It’s one of the vague parts of the Republican tax framework: Some sort of one-time holiday to get corporations to return untaxed overseas profits to the US.
Currently, the US seeks to tax the entire worldwide profits of US corporations, but it only taxes foreign profits once they’re brought back here. So, companies tend to leave foreign profits abroad, which allows them to delay paying taxes, often indefinitely.
In 2004, Republicans implemented a “repatriation holiday” to get companies to bring those profits back. Instead of paying their full tax bill (that is, the 35% US corporate tax minus a credit for whatever taxes they’d already paid to foreign countries on their foreign profits) they were allowed to pay a rate of only around 5%.
The theory was, by allowing these companies to bring their profits home, money would come “off the sidelines” and be invested again in the US. In practice, companies mostly used the cash to pay dividends and buy back shares, distributing the money out to their shareholders instead of investing it.
But since the Republican framework makes noise about doing something like this again, I want to walk through the theory of why we should expect a repatriation holiday to be useless for encouraging investment and growing the economy, even if we didn’t know the results from 2004.
Repatriation does not give firms new flexibility
Suppose you run a firm that has just repatriated a large amount of cash that it had been holding offshore. You have two options: You can invest in growing the business, or you can return the cash to investors. (Note, “investors” can mean shareholders, but it can also mean lenders. Business Insider’s Joe Ciolli wrote last week about why repatriating firms might buy back less stock than they did in 2004 and instead use the proceeds to retire debts.)
Now suppose you run a firm that has not repatriated cash. You still have two options: You can issue debt or equity to raise cash and invest it in growing the business, or not.
You may notice these option sets are very similar. Either way, the firm is reliant on debt and equity markets where investors expect a certain level of return, and a well-managed firm expands only if new investments can generate that return; if the investment opportunities aren’t good enough, the firm lets the investors take their capital and invest it elsewhere.
A repatriation holiday can create a one-time tax windfall for a company, but because it doesn’t change the company’s cost of capital, there’s no reason to expect it change business investment decisions.
Repatriation does not give investors new flexibility
OK, you might say, so what if the firm uses the cash to buy back shares or pay down debts? That leaves new cash in the hands of the company’s investors, and they’re not going to put it under their mattresses. They will invest it somewhere.
This is true. But there’s no reason to believe this would lead to higher aggregate business investment in the United States.
First of all, I should note that while the cash proceeds of a repatriation holiday will flow to investors, most of the repatriated cash that reaches investors is not “income” in the economic sense.
Suppose you own shares of a corporation that owns a large business and also a pile of cash overseas from untaxed profits. Then, the firm repatriates those profits and pays a dividend. Now, you own your piece of the pile of cash and your shares in a corporation that owns only the business, no pile.
The only rise in the investor’s wealth is from the value of the tax forgiven on the repatriated funds — and because this is a one-time benefit, it does not encourage future investment.
In addition to not making you appreciably wealthier, the repatriation holiday hasn’t made you more liquid. You could have accessed this cash all along by selling your shares. And if the company distributed the cash through a share buyback instead of a dividend, you still had to sell your shares (back to the company) to access the cash.
But it is still true, whoever got this cash has to do something with it: Buy shares, buy bonds, put it in a bank. So this money will be sloshing around in the global capital market — much in the way it was before, when a corporation was holding it overseas.
Money ‘on the sidelines’ isn’t on the sidelines
People talk about Apple having hundreds of billions of dollars in “cash” from non-repatriated profits, but this stockpile consists mostly of corporate bonds — that is, Apple lends its accrued profits to other companies, which invest them.
The companies Apple lends to take that capital and invest it where they think they can get the best return, perhaps in the US.
Similarly, if individual investors take their proceeds from a repatriation-driven dividend and invest it in the markets, the firms they’re investing in will invest where they see the best opportunities, perhaps abroad.
Even if a particular investor faces either a bias or a legal restriction that drives where a particular investment goes, this fact should not change the overall allocation of investment capital in the world: If some investors’ demand for US-based investments should threaten to push American equity prices up and yields down, other investors will shift their focus abroad until risk-adjusted returns equalise.
All of which is to say, a repatriation holiday neither reduces the cost of capital for American businesses nor increases the expected return on business investments in America. Therefore, it should not be expected to raise business investment or grow the American economy.
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