Tax Fight Looms

President Barack Obama’s plan to raise hundreds of billions of dollars through increased taxes on business to slow a ballooning deficit is colliding with his effort to spur the economy and boost employment by promoting U.S. exports, industry leaders say.

Rolled out as part of the fiscal 2011 budget proposal are a series of new taxes, reinstated taxes, and a significant reduction of multinational corporations’ ability to defer taxes on overseas earnings. It is feared that such tax policy reform will impede economic growth and make it harder to create jobs and lower America’s near double-digit unemployment rate.

The proposed changes to the U.S. tax code bump up against Obama’s recently announced initiative to double exports in five years, a jump that would push U.S. overseas sales to $3 trillion annually and, the White House says, create 2 million new jobs.

But chemical industry executives contend that Obama’s budget would discourage job creation by adding new costs to business. “Unfortunately, the Administration’s proposed budget will unduly impact the business of chemistry by imposing new or reinstating former taxes that will hurt America’s chemical industry at a time of economic fragility,” says Calvin M. Dooley, president and chief executive officer of the American Chemistry Council (ACC), an industry trade group.

“Contrary to the President’s stated goal of doubling U.S. exports, the new taxes on companies that export would mean higher costs for U.S. producers and less ability to compete in the global market,” Dooley asserts.

Obama’s trade initiative, first announced in his State of the Union address on Jan. 27, would require sustained export growth of about 15% per year, a pace that trade policy experts say is ambitious but achievable.

The President’s goal for a new trade policy that focuses on export growth is welcomed by U.S. business. “We are pleased the Administration shares our view that exports are critical to manufacturers’ competitiveness and ability to grow and create jobs,” says John M. Engler, president of the National Association of Manufacturers, the nation’s largest industrial trade group.

But officials worry that the tax increases included in the Administration’s budget will undermine any hope for an export-led economic recovery. “New taxes would mean fewer American jobs and less revenue at a time when we desperately need both,” Dooley says.

The President’s proposed 2011 budget, unveiled on Feb. 1, calls for almost $500 billion in new taxes on businesses over the next 10 years, including a $19 billion reinstated Superfund tax on most corporations to help pay for the cleanup of abandoned toxic waste sites, and an additional $39 billion in tax increases on energy companies.

Another $59 billion in tax revenues would be raised by eliminating firms’ ability to use the last-in, first-out (LIFO) inventory accounting method. Under LIFO, corporations are able to defer tax liability by deducting the higher cost of recently acquired inventory rather than the lower cost of older inventory.

But the most costly change would generate $122 billion for the government by overhauling a long-standing international tax policy that Obama and some congressional Democrats argue provides incentives for U.S. companies with worldwide operations to move production and jobs offshore.

“To encourage businesses to stay within our borders, it’s time to finally slash the tax breaks for companies that ship our jobs overseas and give those tax breaks to companies that create jobs in the U.S.,” the President declared in his State of the Union message.

One key issue is the U.S. tax code’s treatment of profits earned by foreign subsidiaries of U.S.-based multinational corporations. Profits earned in the U.S. are subject to a combined federal and state corporate tax rate of 39.1%, the second-highest among industrialized countries. Only Japan’s 39.5% combined rate is higher.

However, under the so-called deferral rule, multinationals can deduct expenses related to their overseas operations, but defer paying taxes on the profits from those operations until the money is transferred back to the U.S., usually in the form of cash dividends from the foreign subsidiary to the parent company. As a result, many companies keep money abroad for an extended period to avoid paying the taxes. The Administration says that is depriving the U.S. government of much-needed tax revenue.

Last year, Obama sought to tighten the rule by proposing that companies must also defer taking deductions until their overseas profits are brought back to the U.S. But the revenue-raising initiative fell flat in Congress amid furious opposition from affected industries.

Now, the Administration is limiting its proposal to interest expenses. Deductions from interest expenses related to deferred foreign income could be taken only when the deferred income is recognized in the U.S. “The ability to deduct expenses from overseas investments while deferring U.S. tax on the income from the investment may cause U.S. businesses to shift their investments and jobs overseas, harming our domestic economy,” the President’s budget states.

