Overseas tax fantasy

Sen. John Kerry has cooked up a plan to tax the profits corporations earn overseas so they will be pressed to keep more of those jobs here at home.

But Mr. Kerry’s proposal would “make a bad system even worse,” says a new analysis by economist Kevin Hassett at the conservative American Enterprise Institute. Moreover, his plan includes “a loophole designed to give billions of dollars in tax breaks to the few companies” — including H.J. Heinz, the source of his wife Teresa’s stock inheritance — “that are organized in a particular way.”

U.S. tax rules on overseas businesses are fiendishly complicated. Their impact can be, and often is, easily distorted and demagogued by politicians who, as Abraham Lincoln said, hope to fool “all of the people some of the time.”

According to Mr. Hassett, two important factors emerge from research on the harmful impact of our tax code on U.S. competitiveness overseas.

First, the Internal Revenue Service taxes corporate income on a “worldwide” basis. If a U.S. company earns a profit in France, it must pay taxes on it when the funds are deposited here at home (after taking a credit for foreign taxes they pay).

The credit makes sense. “Most other countries do not tax foreign profits at all,” Mr. Hassett says. “Any U.S. multinational firm that earns money in France, after all, pays French taxes immediately. Why should we add a second tax on top of that?”

U.S. competitiveness in the global economy is also hurt, he says, by the very high U.S. corporate tax rate. “Most countries have reduced their corporate tax rates sharply in recent years. The U.S. has not, and the result is that we are one of the highest tax countries on Earth.” The U.S. corporate tax was “18 percent higher than the non-U.S. average in 2001.”

To reduce these oppressive tax rates and remain competitive, American multinationals move some or all of their production lines to other countries and “avoid paying the very high U.S. taxes by letting profits sit in bank accounts overseas.” They must still pay foreign taxes, “but since those are much lower than ours, the playing field is leveled somewhat,” Mr. Hassett says. “A U.S. manufacturer can produce a good in Ireland for sale in Europe and be competitive despite our high tax rates.”

Enter presidential candidate John Kerry and his plan to create more jobs here at home by immediately taxing any money U.S. multinationals make overseas.

Mr. Hassett argues, I think correctly, that “this will make the negative impact of high U.S. taxes impossible to avoid and force U.S. firms to significantly increase prices.” This in turn will “lead to sharp reductions in market share and employment both at home and abroad, and a likely wave of foreign acquisitions of U.S. companies.”

Indeed, Mr. Kerry tries to lessen this negative impact with a 13/4 percent cut in the U.S. corporate tax rate on all worldwide profits, but that “would not begin to offset the lost benefit of tax deferral,” Mr. Hassett says.

Economist Alan Reynolds of the Cato Institute says Mr. Hassett’s critique is right on target.

“Kerry’s plan is the equivalent of a national economic suicide,” Mr. Reynolds told me. “It would be a gift to the Japanese and Europeans because we would be dropping out of the competition in low-tax markets,”

“This is all about using the tax code to do central planning,” he said, a policy that has never worked wherever tried.

Mr. Hassett, says economist Chris Edwards, also of the Cato Institute, “is raising a very complex issue” about multinational incomes and corporate actions in response to tax rates.

“International corporate investment is increasingly sensitive to tax rates. So, absolutely, if the U.S. were to lower its rate to 20 percent (down from the current 35 percent tax rate), there would be a huge inflow of global investment into the United States that would create U.S. jobs,” Mr. Edwards said.

Mr. Kerry’s advisers clearly feared the harmful effects of their proposal, so they inserted a loophole: Businesses manufacturing products in foreign countries for sale in that country will not face tax liabilities until their overseas revenues are sent home. But Mr. Hassett says this will force multinationals, “in pursuit of tax savings, to introduce newer and smaller production facilities in every country they serve.”

“So why would anyone propose such a thing?” he asks. Well, some companies already operate in this way — especially food companies like H.J. Heinz — in part due to food safety regulations and fear of spoilage.

Heinz runs 57 plants overseas that, in the company’s words, “provide products to consumers in those markets.” Nearly 84 percent of its income is from foreign manufacturing operations. Thus, Kerry’s plan would have a huge impact on H.J. Heinz Co.

“If we assume that deferring U.S. tax on [Heinz’s] foreign income saves them the difference between the U.S. tax and the average foreign tax, then that adds up to annual savings of about $43 million,” Mr. Hassett figures.

As for its stock, with a price-earnings ratio of 19.35, “that means that absent the loophole, the firm’s market value would drop by about $832 million upon passage of the Kerry tax plan,” he says. “Assuming that the Kerry-Heinz family’s share of the company is 4 percent, which is the upper limit of what has been reported, then this loophole saves Mr. Kerry’s family around $33 million. It is easy to see why they might support this loophole, but hard to see why anyone else would.”

But Mr. Hassett says there’s a simpler, fairer incentive that would effectively slow the overseas jobs drain: Cut our corporate tax rate 18 percent to match the world average. “That would be the best way to encourage our firms to locate more activity here at home.”

Donald Lambro, chief political correspondent of The Washington Times, is a nationally syndicated columnist.