REPUB­LI­CAN TAX PLAN MIGHT NOT CURB IN­CEN­TIVES FOR FIRMS

The Gulf Today - Business - - SPECIAL REPORT -

WASH­ING­TON: By slash­ing the cor­po­rate tax rate, the Repub­li­can tax pro­posal could very well cur­tail the widely de­rided prac­tice of com­pa­nies mov­ing head­quar­ters to for­eign coun­tries to re­duce their tax pay­ments.

But how far will the tax over­haul go in ad­vanc­ing a top goal of Pres­i­dent Don­ald Trump’s: keep­ing US multi­na­tional firms from send­ing man­u­fac­tur­ing work and jobs over­seas?

Not very much, many econ­o­mists and tax an­a­lysts think.

By some ac­counts, the Repub­li­can pro­posal in its cur­rent form could in­crease the in­cen­tive for com­pa­nies to make in­vest­ments and man­u­fac­ture abroad.

While there are some im­por­tant dif­fer­ences in the House and Se­nate ver­sions, they share key ele­ments. Both would re­duce the US cor­po­rate tax rate to 20 per cent from the cur­rent 35 per cent. That is a lit­tle less than the world­wide av­er­age rate of 22.5 per cent, ac­cord­ing to the re­search firm Tax Foun­da­tion, and that is likely to tamp down fur­ther what had been a wave of cor­po­rate in­ver­sions, in which com­pa­nies moves their le­gal domi­ciles to a lower-tax na­tions.

The Repub­li­can pro­posal also would fun­da­men­tally change the US tax scheme to a so-called ter­ri­to­rial sys­tem, in which for­eign earn­ings would be ex­empt from US taxes. A multi­na­tional firm’s off­shore in­come would still be sub­ject to taxes in the coun­try where it made those prof­its.

A few coun­tries, such as Ber­muda and the Cay­man Is­lands, have a zero cor­po­rate tax rate, so to pre­vent multi­na­tional firms from pay­ing noth­ing at all, con­gres­sional Repub­li­cans have pro­posed a min­i­mum tax on for­eign prof­its at a rate that is no more than 10 per cent.

But at 10 per cent, that would still be just half the tax rate on an Amer­i­can cor­po­ra­tion’s do­mes­tic earn­ings, mean­ing that it would still make fi­nan­cial sense for US com­pa­nies to shift earn­ings and ac­tiv­ity to places where taxes are lower or pay the min­i­mum on for­eign earn­ings of no more than 10 per cent.

“As long as the rate struc­ture is lower abroad than it is here, we’re go­ing to con­tinue to have an in­cen­tive to shift jobs, pro­duc­tion and prof­its off­shore,” said Steven Rosen­thal, a se­nior fel­low at the non­par­ti­san Tax Pol­icy Cen­ter.

In re­cent years, US multi­na­tional firms have con­tin­ued to in­vest and hire em­ploy­ees at a faster rate in their for­eign op­er­a­tions than in the US. From 2009 to 2014, Amer­i­can com­pa­nies with for­eign sub­sidiaries in­creased their em­ploy­ment abroad by 21.5 per cent while their do­mes­tic pay­rolls rose by about 16 per cent, ac­cord­ing to the lat­est Com­merce Depart­ment data on multi­na­tional ac­tiv­i­ties.

Jared Wal­czak, a se­nior pol­icy an­a­lyst at the con­ser­va­tive-lean­ing Tax Foun­da­tion, agreed that some com­pa­nies will still find it at­trac­tive to move ac­tiv­ity abroad for tax pur­poses, but he nonethe­less ex­pects a slow­down in the over­all shift, if not a re­ver­sal.

Up to now, he said, US com­pa­nies fac­ing a 35 per cent tax on their for­eign earn­ings were highly mo­ti­vated to estab­lish bases over­seas. A favourite among tech firms such as Ap­ple was Ire­land, where the top cor­po­rate tax rate is 12.5 per cent.

With the US rate re­duced to 20 per cent, Wal­czak ar­gued, the gap would be nar­rowed enough that it will be much more at­trac­tive for multi­na­tional com­pa­nies to do busi­ness in the United States and less ad­van­ta­geous to go abroad. What’s more, he said, other changes in the tax plan, such as im­me­di­ate spend­ing for equip­ment and cap­i­tal pur­chases to off­set taxes, would spur firms to in­vest and ex­pand pro­duc­tion in the US.

But that gap may be much big­ger than what meets the eye. The 10 per cent min­i­mum tax would ap­ply only to earn­ings on non­tan­gi­ble as­sets such as patents and in­tel­lec­tual prop­erty hold­ings, which can eas­ily be shifted off­shore on pa­per. There would be no min­i­mum tax on for­eign tan­gi­ble as­sets such as plants and equip­ment, which means firms would find it that much more prof­itable to pro­duce over­seas.

“By the time all the dust is cleared, there’s a net in­cen­tive to shift in­come off­shore and to shift ac­tiv­i­ties off­shore,” said Kim­berly Claus­ing, an eco­nom­ics pro­fes­sor at Reed Col­lege who has writ­ten ex­ten­sively on cor­po­rate tax­a­tion.

Both the Se­nate and House bills have promised to in­clude anti-abuse pro­vi­sions and ways to pro­tect the tax base. But in fact, both ver­sions would re­sult in the fed­eral gov­ern­ment los­ing tax rev­enue on for­eign in­come in the 10th year of the tax plan rel­a­tive to what it would un­der the sta­tus quo, Claus­ing said.

“That’s show­ing us that on net, the in­cen­tive to be off­shore is even higher be­cause the tax base gets even smaller due to these pro­vi­sions,” she said.

One House idea meant to pro­tect the tax base was an ex­cise tax to stop multi­na­tional firms from us­ing trans­ac­tions with their for­eign af­fil­i­ates to re­duce their US taxes. But that pro­vi­sion, af­ter com­ing un­der at­tack by con­ser­va­tive groups, has been gut­ted. Though it was once es­ti­mated to gen­er­ate $155 bil­lion, it is now pro­jected to gen­er­ate only about half that much.

“The un­der­ly­ing idea seems to be that, sub­ject to this quasi­min­i­mum tax, any­thing goes in re­spect of for­eign tax avoid­ance by US multi­na­tion­als,” Ed­ward Klein­bard, a Univer­sity of South­ern Cal­i­for­nia law pro­fes­sor and ex­pert in fed­eral tax pol­icy, said of the House tax bill. “This strikes me as a very con­scious pol­icy.

“US multi­na­tion­als that use Ire­land or other low-tax ju­ris­dic­tions to min­i­mize their for­eign tax bills down to the Ir­ish rate in re­spect of for­eign sales will be enor­mous win­ners,” Klein­bard said.

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