Outsourcing and Obama’s Tax-Disincentives a Lose-Lose Proposition

Tax Disincentives for US Firms Shipping Jobs Overseas is Bad Economics

US President Barack Obama’s proposal to reduce tax incentives for US companies ‘shipping jobs overseas’ spawned a series of debates whether to move jobs out of America or not. The result: US laborers rejoiced, corporate America considered it a blunder, and Indian BPOs were left bewildered.

Indian offshoring industry and the government were thrown into confusion by Obama’s anti-business volte-face. Moreover, Obama chose the worst recession since 1929 to try to reverse freedom to do business by curbing job shipping–in exchange for ‘possible’ extra tax revenue.

Limiting tax benefits on income earned abroad and projecting this move as a ‘solution’ is anti-growth. It’s also job-destroying, protectionist, and unlikely to raise US tax revenue. It can even deter US firms from using tax havens.

After all, capital goes where it costs the least–it’s the reason why US companies started sending jobs 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 stance–. And, surprisingly, it comes at a time 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 firms 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 offshoring’s profitability to re-route US profits back into America is a case of political and economic opportunism among other reasons.

India can levy corporate tax up to 55% on foreign-owned companies, which means Mr. Obama has chosen a poor example by choosing India to prove his point. Mr. Obama contends that the American tax-deferral rules are a hindrance to the US firms that want to reinvest overseas profit at home because these rules make the process very expensive. He further claims that this situation prompts companies to “ship jobs overseas” which in turn 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 job shipping) 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 experts have noted that job shipping is an economic reality and cannot be curtailed by changing the tax code applicable to the firm moving jobs out of America.

Most economic and business experts agree that India will remain a lucrative investment destination for the US. For no other reason than it continues to offer skilled manpower, large and inexpensive labor 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 all the loopholes should be closed and the wealthy should be denied access to tax shelters where they hide the income. However, it does not sound convincing that corporations would stop sending jobs to economically cheaper locations just because the tax laws have been changed.

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

This brings to fore the question: Why does the Obama administration want to curb job shipping 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 job shipping

According to the US Deferral System, the local companies that earn profits in a foreign land are allowed to deduct expenses for overseas operations before submitting those profits back to the US.

Therefore, the US tax system keeps its multinational companies at par with their competitors. However, these multinationals use the loopholes in the Deferral System to evade taxes. They do so by using foreign offices as low-tax havens where they get tax advantage. Therefore, the relevance of the Deferral System is being questioned by the lawmakers.

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 sending jobs to other countries 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 firms 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 job shipping–it will bring down the total volume of international commerce.

In this context, job shipping has and will play an important part in reaping the benefits of globalized work production. Thus, job shipping 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 on 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 send jobs to other countries. Given the revenues it generates from emerging economies and the jobs it helps create back in the US (when such companies expand), gagging job shipping should be the last thing on Obama’s mind.

The savings-tax revenue equation is in favor of sending work outside America:

Even if the US proposes a punitive tax on companies sending jobs overseas or offers a tax break for those that do not, the changes wouldn’t be large enough to offset the 20 percent to 30 percent 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 job shipping is bad economics and—even worse—anti-innovation:

The phenomenon of sending jobs from one country to another 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 percent 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 Infosys Technologies, India’s second largest software company, also buys. It feels that the US proposal is aimed at closing corporate tax loopholes and crack down on tax havens overseas.