Two Bad Tax Ideas for Creating Jobs

By :: June 23rd, 2011

In Washington, bad ideas never go away. Now two old tax breaks have resurfaced with the ostensible goal of creating jobs, despite plenty of evidence that neither actually works. One would create a payroll tax break (aimed at employers instead of workers this time). The other would grant a temporary tax holiday to multinational corporations that bring foreign earnings back to the U.S.

Not only is there little evidence that either of these tax breaks would create jobs but they also fly in the face of all the recent rhetoric about the need to eliminate such preferences from the tax code. Politicians give a speech on Tuesday decrying special interest tax breaks. They give another on Wednesday promoting these subsidies as job creators.

This might be defensible if it were true. But it isn’t.

Let’s start with the tax break for bringing back foreign earnings, a practice known as repatriation. To understand what this is about, take a second to review some history. Multinationals such as Google are highly skilled at reducing their U.S. tax bill to near-zero, in part by shifting income to low-tax countries. However, when they return that money to the U.S. they owe tax here at the top rate of 35 percent. As a result, they keep those earnings overseas more or less indefinitely.

Back in 2004, Congress  granted a two-year tax holiday to firms that agreed to use repatriated profits to make investments and hire workers in the U.S. In 2005, U.S. firms repatriated about $300 billion—far more than in prior years. They saved billions of dollars in taxes. But a 2009 study found that they used every repatriated dollar to pay down debt or make distributions to shareholders, rather than create jobs.  

There is no reason to believe the outcome would be different this time. The firms that are best able to take advantage of the tax holiday are awash in cash at the moment. If they want to hire or invest, they already have plenty of resources to do so without the benefit of another tax break.

Such as scheme would create few jobs and reduce federal revenues by nearly $80 billion over a decade. Most importantly, it would send a terrible signal. Congress would be rewarding firms for successfully manipulating the tax code. The biggest winners in fact would be the very companies that did the best job shuffling profits overseas.   

In fact, yet another tax holiday would likely discourage future investment in the U.S. Multinationals would, perfectly reasonably, come to expect a repatriation tax break every couple of years. So instead of investing in the U.S., they’d increase their stash of foreign profits while they await the next holiday.

The payroll tax story is not so different. Last December, President Obama convinced Congress to include a one-year payroll tax break for workers as part of the deal that extended the 2001 and 2003 tax cuts. Now, Democrats would like to continue it for another year. But with Republicans unwilling to support an extension aimed at workers, Obama and Senate Democrats are peddling a payroll tax cut for companies (most likely for hiring new workers). 

This also promises to be a boondoggle.

We don’t know what the tax cut would be, but let’s say it would reduce the employer share by half, or about 3 percent. That comes out to an average tax cut of about $1,200 for each new employee. Would a company hire a new worker for, say, $38,800 instead of $40,000? Most wouldn't.  At this point in the business cycle, firms hire when they need workers to fill orders, not to get a relatively small tax break.

Of course, companies operating at full capacity would be happy to take the tax cut. But for them, it would be little more than a windfall for doing what they were going to do anyway.

I understand that the unemployment rate is still 9 percent and, with an election looming, pols are desparate to do something to reduce it. But I wish they’d at least come up with some new bad ideas instead of recycling the same old ones.

12Comments

  1. Michael Bindner  ::  2:59 pm on June 23rd, 2011:

    The way to create more jobs is to increase tax revenue, not decrease it – not on companies necessarily but on investors. If a tax holiday is part of that, then I hope they do pay out dividends to investors – but these should be taxed at normal income rates. The proceeds should then be spent creating jobs.

    The economy coming back is what will really create jobs. That won’t happen until uncertainty over housing passes – and the only way to do that is to either force people in trouble to foreclose quickly, allow them to use bankruptcy to avoid foreclosure and reduce their loan balances or simply write their balances down – at least when the Government holds the paper.

  2. Vivian Darkbloom  ::  8:23 am on June 24th, 2011:

    Mr. Gleckman gets a couple of facts wrong here, and a conclusion, too, I think.

    First, if the issue concerns jobs, in singling out Google as the object of his discontent, Mr. Gleckman has chosen a very bad example, indeed. Had Mr. Gleckman carefully examined Google’s annual reports, he would have found that in 2001 Google had 284 employees. The figure for the last quarter was 26,316. The vast majority of those jobs are in the United States. If correlation were causation, we should tax every company like Google.

