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Defending the “Indefensible”

4 min readBy: Scott Hodge

It has never been easy or popular to defend lower taxes for businesses. As I learned recently by appearing on MSNBC’s Hardball, it is even more challenging in today’s highly charged political climate over corporate governance and financial irregularities.

I was asked to come on the program to defend, or at least explain, why some U.S. companies have taken the dramatic step of re-incorporating in low-taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. countries such as Bermuda. As Mike Barnicle, the show’s substitute host said to me: “Scott, you seem like a nice guy, you’ve just got an impossible position to defend.”

Most politicians – including my opponent on the program, Rep. Bernie Sanders (I-VT) – are calling such re-incorporations “unpatriotic” and are seeking to outlaw them in the future.

Setting aside the political rhetoric (in some cases demagoguery), what these companies are doing is little different from what millions of Americans do every day – reside in one jurisdiction and work in another. Here in the nation’s capital, thousands of us live in the Virginia and Maryland suburbs but work in Washington, DC. Why? Lower taxes are one of the main reasons.

In other cities, such as Philadelphia, most workers prefer to live in the low-tax suburbs than pay the city’s 4.5 percent wage tax. Snowbirds flock to Florida for 51 percent of the year to take advantage of the Sunshine state’s warm climate, of course, but the absence of a state income tax probably plays a major role.

Economist Charles Tiebout once described this behavior as “voting with your feet.” The ability of people and firms to relocate to lower-taxed jurisdictions is often credited with promoting tax competition among cities, states, and even countries. At a minimum, the fear of losing residents or businesses can prevent politicians from raising taxes too high compared to their neighbors.

Politicians in New Jersey are about to learn that lesson. Earlier this year, lawmakers there enacted a $1.3 billion tax hike. Among the provisions was a change in the state’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. that is intended to double corporate income tax collections.

The effect on the state’s business climate was immediate. As reported in the NorthJersey Record, Federated Department Stores (the parent company of Macy’s and Bloomingdale’s), announced that the new tax hike would more than double the company’s state tax payments from $4.4 million to $10.1 million next year. In a letter to Gov. James McGreevey, the company’s chairman wrote, “[Federated] cannot and will not absorb a $5.7 million New Jersey tax increase without taking commensurate measures to reduce expenditure there.” The bottom line: Federated plans to lay off 50 to 60 employees at a distribution center and expects future closings of stores or facilities.

Ironically, business and political leaders in New York (which has traditionally been a high-tax state but has cut business taxes in recent years), are now encouraging New Jersey firms to consider moving to the Empire State.

But imagine what would happen if New Jersey had the legal authority to prevent firms from escaping to low-tax New York. Trapped New Jersey firms would become less competitive and continue to cut jobs or lose market share, while New York firms would become relatively more competitive, adding jobs and growing the local economy.

In a similar vein, politicians in Washington should not react to the recent wave of re-incorporations by building a legal wall around the country. They should instead fix the systemic problems in the U.S. international tax rules that are forcing companies to look for relief in offshore tax havens.

To his credit, House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. Chairman Bill Thomas has introduced H.R. 5095, the American Competitiveness and Corporate Accountability Act, which includes 19 over-due improvements to the tax laws governing the foreign operations of U.S. companies and would curb the flight of companies to tax havens.

While these fixes to our international tax laws will clearly allow many firms to compete more effectively overseas, it is still an open question whether these changes are enough to prevent some firms from seeking additional tax relief on their own. Instead of relocating to Bermuda, some may re-incorporate in Ireland, which has a favorable tax treaty with the U.S. and will have a 12.5 percent corporate tax rate next year.

The tax fix missing from the Thomas bill is a cut in America’s high corporate tax rate.

With the increased mobility of capital in the global marketplace, the investment decisions of U.S. multinational firms are much more sensitive to the tax rates of host countries. If taxes are a major determinant to where firms invest abroad, doesn’t it make sense that they would be similarly sensitive to taxes at home? Of course.

At 35 percent, our corporate tax rate ranks as the fourth highest among the 24 leading industrial countries in the world. Countries with lower corporate rates include: France (33.3 percent); Great Britain (30 percent); and, Japan (30 percent). Even socialist countries like Denmark (30 percent), Finland (29 percent), and incredibly, even Sweden (28 percent) have lower rates.

The U.S. started the global tax competition race in 1986 when we lowered our 45 percent corporate tax rate to 34 percent. Sixteen years later the world has passed us by, and our rate has bounced up to 35 percent.

Cutting corporate tax rates may not be the most popular thing for lawmakers to do in today’s political climate, but it’s the right thing.