Rationale for Kerry's Reform: Current tax laws allow companies to defer paying U.S. taxes on income earned by their foreign subsidiaries, providing a substantial tax break for companies that move investment and jobs overseas. Today, under U.S.tax law, a company that is trying to decide between locating production or services in the United States or in a foreign low-tax haven is actually given a substantial tax incentive not only to move jobs overseas, but to re-invest profits permanently, as opposed to bring them back and re-invest in the United States.
Senator Kerry does not believe that we should force a U.S. company that chooses to create jobs in the United States pay higher taxes and suffer a competitive disadvantage with a company that chooses to move jobs to a tax haven and keep profits there permanently.
Foreign taxes are one-third lower than U.S. taxes. When an American company invests in America it can expect to pay an average tax rate of 31 percent. When this company invests abroad, it faces an average tax rate of 21 percent. [Department of Treasury, "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," December 2000]
The average tax rate in the countries America invests in has fallen sharply over the last twenty years proving an increasing incentive to ship jobs overseas. In 1984 the average tax rate paid by American companies on foreign income was 34 percent - even higher than the U.S. tax rate. But the foreign rate has fallen steadily, reaching a low of 21 percent in 1996. Although U.S. deferral rules have been largely unchanged over this period, declining corporate tax rates in foreign countries and a shift in the countries where Americans invest mean that deferral today provides a much larger incentive to ship jobs overseas than it did 20 years ago. [Department of Treasury, "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," December 2000]
Deferring taxes provides a big tax break for corporations and encourages them to keep their profits locked up overseas. American companies do not have to pay taxes on their active foreign income until they bring it back to the United States. If they keep their money abroad, a company can avoid paying U.S. taxes entirely. In addition, this provides an incentive for companies to keep re-investing their money abroad, and not to bring it back to contribute investment and growth to the American economy.
In total, not only do American companies defer paying taxes on income earned abroad, but they end up getting an $8 billion annual subsidy for investing abroad - that is, American companies pay negative U.S. income taxes on their foreign investments. According to a study published by the conservative American Enterprise Institute written by two leading tax economists, including an economist at the U.S. Treasury, American companies get an annual tax subsidy of $8 billion for investing abroad. That is, there taxes are currently $8 billion lower than they would be if all foreign income taxes were entirely eliminated. This is because the current system of deferral and cross-crediting allows companies to effectively receive net tax credits from the U.S. Treasury for their foreign investments. [Harry Grubert and John Mutti, Taxing International Business Income: Dividend Exemption vs. the Current System, AEI Press, 2001]
The tax laws for income earned in foreign countries have been so complicated that the system is almost completely broken. The rules of Subpart F which govern the taxation of foreign subsidiaries controlled by American companies have become increasingly complicated over time, adding to the overall complexity of the tax code and making it easier for companies to exploit loopholes to escape taxes.
Experts agree that deferral provides a substantial incentive for American companies to locate investment and jobs overseas.
Conservative economist Kevin Hassett of the American Enterprise Institute: "The U.S. tax code definitely provides a strong incentive for sending jobs overseas." [WSJ, 3/12/2004]"
Congressional Research Service: "Economic theory is relatively clear on the basic incentive impact of the system: it encourages U.S. firms to invest more capital than they otherwise would in overseas locations where local taxes are low… Accordingly, deferral poses an incentive for U.S. firms to invest abroad in countries with low tax rates over investment in the United States." ["Tax Exemption for Repatriated Foreign Earnings," 10/22/2003]
Martin Sullivan, Tax Analyst. "The U.S. tax system is set up, unfortunately, in a manner that it is far more profitable to set up an operation in Ireland or in Singapore than it is in Des Moines, Iowa." [Kudlow & Kramer Transcript, 3/12/2004]
Steve Liesman, Senior Economics Reporter for CNBC. "Turns out there really are provisions in the tax code that seem to encourage sending jobs offshore… One of the most important is through the ability to defer and often never pay taxes on foreign-earned profits. The result: foreign profits of U.S. companies end up taxed at a lower rate than their U.S. income, creating an incentive to invest overseas in factories. The jobs are where the factories are."
