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Obama Can Run for Foreign Earnings, but They Can Hide

By: Nick Zaiac - @NickZaiac - Feb 12, 2015, 3:17 pm
Legislators look to tax offshore corporate assets to fund Obama's US$4 trillion budget.
Legislators look to tax offshore corporate assets to fund Obama’s US$4 trillion budget. (Flickr)

EspañolLast week, the US Office of Management and Budget released next year’s federal budget, as proposed by the president. The budget sets out to spend about US$4 trillion next year, gradually increasing to over $6 trillion in 2025. It contains many problems, but one is especially troubling: the plan for a new tax on the approximately $2 trillion that US-based companies hold in foreign countries.

This “out-of-the-boxproposal is for a 14 percent “transition” tax on earnings held offshore, combined with a lower rate — from 35 to 19 percent — and no more loophole for future earnings abroad, wherever they may be.

The magnitude of funds currently held by US corporations abroad stems from the unique unfriendly corporate tax system in this country. The United States is one of the few nations in the world that forces corporations to pay taxes on money earned in other countries, even as they pay taxes to other governments.

Many corporations, therefore, hold money out of arm’s reach. They avoid paying the current corporate tax rate of 35 percent, which is due when funds enter US territory and one of the highest in the world. As the Tax Foundation’s 2014 International Tax Competitiveness Index demonstrates, the United States taxes corporate earnings in a worse way than almost every other country in the Organization for Economic Co-operation and Development (OECD).

This proposal would temporarily lower the domestic corporate tax rate to encourage companies holding the $2 trillion in assets to return the money to the United States, thus paying taxes they would not otherwise owe. The revenue the government gains would then be used to pay for new infrastructure investment.

Proponents have likened this idea to a corporate tax holiday. In reality, it is a new tax on money already earned by US-based companies.

The vast majority of countries, including most European and Latin-American nations, don’t use this “extraterritorial” taxation system. This means that US-based corporations are put at a distinct disadvantage relative to many of their foreign competitors. So, they do what they can to avoid this system by holding cash abroad. Often, they use those funds to invest in expanding their foreign operations. In effect, the US government not only taxes foreign earnings, but is now seeking to tax assets that would never have entered the United States in the first place.

And this is where the problems arise. By seeking to tax assets currently held abroad, rather than new earnings, calls to use this cash for new spending amount to taxing overseas wealth held by corporations. It’s a backhanded means of simple expropriation, no better than the more transparent actions taken by populist leaders worldwide.

This tax would make it especially lucrative for US companies to move their headquarters abroad. The trend of “corporate inversions” that began last year would only be accelerated. The much-debated issue revolves around companies buying foreign competitors, and moving the company’s official headquarters abroad. They are then able to take advantage of lower tax rates abroad while avoiding this extraterritorial taxation by the US government on their foreign earnings. Foreign-based firms would not face the new tax that is being proposed. The business owners could also be wary that politicians might seek to repeat this supposedly one-time tax when money is needed in the future.

There are many specific proposals on how to enact this wealth tax. The percentage taxed varies from higher rates in Obama’s budget to lower ones proposed by members of Congress. Yet, the growing acceptance of such taxes is worrying, and even Senator Rand Paul (R-KY) has gotten behind one of the more moderate proposals. Despite the long-term consequences, politicians prefer take the easy option, rather than face painful spending cuts or tax increases for normal people.

There are many benefits to locating one’s company in the United States. The robust legal system protects corporate rights better than few others in the world. The human capital available is hard to compete with, and the domestic market is lucrative. Yet, the burden of taxes is real, and if that burden is high enough, it will make foreign shores ever more appealing.

We cannot place higher burdens on our business owners and expect them not to seek to lighten their loads. Eventually new taxes and regulations simply push companies too far. I worry that the current tax proposal will make the decision to leave clear for many of them.

Edited by Laurie Blair and Fergus Hodgson.

Nick Zaiac Nick Zaiac

Nick Zaiac is a public-policy researcher in Washington, DC. He also serves as a policy analyst at the Maryland Public Policy Institute. His column, The DC Leviathan focuses on the often-ignored bureaucratic agencies, from the Department of the Interior to the General Services Administration. He has been published in the Baltimore Sun, City AM, CapX, and other outlets. Follow @NickZaiac.