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September 17. 2013

Brennan Study Upends Conventional Wisdom on Repatriation

By ACT Staff

A recent, independent report by Thomas Brennan, a law professor at Northwestern University, takes a fresh look at the provision in the American Jobs Creation Act (AJCA) of 2004 that temporarily allowed US companies to claim an 85% deduction for repatriated foreign earnings in excess of a company’s historic average.

Prior research has been cited to support the claim that 90 percent of funds repatriated under the AJCA were used for stock buybacks in 2005.  However, this research equally weighted firms repatriating small and large amounts of foreign earnings, skewing the results.  Prof. Brennan proves that it is mathematically impossible that buybacks could have approached the numbers cited in the prior research.  Consequently, such claims must be false.

Weighting companies based on repatriated cash, over the 2005-9 period, Prof. Brennan estimates that over 70% of repatriated foreign earnings went for acquisitions and debt reduction and smaller amounts for other purposes such as R&D, capital expenditures, and pension funding.

Here’s an excerpt from the Brennan’s paper:

Prior research has shown that firms nevertheless made shareholder payouts with repatriated funds (Blouin andKrull, 2009; Clemons and Kinney, 2008; Dharmapala et al., 2011). These results have come to attention of Congress, particularly the finding of Dharmapala et al. (2011) that $0.60–$0.92 per repatriated dollar was spent in shareholder payouts in 2005 (Permanent Subcommittee on Investigations, 2011). This has impacted international tax reform possibilities by serving as a powerful argument against the implementation of future holidays. In this paper, I prove that the $0.60–$0.92 range for 2005 shareholder payouts is completely incorrect. What I provide is truly a proof and not just a statistical estimate of high probability. In fact, I show that total amount of cash, whether repatriated or not, spent on shareholder payouts in that year was so small that no more than $0.55 per repatriated dollar could possibly have been spent in impermissible ways…. My findings indicate that, for the top-20 repatriating firms … $0.22 per repatriated dollar was spent on share repurchases and dividends, split as $0.20 and $0.02, respectively.

Two other misconceptions that frequently arise in discussions of the AJCA repatriation experience are that (1) any use of repatriated funds for stock buybacks was impermissible, and (2) stock buybacks do not benefit the US economy.  In fact, to qualify for the AJCA benefit, repatriations had to be invested in the United States in a properly approved dividend reinvestment plan specifying usage of funds for permissible purposes.   Using repatriated funds for permissible purposes, such as employee compensation, freed up cash for other purposes.  Such use of freed up cash for stock buybacks was permissible under AJCA and, although amounting to only 27% of repatriated funds, benefited the US economy by allowing shareholders to reinvest in other companies and to finance consumer purchases that stimulated the economy.[1]

While ACT supports permanent reforms to our nation’s outdated tax code, Brennan’s report offers valuable insights on the impact bringing home trillions of dollars locked out from investment here in the U.S. will have on the American economy. ACT believes that we should simplify the code in a way that will create jobs, let American companies compete in overseas markets, and allow them to reinvest in America without penalty. This starts with reforming our international tax system and adopting rules that will encourage businesses to bring home the nearly $2 trillion in foreign profits currently locked out of the U.S. economy.

[1] See, Laura D’Andrea Tyson, K. Serwin, and E. Drabkin,“The Benefits for the U. S. Economy of a Temporary Tax Reduction on the Repatriation of Foreign Subsidiary Earnings,” Berkeley Research Group, Fall 2011.