Advocates for international tax reform argue that allowing U.S.-based global companies to defer paying taxes on income earned abroad is unfair to other businesses and average citizens who must make up for the lost revenue.

“The reality is that when companies fail to pay their fair share of taxes, the burden is passed on to ordinary taxpayers. It’s time for the law to catch up to reality,” says Nicole Tichon, the tax and budget reform advocate for the advocacy group U.S. Public Interest Research Group.

Business executives counter that the deferral provision and other preferences in the tax code prevent U.S.-based multinationals from being double-taxed by the U.S. and by foreign countries. They note that major U.S. trading partners, such as the U.K., France, Japan, and Germany, do not tax their companies’ foreign income.

Deferral has been mischaracterized as a tax break, says Martin A. Regalia, chief economist at the U.S. Chamber of Commerce, the nation’s largest business federation. “Since other countries don’t subject their companies to double taxation, U.S. companies need deferral to stay competitive in the global marketplace,” he says.

“When 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,” Regalia continues. “A huge tax hike on U.S. employers is not the way to stimulate our economy.”

The Administration’s proposed changes to the rules for U.S. taxation of foreign earnings would deepen the disadvantage U.S. companies already face in competing against rivals from countries with lower corporate tax rates, says Stephen G. Elkins, ACC’s director of tax policy.

“The bottom line is that the provisions in the President’s international tax proposals would raise the level of tax on the foreign operations of U.S. corporations,” Elkins remarks. “That makes us less competitive because we are carrying a heavier tax burden than our competitors.”

Any changes, Elkins adds, should be addressed as part of a package overhauling the entire tax system. “These issues are too complicated and there is too much risk for great economic dislocation if structural issues, such as the way the U.S. taxes foreign operations, are taken in a piece-by-piece basis in an attempt to fill in some revenue gap in whatever tax or budget bill is before the Congress,” Elkins says.

Industry officials and some tax analysts also say that any increase in international taxes or the elimination of current deductions and exemptions would need to be offset by a reduction in the corporate rate so the competitiveness of U.S. companies operating abroad is not undermined.

“Going to a flatter corporate tax regime has many attractive ideas attached to it, including less complexity and easier planning,” Elkins says. “But unless the corporate tax rate goes down substantially, we could be in worse shape than we are now.”

Reforming the corporate tax system requires balancing neutrality between foreign and domestic production with international competitiveness, notes Robert Carroll, senior fellow at the Tax Foundation, a nonpartisan group that monitors fiscal policy. “We do not want our tax law to favor foreign production over domestic production, and at the same time, we do not want to put U.S. companies with foreign operations at a disadvantage when they compete abroad with foreign companies,” Carroll says.

The U.S., he points out, is the only large economy that taxes companies on worldwide profits with a tax rate exceeding 30%. Meanwhile, more than 80% of developed nations have adopted territorial systems, in which they tax domestic companies only for income earned at home. This gives multinational companies based in those countries “a major tax advantage over U.S.-based firms that are saddled with a worldwide system,” Carroll says.

Enacting tax reform this year will be an uphill climb, according to Elkins. “I hope Congress will focus its efforts on effective legislation to enhance the economy. I don’t see much likelihood of a comprehensive, broad-based structural set of changes in business tax law. I don’t think they have time or inclination to do that this year.”

But with the Administration’s need for new sources of revenue to fund its increased spending, Elkins says the chemical industry is worried that the government “will enact some things that are terrible tax policy and would be very damaging.”

Congress will have to tackle the expiration of former president George W. Bush’s individual tax cuts at the end of this year, providing an arena where debate over corporate taxes could surface.

Imposing new or reinstating former taxes “could very well result in a fundamental retrenchment of this industry,” Elkins declares. “We’re very concerned that dramatic corporate tax increases would have a long-term, perhaps permanent effect.”