Although perverse to punish individual Americans, American businesses and US-based corporations for helping build the US economy by taxing them more than those who simply want to access the US market to sell their goods and services, “free trade” policies continue to lead the charge in the liberalization of the global economy. Where the GOP-led Congress has teamed up with Democratic President Barack Obama to push for the adoption of the Trans-Pacific Partnership (TPP), which would eclipse infamous NAFTA, the adoption of so-called a “territorial tax” codes represents another arm of the “free trade” threat.
Thanks to the current efforts of Senators Rob Portman and Chuck Schumer, the United States may well be nearing the adoption of a territorial tax code. Portman and Schumer want to replace US taxation of corporate profits earned overseas with a transition tax that would be used to pay for badly needed highway and infrastructure programs. Required to pay the highest corporate tax rate in the world of 35% when corporation repatriate their overseas profits , there is clearly a perverse incentive that explains why US-based companies keep more than $2 trillion in profits overseas while other corporations feel compelled to change their citizenship in a process that is commonly referred to as a corporate inversion.
On the one hand, the Portman-Schumer framework seeks to reduce taxes on intellectual property, which is the true engine of growth and should be favored. On the other hand, the Portman-Schumer offers a much lower rate than an earlier proposal from President Obama, which would have imposed a one-time tax of 14% on current profits stashed overseas and a 19% tax on future foreign earnings. Although the American People would love to have a 14% or 19% income tax, critics feel 14% is too much. In many respects, the laws of competition do make this corporate tax rate too much.
When advanced economies like Japan and the United Kingdom switched to a territorial tax system, they gained a competitive advantage over other countries. With the territorial tax system becoming the norm, they started to lose some of that advantage. If the US switches to a territorial tax system, all of that advantage will be gone. Because the world’s largest economy sets the standards for all other nations, the US transition to a territorial tax system will mean all other nations are forced to embrace the policy. The biggest winners with be corporations, businesses, and individuals that have an advantage in shifting their wealth around the globe, i.e. an opportunity to make more money overseas and safeguard their wealth in stable economies like the US.
Unfortunately, the liberalization of national tax codes does not create a level playing field for international taxation. Before American workers paid federal income taxes, the US Government was largely funded by tariffs and other fees imposed on those looking to access the American economy. As the world grew more complicated and expensive, the Federal government passed the Sixteenth Amendment in order to collect a "fair share" of revenue from American citizens. Because the cost of the government is only going up, governments must increase their revenue. As the free trade trend favors the elimination of tariffs, this means taxes must be increased for domestic taxpayers, which will increase the pressure for those most financially mobile to seek overseas safe havens.
Despite Schumer’s assertion that “Our international tax system is upside down and inside out,” the truth is that the tax systems of nations that embrace territorial tax systems are “upside down and inside out.” The “free trade” and territorial tax system craze creates a perverse inventive to abandon one’s domestic economy in favor of a more “competitive” environment, i.e. the lowest bidder economy while harming businesses that cannot abandon their own ship for a cheaper one. The only reason many economies have not suffered directly from these policies is that they have derived a competitive advantage.
The root of the problem is that policies like these do not allow for the disproportionate funding needs of governments. Given situations like the Islamic State threat, the Ukraine Crisis, and increasing Chinese aggression, governments provide valuable services that help keep the global economy functioning. Because the US economy is the largest and its military budget is also the largest, it must collect the largest amount of revenue. When countries are forced to compete by taxing less, particularly when the burden is too great for their increasingly poor citizens to bear, they cannot afford to invest in global security, which has largely been subsidized by the United States.
Recognizing the developed world under economic liberalization has seen their national debt balloon and the wealth of their citizens concentrated into the pockets of the few, which will eventually lead to crippling instability, simply imposing a territorial tax system without major reforms in the US tax code and US trade relations will only hurt the global economy in the long-run. Maintaining the status quo will only hurt the US and the global economy in the long-run. Surprisingly, Rand Paul’s proposal to flatten the tax code, which includes leveling the capital tax and tariff rate, is far more sensible. Ensuring the individual and small business tax remain progressive, so the burden is not too crushing for the poor, while incentivizing innovation with a reduced tax rate, there is an better alternative to free trade and the territorial tax system for all nations.
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