Democrats' failed bid to curb outsourcing had some crucial flaws

Thursday, September 30, 2010

THERE WILL BE no congressional action to end alleged tax breaks for sending American jobs to other countries, at least not in the near future. A bill backed by the Democratic leadership died in the Senate Tuesday, thanks to a Republican-led filibuster. But the issue is not going away. Democratic candidates plan to campaign on it in the fall election, for the same reasons that President Obama and congressional Democrats backed the legislation: They think it's a good policy -- and good politics. Nothing polls better than "keeping jobs in America."

So it's worth examining the proposal on its merits. At the heart of the matter are tax code provisions that permit U.S. multinational corporations to deduct the cost of moving operations overseas immediately but defer U.S. taxes on money they earn overseas until they transfer the cash back to the parent company. President Obama has proposed to attack this by disallowing the deductions until the deferred taxes are paid. The Senate bill took a slightly different tack, denying the deduction for moves that resulted in offshoring jobs previously done in America, while eliminating the deferral of tax on income that came from importing products from abroad back to the United States. The animating principle -- that tax rules reward "outsourcing" -- is the same, however.

The Senate proposal would have been extremely difficult to administer: How, exactly, would the government connect particular expenses to the export of particular jobs, or identify the revenue attributable to particular goods or services transferred? But more fundamentally, the Senate proposal, like the White House plan before it, reflects basic misconceptions about the conduct of multinational companies. In brief, there are many cases in which opening, or expanding, a subsidiary overseas can create or sustain employment in the United States. Sometimes U.S. firms make parts abroad that they ship to the United States for assembly. If Congress starts taxing the income they make by doing so, some companies will respond by shipping the assembly overseas as well. A 2008 study by economists Mihir Desai, C. Fritz Foley, and James Hines of Harvard Business School found that domestic investment by U.S. firms grows by 2.6 percent for each 10 percent increment in the companies' investment overseas.

In other words, counterintuitive as it may seem, international capital flows are not a zero-sum game for American workers. To set tax policy as if the contrary were true is to invite retaliatory measures by other countries on behalf of their "national champions." There is a strong case to be made for reforming U.S. corporate taxation, which may disadvantage U.S.-based businesses as compared with those operating in Europe and elsewhere abroad. The code is full of irrational loopholes and perverse incentives. But dealing with them piecemeal -- much less dealing with them on the basis of politically popular misconceptions -- will only make matters worse.

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