Tax breaks for outsourcing
John Kerry has been claiming that loopholes in the tax code encourage companies to send jobs off shore. I wondered about this in our earlier discussion on outsourcing.
The Wall Street Journal had an article on Friday that investigated Kerry’s claims of this loophole. While you need to subscribe to get this article (even the MIT library doesn’t subscribe to the online edition), it has been reposted at Dave Farber’s Interesting People list.
Here’s the loophole:
…the ability to defer and often never pay taxes on foreign-earned profits. The result: foreign profits of U.S. companies end up taxed at a lower rate than their U.S. income, creating an incentive to invest overseas in factories. The jobs are where the factories are.
And here’s how it works
The tax code is written in a way that allows companies not to pay the full 35% U.S. corporate tax rate on foreign income when that money remains invested overseas.
Backing up a step, here’s how it works before the loophole: A company earns $100 million abroad in Lowtaxistan where the corporate tax rate is 20%. The foreign subsidiary pays that money to the U.S. parent. The parent then pays $35 million to the U.S. government and takes a credit for the 20% (or $20 million) payment to the Lowtaxistan government. So the net to the U.S. Internal Revenue Service is $15 million.
But here’s how it works with the loophole: The U.S. subsidiary simply keeps the money offshore and certifies to its accountants that the money is invested overseas. It never remits the money to the parent and so never pays the $15 million extra to Uncle Sam.
The buzzword for people in the know in big corporations is “unrepatriated earnings” i.e. money you make off shore that doesn’t come home to the US. Apparently, it’s getting to be more and more prevalent.
These are called “unrepatriated earnings” and they are increasingly commonplace. …
What we know is that the amount of unrepatriated foreign earnings is growing substantially. The non-partisan Congressional Research Service in a report last year said it had increased to $639 billion in 2002 from $403 billion in 1999….
If you look into the issue on companies balance sheets
What you’ll find is something like this from Pfizer.
“As of December 31, 2003, we have not made a U.S. tax provision on approximately $38 billion of unremitted earnings of our international subsidiaries. These earnings are expected, for the most part, to be reinvested overseas. It is not practical to compute the estimated deferred tax
liability on these earnings.”
Pfizer says it added 15,000 U.S. workers through its recent purchase of Pharmacia. Still, only 37% of its work force is in the U.S.
Note that the $38 billion total of unremitted earnings is cumulative over the years. In 2002, Pfizer had $29 billion, so the increase was $9 billion in the past year, helping the company substantially shave its tax bill.
According to the article, this is how the tax code has been set up since the early 1900s, when the ability to move capital and goods so freely was never considered.
And, being the Journal, they, of course, are not advocating fixing the problem by closing this loophole. Nope, they claim that we need to allow our firms this tax break so they can stay competitive with lower taxed nations. Lest our firms simply move off shore. This argument seems fallacious to me. There are lots of reasons that companies decide to stay in the US. Better workers, tradition, infrastructure, rule of law, you name it, we’ve got it.
Looks like a slam-dunk case for the Kerry campaign, they just need to explain it better.
What is the purpose of a “repatriated tax break”, and why is it so controversial?
A: In 2004, Congress passed the American Jobs Creation Act to create new jobs in an effort to boost the economy. One of the results of the act was the implementation of a repatriated tax break, which gave U.S. multinational corporations a one-time tax break on money earned in foreign countries.
The tax break allows foreign earnings to be taxed at a rate of 5.25%, which is significantly lower than the usual corporate tax rate of 35%. Previously, much of the earnings derived from foreign countries were not transferred back to the U.S. because multinationals can defer paying taxes on foreign earnings until they decided to send the earnings back in the form of a dividend.
Ultimately, the government’s rationale is that the tax break would act as a good incentive for American multinationals to send their foreign earnings back to the U.S., and then use the earnings to create more American jobs and/or expand operations in the U.S.
Critics of the idea believe that because the companies aren’t required to use the repatriated earnings for the sole purpose of American job creation (but the bill does prevent companies from using the money for executive compensation, dividends and stock investments), it is not assured that the tax break will increase job creation. Furthermore, the tax break can be seen as a reward for companies that are deferring regular repatriation of foreign earnings and a punishment for companies that regularly send money back. As a result of this, critics also worry that this act sets a bad precedent, as U.S. multinationals may see this tax break as an incentive to withhold future foreign earnings in the hope that another repatriated tax break will occur.
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