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Taxes Hurt Competitiveness Abroad

May 13, 2013 by Ike Brannon

Public Radio’s “Marketplace This Morning” recently ran a piece featuring an in-depth investigation by the Center for Investigative Reporting that highlighted the ability of U.S.-based companies to legally evade paying taxes on the profits earned from their overseas operations.

The story presented a picture of U.S. corporate behavior that no doubt left many people indignant both over the porous nature of the tax code as well as the perfidy of U.S. corporations that, it alleges, are exploiting loopholes to deny the U.S. government much-needed revenue.

Instead of matter-of-factly labeling this behavior as the exploitation of a loophole, it might make more sense to ask whether we should be taxing the foreign income of U.S. companies to begin with. After all, taxing foreign income is a practice few other industrialized countries bother with — and for good reason. 

The U.S. is one of a handful of countries in the 33-nation OECD that requires companies to pay taxes on income earned abroad. Most countries exempt this income for a simple reason: It allows their companies to be more competitive abroad, and that is ultimately a good thing for their country and the companies headquartered in their country.

A U.S. company operating in France does pay income tax on its French profits — to France, a datum the report inexplicably failed to mention. U.S. companies that bring those profits back to America must then pay U.S. taxes on top of the taxes paid to France. This means that U.S. companies operating in France pay an effective tax rate of nearly 40% (the highest in the OECD) while a company from nearly every other country pays the French tax rate of only 25% on those profits.

As a result, the U.S. company finds it more difficult to compete in this market, and its overseas operations will be smaller. The company’s U.S. operations will be smaller too since it will need fewer support staff in I.T., logistics, marketing, and management to support its overseas operations. Allowing U.S. companies to defer paying U.S. taxes until their income is repatriated allows them to narrow the tax gap between them and their competitors.

Senator Carl Levin, the Chair of the Permanent Subcommittee on Investigations, recently issued a report alleging that if U.S. corporations do not face the same (high) U.S. tax rate on their foreign and domestic operations, then they will move domestic operations overseas to take advantage of lower tax rates, but there’s little evidence of that occurring. However, there is a great deal of evidence that companies that locate operations abroad usually do so in order to service local markets by producing low-margin goods close to where they are being sold. Without deferral, Pepsi is not going to produce soda and chips in the U.S. and ship them across the ocean to Poland: They’re more likely going to divest their Polish operations. How does that help the U.S.?

As one U.S. CEO told me, most multinational corporations that are headquartered in the U.S. are here merely as the result of an historical accident. How we tax the international income of U.S. corporations is a complicated and contentious topic that’s currently at the heart of attempts to reform the U.S. tax code. To present deferral as merely some kind of tax scam that U.S. high-tech and manufacturing companies are pulling on the Treasury amounts to an almost jingoistic perspective of the U.S. economic role in the rest of the world. 


Author

Ike Brannon
Ike Brannon

Ike Brannon served as an Economic Growth Fellow of the George W. Bush Institute from 2012 to 2015. He has a Ph.D. in economics from Indiana University and a B.A. in math, Spanish, and economics from Augustana College. View his full bio

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