Our tax code has many ridiculous features, but the booby prize may belong to a provision that discourages companies from investing profits in America and instead encourages them to keep money overseas. It’s a 35 percent tax penalty imposed on U.S. companies that dare to take money they earn in other nations and plow it back into our economy.
Thankfully, Congress is considering whether to dramatically — albeit temporarily — reduce this penalty.
Members of both parties are sponsoring this proposal, known as the Homeland Investment Act. Republicans like the legislation because it would lower the tax burden and boost economic growth. Democrats like the idea because it has almost no effect on government revenues and might even boost tax collections, according to experts at PricewaterhouseCoopers.
How can a proposal simultaneously lower tax burdens and increase tax revenues? Simply stated, the 35-percent tax penalty on repatriated profits is so high that companies keep most of this money offshore; the government collects very little. But if the tax rate were slashed to 5.25 percent, as advocates propose, corporations would bring funds back to America, and the government would get a piece of the action.
But giving the government more money to spend is the last reason to support this proposal. More importantly, it’s a step toward good tax policy, and better tax policy will improve the economy’s performance.
PricewaterhouseCoopers estimates the proposal could attract $400 billion to the U.S. economy next year. This money would be used for new investment, to reduce debt and to bolster pension funds.
The financial services firm JPMorgan estimates the legislation would reduce total non-financial corporate debt by about 3 percent and increase investment spending by 2 to 3 percent over the next two years. This new investment, they believe, would increase economic growth by one-half of a percentage point.
Many people find it hard to believe the tax code punishes companies for investing in America. But this is one of those “only-in-Washington” stories that develops when politicians try to fix one bad law by enacting another bad law. In this case, the original mistake occurred when politicians decided it would be a good idea to tax U.S.-based companies on income earned abroad.
The resultant “worldwide” tax system makes it difficult for American companies to compete in world markets. For example, an American-based company with a subsidiary in Ireland is at a disadvantage because its profits are subject to the 35 percent U.S. corporate income tax, while corporations from most other nations pay only Ireland’s 12.5 percent corporate tax.
This means U.S. firms would pay nearly three times as much tax as an Irish company. The American firm also would pay nearly three times as much tax as a Dutch firm competing in Ireland, since the Netherlands — like most other nations — has a “territorial” tax system (the common-sense notion of taxing only income earned inside national borders).
Looking at these facts, one would think our politicians would shift to a territorial tax system, if only to put American companies on a level playing field with most foreign-based firms. Lawmakers also could lower the corporate income tax rate, which is higher than the tax rate in socialist countries such as France and Sweden.
But those reforms would be common sense — a rare commodity in Washington. Instead, politicians decided the foreign subsidiaries of U.S.-based companies could “defer” any American tax liability by recycling their profits back into their overseas operations.
Compared to the self-destructive policy of immediately taxing overseas profits, this approach is an improvement. It at least allows American companies to be somewhat competitive in global markets. But it does have the nasty side effect of punishing companies that want to invest their foreign profits here.
The ideal solution, of course, is to junk worldwide taxation. The United States shouldn’t be taxing income earned in other nations, just as other countries shouldn’t be trying to tax income earned here. The Homeland Investment Act is a good step in this direction. If it is enacted, our economy will get a boost. And when politicians see how well it works, they might learn the right lesson and make the provision permanent.
– Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute.