Yesterday's underwhelming unveiling of President Trump's Tax plan included a "one-time tax on trillions of dollars held overseas" presumably aimed at encouraging firms to onshore trilions of dollars of cash on the cheap – implicitly creating jobs and making America Great Again.
However, as The Congressional Research Service's detailed study of the last time this was enacted in 2004 shows, the program had little effect. The program was part of the American Jobs Creation Act.
The hope then, as now, was that companies would shovel that money back into the economy in the form of investment and job creation. As CNBC's Jeff Cox notes, it didn't quite work out that way.
Contrary to the intent, the benefits skewed toward a select few companies in a select few industries. Rather than use the money for hiring and capital purchases, companies plowed the cash into share buybacks and dividends, and many of the biggest beneficiaries actually cut American jobs in the years after the repatriation.
"While empirical evidence is clear that this provision resulted in a significant increase in repatriated earnings, empirical evidence is unable to show a corresponding increase in domestic investment or employment," the Congressional Research Service, Congress' nonpartisan think tank, said in a report.
The CRS cited a series of reports into the benefits of repatriation, with a common theme that the 2004 program was "an ineffective means of increasing economic growth."
In the 2004 case, 9,700 companies were eligible to take part in a tax holiday that would bring the overseas cash back at a rate of 5.25 percent, well below the 35 percent rate for profits earned abroad. Of that group, 843 firms participated. They brought home $312 billion in qualified earnings, or about one-third of the total cash held overseas, according to the CRS. That translated into total deductions of $265 billion.
Most of the money went to repairing balance sheets and rewarding shareholders, according to the CRS. According to one study cited, as much as 91 cents on the dollar went to share repurchases, even though that, along with compensation increases, was an expressly prohibited use by Congress.
Prohibited uses for the cash weren't easy to track as the money ended up being commingled with other corporate funds. The CRS study said one of the biggest faults was that the permitted uses were "overly generous" and not "explicitly linked to specific uses."
And in fact some firms laid off staff…
In the 2005-06 time frame, Pfizer, which repatriated $37 billion, slashed 10,000 jobs.
Merck, which brought back $15.9 billion, cut 7,000 jobs, and
HP pared its employment rolls by 14,500 after repatriating $14.5 billion.
But then again, is the point of this repatriation to improve economic growth at all? As we detailed previously, Goldman is convinced that most of the repatriated foreign cash will be used to fund buybacks thanks to historical precedent.
We estimate that $150 billion out of $780 billion of S&P 500 buybacks in 2017 will be driven by repatriated overseas cash. Corporate tax reform will likely be a top priority for the Trump Administration. Our economists expect that tax legislation in 2017 will include a one-time tax on previously untaxed foreign profits. We forecast that S&P 500 companies will repatriate close to $200 billion of their $1 trillion of total overseas cash in 2017, which will be directed primarily towards share repurchases.
Under current policy, US-based firms may defer US taxes on profits earned by foreign subsidiaries until they are repatriated. Once repatriated, foreign earnings are taxed at the US federal tax rate of 35% minus a credit for foreign taxes paid. Rates in other OECD countries range from a low of 12.5% in Ireland to a high of 34% in France. The deferral of tax on foreign profits combined with the high US statutory tax rate incentivize firms to shift as much income as possible to low-tax jurisdictions and to avoid repatriating income generated in those countries to the US.
President-elect Trump and House Republicans have both expressed support for a one-time tax on untaxed foreign profits. In their “blueprint” of potential tax reform, House Republicans proposed an 8.75% tax on permanently reinvested overseas cash and a 3.5% tax on other untaxed foreign earnings. Mr. Trump also proposed similar tax reform during his Presidential election campaign.
Our Washington, D.C. economist Alec Phillips expects that tax legislation will likely pass in 2H 2017. The probability of significant legislative activity has increased as a result of single-party control for the first time since 2010, and Republican singleparty control since 2006. In addition, tax reform appears to be prominent on the policy agenda in 2017. We expect to see initial tax reform proposals around March or April and possible enactment during the second-half of the year.
The reason Goldman expect S&P 500 firms to repatriate $200 billion of their $1 trillion total overseas cash in 2017, is because it complies with historical precedent: US firms repatriated 10% and 20% of their total estimated overseas cash during the 3-month and 6-month periods, respectively, following the enactment of the Homeland Investment Act (HIA) of 2004. Given the firms' forecast of tax legislation during 2H 2017, Goldman predict that S&P 500 firms will repatriate 20% of total overseas cash next year.
And, furthermore, since buybacks were the biggest beneficiary of the repatriation tax holiday in 2004, Goldman expects more of the same this time:
We forecast $150 billion of the total $200 billion of repatriated overseas cash will be allocated to share repurchases in 2017. Share buybacks were the biggest beneficiary of the repatriation tax holiday in 2004. One study estimated that between $0.60 and $0.92 of every $1 repatriated was spent on share purchases (“Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act” (2011), The Journal of Finance 66(3): 753-787). S&P 500 buyback executions rose by 84% in 2004 and 58% in 2005. There was also a jump in dividends in 2004 and sharp M&A growth in 2005, but the rise in buybacks following the tax holiday far exceeded any other increase in cash use
There is one big risk however, to Goldman's estimate, as the bank itself admits: "Increased debt levels, policy uncertainty, and stricter enforcement of rules regulating the use of repatriated cash pose risks to our estimate." Given that S&P 500 net debt/EBITDA is close to all-time highs, firms may choose to allocate a portion of repatriated cash towards debt reduction.
Just like comparisons of the Trump and Reagan ignore that debt/GDP under Reagan was 30% (compared to nearly 100% now), S&P 500 leverage was also significantly below average around the time of the 2004 tax holiday.
To be sure, the HIA of 2004 prohibited firms from using repatriated cash on buybacks in an effort to increase domestic investment but, as Goldman notes, "money is fungible." Still, if a tax reform package passes in 2017 with a similar goal of boosting domestic investment but has stricter regulation of cash use, then capital spending may experience significant increases rather than buybacks.
Incidentally, over the past week, the market has shown little worry that Trump may limit what the repatriated funds will be used for, and has already priced in much of the expected repatriation-funded buyback bonanza, as the following portfolio baskets show.
In short, absent a formal directive from the Trump administration on explicit "use of repatriation proceeds", which curbs or outright limits the $200 billion or so in estimated repatriated proceeds, from being spent on buybacks (according to Goldman roughly 75% of the total amount will be used to pay shareholders) there will be virtually no benefit to the broader economy, and instead corporate shareholders will once again reap the benefits as they have for the past 7 years, a time in which they levered up their companies to all-time highs, with the vast majority of the newly raised debt used to fund, drumroll, buybacks.
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So, to summarize – a yuuge overseas cash repatriation 'deal' is "an ineffective means of increasing economic growth," but will benefit a select few companies in a select few industries who can further lever up their balance sheets, buy back more shares, and transfer wealth to their already wealthy shareholders (and we know how well that has worked out for Main Street in the last 8 years).
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