Tax reform holds huge promise for small biz app developers

Repatriation drives downstream investments and opportunities for tech firms

For small businesses, access to capital is crucial, and members of ACT | The App Association understand this all too well. Small businesses in the app economy participate in an integrated and collaborative market, in which they rely on the technologies, platforms, and investments of much larger firms to operate. With an estimated $2 trillion held by American companies overseas[1], tax reform can bring huge dividends to small tech companies, in the form of special projects, venture funding, and acquisitions paid for by large companies’ repatriated wealth. In a topic that is often dry, small business app developers see a fountain of opportunities in tax reform.

This is not the economy of yesteryear. In this new ecosystem highly integrated tech platforms blur the delineation of markets and distribution of wealth. The current tax debate is often oversimplified to a contest between “big” versus “small” business, which does not consider the symbiotic relationship between the two in the tech industry. Companies within the app community—a staggering majority of which are small- to medium-sized businesses—rely heavily on platforms created by much larger tech firms to sell their products or services. In turn, these larger companies can provide customers with an enhanced product—one that can make calls, send text messages, and accomplish everything from ordering food to monitoring your heart rate. Repatriation reform that benefits big tech companies can spark significant downstream investments for small app companies because their success is so intimately intertwined.

Although our economy has changed immensely, our tax law remains static, at least statutorily. In fact, Congress has not addressed tax reform in more than thirty years. For instance, in today’s economy, a mother of two living in rural Alaska can “export” and share her educational app with a customer living in Mumbai from the comfort of her own home. We can credit this phenomenon, at least in part, to the international reach of internet service platforms. These platforms allow app companies to access any market with an internet connection or 4G LTE network. Unfortunately, this extraordinary economic growth creates great tax hurdles for U.S. companies doing business abroad.

Frankly, our tax system does not accommodate this ever-flattening world (economically speaking, of course), especially when we consider the impact the U.S. repatriation system, or lack thereof, has on potential downstream investment. Under the current corporate tax regime, U.S. companies pay a much higher total tax than foreign companies when they conduct business in international markets. Not only must an American business pay taxes on their foreign profits at that country’s corporate tax rate, but they must also pay an additional 35 percent in U.S. corporate tax, on the same profits, to repatriate them domestically. This creates a chilling effect on downstream investment because the significantly high combined rate of foreign and U.S. taxes ultimately encourages American companies to keep their foreign earnings overseas rather than investing in the United States. This inevitably starves downstream American companies of access to capital by damming the upstream investment base. In short, what our tax system facilitates is not just a chilling effect, but economic frostbite on domestic investment, hurting all facets of the modern-day economy.

Moreover, the current repatriation tax system significantly impacts venture capital. Without such investments, we would not enjoy the robust number of apps or internet services that currently populate and add utility to our mobile devices. In many cases, larger companies invest in smaller companies to help push their innovative products to market. However, if the tax system incents larger companies to harbor their earnings overseas to avoid paying the onerous taxes to repatriate their profits, it consequently discourages them from engaging in acquisitions of other companies or reinvesting their profits into their platforms or networks. This cache response adversely affects vertically-integrated services, especially the app developers we represent, because they benefit, whether directly or indirectly, from that downstream investment.

Ultimately, American consumers lose in this system. One study reported that repatriation taxes deter investment because companies calculate that they receive more “bang for their buck” by leaving their international earnings dormant in foreign subsidiaries, rather than repatriating them back into the United States[2]. If the American tax system offered more incentive to repatriate, American companies of all sizes could use their international earnings for investment toward American infrastructure, education, and research; all of which drive job creation. More specifically, companies could invest their underutilized funds in smaller domestic companies, providing financial resources to help them grow and hire more employees. Until we have a new repatriation tax program, foreign earned profits will continue to sit or be used outside of the United States.

At the App Association, we support sensible and comprehensive tax reform. We encourage our lawmakers to enact laws and policies that open more opportunity to reinvest back into the United States and into the areas driving growth and job creation in our country. We believe tax reform that improves the repatriation system could begin the process to increase access to capital for small companies and, as an added benefit, create more jobs. It follows that if we want to innovate, we must repatriate!

[1] http://business.gwu.edu/wp-content/uploads/2017/03/Event_Rebecca-Lester-GWU-Cherry-Blossom-Conference-2017.pdf.

[2] http://business.gwu.edu/wp-content/uploads/2017/03/Event_Rebecca-Lester-GWU-Cherry-Blossom-Conference-2017.pdf.

Written by Joel Thayer