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Don't Celebrate Trump's Tax Holiday

President-elect Donald Trump has proposed a "tax holiday" – a sharp cut in taxes on corporate profits that are currently held overseas. He argues that a one-time cut in the corporate tax rate to 10 percent will encourage $2.6 trillion in profits to flow back to the U.S., creating millions of new jobs in the process.

It sounds like a no-brainer, but it's not. In truth, this kind of tax cut will create few if any new jobs, and will probably destroy existing jobs.

To understand this strange and sad truth, we need to look how profits get "trapped" overseas in the first place, and what it really means to move them back. To oversimplify just a bit, here's how it works: Big global corporations are made up of many local subsidiaries, and these subsidiaries buy and sell from one another in a global supply chain. For example, a big tech company like Apple can design a product at its U.S. headquarters, license the design to its Malaysian subsidiary to build it, the Malaysian subsidiary sells it to the Grand Cayman Islands subsidiary, which sells it to the German subsidiary, which finally sells it to a consumer.

Since the parent company controls the price that each subsidiary pays to others, it can make profits appear or disappear anywhere in the supply chain. All it needs to do is raise one transfer price and lower another. Smart corporations track which countries have the lowest tax rates, and they fudge transfer prices to make the profits biggest where the taxes are lowest. It's just an accounting trick, and a very profitable one.

But even though the profits may pile up in a tax haven like the Grand Cayman Islands, the actual cash doesn't sit there. The Grand Cayman Island subsidiary takes its cash to the bank, and the bank invests the money around the world, wherever it can earn the highest returns. Even as Apple's profits pile up in some tax haven somewhere, much of its cash is already back in the U.S., invested or loaned out by the international banking system.

Now we can begin to see why cutting the taxes on overseas profits doesn't create jobs:

  1. Much of the money that is said to be "trapped overseas" is already invested in businesses in the United States, simply because it was deposited in a financial institution. Cutting the tax rate may let a corporation spend the money differently, but that only means killing one U.S. job to create another.
  2. Most of the corporations with the biggest accumulated profits overseas don't generate enough new ideas to invest all the cash that they earn. Big tech companies, for example, generate cash faster than they can come up with cool innovations to spend it on. When a company has an idea that needs funding – if the idea is truly compelling – it will either pay the tax involved and bring the money back or simply borrow money where it needs to, at today's very low interest rates.
  3. Companies have developed a wide range of tricks to move money around from country to country without formerly repatriating it. The system is full of loopholes, says the FACT Coalition.

Among economists, this is not a partisan issue. Serious conservatives acknowledge the weakness of profit repatriation as a tool to create jobs. The conservative Heritage Foundation said that a repatriation tax holiday would "have a minuscule effect on domestic investment and thus have a minuscule effect on the U.S. economy and job creation." The RedState blog said that tax holidays for repatriation "may be good for Washington's coffers and executive boardrooms, but the claims of job creation are without merit."

Indeed, back in 2004-05 a similar tax cut was tried, and it failed. It "created almost no jobs," said RedState. That proposal had provisions to force companies to invest cash domestically in order to qualify of the tax cut, but companies figured how to work around the restrictions.

Most disturbingly, repatriation tax cuts will kill the jobs of ordinary Americans even as they raise incomes for senior corporate officers and investment bankers. Since companies don't have enough internal growth opportunities to absorb billions of dollars, the dollars will be used for two main purposes: repurchasing shares and buying up other companies. At least that's what many corporations are telling investors. Merger and acquisition activity typically destroys jobs as companies consolidate operations and lay off redundant staff. The share repurchase activity drives up the stock price, helping investors and senior executive whose pay is closely tied to the stock. Neither of these transactions do much for job creation, other than perhaps increasing the need for pilots who fly private jets and gardeners who care for landscaping at luxury vacation homes.

David Brodwin is a co-founder and board member of American Sustainable Business Council. This blog is adapted from a column recently published in U.S. News & World Report January 6, 2017.