Economic Benefits of Allowing U.S. Multinational Companies to Defer Tax on Foreign Earnings

and the Costs to the U.S. Economy of Repealing Deferral

For years, some politicians have proposed to increase the tax burden on the profits earned by American companies outside the United States, and Congress is now considering legislation that would sharply limit the “deferral” rules that protect U.S. businesses from bearing much higher tax burdens on their earnings abroad than their foreign competitors. Economic research has established, however, that in the global networks of America’s international companies, these foreign investments and jobs do not cut into investment and jobs at home, but rather increase them. As a result, the current proposal to substantially restrict “deferral” would end up reducing American jobs and investment and could impair our economic recovery.

This study analyzes the economic effects of repealing the deferral rules that have governed the way we tax the foreign earnings of U.S. companies since the advent of the corporate income tax in 1913. The administration proposal would not repeal deferral completely, but it does move significantly in that direction. The results will be same – making U.S. companies less competitive in global markets and costing American jobs.

Repealing deferral would lead to the following negative effects for the U.S. economy:

• It would cost at least 159,000 jobs or $7.3 billion in payments to workers, the equivalent of all the health care workers in Colorado. Under certain conditions, ending deferral could affect as many as 2.2 million jobs, or nearly one of every 60 American workers.

• Investments in the United States in plant, equipment and property could fall by as much as $84.2 billion.

• Those who believe that repealing or sharply limiting deferral would generate large tax revenues would be sorely disappointed, since the large job losses, wage cuts and lower investments would reduce tax revenues.

This analysis is based on new economic research that establishes that most of the investments and sales by the foreign subsidiaries of U.S. companies are driven by the fast-growing size of those foreign markets and the development of efficient global production and distribution networks to serve them. Applying the very high, U.S. corporate tax rates to worldwide income, which currently is deferred from tax until it is paid directly to the U.S. parent company, would leave our own companies at a severe competitive disadvantage, since the vast majority of their foreign competitors are based in countries with “territorial” tax systems that never tax business profits earned outside the home country.

Recent research has shown that the foreign and domestic investments, jobs and general operations of U.S. companies complement each other. From 1989 to 2004, increases in the total assets, sales and investments in property, plant and equipment by foreign affiliates of U.S. companies were consistently accompanied by increases in those same categories at the parent companies in the United States. These linkages are especially strong in manufacturing, mining, wholesale and retail trade, and for all industries considered together.

The close linkages between these foreign and domestic investments and job creation mean that while reducing or repealing deferral may be tempting politically, it would produce significant, negative economic consequences. The policy goal of changing the deferral is ostensibly to make the United States a more desirable place for investment and job creation, but such changes would have the opposite effect of reducing domestic investment and job creation.

The Administration and the Congress should take this opportunity to conduct a serious review of the tax code and identify broad reforms that take account of the actual dynamics of the global economy and the need to support the integrated operations and international competitiveness of American companies.

History and Background of Deferral

Source: “The Economic Benefits of Provisions Allowing U.S. Multinational Companies to Defer U.S. Corporate Tax on their Foreign Earnings And the Costs to the U.S. Economy of Repealing Deferral,” Robert J. Shapiro and Aparna Mathur, June 2009.

Additional Background Reading from the National Foreign Trade Council (NFTC)

Addressing Offshore Tax Avoidance Without Harming the International Competitiveness of U.S. Businesses

About the National Foreign Trade Council

The NFTC is the leading business organization on international tax issues, and successfully initiates and resolves significant tax matters affecting U.S. business. The NFTC maintains a Tax Committee which has four Working Groups: Legislative, Regulatory, Non-U.S. Issues and Tax Treaty, which are comprised of U.S. business community leaders who:

Draft international tax legislation;

Lobby for enactment of legislation;

Facilitate the negotiation and ratification of tax treaties;

Interact with Treasury and IRS officials and comment on proposed regulations; and

Interact with foreign governments and comment on proposed tax law changes that will affect U.S. multinationals around the world, particularly in OECD countries.

In addition to developing international tax policies, the NFTC Tax Committee often provides testimony during Senate Foreign Relations Committee tax treaty ratification hearings, and has been identified as the most influential business group dedicated to tax treaties. The NFTC Tax Committee also coordinates efforts on important international tax regulation activities and meets with officials from the U.S. Treasury and foreign governments to facilitate the resolution of bilateral tax treaty issues.