Late last year Senator Max Baucus, chairman of the Finance Committee for a another couple weeks, suggested levying an immediate 20 percent tax on all foreign profits of U.S. companies if those profits are not brought back to the U.S. The result would be a confiscation of approximately $200 billion from the most successful U.S. companies—not unlike Cyprus confiscating citizen’s bank accounts last year because government “needed” the money.
Putting aside for a moment that the scheme would change the rules of the game without warning and that some of those profits are investment in equipment and infrastructure, the Baucus’ proposed policy is probably unworkable but certainly wrongheaded.
Currently, U.S. companies with operations abroad pay the taxes of the country wherever the money is earned but also pay additional U.S. taxes, a 40 percent rate which is the highest in the world, on that money if it is brought home. If those earnings were exposed to the new Baucus tax, U.S. companies would suddenly be at an even bigger global disadvantage, since a U.S. company competing in a foreign country would pay the U.S. 40 percent rate if they bring the money home or face a 20 percent tax increase under the Baucus tax even while their competitor just down the street will be paying the lower local rate.
The reason for all this complicated handling of foreign profits is that the United States maintains a “global” tax system. Under a global tax system a corporation headquartered in the U.S. must pay the corporate income tax on all its income, even if it is earned overseas. The tax is due when the business brings the income into the U.S. In other words, the tax bill is deferred until the money is repatriated, then the company pays the tax, and they qualify for a foreign tax credit to partially compensate for the foreign taxes already paid.
High rates and a global system combine to do great damage to the ability of our companies to compete. The U.S. is the only large economy with both a global tax system and a high corporate tax rate.
Too often those ignorant of international tax policy falsely assert that there is something wrong with companies keeping their earnings abroad rather than subjecting them to a second round of taxes under the most onerous tax system in the world. But tax hungry politicians (who created and perpetuate the mess), and anti-corporatists looking for any way to attack companies, always blame companies for the bad tax policy of the U.S.
But corporations have abundant business reasons to go abroad—it’s not just about taxes. Ninety-five percent of the global market is not in the U.S., so they invest globally to establish and grow sales efforts. Over time those efforts might lead to further investment in other assets such as equipment or buildings.
Rather than having government coerce a course of action, how about an improved system, a territorial system which would tax corporate income earned in the U.S., providing U.S. companies a level playing field to compete globally? This system would wipe out the incentive to keep foreign proceeds overseas by not subjecting every dollar of income to the highest tax rate in the world, and would allow our companies to grow again.
This approach would allow U.S. companies to be increasingly competitive instead of increasingly hobbled by double taxation, providing an incentive to bring their profits home, hence freeing them to make even greater investments in the U.S., leading to more job creation.
And even if the capital was not invested directly in the U.S., the country gains from U.S. corporate growth. As various studies have shown there is a correlation between international earnings and employment in the U.S. so any loss of revenue overseas results in lost U.S. jobs. And small businesses receive a major boost as it is small businesses that predictably top the list of organizations with the greatest percentage of sales overseas, and as larger organizations expand they routinely turn to small businesses for goods and services.
The benefits to our economy of reducing the corporate tax rate and moving to a territorial system are indisputable for individuals, small business and large corporations alike. The investment in the U.S. economy leading to job gains is a victory for all.