    What, if anything, does this phenomenal growth in jobs have to do with Google’s low effective tax rate? Gleckman claims that Google “is highly skilled at reducing their U.S. tax bill to near-zero, in part by shifting income to low tax countries”. As proof, he links to an article he himself penned in December. That article, in turn, refers to an article by Jesse Drucker of Bloomberg. Here, Gleckman makes the same mistake that most journalists in the mainstream media make, but it is very surprising to find that mistake made here in a supposedly non-partisan outlet and one supposedly specialized in tax. Google’s effective US tax rate as reported by Drucker was not 2.4 percent. Drucker reported that this was Google’s overseas tax rate. If one speaks of “US effective tax rate” one normally should think about the effective rate of tax on income generated from US activities. I could understand how, perhaps, one could confuse this with the effective rate of tax on global income since Google is, after all, a US- parented group of companies, but to confuse it with the effective tax rate on overseas income is a mistake that is beyond the pale. And, it severely misinforms readers.

    In fact, Google accrued a considerable amount of US tax on their US operations in recent years (in addition to those considerable payroll taxes for 25,000 plus new employees). According to the reconciliation of their tax provision in their 2010 annual report, Google earned $4.948 billion from domestic (US) operations in 2010 and $5.848 billion from foreign operations. They booked a current tax provision (federal and state) for that domestic income of $2.115 billion and $167 million for the foreign income. They booked a deferred tax expense of $22 million (federal and state) as well as negative deferred tax of $13 million for foreign taxes.

    Google’s effective tax rate therefore comes out something like this:

    Effective rate on US income 43.13%
    Effective rate on non-US income 2.63%
    Effective rate on global income 21.22%

    And, this from Google’s annual report:

    “Our effective tax rates have differed from the statutory rate primarily due to the tax impact of foreign operations, state taxes, certain benefits realized related to stock option activities, and research and experimentation tax credits. The effective tax rates were 27.8%, 22.2%, and 21.2% for 2008, 2009, and 2010.”

    Google indeed enjoys a very low effective tax rate on its non-US income. The fact that they earn more income outside the US than within it should not be surprising given the very global nature of their business and the fact that most users of their service are non-US persons. They are said to have entered into an APA (Advanced Pricing Agreement) with the IRS in 2004 that dictates the licensing terms between the US parent company and its Irish subsidiary. It is quite possible that the IRS was too generous in its allocation of income under this agreement and/or the royalty to be charged. In that case, however, Mr. Gleckman should direct his attention to that issue rather than make incorrect factual statements about their effective US tax rate.

    Should the United States be concerned about Google’s low effective tax rate on foreign earnings, or should this be something to cheer about? Certainly it makes Google more competitive in those markets and the more competitive it is there, the better job opportunities there are at the parent company. Also, in accordance with standard accounting, Google does not take a deferred tax expense for the US tax cost of repatriating those funds back to the United States. Like most companies, it indicates that it intends to keep those earnings indefinitely offshore (for the unstated reason that it is simply too expensive to bring them back). As of the end of 2010, Google had $17.5 billion of such earnings. Assuming a foreign effective tax rate of 2.5 percent on those earnings, the US tax cost of repatriating them at the prevailing US statutory rate of 35 percent would be about $5.69 billion. In theory, this is the amount the US stands to gain by Google’s effective foreign tax planning. The financial decision of a CFO to keep those funds offshore under current law is a no-brainer.

    The current US system of taxing the foreign income of US based companies is badly in need of reform. The US is one of the few countries in the world that taxes US controlled groups on global income rather than just on income earned within its territory. I’m fairly sure that Mr. Gleckman would argue that we should tax Google and others currently on their global income rather than allow them to defer paying tax until that income is repatriated. Would this be good for US jobs? I would like to hear Gleckman’s case on that one, but I highly doubt it. The reason for the current mess is the disparity between the very high US statutory rate of corporate income tax (35%) which many pundits claim is irrelevant because that is not the “effective rate”. This is one instance in which it indeed is very highly relevant.

    Gleckman states that under the 2004 provision US companies repatriated over $300 billion to the US from offshore and that “They saved billions in taxes”. I guess this is one way to look at it, but only if one assumes those funds would be brought back at all absent such an incentive. Another way to look at it is that the US Treasury earned billions in tax revenues that might not otherwise have never been collected.

    So, this brings us to the issue of whether allowing Google (and others) to bring those funds back, under conditions, would be a wise thing to do to stimulate job growth (query: why just job growth and not overall US economic growth?) Gleckman cites a study contending that the last time this was done (in 2004) it did not create many jobs. One can get a report to support just about anything these days, and I’m skeptical about that one. The conditions that generally applied to getting the special treatment were that the funds had to be used to repay debt, buyback shares, or invest it in the US business (rather than abroad). How many jobs did it create the last time? Frankly I’m sure no one knows precisely, just like no one knows how many jobs were created by other types of stimulus programs like “Cash for Clunkers”. Nevertheless, a strong case can be made in favor. If the funds are used to buyback shares, most of the funds would flow back to US shareholders. What would they do with the money? Who knows. Some of it would be spent and some would be re-invested elsewhere in other productive US activities. With respect to Google such a buy-back would generate considerable US tax revenue. Google doesn’t have a lot of debt. My guess is they would invest it in other US business such as their green energy initiatives.

