The best argument against Barack Obama's plan to crack down on tax havens.

The best argument against Barack Obama's plan to crack down on tax havens.

The best argument against Barack Obama's plan to crack down on tax havens.

Who's winning, who's losing, and why.
May 5 2009 7:27 PM

The Fairness Doctrine

The best argument against Obama's tax-haven plan.

Republicans, business leaders, and even a few Democrats don't like President Obama's new plan to crack down on tax havens. But they're having a hard time explaining why. According to the president of the Business Roundtable, John Castellani, it's "the wrong idea at the wrong time for the wrong reasons." Senate Minority Leader Mitch McConnell did a little better, saying that the plan "gives preferential treatment to foreign companies at the expense of U.S.-based companies." And at least Rep. Joseph Crowley, D-N.Y., is candid about his constituency: He wants to make sure it doesn't hurt Citibank.

Politicians are in a tricky spot here: They want to be seen as pro-business, or at least helping businesses create jobs, but they don't want to get painted as cozying up to tax evaders. That means they'll have to be a little more nuanced in their critique.

Obama's plan, which would raise about $210 billion over the next decade, would basically do three things. It would prohibit companies from "deferring" payments of U.S. taxes on profits from overseas investments—they'd have to pay those taxes before being allowed to deduct offshore expenses. It would repeal the so-called "check the box" rule that lets companies shift money to untraceable offshore accounts to avoid U.S. taxes. And it would give the IRS more resources with which to crack down on offshore tax evaders.

But some provisions are more vulnerable than others. First, critics should not try to defend corporations that siphon money into secret offshore bank accounts or shell companies. That's not a winning battle.

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A better strategy may be to focus on businesses—say, shoe or car companies—that simply move their operations to another country because it's cheaper. A spokeswoman for the U.S. Chamber of Commerce did just that, criticizing Obama's provision that would prevent companies from deferring paying taxes. "[W]hen you limit deferral, you limit the ability of U.S. companies to compete, you impede growth in the U.S. economy, and you cause the loss of jobs—both at the companies directly impacted and companies in their supply chains."

Still, any argument that relies on corporate-speak like "supply chains" is going to win little attention and even fewer converts. The best argument may be to get out of the weeds and focus on the big picture. And in this case, focusing on the big picture allows opponents to engage the Obama administration on one of its favorite themes: fairness.

There are two basic schools of thought. One is that all American companies should pay the same tax rates, no matter where they operate. Obama press secretary Robert Gibbs made this argument, saying the provisions should be seen as a matter of "fairness, not something that will put them at a competitive disadvantage." The Obama plan would "level the playing field" for all American companies. (This philosophy that all companies should pay the same tax rate is called "capital export neutrality.")

The other philosophy says American companies operating overseas should have to pay the same tax rates as their local competitors. For example, a Nike factory in Thailand shouldn't be forced to pay a higher tax rate than other factories in the area, which would make it less competitive internationally. In that scenario, allowing U.S. companies to pay lower taxes overseas would also "level the playing field," only it's a different playing field. (This philosophy is called "capital import neutrality.")

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The United States has always embraced the former system, with equal rates for all American companies. Countries like Britain and Japan, however, don't require companies operating abroad or their subsidiaries to pay taxes to the homeland.

"Which is right? I don't know," says Adam Rosenzweig, a law professor at Washington University in St. Louis. "No one knows. That's why our current system is a mishmash." But there is a legitimate debate over which system is better. Some believe it's more harmful to a country's economy to have businesses skipping town for China; others believe it's worse to force those companies to comply with U.S. laws at the expense of competitiveness.

The problem is, this hypothetical—the American company that starts a factory overseas and pays lower taxes there—is just that. Businesses generally do not open factories overseas to avoid taxes. They do it for cheap labor or government subsidies or advantageous shipping routes. Take India: The corporate income tax rate for foreign companies is 40 percent. The U.S. rate for domestic companies is 35 percent. Why would an American company relocate to dodge U.S. taxes only to pay even higher ones in India?

"I tend to think people are driven to make business decisions based on business reasons," says Rosenzweig. "Then they deal with tax reasons." In addition, says Jack Blum of the Tax Justice Network, taxes aren't even calculated as part of a company's earnings. "You're taxed on what you earn," he says. "And that is calculated after the profit of a company is figured out."

So the entire scenario of the American company getting hurt by having to pay U.S. tax rates overseas is something of a red herring.

Still, Republicans and even some Democrats will probably put up a fight in Congress. Some of them will be speaking for the giant multinationals most affected by the legislation. Others may prefer pre-existing proposals, like the Stop Tax Haven Abuse Act, which would slap tax evaders with penalties and require more corporate transparency. But if they choose to duke it out with Obama, they should at least know where to aim.