By Robert Duquette, CPA
This is part four of a five-part blog series analyzing what was promised when the Tax Cuts and Jobs Act (TCJA) was enacted compared with what has actually happened to date. To make your reading and consumption of all this information easier, this analysis covers 13 topics and is presented in five separate blogs.
In my previous blogs I covered …
In this blog I address …
Each issue will be reviewed with independent data, and I will conclude with my own personal verdict and opinion (not that of the PICPA) as to whether that goal was achieved and if the TCJA has been successful so far.
Encourage Companies to Expand in the U.S. and Bring Back Jobs from Overseas
According to several sources that have tracked this issue, the TCJA provided a substantial new incentive to encourage companies not only to continue much of what they had already offshored to take advantage of lower labor costs, lower tax rates, and various base-erosion loopholes, but also to expand their efforts offshore. Specifically, instead of the prior treatment of taxing all foreign earnings at 35% (less applicable foreign tax credits) and instead of repealing the existing base-erosion loopholes, the new law does the following:
- The TCJA provides a new 100% dividend-received deduction on most active, operating income earned overseas that is within a normal rate of return of 10% of foreign invested tangible assets.
- It taxes the remaining foreign income at half the normal 21% or less (with foreign tax credits).
- It provides a deduction (foreign-derived intangible income, or FDII) for significant intangible assets located in the United States that generate revenue from foreign parties vs. U.S. holdings in tangible assets.
The new provisions above provide U.S. businesses with a significant incentive to increase their level of foreign operations, especially tangible assets. Despite some new base-erosion provisions (e.g., the Global Intangible Low Tax Income, or GILTI, tax of 10.5% on excess foreign profits above 10% of foreign tangible assets, and a Base Erosion Alternative Minimum Tax, or BEAT, on certain payments to foreign-related parties), the Tax Policy Center (TPC), the Institute on Taxation and Economic Policy (ITEP), and the Congressional Budget Office (CBO), have all concluded that the TCJA created net additional incentives for continued and expanded offshore profit shifting.
As one political commentator predicted, “Ultimately, many multinational corporations will pay little to nothing in U.S. taxes on their profits earned by shifting call centers and factories overseas.” It appears President Trump was surprised by this and has stated that this was not his intent. And, as it turned out, according to a new academic paper to be published soon, it appears that U.S. multinationals in fact did increase their capital investments overseas significantly more than they did in the United States.
Encourage Bringing Jobs Back from Overseas Goal Achieved?
Corporate “inversions” began in the 1980s when U.S. businesses relocated their headquarters to a foreign country to escape the high U.S. tax rates on the repatriation of earnings from foreign countries. After the inversion, companies would be able to repatriate foreign earnings at a lower rate in the parent company’s new foreign headquarters country.
Over the past seven years, the U.S. Congress and the Treasury issued several anti-inversion provisions. According to the CBO, as a result of this effort before tax reform legislation, the number of inversions slowed considerably from its peak several years ago. The TCJA subsequently added additional penalties to continue to discourage them after 2017. Although 2018 data is not yet available, the Congressional Research Service (CRS) believes the number of inversions is probably minimal given the lack of press releases on new inversion announcements.
Inversion Discouragement Goal Achieved?
Yes, but probably due more to pre-TCJA rule making.
Encourage Companies to Repatriate about $3 Trillion in Overseas Profits
Estimates of unrepatriated earnings held overseas by U.S. companies vary, but the commonly accepted amount of about $3 trillion can be traced to the Brookings Institute and ITEP. What is never mentioned by the media or politicians is that only about $1 trillion of this is held in cash according to a Federal Reserve study. It was always going to be impractical to expect U.S. multinational companies to liquidate or monetize investments in longer-term holdings, physical assets, and subsidiary holdings around the world that arose from previously reinvested earnings.
This $3 trillion amount had often been referred to as “trapped” prior to passage of the TCJA because the repatriation of those earnings would have resulted in a U.S. tax of 35%, less applicable foreign tax credits. The TCJA was supposed to incentivize companies to repatriate those funds by imposing a new, onetime lower rate on pre-2018 unrepatriated earnings: 15.5% on cash earnings and 8% on noncash earnings. The implicit promise was that these offshore funds would flow into the United States and be reinvested directly into capital investment, create new jobs, and increase worker wages.
What was misunderstood by the general public, in my opinion, was that the funds did not actually have to be repatriated to enjoy the low rate. The rate was assessed on whatever the company’s unrepatriated earnings were at the end of 2017, repatriated later or not. Furthermore, since that onetime tax was payable over eight years, there has been no urgency for U.S. businesses to repatriate their previously “trapped” earnings. On top of that, Congress did not require companies to actually reinvest those earnings and create more jobs to enjoy the lower rate.
According to the CRS, only $664 billion was actually repatriated in 2018, which would have been drawn from not just the pre-2018 estimate of $2.6 trillion “trapped,” but also from additional 2018 foreign earnings, most of which was now tax-exempt after the TCJA. Specifically, about $300 billion was repatriated in the first quarter of 2018, then $200 billion in the second quarter, then a bit under $100 billion in each of the last two quarters. (Compare this to the average $150 billion of annual dividends from foreign subsidiaries in the prior three years.)
And as discussed in a previous blog, there is little evidence that repatriated funds were directly used by the U.S. parent company for capital reinvestment or U.S. job creation.
Overseas Profits Repatriated Goal Achieved?
No. A significant amount of cash did get repatriated, but it was only $550 billion more than the average annual historical repatriation, and was nowhere near the $3 trillion amount often mentioned.
In my next blog, I conclude my discussion with the TCJA goal of stimulating additional economic growth and offer a final word on the effectiveness of the TCJA as a whole.
Robert Duquette, CPA, is Professor of Practice in the College of Business at Lehigh University, a member of the Griffin/Stevens & Lee Tax and Consulting Network, and a retired EY tax partner. He has served on PICPA’s Federal Taxation Committee for over 25 years, focusing on federal tax reform and the national debt.
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