Taxing corporations’ foreign profits

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Story by Jason Margolis, PRI’s “The World”

The US government needs the money. The federal debt has ballooned in recent years, and naturally, the debate in Washington is about where to cut spending and how to raise revenue. One idea favored by President Obama is to tax American companies on their foreign profits. But the jury is still out on whether that’s a good idea.

Let’s say a fictional American company is making widgets in Vietnam or Belgium. This company then pays taxes on its profits to the local government. The company only pays taxes to Uncle Sam when profits are brought back to the United States.

President Obama wants to end that practice, and American multinationals don’t like it one bit. But it’s hard for these corporations to argue against the President when he frames the debate like this:

“It’s a tax code full of corporate loopholes that makes it perfectly legal for companies to avoid paying their fair share. It’s a tax code that makes it all too easy for a number, a small number of individuals and companies, to abuse overseas tax havens to avoid paying any taxes at all. And it’s a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.”

So far, the multinationals are staying mute on the topic. Not surprising, says economist Lee Branstetter at Carnegie Mellon University.

“You can sort of understand where they’re coming from, I mean in a sense that there is some controversy here, and they have to look out for their public image.”

But are multinationals shirking their fair share, or is that just a good soundbite for the president? Economist James Hines, a tax expert at the University of Michigan, says the corporations are paying their fair share of taxes in accordance to current rates; so what needs to be examined is what the corporate tax rate should be. The federal corporate tax rate for domestic profits currently stands at 35 percent.

Just across the quad at the University of Michigan Law School, tax expert Reuven Avi-Yonah sees the fair share question differently.

“I think that the comparison has to be with an individual or with a small business that are paying their full 35 percent … clearly in my opinion, the multi-nationals don’t pay their fair share because at least on their overseas profit, they’re paying much, much less than that.”

American corporations pay about 2 percent on foreign profits, according to President Obama. But if the US raises the tax on foreign profits, American corporations may simply move their headquarters to another country.

Lee Branstetter at Carnegie Mellon says that’s not likely to happen any time soon, but in the long run, moving may be the more financially responsible option.

“And if a multi-national company is looking at, over some period of years, a difference in international tax liability on the order of billions of dollars or even tens of billions of dollars, then you might argue that they have a fiduciary responsibility to their share holders to at least consider the option of relocation, if it’s going to mean saving that much money.”

But tax expert Reuven Avi-Yonah doesn’t buy that argument. “I just don’t think that the executives would want to live in Bermuda. The level of services in Bermuda is commensurate to the level of taxation, so you don’t get good schools, you don’t get good roads, you don’t get good of any of these things. So the executives would want to stay in the United States and that’s where they get taxed.”

President Obama’s economic team shares this perspective. The President argues that if American multi-nationals are forced to pay higher taxes on foreign operations, it will push American companies to invest more in operations in the United States. He’s also offering tax incentives to do that.

But some economists like James Hines say it won’t necessarily work out that way. “Even if all you care about is the domestic business operations of these companies, you should not want to excessively discourage their foreign business activities because that’s how they generate a lot of their profits. It makes their domestic, US activities more profitable and more desirable.”

That creates more jobs here in the US, argues Hines. He’s no anti-tax crusader though.  Hines says that as the federal debt grows, the President and Congress are going to have to raise taxes somewhere, or they can simply cut spending. 

PRI’s “The World” is a one-hour, weekday radio news magazine offering a mix of news, features, interviews, and music from around the globe. “The World” is a co-production of the BBC World Service, PRI and WGBH Boston. More “The World.”