Outsourcing and Obama's US tax-disincentives a lose-lose proposition

Outsource or not to outsource, is the unfinished debate that started following US President Barack Obama’s proposal to reduce tax incentives for US companies ‘shipping jobs overseas’. Resultingly, US labour rejoiced, corporate America thought it was a blunder, and Indian BPOs were left bewildered.

Obama’s stance on outsourcing has made the Indian outsourcing industry and the Indian government, confused about the US’s anti-business volta face.  Moreover, he chose the worst recession since 1929 to try to reverse freedom to do business by curbing outsourcing - in exchange for ‘possible’ extra tax revenue.

Contradictory as his plan would seem to many, limiting tax benefits on income earned abroad (for instance while carrying out outsourcing) as a 'solution' is anti-growth. It’s also job-destroying, protectionist, and unlikely to raise US tax revenue or even deter US companies to stop using tax havens.

After all, capital goes where it costs the least – it’s the reason why US companies started outsourcing to India and other nations, and will continue to do so as long as it makes business sense.

This is the most important rationale that goes against Obama’s anti-outsourcing ‘stance’ - that it makes plain bad economic sense. Especially, when the whole world is getting increasingly globalized.

If Obama’s motive was to bring in liquidity in the American economy through this mode, it may not work. US companies will trade off low-cost offshore locations over an increase in their tax, which will still be less as compared with the cost of shifting operations offshore – to ensure future expansion.

It can then be argued that limiting outsourcing’s profitability to re-route US profits back into America, is a case of political and economic opportunism amongst other reasons.  

And citing India is a poor example to exemplify his point – since its corporate tax rate on foreign-owned companies can be as high as 55 per cent.

Shortsightedness vis a vis outsourcing can also be attributed to Obama’s proposal to change the tax code. He has argued that US tax-deferral rules make it more costly for US companies to reinvest overseas profits at home than abroad.

This, he claims, creates an incentive for companies to 'ship outsourced jobs overseas' and reduces investment and job creation in the US.' He might be right – except that his proposals will only compound the problem.

Foreign companies may relish the loss of US corporate competitiveness (via more costly outsourcing) that his proposal will bring in the short term.

Though in the long term, bringing down US investment globally will negatively affect everyone – as spending and investment is a two-way street.

Leading Indian tax and outsourcing experts have noted that outsourcing is an economic reality and cannot be curtailed by changing the tax code applicable to the outsourcer.

Most economic and business experts agree that India will remain a lucrative outsourcing investment destination for the US. For no other reason than it continues to offer skilled manpower, large and inexpensive labour force and immense growth potential.

The US media, too, is not convinced about Obama’s reasons for changing the tax code. An editorial in the Los Angeles Times observed that, 'We're all for closing loopholes and ending tax shelters that enable the wealthy to hide income… ‘

‘… But we're not convinced that changing tax law can stop corporations from steering jobs and capital to countries with the lowest costs.'

Nevertheless, even if the US legislates the new tax code, decisions related with outsourcing work will not rest in its hands. Businesses of all types and size will still be driven by what’s best for their survival and growth.

This brings to fore the question that why does the Obama administration want to curb outsourcing through tax disincentives - if in the medium and long term it will be counterproductive?

Change in tax laws will be difficult to legislate: a positive for outsourcing
The present US Deferral System allows US companies earning profits (say through outsourced work) in a foreign country to deduct expenses for overseas operations. And then to defer payment of US taxes until those profits are repatriated back to the US.

The US tax regime therefore enables US multinational companies operating in foreign countries to be on a more equal footing with their competitors. However, this system is under attack from the US administration as US multinational companies are increasingly found to be evading taxes by shifting their earnings into low-tax offshore havens and enjoying overseas tax advantages.

However, the proposed new US tax code may impact foreign operations of US companies operating abroad and make it more difficult for them to compete with foreign companies.

For this reason, corporate America, opposing Republicans, and companies involved in outsourcing, will make it very difficult for this legislation to get through the US Congress and Senate.  

Outsourcing is chicken and egg economics:
The US can't bake the globalization cake and eat it too. America is the most successful protagonist and multiplier of modern capitalism that has made large scale progress possible.

It can’t, all of a sudden reverse a pro-business and pro-development rule – citing imbalance in tax receipts – surely there’s a more mature way out to increase tax revenue than making it costly for US companies to do business overseas. 

Setting aside the debate about the pros and cons of capitalism, free flow of capital has led to countries such as China, India, Brazil, Mexico and East European countries to optimize resources. If this is stopped or gets affected – via outsourcing – it will bring down the total volume of international commerce.

In this context outsourcing has and will play an important part in reaping the benefits of globalized work production. Thus outsourcing and internationally localizing work tasks is chicken and egg economics and can’t exist without each other.

Obama has said that his administration will use the savings (accrued from the new tax code) to give tax cuts to companies that are investing in research and development to jump start job creation, foster innovation, and enhance America's competitiveness.

Economists also say that the world should not expect global economic revival without the US generating domestic jobs at a war footing.

Complex as the situation is, it clearly calls for expanding the total US economy and not contracting it by penalizing companies that outsource. Given the revenues they generate from emerging economies, and the jobs that this helps create back in the US (when such companies expand) – gagging outsourcing should be the last thing on Obama’s mind.

The savings-tax revenue equation is in favour of outsourcing:
Even if the US proposes a punitive tax on companies outsourcing or offers a tax break for those that do not, the changes wouldn't be large enough to offset the 20 per cent to 30 per cent benefit companies get in lower labor costs when they do certain work offshore.

A tax break can't compete with that kind of arbitrage.

Curbing outsourcing is bad economics and even worse - anti-innovation:
The phenomenon of outsourcing has allowed emerging markets in developing countries to reach into developed economies, offering a talented workforce at a fraction of the price.

US companies generate more than 50 per cent of their revenue from markets outside the US. Nearly half of Silicon Valley startups - including Google – were started by immigrants, and nearly a quarter of U.S. global patent applications are from foreigners.

Given that international talent, in and out of the US, has contributed to America’s growth, Obama’s insistence on ending tax breaks for companies that ship jobs overseas is protective capitalism.

The tax break disincentive for offshoring and early booking of profits by MNCs, says Hari Bhartia, chairman of Chambers of Indian Industry, “will only reduce their competitiveness.”

“It’s a populist posture. Perhaps his (Obama's) intention was not the same. However, it sends a wrong message,”says Bhartia.

Outsourcing, recession, and big money:
Obama's decision is intrinsically related with the recession in the US and its high stakes in the global economy for self-survival.

According to a consultant at KPMG, the Obama administration's move was aimed at keeping American money within the country to keep recession at bay.

The move will have an extremely tough time getting legislated – given that America is one of the largest free markets in the world - otherwise, one will have companies paying as much as 70 per cent of their revenues as taxes.

In effect the change in the tax code is a tactic to ensure that the large profits kept outside the US are brought into the tax net – similar in thought to Obama’s pursuance of money stashed away in Swiss banks.

It’s an analysis that India’s Infosys Technologies, India's second largest software and outsourcing company, also buys. It feels that the US proposal is aimed at closing corporate tax loopholes and crack down on overseas tax havens.