Democratic presidential contenders Hillary Rodham Clinton and Barack Obama have cast it as an outrage that should be a key target for the next president: a tax break they say encourages employers to ship American jobs abroad.
The charge could be dismissed as typical campaign-trail exaggeration during a Democratic primary season marked by populism, except for one thing. Many analysts say it's true. "The U.S. tax system does provide an incentive to locate production offshore," says Martin Sullivan, a contributing editor to Tax Notes, a non-profit publication that tracks tax issues.
At issue is the U.S. tax code's treatment of profits earned by foreign subsidiaries of American corporations. Profits earned in the United States are subject to the 35% corporate tax. But multinational corporations can defer paying U.S. taxes on their overseas profits until they return them to the USA — transfers that often don't happen for years. General Electric, for example, has $62 billion in "undistributed earnings" parked offshore, according to recent Securities and Exchange Commission filings. Drug giant Pfizer boasts $60 billion. ExxonMobil has $56 billion.
"If you had two companies in Pittsburgh that both were going to expand capacity and create 100 jobs, our tax code puts the company who chooses to put the plant in Pittsburgh at a competitive disadvantage over the company that chooses to move to a tax haven," says former White House economist Gene Sperling, a Clinton adviser.
The Democrats, saying the United States has overlooked the costs to working Americans in its rush to embrace globalization, have vowed to eliminate any tax incentive for further offshoring.
Obama also has co-sponsored legislation that would give "Patriot Employers" a tax credit equal to 1% of their taxable income if they maintain or increase the ratio of their U.S. workforce to the number of workers abroad, keep their headquarters in the USA and meet other wage, health care and pension requirements. "We can end tax breaks for companies that ship our jobs overseas and give those breaks to companies that create good jobs with decent wages here in America," Obama said last month in Lorain, Ohio.
But multinationals say that not every job created abroad comes at the expense of a laid-off American. And overhauling the corporate tax system without causing new problems won't be easy.
Sperling concedes that Clinton has not "worked out every detail" of her corporate tax plan. Obama's proposed tax break draws fire both from analysts who say it could be manipulated and business representatives who find it too stingy.
"Big businesses will always look for ways to skirt the tax code. An Obama administration will close loopholes and will tighten (IRS) enforcement so companies cannot go around tax regulations," says Bill Burton, a spokesman for the Obama campaign.
The U.S. has one of the highest corporate tax rates in the world, and its corporate tax code has a well-earned reputation for complexity. But despite the high rate, the U.S. takes in less annual revenue from corporate taxes, measured as a percentage of economic output, than almost all other major economies. Part of the explanation for that shortfall is the allowance for corporations to postpone taxes on foreign income.
"The problem is the company gets to deduct the cost of doing business right away, but they don't have to pay tax on the profits until they bring them back," says economist Jason Furman, director of The Hamilton Project in Washington, D.C.
Reform efforts thwarted
The deferral clause has been in the tax code for more than half a century and has outlasted numerous reform efforts. In April 1961, even as U.S.-backed rebels were dying at Cuba's Bay of Pigs, President Kennedy asked Congress to rewrite tax provisions that "consistently favor United States private investment abroad compared with investment in our own economy."
In 2004, the Democratic nominee for president, Sen. John Kerry, D-Mass., railed against "Benedict Arnold" corporations that exploited the tax system to outsource jobs to low-wage countries such as India.
Now, with ever-larger volumes of capital surging across national borders, corporations' foreign earnings are emerging as part of a broad Democratic critique of globalization. States such as Ohio, where Clinton scored an important primary victory on March 4, and Pennsylvania, which votes April 22, have lost tens of thousands of manufacturing jobs in recent years. Trade agreements and a tax code that encourages corporate flight are to blame, many Democrats say. "We're going to close every tax loophole that still gives one penny of your tax dollars to any company that exports a job," Clinton promised last month.
From 2000 through 2005, U.S. multinationals eliminated 2.1 million jobs at home while adding 784,000 to their payrolls abroad, according to the Bureau of Economic Analysis. At the end of 2005, the most recent statistics available, U.S. corporations employed almost 9 million people outside the United States.
