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From Bad to Worse – Making America Even MORE Uncompetitive

Trying to impose an ideology onto reality never ends well....

One of the great mysteries of contemporary society is how so many people have been able to sail into middle-age (or even senior-status) without ever having had any contact or interaction with, well, basically realities of how the world works. Abstract dorm-room-bull-session debates among sophomore undergraduates are bad enough – but one would think that time and exposure to reality would impose a solid degree of sanity and pragmatism, along with an orientation to results.

But apparently it’s possible to avoid nearly all contact with reality for decades. And it also seems that one of those folks has managed to get himself elected President.

And now he’s launching a mindless jihad designed to make the American corporate tax system – a system that is already badly uncompetitive in the world – even more uncompetitive.

Since I have direct exposure to global business and the international marketplace, this is a topic that I’ve been banging on about for a rather long time – as have a number of others.

The short take is that while policy-makers (sic?) in Washington have been ignoring things going on in the wider world and letting the tax system stand pat, other jurisdictions have been moving aggressively to lower their tax burdens and make their jurisdictions more competitive and more business friendly.

The most obvious (and clarion-like) example is the U.S. federal corporate income tax rate – which has been sitting at 35% for seemingly forever, and which is becoming comparatively uncompetitive just through the actions of others. (For example, the Irish corporate tax rate is 12.5%, while the Estonian corporate tax rate is…. 0%.) The situation with personal income taxes isn’t as clear-cut (all systems are complex), but many other jurisdictions have made a great effort to both flatten and lower rates – something which has been one of the most popular “enablers” of strong economic growth over the past two decades.

But there’s a more dreadful problem that is both unique to the U.S. and which gets little attention.

The U.S. system is unique (in a horrible way) in the world for imposing double-taxation on both corporate profits and personal incomes – when those funds are earned in other jurisdictions and are taxed there.

Let’s let a rather good article in today’s Wall Street Journal provide us with a clear example:

The current tax-deferral system is a clumsy attempt to deal with the fact that most other countries don’t tax their companies’ overseas profits. A German firm doing business in Ireland, say, pays no German income tax on its Irish profits, but it does pay Ireland’s corporate income tax at its 12.5% rate. The U.S. company competing with that German business in Ireland, by contrast, pays Ireland the same 12.5% on its profits — and it then pays Uncle Sam up to 35%, minus a credit for what it paid the Irish. And because almost everyone else’s corporate tax rates are lower than America’s (see nearby table), U.S. companies end up paying higher taxes than their international competitors.

(N.b. – Follow the link to see the table.)

There are three “take-aways” from that discussion:

1) The corporate tax rate in Ireland is much lower than the corporate tax rate in the U.S., making Ireland a much more congenial place in which to do business;

2) Unlike virtually every other jurisdiction in the world, the U.S. imposes U.S. corporate income tax on top of the jurisdiction-of-business corporate tax – in other words, this is a special penalty/tithing just for being a U.S. corporation;

3) Things are a bit muddled in the last part of that WSJ paragraph, so let’s walk through the details via that example. You’re a U.S. corporation doing business in Ireland; you pay a 12.5% tax on your corporate profits earned in Ireland. If you try to bring those profits back home (for things like new plant investments and other fluff of that sort), you get hit with the U.S. corporate profit tax of 35% on top of what you’ve already paid in Ireland; you are then allowed a tax credit to give you back the same amount that you just paid in Ireland. Since that leveling of the credit applies to all other jurisdictions as per their own corporate tax rates, the net result is to basically attempt to impose a blanket 35% overall corporate profits tax rate on all U.S. corporations. Now, let’s leave aside for the moment the complication that this is done not as a rate-computation-adjustment before you pay Washington – but as an ex post facto credit given back to you…. something that is just sitting there waiting for some demagogue to scream about “big tax credits handed out to big corporations, etc., etc.” And leave aside the bigger tax hit you’re taking here relative to your hypothetical German competitor – since that speaks for itself. Because of the way the tax credit system works at trying to impose a blanket 35% rate, the effective transjurisdictional penalty is larger for business done in lower-tax jurisdictions. E.g., after paying your 12.5% Irish corporate taxes, your payment in U.S. corporate taxes amounts to a 22.5% tithing; however, after “paying” your 0% Estonian corporate tax, your effective U.S. tithing is 35%.

Now that’s admittedly a slightly over-simplified description at the level of fine detail – since corporate taxation is very complex, and large companies in particular have strong incentive to have large staffs of excellent accountants to sort everything out and do their job of getting the firm to the minimum possible overall tax rate; in fact, “overall corporate income tax rate” is a followed metric in the analysis of corporate finance. (There’s even one purported “major turnaround” of a large, “name” company over the past 10 or 15 years that, as far as I can tell, amounted mostly to the hiring of a better set of accountants – who were able to find (legal) ways to lower the firm’s overall corporate income tax rate and thus greatly improve the bottom line.) But the basic notions of jurisdictional uncompetitiveness – and the reasons why – are pretty clear.

