Business Week: To Tax, or Not to Tax, Overseas Cash Hoards

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(Original Post)

By Elizabeth Dwoskin on October 10, 2012

One little-mentioned topic in the debate over how to solve the nation’s $16 trillion debt crisis is overseas profits and how companies are taxed on them. Because the current tax code allows corporations to defer taxes on foreign income—which Bloomberg estimates at $187 billion—many opt to keep it overseas indefinitely rather than pay the IRS, at a rate of 35 percent, to repatriate the money. Kimberly Clausing, an economics professor at Reed College, says the U.S. Treasury lost $90 billion (PDF) in 2008 due to multinationals legally avoiding tax payments by leaving money overseas.

Staffers on the Senate’s subcommittee on investigations recently found that Microsoft booked profits in three offshore subsidiaries, an accounting technique that according to the Senate investigators enabled the company to shave $6.5 billion off its tax bill over the past three years. The subcommittee also reported that HP had its overseas subsidiaries make loans to the parent company in the U.S., a way to move money back home without being taxed on it, the subcommittee said. My Bloomberg News colleague Jesse Drucker has reported that from 2007 to 2009, Google avoided paying $3.1 billion in taxes on foreign profits.

The left-leaning advocacy group Citizens for Tax Justice estimates that if all the revenue from corporations’ overseas profits were collected, the Treasury would raise $583 billion over 10 years. That’s not a huge sum, but it’s not necessarily worth overlooking either.

President Obama and Mitt Romney propose very different plans for dealing with repatriation. Romney told donors this past summer that big businesses are “doing fine in many places. … they know how to find ways to get through the tax code, save money by putting various things in the places where there are low tax havens around the world for their businesses.” (Romney also has some of his own wealth in offshore accounts and has said that did not reduce his tax bill.) Romney and Ryan want to lower the corporate rate to 25 percent and install a territorial tax system, in which foreign earnings aren’t taxed at all when they return to the U.S. That approach “will actually encourage American companies to bring back overseas profits where they can be used to hire new employees or invest in new plants at home,” Romney spokeswoman Andrea Saul tells me.

Obama’s plan would reduce the corporate rate to 28 percent and would force companies to pay tax on their foreign income to the IRS annually. There’s one exception: If a company is already paying a certain minimum tax rate in a foreign country, then companies would not owe any U.S. tax. But the president hasn’t spelled out what that minimum rate would be. Rebecca Wilkins, a tax lawyer at Citizens for Tax Justice, tells me that administration officials have privately floated 20 percent to her group. Critics of the proposal say that if that rate were set too low, the plan could discourage money from returning to U.S. shores.

When corporations were given a tax holiday in 2004—they were allowed to repatriate profits at 5.25 percent—the Congressional Research Service found that companies used the extra money to pay dividends, among other things, but not to create jobs. Reed College’s Clausing argues that a territorial system would encourage corporations to shift more profits overseas because they could bring them back home tax-free, making tax havens even more attractive than they currently are.

Romney and other proponents of a territorial tax system point out that most countries don’t tax foreign earnings, putting the U.S. at a competitive disadvantage. But those countries also have stricter rules and policing strategies meant to discourage companies from assigning profits to overseas subsidiaries, Wilkins says. And yet: The European Union, which has a territorial system, is considering abandoning it for the very reason Romney and Ryan say the U.S. should sign onto it—EU countries have had a hard time getting companies to repatriate profits.

Obama couldn’t push his corporate tax overhaul through Congress this year. Nor could Republicans get Democrats to sign on to Michigan Representative Dave Camp’s corporate tax reform plan, which would have exempted 95 percent of a company’s foreign income from taxes. If the issue resurfaces in the frantic budget negotiations expected after Nov. 6, brace for a battle.