DealBook: Tax Policy Change Would Bring Cash Piles Abroad Back Home

Harry Campbell

Apple has a cash problem. It’s not just that Apple has too much cash, $76 billion as of June 30. It’s rather that the bulk of that pile, estimated at $41 billion, is held abroad.

Apple does not want to bring it back to the United States for several reasons, primarily because of the tax consequences, but also because of its own growing foreign presence. Apple is not alone — this problem is an increasing one in corporate America. And the answer may not be more big, all-cash acquisitions, like Google’s $12.5 billion offer for Motorola Mobility.

In an analyst report in May, JPMorgan Chase estimated that 519 American multinational corporations had $1.375 trillion outside the United States. The problem is particularly acute among technology companies, which historically tend to hoard cash because of the cyclical nature of their business.

A recent Moody’s report noted that Microsoft held $42 billion abroad, or more than 80 percent of its cash. Cisco Systems has $38.8 billion, or almost 90 percent of its cash. Google — at least before Monday’s deal — had nearly $40 billion in cash, with more than 43 percent of it held abroad

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Tax policy is driving much of this trend. For multinational corporations, cash earned abroad cannot easily be remitted to the United States. If it is paid back to the United States, it is subject to a dividend tax that can rise to as much as 35 percent. Companies are loath to pay this tax because while they can offset it with taxes paid abroad, the companies still end up paying a relatively high tax rate.

Yet it is not just a tax issue. Many United States companies want to keep cash abroad to focus on high-growth regions for investments and acquisitions.

A recent Standard Poor’s study found that 50 percent of sales by companies in the S.P. 500-stock index are outside the United States. Interestingly, the report also found that these companies paid more in foreign taxes than to the United States government. For Apple, 60 percent of its sales are abroad, and like these other companies, its foreign sales are expected to only go higher.

So, for those who expect that a change in tax policy would prompt Apple and other companies to put their cash piles to use in the United States, don’t be so sure. Even if there were no dividend tax, a large portion of this cash would stay abroad as these companies focus on higher growth overseas for investment.

Still, the current tax policy clearly distorts the practices of United States companies. One of the reasons Microsoft acquired Skype was because it was located in Luxembourg. Microsoft could use its foreign cash to make this acquisition without having to first repatriate it to the United States.

More broadly, many American companies return the cash every quarter to the United States, but then send it back abroad by quarter-end to avoid it being counted as a deemed dividend. The current tax laws thus encourage these companies to engage in cash manipulation and keep too much cash abroad.

In 2004, Congress enacted the American Jobs Creation Act, a tax holiday for companies to repatriate cash. The dividend tax was reduced to 5.25 percent from 35 percent. In exchange for this reduction, Congress required that any cash repatriated be invested in the United States. The cash could not be used for dividends or stock repurchases.

Alas, cash is fungible. A study of this tax holiday, entitled “Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act,” found that in the year following the act, repatriations increased by $230 billion from the previous year, to $299 billion.

Five companies alone — Pfizer, Merck, Hewlett-Packard, Johnson Johnson and I.B.M. — repatriated $88 billion, But the repatriation did not result in increased investment. Instead, companies largely repatriated the money and used their current United States holdings to pay out dividends or engage in share repurchases. This was contrary to what Congress had intended.

While the cash was not used for investment, this does not mean it did not have an overall positive effect on the American economy: shareholders went on to spend this cash. The study’s authors acknowledged this, stating that “presumably these shareholders either reinvested these funds or used them for consumption, thereby having indirect effects on firm investment, employment or spending.”

The tax holiday may therefore have stimulated the economy, although a Congressional Research Service report found that the companies that repatriated the most money actually cut jobs from 2004-6.

Still, the act also had a pernicious effect. American companies now accumulate cash and wait to repatriate these holdings, knowing that Congress will probably declare another tax holiday eventually.

Why engage in this game every few years? Congress could permanently modify United States tax policy to set the rate at a lower amount. This would be recognition that Apple and its like are multinational companies and that this problem is not going away. The world is global, and fencing off cash like this for our best companies is unrealistic.

More important, although these companies will still leave some cash abroad, more of it will come back to the United States. If it were invested, that would be terrific but not necessary as it would also end the distortions that drive even more investment abroad.

Google provided a recent example only this week with its Motorola Mobility acquisition. Google has more of its cash in the United States than other comparable technology companies since it is not a retailer like Apple.

Google is also more willing to take on debt in the United States to finance acquisitions, having completed in May a $3 billion debt raise. This was done to provide it more United States cash. Google provides anecdotal evidence that ending this distortion will end the foreign cash bias.

A permanent tax reduction would not only cut taxes but actually raise revenue, allowing for Republicans to vote for it. And it should be a holiday without restrictions — trying to force companies to invest the money rather than pay dividends is a useless exercise that will create only more bureaucracy.

Even if the money were largely spent on buybacks and dividends and a large portion were kept abroad, it would still be reasonable to expect $300 billion to $600 billion to be repatriated. This money would flow into the economy, making the dividend tax cut a stimulus package that Democrats could support.

A 2008 simulated analysis by Decision Economics found that such a reduction would raise about $50 billion a year for the federal government from the tax received and the increased growth, over a five-year period. Economic growth would be increased by up to $62 billion a year.

The Obama administration has previously been negative on such a tax reduction, but it might want to reconsider. This is the rare tax policy move that both Democrats and Republicans should be able to easily support. It is one that would allow Apple and other big American multinationals to spend money more freely, something needed in a troubled economy. It may even push Apple to finally put to use some of its gigantic cash pile.

Article source: http://feeds.nytimes.com/click.phdo?i=27ecb7f5621f84ae0218e5bda98aab53