free cash for corporations, though the researchers explicitly stop short of making that conclusion and avoid making policy recommendations.

It is at this juncture where the interests of taxpayers and investors diverge. Yes, investors might wish for corporations to repatriate those funds without taxes, bolstering profits and allowing companies to invest wherever might be in the best interest of shareholders. However, taxpayers (a group that certainly overlaps with many individual investors) might have a different point of view. But we digress from the economics and enter the realm of fiscal policy, which is not our intention here.

Our focus is to determine whether there might be any economic (or financial market) effect from allowing corporations to avoid taxes on foreign earnings. Note I did not use the word, "repatriate," since, as noted above, many of those foreign subsidiaries already own U.S. assets. So, from the lens of an economist, not a politician or an investor in an affected company, the net result of allowing the foreign subsidiary to disgorge its profits to the parent company without a tax penalty may not yield economic benefits. As the research demonstrates, those funds are often already here, already invested, and already producing benefits to American workers, consumers and investors. What they are not doing is relieving the fiscal burden of other taxpayers. And those policy implications are not merely in the realm of economics but rather for politicians to debate.


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