Offshoring, Outsourcing and Obama's feeble tax reform

President Barack Obama May 2009, in reference to the subject of outsourcing “you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.”

Obama certainly appears to have drawn the battle lines; Obama v Outsourcing seems like the agenda. Outsource “bashing” however was never going to lose a President public confidence.  US outsourcing companies and Indian outsourcing providers are however thus far unmoved by the proposed tax reform. Prior to deluging into why, we must first consider the difference between outsourcing and offshoring, for the proposed tax reform will have a slight impact on companies that offshore.

Offshoring, is when a US company sends its US jobs overseas to it’s own subsidiary. IBM for instance employs 75,000 employees in India; these employees although in India are employees of IBM. Although outsourcing has become synonymous with outsourcing to India, this is actually incorrect. Outsourcing, takes place when one company has another company do it’s job all together. The vast majority of outsourcing occurs in India, but there is still outsourcing if a New York company outsources one of its programmers by paying a Californian company to complete the work. The distinction between offshoring and outsourcing matters, for the tax reform could make offshoring slightly more expensive whilst outsourcing will remain unscathed.

Offshoring:
During the Bush-era, US offshoring companies could “defer” payment on corporate tax on overseas earned income until it was brought back to the US either as dividends or retained profits.  The offshoring company then would receive a tax credit for whatever tax paid overseas and paid the difference to the US government.

With Obama’s proposed tax reform policy, offshoring US companies must pay immediately US corporate tax, but the offshoring company will continue to receive that credit. This reform is thus fairly insignificant and will not impact the offshoring industry. Companies make vast savings in cost reduction when offshoring, the marginal amount of extra tax paid is not enough to deter companies from offshoring. IBM employs some 75,000 employees in India; this move was not taken because of corporate tax but because employee salaries in India are a 1/5th or 1/6th of those in the US.

In the opinion of Rosanne Altshuler, co-director of the Washington D.C based Tax Policy Center, the tax reform may encourage companies to merge with foreign multinationals, or shift their headquarters overseas and thereby fall under a foreign countries territorial tax system. With regards to the tax reform she says, “I don’t see how the change will increase jobs at home.”

Outsourcing:
The impact on outsourcing is likely to be even less insignificant. US subsidiaries of Indian companies do have earnings in the US or non-Indian based operations; the vast majority of earnings are however from India.  The present proposed tax reform will not affect Indian outsourcing companies.

Outsourcing and offshoring will always be greeted with negative public opinion. It is thus an easy target for politicians seeking to gain public confidence; a true political patriot, who will save your job and protect domestic industry. In reality, the politicians, including President Obama are fully aware that outsourcing and offshoring significantly benefit the US economy. US global dominance is achieved by keeping US companies more competitive than foreign firms and offshoring and outsourcing are fundamental to this. Obama may appear tough on outsourcing and offshoring to India, but his tax reform has little force and hence why we are unlikely to observe any effective protectionist policies.