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February 17, 2017

The US Corporate Tax Structure Is an Incentive to Send Jobs Abroad

The way the US currently taxes corporate income is toxic for American workers when coupled with globalization. It turns free trade, which I think is a good thing, into unfair trade. It is a bizarre structure which only its parents – lobbyists and those corporations which benefit from it – could love.

Problem 1: in theory, the US taxes domestic corporations on their worldwide income with a deduction for foreign taxes paid. But, besides the obvious problem of ever discovering what the true income is in places immune from audit, there’s a huge loophole. Foreign income is NOT taxed until it’s brought home. Obviously, this is incentive NOT to bring the foreign income home if there’s any use at all for it abroad; this costs tax revenue.

Even worse, there’s an incentive to turn domestic income into foreign income. Here’s one easy and very popular way: transfer corporate patents to a subsidiary in a low-tax country like Luxembourg or Ireland and then charge the US corporation huge fees for the use of the patents. The overall corporate earnings don’t change; they just get shifted to the low-tax subsidiary – but they don’t get taxed “until the profits come home” -  like never or not until Congress passes a “tax holiday” to get the money back into the country.  This causes indirect job loss (as well as tax loss)because the incentive is to invest these profits abroad rather than here

But there’s worse. If the corporation build a subsidiary factory in the low-tax jurisdiction and charges a high price to the parent company for goods it buys from that factory, these goods are cheaper to the corporation as a whole than if they were purchased in the US – even if the cost of manufacture is actually the same – because no present taxes are due to the US on the profits of the foreign subsidiary. Now American workers not only have to compete with foreign workers who may or may not be paid less, they also are disadvantaged by their own tax code. That’s a high hurdle to climb.

Problem2: Our competitors mostly use a tax system which rewards exports from their countries at the expense of imports. It’s called a value added tax (VAT) and it’s rebated on exported goods (if you travel and are as diligent as Mary, you may have claimed your VAT rebate at the airport before coming home). The US taxes export sales at the same rate as imports. That sounds fair but it isn’t if everybody else is favoring their exports. The effect is that goods imported to the US are cheaper by the amount of tax that was rebated on them than goods made in the US which are fully taxed. Once again, American workers are paying the price for this disparity in tax policy between us and our trading partners – they either have to get paid less or lose the sale.

Mea culpa: I blindly assumed globalization is a good thing because it IS in economic theory. It took the revolt which propelled Sanders and Trump and even made Clinton a protectionist (after she wasn’t) to make me look harder at whether globalization has resulted in fair trade as well as free trade.

Next post: is a border-adjusted tax the answer?

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