2010 September 27 Monday
Obama Corporate Tax Proposal And Redomestication

Barack Obama, in his infinite wisdom, wants to increase US taxes on the foreign earnings of US corporations. Obama's theory appears to be two-fold:

  • Discourage US corps from investing abroad so that (in theory) US corps will invest more in America. Really, I am not making this up.
  • Get more tax revenue to fund his ambitions for a bigger welfare state to help his most cherished factions among the downtrodden.

Well, you might be thinking that corporations from other countries (e.g. Japan, Germany. China, Britain, India, etc) will displace US corps from foreign markets if US corps face higher costs abroad. Sure nuff. Leaders of Japanese, German, and Chinese corps will cackle with glee as corporations from those countries win those other markets and leave US corps to amortize their R&D over a smaller number of US customers.

You might also be thinking those foreign corps will then displace the US corps from US markets using their scale from foreign operations. Hey, that's how the mercantilists in Japan and, coming soon, China do it with considerable success. But Obama, in spite of thinking he's way more worldly and international than you and me, doesn't seem to have a clear understanding of the whole "US corps no longer dominate most markets" idea. He seems to think he's ruling a country that is back in the 1950s with unchallenged supremacy. Or maybe he's not thinking much at all. Time to go golfing might be the main thrust.

Even without Obama's proposal US corps already have much higher tax rates than corps in any other major country.

The real problem is a U.S. corporate tax rate that over the last 15 years has become a huge competitive disadvantage. The only major country with a higher statutory rate is Japan, and even its politicians are debating a reduction. A May 2010 study by University of Calgary economists Duanjie Chen and Jack Mintz for the Cato Institute using World Bank data finds that the effective combined U.S. federal and state tax rate on new capital investment, taking into account all credits and deductions, is 35%. The OECD average is 19.5% and the world average is 18%.

If you have a choice in where to put your world headquarters why make it in America? Seriously. I can think of lots of reasons to put it elsewhere. This is especially true for any business that has more markets outside the US and inside (i.e. most corps). It is still possible to tap into US worker skills even if a corporation is headquartered abroad. One can use a small number of key US workers or US consultants or US service companies that provide specialized services. Cheap telecommunications, computer networks, and air flights allow much more distribution of work across different sites in different countries.

If forced repatriation of foreign earnings becomes mandatory due to Obama's ambitions then US corps will become more likely to be bought by foreign rivals and more likely to move their headquarters abroad. BTW, the latter move is called "redomestication".

Mr. Obama believes that by increasing the U.S. tax on overseas profits, some companies may be less likely to invest abroad in the first place. In some cases that will be true. But the more frequent result will be that U.S. companies lose business to foreign rivals, U.S. firms are bought by tax-advantaged foreign companies, and some U.S. multinational firms move their headquarters overseas. They can move to Ireland (where the corporate tax rate is 12.5%) or Germany or Taiwan, or dozens of countries with less hostile tax climates.

Think about it. Obama's trying to change the US tax code in a way that will drive US corps to redomesticate. As a corp headquartered in Britain, Ireland, or Switzerland or assorted other suitable countries they'll have no obligation to take profits earned in Brazil, Germany, China, Dubai or India and bring them into the US to be taxed. Only their (smaller) US operations will be taxed the US corporate tax rate.

I first got interested in the redomestication phenomenon a couple of years when one of the stocks in my portfolio went thru a transaction that seemed like a sale where I sold one stock and bought another one of equal value with almost the same name without actually putting in an order. I was trying to figure out what happened and whether I faced a tax liability. Turns out this company I owned stock in had shifted its headquarters to another country and its main corporation became a non-US business. Given that it did most of its business in other countries this move made sense.

I found a web page with the Q&A session of the senior management of this corp where analysts asked questions about its quarterly earnings report right after the redomestication went thru. The CFO said the redomestication went well and would result in a substantial reduction in their total tax bill (about 5% more of their profit would be retained rather than paid in taxes). The amount of money paid to Uncle Sam would go down by much more than the amount paid to another country would go up. That's the real world we live in. The whole top layer managers of US corps move to Britain, Switzerland, or other countries in order to cut taxes and boost earnings.

The US needs to compete. Automatic US business dominance of many lines of business, technologies, and markets is a thing of the past. That means the US government has less leeway to make dumb tax policy decisions. The US government can still make dumb decisions. But the cost in lost market share and living standards in the long run outweigh any benefits the politicians think they gain from their decisions. We need to cut out a lot of dumbness in US government policies. We can't afford as much stupidity as we could afford in the past.

Share |      By Randall Parker at 2010 September 27 07:25 PM  Economics Trade


Comments
Mike M said at September 27, 2010 9:58 PM:

Randall, your assumption is that Obama's chief goal is to improve our economy whereas I believe his primary agenda is to redistribute wealth and equalize outcomes (at least among the non-ruling class). I believe that my assumption makes more sense, in terms of Obama's policies and proposals, than yours.

kurt9 said at September 28, 2010 9:19 AM:

Relax, Randall.

This anti-outsourcing bill failed a Senate test vote.

http://www.marketwatch.com/story/anti-outsourcing-bill-fails-senate-test-vote-2010-09-28-121130?tool=1&dist=bigcharts

AMac said at September 28, 2010 3:05 PM:

Randall, your analysis looks to me to be fundamentally correct.

US corporations pay US corporate tax on their US earnings, and on foreign earnings brought to the US ("repatriated"). For the latter, there is an allowance for foreign taxes paid.

Already, there is a fair amount of maneuvering to gain the best position for taxation. This economic activity is of course fundamentally non-productive.

A pro-citizen corporate tax policy would discourage net offshoring of valuable US jobs (requiring a meaningful definition of "valuable"). It would also discourage non-productive activity, and take into account the increasingly competitive world. Hard to imagine that happening with today's Congress and Executive.


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