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Comments

Mike

I tend to agree with this view... i.e. fixing loopholes in the tax code so companies can't avoid paying taxes. However, I don't see this as quite the slam dunk for Kerry.

First, it seems like the foreign subsidary would be taxed twice, once by the country it is located in and once in the U.S. That doesn't seem right. Second, I do not see what in this policy leads directly to jobs in America. It seems like we are under the assumption that making it more difficult to "offshore" means that jobs will stay (or grow I suppose) in the U.S. It would seem that an equally likely outcome is that growth is just stopped and jobs are lost anyways.

Also, I was always under the impression that the biggest cost savings from offshoring was the lower costs of labor and facilities. Is there any evidence that says closing the tax loopholes will add enough to the cost to overcome those other economic gains to the firm?

I don't like it when corporations can skip out on taxation. I do like Kerry's stance on this issue, but I do not see it stemming the flow of offshoring or addressing the underlying problem ... namely lower worker standards in other countries.

Adam

Good points Mike, I want to clarify my position though. I don't propose double taxing corporations, overseas and at home.

The way it should work, and I believe is intended to work is this.

US corporate tax rate is 35%.
Kurblatistan's is 10%.

The way its intended to work is that Acme Inc runs a factory making kerwidgets in Kurblatistan. They pay 10% tax there, and then only need to pay tax on the difference between Kurblatistan's rate and the US rate. So they would pay Uncle Sam 25%.

What do you think about that?

danny

I think that the smartest tax attorney will always find another hole.

Tax codes and regulations are enormously complex. Just like a chess game - how many moves can you really plan in advance?

...but a slam dunk indeed. Bashing corporations for excess and loopholes is a time tested method for striking fire in the hearts of voters - esp. if these voters are jobless and feeling victimized by outsourcing.

Marc

I understand the issue, but I fail to understand how this can be a "slam dunk" for Kerry. These laws have existed since the early 1900's, how are they Bush's fault? What legislation has Kerry proposed to address this? He's been in the Senate since the 80's, and the Senate (along with the House) is where legislation starts right?

I work in the tech field, and my company, at this moment, is evaluating all phases of our business to see what they can offshore. My job could very likely be included. I'm just as concerned about off-shoring than anyone else, but I can't believe how hypocritical some people are when they drive to work in their Hondas and Toyotas and then complain about off-shoring because it's now their job that could be affected.

We have to be very careful about whatever "solutions" are being proposed. If we erect barriers to off-shoring, other countries will do the same and no one wins. A partial solution lies in fair trade agreements that are equitable for both sides. The American worker can compete and win when the playing field is even.

Long term, we need to have our elected representatives (Kerry and Bush included) actually read our constitution and follow it. If the Federal government were to follow that document, perhaps the corporate world wouldn’t have so many reasons to seek places where regulations, taxes, etc. are more favorable.

Now if you mean that it's a slam dunk issue for Kerry the demagogue, you may be right. My bet is on the truth.

Adam

This story made front page news of the WSJ today. Kerry came out with a big speech detailing how he will close this loophole.

read the Washington Post story

From the Journal...

WASHINGTON -- Democratic presidential challenger John Kerry, looking to capitalize on growing discontent over job losses, is proposing a broad restructuring of the corporate tax code to prod multinational companies to invest more in the U.S.

The Massachusetts senator's plan, to be unveiled in a speech today in Detroit, would largely eliminate the tax break that lets U.S. companies defer tax payments on income earned abroad -- sometimes for a decade or more. That break costs the U.S. Treasury about $12 billion annually. Mr. Kerry would use the additional revenue to reduce the overall U.S. corporate tax rate to 33.25% from the current 35%.

...

Mr. Kerry also would offer U.S. companies a one-year tax break to repatriate earnings now held overseas, a pot of money that the Congressional Research Service estimates at around $600 billion. During that year, repatriated earnings would be taxed at a 10% rate. Congressional Republicans have proposed similar tax holidays. Kerry aides didn't have an estimate of the amount of revenue they expect would be produced by that gambit.

