Impact of Trump’s Tax Plan on Outsourcing

The United States government has approved President Trump’s new tax plan. This plan is being heralded as being friendly to corporations within the United States. Proponents of this tax plan have claimed that it will bring unprecedented prosperity to the United States.

Donald Trump believes that the steep tax cuts along with a favorable regulatory regime will result in a stampede of American as well as other multinationals trying to expand their businesses in the United States.

This plan has faced criticism from several democratic politicians. It is also facing criticism from other nations, particularly within the European Union. In this article, we will have a closer look at how this plan is likely to affect outsourcing of jobs from the United States.

Territorial System

The new tax plan makes the United States tax system a territorial system. This means that the United States will now only be levying taxes on economic activity that takes place within its borders.

Earlier, United States would collect tax on all income derived by its corporations. This means that if an American corporation made a profit in China, they would owe the American government tax money on those proceeds. Only the tax paid to the Chinese government could be deducted as an expense. However, this tax only had to be paid once the cash was repatriated back to the United States.

Many companies believed that it was unfair to levy such heavy taxation on American corporations. They believed that this made them less competitive in the international market. As a result, many American corporations continued to hold money indefinitely abroad.

Now the tax system has changed. Companies will be allowed to make normal profits based on the assets they have abroad. These profits can be repatriated tax-free. Any profits exceeding these normal profits will be taxed at a reduced rate of 21%.

Donald Trump believes that since the United States is the ultimate consumer market for most corporations, a better tax regimen will allow more corporations to expand their operations and create more jobs. However, if one looks closely, there is a hidden incentive to actually offshore more jobs.

The amount of normal profit that is allowed tax-free from a nation depends upon the assets that a company has in that nation. For instance, if Apple has $1000 worth of assets in Bermuda, it will allow repatriating $100 from Bermuda tax-free.

Since the taxes payable in Bermuda are much lower than in the United States, it would make sense for Apple to move more assets to Bermuda and increase the base on which normal profits will be calculated.

For instance, if the base is increased to $5000 then $500 can be repatriated tax-free. This law will, therefore, incentivize American corporations to move the ownership of intellectual and tangible properties to tax havens. Hence, there will be less job creation within America and more offshoring.

Foreign Subsidiaries Holding Money

Donald Trump believes that the tax regime in the United States has become so favorable now that even foreign companies would want to hold their profits in America. Hence, even offshoring companies like Accenture and Infosys will find it more favorable to keep their money in America and pay lower taxes than to repatriate it. As a result, the investments are likely to increase.

Donald Trump believes that these investments will create higher paying local jobs and that outsourcing will take a hit. Also, the higher deposits in American banks will create a higher base on which loans can be given out. As a result, these deposits will help in rapid expansion of the United States economy.

The problem is that corporations have other ways to use their money while still keeping it in the United States. For instance, they could buy back their shares listed on American stock exchanges. This would still benefit the shareholders in their home countries since the value of their shares will increase. Tax cuts cannot change the reality that the workforce in America is much more expensive than it is in nations where jobs are generally outsourced to.

Competing Tax Cuts

All of Donald Trump’s assumptions believe that America will always have the comparative advantage of lower tax rates. This might not be true for a very long time.

Countries like India and China are highly dependent on foreign investment. If they see the inflow of investments going down, they are likely to retaliate with lower tax cuts. The same is the case with many European economies.

Trump’s actions are likely to result in a race to the bottom wherein countries will have to continuously reduce tax rates to attract corporate investments. Over the long run, this will drain the Treasury’s resources. Any benefits accrued by creating more jobs will be more than offset by the revenue loss due to reduced taxation.

The bottom line is that Donald Trump’s talks are akin to false bravado. Outsourcing is dependent on a lot of factors in the global economy. Some of these factors are simply beyond the control of the United States. The new tax regime might benefit the local economy in a lot of ways, but it is not likely to have a severe impact on outsourcing.

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