Taxed to the Max

Hefty tax rates continue to penalize U.S. companies, and the calls for reform are growing louder.

At best, the effects are uneven. “If you do everything the IRS requires of you to take advantage of certain types of incentives, you can reduce your tax rate significantly,” concedes Mark Weinberger, global vice chairman and head of the tax practice for accounting firm Ernst & Young. “But,” he warns, “those incentives are for particular industries and particular size companies, so there are a lot of winners and losers depending on what type of company you are.”

As international tax inequities go, the combination of high statutory corporate income tax rates plus the taxation of U.S. corporations’ overseas income at those higher rates garners perhaps the loudest complaints. Only three OECD nations, including the United States, impose a tax on active corporate income outside their borders. The other two, Japan and the United Kingdom, are mulling an end to the practice.

The biggest reason to adopt a system that taxes U.S. multinational corporations on income earned at home and apply only foreign tax rates to income earned overseas is because it would help U.S. corporations to compete on equal footing with their global counterparts. Moreover, encouraging U.S. companies to repatriate profits stored overseas might inject some badly needed liquidity into the domestic economy for payrolls and capital expenditures.

As rules stand now, Uncle Sam imposes U.S. taxes on top of taxes paid in the foreign jurisdictions when that money is brought home. In 2004, when the tax rate on repatriated earnings was cut to a low 5.25 percent on a one-time basis, the impact was significant: some $362 billion of an estimated $804 billion domiciled offshore was lured home. “It could be very helpful in relieving some of the stress,” says Lewis at Eli Lilly. “Even if companies just deposited their repatriated dollars in banks, it would help the financial system.”

Regardless of the tax breaks it may enjoy as a pharmaceutical company (a sector that has benefited from a number of perks, such as incentives to invest in Puerto Rico), Eli Lilly kicks less money into U.S. coffers than it might, in large part because, like many of its multinational counter- parts, it simply finds ways to keep the money earned overseas working there. As of the end of 2007, according to Lilly’s 2008 annual report, the company had $8.8 billion of unremitted earnings in foreign subsidiaries, all of which, it said, had been or were intended to be permanently reinvested in foreign operations. That may help to keep the tax bill low, but it limits flexibility, thus granting a competitive advantage for its global rivals.

Seeking a remedy, Sen. John R. Ensign (R–Nev.) proposed another tax-repatriation window as part of the economic stimulus package. Had it been adopted, the proposal would have matched the 5.25 percent rate applied in 2004. Economist Allen Sinai estimates that reopening the window would eventually retrieve around $545 billion. While that might be a boost to the stalled (domestic) economy, some skeptics say it could prompt companies to stash even more profits offshore in anticipation of periodic tax holidays.

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