But Mr. Kerry is counting on the money to pay for another part of his plan: a two-year, $22 billion employer tax credit that would cover payroll taxes for new employees. The credit would be available to manufacturers, "industries affected by outsourcing," and small businesses that employ fewer than 100 people.

...

And here are the trade offs that this plan requires, according to the Journal....

Though there is no definitive count of the number of U.S. jobs lost through outsourcing, most estimates peg the figure at between 250,000 and 500,000 in the past three years.

Gary Hufbauer, an analyst at the Institute for International Economics, a Washington D.C., think tank specializing in trade, said the plan would become an invitation for corporations to shift assets into foreign-owned entities to avoid losing tax breaks for work done overseas. U.S. companies also would have an incentive to relocate their headquarters abroad to take advantage of tax breaks offered by foreign governments, he said.

"It would stimulate a K Street boom in creating joint ventures and spin-offs for operations that sell into the U.S. market," said Mr. Hufbauer, referring to the Washington street that's home to the capital's lobbying and legal industry. Kerry aides said that the problem is manageable but that enforcement of tax rules would be crucial.

Tom

Even more on the Kerry plan is available via his website.

I attended a Kerry event to today in DC and they were really pushing his "10 million jobs in the first term" plan. He is going to give a series of three speeches detailing the plan, the first was the one in Detroit. Rumor is the next will involve alternative energy sources.

Adam

The Economist weighs in with their take on Kerry's tax plan for corporations outside the US.

In a nutshell, its too complicated too work, doesn't go far enough (The Economist, like myself, believes in eliminating corporate taxation), and is vulnerable to political manipulation (who decides which industries are vulnerable to outsourcing, and thus eligible for tax breaks).

Marc

This tax scheme of Kerry's misses the point. There are two (maybe more) kinds of outsourcing. In one, a company (say IBM or GM) closes a facility here in the US and opens a new one somewhere else. Since they retain ownership they are the ones who can take advantage of this tax "loophole" and defer their US taxes.

The other kind of outsourcing which is the primary type to affect the IT industry, involves companies subcontracting work to offshore companies. Since the US company doesn't own the offshore company, they don't get this tax break, as it doesn't generate any offshore profits. All it does is (theoretically) lower their costs. Kerry's plan does nothing to address this.

Again I state, if Kerry has all these plans to "fix" this country and to "turn around the economy" where are they? He's a senator, and if he ever showed up for work perhaps he could draft some leglislation.

Another thing, about this "10 million new jobs" plan. Who is going to fill these new jobs? There are only about 8 million unemployed right now. and our current unemployment rate is lower than the average for the entire 1990's. Of course he could be referring to the fact that a lot of people will have to get second (or third) jobs to pay for his tax hikes.

Wake up and smell the coffee Mr. Beuller

Jim

True, that if the corporation that is outsourcing work such as a programming does not own the offshore organization performing the work then they cannot benefit from the tax break. However, I work for the largest financial services corporation in the world and we actually "own," or are materially invested in, the offshore outsource companies we are using. Essentially they are employees of a subsidiary of the corporation. Therefore the corporation gets the tax benefit.

Indeed, I am being forced to push more work offshore, and into even onshore contractors.

The reasons are not always the tax break, though this is huge. It is also the fact that the corporation does not have to provide any benefits like 401(k), pension, health (the "biggie"), and vacation pay.

The corporation wants 100% of the work for 10% of the pay. All the time. Everyday. I'm afraid that many of us will need to boil and eat our lambskins instead of hanging them on the wall. :-)

All work no play makes Jack vote Democrat.

Dick

Several people who have posted on this issue seem to think Senator Kerry's proposals are more electioneering than fact. Let me assure them that they are right. I am a retired CPA (sorry to be an interloper on your tech-oriented web page). (Also sorry for such a ridiculously long screed.) Let me explain in as non-accounting a way as I can.

