President Obama's proposal to shut down or cut back what he calls "tax havens" is aimed at the wrong target during the worst possible time.
America's tax system already inflicts a great deal of harm on businesses. The United States has one of the highest corporate income taxes of any developed country. When combined with state taxes, American corporations face an average burden of nearly 40 percent. By comparison, the median tax rate levied by developed countries is just 30 percent. Even countries like France, Sweden, and the Netherlands, which are hardly renowned for free-market environs, levy lower corporate tax rates than the U.S. Reductions in America's punitive tax levels should be the proper focus of corporate tax policy revisions.
Equally painful is the federal government's tax treatment of business income earned abroad. The United States is among the small minority of nations that tax business income earned outside national borders. This policy of "worldwide taxation" is inconsistent with fundamental tax reform and imposes a heavy compliance burden on U.S.-based corporations. Territorial taxation -- the common-sense notion of taxing only income earned inside national borders -- would enable U.S. companies in foreign markets to compete on a level playing field.
Even the mere act of filing taxes in the U.S. is burdensome in its own right. Based on information collection budget statistics, the income tax on corporations (not including small business or sole proprietorship) extracted 3.2 billion hours of paperwork compliance last year. NTU estimates that the overhead cost of these hours is $159.4 billion. To put that figure into perspective, it represents 54 percent of corporate income taxes collected in FY 2008 and 89 percent of estimated collections for the current fiscal year.
The United States now ranks an embarrassing 65th worldwide (out of 181 countries surveyed) for time spent complying with corporate tax filings, according to a 2009 study jointly published by the accounting firm PricewaterhouseCoopers and the World Bank. The study examined tax compliance burdens faced by a hypothetical flower pot manufacturer and retailer with 60 employees. It estimates that such a company in the U.S. would spend 187 hours filing taxes. By comparison, companies in Hong Kong, United Kingdom, or France would spend just 80, 105, and 132 hours, respectively.
The Administration's preliminary outline of its "tax haven" policy notes that "[n]early one-third of all foreign profits reported by U.S. corporations in 2003 came from just three small, low-tax countries: Bermuda, the Netherlands, and Ireland." It also referenced a Government Accountability Office report, which concluded "that of the 100 largest U.S. corporations, 83 have subsidiaries in tax havens." These are not signs of mass law-breaking or nefarious greed. Rather, they constitute a harsh indictment of laws that threaten the survival of American businesses in the international marketplace. The White House blueprint makes no attempt to correct these flaws, and in fact would amplify them.
The Administration's attack on earnings deferral and foreign tax credit provisions will grievously wound the global economy that has benefited Americans as well as citizens of other countries. For example, the proposal calls for "reforming deferral rules to curb a tax advantage for investing and reinvesting overseas." This "tax advantage" is in reality a recognition that multinational firms are at a disadvantage when it comes to tax rates and income classification rules.
Stripping away this sensible treatment and gutting foreign tax credits are likewise tantamount to protectionism, by discouraging foreign direct investment in other countries. As with tariffs levied upon the trade of goods and services, this could very well lead to retaliatory tax policies against the U.S. that will cost jobs and income in our own nation.
High-tech firms in Silicon Valley and other "blue" areas of the United States will find the earnings deferral modifications especially burdensome to their business models. It is difficult to imagine that even those citizens in Obama country will support such a proposal.
The plan will also virtually guarantee a prolonged economic slump here at home. Even announcing ahead of time that the new provisions wouldn't be implemented until a few years from now won't take the sting out of them. Since all businesses large and small must develop their models on a longer-term horizon, the Administration's changes will still be viewed as the beginning of a dim future that will punish any attempts to expand, invest, or deliver decent returns to millions of middle-class shareholders.
Such signals would be seen all the more alarmingly because of other measures the Administration has already announced, including discriminatory treatment of domestic energy producers, crushing personal tax hikes that will hurt small firms, and new regulatory rampages that will raise operating costs.
President Obama's one worthy proposal to make permanent the Research and Experimentation tax credit shouldn't come at the expense of the few policies that give our companies a fighting chance to compete abroad. Instead, as a first step, he should advocate opening another "repatriation window," which in 2004 allowed hundreds of billions of U.S. business dollars to flow back into the country.
Currently, U.S. companies face a tax disincentive when bringing back the earnings of foreign subsidiaries to domestic bank accounts. If there is any shortfall between the tax paid abroad on those earnings and the U.S. corporate income tax rate (which is almost guaranteed), companies must cut a check to the U.S. Treasury. Needless to say, this doesn't encourage firms to bring earnings back to the United States.
Until elected officials bring corporate tax rates down, reduce tax filing complexity, and tax worldwide income the way the rest of the world generally does, businesses will continue to be forced to look beyond our shores for a fair tax shake.
If the President is truly interested in bringing overseas earnings back to the U.S., he should concentrate on addressing these problems. Developing a constructive response to tax havens abroad shouldn't mean creating fresh tax hells here at home.