But to continue the narrative, this is obviously a very heavy competitive burden to impose on U.S. companies when they operate outside the country. To try to mitigate this burden,

Congress long ago created the corporate tax deferral to compensate for this competitive disadvantage. Under deferral, a company doesn’t have to pay the U.S. corporate rate until it repatriates its earnings. It can retain them overseas or reinvest them abroad with no penalty. But if it brings them home or pays them as dividends, the tax bill comes due.

That’s a sensible attempt to try to do something to ameliorate the obvious effects of a uniquely silly system. It would be better if Washington would upgrade our system to match international norms (!?!?) and just drop the silly double-taxation system. But lacking the sense to do that, at least there was enough sense to try to allow in some measure of sanity.

However….

The German company faces no such quandary. It pays the Irish tax, and it’s free to invest that money in Ireland or Germany or anywhere else. This territorial tax system, embraced by most of the world, eliminates the perverse incentive to hold money abroad that America’s deferral system creates.

In other words, the system is less punative – but it only works if the firm keeps those profits outside the country to keep them out of the grasping, greedy hands of Washington. So naturally, those funds will be invested outside the country – creating new facilities and new jobs outside the country.

At this point, does anyone wonder why “outsourcing” has become so popular? The only wonder is why there isn’t even more of it. The system we have now is grossly uncompetitive, and the only way to remain even modestly competitive in the international marketplace is by pushing more and more operational activities outside the country. (And, in my non-humble opinion, if the White House and Congressional Democrats want to make “outsourcing” an issue, my reaction is “Bring – It – On.” They’ve built a system that makes this a sensible business decision – to the point of being necessary for survival. If they want to ask why, we should be happy to tell them why.)

The solution to this problem is screamingly obvious – eliminate the foolish double-taxation situation, and lower the corporate tax rate to one that is competitive with the rest of the world. This would allow business decisions to be made much, much more strongly on the basis of business needs and opportunities rather than on attempting to cope with an onerous and uncompetitive tax regime.

But reality certainly isn’t in the loop with this crew of non-reality players….

…. but then their real goal isn’t tax reform or U.S. competitiveness. It’s a revenue grab, one made easier by the fact that overseas tax “avoidance” is easily demagogued.

Translation from the White House: “The system is bad, so let’s make it worse! Reality doesn’t matter a bit; all that matters is our abstract notions of ‘fair.’” (And Candidate Obama did say that he wanted to raise the capital gains tax rate, even if that produced less revenue, because that was “fair.”)

And to circle back to “outsourcing,”

To that political end, Mr. Obama conflates tax deferral with the offshoring of jobs — hence the sly reference to Bangalore, India.

What Mr. Obama (and like-minded functionaries) fail to grasp is that the difference between the system we have now and the new one they want to put in place isn’t a choice between jobs in Bangalore and jobs in, say, Peoria. It’s the choice between jobs in Bangalore and not being in business at all.

If you get to that point, there’s only one other option – and that’s where things could get really frightening….

As someone else has noticed,

Consider how double taxation would affect incentives facing U.S.-based multinationals that make more money abroad than they do in the U.S: General Motors, for example. Why would GM endure double taxation on its profitable overseas operations for the sake of its unprofitable U.S. operation? If Obama had his way with double taxation, we might wake up suddenly to find that GM had become a Swiss-based corporation that walked away from its U.S. operation, leaving it in the hands of the UAW and the U.S. Treasury (or maybe the post office). There could be many defections from the Fortune 500 list.

….

People and capital go where they’re welcome, and when they no longer feel welcome, they move on.

That last is indeed the case – and you really have to wonder how disconnected from reality Mr. Obama et al. must be to be so oblivious to the obvious conclusion that they’re playing with fire on this. If you’re GM…. or much more importantly, if you’re Microsoft, or Cisco, or a hugely-profitable U.S. company, why not just re-incorporate and re-HQ in Dublin or Tallinn?

That would of course have political difficulties due just to size and “visibility.” But the real growth engine of the U.S. economy has always been what’s been going on at the smaller, starter end of the scale:

Fewer companies will keep their headquarters in the U.S., especially small or mid-sized firms that can slip away without becoming a political target.

That’s my own wheelhouse, and that’s the really ugly reality.

Most of the discussions of this sort of thing tend to float on clouds of disembodied statistics – of capital flows, of negative GDP impacts, etc. But those discussions rarely – if ever – consider the human impact and the chaos this will bring to the lives of productive people.

I’m one of them.

I’m not an academic or a think-tanker or a politician – no great offense intended :) but many people can comment on how awful these things will be in their effects, shake their heads sadly, and go home for the evening – knowing (probably without even giving it thought) that there will be little direct impact in their own lives.

Not me. It’s frightening for some of us to ponder that we may end up – in the next two or three years – facing a wretched choice between ceasing to do the innovating and creating that we do (and become “community organizers” I guess), and relocating (business, life, family…. everything) to another jurisdiction…. one that will reward rather than punish innovation and development.

If you’re not starting to wonder why your own government is seemingly gearing up to drive you out of the country…. consider yourself lucky (for now). For some of us, while it’s probably unlikely that it would ever come to that, just the notion that it could become feasible and sensible is very, very unsettling….

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