Still, economists say there is no generally accepted estimate of the number of jobs moved offshore to capitalize on more favorable tax treatment. Kimberly Clausing, a professor of economics at Reed College in Portland, Ore., says the corporate tax code may account for up to 3 million jobs being abroad. Gary Hufbauer, an economist who has written a book on international taxation, puts the number at just 200,000.
Home and abroad
Whatever the employment impact, the deferral provision is costing the U.S. government money. A new study published in Tax Notes this month concludes that multinationals shifted almost $50 billion in income to low-tax countries in 2004, depriving the government of $17.4 billion in tax revenue. To recoup some of the lost cash, Congress in 2004 allowed corporations a one-time opportunity to repatriate profits at a special 5.25% tax rate. In 2006, corporations paid $354 billion in federal taxes.
So far, the Democrats have been alone in targeting for change the foreign income deferral. Presumptive Republican nominee Sen. John McCain of Arizona has called for a cut in the corporate tax rate to 25% but has not mentioned deferral.
The Bush administration warned last year that U.S. corporate giants are at a competitive disadvantage in world markets because foreign rivals pay lower taxes in their home countries. The Treasury Department last summer convened a conference on business taxation but has not developed any formal proposal. In an interview with USA TODAY earlier this month, Treasury Secretary Henry Paulson said U.S. multinationals would "shrivel up" if they were discouraged from investing abroad.
"The world has changed today. A global company can be headquartered wherever they choose. … Our global companies are taxed at a higher rate than other global companies around the world, and the trend is disturbing," he said.
Conservative economists also dispute the claim that the tax code causes companies to move jobs to foreign locations. Matthew Slaughter, a Dartmouth College economics professor who worked in the Bush administration, says that historically, multinationals that have added jobs at their foreign affiliates also have expanded hiring in the USA. As U.S.-owned foreign units prosper, their corporate parents must add accountants, marketing specialists and other managers at their U.S. headquarters.
In 2004, Slaughter released a study, based on employment data for the decade ending in 2001, which concluded that U.S. multinationals created two jobs in the USA for every job they added abroad. That comforting conclusion broke down in more recent years. From 1991 through 2005, multinationals created almost as many jobs abroad (3.6 million) as they added at home (3.8 million). "The aggregate statistics look different now," Slaughter says.
Today's U.S. tax system encourages corporations to structure their operations to shift profits to low-tax foreign locales such as Ireland, Bermuda or the Netherlands. That's especially true for companies that benefit from so-called intangible assets that are difficult to value. By assigning patents or other licenses to foreign affiliates, corporations can legally book profits in low-tax venues rather than the USA, economists say.
Evidence of legal tax-shifting can be seen in government statistics. In 2005, U.S. multinationals' units in Ireland, which levies a corporate tax of just 12.5%, reported profits that were twice as large as the profits of all U.S. affiliates in Germany, France and Italy combined. Viewed another way, each employee of a U.S. multinational in Ireland was worth more than $539,000 in profits, while their counterparts in Germany brought in about $16,000, according to the BEA.
"Multinationals move profits created in the U.S. via various accounting techniques. There's evidence they do that rather aggressively," says Clausing, the Reed College economist. "It's a big incentive to have some operations in Ireland. More jobs are in Ireland than would be there in the absence of this provision."
Drugmaker Pfizer, for example, operates five manufacturing plants in Ireland and employs about 2,200 there. The company declined to make an executive available for an interview, but spokeswoman Shreya Jani said via e-mail that taxes are only one consideration in investment decisions. "Other factors include trained workforce, environment, government regulations, union issues, among others," she wrote.
Corporate lobbyists say that any move to eliminate deferral would have to be packaged with a significant cut in the 35% corporate tax rate, something neither Democratic candidate has yet proposed. Otherwise, the largest companies, facing an effective tax increase, would have an incentive to switch their legal residence to another country. Most other nations tax their corporations only on the income they earn in their residence country. "If you don't do it right, you'll only encourage them to move offshore entirely," warns William Reinsch, president of the National Foreign Trade Council, which represents members such as Wal-Mart, Caterpillar and Ford Motor.