Ever hear of a double irish? how about a Dutch Sandwich? These aren't cocktails or bar snacks but rather complex financial strategies used by many American companies to transfer profits they earn abroad to countries with the lowest tax rates. Despite the goofy nicknames, these techniques have a serious purpose: to keep money away from the U.S. whenever possible to avoid paying the higher tax rates in effect at home. Ireland, for instance, taxes corporate earnings at 12.5%, compared with the U.S. rate of 35%.
Big companies like GE and Apple have gotten very good at this game. By some estimates, U.S. corporations have $1.7 trillion in foreign earnings stashed under mattresses abroad. Now they and others say they would be happy to bring foreign earnings home--repatriating them, in accounting lingo--if only the U.S. would change its laws and make overseas profits tax-free. This is known as a territorial tax system: only income generated inside the home country gets taxed by that country. Amid the fiscal-cliff debate over individual tax rates, hardly anyone has paid attention to a number of reforms being advocated by Republicans that would shift the U.S. to such a system. (In the short term, business lobbyists are looking for a temporary tax holiday allowing repatriation at a 5.25% rate for a year, an idea supported by a number of conservative politicians and some liberals.)
Advocates say it would lift the U.S. economy: companies would put this money to good use by investing at home and creating jobs. But while the plan might well goose the stock market, it won't create more jobs. In fact, it might even do the opposite.
We know this because we tried it before. Congress enacted a temporary tax holiday on foreign earnings in 2004, and companies did indeed bring about 50% of their foreign cash--some $362 billion at that point--back into the U.S. But the majority of it went not to research or building factories (and certainly not to higher wages) but to the enrichment of investors through stock buybacks and dividend payments. There's every reason to believe that the same thing would happen this time around. JPMorgan estimates that a tax holiday at the proposed rate of 5.25% would be like another round of Fed stimulus in terms of goading stock prices. No wonder some people are so excited.
What about putting in provisions that would require the money to be spent creating jobs? The government tried that last time around, literally tracking each dollar coming back into the U.S. The problem is that companies can easily get around such provisions by putting foreign dollars in an account labeled "business development" or some such and then using pre-existing U.S. funds to do the buybacks. "Money is fungible, and it's very easy for multinational companies to find ways around these rules," says USC law professor Edward Kleinbard.
In any case, the "we would invest in the U.S. if only we had the money" argument doesn't hold water. Given how low interest rates are right now, it's just as easy to borrow to fund capital spending as it would be to pay a 5% tax. As Warren Buffett has said frequently in the past few months, a lack of cash is not hindering job creation. In fact, banks are in need of major corporations to lend to.