December 12, 2016—The incoming Trump administration is planning to propose a reduction in corporate tax rates in an effort to stimulate U.S. economic growth. We believe that much of the “Trump Rally” since the election can be attributed to his proposed policies which include a likely combination of lower corporate tax rates and infrastructure spending.

One item on the tax agenda is a temporary reduction of the corporate tax rate (from 35% to 10%) to U.S. multinationals’ foreign earnings. “Repatriation” of these earnings would essentially be a distribution of a foreign subsidiary’s earnings to its U.S. parent company. It is estimated there are $2.4 trillion of undistributed accumulated foreign earnings.

One hears the clarion call: “Bring back the trillions of dollars in cash trapped overseas.” Some assert that repatriation tax relief would reap a windfall for the U.S. economy, as well as for the U.S. Treasury, and provide a sizable windfall to fund a massive infrastructure program. If only these assertions had a factual basis. But they don’t. The issues surrounding repatriation are often misunderstood or mischaracterized. The purpose of this blog is to provide some clarity on a complex issue.

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The table above presents an estimated breakdown of U.S. multinationals’ estimated $2.4 trillion in undistributed, accumulated foreign earnings.    

  • We estimate that about $1.08 trillion is capital permanently invested in overseas business operations.  For example, U.S. multi-national companies in energy, mining, industrial, and manufacturing maintain extensive overseas operations into which they have reinvested earnings over the decades. No amount of tax relief would “bring back” this $1.08 trillion, because it would require U.S. multinationals to liquidate ongoing, presumably successful, overseas business operations.
  • About $0.72 trillion is cash available for reinvestment in overseas business operations. Any cash potentially needed for future reinvestment will not be distributed to parents, especially at a 10% tax rate, however, some portion of this $0.72 trillion won’t be needed for overseas reinvestment. The U.S. parent may wish to use this surplus cash for its own investment or financing needs although, as parent companies can issue corporate bonds with coupons far lower than 10%, and keep refinancing such bonds indefinitely, they may choose to use that cheaper funding source. There was a prior repatriation experience in 2004, when the government temporarily lowered the tax rate on distributed earnings to 5.25%. At that time, policymakers expected large distributions to parent companies in an effort to expand U.S. research and development expenditures. As it turned out, subsequent analyses found that the amounts actually distributed were modest and not used as intended, but rather mainly for financing activity, such as share buybacks.
  • Another $0.36 trillion in cash is held by foreign subsidiaries domiciled in minimal tax jurisdictions. Many of these foreign subsidiaries were established by large-cap pharmaceutical and technology companies. These corporate offspring were established solely for the purpose of minimizing their parents’ U.S. taxable earnings and don’t have “real” overseas business operations for which cash may someday be needed. We therefore expect the corporate parents to take advantage of the reduced tax rate and take distributions of a large proportion of this $0.36 trillion.

It is important to highlight that the combined $1.08 trillion in cash is held in U.S. bank accounts and U.S. securities. There is no cash “trapped” outside the U.S. economy.

  • U.S. law specifically allows U.S. multinationals’ foreign subsidiaries to hold U.S. bank deposits and U.S. securities without incurring a tax liability for their U.S. parents. Generally, a U.S. parent must pay the corporate tax only when it (or a related company) receives a distribution from its subsidiary. Think of it this way:  the “patria” in “repatriation” refers only to the U.S. parent, not to the U.S. financial system. Repatriation simply means “distribution to the U.S. parent.”
  • U.S. multinationals, whose functional currency is the U.S. dollar, want their foreign subsidiaries to hold cash and securities in U.S. dollars to mitigate currency risk. Cash can be converted to foreign currencies in micro-seconds when needed for overseas business operations.

Because foreign subsidiaries’ cash is alreadycirculating within the U.S. banking/financial system, it is already supporting the U.S. economy. Repatriation from foreign subsidiaries to their U.S. parents thus merely shifts cash around the U.S. economy. That’s not to say there would be no net beneficial impacts to the U,S. economy from such distributions. It could be the case that the economic benefits of the activity pursued by the U.S. parents, especially if some portion is highly productive capital expenditure, would be greater than the economic benefits derived from the loans supported by the subsidiaries’ deposits with U.S. banks (in part, because only 77.8 cents of every deposit dollar is loaned into the real economy) or from their broader investments in U.S. securities. Obviously, it would be impossible to pin down the exact net economic impacts, but it is fair to say that it won’t be the giant windfall that some suggest. The 10% tax on distributions to the parents will produce tax revenue for the Treasury, but at the cost of losing tax revenue elsewhere in the economy. The new tax revenue will be concentrated and visible, and thus easily earmarked for infrastructure or other purposes, while the tax revenue losses would be diffused, and practically invisible. Again, it is possible that net tax revenues to the Treasury would be positive, if the large companies receiving the distributions can allocate the cash more productively than other participants in the broader economy. However, if the impacts on tax revenue prove to be a wash, then any new infrastructure program would, in fact, end up being fully deficit-financed.

While the overall net macroeconomic and tax revenue impacts of repatriation are murky, it does appear clear that the shareholders of U.S. large-cap stocks, particularly those in the pharmaceutical and technology sectors that had set up foreign subsidiaries in minimal-tax jurisdictions, would stand to benefit. These companies have signaled that they might use these cash distributions to support various combinations of share buybacks, increased dividends, capital expenditure, and mergers and acquisitions. All of these activities could be viewed as positive developments by shareholders, and boost these stocks’ share prices.

Core narrative

We have conviction that lower overall corporate and personal tax rates and a large infrastructure program will be enacted early during the Trump administration. We believe that these actions will tilt upward the trajectory of U.S. economic growth. However, we advise caution against believing the hype surrounding the economic and fiscal impacts of repatriation of foreign earnings. While the overall macroeconomic and fiscal impacts of repatriation are unclear, we do have conviction that U.S. large-cap stocks, particularly in pharmaceuticals and technology, will benefit.  

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