Offshoring... blame the tax code?

[Dave Farber <dave () farber net>]

Delivered-To: dfarber+ () ux13 sp cs cmu edu
Date: Fri, 12 Mar 2004 20:32:05 -0600
From: "Kevin G. Barkes" <kgb () kgb com>
Subject: Offshoring... blame the tax code?
To: "Farber, Dave" <dave () farber net>
Hi Dave,

This was in yesterday's Wall Street Journal, and offers a
point of view I haven't seen anywhere else.

U.S. Tax Code Provisions
Encourage Offshore Jobs

As if U.S. workers didn't have enough going against them.
Turns out there really are provisions in the tax code that
seem to encourage sending jobs offshore.

I have to admit not believing the claim when I first heard
Democratic presidential candidate John Kerry shout about it.
So I thought either Mr. Kerry has trumped this thing up --
in which case there's a good story -- or there's one very
wacky part to the tax code -- in which case, there's a
better story.

Turns out Mr. Kerry is right. Even more compellingly, a
couple of conservative economists I called agree with him.
"The U.S. tax code definitely provides a strong incentive
for sending jobs overseas," says Kevin Hassett, an economist
at the conservative American Enterprise Institute.

Don't go looking in the tax code for a chapter titled "Tax
Break for Hiring Foreign Workers." It doesn't exist. The way
it works is more complicated. One of the most important is
through the ability to defer and often never pay taxes on
foreign-earned profits. The result: foreign profits of U.S.
companies end up taxed at a lower rate than their U.S.
income, creating an incentive to invest overseas in
factories. The jobs are where the factories are.

"How can this be?" you ask, when you know that the policy of
the U.S. government is to tax American corporations on their
world-wide income.

Now we get to the fun part.

The tax code is written in a way that allows companies not
to pay the full 35% U.S. corporate tax rate on foreign
income when that money remains invested overseas.

Backing up a step, here's how it works before the loophole:
A company earns $100 million abroad in Lowtaxistan where the
corporate tax rate is 20%. The foreign subsidiary pays that
money to the U.S. parent. The parent then pays $35 million
to the U.S. government and takes a credit for the 20% (or
$20 million) payment to the Lowtaxistan government. So the
net to the U.S. Internal Revenue Service is $15 million.

But here's how it works with the loophole: The U.S.
subsidiary simply keeps the money offshore and certifies to
its accountants that the money is invested overseas. It
never remits the money to the parent and so never pays the
$15 million extra to Uncle Sam.

Do the math yourself. Which is better?

a) A factory in Lowell, Mass., that will generate $100
million in pre-tax profit that nets $65 million, or

b) A factory in Lowtaxistan that will generate $100
million in pretax profit that nets $80 million.

All things being equal, most people would pick "b." (And
they aren't equal because Lowtaxistan has 750 gazillion
people who will work for two gonzolees a day -- and the
gonzolee is fixed to the U.S. dollar at a rate of 8.65.)

These are called "unrepatriated earnings" and they are
increasingly commonplace. Just go into Free Edgar
(www.freeedgar.com4) or some other SEC search engine (I like
10K Wizard5) and plug in the term "unremitted earnings" or
"undistributed earnings" and search 10-K forms to see how
many annual statements come up.

What you'll find is something like this from Pfizer.

"As of December 31, 2003, we have not made a U.S. tax
provision on approximately $38 billion of unremitted
earnings of our international subsidiaries. These earnings
are expected, for the most part, to be reinvested overseas.
It is not practical to compute the estimated deferred tax
liability on these earnings."

Pfizer says it added 15,000 U.S. workers through its recent
purchase of Pharmacia. Still, only 37% of its work force is
in the U.S.

Note that the $38 billion total of unremitted earnings is
cumulative over the years. In 2002, Pfizer had $29 billion,
so the increase was $9 billion in the past year, helping the
company substantially shave its tax bill.

