It’s the Tax Code, Stupid

Riding high on the nation’s moral indignation over corporate malfeasance, politicians have turned to bullying corporations and interfering with perfectly legal business decisions. The coming elections have fueled the anti-corporate rhetoric as politicians attempt to outdo one another with “get tough on corporate America” proposals that ignore underlying economic problems in a quixotic search for a government quick fix to boost stock prices. While new mandates will do little to address an overvalued stock market or bring more foreign investors into the market, they can hamper the ability of American companies to compete in a global market.

Just recently, Stanley Works, the American toolmaker, was cowed into abandoning a plan to re-incorporate in Bermuda in order to reduce its tax liability. There is nothing illegal about this; in fact, Stanley Works’ rivals had already done so, leaving the company at a serious competitive disadvantage. The move was not a threat to American jobs, because the company’s factories and actual headquarters in the United States would not be affected. If anything, the political push to quash the move poses a real threat to the long-term viability of the company and the jobs it creates. The more fundamental problem lies in the U.S. tax code and its treatment of business in a global economy. It is complex, unfair, and generates benefits for some while hurting others.

If politicians were truly concerned about economic growth rather than re-election, they would focus on this larger problem that poses a significant threat to economic growth. The federal tax code is arcane and riddled with loopholes and special interest clauses for favored constituents. It has become burdensome and incomprehensible. No one in Congress can understand the totality of the tax code, and this is just as true for the business world. The complexity invites creative accounting, as businesses divert resources away from productive activities and toward efforts to minimize their tax burden. The tax code’s thousands of pages leave many gray areas, and tax lawyers and accountants are paid handsomely to mine these areas for loopholes and exemptions.

Nonetheless, Washington continues to avoid the issue of fundamental tax reform. Democrats have already accused the Bush administration of pursuing tax cuts the nation cannot afford, with many seeking to rescind the tax cuts passed last year. Instead, Congress prefers to “shake the money tree” by including complicated tax credits, exemptions, and subsidies in the annual budget that spark furious lobbying efforts to ensure their passage. Adopting a fair, simple, flat tax that eliminated the need for tax loopholes would increase compliance while reducing the associated costs. It would also reduce the role for politicians to sell off tax breaks to the highest bidder, something that Congress appears unwilling to relinquish.

In fact, corporate taxes in the United States are in desperate need of reform. Currently, the United States has one of the highest corporate taxes in the developed world. According to the Tax Foundation, the federal government collects roughly $200 billion annually from corporations. From a global perspective, U.S. companies face a serious disadvantage when competing with foreign companies. And while re-incorporating in Bermuda to reduce the tax burden may seem questionable, it is a rational response to excessive taxes that is driven by the expansive federal tax code.

Yet the political reaction to such practices has not been to revisit the federal tax code; rather, it has been to shut down tax havens. Stanley Works succumbed to political pressure and abandoned its move. Meanwhile, many in Congress have been pushing to bar companies based in tax havens from doing business with the federal government. Others have joined European nations in calling for policies to ban tax havens altogether. Such a policy would do little more than secure the flow of taxes into government coffers. The existence of tax havens provides an important check on the government’s ability to tax, while forcing governments to provide a climate more conducive to business. If the United States wants to attract businesses—and the jobs they create—tax reforms that promote economic growth must be considered. A simple, fair tax code would go far in eliminating the need for tax havens.

Those in Congress who are concerned about American companies relocating abroad to reduce their tax burden should consider fundamental reforms of corporate taxes. Not only would this make America the preferred choice of businesses everywhere, it would provide an opportunity to boost growth in a weak economy. Corporate taxation is one of the most economically inefficient aspects of the tax code, imposing significant burdens on the economy. And it must be remembered that corporations are merely legal entities; the real costs of these taxes are borne by shareholders, employees, and consumers.