President Obama and Treasury Secretary Geithner unveiled a tax
reform plan yesterday that, if enacted, would seriously damage the
international competitiveness of U.S. businesses. The plan
- Limit the ability of American businesses to defer U.S. tax on
their foreign income and
- Reduce the credit for foreign taxes paid.
Both provisions would substantially raise taxes on U.S.
businesses operating globally. Although intended to keep more jobs
in the U.S., these proposals would cost Americans jobs and
Failing to Understand International
The President's proposals demonstrate a fundamental
misunderstanding of tax policy principles and of the incentives
international companies face and the market forces that drive the
In an increasingly global marketplace, U.S. businesses compete
against companies from around the world in U.S. and foreign
markets. They compete through quality, service, and price--all of
which depend on the companies' ability to operate as efficiently as
possible. Rather than exporting their products from the United
States, American businesses often choose to operate in foreign
countries to gain local market exposure and tap into local market
expertise and existing sales channels. In other instances,
companies pursue cost efficiencies. Sometimes this can best be
accomplished from the United States; often it requires major
investments abroad that also synergistically make U.S. operations
U.S. businesses operate internationally to maximize their
competitiveness against rival firms. And in so doing, they make
their U.S. operations and workers more competitive, thus supporting
domestic jobs and wages, while building profitability for their
shareholders. For every worker employed by a U.S. subsidiary in a
foreign country, 2.3 Americans are employed in the U.S. And a
10 percent increase in foreign investment by businesses has been
associated with a 2.6 percent increase in investment in the
businesses' home countries.
Misunderstanding Tax Principles
Income earned by U.S. companies' foreign operations is fully
taxed in the country where it is first earned. For example, income
earned in Germany is taxed in Germany. U.S. tax is then imposed in
addition to the foreign tax. In most instances the U.S. tax is not
due until the money is sent back to the U.S. parent company. This
process is called "deferral," as the tax payment is deferred until
the income comes home, usually in the form of a dividend received
for owning a portion of the foreign subsidiary.
For decades, proposals to eliminate deferral have cropped up and
been defeated. Invariably, Congress comes to recognize the harm
these proposals would do to the American economy. The current
economic weakness and the increasing globalization of business
strongly affirm the importance of Congress once again turning aside
this misguided proposal.
Under U.S. law, both the U.S. government and the government
where income is earned impose tax. To reduce double taxation, the
U.S. allows a tax credit equal to the amount of foreign tax paid.
Current U.S. law already limits the applicability of the foreign
tax credit in numerous ways, all of which result in double
taxation, distorting economic decision making and leaving U.S.
companies at an even greater competitive disadvantage.
The foreign tax credit and deferral are two critical features
that prevent the U.S. corporate income tax from crippling the
international competitiveness of U.S. companies. The President has
proposed to cut back on deferral and to limit the applicability of
the foreign tax credit. This would significantly increase taxes
paid by U.S. businesses, subjecting more U.S. foreign income to
double taxation and severely undermining their ability to compete
abroad and to grow at home.
Sound Tax Policy Supports the
Sound tax policy would move in the opposite direction of that
proposed by President Obama. Income should be taxed in the country
where it is earned, and only by that country. This would be an
economically neutral policy that avoids distorting economic
International companies operate on an integrated, global basis
to be as competitive as possible. Neutral tax policy allows
companies to pursue their competitiveness strategies without
artificial incentives or disincentives from tax policy.
Consequently, the companies are stronger, more flexible, and better
able to expand at home and abroad. Increasingly, governments around
the world understand this and have moved toward adopting a more
neutral policy to advance the international competitiveness of
their companies and the jobs and wages of their domestic
Protectionism by Another Name
The President's international tax plan is fundamentally
protectionist. The theory behind protectionism is to raise tariffs
and quotas to protect domestic producers against foreign goods.
Behind the tariff wall, domestic producers can then charge higher
prices, sustaining their employment levels. This subsidizes the
wages and jobs at the protected industries at the expense of
The notion behind President Obama's proposals is to raise taxes
on U.S. companies to discourage them from operating abroad, thereby
encouraging them to invest at home to meet the demands of the
domestic and foreign markets. Once again, this policy subsidizes
the wages and jobs of a few at the expense of the many as well as
the long-term strength of the economy. Ironically, the Treasury
release on this policy refers to "leveling the playing field." This
policy does no such thing. Instead, it builds a wall behind which a
few can hide from normal market forces. Artificially restricting
the movement of capital is as harmful and self-defeating as
restricting the trade of goods.
J. D. Foster, Ph.D., is Norman B. Ture Senior
Fellow in the Economics of Fiscal Policy, and Curtis S.
Dubay is a Senior Analyst in Tax Policy in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage
Mihir Desai, C. Fritz Foley, and James R.
Hines, Jr., "Domestic Effects of Foreign Activities of
Multinationals," American Economic Journal: Economic Policy,
Vol. 1, No. 1 (February 2009), pp 181-203.