Tax Analysts Blog

The Quirky Economics of $2 Trillion in Offshore Cash

Posted on Nov 18, 2013

The prospects for any near-term meaningful progress on tax reform are fading fast. Some people say the Republican leaders have put tax reform on ice because they don't want any distractions to divert public attention from President Obama's health insurance debacle. In public, Ways and Means Committee Chair Dave Camp, R-Mich., gives the excuse that the government shutdown used up limited congressional time and energy. But that’s just chatter. The truth of the matter is that tax reform never really had much of a chance anyway. Despite all the cheerleading from high-profile deficit hawks like Erskine Bowles and Alan Simpson, and despite all the valiant efforts of Chairman Camp, tax reformers do not have the mojo to get past all the obstacles that modern partisanship and old-fashioned special interest politics have put in their path.

But there is one component of tax reform that will never, ever fade away. Some very powerful people with infinitely deep pockets -- that is, the CEOs of many of America’s largest corporations -- want access to the $2 trillion of profits that they have booked offshore. Much of this enormous pool of money is in tax havens, where single-digit tax rates are the norm. Skillful tax planning has enabled companies to report higher profits to Wall Street. Higher reported profits translate into higher stock prices and more executive compensation. Now they want that money back in the United States to do things like pay dividends to shareholders and acquire other U.S. companies. The problem is that bringing it back to the United States requires companies to pay Uncle Sam a toll charge roughly equal to 35 percent (the U.S. statutory rate) less any foreign taxes paid. So, it is said, foreign profits are "locked out" of the United States. Though the debate about international tax reform can often get white-hot, all sides agree that the United States needs to eliminate the lockout of foreign profits.

To solve the problem, CEOs want Congress to allow them to pay a lower rate--something like 5 percent--if they repatriate foreign earnings. “If you look at it today, to repatriate cash to the U.S., you need to pay 35 percent of that cash. And that is a very high number,” Apple CEO Tim Cook told The Washington Post in May. “We are not proposing that it be zero. I know many of our peers believe that. But I don’t view that. But I think it has to be reasonable.”

A "reasonable" number? For the temporary repatriation tax holiday granted in 2004, Congress let multinationals bring their accumulated foreign profits back home if they paid an effective tax rate of 5.25 percent. (Technically, they got an 85 percent deduction on repatriated income that was taxed at 35 percent.) In Camp's 2011 international tax reform discussion draft, as part of the deal for permanent exemption of foreign earnings from tax, multinationals would be required to pay tax on accumulated foreign earnings at an effective rate of 3.75 percent. (Technically, they would get an 85 percent deduction on accumulated foreign profits that would be taxed at 25 percent.)

At first glance, the 2004 law and 2011 proposal seem very similar--a low rate of tax on accumulated foreign profits. But there is a world of difference between the two. The 2004 holiday imposed tax on a voluntary basis. To be subject to tax, companies had to bring the money home. For many multinationals, even the low 5.25 percent rate was too high, and they kept their previously accumulated profits offshore. So for many corporations, their profits were still subject to lockout -- in effect defeating the main purpose of the legislation. The 2011 approach (which reportedly is also being considered by the Senate Finance Committee) imposed tax on a mandatory basis. All previously accumulated foreign profits, whether or not repatriated, would be subject to a 3.75 percent tax.

This new tax on its own has two fascinating economic properties. First, it imposes tax on previously accumulated earnings without retaining any lockout effect. Businesses must pay the tax, but when it comes time to decide whether or not to bring the money home, the toll charge (35 percent under current law, 5.25 percent during the holiday) is absent. The marginal rate of tax on repatriation is zero. Second, unlike the 2004 approach, under which higher rates of tax could severely reduce repatriations, the mandatory approach can charge any rate of tax -- 3.75 percent, 5.25 percent, 15 percent, or 35 percent; you name it -- and still eliminate the lockout effect. Again, once the tax is paid, the repatriation decision would not involve any toll charge. The lockout effect is eliminated.

This last observation sets the stage for a possible nightmare scenario for multinationals. Congress, desperate for revenue raisers to pay for corporate rate reduction, can impose a large, one-time tax on this enormous pool of profits, raise a ton of money, and at the same time achieve the universal goal of international tax reform -- elimination of the lockout effect. For economists, there are no taxes better than lump-sum taxes on existing pools of wealth or profits, because they don't alter future profit-maximizing behavior. Each percentage point increase in tax on $2 trillion raises $20 billion! A tax rate of 15 or 20 percent on previously accumulated foreign profits may be unreasonable to Cook, but for economists it would be perfectly fine.

