Eliminating Deferral Is A
Bad Idea
The current American corporate tax system, like the corporate tax systems of most countries, taxes corporations more lightly on their foreign earnings than on their U.S. earnings. Most of our competitor nations have what is called a territorial tax system, under which foreign earnings are never taxed. We have a deferral system, under which most foreign subsidiary earnings can be protected from U.S. tax until they are paid up to the U.S. parent as dividends. This, of course, provides a bad incentive. All U.S. corporations have an incentive to move their high value, high profit activities out of the U.S. in order to enjoy a lower tax rate, and earn up to 54% more profit. For this reason, some people in our government have proposed getting rid of deferral and taxing the worldwide income of U.S. corporations currently.
This may sound like a nice idea, but think it through. The U.S. is not unique anymore. We no longer have all the money - in fact, we are heavily indebted to other countries. We no longer have our gigantic technical edge - that lead has faded and we now import more goods of all kinds, including high technology goods, than we export. If our corporations are unable to compete, they will be forced into bankruptcy or will be bought out by foreign rivals.
Consider both common sense and experience. Consider a company that currently has significant foreign activities in tax friendly countries. Suppose that we now end deferral and subject all of its worldwide income to a 35% tax. Suddenly, the corporation is 35% less profitable than it used to be. Put another way, suddenly the corporation would be 54% more valuable if it were owned by a foreign parent. Do you think it will survive as a U.S. owned corporation, or will it be bought out and have all its U.S. headquarters jobs eliminated?
Eliminating Deferral in the Real World
Now consider experience. Our country has seen two cases where deferral was eliminated for particular industries or parts of industries, and in both cases, the results were exactly what you would expect.
First, in the insurance industry, U.S. based companies must pay full, current U.S. tax on all income from insuring U.S. risks, even if they reinsure those risks with a foreign affiliate, i.e. even if a foreign subsidiary takes on the risk of loss. Foreign based insurance companies insuring U.S. risks don't have that problem - they reinsure with a foreign affiliate and avoid U.S. tax. A coalition of insurance companies recently sent a letter to the House Ways and Means Committee leaders that did not ask for relief from taxation for the companies in question, but instead that tax be imposed on profits earned by their foreign competitors from insuring and reinsuring U.S. risks. The coalition pointed out that the current system puts them at an intolerable disadvantage that is destroying the U.S. based companies. "For example, White Mountains Group, EverestRe Group, Arch Capital and PXRe Group LTD moved their domiciles offshore into a no-tax jurisdiction and continue to cover US-based risks. Other US companies and lines of business have simply been acquired by foreign insurance companies domiciled in low-tax or no-tax jurisdictions."
A similar experiment in the shipping industry had comparable results. A recent letter from the Federal Policy Group, a tax lobbying organization, that was printed in Tax Notes, Sept. 10, 2007, p. 997, summarizes the effects of ending deferral on shipping income in 1986 and restoring it in 2004:
"The results of the 1986 act 'experiment' were dramatic. Much of the decline was attributable to the acquisition of U.S.-based shipping companies by foreign competitors not subject to tax on their shipping income. For example, Signapore-based Neptune Orient Lines in 1997 acquired U.S.-based American President Lines, then the largest U.S. shipper. In 1999 Denmark-based A.P. Moller Group acquired the international liner business of Sea-Land Services, Inc., a subsidiary of CSX Corp. and previously the largest U.S. shipper of containers. By becoming foreign-owned, these shipping businesses were able to shed themselves of crippling subpart F taxation and compete again in the global markets. Of course, the movement of these businesses overseas meant the loss of headquarter jobs and related employment in the United States.
"Fewer U.S.-based shipping companies also meant fewer potential investors in the U.S.-flag "Jones Act" domestic trade, which is limited to U.S.-owned enterprises. Thus, one should not have been surprised that the number of U.S.-flag ships also declined following the 1986 act change. Over the 1985-2004 period, the U.S.-flag fleet declined from 737 to 412 vessels, causing U.S.-flag shipping capacity, measured in deadweight tonnage, to drop by more than 50 percent... A 2002 Massachusetts Institute of Technology study expressed concern that the [Effective US Control] fleet, eviscerated following the 1986 act changes, was not large enough to satisfy U.S. strategic needs.
