Monday, June 22, 2020

Familiar tax rules in unusual times

According to a WSJ piece (subscription required) from last Friday by Richard Rubin and Theo Francis:

"U.S. companies brought home $124 billion in foreign profits in this year’s first quarter, the highest level since an immediate rush after the 2017 tax law, according to data released Friday by the Commerce Department.

"The repatriations, made just as the coronovirus-related recession was starting, were a sign of how much companies may have needed cash in their U.S. operations."

This is interesting in relation to thinking about international tax policy, as it reminds us of how contingent and changeable our core assumptions may be, even if based on years of observation and experience. Let me back up to explain.

Until the 2017 tax act, U.S. international tax law had a rule called deferral, under which foreign source income (FSI) earned through foreign subsidiaries wasn't taxable to the U.S. parents until it was repatriated for tax purposes, such as through the payment of a dividend. The rule's origins rested on absurd formalism: the notion that there was actually a meaningful separation between a U.S. parent and wholly-owned foreign subsidiaries (as distinct from foreign branches), simply because they were separate legal entities. The reason the rule persisted for so long was that it was generally contested (both politically and intellectually) how resident multinationals' FSI ought to be taxed, given that (a) the companies' domestic source income was (at least in principle) being taxed here, and (b) nonresident companies' FSI (from our perspective) wasn't being taxed here.

So maintaining deferral, subject to the repatriation tax, was an absurd ceasefire in place that persisted simply because how best to replace it was unclear. The 2017 tax act, for all its faults and foibles, did at least offer up some sort of solution, in which deferral was repealed but the domestic taxability of resident companies' FSI otherwise increased (through the transition tax plus the enactment of GILTI).

One common assumption that guided the entire debate was that US multinationals'' repatriation decisions were extremely tax-elastic. At the core, repatriation is completely meaningless economically IF their internal capital markets function entire seamlessly. While it was known that this wasn't 100% true - causing "lock-in," as companies awaited tax holidays or the repeal of deferral - to create some deadweight loss - it was deemed sufficiently true to be a good basic operating assumption, subject to one's remaining aware of the need for nuance. Second, it was thought to be the case that big U.S. companies generally weren't enormously cash-constrained, and that, for example, even if their U.S. domestic investments were sometimes quite low, e.g., during recent recessions before the current one, this had more to do with a shortage of appealing investment opportunities than of cash.

Maybe this time would have been different. That is, consider again the $124 billion that just came home due to an apparent rise in hunger for available cash. (If it was brought home for other reasons, such as fearing that the funds would be less "safe" otherwise, that might not change the analysis).

This money came home in the absence of adverse tax consequences - at least, from the repatriation itself; subsequent tax burdens from how the cash is used may still end up being affected. So we don't know how much of it would have come home in the presence of a repatriation tax (which would itself have depended on the companies' broader tax positions and ability to use further tax planning).

But if we accept that bringing the money home did matter more than it usually would have, then we get two likely conclusions:

(1) the U.S. Treasury would have gotten unusually high tax revenues from the repatriation tax under 2020 circumstances, making the repeal of deferral more regrettable than it might otherwise have seemed (subject to macroeconomic concerns about getting the $$ now rather than during an upturn), and

(2) the deadweight loss from cases in which companies decided NOT to bring the money hom,e given the tax bite would have been higher than usual under 2020 circumstances, making the repeal of deferral more welcome (i.e., less regrettable) than it might otherwise have seemed.

The overall takeaway depends in part on the relative magnitude of these two effects, i.e., on what would have happened under the counterfactual. We don't know, and it might not be the most desirable place in which to deploy scarce revenue-estimating resources. But the broader point, that things we take for granted may sometimes change, is worth more generally having in mind.


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