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Outsourcing: Carrot or Stick Response?

2 min readBy: Chris Atkins

Representative Charlie Rangel, Chairman of the House Ways and Means Committee, released a statement expressing concern about the fact that Halliburton moved its corporate headquarters to Dubai. In his statement he partially blamed the 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. code, saying that this was:

“…another sad example of American companies increasingly moving off-shore. I am troubled by the continued outsourcing of jobs and am eager to find out how the tax code can be strengthened to encourage American companies to reinvest here rather than abroad.”

Senator John Kerry made similar comments earlier this year during floor remarks after he introduced S.96. That bill would, according to Senator Kerry, repeal deferral of U.S. corporate tax on foreign source income, which would have the impact of increasing corporate tax for those U.S. corporations who have foreign subsidiaries and, he hopes, make it less likely that U.S. companies would expand overseas.

Two prominent Democrats have stated their belief that the design of the U.S. corporate tax system is leading to a measurable decrease in U.S. investment. The question, then, is what to do about it? Should the U.S. punish companies who invest overseas or reward those who locate here?

A surprising answer comes from some ideological cousins in Europe, where governments are eschewing the stick in favor of the carrot. Center-left governments there (Spain for example) have chosen to fight off-shoring by reducing corporate tax rates and broadening the corporate tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .

As a result, companies are more likely to expand in Europe and, not surprisingly, corporate revenues are also up. This is consistent with our finding in a 2005 Special Report.

It’s also consistent with the findings of Martin Sullivan. He talked about this issue in depth during a podcast interview last year, where he expressed his belief that Democrats are going to adopt the carrot approach eventually. Why?

Because, like their European cousins, they will not be able to avoid the competitive pressures and, furthermore, they are soon going to realize that lowering the corporate rate and broadening the corporate base are the only way to maintain the viability of corporate taxation in the global economy. Lowering the rate makes a country more attractive to investment and broadening the base actually eliminates opportunities for tax planning.

A protectionist response that takes the stick to U.S. companies for investing overseas (i.e. repealing deferral, limiting foreign tax credits, and the like) is the wrong way to enhance competitiveness in the global economy. Lawmakers who want to do something about outsourcing should use the carrot approach and first look to reduce the U.S. marginal corporate tax rate, which is the second highest in the world.