Bush Economic Adviser Harvey Rosen: "Profits earned by a foreign subsidiary are taxed only if returned (repatriated). Thus, for as long as a subsidiary exists, earnings retained abroad can be kept out of reach of the US tax system… to the extent that a foreign country taxes corporate income less heavily than it does the United States, deferral makes the country attractive to US firms as a 'tax haven.'"
Kerry's International Tax Reform Proposal: John Kerry is proposing the most sweeping simplification of international taxes in over forty years: eliminating deferral so that companies pay taxes on their international income as they earn it rather than being allowed to defer taxes.
Eliminating deferral so companies are taxed the same whether they invest abroad or at home. John Kerry will eliminate all of the complications in the current Subpart F regime and replace them with a simple system: companies will be taxed on their foreign subsidiaries profits just like they are taxed on their domestic profits. The new system will apply to profits earned in future years - it will not be applied retroactively to profits already earned abroad.
Promoting America's competitiveness in a global economy. Kerry's plan will still allow companies to defer the income they earn when they locate production in a foreign country that serves that foreign country's markets. This will ensure American companies can compete in international markets. For example, if you want to open a hotel in Bermuda, a bank branch in Shanghai to service the Chinese market, or a car factory in India to sell cars in India, you can still defer your foreign income. But if you open up a call center in India to answer calls from outside of India or re-locate abroad to sell cars back to the United States or Canada you must pay taxes just like call centers and auto manufacturers in the United States.
Close abusive international tax loopholes. John Kerry is proposing to end abuses that allow American companies to escape taxes by taking advantage of complicated international tax rules. These abuses include "corporate inversion" where an American company moves its headquarters to a tax haven like Bermuda to avoid taxes, certain types of cross-crediting that encourage companies to shift income and jobs to low-tax havens, restricting tax avoidance through hybrid structures, and other abuses.
Eliminating deferral will improve the efficiency of the economy by making taxes neutral so that they do not encourage companies to over-invest abroad solely for tax reasons. Currently American companies allocate their money not in search of the highest return but in search of the lowest taxes. Eliminating this incentive will increase the efficiency of the economy:
Congressional Research Service: "According to traditional economic theory, deferral thus reduces economic welfare by encouraging firms to undertake overseas investments that are less productive - before taxes are considered - than alternative investments in the United States." ["Tax Exemption for Repatriated Foreign Earnings," 10/22/2003]
Department of the Treasury: "Among all of the options considered, ending deferral would also be likely to have the most positive long-term effect on economic efficiency and welfare because it would do the most to eliminate tax considerations from decisions regarding the location of investment." ["The Deferral of Income Earned Through U.S. Controlled Foreign Corporations," 12/2000]
George Bush's Economic Adviser Harvey Rosen (Member of the Council of Economic Advisors): "The maximization of world income requires that the before-tax rate of return on the last dollar invested - the marginal rate of return - be equated." [Public Finance, McGraw-Hill/Irwin]
Jane Gravelle, Tax Expert: "If the objective is to move in the direction of conforming U.S. tax more closely to capital export neutrality, certain revisions that would move in that direction would be appropriate. These revisions include current taxation of earnings of controlled foreign corporations."
Kerry's Plan to Lower Corporate Rates by 5 percent to Improve Competitiveness. Kerry's plan saves an average of $12 billion annually from eliminating the ability of companies to defer taxes on foreign income and closing corporate loopholes. These savings are all used to cut corporate tax rates by 5 percent.
Cut the corporate tax rate by 5 percent. Kerry's proposal will not increase the deficit or corporate taxes by one dime. All of the savings from ending tax breaks will go towards lowering the corporate tax rate from 35 percent today to 33.25 percent - a 5 percent reduction.
Enhancing the competitiveness of U.S. companies by cutting taxes for more than 99 percent of taxpaying companies. By ending tax incentives to move jobs overseas and using those funds to lower the corporate tax rate the Kerry international tax reform will increase investment and hiring by American companies. An analysis of IRS data shows that more than 99 percent of corporations paying corporate income taxes would see their taxes reduced by Kerry's proposal.
