Tax on Outsourcing Production

After Carrier’s deal with President Trump in late November of 2016, the question of taxes on outsourcing companies has been widely discussed. During his campaign and post-election, President Trump has reiterated his intentions for implementing a 35% border tax on U.S. based firms that move production overseas. While this effort to preserve jobs has yet to be implemented, it is worth looking into the effects it could have on the U.S. economy.

The fear of outsourcing production to foreign states is fueled by the notion that foreign jobs are replacing domestic ones. However, a Federal Reserve Bank of St. Louis paper, by Bandyopadhyay, Marjit, and Yang, shows how although employing cheaper foreign labor decreases demand for domestic workers (a negative substitution effect), the productivity gains that come from doing so actually increases U.S. employment. With the profits they gain from outsourcing production, U.S. firms are able to expand operations domestically, yielding to a total increase in domestic jobs. In a 2010 Wall Street Journal op-ed, Matthew Slaughter explains just that as he considers total employment from 1988 through 2007.

“Over that time, employment in [foreign subsidiaries] rose by 5.3 million—to 11.7 million from 6.4 million. Over that same period, employment in U.S. parent companies increased by nearly as much—4.3 million—to 22 million from 17.7 million. Indeed, research repeatedly shows that foreign-affiliate expansion tends to expand U.S. parent activity.”

Not all economists are in agreement as to the impact of outsourcing being one that is positive. In a publication by the Council on Foreign Relations, economist, Thea Lee, states that, “much of the economic data… fails to distinguish between foreign investment used to serve market demand for U.S. goods and services and foreign investment used to buy cheaper labor abroad.” Lee’s concern refers to whether overseas production is being used for a firm’s self interest, decreasing the cost of labor, instead of being used to help the U.S. economy by increasing demand for U.S. products. However, such concerns fail to recognize the lack of division between the two— cheaper labor abroad means increasing profits for firms, which effectively propels job growth, lowers prices for American consumers, and increases demand of domestic goods and services.

If the Trump administration is looking for effective ways to decrease U.S offshore operations and increase U.S. jobs, perhaps a good place to start is by restricting companies’ abilities to defer U.S. tax on foreign income. Generally speaking, U.S. multinational companies wait till the repatriation of their income from foreign subsidiaries to pay tax and use the income they gain overseas to continue expanding production there. Restricting the deferral process is a concept President Trump spoke about early on in his campaign. The JCT’s Estimate of Federal Expenditures states that the deferral process costs the U.S. $80 billion each year, as companies avoid the 35% U.S. corporate tax rate, one of the highest rates in the world.

It will indeed be interesting to watch how the Trump administration plans to increase jobs in the U.S., but it can safely be said that creating a 35% tax for U.S. based multinationals outsourcing production will not be an effective way in doing so.

 

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