Economic guru Keith Hennessey clearly explains the new tax proposed by President Obama:
Let’s look at three factories, each of which produces $100 of income.
- Your factory A is in the U.S. Your corporation pays a 35% U.S. corporate income tax rate ($35).
- Your factory B is in China. Your corporation pays a 15% Chinese corporate income tax rate ($15). You owe the U.S. government $35 in taxes, minus a credit for the $15 you paid to China. China gets $15, and the U.S. government gets $20.
- Your British competitor’s factory C is also in China. He pays a 15% Chinese tax rate ($15), and no taxes to his home government.
Factory B shows the effect of a worldwide tax system, in which the firm pays the same total tax wherever the income is earned. Taxes are based on the nationality of the payor, not the location at which the income is earned.
Factory C shows the effect of a territorial tax system. Income is taxed only where it is earned.
The U.S. actually has a hybrid. You can defer the taxes you owe from factory B until you bring that income back to the United States. This is an advantage relative to a pure worldwide system.
And then, he explains why Obama’s proposal isn’t wise:
Yes, in a territorial system companies can open factories overseas to avoid higher taxation in the U.S. But the more relevant comparison is whether Intel’s chip fabrication plant in China will be disadvantaged relative to the Malaysian, Brazilian, or French plant in China. If you are worried about a tax system encouraging U.S. firms to build factories overseas, you should worry that in a worldwide system, entire U.S. firms will move to a country with a territorial system.
A worldwide system fails if most other major economies are using territorial systems, and most are. Unless you think you can prevent increased globalization, or that you can convince other countries to change to a worldwide system, I think the international competitive pressure is inevitably toward a territorial system. In a world of increasingly mobile capital, it it both fair and smart for the U.S. to make sure we do not give firms based in other nations an unfair advantage. I also think that international competition to lower taxes is a good thing.
One wonders if Obama’s chief tax man, Timothy Geithner, really understands the above. Given his excuses regarding his failure to pay his own taxes properly, I have my doubts… if he can’t figure out a 1040, how can he comprehend this sort of thing?
Maybe that’s why the plan coming out of the Obama Administration makes little sense.