Update 210: Search for Revenue Leads Overseas;
State of Play on International Tax Reform Debate
Yesterday, the Senate Finance Committee held a hearing on International Tax Reform. It was the first Finance Committee hearing after the announcement of the Big Six tax framework last week.
What do we know about the state of play on international tax policy? What are the probable terms? What is the likely fiscal impact? Who are the winners and losers? And what is the likely legislative outcome? See below.
Current U.S. International Tax Policy
Today the U.S. employs a “worldwide” tax system with deferral, meaning companies that earn profits abroad pay U.S taxes on the income when profits are returned to the U.S.. Companies are allowed a foreign tax credit for any foreign taxes paid in order to avoid double taxation. The statutory Corporate Income Tax (CIT) is 35 percent. Bird according to the Treasury Department, the effective tax rate U.S multinationals pay is in fact lower than the weighted average for other G-7 countries — 28 percent vs 29 percent. This means U.S. multinationals are not facing significantly higher tax rates than their foreign competitors, as is commonly believed.
Today’s debate revolves around the GOP’s desire to shift towards territoriality, a system where profits earned abroad are only taxed by the host nation and not the U.S. -_ incentivizing repatriation. Currently, companies are reluctant to repatriate the $2.6 trillion held abroad as they fear the U.S. taxes due upon repatriation, which would total $760 billion, commonly referred to as the lockout effect. Deemed repatriation has been floated as a tool to levy a tax on all profits currently held abroad regardless of whether or not they are repatriated as a way to collect a portion of the $760 billion though the rate would be drastically discounted as compared to the current rate of 35 percent.
A territorial system will result in companies having an even larger incentive to invert and strip their earnings from the U.S. companies. Inversion — when a company merges with or is acquired by a foreign company and earnings — is accounted so to minimize tax liability. While anti base-erosion rules such as the per-country minimum tax, a minimum tax threshold such that any profits earned abroad not taxed to this level would be charged the difference, or a more crude uniform global minimum tax that does not take into account foreign tax levels have been suggested, they are yet to be defined and will likely not be able to stem the tide of job and profit exodus…. leading to a shrinking tax base, drastically decreasing corporations’ total tax revenues, and exploding the deficit.
Trump Global Tax Plan: Fiscal Impact
Regarding which, the GOP argues that shifting to a territorial system combined with a one-time discounted deemed repatriation tax would incentivize companies to repatriate the $2.6 trillion they have stashed abroad. This is a dubious assertion and would likely damage the county’s fiscal position.
Moving to a territorial tax system would likely increase the deficit both directly and indirectly. For one, multinationals would pay little to no taxes on their foreign earnings which would reduce revenues that might otherwise be gained from full taxation. Additionally, territorial taxation would actively encourage more profit shifting, eroding the corporate tax base and blowing a hole in the deficit.
A deemed repatriation at a discounted rate would similarly damage the country’s fiscal standing. While it is true that short-term revenues might increase due to the one-time tax, coupled with a move to a territorial system, we would no longer tax future tax haven earnings.
The GOP will likely lean on dynamic scoring– the argument that increased economic growth will offset the direct revenue losses resulting from international tax reform– to assert that their tax plan will actually improve the country’s fiscal position.
Per Senate Finance Ranking Member Wyden at yesterday’s hearing, this amounts to nothing more than wishing for a “magic growth fairy.” No reasonable economist expects international tax cuts to pay for themselves. From any angle, the Republican’s international tax proposals will have a negative fiscal impact.
Corporate Winners and Losers
U.S. companies stand to bring back roughly $300 billion in foreign profits should the Trump plan pass. Analysis from Goldman Sachs indicates tech companies would lead the way. That’s not surprising as 11 of the 20 S&P stocks with the highest overseas cash as a percent of market cap are in the IT sector.
The analysis estimated that S&P 500 companies would bring back about a quarter of their total untaxed overseas cash by the end of 2018, basing their analysis on a Bush-era repatriation holiday, when U.S. firms repatriated 25 percent of their total estimated overseas earnings, and current corporate investment trends.
Firms benefitting from the 2004 holiday spent 91 cents of their dollars back on stock buybacks. But today, equity prices are relatively high and recent corporate cash spending by firms with profits stashed abroad suggests they would be less likely to favor buybacks over other potential uses possibly even “investing for growth (capex, R&D, and cash M&A),” the analysts wrote.
Other tech winners: Apple, Cisco Systems Inc., NetApp Inc., QUALCOMM Inc., Oracle Corp., and Microsoft Corp. Non-tech winners would include Amgen Inc., Ralph Lauren, Foot Locker Inc.,General Electric, Abbott Laboratories, Priceline Group, Johnson & Johnson, and Merck & Co. Inc.
Legislative Outcomes — Desired and Probable
If deficits and debt don’t matter — at least yuge tax cuts creating not too much more than a trillion dollars in new debt in the next decade. The area has historically earned bipartisan interest, as both parties want to bring the $2.6 trillion currently abroad back home.
• Democrats — Democrats have been interested in policies to reduce inversions and offshoring, but remain skeptical due to lack of specifics guarding against base erosion. First, Democrats do not see US multinationals as facing serious competitiveness issues, as they have earned record profits in recent years. Greater after-tax profits would likely lead to rewards for shareholders rather than boost worker pay, so since they view territoriality as unlikely to benefit the American worker, Democrats will not be on board. Second, a repatriation tax break would forego a substantial revenue opportunity, so Democrats will work to move fiscally conservative Republicans on the issue.
• Republicans — House Republicans have been clamoring for a territorial tax system for months. The primary justification is to make American businesses more competitive relative to foreign firms. Senate Republicans are just as eager as their House counterparts to move to territoriality. Senator Portman argued it would bring in $144 billion to the American economy, 4,700 companies would become American immediately, and 154,000 jobs would be gained each year. Senate Finance Republicans also believe territoriality reduces acquisitions of American companies by foreign businesses.
Yet fiscal conservatives like Sen. Corker and the House Freedom caucus would prefer not to increase the deficit. After all, the TPC estimates the GOP business tax plans to cost $2.4 trillion over ten years and $3.2 trillion over twenty. Pressure from fiscal hawks could result in Republicans landing on a corporate rate cut above 20 percent with the attempted elimination of loopholes in a territorial system, reducing tax revenue from multinational corporations.