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President Barack Obama has unveiled features of a
new tax reform plan as part of his campaign for a
second presidency, which, if implemented, could impact
the developing world. Given the rising debt of the
government, the resulting pressure to raise revenues
or cut government expenditures and the evidence that
the effective taxation of America's rich falls short
of average, the tax regime was an issue that any Democratic
candidate had to address. The case for raising tax
revenues is strong.
But the opposition to any such increase from many
among those who finance Obama's campaign is also strong.
They harp on the fact that America has the highest
marginal corporate tax rate in the world after Japan.
And Japan is reducing its rate from April this year.
So President Obama had to walk the tightrope. That
he appears to have done well by making three distinctions.
Between rich individuals and corporations, between
a simple and cumbersome tax system and between corporations
that serve America while serving themselves and those
that only look to their own profits.
By making the first of these distinctions, the President
proposes to tax rich individuals more while reducing
taxes on corporates that create productive assets
and provide jobs. He is threatening to impose the
''Buffett rule'' that those earning more than a million
dollars a year should pay a minimum of 30 per cent
of that income as tax. But to balance this, he has
proposed a substantial cut in the US corporate tax
rate from 35 to 28 per cent, with even lower rates
for manufacturing and ''advanced manufacturing''. Clearly,
the idea here is to highlight a push for investment,
growth and jobs.
The second distinction, between a complex and simple
tax system, is made to argue that the reduction in
the corporate tax rate needs to be accompanied by
a simplification of the tax system, which eliminates
multiple concessions that introduce distortions. The
most obvious of those distortions is that while the
US has among the highest marginal corporate tax rates
in the world, the corporate tax to GDP ratio in the
US is among the lowest among OECD countries. The US-based
Center for Tax Justice has found that the US has the
second lowest corporate tax to GDP ratio in the developed
world, falling only behind Iceland. A study by research
firm Capital IQ for the New York Times found that
of the 500 companies included in the Standard and
Poor's stock index, 115 were subject to an effective
total (federal and other) corporate rate of less than
20 per cent during the five years ending 2010. Yet,
over time corporate tax revenues in the US have fallen
from 4 per cent of GDP in 1965 to just 1.3 per cent
in 2009. To justify a corporate tax rate reduction
in this context, President Obama has proposed a rationalisation
of the tax system that puts an end to tax breaks given,
for example, to the oil and gas industry and the private
equity business, and benefits such as accelerated
depreciation, which permits companies to write off
assets against tax at a faster rate than they actually
depreciate in economic terms.
Finally, the third distinction, between profits brought
back home and those retained abroad, is made to argue
that the President intends to end the discrimination
against firms that provide Americans jobs by investing
profits at home as opposed to retaining them abroad.
It is here that the President was strident: ''Our current
corporate tax system is outdated, unfair, and inefficient.
It provides tax breaks for moving jobs and profits
overseas and hits companies that choose to stay in
America with one of the highest tax rates in the world…It's
not right and it needs to change.'' US firms earning
profits abroad and choosing to retain them there are
not taxed in the US on those profits. But if they
choose to bring them home then they are subject to
the US corporate tax regime. This does encourage US
corporations to retain and invest their profits abroad,
especially in countries where the effective tax rate
is significantly lower than in the US. Obama now wants
to give up this ''territorial'' system of taxing profits
of US multinationals and impose a minimum tax that
needs to be paid on overseas profits, whether repatriated
or not.
It is not clear how effective such a system of reducing
the differential tax on repatriated and retained profits
would be. But there is evidence that when tax concessions
are offered on profits repatriated back to the US,
corporations do respond. As the accompanying Chart
shows, US net direct investment abroad, which ruled
high in the latter part of the last decade, registered
a dramatic decline in 2005. The drop in 2005 reflected
the decision by U.S. parent firms to reduce the amount
of reinvested earnings going to their foreign affiliates,
in order to repatriate profits home and take advantage
of one-time tax provisions in the American Jobs Creation
Act of 2004 (P.L. 108-357). That act allowed U.S.
companies that received dividends from foreign subsidiaries
during a specific period (calendar year 2004 or calendar
year 2005) to be taxed at reduced rates, on the condition
that they worked out a domestic reinvestment plan
for the dividends granted that benefit. Many companies
chose to use that opportunity in 2005, when much of
such dividends were paid out, because the act was
signed into law only late in 2004.
If a similar, more long-term, consequence were to
follow the implementation of the proposed reduction
in the tax rates on reinvested as opposed to repatriated
overseas profits of US MNCs, US business may at the
margin choose to return home. In this they would also
be encouraged by the fact that in at least one of
the countries that is their favoured destination,
viz. China, there are signs of labour shortages and
a rise in wages, besides currency appreciation, which
erode its competitiveness as a location. According
to The New York Times, a report recently released
by the Chinese government argues that this year's
post-Spring Festival labour shortage was more pronounced
than in earlier years and also longer and wider in
scope. There are other reports that the migrant worker
pool on the basis of which industry in China's export-oriented
zones grew is shrinking. An important reason is that
the government's effort to improve rural well-being
and reduce the rural-urban imbalance is delivering
results and encouraging workers to stay back in their
rural homes.
This in itself may not ensure the return home of American
business. Many produce in China because it is the
Chinese market that they are targeting. Others may
choose to shift, but to other low-wage locations rather
than back to the US. But the evidence suggests that
Obama's ploy to justify tax concessions to corporations
in a country where they are effectively undertaxed
may end up working.
*This article was originally
published in 'The Hindu' and is available at
http://www.thehindu.com/opinion/columns/
Chandrasekhar/article2953629.ece
