If an American company earns profit in another country, it has to pay that country's income taxes. But if it then chooses to bring that cash back to America, it owes U.S. taxes, minus a credit for foreign taxes already paid.
So imagine Cisco earns $1 billion profit in Switzerland. It will owe
Switzerland's 8.5% corporate tax. But if Cisco then brings the remaining
$915 million back to the U.S. to pay dividends or expand its workforce,
it will owe another 26.5% to the IRS -- the difference between
Switzerland's 8.5% tax rate and America's 35% rate. It's called the
Cisco's other option is to keep the money in Switzerland (or whatever
country it earns overseas profit in). Not surprisingly, that's what most
global corporations choose to do. As of last March, U.S. companies held
about $1.2 trillion in total cash. But almost 60% of that was sitting
in foreign bank accounts, according to Moody's.
Some companies hold the
vast majority of their loot abroad. About 80% of Oracle's (NASDAQ: ORCL) cash is held overseas. Apple (NASDAQ: AAPL) holds close to 70% of its cash outside the U.S.
There are two crazy things about the repatriation tax. The first is
that it doesn't raise much money for the U.S. Treasury. Using the most
bearish assumptions, The Joint Tax Committee estimates that ending the
repatriation tax altogether would raise deficits by about $8 billion per
year -- a rounding error measured against $2.9 trillion in total
revenue. A separate estimate from the Congressional Budget Office shows
that ending repatriation taxes would actually raise federal tax revenue,
since companies would likely bring more cash home to pay dividends,
which are then taxed. Either way, repatriation taxes have a trivial
impact on the federal budget.
Second, the repatriation tax is virtually unique to America. Of the G-7
group of nations, only America exercises a repatriation tax. Among the
34 OECD nations, 26 impose a "territorial" tax system, where profits are
only taxed where they are earned, with no repatriation owed when
earnings are brought back to a company's home country. Two of the last
holdouts, Japan and the United Kingdom, switched to a territorial tax
system in 2009.
With the competition based in countries that use
territorial tax systems, American companies are at a disadvantage. The easiest way for them to compete is to keep foreign profits in foreign bank accounts. The loser is the U.S. economy.