October 31, 2003 | Commentary on Taxes
Don't Penalize Companies for Investing in America
Our tax code has many ridiculous features, but the booby prize may
belong to a provision that discourages companies from investing
profits in America and instead encourages them to keep money
overseas. It's a 35 percent tax penalty imposed on American
companies that dare to take money they earn in other nations and
plow it back into our economy.
Thankfully, Congress is considering whether to dramatically --
albeit temporarily -- reduce this penalty.
Members of both parties are sponsoring this proposal, known as the
Homeland Investment Act. Republicans like the legislation because
it would lower the tax burden and boost economic growth. Democrats
like the idea because it has almost no effect on government
revenues and might even boost tax collections, according to experts
How can a proposal simultaneously lower tax burdens and increase
tax revenues? Simply stated, the 35 percent tax penalty on
repatriated profits is so high that companies keep most of this
money offshore; the government collects very little. But if the tax
rate is slashed to 5.25 percent, as advocates propose, corporations
would bring funds back to America, and the government would get a
piece of the action.
But giving the government more money to spend is the last reason to
support this proposal. More importantly, it's a step toward good
tax policy, and better tax policy will improve the economy's
PricewaterhouseCoopers estimates the proposal could attract $400
billion to the U.S. economy next year. This money would be used for
new investment, to reduce debt and to bolster pension funds.
The financial services firm JPMorgan estimates the legislation
would reduce total non-financial corporate debt by about 3 percent
and increase investment spending by 2 percent to 3 percent over the
next two years. This new investment, they believe, would increase
economic growth by one-half of a percentage point.
Many people find it hard to believe the tax code punishes companies
for investing in America. But this is one of those
"only-in-Washington" stories that develops when politicians try to
fix one bad law by enacting another bad law. In this case, the
original mistake occurred when politicians decided it would be a
good idea to tax U.S.-based companies on income earned
The resultant "worldwide" tax system makes it difficult for
American companies to compete in world markets. For example, an
American-based company with a subsidiary in Ireland is at a
disadvantage because its profits are subject to the 35 percent U.S.
corporate income tax, while corporations from most other nations
pay only Ireland's 12.5 percent corporate tax.
This means U.S. firms would pay nearly three times as much tax as
an Irish company. The American firm also would pay nearly three
times as much tax as a Dutch firm competing in Ireland, since the
Netherlands -- like most other nations -- has a "territorial" tax
system (the common-sense notion of taxing only income earned inside
Looking at these facts, one would think our politicians would shift
to a territorial tax system, if only to put American companies on a
level playing field with most foreign-based firms. Lawmakers also
could lower the corporate income tax rate, which is higher than the
tax rate in socialist countries such as France and Sweden.
But those reforms would be common sense -- a rare commodity in
Washington. Instead, politicians decided the foreign subsidiaries
of U.S.-based companies could "defer" any American tax liability by
recycling their profits back into their overseas operations.
Compared to the self-destructive policy of immediately taxing
overseas profits, this approach is an improvement. It at least
allows American companies to be somewhat competitive in global
markets. But it does have the nasty side effect of punishing
companies that want to invest their foreign profits here.
The ideal solution, of course, is to junk worldwide taxation. The
United States shouldn't be taxing income earned in other nations,
just as other countries shouldn't be trying to tax income earned
here. The Homeland Investment Act is a good step in this direction.
If it is enacted, our economy will get a boost. And when
politicians see how well it works, they might learn the right
lesson and make the provision permanent.
is the McKenna Fellow in political economy
at The Heritage Foundation (heritage.org), a Washington-based
public policy research institute.
Distributed nationally on the Knight-Ridder Tribune wire