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The new tax bill was supposed to put America first as a destination for manufacturing, but one unintended consequence of the legislation means some U.S. multinationals may see an advantage in adding facilities in foreign countries.
But the tax law changes, on balance, are so much more beneficial to U.S.-based business operations that it's unclear how much that new rule will encourage foreign investment from a pure tax standpoint, according to economists who have studied the plan.
U.S. companies have piled up about $2 trillion in cash overseas to avoid bringing it home to be taxed at the 35 percent U.S. tax rate, but with tax law changes coming, the new rate will be 21 percent in the U.S. and foreign profits will be taxed at an even lower rate, based on tangible depreciable assets.
For these types of profits, the tax bill allows companies to have tax-free treatment for a portion of their foreign income up to what is considered a reasonable amount of return, and then taxed at the parent's rate on half the remainder.
Gavin Ekins, research economist at the Tax Foundation, says if a company for instance had a tangible asset of $10 million, perhaps a plant in a foreign country, the company could earn a reasonable rate of 10 percent, or $1 million before the profits are taxed at the parent company's rate. "Let's assume they're making 20 percent. This provision would say if you're making $2 million, that would mean $1 million is above normal or above a routine return. You're going to have to include half that into your parent company's taxable base," he said.
A company could decide to avoid paying taxes on its above normal, "super" foreign profits if it were instead to invest in a new foreign plant or other tangible asset, which would result in greater tangible depreciable assets. That would provide a bigger base of assets against which profits would be taxed, possibly making the tax hit smaller.
So in theory, the more tangible overseas assets, the less taxes on foreign earnings, and potentially less taxes altogether if a company chooses to locate a plant outside the U.S.
"There is a small incentive to locate your tangible depreciable assets overseas because of this," Ekins said. But he and others doubt there will be a stampede to build more overseas because of the new advantages at home.
Gary Hufbauer, Reginald Jones senior fellow at the Peterson Institute, says the move to tax foreign profits is a big change for companies that used the current law to leave profits untaxed overseas.
"They're not screaming," he said. "They love their new lower U.S. tax rate. They're willing to take the hit on their past earnings."
"What is true today, under today's law, a firm can invest abroad and retain the profits abroad and never be taxed here," Hufbauer said. "When you look at macroeconomics, you're going to get a huge decrease in the U.S. and on balance, a tax increase on doing business abroad."
The tax plan has been touted as a "territorial" system, which would normally not tax foreign profits.
"It's a halfway territorial system. What it does is it taxes companies on their unusually high earnings in their foreign subsidiaries, and if they have a lot of transactions with their foreign subsidiaries, they're under scrutiny for possible base erosion, so they would be taxed there as well," Hufbauer said.
The new tax law also applies taxes to intangible assets held overseas, in an effort to encourage U.S. companies to bring things like licenses and copyrights home.
Ekins said the U.S. is moving to a corporate tax rate, that even with state and local taxes, makes the U.S. more competitive than many other countries, with an overall rate of about 25 percent.
He said if the bill is approved, the U.S. would be 13th on the list of tax rates for Organization for Economic Cooperation and Development countries.
"If we had put this rule into place and not changed the overall corporate tax rate, I would expect some real movement of U.S. industries out of the U.S. and into other areas of the world," Ekins said.
"This is putting the U.S. in the middle of the OECD as far as tax rates. I think because of that I don't think there's going to be that outflow. A lot of companies are going to find there's no better place to go," he said.
France has the highest tax rate and Belgium is third after the U.S. Both are cutting taxes, and that would leave Germany and Japan as the countries with the highest corporate tax rates. The House is expected to vote on the tax bill Tuesday, while the Senate votes Wednesday.
"I would argue the incentive is greater for them to stay or bring [investment ] back to the U.S.," said Joseph LaVorgna, chief economist, Americas at Natixis. Lavorgna said the 21 percent tax rate, accelerated depreciation, deregulation for many industries and low energy costs are among the impetus to reinvest in America.
Source: OECD, Tax Foundation