Catalytic Tax Changes

Steve Forbes

Two quick, temporary changes to the tax code would help rouse the economy: Allow companies to repatriate their overseas profits at little or no cost; suspend the tax that companies pay when they repurchase their debt at a lower price than that for which it was issued.

In a rare moment of enlightenment in 2004, Congress permitted companies to bring profits into the U.S. that they had earned and left abroad, paying a tax of only 5.25%. Prior to that one-time tax break, and again now, such repatriated profits were and are taxed at the full U.S. federal rate of 35%, so it's no surprise that companies leave boatloads of money overseas. Results: $312 billion was brought home, which helped improve corporate cash balances and balance sheets and gave Uncle Sam a quick $18 billion in extra revenue.

Today American companies hoard more than $500 billion in foreign-earned profits in overseas bank accounts. Why not put that 5.25% rate into effect again for the next two years? Corporations could bring their cash home to pay down debt, bolster pension plans and even invest in new plant and equipment.

Of course, we should also slash our profits tax, which is the second highest in th developed world. But the Obama Administration is only at the beginning of its economic learning curve - although it might be able to swallow a temporary cut of expatriate profits.

The second measure relates to a positive phenomenon numerous companies employed in the 1970s and 1980s that enabled them to restructure their balance sheets and avoid bankruptcy: They used stock or cash to buy back their debt. Currently American corporate bonds are selling at a steep discount. Why aren't companies taking advantage of these bargain prices and retiring their debt, thus reducing their liabilities? During the stressful 1970s and 1980s Chrysler, Westinghouse, Occidental Petroleum (nyse: 
OXY - news - people) and other reduced debt loads by doing precisely that - exchanging their debts for cash or equity.

Today companies would be punished if they did this. Take Macy's (nyse: 
M - news - people). The company spent some $5.8 billion in cash in 2006-07 to buy back stock instead of buying its discounted debt. Why? Because if it had purchased its bond, say, at 60 cents on the dollar, it would have owed a 35% federal income tax on the saved 40 cents. The reduction in debt - 40 cents on the dollar - would have been treated as taxable income. To avoid such liabilities, Macy's ended up hurting itself badly. Its stock has been hammered to single digits, while the debt still burdens its balance sheet.

As James Barth, Michael Klowden and Glenn Yago of the Milken Institute recently wrote in the Wall Street Journal, "Too many financial institutions and industrial companies are struggling under the wrong capital structure... Tax-code and regulatory changes [made] in the 1980s [now treat] the difference between the original issue price of debt and the lower amount for which it's repurchased as taxable income. The resulting tax liability... blocks necessary restructing... [and] also create a perverse preference for bankruptcy."

What is Congress waiting for?

Steve Forbes is President/CEO of Forbes and Editor-in-Chief of Forbes magazine
Copyright 2009. All Rights Reserved.

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