As part of his recent “to-do list” presented to Congress, President Obama suggested that one useful form of economic stimulus would be to “stop rewarding companies who ship jobs overseas, and use that money to cover moving expenses for companies that are moving jobs back here to America.” It’s hard to disagree that this proposal sounds like good politics, but it’s also very bad policy.
As he is wont to do, the president is offering a piece of legislation that he and his party have proposed multiple times before. Democrats in the House and Senate have attempted to introduce numerous bills, such as the Offshoring Prevention Act of 2011, that would strip companies of tax deductions for operations performed overseas and offer tax credits to companies that hire American workers to replace overseas employees.
The president’s framing of the issue was misleading. There are, as any skeptical observer would probably suspect, no specific tax benefits offered to American companies that outsource their labor force or operate overseas operations; they are merely eligible for most of the same business tax credits that are available to all other American companies. The proposed change is something like the Democrats’ plan to eliminate purported “government subsidies for oil corporations” — that is, stripping them of the tax benefits that all American companies enjoy, because of a purportedly undesirable activity they perform.
The overseas operations of American corporations are subject to U.S. corporate tax, but under the proposed policy, they would lose almost all their ability to reduce their tax liability through deductions or credits. For instance, if a corporation builds a plant overseas, they wouldn’t be able to count their physical plant’s depreciation as a tax write-off under the president’s proposal.
In some cases, of course, that would accomplish the aim of discouraging American companies from investing or doing business overseas, and some of that business might happen here instead. But the negotium that never happens at all because of these tax hikes, of course, will be at the expense of the employees and stockholders of American corporations that want or need to expand overseas. Furthermore, it is a widely accepted tenet of business accounting that a company should be able to deduct its expenses before paying tax on its earnings. Obama’s proposal would strip away such utterly ordinary protections, putting American companies at a huge disadvantage compared with foreign firms.
The president isn’t trying to eliminate these tax deductions in the name of fiscal responsibility, but instead to pay for another distortion in the tax code: providing tax cuts for corporations that hire American workers to do a job they’d had others doing overseas. There’s a lot to dislike about the idea of the U.S. government paying corporations to fire workers abroad and hire ones in America. For starters, it’s based on at least two deeply flawed assumptions: that countries grow rich through protectionism, and that trade economics is a zero-sum game.
Furthermore, it’s not even clear that it would work. As Ryan Ellis, policy director at Americans for Tax Reform, argues, tax credits for “insourcing” jobs to America would fail on a couple of levels. First, it’s an invitation for fraud and abuse; there’s essentially no way for the government to determine when a corporation really has replaced a foreign worker with an American one. Second, the actual tax credit that would be provided, a two-year holiday from employers’ payroll taxes, is too small to motivate much activity at all (except fraud and abuse, which can be done with a computer for virtually no cost). Ellis points out that “in any kind of business planning, decisions are made at the margin”; changing just one expense of hiring employees isn’t what makes an investment decision attractive where it hadn’t been before. In order to do that, a company has to expect consistently higher profits than it would otherwise make, and increasing competitiveness that way requires real tax reform, not patchwork policies that will quickly expire.
So the president’s proposals are designed to appeal to voters, not entrepreneurs. Does his rival, Mitt Romney, do any better? In a recent ad, Obama assailed Romney for offshoring jobs as a Bain manager and accused him of “still pushing tax breaks for companies that ship jobs overseas” — an interesting way to describe the position that American companies paying U.S. taxes deserve the same tax exemptions regardless of where they’re doing business. In fact, Romney has a much better, albeit less campaign-friendly, proposal for offshore taxes than Obama’s.
Romney’s economic plan calls for a transition to a territorial tax system, a common-sense reform that would correct one of the craziest provisions of the current U.S. tax system. Today, American companies and citizens are subject to American corporate or individual income taxes no matter where in the world they’re doing business, even though they normally pay local taxes as well. The U.S. is essentially the only country in the world with such a policy, and the only way around it is for corporations to defer repatriation of their earnings (that is, keep them abroad), or for individuals to renounce their citizenship (though there are individual credits and exemptions available, too).
A territorial tax system would allow American corporations and citizens abroad to pay just the local tax rate to the local government. Such a system would be hugely advantageous in two ways: American corporations would be able to compete with foreign corporations anywhere in the world on a level playing field, and they would be more likely to return their foreign profits to the United States. Doing so wouldn’t require paying any more in taxes (as it does now); large amounts of capital could come home to be invested in U.S. businesses or paid in dividends to shareholders. President Obama’s proposal seems to deal with the issue of American companies’ earnings being stuck offshore in another way: He’d make them much harder to come by in the first place.
In 2011, Senator Sherrod Brown (D., Ohio) claimed that the Offshoring Prevention Act would “require that companies that send factories and jobs overseas play by the same rules as ones supporting jobs in the U.S.” This laudable free-market sentiment might play as well as the president’s outsourcing rhetoric — but it correctly describes Mitt Romney’s tax proposal, rather than the president’s.
— Patrick Brennan is a 2011 William F. Buckley Fellow at the National Review Institute.