Tag: foreign direct investment

Investment Flows and Corporate Taxes

The Obama administration is showing interest in reforming the U.S. corporate income tax. That’s good news because a lower corporate rate would boost domestic investment, which in turn would generate more jobs and higher wages and incomes.

A lower corporate rate would also attract more inflows of direct investment from abroad—foreign-based businesses expanding their plants and building new plants in the United States.

I updated this chart from our book, Global Tax Revolution. It shows that during the 1980s, the United States enjoyed higher inflows of foreign direct investment (FDI) than outflows. But since then, the pattern has reversed—our companies are now investing more abroad than foreign-based companies are investing in the United States. (Data is from the BEA).

There are numerous factors that affect these flows, but there is no doubt that taxation plays an important role. If we cut our corporate tax rate, we would attract more investment (move the black bar upwards), which would be good for the U.S. economy.

There is an important caveat with the data, however. A large portion of FDI involves mergers and acquisitions. If a foreign company takes over a U.S. company, that’s an investment inflow. If such a takeover is a market-driven event that increases efficiency, that’s fine with me. However, there is evidence that foreign companies are taking over U.S. companies because we have anti-competitive “worldwide” corporate tax rules.

So the solution is to move to a “territorial” corporate tax system and substantially reduce the federal corporate tax rate. That way, we wouldn’t artificially encourage the takeover of U.S. firms, while also attracting larger inflows of job-generating greenfield investments.

A final note on the chart: it clearly shows that U.S. international investment has exploded in magnitude over the last couple of decades. That explosion has greatly increased the importance of having a competitive corporate tax code. So good for the Obama administration for looking into possible reforms.

Buy American Hurts Most Americans

Earlier today, Doug Bandow weighed in with some commentary on the problems that Buy American provisions are creating for both Canadian and American businesses. Let me reinforce his view that such rules are anachronistic and self-defeating with some thoughts from a forthcoming paper of mine about the incongruity between modern commercial reality and trade policies that have failed to keep pace.

Even though President Obama implored, “If you are considering buying a car, I hope it will be an American car,” it is nearly impossible to determine objectively what makes an American car. The auto industry provides a famous example, but is really just one of many that transcends national boundaries and renders obsolete the notion of international competition as a contest between “our” producers and “their” producers. The same holds true for industries throughout the manufacturing sector.

Dell is a well known American brand and Nokia a popular Finnish brand, but neither makes its products in the United States or Finland, respectively. Some components of products bearing the logos of these internationally recognized brands might be produced in the “home country.” But with much greater frequency nowadays, component production and assembly operations are performed in different locations across the global factory floor. As IBM’s chief executive officer put it: “State borders define less and less the boundaries of corporate thinking or practice.”

The distinction between what is and what isn’t American or Finnish or Chinese or Indian has been blurred by foreign direct investment, cross-ownership, equity tie-ins, and transnational supply chains. In the United States, foreign and domestic value-added is so entangled in so many different products that even the Buy American provisions in the recently-enacted American Recovery and Reinvestment Act of 2009, struggle to define an American product without conceding the inanity of the objective.

The Buy American Act restricts the purchase of supplies that are not domestic end products.  For manufactured end products, the Buy American Act uses a two-part test to define a domestic end product: (1) The article must be manufactured in the United States; and (2) The cost of domestic components must exceed 50 percent of the cost of all the components. Thus, the operational definition of an American product includes the recognition that “purebred” American products are increasingly rare.

Shake your head and chuckle as you learn that even the “DNA” of the U.S. steel industry, which pushed for adoption of the most restrictive Buy American provisions and which has been the manufacturing sector’s most vocal proponent of trade barriers over the years, is difficult to decipher nowadays. The largest U.S. producer of steel is the majority Indian-owned company Arcelor-Mittal. The largest “German” producer, Thyssen-Krupp, is in the process of completing a $3.7 billion green field investment in a carbon and stainless steel production facility in Alabama, which will create an estimated 2,700 permanent jobs. And most of the carbon steel shipped from U.S. rolling mills—as finished hot-rolled or cold-rolled steel, or as pipe and tube—is produced in places like Canada, Brazil and Russia, and as such is disqualified from use in U.S. government procurement projects for failure to meet the statutory definition of American-made steel.

Whereas a generation ago the cost of a product bearing the logo of an American company may have comprised exclusively U.S. labor, materials, and overhead, today that is much less likely to be the case. Today, that product is more likely to reflect foreign value-added, regardless of whether the product was “completed” in the United States or abroad. Accordingly, Buy American rules and trade barriers of any kind (as appealing to politicians as they may be) hurt most American businesses, workers, and consumers.

It’s time to wake up and scrap these stupid rules.