The
Government Should Not Pay Companies To Export Good Jobs
We all know that globalization is hurting a broad group of American workers. Given a choice between paying U.S. level wages or paying workers in a developing country $1.00 an hour, companies will tend to choose the latter. Even if a company would prefer to hire American workers, they are competing against other companies that will use the cheap foreign labor, and eventually it must fall in line or fail. In industries that rely heavily on manual labor, this trend cannot realistically be reversed. America cannot and should not try to compete for low wage, low skill, low value jobs. Trying to do so would end up causing us to sacrifice standards that are important to our society, such as the minimum wage. Instead, we must seek to obtain the promised upside of globalization, good new jobs in higher value industries that can afford to pay U.S. wages.
Those industries are tax sensitive. They earn high profit margins relative to the cost of manufacture, and so tax is a major consideration in where they locate their activities. Does the U.S. tax system attract those activities here? No, exactly the opposite! For a given operation that earns $100 of profit before tax, the corporation will keep only $65 if the operation is located in the U.S., but it may keep the full $100 if it is moved abroad. That is a 54% increase in profit just by moving the operation and jobs out of the United States. This is insane. The U.S. could afford such a system back when we were far ahead of everybody else, with greatly superior technology, an elite workforce, and relatively great wealth. But we can't afford it now. We are now a debtor nation. We have lost much of our technical lead and are fading fast, and we are no longer able to retain these jobs in the face of foreign competition when corporations are punished for operating here.
Imagine that you represent a German corporation that wants to build a factory to supply the U.S. market with a particular product. You are deciding whether to locate the plant in the U.S. or in the Dominican Republic (“D.R.”). What are the trade-offs?
U.S. –
· Wages will be relatively high.
· A big chunk -- 35% -- of your net profit would be taken away by U.S. federal tax (plus a percentage for state income taxes, too).
· Sales taxes on the equipment and raw materials you purchase will be high.
D.R. –
· Wages will be about $1 an hour.
We all know that globalization is hurting a broad group of American workers. Given a choice between paying U.S. level wages or paying workers in a developing country $1.00 an hour, companies will tend to choose the latter. Even if a company would prefer to hire American workers, they are competing against other companies that will use the cheap foreign labor, and eventually it must fall in line or fail. In industries that rely heavily on manual labor, this trend cannot realistically be reversed. America cannot and should not try to compete for low wage, low skill, low value jobs. Trying to do so would end up causing us to sacrifice standards that are important to our society, such as the minimum wage. Instead, we must seek to obtain the promised upside of globalization, good new jobs in higher value industries that can afford to pay U.S. wages.
Those industries are tax sensitive. They earn high profit margins relative to the cost of manufacture, and so tax is a major consideration in where they locate their activities. Does the U.S. tax system attract those activities here? No, exactly the opposite! For a given operation that earns $100 of profit before tax, the corporation will keep only $65 if the operation is located in the U.S., but it may keep the full $100 if it is moved abroad. That is a 54% increase in profit just by moving the operation and jobs out of the United States. This is insane. The U.S. could afford such a system back when we were far ahead of everybody else, with greatly superior technology, an elite workforce, and relatively great wealth. But we can't afford it now. We are now a debtor nation. We have lost much of our technical lead and are fading fast, and we are no longer able to retain these jobs in the face of foreign competition when corporations are punished for operating here.
Imagine that you represent a German corporation that wants to build a factory to supply the U.S. market with a particular product. You are deciding whether to locate the plant in the U.S. or in the Dominican Republic (“D.R.”). What are the trade-offs?
U.S. –
· Wages will be relatively high.
· A big chunk -- 35% -- of your net profit would be taken away by U.S. federal tax (plus a percentage for state income taxes, too).
· Sales taxes on the equipment and raw materials you purchase will be high.
D.R. –
· Wages will be about $1 an hour.
None
of your profit will go to income tax.
· Like most countries, it has a value-added tax (“VAT”) rather than a sales tax, and businesses don’t bear any cost from the VAT charged on equipment or raw materials.
Which jurisdiction would you choose? Absent especially high shipping costs, the financial answer is clear. The fact that the U.S. retains as many plants as it does is a testament to the fact that U.S. corporations, on the whole, have a substantial degree of loyalty to their home country.
Now say you are a U.S. corporation trying to compete against a German-owned rival. Your plant is in the U.S. The German company’s plant is in the D.R. All else equal, will you be able to compete? Even if you can, suppose the German rival looks at your business and says, “If I buy them, I can move the production to the D.R. and save on labor costs, plus instantly increase the after-tax profit by more than half due to the elimination of the income tax.” Do you think the U.S. company will resist being acquired and having both its U.S. headquarters and its U.S. factory eliminated?
These examples show why the U.S. has maintained a policy that permits the international operations of U.S. companies to be somewhat competitive with their foreign rivals. If a U.S. company puts overseas operations into a foreign subsidiary, the income from those operations won’t be taxed by the U.S. until it is brought home as a dividend. So, rather than being acquired by the German rival and having its U.S. headquarters eliminated, the U.S. corporation can move its own plant to a D.R. subsidiary and avoid current tax on the profits.
However, the U.S. corporation is still not fully competitive with the German rival, because it still must pay U.S. tax on its profits sooner or later. Further, the U.S. corporation is discouraged from reinvesting its profits in the U.S. economy, because it will lose more than one-third of that profit to tax as soon as the cash hits the U.S. Likewise, when the U.S. corporation is considering how best to expand, it sees that an investment of $100 in foreign operations will have the same net earnings cost as an investment of $65 in the U.S., because the foreign cash is pre-tax dollars while the U.S. cash is after-tax dollars. (In other words, spending $65 in the U.S. requires the corporation to bring home $100 and lose $35 to tax.)
Because of these limitations, some commentators have advocated moving the U.S. to a territorial tax system, which is what most of our competitor nations use. Under a territorial system, income earned outside of an enterprise’s home country is exempt from tax, and earnings can be freely repatriated for investment in the home country. However, such a system still makes it financially difficult for a U.S. corporation to decide to locate its plant in the U.S. rather than in the D.R. Wage rates aside, the D.R. plant will be over 50% more profitable than the U.S. plant. It is tough to ignore that difference.
Further, enacting a territorial tax system in the U.S. still would not encourage that German rival to locate its plant here. The German firm would also realize that a plant in the D.R. would be over 50% more profitable than a U.S. facility. Since the company would have no loyalty to the U.S., it is clear where it would choose to build the plant. Under the Shared Economic Growth proposal, the corporate-level tax on U.S. operations would be reduced to zero. Under that system, there would be no tax penalty to either the corporation or its shareholders for building a plant in the U.S. rather than in the D.R. In fact, if the D.R. imposed any income tax at all, then there would be an incentive to build a U.S. plant instead.
Doesn’t that make more sense?
· Like most countries, it has a value-added tax (“VAT”) rather than a sales tax, and businesses don’t bear any cost from the VAT charged on equipment or raw materials.
Which jurisdiction would you choose? Absent especially high shipping costs, the financial answer is clear. The fact that the U.S. retains as many plants as it does is a testament to the fact that U.S. corporations, on the whole, have a substantial degree of loyalty to their home country.
Now say you are a U.S. corporation trying to compete against a German-owned rival. Your plant is in the U.S. The German company’s plant is in the D.R. All else equal, will you be able to compete? Even if you can, suppose the German rival looks at your business and says, “If I buy them, I can move the production to the D.R. and save on labor costs, plus instantly increase the after-tax profit by more than half due to the elimination of the income tax.” Do you think the U.S. company will resist being acquired and having both its U.S. headquarters and its U.S. factory eliminated?
These examples show why the U.S. has maintained a policy that permits the international operations of U.S. companies to be somewhat competitive with their foreign rivals. If a U.S. company puts overseas operations into a foreign subsidiary, the income from those operations won’t be taxed by the U.S. until it is brought home as a dividend. So, rather than being acquired by the German rival and having its U.S. headquarters eliminated, the U.S. corporation can move its own plant to a D.R. subsidiary and avoid current tax on the profits.
However, the U.S. corporation is still not fully competitive with the German rival, because it still must pay U.S. tax on its profits sooner or later. Further, the U.S. corporation is discouraged from reinvesting its profits in the U.S. economy, because it will lose more than one-third of that profit to tax as soon as the cash hits the U.S. Likewise, when the U.S. corporation is considering how best to expand, it sees that an investment of $100 in foreign operations will have the same net earnings cost as an investment of $65 in the U.S., because the foreign cash is pre-tax dollars while the U.S. cash is after-tax dollars. (In other words, spending $65 in the U.S. requires the corporation to bring home $100 and lose $35 to tax.)
Because of these limitations, some commentators have advocated moving the U.S. to a territorial tax system, which is what most of our competitor nations use. Under a territorial system, income earned outside of an enterprise’s home country is exempt from tax, and earnings can be freely repatriated for investment in the home country. However, such a system still makes it financially difficult for a U.S. corporation to decide to locate its plant in the U.S. rather than in the D.R. Wage rates aside, the D.R. plant will be over 50% more profitable than the U.S. plant. It is tough to ignore that difference.
Further, enacting a territorial tax system in the U.S. still would not encourage that German rival to locate its plant here. The German firm would also realize that a plant in the D.R. would be over 50% more profitable than a U.S. facility. Since the company would have no loyalty to the U.S., it is clear where it would choose to build the plant. Under the Shared Economic Growth proposal, the corporate-level tax on U.S. operations would be reduced to zero. Under that system, there would be no tax penalty to either the corporation or its shareholders for building a plant in the U.S. rather than in the D.R. In fact, if the D.R. imposed any income tax at all, then there would be an incentive to build a U.S. plant instead.
Doesn’t that make more sense?
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