    And, if Gleckman is not happy with the conditions that were attached to the last repatriation provision, perhaps he could suggest tighter restrictions that would result in more US job creation rather than, based on the wrong facts, simply dismissing the idea out of hand.

    One thing is certain. Bringing that money back to the US strikes me as better for the US economy and for the US job market than simply having those funds sit offshore.

  3. Michael Bindner  ::  12:12 pm on June 24th, 2011:

    I agree that the tax code should be changed to allow Google to repatriate their money to their American shareholders – but only on the condition that this money is taxed at normal income rates, rather than a special dividend rate. The normal rate could, of course, be decreased – but only if some type of VAT/Net Business Receipts Tax is also put in so that the money is taxed when eventually spent (both visibly and invisibly).

  4. Vivian Darkbloom  ::  12:33 pm on June 24th, 2011:

    “I agree that the tax code should be changed to allow Google to repatriate their money to their American shareholders – but only on the condition that this money is taxed at normal income rates, rather than a special dividend rate.”

    That’s very generous of you. How exactly would you propose to “change the tax code” in this respect.? Mr. Bindner, it does not appear that you are familiar with how dividends received by US parent corporations from their foreign subsidiaries are currently taxed under the Code. Those dividends are “grossed up” to the amount of the dividend plus the underlying foreign tax paid on those earnings. That “grossed-up” amount is then taxed at normal corporate income tax rates, with credit for underlying foreign taxes paid on that same income!!

  5. Vivian Darkbloom  ::  12:47 pm on June 24th, 2011:

    If you are proposing that in the event Google were to dividend that amount, or part of it, to (US) shareholders, the US Treasury would get an even larger amount than they would under my above calculation on those earnings. There are very few things the US government can do to BOTH stimulate US economic activity AND add current income to the Treasury. This is one of them. Assuming it would work the same way the 2004 bill worked, they would get roughly 20 percent on each dividend repatriated back that is used to dividend to shareholders. Nevertheless, I could live with a proposal that would increase the tax rate on dividends paid to (US) shareholders to the extent this special provision would be used if that is what it would take to pass, even though such a rule would be difficult to administer. Such a rule should provide that earnings come ratably from US earnings and from foreign earnings and that any funds used for other purposes (such as investment in US property) be subtracted first.

    Alternatively, a solution would be to simply restrict the benefit to the funds used for activities that are more directly related to job production.

    These types of suggestions are more productive than simply mistating the facts and rejecting the idea out of hand, which is what was done here.

  6. Hoppe  ::  9:55 pm on June 25th, 2011:

    One part of the recipe to keep jobs from leaving our shores is to have corporate earnings taxed at a competitive rate with foreign countries. It is that simple.

    Keeping rates high, then legislating a “holiday” every few years only enriches the pockets of the legislators that sponsor and vote for those bills.

    Cut the crooked congress out of the equation. In fact, they would lose most of their power if a “flat” tax were enacted for all.

  7. Vivian Darkbloom  ::  1:10 pm on June 26th, 2011:

    That’s right, but I think it needs further explanation (the answer is simple but the explantion is not).

    When looking at how much tax US corporations pay, both sides are hopelessly confusing the data. Those who say we need to cut corporate tax rates like to simply cite the statutory rate of 35 percent and compare that with foreign statutory rates. By this measure, the US comes out as one of the highest taxing countries in the OECD.

    Those opposed to corporate tax cuts oppose this comparision by citing the “effective rate”. However, as here, they most often misstate the data by using the effective rate on global earnings and pretend that it is the rate on US earnings (an in-appropriate comparison because most countries don’t tax foreign earnings of their resident corporations at all). They then compare that global effective rate to the foreign statutory rate and conclude US corporations are lightly taxed. That’s an inappropriate comparison.

    The fact is that US corporations pay a relatively high effective tax rate on US domestic earnings and a very low effective rate of tax on foreign earnings. Google is a prime example of this. They are able to do that by virtue of relatively lower foreign statutory rates and very, very effective international tax planning. That is perhaps one reason why, non-tax considerations aside, US corporations prefer to invest abroad. It is certainly why those earnings are kept abroad because when those earnings are repatriated, they are subject to the 35 percent tax (less credit for foreign taxes paid).

    Hoppe is absolutely right that the current pattern of declaring “tax holidays” on repatriated earnings is not goodlong-term tax policy, although it might be an effective short term stimulus measure. Good tax policy would entail a permanent solution to the problem. I think the best solution would be to reduce the statutory corporate income tax rate and reduce some of the tax expenditures available to US corporations. These tax expenditures apply more to domestic earnings than to foreign earnings.

    Given the signal from the last repatriation legislation and talk of another one, and combine this with talk of major international tax reform, you can see why US corporations will leave those earnings offshore until such time as the situation on how those earnings will be taxed is clarified.

    This is one of those “uncertainties” that is holding back economic recovery.

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