The federal government would love nothing more than to apply the 35% corporate tax to the estimated $1.7 trillion in cash U.S. multinational companies have designated as foreign investments - and outside the grasp of the Internal Revenue Service.
U.S. companies don't have to pay tax on profits made overseas unless they bring the cash home.
While eliminating this break looks tempting - the Congressional Budget Office (CBO) estimated in a report this month that it would generate $114 billion in revenue over 10 years - such a move could have a variety of negative consequences that would hurt U.S companies as well as the U.S. economy.
One problem is that eliminating the break would put a major burden on many U.S. companies, which use the loophole specifically to avoid the 35% corporate tax rate - among the highest in the world.
The result is that billions in profits never get repatriated to the U.S. Most of the cash holdings of many major U.S. companies, in fact, technically reside overseas. Microsoft, for example, holds 87% of its cash in foreign-controlled accounts.
Washington Plots to Tap U.S. Companies' Cash
Amid all the recent budget debates, some in Washington see corporate America's $1.7 trillion foreign cash hoard as ripe for the picking.
Some Democratic lawmakers - as well as U.S. President Barack Obama - have suggested that the tax-deferral rule for foreign profits be reduced or eliminated as part of a deal that would reduce the corporate tax rate from 35% to 28%.
But Money Morning Chief Investment Strategist Keith Fitz-Gerald warns that any tinkering with the corporate tax code needs to be done very carefully, with a wary eye toward how the changes might affect how businesses behave.
"It's not just a matter of fixing the tax system," Fitz-Gerald said. "They have to fix what they hope to accomplish with the tax system."
Fitz-Gerald pointed out that though U.S. corporations are often portrayed as villains or tax cheats for pursuing tax-avoidance strategies, they have little choice. They have a fiduciary duty to maximize the use of any tax break available.
"The tax code is punitive," Fitz-Gerald said. "The companies are doing what they're supposed to be doing."
Fitz-Gerald said simply wiping out the deferral for foreign profits might create unforeseen problems.
For example, most of the "foreign" cash that U. S. companies hold is in fact invested in U.S. government securities in U.S. banks. Its designation as overseas cash is essentially an accounting sleight of hand.
"The money is already here," Fitz-Gerald said. "The U.S. government has to think carefully about this." If the break is eliminated, "that money could be used for other purposes and removed from government securities."
U.S. Companies Need Cash Where the Growth Is
But the biggest concern Fitz-Gerald has is how the change would affect the ability of U.S. companies to invest their cash in their foreign operations.
"Having access to overseas capital is necessary to be competitive," he said, noting that the purpose of the break is to encourage companies to invest in growth opportunities overseas.
"The growth and profits potential is higher overseas than here at home," he said.
Forcing U.S. companies to repatriate their foreign profits for taxation would create a disincentive for such foreign investment at a time when much of the world's economic growth is expected to take place outside of the U.S. in countries in Asia and South America.
That ultimately would hurt corporate profits and depress stock prices - something the government doesn't want.
Yet Fitz-Gerald also sees some benefit to putting at least some of that cash to use in the U.S., if it is invested properly.
Fitz-Gerald said any attempt by the government to bring overseas cash home would need to have ironclad rules for how it could be used - a mistake the government made with the 2004 tax holiday on foreign profits.
"They didn't take it far enough," he said. "The government would need to tie it specifically to domestic use."
Even with restrictions on how the cash could be spent, Fitz-Gerald isn't sure that approach is the best way to go.
"That's the dilemma," Fitz-Gerald said. "Is the opportunity cost of bringing that money home higher than the opportunity cost of leaving it overseas?"
In the end, he said, there are no easy or obvious answers on what should become of all that cash U.S. companies have declared as foreign holdings.
"I love my country. I want that money brought home, I want it put to use for Americans," Fitz-Gerald said. "But it's a very thorny issue."
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The Wall Street Journal:
Firms Keep Stockpiles of 'Foreign' Cash in U.S.
Limiting corporate tax deferral could raise $114 billion: CBO
Often-Rejected Tax Increases Remain Among Obama Options