Corporate Tax Cut Windfall

Wall Street Journal
Tuesday, July 1, 2008

For those who still claim that tax rates don't matter to economic decisions or U.S. competitiveness, we present Exhibit A: the 2004 American Jobs Creation Act.

This law gave American companies a one-year window in 2005 to repatriate earnings from foreign subsidiaries to the United States at a 5.25% tax rate. Normally companies must pay the 35% U.S. corporate tax rate, minus a credit for whatever foreign taxes they paid on those earnings.

The IRS examined the results from this tax cutting experiment and found that the money came back in a flood. More than 800 U.S. corporations repatriated $362 billion from foreign operations. Congress's Joint Committee on Taxation had predicted closer to $200 billion. These dollars are now being invested in the U.S., rather than remaining in Europe or China. This capital infusion may be one reason that U.S. business investment rose 9.6% in 2005 – the highest rate in more than a decade.

Many Democrats, liberal groups and even some economists in the Bush Treasury opposed the measure four years ago, predicting it would lose revenue and merely be a tax holiday for profitable corporations. The Joint Tax Committee estimators also blundered again by predicting a mere $2.8 billion in revenue gains in the first year and then big losses after 2005. As always, they underestimated how tax reductions change behavior. The tax incentive raised $18 billion in 2005, and revenues have continued to exceed estimates. Instead of getting 35% of nothing, as U.S. companies kept their cash abroad, the Treasury took in 5.25% of the hundreds of billions the companies brought home.

One lesson here is how hypersensitive the trillions of dollars of annual global capital flows are to tax rates. It also underscores how damaging the U.S. corporate income tax is to American firms. Over the past decade the U.S. has gone from a below-the-average corporate tax nation to the second highest rate in the industrial world. (See table.) Many countries have slashed their corporate rates to as low as 10%. The economic impact is even worse because the U.S. is one of the few countries that taxes foreign subsidiary income when it is repatriated.

Most countries let their companies pay taxes in the country where the income is earned, and the few countries that do tax repatriated income are changing their models. Japan is the only developed nation with a higher corporate tax rate than the U.S., but the Japan Times reports that the government wants to change its tax laws to stop taxing repatriated capital.

America's tax laws are repelling capital at the same time the rest of the world is inviting these dollars and the jobs and growth that inevitably follow. House Ways and Means Chairman Charlie Rangel wants to dig the ditch deeper by taxing American companies on their foreign earnings whether or not they bring the money back to the U.S. He thinks this will raise money for the Treasury, but the likelier effect is that more American multinationals will relocate abroad.

Senator John Ensign of Nevada, the author of the 2005 holiday bill, is proposing to do the same again for one year to stimulate the economy. As a rule, we don't like temporary tax cuts because they don't provide permanent incentives. But the 2005 holiday was an exception that proved the folly of current policy.

The best response going forward would be for Congress and the next Administration to reduce sharply the corporate tax rate so it is competitive with falling rates around the world. John McCain is proposing to cut it to 25%. If Barack Obama really wanted to "run to the center," he'd see that and cut it even further. As the 2005 results show, he'd then have more tax revenue to spend on his many social programs.