President Barack Obama is very insistent on the need to “save American jobs.” The spending and the Buy American provisions of his massive stimulus package, approved by Congress in February, were meant to “create or save” millions of U.S. jobs. “Saving jobs” was also the stated goal of his recent pledge to eliminate tax advantages for companies that do business overseas. But instead of saving American jobs, Obama’s new corporate tax is apt to worsen what is already the highest unemployment since 1983 and make America’s companies even less competitive in the global marketplace.
Last spring, partly in response to the anti-bailout tea parties that were sweeping through the country on and around the April 15 tax deadline, the president announced that he plans to simplify the tax code. That sounds like a worthwhile goal, but it turns out that forObama, simplification means taxing previously untaxed income.
For instance, the proposal targets what executives consider to be a lifesaving feature of an otherwise depressing corporate tax code: permission to indefinitely defer paying U.S. taxes on income earned overseas. According to the Obama administration, this practice keeps $700 billion or more of American corporate earnings in overseas accounts, beyond the taxman’s reach.
The president also wants to overhaul what he describes as a “much-abused” set of tax regulations known as the “check-the-box” rules. These regulations give companies some latitude in deciding where their subsidiaries will be taxed and make it easier for multinationals to transfer money between countries. The result, which Obama frowns upon, is that many companies have placed their offshore subsidiaries in low-tax countries.
While he’s at it, the president wants to restrict tax credits that the U.S. grants companies to offset taxes they pay to foreign governments.
Until now, Obama said when unveiling his plan in May, we’ve suffered under “a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.” This notion is wrong in several ways.
It is a mistake to assume that U.S. domestic firms and U.S. multinationals are primary competitors, engaged in a zero-sum struggle. In fact, the true competitors of U.S-based firms with international operations are mainly foreign-based companies. And in that competition, the existing U.S. corporate tax code puts American firms at a clear disadvantage—one for which the alleged tax loopholes were intended to compensate.
The U.S. corporate tax rate is simply too high. When you add state corporate taxes to the 35 percent federal rate, you arrive at a whopping 40 percent average corporate tax burden, the second highest among the 30 countries in the Organization for Economic Cooperation and Development (OECD).
Economists are in broad agreement that cutting the corporate rate is a national priority. In a 2002 study, American Enterprise Institute economists Kevin Hassett and Eric Engen argued that the most efficient corporate tax rate is zero. The mobility of capital income means that even a small amount of tax introduces large distortions into an economy as capital flies away to a lower tax environment. More interesting, if counterintuitive, is the fact that because of capital mobility the people who stand to benefit most from a corporate tax cut are workers. In a 2006 study, the economist William C. Randolph of the Congressional Budget Office concluded that “domestic labor bears slightly more than 70 percent of the burden” imposed by corporate taxes.
Not only is the U.S. rate too high, but the U.S. government also taxes corporations on their worldwide income. That means profits made by an American-owned computer plant are subject to U.S. tax whether the plant is located in Texas or Ireland.
Most other major countries do not tax foreign business income as aggressively. In fact, about half of OECD nations have “territorial” systems that tax firms only on their domestic income.
The combination of high rates and a competitive global marketplace makes the U.S. corporate tax system extremely punishing. Imagine a French firm competing with a U.S. firm for business in Ireland. The Irish government taxes each subsidiary on its Irish income at the (low) national rate of 10 percent. Fair enough. But unlike the French competitor, the U.S. parent company must also register its Irish affiliate’s dividends back home as income, which is then taxed. If the company can meet certain requirements, it can receive a credit for taxes paid to the Irish treasury. But the firm would still have to pay American taxes at the American rate on the Irish income minus the tax credit. The result is double taxation, costly paperwork, and less competitiveness than the French.
These differences have important implications for American companies competing in foreign markets. Because of higher tax costs, U.S.-based firms are losing foreign market share, generating lower returns for American shareholders, and hiring fewer skilled workers back home in the United States. Under these conditions, it’s no surprise that American multinational companies that want to sell their goods abroad try to keep as much cash out of the U.S. as they legally can. It’s a matter of survival.
Other countries understand this. Several nations, most recently including Japan and Britain, are moving to a territorial system, taxing only corporate profits earned within their borders. By contrast, Obama is proposing to move in the opposite direction: He wants to make U.S. companies doing business abroad as miserable as U.S. companies doing business at home.
What will happen if the president succeeds? To stay competitive some American companies will change their structures to become foreignowned firms. This is called corporate inversion: A company switches to the flag of a lower-tax jurisdiction. Such transactions generally have little real effect on U.S. business operations. Firms still pay taxes on all U.S. income, but they no longer pays U.S. tax on foreign income. Companies that can’t afford the costs of inverting probably would have to reduce operations and/or fire workers.
Corporate inversions are just one of many ways in which a U.S. firm can end up being owned by a foreign parent company. A forward-looking American startup may decide to incorporate abroad to enjoy long-term tax savings. That means fewer new jobs in the United States. Foreign acquisitions of U.S. companies have soared from $91 billion in 1997 to $340 billion by 2007.
Is it the president’s goal to destroy jobs? Probably not. So instead of making the corporate tax system worse, why not reform it? Why not avoid old protectionist tricks such as Buy American provisions and instead let U.S. firms compete abroad without the chains of the U.S. tax code?