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There’s been talk escalating this week in Washington about offering U.S.-based multinational companies a tax break to bring home their earnings from foreign subsidiaries.
It’s well known that the U.S. is sitting in an unsustainable fiscal situation with a record budget deficit and record debt levels. That’s put the country in a vulnerable position, well in the path of a spreading global sovereign debt crisis.
All the while, it’s estimated that U.S.-based companies are sitting on $1 trillion worth of foreign earned profits offshore — escaping the tax man.
At the current top corporate tax rate of 35 percent in the U.S., that’s a sizable amount of tax revenue that’s going unclaimed.
The question is: Will the U.S. Treasury ever get their hands on that money?
That’s Where the Tax Holiday
Proposal Comes In …
House Majority Leader Eric Cantor is speaking up for legislation that would allow multinational corporations a one-time tax break to bring earnings from foreign subsidiaries back to the U.S.
The incentive would likely include slashing the tax rate from 35 percent to 5 percent for earnings repatriated in a specified time frame.
In other words, the assumption is that 5 percent of something is better than 35 percent of nothing.
And the theory is that the repatriation of this overseas money would slightly reduce the budget deficit. Plus it could put companies in a better position to invest, expand and add jobs, thereby improving GDP growth.
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The White House, however, doesn’t seem interested in playing along so far. This week Treasury Secretary Tim Geithner said, “We are not going to look at a repatriation holiday outside the context of comprehensive reform.”
The government’s fear: They’ll lose negotiating leverage with the business community for broader corporate tax reform — their effort to close loopholes that are allowing big corporations to skirt taxes altogether.
But given the tenuous economic environment and global pressures for credible plans to deal with debt and deficits, this corporate tax break could very well take hold.
If It Does Pass, How Will
It Influence the Markets?
For that answer, let’s take a look back at 2005 when nearly $300 billion came home after the Homeland Investment Act (HIA) of 2004 was passed. Similarly, the HIA of 2004 allowed U.S. companies to repatriate earnings at a 5.25 percent tax rate, as opposed to the prevailing top corporate tax rate of 35 percent.
Studies show, however, that the desired influence on the economy never transpired. Companies didn’t use the money to add to their workforce and make investments. Rather, they paid the lion’s share out to shareholders.
For the U.S. stock market the effect seemed fairly muted. Stocks in 2005 were choppy, but finished in positive territory for the year, up just 3 percent.
Yet there was one area of the financial markets where the influence was clear: Currencies … namely the dollar.
Here’s a chart of the dollar index …
You can see the dollar made a steady climb throughout 2005. In fact, the first trading day of 2005 marked the low for the year. That $300 billion worth of foreign currency converted into U.S. dollars ultimately sent the dollar up 14 percent in 11 months.
So, if you have any investments exposed to foreign currency fluctuations, be sure to keep an eye on these developments in Washington. It could prove quite meaningful for the dollar.
Regards,
Bryan
{ 3 comments }
Is not true that some for foreign countries are beginning to wake up to tax dodging of these multinationals and have started to imposing their tax. Far exceeding the 5% Candor is suggesting. The multinationals will only be able to hide but so long.
Time is well over due!!!
Bryan, your second paragraph reads:
“It’s well known that the U.S. is sitting in an unsustainable fiscal situation with a record budget deficit and record debt levels. That’s put the country in a vulnerable position, well in the path of a spreading global sovereign debt crisis.”
But is it well known that our country’s unsustainable federal fiscal situation is also dangerously out of control because our leaders in Washington don’t have the political courage to publicly offer and pursue a viable and aggressive plan to both cap the soaring debt (already $14 trillion) by eliminating budget deficits and then achieving budget surpluses to begin significantly paying it down to reduce its huge interest cost. Why? Because a truly viable (achievable) plan will require painful government spending cuts and tax increases that will disenchant even the most patriotic voters.
Therefore, like the credit rating agencies, our leaders are going to continue avoiding the already exisiting and growing federal debt crisis until after the current 2012 election campaign is mercifully over hoping the debt crisis doesn’t erupt into a volcanic-like disaster sooner. Such a tactic is why Obama evaded the debt problem in his January SOTU address without any sigificant post-address criticism from Republicans.
If the corporate tax holiday were only on repatriated earnings from overseas subsidiaries I’m not sure what the problem would be. Whatever comes back is a windfall, tax wise. It is naive to think that the money will be used to create jobs because it won’t. Some of it may even be used to send more jobs offshore, corporations have no loyalty to anything but profit, that is their purpose. However as you point out 5% of something is better than 35% of nothing and at this point the Government needs to be looking after it’s one source of income, taxes. If this increases tax revenues and if that money is funneled into deficit reduction then it is a positive. Given the fiscally irresponsible path that the Government has been on those are very big ifs.