Tax reform won’t bring back billions in cash held abroad: Holtz-Eakin
Treasury Secretary Jacob Lew announced Monday night he would begin cracking down on American companies that avoid taxes by moving their headquarters overseas. Lew will stop these so-called “tax inversions” by making it more difficult for smaller foreign companies to take over larger U.S. companies, and by making “hopscotch” loans—where U.S. companies get around paying taxes on dividends by distributing earnings as a loan to a foreign company—taxable.
Tax inversions have been of great interest lately with some high-profile foreign mergers: Burger King agreed to be acquired by Canada's Tim Hortons (THI) and U.S. pharmaceutical company AbbVie (ABBV) was recently acquired by UK company Shire (SHPG).
Stockpiles of cash abroad
On top of tax inversions, many U.S. politicians lament companies that keep stockpiles of cash abroad. The Securities and Exchange Commission has expressed concern that companies aren’t being honest with investors about their liquidity because of the money held overseas. In 2012, for example, General Electric (GE) had $85.5 billion in cash, but only $30.7 billion in the U.S., Microsoft (MSFT) had $66.6 billion, but only kept $8.6 billion at home.
Around three-quarters of all U.S. corporate cash is held abroad to avoid the U.S. top corporate tax rate of 35%. Meanwhile 80% of blue chip companies listed on the S&P, including Apple (AAPL), Boeing (BA) and Ford (F), are borrowing money to pay dividends instead of repatriating their overseas cash. Companies actually get a double tax advantage by borrowing money to pay shareholders and because the Fed's interest rates on the loans are remarkably low. Critics of the practice say it hurts growth in the U.S. with companies choosing to hold the cash rather than hiring new employees with it.
Congress has long debated an overhaul of the corporate tax code to address just such issues, but effective action on that front is probably not realistic in the short or medium term.
It’s a bank thing
U.S. corporations now hold $2.1 trillion abroad, an amount that has nearly doubled since 2008. Big banks, however, have an excuse says Douglas Holtz-Eakin, President of the American Action Forum and former director of the Congressional Budget Office.
“You can change the tax law in the United States, but that doesn’t change the laws overseas,” he says. “Those laws say something like $231 billion for America’s six biggest banks has to stay overseas.”
Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), Goldman Sachs (GS), Morgan Stanley (MS) and Wells Fargo (WFC) must keep a large portion of their money abroad in order to comply with international bank regulations.
“There are a lot of people here who want that money,” says Holtz-Eakin. “The tax inversion guys want to fix the code to get the money back; the government wants to tax it—but no one is going to see that money.”
When you look at a company with money abroad, says Holtz-Eakin, you have to ask if it has some kind of financial services footprint. Apple, which keeps $138 billion in cash overseas and just $18 billion domestically, could be required to repatriate its cash but others like insurance companies might not be able to.
“We think of this as the lower bound, there’s probably more money that’s got to stay abroad, so you’ve got to be careful when you toss around that $2 trillion figure,” says Holtz-Eakin.
Reform
“We certainly need to get the U.S. corporate rate down,” says Holtz-Eakin. He believes we need to work towards a modern international tax system. The U.S. currently sports a 35% top corporate tax rate, the 32nd most competitive tax code out of 34 OECD countries. It is one of the only developed countries without a territorial tax system that exempts foreign profits from domestic taxes.
“It’s not just the inversion problem,” says Holtz-Eakin who points to German firm Siemens AG buying U.S. oilfield equipment maker Dresser-Rand (DRC) for $7.6 billion cash. “They won’t pay a second layer of tax back in Germany,” he says. “And that gives them an advantage… in the headquarters war, the U.S. is always going to lose.”
