Tuesday, September 19, 2017

Stranded profits

The tax reform discussion includes the idea that by moving to a territorial system, US companies will bring lots of money stranded offshore back to the US, unleashing a wave of investment here. While I think a territorial system makes sense, as does reducing or eliminating the corporate tax, as a pure matter of economics, I don't think this repatriation argument makes sense.

Here's why. (The following is a story, not a fact about Apple accounting.) Apple sells an Iphone in Spain. Apple Spain pays a huge licensing fee on software, owned by Apple Ireland, so it's not a profit in Spain. Apple Ireland thus collects huge amounts of cash from all over the world, taxed at the low Irish corporate tax rate. Apple Ireland deposits this cash in an Irish bank. (I presume they do fancier things with the money, but I'm telling a story here). The cash is "stranded" overseas, right?

No. The Irish bank can lend the money anywhere. It can buy US mortgage backed securities, it can lend the money wholesale to US banks who lend it out to US businesses. It can even lend the money to Apple US. If Apple or any other US company wants to invest, they can borrow from the Irish bank. Conversely, if profits are repatriated to US banks, those banks can lend the money overseas.

If Apple's Irish bank invests exclusively in, say Spanish condos, then the Spanish bank that would have made the condo loan instead loans to the US. Conversely, even if the profits are "repatriated" to a US bank, if investment opportunities are better abroad, that's where the investment will happen.

You can't avoid two fundamental truths: 1) Money is fungible. 2) Savings - Investment = Net Exports.

Yes, there are some second order effects. If money comes back to US banks, US banks get to earn the fees. Internal capital can be cheaper then external; it's inefficient to send your own money to yourself through a bank. But these are second order, and that's not the argument being made.

It's still a good idea, but for other reasons. Reduction or elimination of corporate taxes will make US investment more profitable, and that will attract money from abroad. But don't count on a wave of repatriated profits to mean much more than a big financial change.  Even if it happens. There are many other reasons to keep pots of money overseas these days. Bad arguments for good policies are not, in the end, a good idea.


  1. It seems unlikely that repatriation would lead to extra investment because: (1) the cost of capital is so low that if there are profitable investments available they would have been financed by some other mechanism; and (2) the last time there was a repatriation holiday the money was not used for investment.

    My preferred solution to the cash horde would be to allow companies to repatriate at a low tax rate on the condition that the net proceeds be distributed as dividends.

    As you note, the "stranded" profits get cycled back into US dollar assets (probably including Treasuries and excess bank reserves). There are however two problems: (1) the tax driven accumulation of those funds contributes to the global savings glut and is a fiscal drag on the world; and (2) arrangements like the one you describe for Apple understate American exports, overstate the merchandise trade deficit and so contribute to the American trade animosity which is threatening the global economy.

  2. The rules on the use and investment of foreign profits are a lot more restrictive than you think.

    "It can even lend the money to Apple US." The IRS would probably characterize that as a taxable transaction.

    Furthermore. There are good reasons not to invest money in banks in tax shelter jurisdictions, which may not be adequately capitalized. Most of such money is invested in short term money market instruments.

    The problem with your scenario is that it leaves reinvestment choice with the financial system instead off dispersing it into more hands, or I should say more minds, who may find much better uses for the resources than funding German Banks.

    1. I also think that the IRS would tax Apple if Apple Ireland lent to Apple Cupertino. However, it wouldn't be taxable if Apple Ireland lent to Google Mountain View and Google Ireland lent to Apple Cupertino.

    2. I don't think he meant Apple Ireland lending to Apple USA; I think he meant the Irish Bank lending to Apple USA.

  3. You could create a territorial system and say that it only applies to new economic activity. Might be temporarily annoying, but once Apple et al know that they won't be getting any special repatriation profits, then they can switch to the new one.

    Better yet, threaten to raise the tax rate on old activity higher than the new territorial system unless they pay the old rate in like 3-6 months on anything that won't be covered on the new system.

  4. Sure, any bank can lend money anywhere in the world. Do they? Are the loans of banks in fact not disproportionately made in geographic areas where the banks operate?

