The Continuing De-Construction of Capitalism

On Monday, the Obama administration announced plans to change the tax code to (in their words) "close" international tax loopholes.

Part of it was closing done loopholes allowing individuals to create phony shell corporations in countries without income taxes. From a political sound bite perspective it sounds great and most people probably agree with it.

The second part was aimed at multi-national corporations who make profits overseas but do not repatriate the proceeds (bringing them back to the U.S.). This is the dangerous part that most people do not seem to understand.

As an example under the current tax law, let’s say you make a car in the U.S. for $15K and sell it in Brazil for $20K. You would charge the Brazilian subsidiary $15K for the car leaving $5K in profits in Brazil.

You would pay income tax on the $5K. If Brazil’s marginal tax rate was $10% that would be $500. If you re-patriot the profit (bring it back to the U.S.) you get a credit for the $500 paid to Brazil and pay the difference to the U.S. If the U.S. marginal rate is 35%, these means $1,750 in taxes less $500 credit for a net tax bill of $1,250 when you repatriate the profits.

In the global economy today, dealing with multiple tax jurisdictions is standard practice. Countries look at these transfer pricing agreements to make sure they are fair market value. I see this in my job as we deal with foreign taxing authorities. Some countries (including the U.S) require mark-ups on some of these transactions to insure that there will be some profit left in their country (and creating tax payments to the country).

Companies will leave profits in foreign countries for a number of legitimate reasons. The primary reason is to re-invest it and expand overseas operations. Sometimes they will leave it overseas at the lower tax rate and repatriate it during more favorable times (i.e. downturns when they might be operating at a loss).

The Obama administration sees it primarily as tax avoidance. Their message is that if you do not pay taxes on it you will not be able to deduct the expense to create the goods or services here in the U.S.

For service oriented companies, this will accelerate them move to offshore work. If tax conditions are not favorable they will move the work to more favorable locations. As a leader of a company, why would you allow a more costly scenario to continue to exist?

Manufacturing companies will not be able to react as quickly, but it will also drive jobs offshore over time as they setup new assembly plants overseas.

This administration continues to make moves that handcuff businesses and will continue to slow the economic recovery. Instead of making incentives for companies to create jobs, they continue to create rules they think will force companies to create jobs when in reality it will probably have the opposite effect. The bottom line it is another assault against capitalism.