The Tax Repatriation Issue

The idea of a corporate income tax repatriation holiday seems to have fallen off Washington’s political agenda for now, but since a lot of very rich well-known companies would benefit from it I imagine the idea will come back and in light of Apple CEO Tim Cook’s remarks today I thought I should try to explain it.

The way the American corporate income tax works is that the actual location of the corporate income in question matters. So if Apple runs a subsidiary in Japan that earns huge profits selling iPhones to Japanese people, the federal government deems this none of the IRS’ business. The tax is paid only on American income based on US-based operations. And obviously US-based multinationals are happy to not pay those taxes. The problem arises, however, because in order to use those profits to pay a dividend or acquire a US-based company you would need to bring those foreign profits home and pay taxes on them. This becomes a scenario where the high statutory rate of the corporate income tax makes a big difference. As we’ve seen before, thanks to extensive availability of loopholes and deductions the overall corporate income tax burden isn’t very high. But the headline rate is 35 percent. That’s kind of a big deal. If it was somehow possible for Congress to commit itself to never altering the corporate income tax, at some point the stockpiles of foreign cash would just get too ridiculous and firms would suck it up and pay the bill. But because everyone knows there’s a chance that congress will either cut the corporate income tax rate or declare a temporary “repatriation tax holiday” the rational shareholder prefers to not get paid a dividend out of foreign earnings. Better to sequester the funds abroad and wait for President Romney to create a more favorable tax environment. So in a funny way, the fact that a tax holiday might happen ends up strengthening the case for doing a tax holiday.

More fundamentally it strengthens the case for corporate income tax reform and over the long term for finding a different, less distortionary form of revenue.