Kerry, Exporting Jobs, and Taxes

John Kerry's acceptance speech last night made reference to the US rules for taxing multinationals. I thought that his comment presents a nice opportunity to pull together some of the prior analysis and extend it to outsourcing.

Kerry promised to:

close the tax loopholes that reward companies for shipping jobs overseas. Instead, we will reward companies that create and keep good paying jobs where they belong, in the good old U.S.A. We value an America that exports products, not jobs. And we believe American workers should never have to subsidize the loss of their own job.

His web site says a bit more:

Close Loopholes In International Tax Law That Encourage Outsourcing. Today's tax law provides big breaks for companies that send American jobs overseas. Current “deferral” policies allow American companies to avoid paying American taxes on the income earned by their foreign subsidiaries and encourage them to keep their profits parked overseas, not reinvested in America. As president, John Kerry will end deferral that encourages outsourcing and will shut down other loopholes to make the tax code work for the American worker, not provide tax breaks for companies that ship jobs overseas.

Kerry is troubled by the ability of US corporations to defer a full US tax indefinitely by using foreign subsidiaries to do business in low-tax jurisdictions. Accordingly, he would look through these corporations and impose a current US tax as the subsidiaries earn money (reduced, of course, by a credit for any foreign taxes on those earnings). This is consistent with current financial accounting rules, as earnings of foreign subsidiaries are included immediately in the parent's (consolidated) financial statements. (Although, as noted in a prior post, the US taxes on those earnings are not booked until the earnings are paid to the US parent as dividends.)

There is an important point in the Kerry website note: The US respecting foreign subsidiaries rewards outsourcing. By “outsourcing,” I mean a US business having an independent foreign business provide goods or services for the US business that, historically, the US business provided for itself. To the extent that (i) the independent foreign business is in a low-tax country and, this may be unlikely, (ii) those low taxes are reflected in lower prices from the foreign business, little can be done to reduce the US tax incentive to export. But, under current law, outsourcing makes it easier to move the extra profit in a multinational — which, in this context, most would view as profit attributable to non-asset intangible value, like know-how and non-patented technology — outside the reach of an immediate, full US tax. Kerry's proposal to look through foreign subsidiaries would get at this incentive to outsource.

It is important to note that full look-through does not eliminate all incentives to move offshore. Most obviously, there still are problems from the averaging of foreign tax rates for purposes of the limit on the foreign tax credit. (This was discussed in an earlier post.) For example, a US business with operations primarily in high-tax countries still will be able to avoid all tax on some item of US income by moving the US income to a law-tax jurisdiction. Similarly, a US business with operations primarily in low-tax jurisdictions can move US income to a high-tax jurisdiction at no extra tax cost. These problems will be worse once the ETI bills become law, as they cut back on the 1986 restrictions on averaging.

This entry was posted in Law: Tax. Bookmark the permalink.

10 Responses to Kerry, Exporting Jobs, and Taxes

  1. pgl says:

    Excellent analysis (as usual)! This kind of income shifting still strikes me as inconsistent with the arm’s length standard but as my post Thurs. at Angrybear, the IRS is still doing a poor job of policing this.

  2. Tom says:

    I will (begrudgingly perhaps) concede that the deferral of U.S. income tax by the reinvestment of the foreign source earnings outside the foreign country where earned makes little economic sense. It seems to represent a subsidy for U.S. businesses to invest outside the United States. However, to the extent that the foreign source earnings are neither repatriated to the U.S. nor reinvested in a foreign country other than the country where earned, immediate U.S. income taxation of those earnings places U.S. businesses at a competitive disadvantage. A foreign competitor can obtain a real competitive advantage if its home country does not currently tax foreign source earnings. Thus, this tax “solution” to loss of jobs from outsourcing may not necessarily create (or prevent the loss of) more U.S. jobs, but may perversely encourage more net imports as U.S. businesses become less competitive. I still maintain that you are looking at less than the whole picture, George. But I am sure you will explain to me why I am wrong. Won’t you?

  3. GeorgeMundstock says:

    There is no necessary competitive disadvantage in taxing the US company at the US rate (after allowing crdit for any foreign income taxes). Assume that an income tax is borne by capital, and not reflected in prices for goods and services, which is a common assumption. Then, taxing a US company at a lower rate offshore than in the US just gives a windfall to the owners of the US company for leaving the US. That their competitors might pay less taxes is irrelevant — because of the assumption that income taxes do not affect prices. Conversely, if you view the income tax as a sales tax (as some US states do, in effect, by allocating income based solely on a sales factor), then the US should only tax US sales income. But, there is little evidence — even in small, open economies — that income taxes are sales taxes.

