Tuesday, March 21, 2006

U.S. Companies Bring Profits Home

The American Shareholders Association (ASA) has released a report on the effects of a change in U.S. tax law affecting foreign earnings. By way of background, U.S. companies with foreign subsidiaries are not taxed on foreign earnings until they were repatriated. This rule incentivizes continued foreign investment and capital spending, rather than bringing those profits back to the U.S. where they would be taxed at ordinary rates. Congress changed the incentive structure by imposing a low tax rate of only 5.25 percent on repatriated earnings. However, like those sale ads that induce us not to dally, this offer is for a limited time only.

U.S. companies took advantage of this opportunity, bringing back over $200 billion to the U.S. in 2005. Total flows are estimated at nearly $300 billion. This additional money flow is significant, and we should see positive domestic impacts from these funds that are now available to deploy here in additional ventures. For the first time on record (recorded since 1952), foreign earnings retained abroad were negative.

In terms of the significance of the size of these cash flows, the report explains that they match the effects on GDP of the combined Bush tax cuts. In other words, looking to 2005, the Bush tax cuts enacted from 2001-2004 had an impact of 1.76 percent of GDP, whereas the flows represented 1.74 percent of GDP – nearly the same amount. This means that businesses and individuals have more money to deploy toward activities they believe will be productive. If you believe people make better choices than governments, then you will be delighted with this development.

And by the way, even the tax and spend crowd (as opposed to the borrow and spend crowd, which seems to include much of the republican establishment these days) should still be pleased: the federal government will still reap more taxes from these repatriated earnings than the taxwriters expected. Looking down the road, new taxes are also likely to be generated (at higher rates than 5.25 percent) on future earnings from enhanced domestic investment.

It’s a competitive world out there – we need to be running as fast as we can. This change in law helps us. And if lower tax rates can do this for repatriated earnings, think what we might accomplish through lower tax rates on capital investment!

(The report is discussed in today’s BNA Daily Tax Report; for nonsubscribers, the ASA report is available here:

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