Distinction between Offshoring and Outsourcing Matters
President Barack Obama May 2009, in reference to outsourcing, said, “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 vs. ‘Shipping Jobs Overseas’ seems like the agenda. However, this stance was never going to lose a President public confidence. US companies that ship jobs overseas and Indian service providers are however thus far unmoved by the proposed tax reform. Prior to delving into the reason behind it, we must first consider the difference between moving projects to another firm and offshoring, for the proposed tax reform will have a slight impact on companies that offshore.
Offshoring is when a US firm sends its US jobs overseas to its own subsidiary. IBM, for instance, employs 75,000 employees in India; these employees although in India are employees of IBM. Though sending jobs to another firm has become synonymous with offshoring to India, this is actually incorrect. The former takes place when one company has another company do its job all together. The vast majority of work sent by Western clients is done here in India, but there is still job shipping if a New York company sends one of its programmers by paying a Californian company to complete the work. The distinction between offshoring and ‘sending jobs to another firm’ matters, for the tax reform could make offshoring slightly more expensive while job shipping from one company to another will remain untouched.
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.”
Job shipping from one company to another
The impact on the business of shipping jobs from one company to another 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 companies.
The business of shipping jobs from one company to another 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 will save your job and protect domestic industry. In reality, the politicians, including President Obama, are fully aware that these business models significantly benefit the US economy. US global dominance is achieved by keeping US companies more competitive than foreign firms and offshoring and job shipping to another company are fundamental to this. Obama may appear tough on shipping jobs to India and other developing countries, but his tax reform has little force and this is why we are unlikely to observe any effective protectionist policies.