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?
Good letter to the editor in the WSJ yesterday on that same article, by the CEO of Loews. He pointed out some other anti-competitive and anti-investment impacts of our tax policy:
“Unbeknownst to many, GAAP allow corporations to avoid the accrual of taxes on foreign earning if the can attest that they will not bring those earnings back to the U.S.”
“Another part of the same GAAP rule states that if a company does bring back foreign earnings in violation of its attestation, then forever going forward the company will ahve to accrue U.S. taxes on their foreign earnings.”
“The accounting penalty for repatriating even a penny of foreign profits is so great that those foreign funds will not come back to the U.S. unless the rate is reduced in a manner similar to 2005. In the meantime the current law is having a perverse effect on our economy. It is forcing the reinvestment of the earnings of U.S. corporations offshore rather than here where it will create wealth and jobs.”
How ludicrous is that???
John Hunter says
The bigger problem is failure to link taxes to services. The companies “leaving” actually don’t leave. They just say they leave and continue to expect to gain all the benefits of the USA without paying for it. If they actually chose to leave then lets look at the reasons. So far though they don’t – they setup complete front companies and attempt to avoid paying what they owe.
These companies are just playing games, trying to get away with financial maneuvering to avoid paying what they owe. How crazy is it that these same people playing these games pay huge amounts to our politicians and those politicians take the money. Patriotism? Lets not confuse someone waving a flag with someone that lives to the ideals the country stands for. And pretending your are not American to try to avoid paying taxes is the opposite of patriotic.
On the individual front there are interesting things ahead. I think the idea of nation states is going to be challenged by a highly mobile workforce. And if you don’t care about the USA, or France or Singapore and have valuable skills I can imagine several countries are going to fight to gain their own brain drain advantage the USA has gained for many years. It will be interesting to see how that plays out. And very challenging for countries, I imagine. My cynical guess is most western countries will find ways to provide those high wealth individuals very favorable terms. So if one wants lower taxes for the wealthy my guess is they will be very pleased 20 years from now.
Dan McD says
John’s last paragraph is very prescient. Once organizations begin to recognize the value of knowledge workers instead of the cost of assembly hands those knowledge workers will become a commodity just like steel.
So take that with John’s other point on patriotism. Are companies expected to be patriotic like individuals? I don’t know. If they aren’t, then at what point do the workers begin to become “patriotic” to the company instead of their country?
Another point: there are already several companies so global that they have HQ’s in multiple countries, so they truly have no home country. What are they? What then differentiates a truly global organization from a physical nation? Then which is more agile, more flexible, and therefore more poised to succeed over the long haul?
Perhaps we have some serious blinders on thinking about the future of China and India. Perhaps we should be thinking of Tata and GE and Google.