During the presidential campaign, both major party candidates talked about incentivizing corporations to bring their earnings held offshore back to the United States. The current barrier is a high corporate tax rate. If this cash does come back to our country, what could be the benefit to investors and the economy?
Democrats and Republicans have both seen a need for corporate tax reform. However, progress has been non-existent as the sides have not been able to compromise on the numbers. There appears to be agreement to lower the corporate tax rate to be more globally competitive; remove tax loopholes; and simplify the tax code. In addition, all see the need to incentivize corporations to move cash that is currently held offshore back to the United States.
While it seems premature to discuss the impact of lowering tax rates and closing loopholes, we can start the discussion on the potential impact of repatriating corporate cash balances from outside of the US.
Why Corporations Hold Cash Offshore?
When US corporations make profits anywhere in the world, they are required to pay the US government corporate tax of 35 percent. However, this tax is not payable on profits made outside of the US until the money is brought back into the country. Since there is no time requirement, the corporations can hold the money offshore as long as they would like.
According to Jeff Cox with CNBC.com, American corporations hold $2.5 trillion overseas, which is an increase of about 20 percent from two years prior. If the US collected the 35 percent tax on $2.5 trillion of offshore profits, the government would receive $875 billion of tax revenue.
The 35 percent US corporate tax rate is the highest such tax in the world. Therefore, corporations do not want to pay the tax until they absolutely need to bring the funds to the US.
In order to provide an incentive for corporations to bring cash home, the US government may need to agree to accept a lower tax rate. If the rate is 15 percent, the US tax revenue on the total offshore cash would be $375 billion. Still a significant amount of revenue!
Impact of Corporate Cash Brought Back Home
If corporations bring some or all of the offshore cash back to the US, even though required to pay the tax, they would be suddenly flush with capital that they could put to work. The overall impact on our economy would be positive, i.e., contributing to economic growth and potentially bringing value to shareholders. Here are a few options that may be considered:
Invest in themselves: To the extent corporations expand their business by investing in new equipment and/or hiring more people, the value of the company can potentially increase. Suppliers would benefit as well through improved sales, providing a positive ripple effect on our economy.
Pay down debt: While most corporations have likely taken advantage of low interest rates to refinance debt, this could be an opportunity to pay off debt and strengthen the corporate balance sheet.
Merger/Acquisition: With cash on hand, some companies may have the opportunity to purchase or merge with others, hoping to improve market share and reduce overall expenses. However, there are risks to this strategy, i.e. paying too high of a price or the benefits of synergies never materializing.
Share buybacks: Corporations can use the money to buy back shares of stock. If the price is reasonable, this strategy can successfully consolidate ownership by reducing the number of shares outstanding; allow a corporation to purchase shares at an undervalued price; and benefit the company’s financial ratios. All could potentially lead to a positive impact on existing shareholders.
Initiate or increase dividends: More cash in shareholder pockets allows for more individual investment or increased consumer spending. Either is a positive. Paying dividends provides an additional benefit to the government as well. Essentially, corporations pay a tax to bring the money home and then shareholders pay a tax to receive it as dividends.
While sentiment in DC can change quickly, corporate tax reform seems to have a good chance of getting done at some level. Reduction in tax rates to be more globally competitive; closing loopholes that benefit some over others; and providing an incentive to bring profits back to US could potentially provide long-term benefits to both investors and the US economy.
Contributions were made to this article by Bill Wendling, CFA, an Investment Manager at Bedel Financial Consulting Inc.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money" segment. Elaine’s book, "Advice You Never Asked For… But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at email@example.com.