Tax Policy Killing Our Manufacturing Base

Business Week is a venerable magazine that I was only minutes away from canceling because their content was the typical irrelevant journalistic crap when recently they were taken over by Bloomberg.  All the sudden I would say now that Bloomberg / BusinessWeek is the single most useful magazine I subscribe to, more valuable than Forbes, Fortune, or Barron’s.

Their articles are in-depth and hard hitting.  Rather than assume that you are a “lay” or “casual” reader, Bloomberg does actual research and writes for sophisticated readers wanting to learn more about a topic that they have some familiarity with.  Also rarely do they use the journalistic old-hat trick of trying to link every story to some sort of “man on the street”.

Bloomberg wrote an excellent article titled “Google 2.4% Rate Shows How $60 billion Lost to Tax Loopholes“.  While the US corporate income tax rate is the highest in the developed world at 35% (we are neck-in-neck with Japan, but they have proposals to reduce their rate) certain industries in particular can use loopholes to avoid paying virtually any tax at all.

Google uses a strategy known as “Double Dutch” which moves income through a number of subsidiaries in Ireland, the Netherlands, and Bermuda to avoid paying US taxes.  Theoretically they are “deferring” taxes to some future period, but they can defer them forever by never bringing the cash back into the United States.

This sort of activity is most suited to those types of companies with intellectual property, and if possible, some sort of world wide presence (although this is not really required).  It is not a co-incidence that the US fields some of the most competitive companies in this space including pharmaceuticals, technology and finance.

What isn’t discussed here nor typically understood is the same forces that provide a competitive advantage through low (effective) taxation to the above types of companies provide a disadvantage to those types of companies unable to reduce taxes due to the same types of arrangements and must pay the punishing US corporate tax rate.  Any wonder why heavy manufacturing sets up elsewhere around the world than in the US; it is much more difficult to do these sorts of tax arrangements if you have a physically intensive type of operation such as manufacturing, so they have fewer opportunities to reduce the tax burden.

Remember that good tax policy has 2 key elements:
– it collects the planned revenue amount
– it does not significantly distort economic behavior

Through the use of transfer pricing and other loopholes involving multiple countries our tax policy is effectively collecting nothing for Google, and little for many other similar companies such as pharmaceuticals.  Thus the policy is failing on that front.

And the burden of corporate tax collections fall on other companies, making them less effective, and impacting corporate decision making on the margins to not invest further in the USA in many cases, thus distorting economic activity.

Hats off to Bloomberg BusinessWeek for such a well written article, putting into understandable terms the use of loopholes that enables Google to pay virtually nothing while many other US companies are hammered with the highest rates in the developed world.

Cross posted at LITGM