Corporate Tax Cut Windfall

For those who still claim that tax rates don't matter to eco nomic decisions or U.S. corn- petitiveness, we present Ex hibit A: the 2004 American Jobs Creation Act.
This law gave American companies a one-year window in 2005 to repatriate earnings from foreign subsidiaries to the United States at a 5.25% tax rate. Nor- mally companies must pay the 35% U.S. corporate tax rate, minus a credit for whatever foreign taxes they paid on those earnings.
The IRS examined the results from this tax cutting experiment and found that the money came back in a flood. More than 800 U.S. corporations repatri ated $362 billion from foreign opera- tions. Congress's Joint Committee on Thxation had predicted closer to $200 bil lion. These dollars are now being in- vested in the U.S., rather than remaining in Europe or China. This capital infusion may be one reason that U.S. business in- vestment rose 9.6% in 2005-the highest rate in more than a decade.
Many Democrats, liberal groups and even some economists in the Bush Trea sury opposed the measure four years ago, predicting itwould lose revenue and merely be a tax holiday for profitable cor porations. The Joint Tax Committee esti mators also blundered again by predict- ing a mere $2.8 billion in revenue gains in the first year and then big losses after 2005. As always, they underestimated how tax reduc tions change be- havior. Thetaxin centive raised $18 billion in 2005, and reve nues have contin ued to exceed esti mates. Instead of getting 35% of nothing, as U.S. companies kept their cash abroad, the Treasury took in 5.25% of the himdreds of bil lions the compaiiies brought home.
One lesson here is how hyper-sensi tive the trillions of dollars of ammal gb- bal capital flows are to tax rates. It also underscores how damaging the U.S. cor porate income tax is to American firms.
Over the past decade the U.S. has gone from a below-the-average corporate tax nation to the second highest rate in the industrial world. (See table.) Many countries have slashed their cor porate rates to as low as 10%. The economic impact is even worse be- cause the U.S. is one of the few countries that taxes foreign sub- sicliary income when it is rep atri ated.
Most countries let their compa flies pay taxes in the country where the income is earned, and the few countries that do tax repatriated in- come are changing their models. Japan is the only developed nation with a higher corporate tax rate than the U.S., but the Japan Times reports that the gov ernment wants to change its tax laws to stop taxing repatriated capital.
America's tax laws are repelling capi tal at the same time the rest of the world is inviting these dollars and thejobs and growth that inevitably follow. House Ways and Means Chairman Charlie Ran- gel wants to dig the ditch deeper by tax- ing American companies on their foreign earnings whether or not they bring the money back to the U.S. He thinks this will raise money for the Treasury but the like- Her effect is that more American multina tionals will relocate abroad.
Senator John Ensign of Nevada, the au thor of the 2005 holiday bifi, is proposing to do the same again for one year to stimu late the economy. As a rule, we don't like temporary tax cuts because they don't provide permanent incentives. But the 2005 holiday was an exception that proved the folly of current policy.
The best response going forward would be for Congress and the next Ad- ministration to reduce sharply the corpo rate tax rate so it is competitive with fall- ing rates around the world. John McCain is proposing to cut it to 25%. If Barack Obama really wanted to "run to the cen ter," he'd see that and cut it even further. As the 2005 results show, he'd then have more tax revenue to spend on his many social programs.