Large multinationals based in the United States – among them General Electric, Pfizer, Apple and Citigroup – have been hoarding record amounts of cash overseas, mainly because of the 35 percent tax they would have to pay if they brought it back to the United States.
The American Jobs Creation Act of 2004 offered a temporary tax holiday that allowed firms to repatriate cash at about a 5 percent tax rate, but there were strings attached. The repatriated money was to be used only on permissible activities like research and development, capital expenditures and pension funding. It was not to be used for shareholder dividends or share repurchases.
The purported goal of the legislation was to create jobs, not simply to enrich shareholders at the expense of federal tax revenue. In recent years, companies have lobbied for another tax holiday.
Tax policy experts are suspicious of tax holidays, and most experts question the effectiveness of attaching strings to such legislation. Because cash is fungible, companies might be expected to use the repatriated money for permitted domestic activities that they would have conducted anyway, freeing up other cash to be used for dividends and stock buybacks. If companies merely reshuffle the use of cash without changing behavior, then the tax holiday amounts to a windfall to shareholders, not an effective economic stimulus.
The 2004 tax holiday brought back $312 billion in extraordinary cash dividends from foreign subsidiaries. How much of that cash was used for permitted activities, and how much for impermissible dividends and stock buybacks? A 2011 paper by Dhammika Dharmapala, C. Fritz Foley and Kristen J. Forbes, published in The Journal of Finance, estimated that 60 cents to 92 cents of every repatriated dollar was spent on shareholder payouts in 2005. The paper is Exhibit A in the case against future tax holidays.
A new paper by Thomas J. Brennan of the Northwestern University School of Law challenges that study and finds that, for the 20 companies that repatriated the most cash, 78 cents of every dollar was spent on permissible uses, and just 22 cents on impermissible shareholder payouts. Extending the analysis to 341 companies outside the top 20, Mr. Brennan estimates that about 40 cents of every dollar was spent on impermissible shareholder payouts, still much lower than the earlier estimate.