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US Tax Developments - Stimulating the US Economy

By Editorial
October 18, 2011

In recent weeks, efforts to stimulate the US economy have centred on two major pieces of tax legislation introduced into the United States Congress, both having the avowed intention of boosting job creation; but there is considerable doubt whether the proposals will achieve their sponsors' desired outcomes.

On October 6, Senators John McCain (R - Arizona) and Kay R. Hagan (D - North Carolina) introduced the bipartisan Foreign Earnings Reinvestment bill to help reinvigorate the American economy by offering American multinationals the chance to temporarily bring back overseas earnings to the US at an effective tax rate of 8.75% through a temporary dividends received deduction of 75%. Companies which increase their domestic "qualified payroll" by at least 10% in 2012 would qualify for a lower effective earnings repatriation rate of 5.25%.

America's system of world-wide taxation, under which corporations have to pay the statutory corporate tax rate of 35% on repatriated earnings, means that there is an estimated USD1.4 trillion in foreign profits parked in overseas subsidiaries of US firms. McCain says that this "common sense" legislation would encourage US multinationals to send a substantial proportion of this cash pile back to the US where it could be put to good use in expanding domestic operations and, in the process, boosting employment.

The idea has, though, been tried before and has many critics.

One recent study by the Institute for Policy Studies (IPS) suggested that a similar temporary tax holiday in 2004, which also reduced the effective corporate tax rate on repatriated earnings to 5.25%, failed to create the jobs that had been promised from the measure. Indeed, the IPS points to a government study which found that the largest beneficiaries of the tax break actually laid-off tens of thousands of workers in the two years after the repatriation windfall.

Another report, by the Heritage Foundation, concludes that the McCain/Hagan bill would have "little or no effect on investment and job creation" because the sorts of investments the Senators are seeking to attract are already being financed out of accumulated earnings and those that aren't can easily be financed by borrowing at historically low interest rates. The report argues that little will be achieved with such tax breaks unless the US switches permanently to a territorial system of taxation whereby companies pay US taxes only on US-source income.

Given that this would require a fundamental shift in the way companies and individuals are taxed in the US, and the fact that Congress is rarely able to agree on anything of such importance these days without a protracted fight, a permanent exemption or partial exemption of foreign-source earnings looks a long way off. Besides, the Obama administration is opposed to the idea anyway.

The legislative proposal that has attracted far more headlines recently, however, is the American Jobs bill, which, perhaps, could be President Obama's last chance to have a positive impact on the US economy before campaigning begins in earnest for the presidential elections next year.

The centrepiece of the American Jobs bill is USD240bn in employee payroll tax cuts in 2012, accompanied by tax credits for employers who hire the long-term unemployed, or services veterans and those with services-connected disabilities. The bill would also extend the allowance for businesses to deduct immediately 100% of the cost of qualified investments until the end of 2012.

All this sounds fine until one drills down into the text of the bill and finds that the tax cuts are paid for by a collection of revenue offsets that Obama has been attempting to get onto the statute book since the start of his presidency, but which have been successfully blocked by the Republicans in Congress on every occasion. The offsets include limiting deductions for high income taxpayers and removing various other tax breaks which benefit wealthy individuals and large corporations, particularly in the oil and gas industry.

Since the mid-term elections, the Republicans have increasingly become the 'anti-tax' party and have obstinately refused to countenance any increases in taxation, even if partnered with deficit-reducing spending cuts, using their majority in the House of Representatives to block tax-hiking legislation. In a conciliatory gesture, John Boehner, the Republican speaker of the House, has said that the Jobs bill provides opportunities for the Democrats and the GOP to find common ground on the issues of tax and job creation. However, in an illustration of the ideological divide in Washington, and hinting at the battle to come, Boehner told the Economic Club of Washington in a speech shortly after the President sent the Jobs bill to Congress that tax credits represent a sticking plaster solution to a structural problem and would merely complicate the tax code and encumber businesses with more regulation at a time when they should be focussed on growth. He also reiterated that the Joint Committee on deficit reduction has "only one option" before it: that of "spending cuts and entitlement reform".

Boehner said that businesses are not going to hire someone for a USD4,000 tax credit if government mandates impose long-term costs on them that significantly exceed the temporary credit. However, the non-partisan Tax Foundation has pointed to a much simpler flaw in the American Jobs bill - the fact that the legislation does not specify that a lay-off cannot accompany the new hire. Therefore, as Tax Foundation economist David S. Logan observed, a firm could fire an employee, hire a new one to do the same job, and collect up to USD9,600 for its efforts - which could result in a loss to the US Treasury with no net reduction in unemployment.

So, it would appear that the stage is set for another battle-royal in Congress. The Republicans hold all the cards in the form of their majority in the House, and are likely to continue to frustrate the Administration's efforts to stimulate the economy while tax increases are used to offset tax cuts elsewhere. In fact the Jobs Bill hasn't even reached the House of Representatives, failing to win the 60 Senate votes it needed to go forward.

The foreign profits repatriation tax holiday may have wider cross-party support, but is likely to have its critics on both sides of the aisle for various reasons - Democrats on the left will oppose any 'tax giveaways' to large corporations, while the more radical end of the Republican party will want this measure considered as part of legislation which cleans up the US tax code. It could be that both measures will eventually end up as part of the same ticket, along with a fresh attempt to permanently extend the research and development tax credit, but their passage into law is far from assured.



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