Taxes and Outsourcing of Jobs

Corporate spokespeople argue outsourcing of jobs is good for the US economy. It may be attractive to the corporate officers but not for the employees. It is no coincidence that corporate tax collections relative to sales have decreased as jobs have been transferred overseas.

The argument that outsourcing of jobs is good for the US economy is a latent attempt to justify the results of a poorly enforced special interest tax code. Companies claim that the transfer of jobs, especially high-tech and pharmaceutical jobs, is due to lower labor costs. While some jobs are moved to developing countries to take advantage of lower labor costs, most are moved to avoid paying US taxes. This is particularly true of high tech and pharmaceutical jobs.

In addition, the loss of manufacturing jobs, especially high paying manufacturing jobs, will result in the loss of additional jobs. That is jobs that provide services to those employed in the manufacturing industry. For every manufacturing job the economy loses it also loses one-to-three secondary and tertiary jobs such as grocery clerks, construction workers, gas station attendants, tax professionals and state and local government jobs.

The high-tech and pharmaceutical industry is so heavily capitalized that the manufacturing labor costs are relatively small compared to the capital costs and administrative, marketing and sales costs. The costs due to additional handling and transportation costs and the additional loss due to theft and breakage from shipping goods from foreign manufacturing facilities more than offsets any labor cost savings. Not only does the US lose jobs but just as important is the transfer of technology abroad.

For example, a computer company makes a chip in the US, ships it to a foreign country (that provides a tax holiday to attract the company manufacturing facility) where it is installed in a computer and returned to the US. Most of the costs (research administration sales and marketing) are assigned to the US operation but the revenue is credited to the foreign manufacturing operation. With a tax holiday the company pays no taxes in the foreign country and pays little or no taxes in the US. Once the tax holiday is over in that foreign country, the US company packs up and moves to another country where it receives another multiple-year tax holiday.

The IRS may audit the company and adjust the profits to better reflect the actual source of profits. Assuming they are audited, the company will then negotiate directly or after filing an appeal will settled with the IRS for a small fraction of the actual taxes due, usually for five-to-ten cents on the dollar. The IRS system of rewards have the agents getting credit for setting up taxes due, not collected, and the appeals agents getting credit for clearing cases, not taxes collected. As a result there is an incentive in appeals to settle these cases quickly. In addition, these settlements frequently occur as a result of Administration or Congressional pressure.

The solution to both the outsourcing of jobs and corporation tax avoidance is fairly simple. Replace the corporate income tax with a corporate value added tax (sales tax). At each stage of production the company pays a tax on sales. As a company adds value, additional manufacturing or sales cost, that company pays taxes on the total value of their sales.

They can deduct from their taxes the amount of tax already paid by suppliers of goods and services to that firm. If the product is exported all taxes are refunded, that is no taxes are paid on exported goods. Foreign companies selling in the US, that have avoided paying corporate income taxes, would pay the tax on the value of all sales and services in the US. This would include services preformed by US companies from foreign locations such as telephone tech support. As a result US companies would be more competitive both in the US and abroad.

The benefits of replacing the corporate income tax with the value added tax far outweigh the cost. The main argument against a value added tax seems to be that companies would use the tax as an excuse to raise prices. This implies that companies are charging less than they would without a corporate sales tax.

Yes, there would be some adjustments, as companies previously avoiding taxes are now required to pay taxes. They would adjust their output and prices to maximize profits. Some marginal firms that now shift this tax burden to other taxpayers may fold. However, firms that are being penalized by paying more than their fair tax share would benefit. Small business would benefit as most are unable to take advantage of these tax avoidance schemes.

The major advantage would be the transparent nature and the simplicity of administering the tax. It would be clear which firms are paying the tax and which are not paying the tax. By not taxing exports, which is consistent with international trade agreements, our exports would be more competitive. Also, imports would be more expensive. Outsourcing of jobs to avoid taxes would no longer make sense, as there would be no tax advantage. Taxes collected would increase as the economy grows.

Will it happen? Lawyers and accountants would oppose the change, as less of their services would be required. Politicians would also oppose the change. Politicians have two major ways to reward their financial supporters, those people that contribute to their election campaign. One way is to fund programs and push government contracts that benefit directly and indirectly these financial backers for office. The other is to design tax policies that also benefit individuals, companies and industries. The IRS agents usually comes up with a different description of Congress’ tax bills--the Timber Relief Act or the Oil Industry Subsidy Act-- that better describes the actual intent of these “tax simplification or tax assistance bills.

If congress is serious about discouraging the outsourcing of jobs and also to discourage companies from moving their headquarters and other operations outside the US then they should replace the corporate income tax with a value added tax.

EW Eboch, Ph.D.
Economist