"Outrageous," you say. "Another example of the
corporate-kowtowing Bush administration helping its
boardroom buddies."

WHEN U.S. JOBS GO ABROAD

Good sound bite, as we say in TV-land. But it's just not
true, because the Bush administration didn't put this on the
books.

"Then it must have been those care-to-the-wind free-trading
Clintonites!" I hear you cry.

Nope.

And don't waste your breath with Bush I, or Reagan. As far
as I can tell, what is called "active foreign income" has
never been taxed at the U.S. rate since the enactment of the
corporate tax in the early 1900s.

And yet, who back then could have imagined that outsourcing,
or sending jobs overseas, would be a major problem? More
importantly, perhaps not even a decade ago, no one could
have imagined the places where American companies could now
invest or the ways in which technology makes it so easy to
set up and operate foreign facilities.

What we know is that the amount of unrepatriated foreign
earnings is growing substantially. The non-partisan
Congressional Research Service in a report last year said it
had increased to $639 billion in 2002 from $403 billion in
1999.

(I probably should mention that my full-time employer,
General Electric, is among the leaders with $21 billion of
unrepatriated earnings. That helped the company achieve an
overall corporate tax rate of 21.7%.)

Companies say this money is growing because they are pushing
into foreign markets and locating their facilities near
their new markets. They add that the system helps keep them
competitive with foreign rivals, who often enjoy lower tax
rates. An IBM spokesman told me that "Our decisions on the
location of research centers are based on access to locally
based talent, far more than local labor or tax rates."

Some companies say this helps create jobs in the U.S. with
the export of high-value U.S. goods and services to the
foreign subsidiaries.

Still, writes the Congressional Research Service, the
ability to defer taxes on this income "poses an incentive
for U.S. firms to invest abroad in countries with low tax
rates over investment in the United States.''

"So fix it,'' you say.

Ahhh, but that's easier said than done. When two things are
of different heights there are two ways to level them. You
can cut the higher one down, or raise the lower one up.

In this case, you can end the ability to defer these taxes,
effectively raising overall corporate taxes. Or, you could
lower U.S. corporate taxes to a more globally competitive
level.

"Brilliant," you say, "a U.S. corporate tax cut will end the
incentive to go abroad."

Not so fast. As the biggest and best economy in the world,
the U.S. is a price maker. We set the standard. A U.S. tax
cut might only ignite an international game of tax chicken
where all the Lowtaxistans cut their rates below our new,
lower rate.

Of course, the revenue will have to be made up elsewhere,
which would mean higher individual taxes.

"Hmm, I'm not liking that fix so much. How about ending the
loophole? That's the one I really liked in the first place."

You're a hypocrite, and not a very good economist. That
would be a great incentive to send corporate headquarters
offshore where we couldn't get any taxes from U.S.
corporations. It would also hurt our companies who are
competing with international competitors. Money will find
the lowest tax rate, so if there are incentives to go
offshore we must end them, and if ending those incentives
means lowering the U.S. corporate tax rate, we must also
find a way to pay for that.

If you'd like to reach Steve Liesman, write to him at
steve.liesman@nbc.com10, and place "Attn: Macro Investor" in
the subject line, or write to newseditors@wsj.com11 to have
a comment published about the Macro Investor.


Regards,

KGB

-----
Kevin G. Barkes
Email: kgb () kgb com | Web: www.kgb.com
Eff the Ineffable, Scrute the Inscrutable:
http://www.cafeshops.com/kgbstuff.9211569
KGB Report:
http://www.kgb.com
National Temperature Index:
http://nationaltemperatureindex.com
DCL Dialogue on line:
http://www.kgb.com/dcl.html
Random Quotations Generator:
http://www.goodquotations.com
Over 11,000 searchable quotations.

-------------------------------------
You are subscribed as interesting-people () lists elistx com
To manage your subscription, go to
 http://v2.listbox.com/member/?listname=ip

Archives at: http://www.interesting-people.org/archives/interesting-people/