  4. Tom says:

    Let’s assume you are correct in asserting that the investor absorbs the income tax cost by realizing a lesser after-tax return on the investment, and that a higher income tax on U.S. capital investments made outside the U.S. will inevitably reduce the return on such investment. As a result, U.S. investment in low tax foreign countries will be less profitable than non-U.S. investment in low tax foreign countries when the non-U.S. investor’s home country does not currently tax the income from the low tax country. Now the idea that a more profitable business does not have a competitive advantage because the higher profitability is attributable to a tax advantage (as opposed to, say, a cheaper labor advantage) is, to be blunt, nonsense. A bottom-line advantage is a bottom-line advantage. Say it ain’t so, George, but also tell me why!

  5. GeorgeMundstock says:

    T-Dog, You look at it backwards from the way economists do.. (Assuming that an income tax is not effectively a user fee, in which case, it should be a deduction.) Look at it from the point of view of the relevant economic actor, the corporate manager making the investment decision: The foreign investor faces its tax rate. The US investor looks at its tax rate. If the US investor gets a lower rate in one country than another, it moves to the low-tax country. This is a windfall, not a level playing field.

    Under tradtional economic theory, which I am not sure is right here, an income tax is different from other offshore costs, because the income tax goes down as the price goes down. As long as the US person covers its non-income tax costs, it will make an after-tax profit. Thus, says traditional theory, income taxes should not impact pricing (ignoring the effect of an income tax on saving and, thus, on the cost of capital). Me, once one takes capital mobility into account, I’m not so sure. Hence, I am, not sure Kerry is right, per se. But, as suggested by my Sue hypo, I do want the US to tax the return on the intangible capital of US persons developed in the US. Kerry’s proposal will get that.

  6. Tom says:

    Willllburrrr, I think you should talk down to me since I seem to be lost in your terminology. The way I see it, a U.S. manufacturer will normally move all or a part of its manufacturing facility outside the U.S. to cut costs, such as labor or materials. If the U.S. manufacturer’s foreign competitors also relocate to the same low tax country to produce the same product, those competitors will have a competitive advantage should the U.S. currently impose a higher U.S. income tax on the foreign source manufacturing income than the effective rate imposed on the foreign competitors by their home countries’ tax system. As you know, there is no tax deferral merely because the U.S. manufacturer chooses to incorporate in a low tax country; the production must actually occur in the low tax country to be deferred from the higher U.S. tax rate. Unless the U.S. manufacturer can defer the income attributable to the manufacturing function that actually takes place in the low tax country, the U.S. manufacturer will have difficulty competing with the foreign manufacturer for sales of the same product since each dollar of sales will produce on average a lower rate of return on the U.S. manufacturer’s investment than on its competitor’s investment. The U.S. should encourage the U.S. manufacturers to remain as competitive as possible, not penalize them by effectively imposing a higher tax rate on their foreign source manufacturing income than the rate paid by foreign competitors. I still maintain that the playing field is not “level” for U.S. investors when the foreign income taxation on similarly situated manufacturing is taxed differently due to differences in the home country’s tax rates. What am I missing????

  7. Quentin Smith says:

    These tax breaks have resulted in US corporate penetration of foreign markets. Do you want to cripple continued penetration as the global economy continues to evolve and mature?

  8. GeorgeMundstock says:

    There is no economic evidence that the current breaks for moving jobs offshore increased the welfare of the people of the US. In fact, there is no evidence that the incentives improved competitiveness. Rather, they probably were just windfalls for US-based multinationals.

  9. GuardianAngel says:

    ummmm… so US multi-nationals just stuff matresses full of money and sit on them ???

    i thought they employed people and produced more product with the money they make .. silly me …

  10. Rick says:

    The assumption that corporations pay income taxes is open for discussion in my judgement. Income taxes are a cost of business – why the use of the phrase “net profit” which is measured in after tax dollars otherwise. The rationale behind the forign originated income deferment is to make US Companies (Multi- Nationals) competitive with foreign companies. I dispute the concept that Income Taxes have a zero effect on prices. Taxes are passed through to the “consumers” in the form of higher prices than other wise. If these “tax costs of doing business” are not uniform among all competitors, the group having the tax advantage will have the competitive advantage.
    If we unilaterally change the system, our corporations will be at a competitive disadvantage. The prime “Jobs” issue is the high productivity/ efficiency growth we have “enjoyed”. The statistic that jumps out is that for each point in real productivity gained 1.2MM jobs are lost if there is not volume / market growth. We have had average gains in excess of 4%. We need incentives for job training and R&D to retrain US displaced workers and research credits to promote other market technologies such as alternative energy generation. I do admit that the Kerry arguement is an effective populist claim.
    I was very surprised that Clinton proposed and supported passage of NAFTA in 1997. It has similar “job effects” by making it easier to move heavy manufacturing jobs (read Union jobs).

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Notify me of followup comments via e-mail. You can also subscribe without commenting.