Would Territorial Taxation Create 800,000 Jobs Abroad at the Expense of U.S. Jobs?

Jake Tapper reports that President Obama will attack Mitt Romney for the Republican challenger’s support of territorial taxation. This appears to be sparked by a new study appearing in today’s Tax Notes publication, in which Professor Kimberly Clausing calculates that a territorial system would increase employment in low-tax countries by 800,000 workers. According to Tapper, “The president will make the argument today that those overseas jobs would be created at the expense of jobs created in the U.S.”

Under the current “worldwide” tax system, the U.S. taxes all earnings of its corporations, including those earned abroad. While this U.S. tax can be deferred if earnings are reinvested abroad, tax is incurred once earnings are “repatriated,” or brought back to the U.S. Most other major industrialized countries employ a “territorial” system, whereby a government taxes only those earnings originating within its borders.

With the worldwide system, U.S. companies are at a competitive disadvantage because they face tax costs for repatriation not incurred by foreign competitors, and because the U.S. holds the highest tax rate in the developed world. A territorial system would give U.S. companies an even playing field to compete against foreign multinationals in every market.

Opponents of territorial taxation view the system as a corporate handout, lowering taxes for multinationals and making foreign investment look more attractive. This is where Kimberly Clausing’s analysis enters the debate. Using estimates of U.S. company responsiveness to global effective tax rates from 1982-2004 and assuming that responsiveness would increase under a territorial system, she estimates 800,000 jobs created abroad, based on the current effective tax rate for domestic investment, 27.1 percent.

There are three problems with this analysis and the notion that these jobs would come at a cost to U.S. workers:

• First, her measure of 800,000 jobs is simply foreign employment growth. It does not mean job “displacement” or “migration” out of the U.S. Clausing herself notes that “if U.S. unemployment rates are low, jobs abroad need not displace jobs at home” (Tax Notes subscription required). Her qualification on unemployment rates may actually be backward, but the general point is that job creation abroad does not mean job destruction at home. To the contrary, empirical research indicates that foreign employment growth increases demand for exports and increases productivity of U.S. workers.
• Second, this calculation uses the current U.S. effective tax rate. Romney’s plan, as well as other territorial proposals, would lower the marginal tax rate to 25 percent and reduce the average effective rate even further. With a smaller difference between the U.S. rate and alternate offshore destinations, overseas employment would not be so dramatic.
• Third, the calculation ignores the job-importing effects of a lower U.S. tax rate and elimination of the repatriation tax. Just as U.S. companies increase investment when foreign taxes are reduced, so too would foreign companies increase investment in the U.S. after a tax cut. Likewise, with a territorial system, U.S. companies would gain access to $1.4 trillion in overseas earnings currently “locked-out” by the repatriation tax. This alone has been estimated to have the stimulative capacity to create up to 5 million domestic jobs.

Claiming that Clausing’s study finds that the U.S. would lose 800,000 jobs under a territorial system is disingenuous at best. Clausing’s analysis must be read within context, and that context is the implausible scenario of the U.S. implementing a territorial tax system without lowering its tax rates. Even then, those jobs would not be “leaving” the U.S.

As Tapper notes, the President’s own Export Council, Simpson-Bowles Commission, Council on Jobs and Competitiveness have advocated for a territorial system. These independent boards and others have advocated for territorial taxation on its merits: that it would end the trapped earnings problem and make U.S. companies more competitive in the international marketplace.

More on territorial taxation here.