Bring on the corporate tax holiday!April 29, 2011: 5:00 AM ET
Giving companies a tax break on repatriated profits may not lead directly to new jobs, but it would likely boost the economy by propping up the dollar and fueling stocks.
By Vishesh Kumar, contributor
FORTUNE -- When it comes to the hot button issue of a tax holiday for US corporate profits held overseas, many lawmakers are once bitten, twice shy.
That's understandable -- the last time Congress decided to give companies a temporary tax break on repatriated funds in 2004, a furious backlash followed. Companies said they were cash-strapped and that a temporary holiday on repatriation taxes would allow them invest their foreign profits at home, to fund research and development and create jobs. But after all the motherhood and apple pie talk, companies promptly used the money instead to boost their stock prices by buying back stock and issuing dividends.
Now another push to greatly reduce domestic taxes on repatriated profits is underway, led by multinational companies like Apple (AAPL), Cisco (CSCO), and Duke Energy (DUK). Last week, PepsiCo (PEP) entered the fray when CEO Indra Nooyi also voiced support of the effort.
Much like the last time around, companies are likely to promise jobs but use the cash to fund buybacks, dividends, and mergers if another holiday is granted. But with a weak dollar and soaring commodity prices, that might be precisely what the economy needs at this point.
Roughly $1.43 trillion currently sits overseas in perpetuity, according to Citigroup estimates, and everyone agrees the corporate tax code is broken. The U.S. statutory tax rate of 35% is among the highest in the world but corporations are skilled at finding loopholes and famously tend to pay far less.
Meanwhile, the economy is showing signs of weakening again and the national mood, along with President Obama's approval rating, is sinking. Soaring gas and commodity prices are creating new economic hurdles, while the Fed's most recent stimulative measure -- a second round of quantitative easing -- will expire in the summer. Concerns about the deficit loom large.
During the last tax holiday, a widely cited study found that every $1 in repatriated profits produced a 60- to 92-cent increase in payouts to shareholders. "Even firms that showed some evidence of being financially constrained or that explicitly lobbied for the tax holiday did not increase domestic investment," the authors wrote.
But that doesn't mean the more broadly stimulative impact of the holiday should be dismissed. The S&P 500 rallied 6.5% upon the measure's passage in 2004 and gained 15% by the end of the next year. GDP growth clocked in at a solid 4.3% for 2005.
Companies used the funds to reduce debt, acquire companies, repurchase shares and issue dividends, Steven Englander, head of G10 foreign exchange strategy at Citigroup, wrote in research note in March. "This was pretty positive for asset markets and the economy in 2005, in fact 2005 was the only strong growth year in the decade in which U.S. growth was not fed by 'bubble' forces that eventually blew up," Englander wrote.
Not only are the sums much larger today -- $1.43 trillion has been stashed abroad since 2006, compared to the $900 billion held in 2004 -- but lifting stock prices is an explicit goal this time around.
"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," Englander wrote.
Some are skeptical (even in Fortune.com pages) about whether the so-called wealth effect shores up the economy by boosting consumer spending. But the evidence suggests that, crude and unfair as the mechanism seems, it gets the job done.
The Commerce Department charts a close correlation between household wealth and spending. During the fourth quarter of 2010, household net worth grew 5.9% to $56.8 trillion and the department's chief economist, Mark Doms, notes that the increase "was primarily driven by financial assets, which is based on stock prices."
Consumer spending grew 4.4% over the same timeframe, the biggest gains in more than four years, and has now increased for nine months in a row amid a rallying stock market.
A tax holiday could help prop up the slumping greenback as well. Companies looking to repatriate funds would have to buy dollars -- substantial amounts of them, given the major sums involved. And since oil and commodities are denominated in dollars, a rallying greenback would help bring down prices and keep these key risks to the economy in check.
The dollar rallied against the euro in 2005, though it's hard to pin it entirely on tax breaks since the Fed was expected to tighten ahead of the ECB at that time as well. But Englander estimates the dollar would get a major 10% to 20% boost against the euro this time around.
Importantly, any such tax measure would cost a pittance when compared to the massive amounts being thrown around in attempts to stimulate the economy these days, as Englander points out. Senator Max Baucus (D-MT) put the price tag for another holiday at $30 billion over ten years when discussions came up in 2009.
So far, the Obama administration has adamantly opposed the tax holiday, saying instead that it would only consider such a measure as part of a broader corporate tax reform package.
But that won't stop companies like Oracle (ORCL) and Pfizer (PFE) from continuing to push for it, and their lofty claims should be ignored. They won't likely use the money to hire more people or invest in their businesses. They'll return capital to shareholders via buybacks and dividends, boosting share prices and giving the stalling economy just the kick it needs.
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