Just like back in January when rumors of tax repatriation holiday started creeping up, the past week has seen a surge in speculation that the Homeland Investment Act part 2 may be coming back. Unfortunately, neither now, nor in January, nor during the original HIA back in 2005, did this tax repatriation of billions in cash do absolutely anything to stimulate the economy, and in fact the waves of layoffs that followed likely added to the weakness that would become apparent with the December 2007 transition into the Second Great Depression. Yet that will not stop big multinational companies from lobbying for this one time gift which will allows management teams to buy back shares, and lock in individual profits on their insider holdings (certainly expect an unseen wave of insider selling in the aftermath of a HIA 2 should one be implemented). As for the economic rationale, there is none. We discussed this back in January and February extensively, but for hose who may have forgotten, here is a good recap courtesy of David Rosenberg's latest leter to clients.
Tax Breaks for Companies
At a time when nearly half of the ranks of the unemployed have been looking for work fruitlessly for at least six months, and a time when they are about to lose their long-term jobless benefits, it is amazing to see so many folks out there calling for the White House to stimulate the economy by allowing businesses a form of tax holiday to bring home their locked-up profits from abroad. This is being touted as a low-cost scheme to get the economy moving (the NYT had a good article on this proposed strategy yesterday).
First off, the major contributors to employment are small businesses, and they don't have locked up earnings abroad — they are paying their 35% top marginal rate rather than avoiding it. Second, the Bush team tried this gimmick in 2005 with absolutely no impact on capital spending or employment growth, though it sure did help out on the stock buyback programs and divided payouts. So would it be good for the stock market? Very likely. But a lot of this locked-up cash sitting abroad is centered in the pharma industry and as such it was nifty to see how the NYT tracked what Merck did with the $15.9 billion it brought home back in 2005 — "according to regulatory filings, though, the company cut its work force and capital spending in this country in the three years that followed."
Here is what Kristin J. Forbes, an MIT economics professor who was on the Bush team back then (and led a study by the NBER showing there to be little impact outside of helping reduce the deficit temporarily) said on the matter:
"For every dollar that was brought back, there were zero cents used for additional capital expenditures, research and development, or hiring and employees wages."
Quite an admission of failure. It does stand to reason as to why such a policy today would have any impact since this is not exactly a business sector that is starving for liquithty as it is.
And below we repost some of the salient points from Citi's Steven Englander who essentially said the same thing 6 months ago:
HIA-2 under discussion
- HIA is attractive as a way of reducing effective corporate taxes temporarily and improving the tone of the US corporate sector, but the direct impact on investment and employment appears limited
- The total flows are likely to be much higher than in 2005
- The non-USD share is less certain but may be somewhat lower
- Central banks may see this as a golden opportunity to diversify
A renewed program to allow repatriation of foreign profits at favourable tax rates is again under discussion in the context of broader corporate tax reform. Proponents argue that it provides inexpensive stimulus to the US economy at a limited budget cost. Opponents argue that it provides few practical benefits; rather it creates incentives to keep earnings abroad in anticipation of subsequent rounds of HIA (Homeland Investment Act – the actual name of the bill was the American Jobs Creation Act of 2004, but we will use HIA-1 to refer to the 2004 bill and HIA-2 to refer to any prospective 2011 measure).
And the pros and cons:
- In 2005, HIA-1 delivered much less in direct employment and investment than promised. For example, see “Tax Incentives and Domestic Investment: An Empirical Analysis of the Repatriation Decisions of U.S. Multinational Corporations Following the Implementation of the Homeland Investment Act of 2004” Michaele L. Morrow, Ph.D,. Dissertation, Texas tech University, May 2008, or “Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act “ J Dhammika Dharmapala, C. Fritz Foley and Kristin J. Forbes, Journal of Finance, forthcoming (2011).
- Under HIA-1, the incentives to increase employment and investment were limited. The major impact of HIA-1 was to allow foreign earnings to be repatriated at low tax rates, with few binding additional requirements. From firm’s point of view, HIA-1 was equivalent to a lump-sum tax benefit which would generate additional investment and employment primarily in cases in which firms had restricted access to credit markets. Firms with large amounts of profits abroad probably could borrow domestically for hiring or capital expansion so would not have been constrained in their prior investment decisions.
- Crafting a bill that increases direct marginal incentives for employment and investment is difficult. If the requirements are too stringent, firms will simply pass on repatriation. If firms are already unconstrained with respect to hiring and investment, a marginal increase may bring forward investment plans into 2011, with some payback in subsequent years. If the terms are relatively lax, as in HIA-1, the impact on direct employment and investment will be small.
- The firms that have the money abroad (tech, pharma) are not the sectors that need the most balance sheet help (households, real estate, state and local government) nor does it help firms whose operations are primarily domestic.
- Repeating HIA produces incentives for firms to keep funds abroad. There is the risk that firms will see HIA as a once or twice a decade low-tax repatriation opportunity. The extent of these incentives depends on the gap between US domestic and foreign tax rates. The combined effect of HIA plus a reduction in US corporate rates would largely mitigate these incentives. Surprisingly, BEA data suggests that until the possibility for HIA-2 emerged again in early 2009, the aggregate dividend repatriation rate was not much lower than it had been prior to HIA-1(Figure 1), and the low repatriation since 2009 could also reflect limited US investment possibilities.
- HIA-2 presents an opportunity for the Obama Administration to demonstrate its commitment toward a more business friendly approach to an important constituency.
- HIA-2 eases access to funds that are viewed as locked abroad to some degree. A corporate tax system that encourages firms to keep cash abroad while borrowing domestically is arguably less than optimal.
- The sums involved are substantial. There are estimates of up to USD 1 trn kept abroad - roughly half the cash currently held by US corporates. Data from the BEA shows USD1.2 trn of un-repatriated earnings since 2006, significantly more than had been accumulated over the 1990-2004 period (Figure 2).
- The tax costing can be relatively benign because the low tax rate is largely offset by the increase in flows. The repatriation flows in response to the lower corporate tax rate are so high that they largely pay for themselves (in subsequent years, costing depends on how much flows are expected to be reduced by anticipation of future HIA)
- In contrast to 2005, improving balance sheets and financial statements is higher on the list of policy priorities. One of the Fed’s stated objectives in QE2 was improving the attractiveness of other asset markets relative to the bond market, so in 2011, balance sheet improvement can be viewed as a macroeconomic policy goal.
- 2005 was one of the best years of the decade in terms of asset markets and growth so indirect effects may have been large. It is hard to pin down these indirect effects (and obviously there were broader macroeconomic forces at play) but 2005 was a year of strong employment and investment growth (Figure 3), a strong USD, and sharply revised expectations of how quickly the Fed could normalize rates. From the time the bill was passed in late 2004 till the end of 2005, expectations of Dec 2005 short rates rose from just over 3% to 4.5% (Figure 4).
- No one’s ox is gored, at least not directly. It is difficult to craft a stimulus package that is relatively cheap in budget terms and which provides broad stimulus and that does not carry a well-defined set of losers. Especially if combined with broader corporate tax reform that narrows the gap between US and foreign corporate tax rates, HIA-2 may be viewed as more attractive and practical than other more theoretically attractive stimulus measures.
Lastly, for all those who believe that HIA 2 will be an unequivocal benefit for the S&P, this piece by Goldman Sachs from January reminds that the biggest impact from all that fund flow will likely serve as a major catalyst for USD strength. Recall that nothing in the current centrally planned market is more important than the weakness of the USD. If indeed, the HIA 2 is contemplated as a short-term boost to the S&P, will it backfire even with that modest purpose of making the mega rich even richer? Goldman seems to think so.