Repatriation tax holiday may have allowed multinational corporations to manipulate earnings
We鈥檝e known for years that the 2004 repatriation tax holiday did little to boost domestic investment or create US jobs, as promised by its backers.聽Now we are learning that many multinational corporations were not even interested in using the temporary holiday to cut their taxes. Instead,聽according to a new study, it may have been聽little more than an easy way聽for them to聽manipulate earnings to polish their financial statements.
Yet Congress remains聽seduced by聽the idea. After all,聽it looks free money鈥揳 plan that聽raises revenue but can聽be promoted as a tax cut. That鈥檚 why a decade ago lawmakers enacted a temporary tax break for multinational firms that brought their foreign earnings back to the US. And that鈥檚 why pols as diverse as Senate Democratic Leader Harry Reid (D-NV) and Senator Rand Paul (R-KY) are pushing for a new version of a repatriation holiday today.
It was a terrible idea back in 2004. It is still a terrible idea鈥攁nd two very different analyses help explain why.
The first, by the congressional Joint Committee on Taxation, estimates that while cutting taxes for one year on repatriated earnings briefly generates new revenue, it significantly increases the deficit even within Congress鈥� usual 10-year budget window.
According to聽, such a holiday would boost federal revenues by about $19 billion over the first two years as firms pay some tax on funds they would otherwise have kept overseas tax-free. But since multinationals are getting a tax break for bringing money back they would eventually have returned anyway (at higher rates), JCT figures the tax holiday would add almost $96 billion to the deficit over a decade. So much for free money.
罢丑别听, by financial accounting experts Michaele Morrow of Northeastern University and Robert C. Ricketts of Texas Tech, looks closely at how firms responded to the 2004 tax break. Their fascinating conclusion: For many multinationals, the benefit of the holiday was not primarily tax savings at all. Rather, it provided an easy way to manage the earnings they report to shareholders by manipulating their financial statements.
To put it a bit more crudely: Congress let multinationals pay deeply discounted taxes on $350 billion in repatriated earnings largely to make them look good to Wall Street analysts.
The study, published in聽The Journal of the American Taxation Association, found that while some multinationals used the tax holiday to boost reported earnings, others took advantage of the tax break to reduce book income, all in an attempt to exactly match analysts鈥� expectations. Either way, many聽firms were not interested in maximizing real shareholder wealth by reducing taxes. Rather, they brought back only the amount necessary to hit financial reporting targets.
Morrow and Ricketts were answering a perplexing question: If about $800 billion in foreign earnings was available for repatriation at low tax rates, why did firms bring back only $350 billion?
To find out, they surveyed 596 multinationals that reported pre-tax foreign earnings and found less than 60 percent brought any money back at all, and overall they repatriated only about 44 percent of the amount they could have returned.
Why would a firm pass up a chance to bring money back to the US at a steeply-discounted tax rate?
The authors conclude there were two major reasons. The first, and most obvious, is that multinationals had better investment opportunities overseas, even after factoring in the very low tax on repatriated profits. For those firms, the tax holiday had no effect on either their investment decisions or their tax liability.
The second answer is less apparent to those of us who are not accounting geeks. In the words of Morrow and Ricketts, 鈥渇irms may have viewed the tax holiday primarily as an opportunity to manage reported鈥arnings rather than an opportunity to save taxes.鈥�
The good news, I suppose, is that since firms may not have been interested in maximizing tax savings, the revenue loss was not as bad as it might have been. But backers insisted the 2004 tax holiday would boost domestic investment and create new US jobs. Extensive聽聽has found little or no evidence that either happened.
Add it all up and the 2004 law appears to have gone far off the tracks. Firms didn鈥檛 increase domestic investment. They didn鈥檛 hire more US workers. Now we learn they didn鈥檛 even maximize their tax savings. Instead, in many cases, the tax holiday was mostly an opportunity to burnish their financial statements.
As Congress considers whether to declare another holiday, it should ask itself whether that鈥檚 the best use of tax revenue.
