J.D. Foster: Tax Reform and the Coming Influx of Business Investment
By J.D. Foster Senior Vice President, Economic Policy Division, and Chief Economist
An economist will see something work in practice and then insist it doesn’t work in theory. Economists often don’t often have the best of reputations as jibes like this reflect, which is unfair in a sense because economists disagree over so many issues some of them have to be right some of the time, right? And then along comes a New York Times article reinforcing these unfortunate impressions.
The article suggests tax reform may trigger a mass exodus of American companies and American jobs. The article quotes one Kimberly Clausing of Reed College in Portland Oregon attempting an anti-Trump meme, “It’s sort of an America-last tax policy.” Ms. Clausing and others quoted in the article from Harvard Law School and the formerly non-partisan Tax Policy Center remind us again why economists struggle for their reputations.
These folks’ complaint is that tax reform adopted a system of international taxation whereby the United States only taxes the income earned in the United States. Every other industrialized country has some form of this tax system, so of course if Ms. Clausing et al were correct, then we should see companies fleeing every other industrialized country, often finding refuge in the United States. The newspapers should be filled with stories of communities in Europe and Japan made destitute as their international companies flock to Iowa, or even Oregon. Not.
Here’s the deal – American multinational companies have to compete with foreign companies which are subject only to foreign tax. If American companies have to face U.S. and foreign tax on their foreign income, then American companies are at a disadvantage. As more and more foreign companies join U.S. companies in the ranks of first-class competitors, U.S. companies have increasingly been forced to mitigate the disadvantage imposed on them by U.S. tax policy, both the high U.S. tax rate and the uncompetitive international tax system. Hence the spate of inversions that arose a few years back.
Had tax reform featuring a much lower tax rate and a better international system not been adopted, as when the Obama Treasury Department temporarily impeded the inversion route, the next few years would have seen the widespread adoption of a more direct approach: a stampede of foreign companies buying up U.S. companies, shifting employees and critical economic functions like research and development overseas. Why? Consider the following example.
U.S. company A has operations in foreign country B. Through 2017 the income earned by those foreign operations is subject to U.S. tax. Along comes foreign company F, which buys U.S. company A. Result: all of U.S. company A’s foreign income is now F’s income and untaxable by the U.S. The U.S. can only tax F’s income earned in the U.S. Being bought by a foreign company would have been do-it-yourself tax reform with a big tax cut kicker for U.S. companies and their shareholders.
By moving to a modern international tax system, Congress and the President have derailed what would surely have become a wave of foreign companies buying U.S. companies solely to escape the U.S. tax disadvantage. And by lowering the corporate tax rate to 21%, tax reform has made the U.S. an even better place to do business – for both U.S. and foreign companies.
Rather than triggering an exodus, U.S. and foreign companies will be ramping up their investment in the U.S. substantially following tax reform. We may even see a substantial inflow of foreign companies seeking the many benefits a U.S. domicile has to offer. Some may even wind up in Oregon where Ms. Clausing can study the real world effects of tax policy.