A new study has cast doubt on claims from legislators and lobbyists that a tax holiday for multinational corporations on their repatriated foreign earnings would spark an economic revival in the U.S.

Lillian Mills

The study analyzes the impact of a tax holiday that was tried in 2004 and finds that it mainly benefited mature companies that already had the means to create jobs at home. The study was written by Lillian F. Mills, a professor at the University of Texas at Austin, who carried out the research with Susan M. Albring, an assistant professor at Syracuse University, and Kaye J. Newberry, a professor at the University of Houston. It appears in the new issue of The Journal of the American Taxation Association, published by the American Accounting Association.

A group of multinational corporations, under the banner of the Win America Campaign, has been lobbying Congress for passage of repatriation legislation that would allow them to bring home approximately $1 trillion in foreign earnings at a reduced tax rate to spur investment in the U.S. They cite studies from Dr. Laura Tyson, former chair of the Council of Economic Advisors, and former Congressional Budget Office director Douglas Holtz-Eakin predicting that a tax holiday would give a boost to GDP of $178 billion to $336 billion and generate 2.5 million to 2.9 million new jobs. A number of lawmakers have thrown their support behind legislation for a tax break on repatriated foreign earnings (see McCain and Hagan Introduce Repatriation Tax Holiday Bill).

The new study, however, finds little reason for another tax holiday. It is based on an analysis of an earlier tax holiday on foreign earnings mandated by the American Job Creation Act of 2004. The bill temporarily reduced taxes owed by American multinational corporations on foreign earnings from the standard rate of 35 to 5.5 percent and resulted in the repatriation of an estimated $312 billion.

The new research finds that the AJCA mostly benefited relatively mature companies that had had the means to invest and create jobs all along without the financial boost provided by the legislation. The legislation did not even significantly advance a less intensely promoted purpose of the bill: to enable companies battered by a recent recession to strengthen their balance sheets.

"In essence, the corporate rich got richer, and, although the corporate needy and financially stretched may not have gotten poorer, they derived relatively little advantage from the bill," said Mills.

"None of the many studies of AJCA has been able to document the major increase in investments and jobs that was the main selling point for the legislation,” she added. “What they found, instead, was an upsurge in corporate stock repurchases, an activity associated with lack of investment opportunities and of primary benefit to company shareholders rather than to the economy as a whole. Our research nails down a key reason for these findings by focusing on whether companies faced financial constraints."

The study begins with a comparison of two hypothetical companies that each earn $1 billion abroad, but one of which "prospers domestically and faces few debt covenants" while the other "runs short of cash and faces restrictive debt covenants." The latter company regularly repatriates cash earned abroad "because it is cheaper for the parent to accelerate the repatriation tax than to pay higher debt costs (e.g., higher interest rates or costs associated with technical violations of covenants). When the tax holiday occurs, the first firm responds by repatriating the $1 billion in cash; the second cannot, because it has already been repatriated."

The professors focused on a sample of 421 American multinational corporations for which the necessary extensive financial data is available. They found that what they hypothesized bears a striking resemblance to how companies actually responded to the AJCA. Firms that repatriated foreign earnings during the tax holiday (an average of about $952 million each) had significantly fewer restrictive covenants on their private debts than non-repatriators did and were far more likely to have access to the bond markets.

Among holiday repatriators, 6 percent had bond ratings of AA- or better, compared to only 1 percent of companies that did not repatriate. An additional 25 percent of holiday repatriators had bond ratings of A+, A or A-, compared to only 7 percent of non-repatriators.

Overall, "access to public debt is associated with a 13-percentage point increase in eligible foreign earnings repatriated during the holiday," the professors concluded. This and other findings "suggest that firms with fewer external debt constraints had more flexibility to fund domestic operations with debt financing versus repatriating foreign earnings...However, we find little evidence of debt repayment, [a finding] consistent with firms' primarily using the repatriated funds (or freed-up cash ) for stock repurchases."

Mills doubts there would be a way to write tax repatriation legislation that would produce a different outcome than in 2004. "The AJCA specifically prohibited the use of repatriated funds for stock buybacks, but there is little doubt that companies repurchased shares on a large scale, if not directly then by using the tax break to free up other funds that could be used for buybacks,"  she said. With credit as tight as it is today, she added, a repeat of the AJCA could accentuate the gap between the corporate haves and have-nots even more than the 2004 legislation did.

Better than another holiday, she noted, would be permanent lowering of corporate tax rates that would stimulate more domestic start-ups and attract start-up investment from abroad.