"The 2002 MIT study pointed directly at the loss of deferral as the culprit.
"The combination of U.S. tax laws passed in 1975 and 1986 resulted in a business environment where EUSC shipowners could no longer avoid paying tax on current income. This change put them at a major disadvantage to their foreign competitors who often paid little or no income tax... Consequently, EUSC shipowners have greatly reduced their investment in EUSC ships since the Tax Reform Act of 1986... The impact of the deferral's restoration on OSG, the leader in urging the 2004 legislation, was nearly immediate. In 2005 OSG posted exceptional financial results, earning $465 million in net income, a company record attributed in large part to the 2004 legislation. OSG had gained the confidence needed to take investment risks and again become a growing enterprise.
The current American corporate tax system, like the corporate tax systems of most countries, taxes corporations more lightly on their foreign earnings than on their U.S. earnings. Most of our competitor nations have what is called a territorial tax system, under which foreign earnings are never taxed. We have a deferral system, under which most foreign subsidiary earnings can be protected from U.S. tax until they are paid up to the U.S. parent as dividends. This, of course, provides a bad incentive. All U.S. corporations have an incentive to move their high value, high profit activities out of the U.S. in order to enjoy a lower tax rate, and earn up to 54% more profit. For this reason, some people in our government have proposed getting rid of deferral and taxing the worldwide income of U.S. corporations currently.
This may sound like a nice idea, but think it through. The U.S. is not unique anymore. We no longer have all the money - in fact, we are heavily indebted to other countries. We no longer have our gigantic technical edge - that lead has faded and we now import more goods of all kinds, including high technology goods, than we export. If our corporations are unable to compete, they will be forced into bankruptcy or will be bought out by foreign rivals.
Consider both common sense and experience. Consider a company that currently has significant foreign activities in tax friendly countries. Suppose that we now end deferral and subject all of its worldwide income to a 35% tax. Suddenly, the corporation is 35% less profitable than it used to be. Put another way, suddenly the corporation would be 54% more valuable if it were owned by a foreign parent. Do you think it will survive as a U.S. owned corporation, or will it be bought out and have all its U.S. headquarters jobs eliminated?
Eliminating Deferral in the Real World
Now consider experience. Our country has seen two cases where deferral was eliminated for particular industries or parts of industries, and in both cases, the results were exactly what you would expect.
First, in the insurance industry, U.S. based companies must pay full, current U.S. tax on all income from insuring U.S. risks, even if they reinsure those risks with a foreign affiliate, i.e. even if a foreign subsidiary takes on the risk of loss. Foreign based insurance companies insuring U.S. risks don't have that problem - they reinsure with a foreign affiliate and avoid U.S. tax. A coalition of insurance companies recently sent a letter to the House Ways and Means Committee leaders that did not ask for relief from taxation for the companies in question, but instead that tax be imposed on profits earned by their foreign competitors from insuring and reinsuring U.S. risks. The coalition pointed out that the current system puts them at an intolerable disadvantage that is destroying the U.S. based companies. "For example, White Mountains Group, EverestRe Group, Arch Capital and PXRe Group LTD moved their domiciles offshore into a no-tax jurisdiction and continue to cover US-based risks. Other US companies and lines of business have simply been acquired by foreign insurance companies domiciled in low-tax or no-tax jurisdictions."
A similar experiment in the shipping industry had comparable results. A recent letter from the Federal Policy Group, a tax lobbying organization, that was printed in Tax Notes, Sept. 10, 2007, p. 997, summarizes the effects of ending deferral on shipping income in 1986 and restoring it in 2004:
"The results of the 1986 act 'experiment' were dramatic. Much of the decline was attributable to the acquisition of U.S.-based shipping companies by foreign competitors not subject to tax on their shipping income. For example, Signapore-based Neptune Orient Lines in 1997 acquired U.S.-based American President Lines, then the largest U.S. shipper. In 1999 Denmark-based A.P. Moller Group acquired the international liner business of Sea-Land Services, Inc., a subsidiary of CSX Corp. and previously the largest U.S. shipper of containers. By becoming foreign-owned, these shipping businesses were able to shed themselves of crippling subpart F taxation and compete again in the global markets. Of course, the movement of these businesses overseas meant the loss of headquarter jobs and related employment in the United States.
