Repatriated profits tax
Repatriated income tax is a deduction made at home for income earned in foreign countries. Income earned abroad by subsidiaries of the United States’ multinational corporations is taxed based on the difference by which the tax rate in the U.S. exceeds that of the foreign country. Marr and Huang (3) explain that the taxation of the margin ensures that there is no double taxation. Keightley and Sherlock (2) discuss that most corporations fall under the 35% tax rate. However, firms are charged lower rates for the first level income bracket. For example, a 15% tax rate for the first $50,000 (Keightley and Sherlock 2). Firms that earn between $100,000 and $335,000 are supposed to pay 39% as corporate tax. A firm that was taxed 20% in the foreign country may need to remit only 15% of its net income when it falls under the 35% tax rate bracket. Corporations are taxed based on their net income abroad, but they are required to pay the government only when they transfer income back to their home country. Foley et al. (24) explains that firms operating in countries with lower tax rates are more likely to indefinitely postpone the transfer of income to their home country. Grubert (4) explains that the cost of avoiding tax is higher for mature subsidiaries, which eventually makes them transfer income to the parent company.
The 2004 Tax Holiday and its impact on the U.S. economy
The 2004 Tax Holiday was approved by Congress in response to the indefinite deferral of income by subsidiaries of multinationals incorporated in the U.S. The 2004 Tax Holiday was issued in the American Jobs Creation Act (P.L. 108-357), extending a tax cut for repatriated profits within a year. Marples and Gravelle (2) explain that firms were allowed to pay 85% less of the corporate tax that they owed the government. A firm that would have paid 35% was required to pay only 5.25% in taxes. Usually, firms are required to pay the tax margin, which results in a much lower effective tax rate than 5.25%. For example, a firm with a margin of 15% was allowed to pay 2.25% effective tax. Grubert (5) highlights that about $400 billion was transferred to the U.S. in response to the Tax Holiday, contrary to popular theory that firms are less sensitive to the repatriation income tax. The 2004 Tax Holiday came with regulations that required firms to spend the cash in investment activities. It barred firms that benefited from the Tax Holiday from using a large part of the transfers to repurchase stocks and pay dividends. However, Marr and Huang (1) suggest that the restrictions did not prevent firms from using a large part to repurchase stock and pay large dividends.
One of the direct effects of the Tax Holiday is an increase in cash inflow. Marples and Gravelle (3) explain that repatriated income increased by 266% in the Tax Holiday. Marples and Gravelle (6) suggest that there is little evidence that firms used the repatriated earnings in investment activities. Cash spent in dividends will end up being spent by individuals, inducing demand for goods and services. However, studies indicate that induced demand from the cash inflow was minimal (Marples and Gravelle 9). In addition, simulated studies have also indicated a very low multiplier for the cash inflow emerging from the repatriated profits. The multiplier ranges between 0.18 and 0.34 for repatriated earnings (Marples and Gravelle 9). It shows that repatriated earnings are less effective in inducing demand.
The 2004 tax holiday was supposed to create jobs through increased investment. Contrary to expectations, statistics indicate that the top 15 firms that were the main beneficiaries of the Tax Holiday reduced the size of their workforce, despite the economic growth in the U.S. at the time (Marr and Huang 8). Pfizer reduced its workforce by 10,000 workers, Merck by 7,000, Hewlett-Packard by 14,500, and Ford by more than 30,000 between 2005 and 2006 (Marples and Gravelle 6). The expected effect of increasing jobs was not achieved.
Another effect is that the Tax Holiday was followed by a period with an increase in deferrals from firms that benefited from the Tax Holiday. Marples and Gravelle (5) elaborate that the average growth of deferred income is 72% for all firms and 81% for firms that benefited from the 2004Tax Holiday between 2005 and 2009. One of the reasons for the rise in deferrals is that firms expect another tax holiday. The Tax Holiday has resulted in loss of tax revenue that would have been collected from income repatriation. Marples and Gravelle (11) explain that a tax holiday similar to the one offered in 2004 would result in a loss of revenue amounting to $78.7 billion in a decade. Firms would release their accumulated earnings with the intention of starting to accumulate earnings afresh. The Tax Holiday resulted in an increase in revenue in the year in which it was issued with less revenue in the years that followed.
Proponents suggest that the income would not have been repatriated altogether. Opponents suggest that mature subsidiaries will have to repatriate income eventually. Marr and Huang (2) recommend tax reforms that require firms to remit taxes as a better alternative. The government will then use the funds to fund infrastructure, as an alternative to private investment. It will create jobs and induce demand in the economy better than a tax holiday for repatriated earnings.
Foley, Fritz, and Jay Hartzell, Sheridan Titman, Garry Twite 2007, Why Do Firms Hold So Much Cash? A Tax-based Explanation. Web.
Grubert, Harry 2009, MNC Dividends, Tax Holidays and the Burden of the Repatriation Tax: Recent Evidence. Web.
Keightley, Mark, and Molly Sherlock 2014, The Corporate Income Tax System: Overview and Options for Reform. Web.
Marples, Donald, and Jane Gravelle 2011, Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis. Web.
Marr, Chuck, and Chye-Ching Huang 2014, Repatriation Tax Holiday Would Lose Revenue and is a Proven Policy Failure. Web.