In our recent video, “Election 2016: Implications for Business,” (click to view) I mentioned the problem we are facing with tax inversions. Tax inversions are when US corporations change domiciles to a foreign nation to reduce their tax burden. For companies remaining in the US, the issue boils down to the repatriation of profits earned abroad. To avoid paying added taxes on foreign earnings, many companies do not bring those earnings back to the US. Strategas, a research firm specializing in macro-economic research, estimates that S&P 500 companies are holding approximately $2.4 trillion abroad as a result.
In an attempt to repatriate some of these earnings, a onetime tax has been recommended. The latest bipartisan proposal, recommended in 2015, comes from Senators Barbara Boxer (D-CA) and Rand Paul (R-KY). A similar bipartisan proposal from Senator John McCain (R-AZ) and Kay Hagan (D-NC) was made in 2011. The Boxer-Paul proposal would create a tax holiday that allows companies to pay a 6.5% tax on profits they bring back into the US. This break would create a substantial discount from the ordinary 35% US corporate tax rate.
The last time a tax break to repatriate foreign earnings was enacted was in 2005. At that time, approximately $600 billion was held overseas. Due to the tax holiday, more than half of that was voluntarily brought back to the US. Repatriated earnings were taxed at 5.25%.
Opponents of this type of a tax break argue that this holiday gives corporations an incentive to keep future profits off shore until another holiday is given. Also, that these repatriated earnings will not create jobs and will go only to shareholders. Subjective evidence from the aftermath of the 2005 tax holiday are given to support the claims. However, there was a clear pick-up in employment during the fifteen month period that companies had to repatriate earnings. As soon as the tax holiday ended, job creation fell back to pre-holiday levels.
Regardless, with such divisiveness in Washington, the potential for a tax holiday is slim. The best chance is if the government stays divided with no one party controlling the White House, the Senate, and the House. Democrats will need the tax revenues the holiday will create to fund their infrastructure initiatives and Republicans want to make changes in the corporate tax code. Who knows? A deal could be struck.
In any event, a one-time tax holiday will not resolve the current problem, nor will moving to a territorial system as used in France, the Netherlands, and Belgium, where the double taxation of earnings is eliminated. As long as foreign nations tax corporate earnings at a lower rate, US companies will have an incentive to keep profits off shore and move operations overseas (needless to say, this is not the only reason on which companies determine domicile).
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.