Senator Kerry's first proposal, temporarily reducing the tax rate on "repatriated earnings", is something that can be done, but it probably will raise very little tax revenue. That is because UNrepatriated earnings are nothing but what we bean counters call "retained earnings" that happen to appear on the balance sheets of foreign subsidiaries of US companies. Retained earnings are the cumulative profits of the company, reduced by any dividends they have ever paid. Companies essentially never pay out all their retained earnings as dividends, because it is such an inexpensive form of financing -- it's like borrowing (from the owners of the company) without paying interest. Just look at the financial statements of any corporation. Unless they are in extremely bad shape, they will always have retained earnings on the balance sheet.

Foreign subsidiaries are no different from other companies. It makes no sense to pay dividends to the US parent company (i.e. repatriate the earnings) if they have, or expect to have in the reasonably near future, any need for local financing. Furthermore, some foreign governments impose a "withholding tax" on dividends sent outside of their borders.

Actually, the "tax holiday" might even lose tax revenue -- and I think it probably would. The reduced tax rate won't be enough of an incentive to generate significant amounts of incremental repatriated earnings, so most of the repatriations elegible for the reduction would have been sent here anyway. That's because the only earnings that can easily be repatriated are cash and liquid assets; anything more than that would require the foreign subsidiary to sell something they previously invested in, like a building or some equipment. They're not likely to do that, because, presumably, the assets are employed profitably in their business.

Senator Kerry's second proposal, taxing unrepatriated earnings is, I'm afraid, totally unworkable. First, although I'm not a lawyer, I doubt that it is legal for the US to tax assets (that's what profits are after they are earned) belonging to a foreign entity and located in a foreign country. Consult your local international tax attorney.

Assuming the proposal passes the legality test, here's an example of what could happen: Suppose a company in Lowtaxistan is owned 50% by a US company and 50% by a company in France. It was started many years ago, and no one thought it would grow to be very large. But suddenly the widgets they make are in enormous demand, and the Lowtaxistan company makes a gazillion dollars of profit. The French company is a huge conglomerate for which widget manufacturing is a trivial side business. The US company, on the other hand, is much smaller and can't pay the tax on its 50% of the unrepatriated earnings without getting some cash from Lowtaxistan. But the French company won't agree, so the US company, unable to pay its taxes, goes out of business. That's a great way to protect US jobs.

Then there's the issue of who is the parent company subject to tax on the foreign affiliate's profit? Corporate organizations can be positively Byzantine in their complexity -- remember Enron? Let's say there is a corporation in country A that is 50% owned by an affiliated corporation in country B and 50 % by an unrelated corporation. The corporation in country B is, in turn, 100% owned by a joint venture that is owned 30% by an affiliated US corporation, 30% by an affiliated corporation in country C and 40% by another unrelated company. The affiliates in country C and the US are owned 50% by an affiliated partnership in country D and 50% by a US affiliate. OK, how much of the Country A company's income should be taxed in the US? And what country's tax rules should be used? And should the rules be based on corporate, joint venture or partnership tax law? And if you think this organization is complicated, just wait until we start trying to tax unrepatriated foreign earnings.

But the real question is, what is the amount of profit to tax? (Unfortunately, this is where I have to bring in a couple of accounting issues.) Under our current system it's (relatively) simple: If the cash arrives here, it is taxed. The problem with Senator Kerry's proposal is that foreign countries don't define taxable income the same way we do.

One possibility would be to just apply our tax rate to taxable income determined under the foreign country's law. One result of that would be allowing tax deductions for things we don't allow here. A very real example is that some countries allow an immediate deduction for capital assets like machinery; we require companies to spread the deduction over a period of years (that's called depreciation). Or what if the foreign country doesn't have just one figure called "taxable income"? They might calculate income in two different ways, then assess tax based on just one of them. (Ever heard of the Alternative Minimum Tax? That's what it does.) Or there might be different tax rates for diferent types of income (ordinary income vs. capital gains). Or what if the foreign affiliate isn't a corporation, so they don't even file a corporation tax return?

