Q: When can you be sure President Barack Obama is proposing a tax increase?
A: When you hear him propose a tax cut.
On Wednesday, the president announced his plans to modify the U.S. tax code by cutting the corporate income tax rate from 35 percent to 28 percent. Our current rate is the second-highest in the OECD, and about to be the highest with Japan cutting its rate in April. Currently, our corporations’ average total income tax rate, including the typical state tax rate of just over 4 percent, gives us the highest corporate taxes in the industrialized world, above 39 percent.
If cutting the corporate income tax rate were all the president was trying to do, one might call it a good start, but only a start since the average total corporate tax rate of over 32 percent for American corporations will still be far above the OECD average of 25 percent.
High corporate tax rates lead to reductions in capital formation and foreign direct investment, particularly in more profitable companies and industries. High taxes are associated with “re-allocation of resources towards possibly less productive sectors.” And high taxes favor companies that use debt over companies that raise money through equity (stock) offerings — the latter group including most startups and technology companies where a majority of America’s employment growth is to be found.
Unfortunately, but not surprisingly for a man who is unable to propose serious spending cuts other than at the Department of Defense, reducing a tax rate is not all Obama is proposing.
The administration’s plan also includes eliminating a wide (but as yet unspecified) range of loopholes and deductions. Eliminating loopholes and deductions to make reducing rates a revenue-neutral but less economy-distorting endeavor is a good, indeed indispensable, part of sane tax policy.
When we see the details, however, expect the closed loopholes to target oil and other non-“green” energy companies with particular aggressiveness, meaning higher gasoline and home heating oil prices for all Americans. After all, Obama needs to pay for his increasing the subsidy for the Chevy Volt from $7,500 to $10,000 per vehicle — for a car whose average buyer has an annual income of $170,000. Now that’s income redistribution!
Obama’s new tax plan is not aiming to be revenue-neutral; instead it is intended to help reduce the deficit, which is to say it is intended to be a net tax increase of the most economically-damaging sort. And that brings us to the heart of the Obama proposal: a shiny new tax on American companies’ foreign-earned (and not repatriated) profits.
This “minimum tax on foreign earnings” is the core of Obama’s tax hike disguised as a tax cut. This is economic cretinism, or more accurately economic masochism, writ large. The administration suggests that taxing foreign earnings will stop “giving companies an incentive to locate production overseas or engage in accounting games to shift profits abroad.” But, typical of those who live in a Keynesian statically-modeled world, Obama and Treasury Secretary Geithner forget that corporations, like people, respond to incentives, and perhaps even more so.
For example, Tyco International reincorporated in Bermuda in 1997, as did Ingersoll-Rand and Foster Wheeler four years later. Cooper Industries and Nabors Industries joined them in shorts and long socks in 2002.
In 2004, a proposal was brought to Tyco shareholders arguing that they should reincorporate in the U.S. because lesser shareholder protection in Bermuda was a negative for the stock price. Shareholders rejected the measure emphatically, with 93 percent voting against moving back to the tax-hungry United States. In 2009, Tyco moved its headquarters from Bermuda to Switzerland where it will pay a 16 percent total corporate tax rate – scheduled to decline to just under 14.5 percent next year. Foster Wheeler also reincorporated in Switzerland in 2009.
A 2005 report of the Joint Economic Committee of Congress suggests that “the shifting of profits out of the United States has been estimated to total about $75 billion a year and to cost the U.S. Treasury $10 billion or more per year.”
Politicians of all stripes have demonized “corporate inversions,” whereby a company’s official address is offshore but most of its management team and company operations remain in the U.S. Such companies are called “tax dodgers,” “ex-patriots,” and worse. Expect similar divide-and-conquer rhetoric from Obama and Geithner as they market their destructive, ill-conceived plan.
A company’s fiduciary responsibility is not to the U.S. Treasury; it is to shareholders who, it should be noted, pay taxes on capital gains and dividends earned through investment in the company’s shares. Since, all else being equal, lower corporate taxes should lead to higher stock prices and higher dividend payouts, much of the corporate tax revenue lost to the Treasury is recovered through individual income tax payments. This impact is magnified by lower corporate taxes also being associated with higher wages, about which more in a moment.
It remains as true as ever that corporations don’t pay taxes; their employees, customers, and investors do.
Obama’s proposal to tax foreign earnings of American companies, rather than incentivize them to increase production in the U.S., will cause them to reincorporate in Bermuda, Bern, or any of the other tax-friendlier jurisdictions around the globe.
Even our hockey-mad friends to the north have, over the past four years, slashed their federal corporate tax rate from 21 percent in 2007 to 15 percent now. Even adding the typical 10 percent provincial corporate income tax, American companies with substantial overseas earnings could, if Obama’s plan passed, lower their tax bills by moving to any of the beautiful cities of Vancouver, Toronto, or Montreal.
Leaving the U.S. just what some companies, especially large and profitable companies, will do if President Obama’s corporate tax proposal becomes law.
And leave they should, not only in the interest of their shareholders but also in the interest of their employees.
Economists Kevin Hassett and Aparna Mathur find that “a 1 percent increase in the corporate tax rates leads to a 0.5 percent decrease in wage rates. For example, if the corporate tax rate increases from 35 to 35.35 percent, which is a 1 percent increase, a $10-per-hour wage rate will decrease 0.5 percent to $9.95. Using information on U.S. wages and tax revenues, this estimate implies that every additional dollar of tax revenue leads to a $4 decrease in aggregate real wages. Examining the effects of tax rate changes on wages one year later, rather than five, they find that a $1 increase in tax revenues leads to a $2 decrease in wages.” Even less aggressive studies find that “between 45 and 75 percent of the corporate tax is borne by labor.” Few policy positions are as self-destructive as the left’s persistent push to bleed corporations.
Why, Why, you may ask, was the Obama administration in a mad rush to tell the world about their new tax plan? The answer, of course, is politics, which explains not only why the president, the treasury secretary, and their useful idiots in the media are trumpeting the “tax cut” headline instead of the “tax hike” truth, but also why the announcement came on Wednesday morning: On Tuesday, CNBC’s Larry Kudlow reported “Team Romney tells me there will be a bolder tax-cut plan released either at the debate [Wednesday] night (if Mitt gets it in) or more formally at his Detroit Economic Club speech on Friday.”
The administration’s reaction was to race to get their tax “cut” out early on Wednesday to interrupt any attention former Massachusetts Governor Mitt Romney’s new tax plan might attract. And while Romney also moved up his time-table, releasing some details of his plan Wednesday morning instead of in the evening, Obama’s tactic was somewhat successful in distracting the public eye from a revamped Romney tax plan. Nevertheless, in a coup for Romney, the Wall Street Journal, formerly less than enthusiastic about Romney’s economic proposals, called his new approach “the right policy” (while attacking aspects of Republican challenger Rick Santorum’s tax plan).
Team Obama may be patting itself on the back, admiring its cleverness in preempting Romney and monopolizing, or at least sharing, the tax cut discussion in a single day’s news cycle — which now has a duration slightly longer than a “tweet.” But with Romney’s newly aggressive reduction of personal and corporate tax rates, Obama’s cynical proposal looks even worse by comparison than it does on its own.