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Trump Tax Plan May Free Up Corporate Dollars, but Then What?

The following article by Patricia Cohen was posted on the New York Times website August 29, 2017:

Republicans say that a tax overhaul will free up funds for investment and stimulate the economy, a result that has proved to be elusive in the past. Credit Mike Blake/Reuters

The tax overhaul promised by President Trump and Republican congressional leaders is lugging a remarkably heavy load. The goal is not only to reduce the tax bills of corporations and small businesses, but also to stimulate investment, create jobs, increase global competitiveness and promote economic growth.

Whatever the intentions, though, pushing the world’s largest and most diversified economy in any particular direction is a colossal undertaking. In addition, there is a large and sophisticated tax avoidance industry dedicated to frustrating the most carefully worded proposals.

And as Mr. Trump prepares to outline his corporate tax overhaul ideas in a speech on Wednesday in Springfield, Mo., economists and tax experts warn that the path is likely to be treacherous.

Consider the tantalizing $2.6 trillion in global profits that American companies are keeping out of their home accounts and out of the Internal Revenue Service’s reach.

A pro-growth tax policy would presumably aim not only to reach profits kept abroad as a tax dodge, but also to encourage companies to use that money to expand their business and hire more workers.

That was what President George W. Bush set out to do in 2004 when he imposed what was meant to be a one-time reprieve and lowered the tax on those funds to 5.25 percent from a potential top rate of 35 percent. More than $300 billion flowed back into the United States, but despite safeguards, companies used most of the money to pay shareholder dividends or buy back stock, not to reinvest.

“Repatriation has little effect on real investment in the United States,” said Alan Viard, a tax expert at the conservative American Enterprise Institute and a former senior economist at the Federal Reserve Bank of Dallas.

That’s because repatriation is not really about geography. Most of the money is not stashed in some underground vault overseas, but already in American financial institutions and capital markets. Repatriation is in effect a legal category that requires a company to book the money in the United States — and pay taxes on it — before it can be distributed to shareholders or invested domestically.

The whole notion of earnings trapped offshore is misleading, Steven M. Rosenthal, a tax lawyer and senior fellow at the Urban-Brookings Tax Policy Center. “The earnings are not ‘trapped,’” he said. “They’re not offshore. They’re not even earnings. They’re accounting gimmicks that allow earnings to be shifted abroad.”

What’s more, companies already get something akin to tax-free repatriation by borrowing against those funds, with the added bonus of being able to deduct the interest paid on those loans from their tax bill.

A shortage of cash does not seem to be what is holding back companies from expanding. Corporate profits are higher as a share of the nation’s gross domestic product now than they have been in decades, said Kimberly A. Clausing, an economist at Reed College who studies the taxation of multinationals. According to a study by Treasury Department economists, “excess” or above-average profits by a few global giants have increased.

“It’s not clear that giving them an even higher share of profits, or a windfall, is going to lead to extra investment,” she said.

A recent survey of business leaders by the international accounting and advisory firm Friedman, for example, found that just 23 percent would reinvest repatriated funds. Most would use the money to pay dividends or engage in share buybacks.

To some economists, offering technology companies like Apple and Microsoft and pharmaceutical companies like Merck and Pfizer a discount on the corporate taxes they would normally owe simply rewards bad behavior.

“A lot of the funds got overseas in the first place via tax dodges, so giving firms a tax break on the money coming back seems like compounding the problem,” said William Gale, co-director of the Tax Policy Center and a former economic adviser to the first President George Bush. Repatriation at a discount rate “is a tax break,” he said.

If taxing foreign earnings that have already accumulated overseas is difficult, so is eliminating incentives that reward companies for continuing to keep profits in tax havens. To that end, Mr. Trump and the Republican leadership have pushed to slash the corporate tax rate and switch to what is known as a territorial system that would tax only profits earned in the United States and not those earned in other countries.

Mihir Desai, an economist at Harvard Business School, likes that approach. “We currently have the worst of all worlds,” he wrote in an email. “We have a high marginal rate,” which encourages companies to avoid taxes and puts the United States at a global disadvantage.

“And we have low average rates” — because of all the loopholes — “which indicate that we’re not collecting as much as we used to, given the very high level of corporate profits.”

The crucial questions are how to pay for a lower rate and how to prevent abuses. Corporate tax cuts that lead to huge deficits could hobble the economy. And a territorial system without sufficient safeguards could end up encouraging even more businesses to shift profits, operations and jobs to countries with lower tax rates.

Other nations with territorial systems have tried to prevent companies from wriggling out of paying taxes, while tax experts have suggested proposals ranging from a minimum global tax to tighter rules to prevent companies from relocating their patents and copyrights to tax havens like Bermuda and the Cayman Islands.

But skeptics worry that making the system airtight is impossible. “It’s an endless cat-and-mouse game,” said Matthew Gardner, senior fellow at the Institute on Taxation and Economic Policy, a research group based in Washington. “What’s driving companies to engage in paper transactions is not our 35 percent tax rate,” he said, but other countries’ willingness to undercut whatever rate the United States settles on. “You can never win if you are competing against their zero tax rate.”

Mr. Gardner argued that a broader definition of American competitiveness is needed that includes not only the tax system, but also the business infrastructure that the tax system supports — bridges and roads, health care, education and research and development. “If all you think about is the tax rate, then it should be zero,” he said. “Competitiveness is about finding the right balance.”

The damage inflicted by Hurricane Harvey on Texas — which Mr. Trump has promised to help address with federal money — shows how quickly new budget demands can materialize.

Establishing rates that are sustainable over the long haul contributes to economic growth. “If Republicans cut tax rates to levels that are unsustainable, everyone will believe rates will go up,” said Joseph E. Stiglitz, a Nobel Prize-winning economist and the author of several books on globalization and economic inequality. “And that means you’re going to get even less investment, because they are looking at future tax rates.”

In general, though, Mr. Stiglitz argued that the link between tax cuts and economic growth is vastly overstated. “There is no evidence that cutting the tax rates stimulates more investment,” he said.

“Growth is low because labor force growth is slow,” and it is only going to grow slower because of immigration restrictions, he said. “And we’re not investing in education and research, which is why productivity is slow. The notion that changing taxes is going to lead to a growth spurt is pure nonsense.”

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