The outlook for US corporate tax reform in 2017 seems auspicious. Reform might combine three elements: a lower corporate tax rate, a tax repatriation holiday, and a larger role for "pass-through" taxation. This blog discusses the tax repatriation holiday.
US multinational corporations (MNCs) are estimated to hold more than $2 trillion of earnings in their controlled foreign corporations (CFCs; also known as foreign affiliates or foreign subsidiaries). It is unknown what proportion of these earnings is held in cash and other liquid assets, and what proportion has been reinvested abroad, but the liquid share is probably less than half. Potential US tax liability largely explains why the liquid portion is retained abroad and not repatriated in the form of dividends to the US parent corporation. In approximate terms, the potential US tax liability on repatriated earnings is the US federal statutory tax rate of 35 percent minus the foreign tax rate. For example, if the foreign tax rate is 15 percent, the potential US liability would be about 20 percent of the repatriated dividends. Experience shows that US MNCs seldom repatriate earnings held abroad when the additional US tax take exceeds 5 percent.
During his two terms in office, President Barack Obama has repeatedly attempted to tax CFC earnings on a current basis, whether or not repatriated to the parent firm, but Congress has consistently rejected his proposals. The main congressional objection is that current taxation would put US MNCs at a sharp disadvantage relative to foreign MNCs headquartered in foreign countries. Nearly all home countries for foreign-based MNCs either practice territorial taxation—meaning that they do not tax CFC earnings at all—or tax such earnings at preferential low rates, such as 10 percent.
A further concern of congressional opponents is that Obama's taxation proposals have had the unintended effect of prompting more US-based MNCs to think about "inverting." Indeed, during the past four years, a few dozen US MNCs have inverted.1 The corporate rationale is to permanently avoid the 35 percent US tax bite on unrepatriated foreign earnings.
Members of Congress on both sides of the aisle seem eager to address both the prospect of future inversions and magnitude of CFC earnings that have been "locked out" by the high cost of repatriation. Some proposals have looked to the American Jobs Creation Act (AJCA) of 2004, which allowed corporations to repatriate offshore earnings at the substantially reduced rate of 5.25 percent. The AJCA successfully motivated about 840 US firms to repatriate some $360 billion of foreign earnings. However, the money was not generally used in an easily traceable manner to fund productive investment in US plant and equipment, as had been hoped.
Recent proposals seek to improve on the AJCA by tying the preferential tax rate to productive investment. One approach would encourage US corporations to purchase "infrastructure bonds" that would capitalize a US infrastructure investment bank. In particular, John Delaney (D-MD) proposed that corporations should be allowed to repatriate, at a preferential tax rate, some multiple of their purchase of low-yield infrastructure bonds. Variants of this approach could tie repatriated money to "qualified" infrastructure projects undertaken by the US parent firms or to plant and equipment outlays or to R&D expenditures above a baseline level.
A repatriation holiday with a hypothetical 10 percent tax rate would bring tax revenue to the US Treasury. For tax-scoring purposes, this could be seen as an offset to the static revenue impact of a lower US corporate tax rate, or as an offset to the static revenue loss from enabling manufacturing firms to qualify as master limited partnerships. For example, if a repatriation holiday attracted $500 billion of retained earnings held abroad, the US tax collection would amount to $50 billion.
1 Facing the prospect of an inversion by the pharmaceutical giant Pfizer in 2016, the US Treasury rewrote the applicable tax regulations, adding a retroactive twist that blocked the deal.