Date: Sat, 9 Oct 2004 00:05:53 -0700 From: Norm Matloff To: Norm Matloff Subject: LAT article shows Kerry's offshoring "fix" isn't To: H-1B/L-1/offshoring e-newsletter Very good article, explaining in detail why Kerry's tax plan re offshoring would accomplish very little. See also http://heather.cs.ucdavis.edu/Archive/Kerry.txt Norm http://www.latimes.com/business/la-fi-kerryjobs8oct08.story Kerry's Plan to Rein In Outsourcing Has Holes By David Streitfeld Times Staff Writer October 8, 2004 Democratic presidential candidate Sen. John F. Kerry cites the shuttered steel plant in Massillon, Ohio, as a symbol of what's wrong with the economy under President Bush. Under current tax laws, Kerry has complained, the owners of factories like Massillon Stainless get "special breaks" for outsourcing work. Not only were the jobs at the steel plant sent overseas, but so was the equipment. Kerry may well bring up outsourcing at tonight's second presidential debate, especially if the national employment report for September, set to be released today, is weak. Yet changing the tax code to keep companies from shipping work abroad - a centerpiece of Kerry's proposal to create 10 million jobs in the U.S. - may not do much to solve the problem. Some economists note that getting a tax break is only one reason that companies outsource, and rarely the most important. Others maintain that the outsourcing of office work - the big growth area of the future - will be hard to control. And even with factories, there are cases that apparently wouldn't be affected by the kind of change in the tax law that Kerry is talking about. Among them: the Massillon steel plant. That's where, as Kerry mentioned in his July speech accepting the Democratic nomination, veteran worker Dave McCune "saw his job sent overseas and the equipment in his factory literally unbolted, crated up and shipped thousands of miles away along with that job." Yet here's what Kerry didn't say: When that happened in late 2002, Massillon was owned by Jindal Stainless Ltd., the largest stainless steel producer in India. And an Indian company closing an American plant, cutting 100 jobs and sending its gear to China, would presumably fall outside the scope of the proposals Kerry is advocating. "Traditional low-wage manufacturing jobs - the backbone of so many communities for so long - are fleeing," said Douglas Shackelford, a professor of taxation at the University of North Carolina. "Maybe we can slow it down a tad" by altering the tax code or taking other steps, "but we're just talking about whether a factory closes in one year or two." Massillon, about 50 miles south of Cleveland, has outsourcing examples to spare. World Kitchen closed its Massillon plant in July, laying off 200 workers. The privately held Reston, Va., company said it would start buying its Baker's Secret cookware from Asian suppliers instead of manufacturing it. "We weren't chasing a tax break," said Doug Arnold, World Kitchen's vice president of human resources. But many companies do pursue tax breaks. Most corporate tax advisors would suggest that a firm in World Kitchen's position set up a subsidiary in a low-tax haven that would purchase the cookware and then sell it to the American company. Under Kerry's plan, such a maneuver would no longer be as attractive. Kerry seized on the outsourcing issue during the winter primaries, repeatedly referring to companies and executives who transferred jobs overseas as "Benedict Arnolds." This happened against a backdrop of weak job creation, highly unusual so long after the end of a recession. The economy needs to create at least 150,000 jobs a month just to keep pace with population increases. In August, employment rose by 144,000, which looked good only in comparison with the 73,000 gain reported for July. Faced with such sluggish job growth, Bush has a good chance of becoming the first president since Herbert Hoover to suffer a net decline in jobs during his term. Economists' average expectations of 150,000 net new jobs in September would not make enough of a dent to change that undesirable distinction. When Kerry announced his economic program at the end of March, he said it would create 10 million jobs in four years. Critics said the memo backing up this claim, by Harvard economics professor and Kerry advisor Lawrence Katz, never detailed how the policies would directly produce the jobs. The memo is no longer on Kerry's website, and the candidate now talks more vaguely about "millions" of jobs in speeches. Jason Furman, a Kerry economic advisor, said the campaign wasn't backing off its claim of 10 million jobs. He added that the Katz memo was dropped from the website by mistake. Predicting job growth is easy politics but hard without a crystal ball. The global economy is an immensely complicated affair, and unanticipated events - terrorism, a sudden slowdown in new economic heavyweight China, continued oil price rises - could knock it for a loop. A president also needs to have the economic recession-recovery cycle in his favor. Some industries, like steel, will be hard-pressed to ever return to anything approaching their glory days. Massillon Stainless, for one, supplied its shiny metal to a long list of American icons, including the