While the Obama administration touts its recent rules to limit corporate inversions as a step forward towards fixing our broken tax code, it is clear this administration fundamentally misunderstands the problems that are driving American companies abroad. In the long run, punitive Treasury Department regulations will only make America less competitive while this administration ignores the core problem: a hopelessly outdated corporate tax code.
While President Obama publicly insists he wants tax reform, his administration has sought to criticize the components of any meaningful plan. This was evident in a speech given last month by Jason Furman, chairman of the president’s Council of Economic Advisers, who objected to bipartisan proposals for the creation of an intellectual property tax box regime here in the United States.
Under an IP box, the profits that accrue to patents and other types of intellectual property are taxed at a lower rate than other forms of revenue. The motivation for doing so is to induce multinationals to keep their intellectual property in the country.
The advantage of implementing an IP box, as compared to merely lowering corporate tax rates, is that it represents a more economical way for a country to incentivize economic activity. The main reason that the corporate tax rate hasn’t been reduced yet, even with members of both parties insisting that doing so is an imperative, is because there’s no easy political way to make up the revenue that would be lost from reducing tax rates by ten percentage points, the minimum rate reduction deemed sufficient to bother with. The various corporate deductions, exclusions and credits we could eliminate to pay for the rate reduction have well-heeled defenders and numerous champions in Congress, and no one pretends that Congress could fully pay for an across-the-board rate cut of that magnitude.
However, an IP box represents a way to reduce taxes solely on capital that is highly mobile and most at risk to be moved to another country. Therefore, it’s much easier to finance than any sizable corporate tax rate reduction while still encouraging U.S. multinationals to keep their patents and intellectual property in the United States.
When companies move their intellectual property abroad, jobs invariably go with it—not just the workers who come up with innovations but often those involved in the production of goods. There are widespread economies of scope in many high tech and bio-pharmaceutical companies for whom it makes sense to co-locate production and R&D in the same place. By adopting an IP box, we give U.S. companies a reason to keep innovations and jobs in the United States.
That’s the story the proponents of an IP box tell, anyway, and it’s one that many governments find convincing: Fourteen countries—China and a dozen European countries—currently have some form of an IP box, and the OECD’s recently-concluded BEPS project basically enshrined the innovation box as an acceptable tax regime for its member countries: it’s only a matter of time before the rest of the OECD’s members adopt an IP box.
This should be a wake-up call to the United States. While developed nations are arming themselves with tax incentives to lure American IP overseas, the administration wants to practice unilateral disarmament. Every month we delay, more American patents, jobs and capital will move overseas.
It’s worth noting that the Obama administration’s representatives to the OECD conference voted for the action item that paved the way for its member countries to adopt an IP box tax regime. For the administration to assert that this is poor tax policy now doesn’t make any sense, and comes too late to make a difference.
But Jason Furman’s objection to an IP box skirts these issues entirely. His primary objection is that, he says, it is a poor way to incentivize innovation and that they would rather Congress incentivize research in other ways. For him to pretend this is its primary intent and object to it on those terms amounts to pure obfuscation.
The motivation for an IP box is to alter the sad reality that our current tax code incentivizes U.S. companies to move their economic activities out of the country. It’s not an innovation story–it’s a location story. Furman knows that and is trying to change the subject.
The Obama administration recognizes that the tax code does a lousy job at encouraging investment and economic activity in the United States. Furman said so in his speech denigrating IP boxes. However, their solutions—a slightly lower corporate rate, a tax on every dollar of income earned by a U.S. multinational overseas, and a prohibition on inversions—make for good political talking points but terrible policy.
An IP box would forego relatively little tax revenue while helping to fix a glaring flaw in the U.S. corporate tax code. Furman’s objections skirt the issue and amount to a refusal to engage on a pressing issue facing the U.S. economy.
Ike Brannon is president of Capital Policy Analytics, a consulting firm in Washington, D.C.
