Wednesday, 1 October 2014

The Growth of Offshore Corporate Cash Pools



The European commission is attempting to claim back tax on billions of profits made by Apple through its Irish operations.  This story is interesting in itself in illustrating the issue of tax base erosion and profit shifting in an increasingly globalised world.  However, it also has macroeconomic implications that go beyond the effect on government tax revenues.

Apple is just one of many US parented[1] multinational corporations that have organised their affairs so as to be able to pay a very low effective rate of tax on profits earned outside of the US.  In many cases this has been accompanied by a shift of profits out of the US, either as a result of relocating productive activity or, more controversially, by things like the choice of location of intellectual property rights.

The profits from these operations, which have been substantial, must then be retained offshore to avoid a significant US tax charge which would arise on repatriation.  This has led to the accumulation of large pools of liquid assets held by corporate entities outside of the US, generally denominated in or hedged into dollars.  Apple's last 10-K showed $147bn of cash and available-for-sale securities, much of which is likely to be in non-US entities.

Looking at sectoral flows and balances, one notable feature of recent times has been the reversal of the standard model in which households save and firms borrow.  The recent trend has been for falling household surpluses whilst non-financial corporates have become net savers.  Globalisation and the incentive that creates to accumulate offshore cash piles has been part of the reason for this.

If these funds were to be repatriated they would appear as current account income for the US.  Instead, by accumulating dollar assets, they help fund the deficit.  So the process by which US production and profit has been moved offshore, contributing to the size of the deficit, has at the same time contributed to funding it.

This rise of large corporate cash pools has had further implications.  With the substantial amounts involved, these investors are increasingly looking to diversify their credit risk.  Placing all the money on deposit, even spread around between different banks, would result in some massive exposures.  So investors like this are hungry for deposit substitutes, particularly those that are collateralised.  Securitisation allows the financial sector to create the assets suitable for use as collateral, so this demand for secured on-demand claims helped feed the growth of shadow banking[2].

Understanding the way that multinational corporates have structured themselves helps shed some light on certain international and intersectoral flows, some of which have had important macroeconomic consequences.  The international tax system has been a key element in shaping these structures.



[EDIT - As Ramanan has pointed out to me, undistributed earnings of all foreign associated enterprises are treated as distributed and re-invested.  Retention, rather than distribution, therefore has no impact on the current account, but rather results in two offsetting movements in the financial account.  Movement of productive activity would therefore affect the balance of trade, but not necessarily the current account.]



[1] This applies to other jurisdictions as well, but it is most notable in the case of the US.
[2] See Pozsar, Z. (2011) Institutional Cash Pools and the Triffin Dilemma of the U.S. Banking System for more on this.

4 comments:

  1. Nick,

    Why would repatriation of profits accumulated by corporations affect the current account of balance of payments now?

    It shouldn't affect it. Instead it will affect the financial account.

    Reinvested earnings of direct investment abroad affects the current account balance at the time, so for US corporations they would have affected it in all quarters and years over many many years now.

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    1. Hi Ramanan,

      Yes - I think you're right. I had assumed this applied only to unincorporated entreprises, like branches, but having checked, I think I was wrong on that.

      I'll make an amendment - thanks for pointing this out.

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    2. Hi Nick.

      "If these funds were to be repatriated they would appear as current account income for the US. Instead, by accumulating dollar assets, they help fund the deficit. So the process by which US production and profit has been moved offshore, contributing to the size of the deficit, has at the same time contributed to funding it".

      If i understand correctly, with the amendment you made, the funds for the deficit must come from other sources (speaking in terms of sectorial flow and balances). Is that correct?

      Iñigo

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    3. Yes. It's not necessarily possible to say which bit funds what, but if we assume that the reinvestment of foreign earnings is funded by the accumulation of dollar liquid assets, then something else must be funding the (current account) deficit.

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