Destroying Jobs in Order to Save Them

Obama's corporate tax "reforms" make a bad situation worse.

Veronique de Rugy from the August/September 2009 issue

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.

Comments

MJ|7.14.09 @ 7:24AM|#

Should we be surprised that in formulating corporate tax policy Obama chooses to be a good leftist rather than a good policymaker? Given the left's usual talking points about how corporations are evil, not paying their fair share, and that any tax break for the rich is burden on the poor, any Democrat politician that owuld go against that consensus is his party would have to be particularly brave. Obama has proven by his past record to be a coward on controversial issues. And then there is the distinct possiblity he actually is a true believer in party's destructive economic prejudices and policies.

Taxed Enough Already|7.14.09 @ 7:45AM|#

So 0bama's looking to simplify our taxes by raising them, eh? Well, you know the old joke about that, don't you? The new simplified 1040EZ tax forms will be one page and have just two lines on them:

Line 1: How much did you make this year? _____.__

Line 2: Send it in.

LibertarianBlue|7.14.09 @ 9:57AM|#

MJ

Some of the Blue Dogs are speaking out so Obama is hitting road blocks but they will be only temporary. In addition does anyone actually believe Obama will do anything remotely close to good policy?

|7.14.09 @ 10:02AM|#

Obviously, the only solution to rising unemployment is to tax the organizations that create jobs.

Xeones|7.14.09 @ 10:05AM|#

"No business wants to invest in a place where the government skims 20 percent off the top." --Barack Obama

|7.14.09 @ 10:18AM|#

FYI: quoting the American Enterprise Institute on anything impairs your credibility with me.

Fuck AEI.

|7.14.09 @ 10:21AM|#

Fuck Fred Kagan.

SimsP|7.14.09 @ 12:08PM|#

It's sad when "Corporate Inversion" sounds promising.

|7.14.09 @ 12:21PM|#

There are another onuses associated with taxation of corporations. The owners, i.e., the stockholders, are taxed on the dividends paid from the already taxed profits. If the entity was a sole-proprietorship or partnership rather than a corporation, the owners are taxed only once on the profits - except maybe in New Mexico where any business entity is also taxed on gross receipts independent of any profit. By any decent standard such excessive taxation is simply unjust.

|7.14.09 @ 1:01PM|#

Corporations that don't invert will be ripe for acquisition by international firms who will pick up an immediate, and possibly significant, return based on the difference in tax rates, and thus accelerating the decapitilization of the US economy. Citizens may wish to be patriotic, but shareholders will no longer allow businesses to be and capital will flow quickly to countries that understand that.

Our owners, the Chinese, must be loving this. It's like a cherry on top of cap & trade.

perilisk|7.14.09 @ 1:10PM|#

"By any decent standard such excessive taxation is simply unjust."

Limited liability corporations are given special legal protections that could almost certainly not arise naturally without government intervention (unless a company literally got a limited liability agreement with everyone who could ever potentially sue them). Every limited-liability corporation is implicitly a private-public partnership and as such it's only fair that they are subject to additional taxes and regulation.

LarryA|7.14.09 @ 1:54PM|#

Every limited-liability corporation is implicitly a private-public partnership and as such it's only fair that they are subject to additional taxes and regulation.

Proving that a policy can be "fair" and "stupid" at the same time.

Paul Krugman|7.14.09 @ 3:01PM|#

Nuh uhhh.

|7.14.09 @ 3:09PM|#

I have no idea how that is even supposed to make sense. It's like the new CAFE standards. You claim you want to help save American companies and jobs yet, at the same time, you make it harder for these companies to turn a profit.

I'm beginning it wonder if this jug-head (Obama) is just as brain damaged as the last one (Bush).

|7.14.09 @ 3:23PM|#

To Perilisk: The argument was against excessive, here double taxation on the same income. Many other public-private entities receive limited liability protection under law, e.g., unions, physicians (laws putting caps on tort claims) and politicians (laws exempting them from certain laws they themselves passed) - yet they are not subject to double taxation. So I stand by my statement: "By any decent standard such excessive taxation is simply unjust."

FYI|7.14.09 @ 5:27PM|#

P. Brooks is a known idiot.

Chad|7.14.09 @ 6:15PM|#

Yes, the corporate tax rate should be set to zero.

Yes, capital gains should then be taxed as regular income.

Problem solved.

|7.14.09 @ 9:23PM|#

Despite the fact that we all will be paying higher taxes, every person on American soil will be able to afford housing. Obama announced his new Housing Dictate at a recent town hall in Texas.
See details here:

http://www.velveetaelvis.com/Breaking_News_.html

Right Wing Cynic|7.15.09 @ 9:34AM|#

"I have no idea how that is even supposed to make sense. It's like the new CAFE standards. You claim you want to help save American companies and jobs yet, at the same time, you make it harder for these companies to turn a profit."

Think of the bigger picture. It all makes perfect sense if the goal is to make the federal government (and its cronies in big business and labor) the exclusive agent(s) for allocating income and wealth (which I believe it is). This is simply one in a series of income/wealth transfers to the well connected (think UAW and Goldman Sachs), from the rest of us. Similar transfers to energy companies (the rigged Cap and Trade scam) and drug/insurance companies ("health care reform") are also in the works. When people wake up to how badly they are being screwed here, it is going to be ugly.