Understanding Lockout

Abstract

Based on the notion that the size of an initially-smaller but faster-growing investment would eventually reach and exceed the size of an initially-larger but slower-growing investment, the “full-value model” developed in this paper shows that the assumption that repatriation is eventually unavoidable is not necessary for the new view result to hold. This idea establishes the new view optimum as the benchmark retention optimum for defining lockout and narrows down the real income reasons for lockout to only one: an expected reduction in the repatriation tax rate, either statutorily or effectively through tax planning. Modeling lockout then helps to understand real-income lockout and book-income lockout, their determinants, implications and efficiency costs, and demonstrates that real-income and book-income lockouts cannot coherently coexist. Modeling real-income lockout highlights the social harm in repatriation tax holidays and in the uncertainty regarding the future of the current system. Modeling book-income lockout identifies information asymmetry combined with either myopic earnings management concerns or managerial decisions driven by management’s personal interests as the only possible reasons for book-income lockout. The model also identifies, quantifies and highlights the social and private (firm-level) efficiency costs of book-income lockout. The model shows that reporting and earnings management concerns lead U.S. multinationals to capitalize the benefits of deferral into the cost of foreign direct investment. By doing so, U.S. multinationals deviate from the social and private real-income optima and shift economic benefits of deferral to foreign factors against the firms’ real-income interests and contrary to any sound policy rationale. This conclusion emphasizes the social need for eliminating deferral either by repealing the repatriation tax or by taxing currently as earned all foreign earnings of U.S. multinationals.

Keywords: International tax, deferral, lockout, new view, full value model, real income, book income, GAAP, efficiency costs

JEL Classification: H20, H21, H25, K34