April 7, 2004
Finally, the campaign has generated a new economic policy
idea. Senator John Kerry believes
the current corporate tax code encourages companies to invest abroad.
He wants to alter corporate taxes to stop this purported bias.
At issue is the ability of multi-nationals to defer taxes
paid on earnings abroad until those earnings are repatriated in the U.S.
According to Kerry’s staff, the U.S. loses $12 billion per year because
of these deferred taxes.
Moreover, companies may be searching for ways to invest
abroad in order to continue the tax deferral.
After all, any tax liability that is deferred is the equivalent of
receiving a zero interest loan on the tax liability.
(This is one of the reasons that I encourage everyone who
can to fully utilize their individual tax deferred opportunities.
Over time, individuals should be able to earn more than zero on their tax
Companies also can earn more than zero by building
facilities abroad. As they do, jobs
that might have been created in the U.S. instead are growing in international
subsidiaries of U.S. companies.
By taxing earnings as they accrue abroad rather than when
they are repatriated, Kerry hopes to be able to lower the domestic corporate tax
rate to 32.5 percent. Thus, by
eliminating tax deferral abroad and lowering the tax consequences of doing
business at home, the Senator hopes to encourage more domestic job creation at
the expense of international job growth.
In principle, the Senator is correct in his assertions.
The corporate tax code is biased toward globalization.
However, the impact is not substantial.
After all, most large corporations in the international arena can get
loans near the Libor rate, which currently is about 1.25 percent.
The gap between zero and 1.25 is not that great.
Therefore, the job loss created by this “bias” in the
corporate tax code currently cannot be large.
(It is unlikely that corporations are making decisions that are altered
by such a small difference in financing.)
If inflation ever again becomes substantial, the zero
interest loan on deferred tax liabilities might make a difference in determining
whether international earnings will come home.
Therefore, it is useful to decide whether the globalization bias in the
tax code should be changed.
As a rule, I believe distortions from market solutions
should develop only if there are market imperfections that require some degree
of intervention. Even then, the
intervention needs to be useful.
For example, reducing pollutants may be socially desirable.
However, requiring that any investment in polluting facilities cannot be
approved until all such facilities are brought to best practices may lead to
many such facilities never being brought up to better practices.
Thus, such requirements are not useful because they do not create
Of course, the tax code is distorting market solutions by
allowing a benefit to companies with earnings abroad that is not available to
domestic producers. So, changing
the code as Kerry suggests would re-establish the rule of market forces without
But why was this bias allowed to enter the code?
Apparently, most nations have much lower corporate taxes than our nation
does. If taxes needed to be paid on
earnings abroad, American companies would be at a competitive disadvantage.
Therefore, the bias was established to make a more level playing field
between American owners of production abroad and international owners of similar
However, in treating international production of domestic
companies differently than domestic production, the playing field became uneven
between the local and international production of domestic firms.
On the principle I outlined above (interfere with the
market only when there is a market imperfection), the case for retaining this
tax bias is based upon what market imperfection is greater. Do we care more about our international production being
competitive with other international producers or with our domestic production
being competitive with our international production?
In the current frenzy over outsourcing of jobs, I think I would opt for reducing the imperfection between domestic and international production. Therefore, I would favor the Kerry proposal. Nevertheless, we must realistically expect that it will have little impact upon the location of world production under current economic conditions.