Multinational corporations based in the United States have an estimated $1 trillion in foreign earnings stashed abroad, and many are keen on bringing that money back into the U.S. But doing so would require companies to pay up to 35 percent in taxes. So rather than pay the taxes owed, a group of firms are preparing to lobby for a one year tax holiday that would lower rates on repatriated foreign income to 5 percent, claiming that the extra money would allow them to hire more workers. But is a corporate tax holiday an effective way to fight unemployment?
Probably not, according to research by Mitchell Petersen. Petersen, a professor of finance, along with Mitchell Faulkender of the University of Maryland analyzed the effects of the tax holiday embedded in the 2004 American Jobs Creation Act on job creation and retention. They discovered that investment at most firms did not increase appreciably, meaning relatively few jobs were created or saved for the money spent.
Whether the current proposal being lobbied by Apple, Cisco, Oracle, Duke Energy, and Pfizer among others spurs job creation depends on the amount of capital the companies can access, Petersen said. “If the firms are not constrained for capital (they have internal domestic capital or they can borrow or sell equity), we should expect to see no change in investment or employment,” Petersen said.
“Firms that are well financed, and many of the firms with profitable foreign operations are well financed, do not invest more because they are short of great ideas and projects not because they are short of capital.”
Given that firms in the U.S. are sitting on a collective $2 trillion in reserves, it seems unlikely that many companies are short of capital. For the tax holiday to work, Petersen said, financing for new endeavors must be either difficult to obtain or prohibitively expensive, leaving foreign income as the only viable option. “The firms that are lobbying for this tax change need to argue that they have great project, but can’t raise the funds to finance them,” he added.
Should the companies successfully argue their case, the repatriated income would likely move investment and consumption forward. Much like the cash for clunkers program, such programs can “make the economy look better today, but worse in the future,” Petersen said. “If you discount or ignore the future enough, this looks like a good idea.”
“This policy is essentially government borrowing,” he continued. “The government gets more tax revenue today, and less in the future. Given the firms want to do it, this suggests the net effect is a fall in the present value of taxes the government will receive.”
Since the companies favor the tax holiday, shareholders would too, by extension. Firms that are able to fund their existing plans for investment could hand out the repatriated money as a dividend. Those without sufficient funds would likely invest the money, but Petersen’s previous work suggests the actual amount of investment will be low. The firms lobbying for the holiday are acting in their best interest, Petersen said, but “if we as a society or a tax payer, disagree with these rules, then we should speak up. We can’t quietly expect others to look out for us.”