    1. I wrote "bank" just to keep it simple. Apple Ireland surely participates in credit and financial markets directly or through a variety of intermediaries located all over the place.

  5. Brookings Institute 2011: Some observers are calling for a “repatriation holiday” on profits held by foreign subsidiaries. Some members of Congress, eager to stimulate our fragile economy, are listening. They shouldn’t. A tax holiday on repatriated funds is a proven failure — expensive in both direct and indirect ways. It was already tried in 2004 and didn’t work.

    Center on Budget Priorities and Policies 2014: Repatriation Tax Holiday Would Lose Revenue And Is a Proven Policy Failure.

    Sure.. it failed before.. But this time it will be different, right? Sheesh!

    1. John E.,

      What John C. is referring to is this:


      These guys do a pretty good job of describing territorial taxation systems and their benefits / pitfalls. A territorial tax system was included in David Camp's (former House Ways and Means Chair) 2014 tax overhaul proposal.

  6. John,

    You seem to be contradicting yourself here.

    On the one hand:

    "Reduction or elimination of corporate taxes will make US investment more profitable, and that will attract money from abroad."

    In the next paragraph you say:

    "There are many other reasons to keep pots of money overseas these days."

    If there are SO MANY (care to list them?) reasons to keep money overseas, why will lowering the corporate tax rate attract that money from abroad?

    Perhaps instead of worrying what the corporate tax rate is, we should worry about those other reasons that you didn't share?

  7. The argument over repatriation of profits was never about lending but taxation: the US government wants to tax profits that are sheltered in Ireland. The Celtic Tiger got that way from, in part, having high-paying white collar jobs to shelter US corp tax profits and in US corp subs paying the Irish government tax on those profits.

  8. Much of the money earned outside of the U.S. support operations outside of the U.S., e.g. R&D, operations, investment in plant and materials, etc. So the money can never "come home." Or, if you like, home is the world.
    Business has taken the internationist's imperative to heart.

  9. Yes, I know, you're telling a story. However, the detail is that the Irish (Apple) money goes to Bermuda (I think) from where it goes to a Nevada company owned by the Apple Bermuda entity.This is still, according to the tax code, offshore. It's in the US, invested in the markets (as you say) but it has not been repatriated in the tax sense, as it is Apple (offshore somewhere) which has legal ownership.

    So, yes, the story, in its essence, is correct.

    But it's worth noting that the same story also applies to all those billionaires just hoarding their money. You know, the Elizabeth Warren sort of thing, they don't spend it, they don't stimulate the economy, we should tax it off them to give to poorer people who will spend it. Well, OK, but those billionaires are keeping it all in the bank and the bank is lending it out so it isn't in fact being hoarded at all. Same story.

    1. "Hoarding" isn't quite right.
      Warren may be ignorant enough to keep the money under her mattress, but for most rich folks, the money is invested, lent out, or otherwise put to use.
      Besides which, BETTER the money under the mattress, rather than in the hands of hacks, cronies and dirigistes.

  10. Monopolies are bad.
    That means that "tax regime coordination" is an evil and nations must be made to compete.
    Low-tax/low-benefit states can compete with high-tax/high-benefit states, and high-tax/low-benefit states can go heck (he said, mindful of the moderator).

  11. My quick observation. 1) relative taxation among trading partners does not have to be equitable or the same, different country/nation economies are different; 2) it is not possible to make tax policies equal among the different nations, same reason as stated; 3) huge companies with established presence for tax purposes in different countries of the world gain advantages because of that, it is not unfair or monopolistic in character but one of the benefits of being large and truly global. A move to make tax policies equal to bring advantage to smaller competitors (vs. really 'uge companies like Apple, is socialistic, not free enterprise. Danley Wolfe UChicago XP54 ('85)

  12. To add an interesting twist on this, much of this cash "trapped" overseas is often held by the foreign subsidiary in a US bank, denominated in dollars. For example, see https://library.wilmingtontrust.com/wilmington-wire/repatriation-of-foreign-earnings-is-there-anything-to-bring-back.


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