Tuesday, August 30, 2011

Stop Taxing Corporations on Foreign Earnings

As many investors know, U.S. corporations are holding large amounts of cash on their balance sheets. Some commentators argue they are doing so because they believe investing is too risky right now. Furthermore, they ask, if these corporations, which are run by very sophisticated managers, are unwilling to put their money to work, does it make sense for ordinary investors to risk their own money in the stock market at this time?

I took a look at some of the largest corporations in the S&P 500. I examined their most recent SEC filings. As shown in the table below, they are indeed holding lots of cash and short-term marketable securities that could be quickly converted into cash.

Perhaps we can conclude from these large cash balances that these companies are reluctant to invest because of economic uncertainties and other risks, including political risks. Yet, at least to some extent, we can also conclude that the decision to pile up cash is motivated by taxes. After all, many of these companies have significant operations abroad. To a large extent, their cash balances reflect profits earned overseas. Repatriating those profits would result in significant U.S. tax liabilities.

Consider this statement from Google's most recent 10-Q filing with the SEC, "As of June 30, 2011, $18.8 billion of the $39.1 billion of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds."

Perhaps Google does not need to invest the money in the U.S. right now, but it is clearly objecting to the tax consequences it would face if it did try to bring the money home. It's pretty clear that Google would probably repatriate at least some of this $18.8 billion if it did not have to pay an onerous tax.

Google is not the only company on the list to mention repatriation and taxes. Several companies commented on this. Here's what Microsoft had to say in its most recent 10-K: "We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds currently held in foreign jurisdictions may result in higher effective tax rates for the company."

By forcing companies to pay a tax that runs as high as 35% on repatriated profits, our government is all but ensuring that the money stays overseas. It seems like common sense to reduce this tax rate dramatically. Better yet, why not eliminate it entirely? Doing so could be one of the most effective job creation initiatives the government could take.