Are Lawmakers Forgetting the Benefit Principle of Public Finance?

March 24, 2015

Truly an issue at the heart of public finance, the current quandary of how to fund U.S. infrastructure spending has risen to new levels. Among a handful proposals circulating in Congress, John Delaney (D-MD)—in what he purports is “a natural deal”—has introduced H.R. 625, which would levy a retroactive tax on accumulated foreign earnings of U.S. multinationals, in order to fund an infrastructure bank and the soon-to-be bankrupt Highway Trust Fund. Although seemingly reasonable to some, H.R. 625 represents a logical fallacy of the finest specimen.

Citing declining U.S. competitiveness and underinvestment in infrastructure, Delaney, at a March 3 event at the American Enterprise Institute, outlined his vision for killing two birds with one stone (bill): Solving chronic U.S. infrastructure funding issues and reducing the incentive for U.S. multinationals to hold foreign profits offshore.

In the case of H.R. 625, Delaney uses taxation of deferred foreign income (subpart F income) as a funding mechanism for U.S. infrastructure. Specifically, the bill includes an assessment of an 8.75 percent tax rate on foreign retained earnings, regardless of the current degree of liquidity of such earnings. For example, a U.S. multinational that has reinvested foreign profits into a factory sometime after 1986 will pay the same rate as if those earnings are currently in the form of cash.

This sort of funding mechanism, however, lacks a logical rationale and is yet another temporary measure. Significantly, Delaney’s proposition fails to take into account the important matching benefit principle in public finance: How have U.S. multinationals’ subsidiaries benefitted from U.S. infrastructure in accumulating foreign earnings? Most public finance aficionados would see little, if any, connection.

To highlight this concept, consider costs that the U.S. incurs for its national defense, legal system, or national police (FBI). These items are public goods and, thus, benefit all members of society—but almost exclusively those in the U.S. In a positivist perspective, it makes little sense for an entity that operates in a different jurisdiction and does not use these public goods to actually pay for them.

Moreover, H.R. 625 is problematic in that it only provides a relatively provisional cure and lacks the characteristics of a long-term and stable infrastructure funding mechanism that is so desperately needed. A key takeaway from the subsequent panel discussion at the AEI event is that there is an important distinction between a funding and a financing problem. The U.S. does not have a financing issue; infrastructure financing through the private sector works well, unless funding becomes unpredictable and occurs on an ad-hoc basis. However, there is clearly a funding issue, and as a resolution to that, taxing foreign accumulated profits since 1986 is arguably more of a transitory remedy.

Instead, a user fee focused approach would better adhere to the matching benefit principle of public finance. A gas tax increase or a mileage-based user fee system are two options to consider for raising revenue for infrastructure investment and the Highway Trust Fund. Although Delaney refuted the long-term viability of a gas tax—citing fossil fuels as a declining tax base in the long run—other participants during the panel discussion acknowledged its benefits and desirability as a source of funding. Steve Symms, a former U.S. senator, mentioned Ronald Reagan’s famous quotation that a gas tax really is not a tax at all; it is a user fee for driving on public roads.

The mileage-based user fee may have important privacy implications. But proposals exist that circumvent the government from knowing where you drive or park your car. For example, at the recurring vehicle inspection most people go through, each car’s odometer could be checked to determine how far the car has been driven. Implementing more widespread toll-based roads is also a potential solution.

The Tax Foundation’s Kyle Pomerleau has produced a report that discusses options to fix the Highway Trust Fund, where he specifically analyzes the feasibility of a gas tax increase.

A gas tax increase or some form of mileage-based user fee solution illustrates the virtue of the matching benefit principle. Costs are matched with the benefits enjoyed. Through this perspective, the flawed reasoning for a retroactive tax on accumulated foreign profits as a funding mechanism becomes increasingly evident.

In light of this argument, H.R. 625, as “a natural deal,” is truly a logical fallacy. In essence, it is an exemplar of lawmakers cutting corners, choosing what might be a politically easier, but principally wrong, path to trek.

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