Based on the Mini-Case “Profit Repatriation,” how would you expect the Tax Cuts and Jobs Act of 2017 to affect the stock of foreign-earned income held outside the United States by U.S. firms?

Profit Repatriation

Until the Tax Cuts and Jobs Act of 2017 went into effect in 2018, a U.S. parent firm that used transfer pricing to avoid paying taxes in the United States faced incentives to keep the money in foreign countries. Unlike most other countries, the United States taxed its multinational corporations on their repatriated foreign earnings (earnings brought back to the United States). U.S. companies could avoid these taxes as long as the profits remained overseas.

Sophisticated managers used transfer pricing to shift profits to low-tax countries and then invested these profits offshore. Goldman Sachs estimated that U.S. corporations held $3.1 trillion outside the United States as of 2017. 

Apple had had the largest overseas cash hoard ($246 billion), followed by Microsoft ($132 billion) and Cisco Systems ($68 billion). 

Periodically, large U.S. corporations would lobby for a repatriation holiday— paying a low federal tax rate such as 5% or 6% on repatriated earnings instead of the much higher normal corporate rate. These firms argued that the tax break would stimulate the economy by inducing multinational corporations to invest repatriated earnings in the United States, creating hundreds of thousands of jobs. 

However, the American Jobs Creation Act of 2004 provided a temporary repatriated profits tax rate of 5.25% but did not result in significant domestic investment. In 2005, 800 firms repatriated $312 billion back to the United States, paid $16 billion in taxes, but returned 92% of the repatriated money to shareholders in dividends and stock buybacks rather than use this money to expand domestic operations.

The U.S. tax law that went into effect in 2018 includes a retroactive tax rate of 15.5% on most corporate earnings held overseas and 8% on some (less a credit for taxes paid in the foreign country). The tax applies whether earnings are repatriated or not. Corporations get the benefit of a reduced corporate tax rate but can no longer avoid paying U.S. taxes by keeping earnings abroad. In the first quarter of 2018, about $300 billion (10% of the outstanding stock) was repatriated. Going forward, U.S. corporations will not have to pay U.S. corporate tax on most foreign earnings.