Aesop, the legendary Greek author of many beloved children’s stories, may actually have been an economist. He certainly had something relevant to say to today’s Washington leadership about how to thaw our chilled business climate.
Remember Aesop’s story about the contest between the sun and the wind? In the fable, the two heavenly forces are debating which of them is more powerful when they see a man walking down a lonely road. They decide to settle their dispute by seeing which of them can get the man’s coat off the fastest. The wind tries first, blowing fiercely at the man’s shoulders. But the man pulls the coat closer, and the wind cannot get it off. Then the sun takes its turn. It shines gently on the man, slowly warming him, until he decides to take the coat off himself.
I thought of this story the other day as I considered the tax policy debate, and the Obama administration’s fervent desire to get corporations to start spending the trillions of dollars they have salted away. For economic recovery to take hold, businesses must be convinced to relax their grip on that cash.
Businesses have faced a blustery political climate since 2007, when Democrats took control of Congress, and things got downright icy after President Obama took office in 2009. There has been harsh rhetoric about tax rates and “speculators” and “fat cats,” accompanied by a flurry of gusty policy action, ranging from union-friendly reinterpretations of existing labor law, to health care mandates and other payroll costs, to establishing (at some local levels, but not federally) “living wage” requirements. When all else fails, the playbook calls for hauling executives before Congress and grilling them on national television, often about trivia such as the use of corporate jets.
There has been the occasional ray of warmth, such as the administration’s decision last week to allow BP to drill once again for oil in the Gulf of Mexico, that is supposed to send a signal that things are fine again. But it is no wonder business leaders continue to cling to their cash. They have no idea from one minute to the next which way the political winds are going to blow.
The debate on international tax policy illustrates this. Under the current system, American companies must pay taxes to the U.S. government, even when their income comes from sales made in other countries. However, the tax bill doesn’t come due until the companies bring their profits back to the U.S. So if a corporation makes $1 million in India and uses that money to reinvest in India, it can defer its tax to the U.S. If, however, the corporation wants to reinvest the money stateside, it must hand over 35 percent to Uncle Sam.
Predictably, companies do everything they can to keep foreign-earned profits from returning home. The result is that less money makes it into the U.S. economy. Currently, American companies are keeping around $1 trillion in untaxed profits outside the U.S., according to Bloomberg.
The Obama administration’s proposed solution is to severely limit companies’ ability to defer taxation of overseas profits. That way, the burden would be just as heavy whether companies reinvest abroad or in the U.S. The administration expects that this will prompt companies to bring more money back to the U.S. It won’t; instead, it will simply give a major economic boost to competing corporations organized anywhere in the world except here – because the U.S. stands virtually alone in this world-wide approach to corporate taxation. Right now, American companies can at least maintain their competitive position by investing foreign profits in research, production and marketing abroad, as other nations’ companies do. The administration plan would just cut off the foreign profit stream, weakening American companies and resulting in even less tax revenue in the long run.
The sunshine approach comes from Rep. Dave Camp, chairman of the House Ways and Means Committee, who announced recently that he is working on legislation that would shift the U.S. to what is known as a “territorial tax system.” In territorial systems, only income earned within a country’s own borders is taxable there. Income earned abroad is exempt. This is how the rest of the world taxes corporate income.
The transition to a territorial system would lower overall corporate taxes, an important first step toward making the U.S. a friendlier place for businesses. By giving businesses incentives to grow, policies like the territorial tax system get companies to voluntarily release their cash reserves, putting money into the economy by purchasing new equipment and hiring new employees.
We’ve given Obama’s windy, anti-corporate policies a fair shot. It hasn’t gotten us anywhere; businesses have only pulled their coats closer. It's time now to give Camp’s sunshine a chance to do its work.