US President Obama set off a lot of alarm bells all over the world with his “Buffalo vs. Bangalore” speech, where he promised to revoke tax breaks that “reward our companies for moving jobs off our shores”.
Not that the Hatter doesn’t trust the usual gaggle of journalists that report on these things, but he is of a suspicious bent, often unreasonably so. The lack of specific information on what exactly was a bit jarring to his oversensitive soul, so he went off to find some.
Apparently, the plan hasn't been fully released yet, but reactions to it have been coming in already. We have a little more detail than we did earlier, in the form of some clarifications from the Man himself.
So, should Bangalore be getting their collective dhotis in a knot? Are we in for punitive taxation on outsourcing? Is this the end of Silicon-Halli's cost competitiveness?
The details, sketchy though they may be, were more interesting than the Hatter imagined they would be. Here's what he understood, simplified just a little bit so his head doesn't hurt as much:
The status quo is thus. Imagine a hypothetical US corporation, let's call it Acme Corp. Let's say Acme Corp sells $1000 worth of stuff a year. If Acme makes its stuff in the US, using US labor, its costs are $800 - netting it a $200 profit. Say the tax on that profit is 30%. Acme pays $60 to the guvmint and keeps $140. Not a bad business, eh? That is, until ChinChin Inc from Shanghai starts selling its stuff for $800. Now Acme has to match ChinChin's price, which wipes out its profit.
So, Acme reluctantly moves production overseas to Elbonia, where its costs are $400. Now, it can sell stuff at $800, and make a handsome profit. The lark's on the wing, the snail's on the thorn and the spirit of David Ricardo smiles.
But wait, how much tax does Acme have to pay? Whom does it pay to? The US Guvmint or the Elbonian Guvmint? Or both? Or neither?
The answer, my friends, is stranger than one can imagine. Assume $400 of those sales came from the US and $400 from other parts of the globe - fair enough in these globalized days. US tax laws say Acme pays US tax on its US profits of $200. Also, it pays US tax on its foreign profits of $200, but can claim credits for any foreign taxes it paid on that profit. So far so good.
And it gets better. Thanks to all the lobbying that Acme and its pals have done in the past, the US guvmint doesn't require it to pay taxes on foreign profit of $200 until the money is brought back into the US. If Acme reinvests that money in Elbonia or elsewhere, the tax can be "deferred" - not paid until the money is brought back.
The really clever part is that Acme gets to claim its cost of production in Elbonia as expenses, though it defers paying tax on the profit.
So, Acme's US profit is $200, its foreign profit is $200. In generating the foreign profit of $200, Acme spent $200 in Elbonia, which it can claim as expenses, making its net US taxes zero. Yes, zero. Did I say something about being stranger than one can imagine?
And Acme can create a subsidiary in the Cayman Islands (which doesn't tax income), and pretend its foreign profits came from there, and never pay any tax on foreign income, while all the while claiming foreign costs as expenses. Nifty deal, whoever they paid to lobby for that really earned his money! The US Guvmint ends up subsidizing Acme's investment in Elbonia to the tune of 30%!
So, all the while US multinationals investing in Bangalore or Shanghai or Ukraine, or even Belgium, had been claiming costs there as expenses, while never paying taxes on their foreign profits. The sheer brilliance of this trick has left the Hatter a bit dizzy.
This is what Obama wants to do away with - foreign tax deferral coupled with being able to claim foreign costs as expenses, leading to the US government effectively subsidizing foreign investment of US corporations.
So what if Obama does as he threatens, and defer expense credit on deferred foreign taxes? US MNCs will now have to account for the full cost of investing abroad, and cannot expect an effective subsidy from the US taxpayer. Will this mean they'll invest in the US instead? No!
Why not? Because it remains cheaper to invest outside the US, even though less so without the tax break (read subsidy). Assuming they're rational (to be fair, that's not a word the Hatter would associate with any of his employers thus far), they will continue to invest abroad at the cost of the US, and make the same pre-tax profit. Only, they'll pay more taxes on the profit.
So, no new jobs will be created in Buffalo. Acme will still invest in Elbonia. Tech MNCs will still invest in Bangalore. The US Guvmint just gets to keep more of their profit as tax. And spend it.
Then why talk about creating jobs in Buffalo?
This is where the Man's political genius shines through. Obama has succeeded in framing the debate as a jobs-for-americans debate. That means he gets public support on this while he takes on the lobbying power of US Business, which knows what this is really all about - making them pay their taxes. Keep the job rhetoric loud enough, get enough constituents pressurizing Senators and the lobbying might not work. Brilliant, bordering on evil genius level.
Tip o' the hat to Barack Obama. Well played, sir!
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