Bad Tax Policy: You Can Run…

The worst Supreme Court decision of all time? One of the leading candidates has to be the infamous 1857 Dred Scott decision, in which the Supreme Court ruled that slaves did not gain freedom by escaping to non-slave states. Instead, they were considered property and had to be returned to their "owners."

Some U.S. companies soon may be treated in a similar manner, thanks to legislation being touted by Sens. Max Baucus, D-Mont., and Charles Grassley, R-Iowa.

It all starts with the internal revenue code, which forces U.S.-based companies to pay an extra layer of tax on income earned in other countries. In an effort to protect the interests of workers, shareholders and consumers, some of these companies are escaping bad U.S. tax law by re-chartering in Bermuda.

This is a win-win situation for America. We get to keep factories and headquarters in America, and our companies remain on a level playing field with businesses based in Europe and elsewhere.

Not so fast, Sens. Baucus and Grassley are saying. They want to stop "corporate expatriations," even though they keep American jobs in America and help U.S. companies compete with their counterparts in Europe and Asia. Their legislation would forbid U.S. companies from re-chartering in countries with better tax laws.

The politicians who support this are acting as if these companies belonged to the government. Yet when House Minority Leader Richard Gephardt, for instance, accuses them of being "unpatriotic," he never explains what's so patriotic about higher taxes and non-competitive tax policy.

Republicans are doing their share of business-bashing, too. Sen. Grassley claims that corporate expatriations are "immoral," as if companies would be moral if they instead kept their U.S. charters and fired some of their workers.

If politicians are upset that some companies want to re-charter, they should blame themselves for trying to tax "worldwide" income. An American firm competing against a Dutch firm for a contract in Ireland, for instance, must pay a 35 percent tax on its income -- and the lion's share goes to the IRS. The Dutch firm, by contrast, pays only the 10 percent Irish tax on its Irish-source income because Holland doesn't tax income earned outside its borders.

Before giving the IRS more power, politicians should consider the following:

• Expatriation helps control government waste. High-tax California can't stop companies from moving to low-tax Nevada. Knowing this helps deter the big-spenders in the state capitol from wasting even more money. The politicians in Massachusetts must exercise some restraint because they know local businesses can flee to low-tax New Hampshire. Nations also should be subject to market discipline. This is why Washington politicians shouldn't stop companies from escaping bad U.S. tax law.
• Expatriation protects American jobs. Re-chartering in another jurisdiction doesn't mean that factories will go overseas. Nor does it require a company to move its headquarters. It simply means that a company is chartered under the laws of a different jurisdiction, much as many American companies are chartered in Delaware but operate factories and have their home offices in other states. In the case of expatriations, the newly formed foreign company still maintains its U.S. operations, but now won't have to fire workers since it can compete more effectively with overseas businesses.
• Expatriation is not tax evasion. All corporations, regardless of where they're based, pay tax to the IRS on all profits they earn in the United States. This is true of U.S.-based companies, and it's true of all foreign-based companies -- including those that expatriate. All that changes is that expatriating companies no longer have to pay taxes on income earned outside America's borders. Since worldwide taxation is misguided tax policy, this is a positive result. Indeed, every tax reform plan, including the flat tax, is based on this common-sense principle of "territorial" taxation.
  

Now is hardly the time, with the economy in the midst of recovery, for Washington politicians to make U.S. companies less competitive. Nor is it the time to give the IRS the power to prohibit businesses from re-chartering in jurisdictions with more sensible tax laws. Instead of treating companies as if they're federal property, Sens. Grassley and Baucus should be fixing the problems in the tax code.

Daniel Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation (www.heritage.org), a Washington-based public policy research institute.