"Fewer U.S.-based shipping companies also meant fewer potential investors in the U.S.-flag "Jones Act" domestic trade, which is limited to U.S.-owned enterprises. Thus, one should not have been surprised that the number of U.S.-flag ships also declined following the 1986 act change. Over the 1985-2004 period, the U.S.-flag fleet declined from 737 to 412 vessels, causing U.S.-flag shipping capacity, measured in deadweight tonnage, to drop by more than 50 percent... A 2002 Massachusetts Institute of Technology study expressed concern that the [Effective US Control] fleet, eviscerated following the 1986 act changes, was not large enough to satisfy U.S. strategic needs.
"The 2002 MIT study pointed directly at the loss of deferral as the culprit.
"The combination of U.S. tax laws passed in 1975 and 1986 resulted in a business environment where EUSC shipowners could no longer avoid paying tax on current income. This change put them at a major disadvantage to their foreign competitors who often paid little or no income tax... Consequently, EUSC shipowners have greatly reduced their investment in EUSC ships since the Tax Reform Act of 1986... The impact of the deferral's restoration on OSG, the leader in urging the 2004 legislation, was nearly immediate. In 2005 OSG posted exceptional financial results, earning $465 million in net income, a company record attributed in large part to the 2004 legislation. OSG had gained the confidence needed to take investment risks and again become a growing enterprise.
In
January 2005, just three months after enactment of the 2004 legislation, OSG
acquired Stelmar Shipping, an Athens-based international shipper of crude and
petroleum products, thereby reversing the trend of foreign takeovers of U.S.
shipping companies. The acquisition of Stelmar increased the size of OSG's
foreign-flag fleet by 80 percent, from 50 to 90 vessels.
OSG also began committing itself to a major expansion of its U.S.-flag fleet. Before enactment of the 2004 act, OSG's U.S. fleet had been declining in size. In 1996 OSG's U.S.-flag fleet consisted of just 16 operating vessels, and by 2004, the fleet had shrunk to just 10 operating vessels. In June 2005 OSG ordered 10 new Jones Act tankers to be built at the Aker Philadelphia shipyard, today an employer of approximately 1,300. And in February and March 2007, OSG announced plans to commission six new U.S.-flag vessels to be built at the Aker Philadelphia shipyard and Alabama's Bender shipyard."
A Better Solution
The threat to U.S. corporations from repeal of deferral is not just a bogeyman. Experience shows that it is real, and that makes sense. Corporate tax makes a huge difference in the value of a corporation. If we suddenly inflict a huge value drop on our U.S. corporations that can be undone simply by having them acquired by foreigners, they will be acquired. That is life in the real world in the 21st century.
Fortunately, we have a better option. The Shared Economic Growth proposal gets rid of the incentive to export U.S. operations in a manner that actually gives U.S. corporations a competitive advantage. We can easily afford it, and our economy needs it.
Wouldn't that be a better idea?
OSG also began committing itself to a major expansion of its U.S.-flag fleet. Before enactment of the 2004 act, OSG's U.S. fleet had been declining in size. In 1996 OSG's U.S.-flag fleet consisted of just 16 operating vessels, and by 2004, the fleet had shrunk to just 10 operating vessels. In June 2005 OSG ordered 10 new Jones Act tankers to be built at the Aker Philadelphia shipyard, today an employer of approximately 1,300. And in February and March 2007, OSG announced plans to commission six new U.S.-flag vessels to be built at the Aker Philadelphia shipyard and Alabama's Bender shipyard."
A Better Solution
The threat to U.S. corporations from repeal of deferral is not just a bogeyman. Experience shows that it is real, and that makes sense. Corporate tax makes a huge difference in the value of a corporation. If we suddenly inflict a huge value drop on our U.S. corporations that can be undone simply by having them acquired by foreigners, they will be acquired. That is life in the real world in the 21st century.
Fortunately, we have a better option. The Shared Economic Growth proposal gets rid of the incentive to export U.S. operations in a manner that actually gives U.S. corporations a competitive advantage. We can easily afford it, and our economy needs it.
Wouldn't that be a better idea?
No comments:
Post a Comment