A second possibilty would be to calculate what the tax on the foreign affiliate would be using US tax rules. Believe me, that one would be a nightmare! I could give many examples, but one is that, in order to keep proper US tax accounting records, you would need an employee at the foreign location who knows US taxes, who knows the accounting rules of Lowtaxistan and who also is fluent in Lowtaxistanese; and the government of Lowtaxistan might also require that (s)he be a Lowtaxistani citizen. There aren't many of those people around. Then there are all the US tax laws that specify dollar amounts. (Things like "the tax is $500 plus 10% of the excess over $5,000.") Do we need to keep a separate set of books in dollars? And what do we do when the exchange rate changes?

"Hold on!" you say, "Why be so complicated? Just tax whatever they report on their US financial statements as income, and don't worry about any country's tax laws." Fine, but guess what will happen to the foreign affiliate's profits? They'll shrink like a pat of butter on a hot griddle. Why's that? Well, when accountants have an incentive to keep profits low, they can find ways to do so. One example: Most companies use a faster (higher expense) depreciation method for tax purposes and a slower (lower expense) one for financial statements. They could just start using the same depreciation method for books and for tax. Presto: Lower profits in Lowtaxistan. The Lowtaxistan tax authorities won't care, because they'll still collect the same amount of tax. Would US tax auditors catch it? Not likely. There are lots of judgment calls in financial statement accounting. The purpose of tax laws is to avoid such "flexibility" and establish a strict set of rules everyone has to follow in determining taxable income. (I'm not saying that effort is always successful, but it clearly is the objective.) And no, the answer is not to force companies to report financial statement income using tax rules. Tax laws are designed to raise revenue; accounting rules are designed to fairly report information to investors. The two objectives don't mix.

Finally, if Congress ignores all the complications and enacts the unrepatriated earnings tax anyway, the IRS will have to issue regulations so convoluted and complex that only the best tax minds will understand them. Most of those people work in the private sector; very few work for the IRS. How much money do YOU think the new law would raise?

Dick

I'm going to get another posting on this page before someone tells me to keep my non-MIT opinions to myself.

Kudos, Adam, for realizing that the corporate income tax makes no sense. (Ever feel like Don Quixote?)

There are other reasons, but, did you know that the corporate income tax is one of the most REGRESSIVE taxes there is? Think about it: You're a billion-dollar corporation, and you pay a quarter billion a year in taxes. Where does the money come from? All your rich stockholders? (Like the teachers and longshoremen with pension money invested in your stock?) Your fat-cat CEO? No! You just increase your selling prices so that your customers pay the freight.

So remember: Next time you buy a computer or a candy bar, you're paying some mega-corporation's taxes.

Tom

Dick, thanks for contributing to the discussion, my head is spinning. Don't worry, no one here is going to kick you out.

Jesse Tomasek

I have just started working offshore on a ship this year and I was told that I can get between $45 to $65 a day tax break neaxt year. Is this true? how can I find out?

Double tax

If US company pays tax for income in country X, should it then pay tax on income from US to country X?

Laissez

Thank you for this article. I agree with you extremely on these views of outsourcing jobs. I am from India and I think it is bad we outsource jobs there too much. We need to limit outsourcing because we are losing jobs in America. Your name is very ironic.

Steve @ 2011 Tax

Seems that eventually the corporation would want to deliver earnings back to the US to compensate investors and management that is not located in the outsourced country.

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Hello, this is very good information about Taxation. Really I like this part of your blog "The tax code is written in a way that allows companies not to pay the full 35% U.S. corporate tax rate on foreign income when that money remains invested overseas.

Backing up a step, here's how it works before the loophole: A company earns $100 million abroad in Lowtaxistan where the corporate tax rate is 20%. The foreign subsidiary pays that money to the U.S. parent. The parent then pays $35 million to the U.S. government and takes a credit for the 20% (or
$20 million) payment to the Lowtaxistan government. So the net to the U.S. Internal Revenue Service is $15 million." Thanks very much for sharing this information. Keep posting.

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Outsourcing is really the only option for companies that can't afford to pay full wages for work they need done. It certainly hurts the American economy.

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Outsourcing is really the only option for companies that can't afford to pay full wages for work they need done. It certainly hurts the American economy.

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