October 20, 2004

What this Congress has done to respond to a developing economic problem in corporate taxation is beyond reason. 

Almost two years ago, the World Trade Organization declared that tax subsidies provided to American exporters was unfair trade behavior.  Early this year, the European Economic Union used that declaration to begin using retaliatory tariffs against exported American products.  By the beginning of October, those tariffs had increased to 12 percent and clearly were beginning to impact American sales in Europe. 

A consensus quickly formed to provide some alternative tax stratagem that would remove the credits but provide alternative relief for American producers.  The heart of the new corporate tax bill was to remove the $50 billion credit (scored over ten years) and replace it with an equal tax reduction for all American manufacturers. 

Then the political season approached.  Senator Kerry argued that corporate tax codes encouraged companies to invest abroad the profits they earned abroad.  By doing so, they could avoid taxation on those earnings.  He was going to tax those profits whether they were brought back home or not and use the proceeds to cut all corporate taxes from 35 percent to 32 percent  In this way, he argued, the tax code would remove a bias for investing abroad and would lower the after tax cost of production at home. 

To blunt this program, the Republican led house decided that all manufacturers, but not all domestic producers, would have their taxes reduced to 32 percent.  Moreover, those choosing to repatriate their accumulated $600 billion in offshore profits would be taxed only 5.25 percent to bring them home.

The former adjustment cost almost $75 billion but the taxation of repatriated profits, even at the 5.25 percent reduced rate, would generate some additional revenues that are not now being collected.  Additional customs fees would restore some of the cost wedge between imported and exported goods and close the gap between tax increases and tax reductions. 

Then the stakes escalated.  Tobacco farmers could see the handwriting on the wall with respect to the value of those acreage quotas they were allocated in the 1930s.  They petitioned for a buyout by the Federal government.  Add $10 billion. 

Then someone decided that citizens in states without an income tax should have some of their sales taxes offset by federal deductions.  Add a higher degree of complexity, some potential inequity and more billions of dollars in lost revenues.  Fortunately, the relief was only allowed for two years.  (If the President asks for tax cuts to be made permanent, would this sales tax deductibility be included?)

Then the definition of manufacturing was widened far beyond what the industrial classifications measure.  Indeed, most major construction activity is classified as manufacturing for the reduced tax rates.  Movies are manufacturing, unless they are sexually explicit.  (This really is in the bill.)

Somehow cruise ships received tax reductions as well.  Donuts baked in a grocery receive the 32 percent tax treatment while those only distributed there are subject to the 35 percent rate.  Can anyone see the growth in complexity that Congress is putting into the tax codes? 

Not to be outdone, the S corporation lobby got a widened definition of what defines such a corporation, small businesses got even more immediate expensing on capital goods (raising the limit to $100,000) and multinationals received new definitions of interest and other offshore expenses for tax purposes. 

As all these additional “benefits” raised the revenue lost by the legislation, the Congress sought some loopholes to close.  They found that the sale-leaseback by state and local governments that provided tax benefits to investors could be closed.  Other creative public financing stratagems were restricted. 

When the work of the Congress was done, Congress could claim that the deficit was not impacted by the legislation. 

The World Trade Organization will not declare that this bill has eliminated the unfair trade practice until it has studied Congress’ work.  Those accounting and financing definitions for multi-nationals could still cause some trade problems.  However, everyone wants to get away from the retaliatory tariffs that currently are distorting trade.  Even Europe realizes that higher prices on what they import because of higher tariffs do not make them better off. 

Now we know what solutions to problems we can get when Congress is asked to act. 

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