We’ve talked a lot the last couple weeks about outsourcing and offshoring, whether driven by a lack of understanding of real-world economics, the value of knowledge, or the risk of long supply chains. But there’s another aspect that does directly affect U.S. competitiveness, and we’ll briefly and gently tip-toe over the political line to bring you the story.
For those who still claim that tax rates don’t matter
to economic decisions or U.S. competitiveness, we present Exhibit A:
the 2004 American Jobs Creation Act. This law gave American companies a one-year window in
2005 to repatriate earnings from foreign subsidiaries to the United
States at a 5.25% tax rate. The IRS examined the results from this tax cutting
experiment and found that the money came back in a flood. More than 800
U.S. corporations repatriated $362 billion from foreign operations. These dollars are now being invested in the U.S., rather than remaining
in Europe or China. This capital infusion may be one reason that U.S.
business investment rose 9.6% in 2005 – the highest rate in more than a
The naysayers were out in force, but once again the facts spoke.
Many Democrats, liberal groups and even some economists in the Bush
Treasury opposed the measure four years ago, predicting it would lose
revenue and merely be a tax holiday for profitable corporations. The
Joint Tax Committee estimators also blundered again by predicting a
mere $2.8 billion in revenue gains in the first year and then big
losses after 2005.
What’s the lesson, again?
As always, they underestimated how tax reductions change behavior. One lesson here is how hypersensitive the trillions of dollars of
annual global capital flows are to tax rates. It also underscores how
damaging the U.S. corporate income tax is to American firms.
That pesky Laffer Curve again. Unfortunately it doesn’t look like the situation will turn around any time soon; in fact it will probably get worse.
Over the past decade the U.S. has gone from a
below-the-average corporate tax nation to the second highest rate in
the industrial world. (See table.) Many countries have slashed their
corporate rates to as low as 10%. The economic impact is even worse
because the U.S. is one of the few countries that taxes foreign
subsidiary income when it is repatriated.
Most countries let their companies pay taxes in the
country where the income is earned, and the few countries that do tax
repatriated income are changing their models.
The sensitivity to tax rates doesn’t just affect corporations; individuals react in a similar fashion. We discussed these flights of knowledge a year ago, and coincidentally an editorial in the same issue of the WSJ also describes the individual scenario.
… celebrity chef Alain Ducasse changed his citizenship this month from high-tax France to no-income-tax Monaco. Plenty of other Frenchmen have moved abroad to escape their country’s confiscatory taxes. Americans should be so lucky: Ours is the only
industrialized country that taxes its citizens even if they live
overseas. That hasn’t been a big problem as long as U.S. tax rates have
been relatively low. But with Barack Obama promising to raise rates to
French-like levels, this taxman-cometh policy could turn Americans into
the world’s foremost fiscal prisoners.
France has recognized the problem and is doing something about it.
President Nicolas Sarkozy has capped the total that
high-earning Frenchmen like Mr. Ducasse can pay in income, social and
wealth taxes at 50% of earnings. Mr. Sarkozy set this "fiscal shield" because he knows
that tax rates affect behavior. When he visited London this year, he
observed that the British capital is now home to so many French bankers
and other professionals seeking tax relief that it’s the
seventh-largest French city. Those expatriates choose not to use their
creativity and investment capital to benefit France and its economy.
Maybe someday we’ll learn. Hopefully before too many companies relocate to Dubai and Bermuda. It’s a global world, remember?