Read Comments (5)

vivian darkbloomNov 18, 2013

Shame on you Martin Sullivan. You appear to be "Missing Half the Cash"? $2
trillion? Gimme a break. Didn’t you get the scoop from your colleague David
Cay Johnston?: He broke that story quite some time ago (when the WSJ claimed
the number was only $1.7 trillion).

There seems to be serious factual problems with your claim! And, to make
matters worse, you did not attribute that number to any source. And, per
Johnston “attribution is fundamental to a fundamental of journalism. In that
spirit, here’s *that* source:

emsig beobachterNov 19, 2013

In a previous response to one of your posts, I stated that a 20% tax rate on
repatriated profits represents splitting the difference between the current
rate of 35% and the 5% rate bandied about by our titans of industry.

If our titans of industry really want their electronic blips back in the good
ol' U.S. of A, they can borrow the money from themselves. Would borrowing funds
from these tax haven banks actually harm their respective balance sheets and
therefore reduce executive compensation?

Yielding to pressure applied by the titans of industry to our supine Congress
only creates moral hazard, unless the Congress recognizes the reality of the
situation and adopts territorial taxation. In that case, I propose that there
should be no reduction in the tax rate on currently retained profits booked in
tax havens -- whether repatriated or not.

Parenthetically, I believe the tolls are too high on the I 95 corridor between
Washington, DC and New York City. I will ask Congress to reduce the tolls on my
return trip by 85%. I too can do wonderful things with the money I would save
by not paying tolls.

vivian darkbloomNov 19, 2013

"To solve the problem, CEOs want Congress to allow them to pay a lower
rate--something like 5 percent--if they repatriate foreign earnings. “If you
look at it today, to repatriate cash to the U.S., you need to pay 35 percent of
that cash. And that is a very high number,” Apple CEO Tim Cook told The
Washington Post in May. “We are not proposing that it be zero. I know many of
our peers believe that. But I don’t view that. But I think it has to be
reasonable.”

A "reasonable" number? For the temporary repatriation tax holiday granted in
2004, Congress let multinationals bring their accumulated foreign profits back
home if they paid an effective tax rate of 5.25 percent. (Technically, they got
an 85 percent deduction on repatriated income that was taxed at 35 percent.) In
Camp's 2011 international tax reform discussion draft, as part of the deal for
permanent exemption of foreign earnings from tax, multinationals would be
required to pay tax on accumulated foreign earnings at an effective rate of
3.75 percent. (Technically, they would get an 85 percent deduction on
accumulated foreign profits that would be taxed at 25 percent.)"

Your explanation and Cook's are both misleading. If the proposal is similar to
the 2004 Act, then the "effective tax rate of 5.25 percent" is not the
effective *US tax rate* It would be the effective foreign *and* US tax rate
because the law would allow a pro-rata foreign tax credit for the amount (say,
15 percent) of foreign earnings that are not deductible from the base.

Per a recent study by the Tax Foundation, the average foreign tax rate paid by
US corporations on their non-US earnings is about 25 percent (this obviously
varies enormously per company). So, on average, the residual US tax rate if
all earnings were repatriated and subject to the current law pre-credit US tax
rate of 35 percent would be only 10 percent after foreign tax credits (and this
excludes any foreign dividend withholding taxes, but these are generally
minimal today).

Under a 5.25 percent tax rate, and assuming the same average foreign tax rate
of 25 percent, the residual US tax would be 1.5 percent. Thus, in this
example, the differential is not between 35 percent and 5.35 percent, but
between 10 percent and 1,5 percent.

Eugene Patrick DevanyNov 27, 2013

Imagine a C corporation rate of just 8% - tax deferral solved.

Consider an “optional” 2% tax on average net wealth (excluding $15,000 cash and
$500,000 retirement funds) could be paired with a flat 8% income tax (and no
payroll taxes) for about 95% of the population. In the alternative, a higher
26% individual income tax rate (plus deferred capital taxes on gains, gifts and
estates and no wealth tax) could be paid by anyone (but they would likely be
very, very rich). A 4% VAT on business would enable a reduction of the C
corporation rate to 8% and elimination of payroll taxes.

Covert SecurityJan 5, 2014

Sir enjoyed hearing you speak on the TV last night. Thanks for the
enlightenment as to tax cheating corp hide outs.
Whatever happened to the BCCI cheats?

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