Repatriation Relief and that “Surge” in Tax Revenues

One of the Big Four accounting firms is telling its clients:

The American Jobs Creation Act of 2004 (AJCA) is providing $137 billion in tax cuts over 10 years and comprises three major elements: tax relief for U.S.-based manufacturing activities, reforms in the taxation of multinational businesses and four dozen targeted items of business income tax relief. The act also contains targeted individual tax cuts and excise tax reforms.

Part of this $137 billion comes from changes in section 965 addressing how repatriated profits will be taxed. U.S. multinational corporations have a one-time opportunity to repatriate low-taxed foreign earnings at an incremental U.S. tax cost as low as 5.25%.

Michelle Leder provided this estimate of the significance of this provision:

IBM, for example, is banking a $2.8 billion refund = well, better to call it a “tax savings” – because instead of paying the normal corporate tax rate of 35 percent on $9.5 billion in profits it earned overseas, the company paid only 5.25 percent … Analysts anticipate that American companies will have repatriated around $350 billion in 2005 as a result of the law. While it’s hard to make a straight calculation because of the vagaries of the tax code, that works out to a savings of roughly $104 billion on corporate America’s tax bill. At Pfizer, the pharmaceutical giant that announced the single largest repatriation – $37 billion – the one-time windfall works out to approximately $11 billion.

5.25% times $350 billion would translate into almost $18.4 billion in one-time tax revenues but at what cost? Ms. Leder’s $104 billion is assuming that the U.S. Treasury would have received in the same year 35% times $350 billion or $122.5 billion.

Well maybe we should admit a coupe of qualifying factors. One comes from the foreign tax credit where the Treasury collects the difference between 35% and the tax rate charged abroad. Since we are talking about deferral strategies which are typically used by putting these profits into low-tax jurisdictions, let’s assume a 10% foreign tax rate so the differential is only 25%. In other words, the calculation should be 25% times $350 billion or $87.5 billion. Secondly, deferral implies time value of money. Let’s assume the profits would not have been repatriated for another 5 years and let’s use a 5% discount rate, which means we gave up $68.5 billion in present value terms to get $18.4 billion now.

So as the Bush Administration crows about the “surge” in taxes, let’s just remember that this is yet another example of Enron accounting where in reality the government gave away $50 billion on net.