Imagine if U.S. companies could add well over $1 trillion to their U.S. coffers in an instant without having to sell a subsidiary, issue a single share, or incur a penny of debt. While every company would no doubt use its repatriated cash differently, the windfall could fund a return of capital to shareholders through increased dividends and share buybacks. It might instead be used to repay existing debt, fund capital expenditures, or make strategic acquisitions.
It doesn't really matter how companies would eventually deploy the cash. The important thing is that the cash would be used—put to work here in the U.S.
Given the weak domestic economy, why hasn't this already happened? The answer is clear: U.S. tax policies penalize the repatriation of so-called "foreign source income," essentially the profits earned by foreign subsidiaries of U.S. corporations. The corporate cash pile is not being hoarded or held on the sidelines, as many pundits have suggested. It is being kept offshore by our tax structure.
Unlike most other countries, the U.S. taxes profits earned overseas by its corporations. The federal tax code then defers the tax on the non-U.S. profits until the corporation brings them into the country. Since repatriating these profits means incurring taxes of up to 35 percent, most overseas profits ultimately remain offshore.
Given the weak economy and the debate over the need for additional stimulus and further quantitative easing by the Federal Reserve, bringing home hundreds of billions—possibly trillions—of dollars should be an economic priority. Although most companies would need to keep some cash overseas for working capital and capital expenditures for non-U.S. operations, clearly U.S. firms have far more cash overseas than is needed there.
A Terrible Choice: Hoard or Pay?
Repatriation on such a scale would effectively amount to the largest-ever economic stimulus event. Not only would the cash go right where it is needed most—the private sector—but this stimulus would not add a single dollar to the federal budget deficit. In fact the economic growth created through the deployment of this corporate cash would generate billions in additional tax revenue.
Most successful U.S. multinational companies face this dilemma: Keep the cash overseas or bring the profits home at a cost of up to 35¢ on every dollar repatriated. This is not merely a theoretical debate over tax policy. It has profound practical implications.
Recently Microsoft (MSFT) opted to sell billions of dollars in debt to fund its dividend payments, even though it has approximately $37 billion in cash and short-term investments on its books. Since most of the cash is overseas, borrowing makes better economic sense than repatriating it because the cost of borrowing is far lower than paying tax would be.
Microsoft is not alone. Cisco Systems (CSCO), whose Chief Executive Officer John Chambers is a vocal critic of U.S. tax policy, has an estimated $30 billion in cash outside the U.S. Other leading tech companies with significant cash overseas include Dell (DELL), Hewlett Packard (HPQ), International Business Machines (IBM), and Intel (INTC). Pharmaceutical giants Johnson & Johnson (JNJ), Merck (MRK), and Pfizer (PFE) also have billions in unrepatriated foreign profits.
A tax holiday on repatriated overseas cash is not without precedent. In 2004, the Homeland Investment Act reduced the tax rate on repatriated overseas profits from 35 percent to 5.25 percent. Granted a lower tax rate, U.S. corporations responded by repatriating an estimated $315 billion in 2004.
Obama: Tax Overseas Profits
Critics of any reduction in taxes on repatriated overseas profits—even a temporary one during an economic rough patch—argue that to do so would reward companies for outsourcing American jobs. Not surprisingly, the AFL CIO and its political allies are the leading opponents of any proposed tax holiday. In the view of organized labor, overseas profits should be subject to U.S. tax, even if those profits are never repatriated.
President Barack Obama supports organized labor's position. Last year he proposed taxing the overseas profits of U.S. corporations. The current tax provisions provide a loophole that "has actually given billions of dollars in tax breaks that encourage companies to create jobs and profits in other countries," the President said.
Key members of Congress agree with the President's position. "There's another phrase for repatriation—it's called rewarding the outsourcing of jobs. If we allow U.S. corporations to once again send the money they earn abroad back to the U.S. at a discounted tax rate, it will only lead to more companies moving their profits offshore," according to Senator Byron Dorgan (D-N.D.).
This fiery rhetoric is fueled by a broad mischaracterization of the purpose and effect of international growth and investment by U.S. companies. Unions and their allies in Congress see all such moves as simply outsourcing American jobs. While that may be the case in a small percentage of situations, the reality is far different from the picture they attempt to paint.
Rather than weakening the economy, successful multinational companies have actually been engines of growth. As Harvard Business School professor Mihir Desai has noted, when U.S. businesses "expand abroad, they expand at home." John Castellani, president of the Business Roundtable, makes the point that efforts to punish companies that are successful abroad "will reduce the ability of U.S. companies to compete in foreign markets, which will not only reduce jobs, but will also cripple economic growth here."
Reduce Tax on Repatriated Profits?
Companies' ability to expand their businesses in the global marketplace is good for both investors and workers alike. Companies that succeed internationally need to expand their research, development, management, human resources, information technology, marketing, and financial teams. Most of those new jobs wind up right here in the U.S.
In fairness, it is important to mention that not all labor leaders oppose measures to reduce taxes on the repatriation of overseas profits. Andy Stern, former president of the Service Employees International Union, has proposed a novel approach. Stern suggests reducing the tax rate on repatriated overseas profits to 5.25 percent. There's a big string attached: Stern wants the resultant revenue to fund programs specifically designed to create employment in the U.S.
Some who oppose a tax holiday on repatriated overseas cash point to a study by the National Bureau of Economic Research: "Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act." The NBER study shows that a large percentage of the funds repatriated in 2004 were used for dividends and share buybacks.
While the NBER study's findings are probably accurate, opposing a tax holiday on repatriated overseas profits on these grounds misses the point. Pumping new cash into the economy will have a positive impact. Even if companies simply return the capital to their shareholders, that is a positive outcome; investors will either spend the cash or reinvest it. Robert J. Shapiro, undersecretary of Commerce during the Bill Clinton Administration, agrees, concluding that "the repatriation of overseas profits would certainly be in the economy's interest to bring this money home."
With a stagnant economy, persistently high unemployment, and ballooning federal and state budget deficits, Congress and the President need to put aside partisan differences and eliminate or sharply reduce taxes on the repatriation of profits earned around the world. With an era of slow growth here—and rapid economic expansion in places such as China, India, and Brazil—our tax policy needs to recognize that an increasing share of corporate profits will be earned outside the country. U.S. tax policy should create incentives for companies to seek growth and expansion around the world, wherever and whenever those opportunities arise.
Permitting the repatriation of those profits would have a positive economic effect that our tax policy should recognize and facilitate. Given a subpar U.S. growth rate—and joblessness hovering around 10 percent—the sooner this happens, the better.