Lowering the tax differential with foreign countries. The tax differential between U.S. corporate rates and foreign corporate rates have grown over the last two decades. Kerry's proposal would begin to narrow that gap again.
Kerry's One-time Holiday to Encourage Companies to Reinvest their Foreign Profits in America: Kerry's plan will unlock billions of profits that are stuck abroad, encouraging American companies to bring their profits back to America and re-invest them to jump-start the economy. This holiday will work to increase investment because it is part of a comprehensive plan to transition to a new system that eliminates deferral and the associated incentives to keep profits overseas.
More than $639 billion of American profits are stuck abroad. At the end of 2002 American companies were keeping $639 billion in profits abroad, avoiding having to pay taxes on this money. This is up sharply from $403 billion in profits in 1999. [CRS, "Tax Exemption for Repatriated Foreign Earnings," 10/22/2003]
Encouraging companies to bring that money back to America with a one-year, 10 percent tax holiday. Kerry's plan will encourage companies to bring that money back and invest it in the American economy. For a one-year period only, Kerry will provide companies with a special low rate of 10 percent on any profits they reinvest in the United States for companies with a domestic reinvestment plan. This rate will only apply to repatriations in excess of average repatriations over a base period.
Increasing investment. By ending future incentives to keep profits abroad and combining this with an appropriate transition that provides a one-time tax holiday this would increase investment and stimulate the American economy, helping to re-start job growth.
Paying for the New Jobs Tax Credit. The tax holiday would result in an immediate revenue gain which would pay for the New Jobs Tax Credit - another boost to job growth in America.
Restarting job growth today with a New Jobs Tax Credit for manufacturing, other industries affected by outsourcing and small businesses. John Kerry is proposing an expanded version of his New Jobs Tax Credit to provide a tax credit to cover employers' payroll taxes for new jobs created in manufacturing, other industries affected by outsourcing, and small businesses.
Tax credit covers employer's payroll tax costs for new hires. Kerry's New Jobs Tax Credit will cover the employer's increase in payroll tax costs. If a company currently employing 100 people goes up to 110 people, this company would get a tax credit to cover the added payroll tax costs it would need to pay for those 10 extra employees.
Applicability of the credit. The Secretary of the Treasury - in consultation with the Secretaries of Labor and Commerce - would determine which industries were classified as "manufacturing and other industries affected by outsourcing." This determination would be based on industries - and companies - where the majority of the employees are engaged in manufacturing or potentially subject to outsourcing, a category that would include call centers and software workers. The small business credit would be available to businesses that employ up to 99 people.
Academic research demonstrates that New Jobs Tax Credits increase employment. According to one study, "Those firms that knew about the program hired over 3 percent more workers than other firms." [Jeffrey Perloff and Michael Wachter, "The New Jobs Tax Credit: An Evaluation of the 1977-78 Wage Subsidy Program," AER Papers and Proceedings, May 1979.]
Top Princeton labor economist Alan Krueger notes value of previous new jobs tax credit: "[T]he Bush tax cuts were aimed not specifically at job creation... In previous recessions, counter cyclical policy was focused on job creation." Krueger notes when a new jobs tax credit "which gave employers a tax rebate if they expanded employment" was previously utilized studies "suggested that the tax credit spurred job growth." [New York Times, July 24, 2003]
Small businesses owners that create jobs would pay lower taxes and provide health care to their workers would pay lower taxes under Kerry than under Bush. Here are four examples of small businesses and how they fare under the tax plans of Kerry and Bush:
KERRY NET TAX CUT* BUSH TAX CUT
95% of small business owner making $200,000 (AGI) even if they do not create any jobs No tax change No tax change
A small business owner making $100,000 who hires 1 additional worker making $30,000 $2,295 tax cut No tax cut
A small business owner making $250,000 who hires 2 additional workers making $30,000 $2,739 tax cut No tax cut
A small business owner making $500,000 who hires 4 additional workers making $50,000 $2,969 tax cut No tax cut |
