The U.S. needs an overhaul of the corporate tax system, not a temporary tax break

MIT Sloan Prof. Kristin Forbes

Today U.S. multinationals have more cash stashed overseas than ever before –according to several estimates, companies have more than $1 trillion in profits squirreled away in foreign subsidiaries. Many of the companies with the most money abroad – including powerhouses from Apple to Google to Pfizer – say they’d like to bring a large portion of it back to the U.S.

This comes with a catch, however. The companies want a temporary tax holiday – nearly identical to the one passed in 2004, and the subject of my recent paper – that would allow them to repatriate profits attributed to their foreign operations at a 5.25 percent tax rate instead of the usual 35 percent. Most of the funds returned to the U.S. will likely be paid to shareholders rather than used for investment and new hiring (as the companies lobbying for the holiday claim). But the tax break would raise billions of dollars for the government and bring cash back to the U.S., which is arguably a good thing. (It’s no secret that the Obama administration has recently made overtures to reboot its relationship with the business community, and this is one way to do it. The tax break would make companies happy, and send some much-needed funds flowing back into the U.S. economy.)

But I worry. The U.S. desperately needs a much larger overhaul of the corporate tax system, and a temporary tax break on overseas profits is not the solution.

There are a number of reasons why there is far more cash stashed abroad today than in the past. First, companies’ growth overseas has been much higher than it has been domestically. Companies are making higher international profits and simply keeping the money abroad to invest in their foreign operations. A second reason that companies may be keeping a big chunk of their cash overseas is that they have seen the effects of the last tax holiday, and they are biding their time until the next one. It appears that even just the talk of another “one-time” holiday is enough of an inducement for companies to keep their foreign profits in overseas accounts.

A third and final reason has to do with the fact that the tax differential has changed, making it much less attractive for companies to bring back money from overseas. Over the past 15 years or so, other countries that had higher tax rates than the U.S., such as the United Kingdom, have lowered their tax rates. But the U.S. has kept its tax rate the same, and now at 35 percent – 39 percent when the average state corporate tax is included – it is one of the highest corporate rates in the world. Only Japan has a higher rate. (The average rate in the other industrial countries of the Organization for Economic Cooperation and Development is 25 per cent). It’s not surprising that companies choose to be taxed by the country where they earned their profits because they pay far less—or even to find accounting methods to shift their reported earnings to foreign destinations with lower tax rates.

This, in my view, is the biggest problem. The extra tax that U.S. multinationals must pay when they bring foreign profits back home provides an incentive for those companies to leave those profits there. They then might choose to spend that money to expand foreign operations instead of bringing the funds back to the U.S. to invest in new plants and equipment here. And it’s getting easier and easier for companies to shift their headquarters to places where the tax rate is lower. Those HQ jobs are not the kinds of jobs we want to lose.

We must find a way to raise revenues more efficiently without slowing growth and corporate tax reform should be part of that package. If corporate tax reform is not enacted in the U.S. soon, companies will have an incentive to not only continue keeping a large share of their profits abroad, but also to shift their headquarters out of the U.S. This will be bad for U.S. workers, bad for U.S. companies, bad for U.S. investors, and bad for the U.S. fiscal position. Providing lower taxes on foreign earnings will be an important bargaining chit to gain some major companies’ support for fundamental corporate tax reform. Please don’t waste this chit.

Kristin Forbes is the Jerome and Dorothy Lemelson Professor of Management and Global Economics at MIT’s Sloan School of Management. She served as a Member of the White House’s Council of Economic Advisers from 2003 to 2005, where she was the youngest person to ever hold this position, and currently serves as a member of the Governor’s Council of Economic Advisers for the state of Massachusetts.

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