Empire State Building, World Trade Center towers and Chrysler building. But under a succession of owners, employment declined from 1,200 people in 1976 to 750 in 1984 to 500 in 1999. "You have to be realistic," said Alan Auerbach, a UC Berkeley economics professor who has advised the Kerry campaign. "There are limits to what Bush could have done to create jobs, even if he had adopted the best policies," Auerbach said. "It's fair to say that. It's also fair to say he didn't try." Bush inherited an economy that was slipping into recession even before the 2001 terrorist attacks. His job-creation policy involved cutting taxes as much and as quickly as possible. In early 2003, for example, the White House Council of Economic Advisors said speeding up the tax cuts would boost nonfarm employment to about 137 million by late 2004. The cuts were duly enacted, but employment is only 131.5 million - 4 million lower than the council was predicting even without the quicker cuts. Kerry's plan certainly sounds straightforward and reasonable, economists say. "If a company is trying to choose between building a factory in Michigan or Malaysia, our tax code actually encourages it to locate in Asia," the candidate wrote in an article for the Wall Street Journal. That's because of a long-established policy known as deferrals. A factory in Michigan gets taxed at the standard U.S. corporate tax rate. A U.S. factory in Malaysia gets taxed by Malaysia, but not by the U.S. until the profit enters the U.S. "Changing the tax code is not going to solve the outsourcing problem, but it will reduce it by removing an incentive. I don't think there can be any doubt about that," said Samuel Thompson, a tax expert at UCLA who has just published "Citizen's Guide to U.S. Economic Growth and the Bush-Kerry Economic Debate," a book that examines the candidates' proposals in depth. Kerry says that U.S. firms setting up enterprises overseas will be taxed at U.S. rates only if they're serving the U.S. market. This would be easy to enforce if a California firm is making shoes in China to sell in California. But what if a U.S. company hires an Indian outsourcing firm to run its computer technology department from Bangalore? That's an expense for the U.S. company, not something it will book as a taxable profit. "Kerry's right in showing that tax policy does have the effect of encouraging the export of manufacturing jobs, but I'm not sure that extrapolates to the services industry - which is where most outsourcing is happening," said Marc Hebert, executive vice president of Sierra Atlantic, a Silicon Valley software firm that does development work in India. With a projected $12 billion in revenue raised by eliminating tax deferrals, Kerry would give all companies a small tax break. Cutting the federal corporate tax rate from 35% to 33.25%, he says, would reward companies loyal to America. Even business groups that don't like Kerry's proposal on deferrals, such as the National Assn. of Manufacturers, like this one. "Reduced taxes encourages job creation," said Dorothy Coleman, the association's tax policy vice president. Others are less sure. "Corporations have so many ways to save on taxes now," said Duke University finance professor John Graham, whose research has shown that many companies pay less than 35%, if they pay anything at all. "I don't think that's the direction we need to go in terms of helping the economy." But it's a direction the nation is likely to be going in any case. On Thursday night the House passed a $140-billion business tax overhaul that effectively reduces the corporate tax rate on manufacturing to 32%. The Senate is expected to follow suit as early as today. Regardless of whether changing multinational taxation has an effect on employment, a number of economists think it's a fine idea from a revenue point of view. It has been proposed before but hasn't passed Congress amid resistance from corporate interests, which say it would undermine competitiveness. "This is an old idea, and to finally pass it would be wonderful," said George Mundstock, a law professor at the University of Miami who worked in the Treasury Department's Office of Tax Legislative Counsel during the Reagan administration. "It would raise a lot of money and not hurt the country's competitiveness." The overseas profits reported by multinationals have been soaring - up more than 50% since 2001 - without a commensurate rise in income-producing activities, according to an analysis in the journal Tax Notes. Moreover, companies appear to be funneling as much as $75 billion of domestic profits to such low-tax havens as Bermuda in "an aggressive use - or abuse - of the nation's tax laws," former Treasury economist Martin Sullivan wrote. "The U.S. system of taxing international income is breaking down," Sullivan said, concluding that the U.S. Treasury was losing at least $10 billion and perhaps as much as $20 billion a year. Part of Kerry's plan involves getting that money back to the U.S., where it can be invested domestically. To achieve that goal, he would declare a one-year tax holiday where the funds would be subject to a 10% tax rate. This, too, would be eclipsed by Congress' pending tax overhaul bill, which declares a holiday rate of 5%.