Tuesday, March 21, 2006

Tax cut on repatriated earnings

Courtesy of the always-helpful TaxProf Blog, I note that the American Shareholders Assocation has just published a report concerning the recently enacted temporary tax cut on repatriated earnings, permitting U.S. multinationals, for a short time window only, to bring back overseas funds and pay tax on them at only a 5.25% rate rather than the full rate. The report shows that the amount repatriated vastly exceeds amounts projected by the Joint Committee on Taxation. The total is expected to surge past $300 billion, as opposed to a projected total of $130 trillion.

I always thought this was horrible legislation, a view shared by most who were not on the lobbying payroll of the groups seeking it, and shared even by those (including me) who believe that there is much to be said for a permanent low tax rate on repatriated foreign source active business income, or indeed U.S. exemption (making our system a territorial one purely on U.S. source income). The problem lies in the temporary character, which you can't credibly say will be once only. (You can say it, but don't expect anyone to believe you.) So foreign tax repatriations after the window closes will be down, I would expect, not only because pent-up repatriation demand has been satisfied but because people are waiting for the next low-rate holiday.

The unexpected flow of dividends makes the provision even "better" than its enactors expected, from a totally myopic point of view. Current revenues are increased, making the deficit smaller, if enough of these funds would otherwise have remained abroad for now. But future revenues, outside the budget window, are reduced, very likely by a much greater present value than the short-term increase. You can be certain that this gimmick will be used again and again in the coming years - increasing short-term revenues in exchange for damaging the U.S. government's long-term fiscal position. The push to encourage conversion from traditional IRAs to Roth IRAs (the cost of which is back-loaded) is the most prominent example of this, but surely will not stand alone.

I must say I'm not surprised by the under-estimate, even though I'm certain that the Joint Committee did its revenue estimates reasonably and in good faith. There was so much lobbying muscle behind this provision that you knew a lot of money had to be involved.

On the other hand, it's a bit surprising that the companies are willing to pay 5.25%. Current wisdom among the leading international tax economists and lawyers is that the repatriation tax is awfully easy to avoid, so why pay anything? I suspect that it has something to do with accounting. Even if the companies pay more tax than they would have otherwise, management would likely be fine with that if it permitted them to free up deferred tax liabilities that they had booked for financial accounting purposes. As I once heard an investment banker remark, "Saving taxes is all very nice, but reported earnings per share make the world go round."

7 comments:

Anonymous said...

Hi Dan,
I think you are right, plus, for many MNEs continuous deferral is costly (direct and indirect costs) and they may predict that such costs will continue to be significant or even grow, so for them five percent with almost no strings attached looks better than (maybe) costly and maybe risky deferral.
Yariv

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