The merits of funding U.S. infrastructure investments with a corporate tax holiday

The U.S. Highway Trust Fund is in a bit of a bind. Absent transfers from general federal funds, the trust fund will run out of money very soon. Even with financial support from general funds, the trust has a projected cumulative deficit of $168 billion over the next 10 years. At the same time, approximately $2 trillion in profits from U.S. corporations is sitting overseas as companies are unwilling to bring profits into the United States due to the taxes they’ll have to pay.

Sensing an opportunity, members of Congress from both sides of the aisle are considering a proposal that would allow those corporate profits to be brought back to face a lower tax rate, with the resulting funds contributing to the Highway Trust fund. If we assume a 6.5 percent tax rate, as proposed by the Invest in Transportation Act, then all of the foreign earnings coming to the U.S. would generate about $130 billion. If this proposal sounds familiar, it’s because something very similar was implemented more than 10 years ago. The results from that experience should make policymakers skeptical about its promise this time around.

The temporary reduction for foreign profits returning to the United States is known as a repatriation tax holiday. The thinking behind the act back in 2004 was that by inducing companies to bring earnings back to the United States, the temporary tax reduction would increase investment and employment in the United States, and therefore boost economic growth. Yet, the overwhelming evidence from the last time shows these promised results didn’t happen.

In a paper published in the Journal of Finance, economists Dhammika Dharmapala, C. Fritz Foley and Kristin J. Forbes found that repatriations didn’t increase investment, employment, or corporate research-and-development spending in the United States. But one thing did increase: pay-outs to shareholders. In fact, the authors found that every $1 brought back to the United States was associated with just about $1 in shareholder payouts despite measures in the bill designed to prevent this from happening. Other research on the repatriation has found similar effects: Shareholders were large beneficiaries, though the size of the benefit was smaller in these other studies.

Details about the current proposal are sparse, so it’s hard to tell if it would avoid the problems inherent in the 2004 law. Yet the latest proposal has some apparent flaws, too. The funding of the Highway Trust Fund via repatriation would constitute an increase in the long-term federal deficit. Under current law, the assumption is that these earnings will eventually get taxed at the current higher rate. But with the holiday some of this revenue would get pulled forward into the present and taxed at a lower rate. That is, the new tax revenues, earmarked for the Highway Trust Fund in the same way that payroll taxes get earmarked for Social Security, would be traded for the lost future tax revenue from taxing those foreign earnings at a higher rate.

Borrowing isn’t necessarily a problem. But, as Chris Sanchirico points out at TaxVox, there are perhaps more efficient and equitable ways to borrow for infrastructure investment. What’s worse, a second repatriation would give firms an incentive to hold out for another round of repatriation down the line. As Sanchirico and Jared Bernstein at the Center for Budget and Policy Priorities point out, why pay the full rate when you know the government will eventually give you a pass?

The Highway Trust Fund is in need of more revenue, to be sure. But finding that revenue by giving a temporary tax cut that was found to be ineffective the first time around doesn’t seem like the right step forward.