Commentary

Demonizing Foreign Investors for the Sins of U.S. Tax Policy Is as Dangerous as It Is Absurd

Blaming foreigners for homegrown economic woes is a tradition of sorts in Washington. In recent years, the favored scapegoat has been China and its folkloric trade indiscretions. But, lately, some have taken to demonizing foreign companies for the sins of a broken U.S. corporate tax system. Given the importance of foreign multinationals and their U.S. affiliates to the U.S. economy, let’s hope policymakers don’t do anything we’ll regret.

U.S. corporate tax policy is punitive, especially toward U.S. companies. U.S. multinationals are subject to double taxation-first at local tax rates in the foreign countries where they operate and then by the Internal Revenue Service at up to 35 percent (the highest rate among the world’s 34 richest economies), when profits are brought home. Foreign multinationals are subject to lower tax rates at home than in the United States, and the profits they earn abroad generally are not taxed a second time.

The U.S. tax system compels U.S. companies to devote as much attention to tax avoidance as they do to pursuing genuine market opportunities. Keeping profits offshore, instead of repatriating them, is the most common form of tax avoidance for U.S. multinationals. Current estimates value those resources at $2 trillion, which represents a large opportunity cost to the U.S. economy.

Given the importance of foreign multinationals and their U.S. affiliates to the U.S. economy, let’s hope policymakers don’t do anything we’ll regret.

Over the past couple of years, there were several high-profile transactions where U.S. companies acquired foreign companies and then reestablished the entity as foreign-headquartered to reduce their tax burdens. It’s not difficult to see how the broken tax code would encourage these kinds of reorganizations. However, concern over declining tax revenues caused the U.S. Treasury Department to impose new restrictions last year on these so-called corporate inversions, which have subsequently declined in popularity.

Now some are claiming that the Treasury, by impeding inversions, has created a new incentive for foreign acquisitions of U.S. companies. Combined with the advantages that foreign multinationals already have on account of the repatriation tax, which limits the cash available to U.S. multinationals to invest at home, foreign acquisitions should be expected to continue, they argue - to the detriment of the U.S. economy.

Implicit in this argument is the fallacy that outbound investment - the purchases of foreign companies by U.S. companies - is good for the United States and inbound investment, somehow, is not. It considers acquisitions of foreign companies by U.S. companies to be points for Team USA, and acquisitions of U.S. companies by foreign companies to be the other team’s points.

Republican Senator Rob Portman, who is running for reelection in Ohio - a state where the electorate warms to these “Us versus Them” characterizations of trade and investment - seems to share the concern that the tax code advantages foreign-owned businesses. Portman is chairing a committee hearing on July 30 that will “explore the impact of the U.S. corporate tax code on foreign acquisitions of U.S. businesses and the ability of U.S. businesses to expand by acquisition.”

Although foreign multinationals might enjoy some tax advantages by happenstance, they suffer costs, as well.  First, by encouraging U.S. multinationals to keep profits abroad, America’s repatriation tax puts more resources in the hands of foreign affiliates of U.S. companies abroad, where they compete for business (and businesses) in the backyards of foreign multinationals. Second, those same high U.S. corporate rates are assessed on the profits of these foreign companies’ U.S. operations.

In fact, U.S. affiliates of foreign companies carry a larger tax burden than the average U.S. private sector company, accounting for 11.8 percent of taxable U.S. corporate income, but paying 13.8 percent of all U.S. corporate income taxes. U.S. affiliates of foreign companies even pay a higher effective tax rate than the U.S. private sector average: 26.9 percent versus 22.9 percent.

When U.S. companies invest abroad, it is those companies - their management, workers, and shareholders - that benefit. Of course those benefits trigger domestic economic activity, create jobs at home, and expand the tax base, too. But relative to inward investment, the benefits of outward investment accrue to the U.S. economy more slowly and through narrower channels.

The U.S. economy benefits more - and more directly - from foreign investment in the United States. Foreign acquisitions of U.S. companies, like “greenfield” investment, spark domestic supply chain activity, lead to more capital investment and more research and development spending, create higher paying jobs, introduce best business practices, and expand the tax base. Numerous studies in recent years - from academia, think tanks, and various business groups - show how the U.S. economy benefits from foreign acquisitions of U.S. companies.

A detailed study published by the Organization for International Investment presents extensive evidence that U.S. subsidiaries of foreign-headquartered companies (U.S. “affiliates”) have had an overwhelmingly positive effect on the U.S. economy - and on other U.S. companies.  Between 2001 and 2010, overall U.S. private-sector GDP increased by 39 percent, which was boosted by the 56 percent GDP increase experienced by affiliates. Over the decade, affiliates increased their U.S. stock of property, plant, and equipment by 46 percent - double the overall private-sector rate of increase.

Even though affiliates account for less than 0.5 percent of all U.S. companies with payrolls, they punch well above their weight, accounting for: 5.9 percent of private-sector value added; 5.4 percent of private-sector employment; 11.7 percent of new private-sector, non-residential capital investment, and; 15.2 percent of private-sector research and development spending. They earn 48.7 percent more revenue from their fixed capital and compensate their employees at a 22.0 percent premium to the U.S. private sector average.

Affiliates raise average U.S. economic performance by boosting output, sales revenue, exports, employment, and compensation. They demonstrate stronger than average long-term commitments to operating in the United States with rising levels of capital investment, reinvested profits, research and development spending, and cultivation of relationships with U.S. suppliers. Moreover, U.S. companies benefit from exposure to the best practices employed by affiliates, many of which are world-class companies that succeeded in their home markets and have what it takes to succeed abroad.  Competitive jolts, technology spillovers, and the hybridization and evolution of ideas are all difficult-to-quantify benefits of the infusion of foreign direct investment.

The problem is that some U.S. policymakers inadequately grasp that we live in a globalized economy, where the United States is competing with other countries to attract investment in domestic value-added activities. Employers looking to build or buy production facilities, research centers, biotechnology laboratories, hotels, and shopping malls consider a multitude of factors, including size of the market, access to appropriately skilled workers, ease of customs procedures, condition of transportation infrastructure, legal and business transparency, and the burdens of regulatory compliance and taxes, to name a few. Globalization means that public policies - including tax policies - are on trial.

While an overhaul of the tax code would be welcomed by both foreign- and U.S.-based multinationals, one-off “reforms” designed to reduce the number of foreign acquisitions would only drive badly needed investment away at great cost to the U.S. economy and its workforce.

Daniel J. Ikenson is the director of Cato Institute’s Herbert A. Stiefel Center for Trade Policy Studies.