After years of national hand-wringing about trillions of dollars in profits held abroad by multinational companies, the Tax Cuts and Jobs Act mandated repatriation of those earnings at a greatly reduced tax rate.
That concern should hardly come as a surprise. A wave of stock buybacks spurred by an earlier corporate tax holiday, the American Jobs Creation Act of 2004, provoked The New York Times to accuse Congress of using “phony labels like ‘job creation’ and … ‘economic growth’ to justify excessive tax cuts that increasingly serve to concentrate wealth among the few.”
Will Congress’ latest effort to bring overseas profits home spur broader benefits than the recent upsurge in buybacks has suggested? New research provides some reason to hope that it will.
A paper in the current issue of the Journal of the American Taxation Association, published by the American Accounting Association, investigates the effect of the 2004 law on corporate research and development. It reports that, notwithstanding the surge in stock buybacks that occurred, repatriation resulted in a $30 billion R&D spending surge.
That equated to about 11% of the total of $268 billion brought home by the sample of 395 companies included in the study.
Probing the four years preceding and following the bill’s enactment (2001 through 2009), Qi Dong and Xin Zhao of Penn State University at Erie report that the legislation resulted in an average annual increase in R&D of $47 million per repatriating company.
“For comparison,” they write, “the average increase in R&D expenditure is $5 million for non-repatriating firms during the same period. Therefore, the incremental increase in R&D expenditure for repatriating firms is $42 million.”
Among repatriating companies, the average annual expenditure on R&D increased from about $151 million to about $198 million, a boost of more than 30%.
The study contrasts with earlier research concluding that companies that repatriated earnings following the 2004 legislation tended to be those with rather limited investment opportunities both at home and abroad.
That paucity, it was argued, explained the companies’ failure to fund domestic investment through debt financing before the tax holiday. But that failure, Qi and Zhao maintain, may not apply to R&D, because R&D is not normally funded through debt but rather through internal equity, which is considerably enhanced by a large tax break.
Why focus on R&D? The professors provide three reasons:
- R&D is a critical driver of the competitiveness of the U.S. economy and therefore a relevant output for policy evaluation.
- Unlike other forms of investment by U.S. multinationals that could be spread all over the world, R&D expenditure is mostly incurred domestically.
- The two industries with the highest amount of repatriation as disclosed by the IRS — pharmaceutical/medicine and computers/electronics — are heavily reliant on R&D investment. Therefore, whether firms in those industries further strengthen their competitive advantages by spending the repatriated funds on R&D is of particular interest to policy-makers and investors.
The study’s conclusions are based on comparing data from the 395 repatriating firms with those of two comparison groups: more than 6,200 U.S. multinationals that did not repatriate, and a select group of non-repatriators that were matched with the 395 on the basis of size and industry.
As would be expected, the professors took pains to ascertain that the greater increase in R&D spending by repatriating firms compared to non-repatriators was indeed attributable to the tax holiday, quite apart from other factors that can affect company spending.
They achieved this in two principal ways: (1) through matched controls (as indicated above); and (2) in the analysis involving the full sample of nonrepatriating firms, by controlling for such factors as company size, profitability, debt, and Tobin’s Q (a measure of the appeal of companies’ stocks to investors).
In both analyses, the relationship between post-legislative repatriation and increased R&D was statistically significant after controlling for other factors affecting expenditure.
Asked whether they believe the current repatriation will result in an R&D increase similar to what occurred following the 2004 legislation, the professors say it’s too early to tell. Possibly, they add, the effect may actually turn out to be greater, since the current repatriation tax break is accompanied by a permanent sharp reduction in the statutory corporate tax rate, offering firms pondering domestic investments a new incentive to make them.