In his remarks to Congress Tuesday night, President Obama repeated a liberal clarion call to eliminate a tax incentive for U.S. businesses to invest and move jobs overseas. Most Americans surely have no idea what he’s talking about. And most Americans would surely oppose any tax provision that would encourage American companies to ship jobs overseas. I would, too.
But what’s he really talking about? He doesn’t say. But since we’ve heard this rhetoric dating back since before the Kennedy Administration, it seems safe to assume the President is referring again to a bugaboo called “deferral”. Before describing how this tax provision works, one simple fact suggests the reality differs fundamentally from the President’s rhetoric: Through the Kennedy, Johnson, and Clinton Administrations, and through decades of Democratic control of the House and Senate, this tax provision has remained fundamentally unchanged. If it were really a tax subsidy to move jobs overseas, wouldn’t it have been repealed long ago?
The premise of the attack on deferral is that when American companies invest abroad, they do so at the expense of investment at home. To be sure, there are isolated cases where this kind of investment displacement occurs. But overwhelmingly, American companies invest abroad because there are good opportunities overseas in addition to their investment opportunities at home, in much the same way that foreign companies invest in the United States because our economy, markets, and institutions create good opportunities for foreign investors.
Recent research underscores this point. Not only does foreign investment by American companies not reduce their aggregate investment levels at home, foreign investments so increase the overall competitiveness of U.S. companies that they are then able to increase their domestic investment. Specifically, every $10 invested abroad by a U.S. multinational company increases investment at home on net by $2.60.
The tax provision in question simply allows U.S. companies to pay tax on the earnings of their foreign subsidiaries when that income is brought home. As long as the income remains overseas, the payment of any U.S. income tax is deferred. From the taxpayer’s perspective, deferral is only relevant when the foreign subsidiary is in a relatively low-tax jurisdiction. The reason is that the taxpayer only owes U.S. tax to the extent the U.S. tax rate exceeds the foreign jurisdictions tax rate. So there is no residual U.S. tax on earnings in high-tax jurisdictions like Japan, the U.K., and Germany.
The U.S. system of taxing foreign source income reflects a protectionist view that the U.S. should actively discourage U.S. investment abroad. In that sense, it is the income tax analog to erecting tariffs on imports, a backdoor form of protectionism. The effect of tax deferral is to mitigate somewhat the anti-competitive, distorting effects of U.S. tax policy. Eliminating deferral would not eliminate a tax subsidy to U.S. firms investing overseas as President Obama asserts; it would raise even higher the existing barriers to those investments. To U.S. companies trying to compete, there’s a world of difference.