Judd Gregg: The full impact of tax reform

Judd Gregg: The full impact of tax reform
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There are an important series of side-products occurring as a result of the passage of the tax bill in December.

They swirl around the law’s treatment of the overseas income of American corporations.

Under the bill, the liquid assets representing the earnings accumulated over the years by U.S. companies’ foreign operations are deemed taxed at 15 percent. 


The overseas hard assets, investments, plants and equipment of those companies are deemed taxed at 8.5 percent.


Since it is estimated that there might be as much as $2.5 trillion subject to this deemed tax, the windfall to the U.S. treasure could be dramatic. Apple alone has booked a $38 billion tax charge as a consequence.

What is interesting is this:

These assets would never have been taxed if we had continued under the prior counterproductive rules.

Under those prior rules, the tax was only realized when the funds or assets were brought back to the U.S. At that time, the tax rate could be as high as 35 percent, the top rate that corporations pay.

For this reason, virtually no assets were ever returned to the U.S. It would have been malfeasance for corporate leadership to subject their shareholders to such a punitive tax rate. 

Not only did the funds not return here. They were reinvested overseas, creating jobs and economic growth in countries that are economic competitors.

Truly, it was a self-inflicted economic wound.

But this is only the preamble to the story that is going to be told, as a result of the changes to our tax laws on foreign earnings.

The companies that are paying this deemed tax are obviously stuck with the pleasurable issue of what they do with all these funds that they can now bring back here.

Equally interesting is the fact that, although these companies have recognized for accounting purposes billions of dollars in tax liability in the fourth quarter of last year, for the most part they do not need to pay the entire tax bill immediately.

They can spread their deemed tax bill over eight years. This means, for example, that Apple pays the actual $38 billion in tax in equal installments over eight years.

This option significantly aids their cash position.

Companies are in essence getting to use cash they would use to pay the tax upfront for eight years on a declining basis without penalty.

It’s a good deal and a logical one, since the tax was unanticipated. Cash is still king and they can do a lot of good things with this extra cash.

The taxpayers are also winners.

First, the federal government will over eight years realize some really large tax payments on earnings that would otherwise never have been subject to taxes. 

Second, no matter what these companies do with the significant repatriated funds they bring back, the activity will create taxable events.

If the funds are used to repurchase stock, that is a taxable event. If the funds are used for one-time dividend increases, that is a taxable event. If the funds are used to increase the salaries of the corporation’s employees, that is a taxable event.

The federal treasury gets a double benefit — the deemed tax and the taxes on the economic activity repatriation generates.

It should make a lot of liberals happy to have all these newfound funds.

But they are not happy. The rules used to score the tax bill are essentially drawn from a static model. The new revenues, which have been grossly underestimated, were compared in this model to the lost revenue from the corporate tax rate cut, which was grossly overestimated.

When all the dust settles from this tax bill, there will be significant unscored revenues coming to the federal government.

In addition, foreign earnings of American corporations will be taxed pursuant to a territorial system in future — a principle that mimics the policy of other industrialized nations.

Even so, there maybe some clouds on the horizon of our nation’s economic growth.

Among them is the possibility of a renewed round of inflation driven by too many people being employed and thus driving up wages too fast.

That seems to be what caused the dramatic gyrations of the stock market last week, at least in part.

What an interesting problem to have.

Unfortunately, the Federal Reserve’s response is predicted to be to raise interest rates even faster then it may have forecast.

Such acceleration is intended to dampen down these inflationary pressures. But the market fears that such acceleration will slow growth and possibly be a precursor of a recession. 

This brings about another reason why the Federal Reserve wants to increase its pace. It needs to have rates high enough to be able to reduce them should such a recession occur.

This is one of those counter-intuitive policy approaches that only a group of economists could love: raise rates to cut rates.

This brings us back to the actual effect of the repatriation of funds under the new tax bill and the new territorial system. 

It will work. It will generate significant economic activity. It will install a new engine of previously-unrealized revenue for the federal government.

It will also be seen by the Federal Reserve as one of the drivers of a too-hot economy, and potentially inflation. It will be too much of a good thing.It will be seen as one of the forces that must be dealt with by raising interest rates.

Once again, this looks like a case of “no good policy goes unpunished.” 

Equally, it is important to never underestimate the ability of the  government to step on its own toes.

Judd Gregg (R) is a former governor and three-term senator from New Hampshire who served as chairman and ranking member of the Senate Budget Committee, and as ranking member of the Senate Appropriations Foreign Operations subcommittee.