IMGCAP(1)]The impact of the financial crisis and resultant recession, even if now officially ended, continues to be felt.
That is clearly demonstrated by still-sluggish economic activity, slowly recovering employment (assuming that this is not merely a statistical artifact caused by migration from the officially defined labor force), and record levels of pessimism.
One of the more controversial responses has been the call for a replication of the “tax holiday” bestowed by the 2004 American Jobs Creation Act, specifically the one-year-only provision granting an 85 percent dividends-received deduction to U.S. corporations for repatriations of foreign subsidiaries’ earnings.
The goal of that provision, and of its proposed re-run, was to attract cash held abroad, hopefully to be invested in domestic facilities and for the hiring of American workers, thereby stimulating the economy.
Of the estimated $1 trillion of earnings then held abroad, perhaps $350 billion were repatriated. Today, with as much as $1.5 trillion held by foreign subsidiaries, as much as $500 billion of fresh capital inflows could presumably be generated. Given prior academic research and a
Prior academic and other research rather clearly revealed that the funds repatriated by the 2004 AJCA failed to achieve the stated objective, and that stock buy-backs and dividends paid by the parent companies absorbed more than 90 percent of the remittances—although funds returned to shareholders in this way, to the extent later deployed for consumer purchases or personal or business investments, might have had a similarly salutary impact, a possibility that seemingly has not been fully researched.
Given the fact that a preponderance of economic activity in the U.S. is consumption driven, the recycling of dividends and stock buy-back proceeds in this manner should be seen as a likely driver of the hoped-for salutary effects, although arguably the marginal propensity to spend by recipients of such corporate largess (the investor class, which may not be an accurate cross-section of all consumers) could be lower than desired.
The report (in the Democratic majority view, at least) cites this previous experience, and notes that although the AJCA explicitly encouraged job creation and research and development spending, and explicitly prohibited stock buy-backs and executive compensation, the fungible nature of cash made enforcement a practical impossibility.
Consistent with other research, the Senate report finds that the actual benefits accrued to a relatively small number of corporations ($150 billion of the benefits were received by only 15 companies), and that these enterprises subsequently decreased their domestic employment rolls and lowered research and development expenditures. Even ignoring the possibility that this observation could be an example of the post hoc, ergo propter hoc fallacy (i.e., these companies could well have cut employment and R&D spending even more drastically absent the infusion of foreign-held earnings—a speculation somewhat analogous to the Obama administration’s unprovable claims of “jobs saved” during the recent rise in unemployment), it must be acknowledged that the benefits from the AJCA are difficult to demonstrate.
The near-impossibility of tracing the sources and uses of corporate cash is further demonstrated by the fact that corporations already hold large domestic cash balances. Some of these holdings are the result of repatriations of foreign earnings, which have been significant (well over $100 billion a year) notwithstanding being subject to U.S. income taxes. But some of these cash reserves have been shown to be the result of various maneuvers that facilitated indirect repatriations that were not subject to tax, for example by using foreign assets to collateralize domestic borrowings. The important point is that low levels of domestic investment have not been a consequence of inadequate domestic cash reserves that need to be supplemented by repatriations of foreign-held earnings. Rather, the constraints have to do with profitable investment opportunities, properly considered on an after-tax basis.
Studies have suggested that American companies’ disinclination to repatriate the earnings of their foreign subsidiaries has not been primarily motivated by the availability of a tax deferral, but rather by the perceived lack of profitable domestic investment opportunities. One study found that domestic operations of U.S. multinationals were not financially constrained at the time of the AJCA, meaning that the paucity of job-boosting domestic outlays was not due to a lack of investable funds, but rather reflected the dearth of profitable opportunities. The ability to access capital at a lower cost (via tax-favored repatriations) would not be expected to boost domestic investment, domestic employment, or R&D under such circumstances. If anything, this description is even more apt today, with interest rates being at all-time lows, making borrowing appealing if only confidence in the economy and a supply of attractive investments existed.
Businesses do not have a patriotic duty to invest in unprofitable ventures simply to create jobs. The proper role of business is to maximize the wealth of shareholders, as the fundamental principles of finance teach. In good times, this role creates jobs and wealth for society at large. National tax policy has a major impact on whether these goals will be congruent. Apparently this has not been the case, however, as the relatively high U.S. corporate tax rate (compared to almost all other nations’ rates, ours are very high) makes foreign investment more attractive—even putting aside differential labor costs, which is a separate but not dissimilar issue.
One unfortunate effect of the political jockeying that has long interfered with rational economic behavior is captured by the expression crony capitalism, which has further distorted the economic playing field for many industries. “Crony capitalism,” a term that has gained a good deal of currency, has lately been applied specifically to circumstances in which high tax rates are broadly imposed, but are then accompanied or followed by special exemptions, as for politically favored industries or groups that threaten to relocate to lower tax jurisdictions or to move operations to low-cost countries such as China. The net effect is to heavily tax those who cannot exert pressure for special treatment, sparing those who can do so.
This trend was most recently demonstrated in Illinois, where substantial state personal and corporate income tax rates were imposed Jan. 1, 2011, followed by exemptions or other tax breaks for “squeaky wheel” major employers such as Sears and the parent of the Chicago Mercantile Exchange. The lobbying for a replay of the AJCA can be seen as a further illustration of this phenomenon, this time favoring those companies that, by virtue of having international operations producing earnings that can be cached overseas, can exert pressure for tax relief that other, domestic-only corporations cannot enjoy. Even if a tax holiday on repatriated foreign earnings could be rationalized as a boost for domestic employment, it still represents government-imposed distortion of the macro-economic environment that predictably will have yet-unimagined deleterious consequences.
There are good reasons to oppose a reprise of the AJCA of 2004. With or without such an exemption, however, America must present a more attractive investment climate, including enacting more competitive income tax rates, before jobs growth and other accoutrements of economic recovery will meaningfully occur.
Barry Jay Epstein, Ph.D., CPA, CFF, is a partner at
