Complaints About “Tax Havens” Are Misguided

There’s nothing like policy “reform” proposals that basically amount to doubling down on a bad idea. That’s what UMass-Amherst professor Nancy Folbre’s corporate tax avoidance piece on amounts to. The gist: the U.S. should try harder to tax the income that American companies receive from their overseas operations. Such a policy, ostensibly meant to discourage businesses from “offshoring” jobs and profits, would simply further discourage investment in the U.S. and worsen the problems with our existing system.

Folbre is essentially advocating moving the U.S. farther towards a “worldwide” system of corporate taxation, wherein all a company’s profits — no matter where they’re earned — are taxed by Washington. Others support a more “territorial” system, where businesses only pay tax on the share of profits earned within the U.S. The current system is somewhere in between; it ostensibly taxes all corporate income from anywhere, but allows businesses to defer those payments until the profits are brought back home.

The problem is that worldwide systems, which often result in higher taxes for companies that operate abroad, have proven increasingly uncompetitive. Successful entrepreneurs aren’t job-creating automatons that will happily pay the government however much it thinks is appropriate. They’re individuals that respond to incentives, just like anyone. And like citizens themselves, corporations facing an uncompetitive tax system will pack up and move.

Tax advocates like Professor Folbre want to short-circuit this system of tax competition, which encourages companies to invest in low-tax jurisdictions. Rather than growing tax revenue by attracting new business to the U.S. through a competitive business environment, they want to increase taxes by revoking the deferral for taxation of overseas income and instituting new regulations to punish “tax avoidance.”

The problem is we’ve already tried tightening the screws on corporations — it didn’t work. As Scott Hodge noted last week, ” After a number of U.S. firms reincorporated offshore during the 1990s and early 2000s, U.S. lawmakers chose not to address the underlying causes of these defections-our high tax rates and the world-wide tax system. Instead, they enacted legislation that effectively made it illegal for companies to move offshore. Today, U.S. firms may not be moving their headquarters offshore, they are either getting purchased by foreign companies (see Anheuser Busch) or they are simply choosing to leave their profits abroad-at least $1 trillion by some estimates. ”

Meanwhile, the rest of the world has embraced tax competition. Great Britain, Japan and Canada will (or have already) cut their corporate tax rates this year, though Japan’s move may be postponed following the recent earthquake. This will leave the U.S. with the highest corporate tax rate in the developed world — not a place we want to be as jobs and economic growth dominate the political agenda. Trying to “improve” our broken corporate tax system with bigger tax bills and more regulations is a non-starter.