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CF&P Strategic Memo, September 13, 2002

Date:    Friday, September 13, 2002
To:       Supporters of Tax Competition
From:  Dan Mitchell, Heritage Foundation Senior Fellow
Re:      The Battle against Fiscal Protectionism

General Background

Goaded by an anti-competitive U.S. tax system, several American-based companies have chosen to re-incorporate in jurisdictions with better tax laws (a process often known as "inversion" or "expatriation"). This has generated a political backlash, and the House and Senate recently approved amendments to the Homeland Security bills that would punish companies that are incorporated in so-called "tax haven" countries. Offered by Rep. Rosa DeLauro and Senator Paul Wellstone, these amendments prohibit companies from competing for contracts with the new Department of Homeland Security.[1] Several Members of Congress may offer similar amendments to other pending Appropriation bills.

These proposals are bad public policy. Anti-competitive tax law is the cause of the problem, and anti-expatriation provisions simply create an additional disadvantage for U.S.-based companies that do business in international markets. American workers and shareholders are the ones who ultimately bear the costs of these misguided policies. Instead of resorting to fiscal protectionism, lawmakers should fix the portions of the tax code that hinder U.S. competitiveness.

Most other nations use a "territorial" system to tax resident corporations, which means the foreign-based firms pay tax to each country where they earn income – but they do not have to pay a second layer of tax to the nation where they are chartered.  By freeing a company from having to pay U.S. tax on income earned in other nations, "inversion" enables a company to maintain factories and headquarters in the U.S. and yet still compete on a level playing field in world markets.

This explains why corporate "expatriation" is a process that benefits the American people. It is American workers who benefit when a company is a stronger competitor in world markets. It is American shareholders who benefit when a company is on a level playing field with foreign competitors. And it is American consumers who benefit when a company can charge lower prices because of better tax treatment.

The Wellstone and DeLauro amendments are designed for political rather than legislative goals. Looking forward to the November elections, sponsors hope to demonize corporations by creating a public perception that firms are engaged in a shady form of tax evasion. This demagoguery is false. The actions taken by these companies were (and are) in complete compliance with U.S. tax laws and regulations.  These companies continue to pay taxes to the IRS on all income earned in the U.S., and they pay all applicable tax to other governments on income earned in all the countries where they do business.

An International Disadvantage

The Wellstone/DeLauro amendments punish the victims. The Internal Revenue Code hinders the competitiveness of American-based companies. Glenn Hubbard, chairman of the Council of Economic Advisers, has noted that "from an income tax perspective, the United States has become one of the least attractive industrial countries in which to locate the headquarters of a multinational corporation."

Bad tax policy deserves the blame. The number one problem is that U.S. tax law subjects corporations to taxation on their worldwide income, while many foreign countries only tax their resident corporations on income earned within their borders. This puts U.S. corporations at a competitive disadvantage with their foreign competitors.

  • As the U.S. Chamber of Commerce noted in a letter sent to Congress in opposition to the Wellstone Amendment: "Rather than alleviating the disadvantage foisted upon our corporations by inequities in the U.S. tax code, Congress proposes to supplement it with a non-tax disadvantage.  This doesn't fix the system—it only makes it worse."
  • According to the Cato Institute, only three member companies in the Organization for Economic Corporation and Development have higher corporate tax rates than the United States. This high rate is just the tip of the iceberg. The U.S. also double-taxes dividend income, taxes capital gains (with no indexation for inflation), and imposes numerous other provisions that hinder competitiveness.

Unintended Consequences

The Wellstone/DeLauro amendments are not just about tax policy. They also will have important – and negative – consequences on budget policy, trade policy, employment, mergers, and exports.

  • For the first time, the Congress will use listing on a U.S. exchange as a test to apply the U.S. tax code to foreign companies.  The chilling effect this will have on non-U.S. companies as they consider whether to list on the U.S. exchanges is clear.
  • Banning certain companies from competing for government contracts reduces the pool of potential competitors for government work. Reducing competition will lead to higher costs for taxpayers.
  • The Wellstone and DeLauro initiatives are poorly crafted. The amendments supposedly target companies that "expatriate," yet the proposals fail to distinguish between companies that "inverted" and those that received their original charter in low-tax jurisdictions.
  • No longer will quality of product and price govern the awarding of government contracts. Even if a "banned" company offers the best product or service, it is placed out-of-bounds by these laws.
  • The Wellstone amendment does not have a time frame regarding incorporation dates and is not limited to so-called tax haven countries. As U.S. Senator Phil Gramm (R-Texas) stated during the debate in the Senate, "…even if your product is better, even if your product would save lives, even if your product would save money, if anyone cares about saving money—then you cannot sell it to us if, in 1812 you were domiciled in Boston and you moved to London and you did not change your ownership by moving."
  • Many of these companies employ thousands of Americans. This legislation is, in effect, writing "pink slips" for thousands of workers around the country.
  • Foreign companies that do not fall within the ban are already positioning themselves to move into the vacuum created by legislation. A French-based firm is preferred to a Bermuda firm, even though both would only be obligated to pay taxes to the IRS on income earned in America.  "So if you have always been foreign, you can deal with the Federal Government," said U.S. Senator Fred Thompson (R-Tennessee) during the debate on the Wellstone amendment. "But if at one time, at any time in your past history, you were an American company, you can't. That doesn't make any sense to me."
  • As Business Week's Howard Gleckman noted in a September 9th article, "American companies are becoming attractive targets for overseas takeover—in part because they'll pay lower taxes as foreign-owned businesses." There is nothing wrong with cross-border mergers, of course, but it presumably would be a good idea if the U.S. tax code did not put American-based companies in a defensive position.
  • In that same vein, U.S. Senator Orin Hatch (R-Utah) wrote in the July 23rd Investors' Business Daily that anti-corporate inversion legislation treats a symptom while the disease thrives. "If we fail to treat the disease, U.S. firms that resist the siren song emanating from Bermuda' shores could find themselves the targets of hostile takeovers by foreign competitors. Founding a new corporation in the U.S. could become as quaint and old-fashioned as wearing an ascot and spats."
  • Legislative bans on certain foreign companies being able to compete for government contracts is directly counter to the long-established policy of the U.S. to open international government markets. The Global Government Procurement Agreement prohibits the U.S. or any participating country from treating foreign suppliers less favorably than domestic supplies.  Over the past twenty years, this policy helped U.S. companies sell more than $340 billion in goods and services to foreign governments. U.S. Senator Fred Thompson (R-Tennessee) said the legislation might violate international agreements and "we would giving governments an excuse to ban U.S. companies from bidding on government contracts."

Contrary to American Values

Competition is a process that Washington should nurture and protect, but the Wellstone/DeLauro approach is contrary to the spirit of fair play. Instead of fixing the tax code so American companies can compete on a level playing field with companies from other countries, politicians are seeking to make it harder for them to meet the challenge of foreign competition.

  • Companies that qualify for government contracts and successfully fulfill their responsibilities should not be barred from future contracts because of retroactive legislation.
  • Washington should encourage more companies to bid for more contracts because competition leads to better products and better services for the best price. Washington creates too many rules and restrictions when it comes to awarding contracts.  Denying companies the right to bid will only lead to higher prices and inferior services.
  • The cost and quality of a product or service is more important than the location of incorporation. Americans have a right to buy the best, and we expect Washington to do the same. As Americans, we will not tolerate an inferior product or service or, worse yet, a more expensive product or service that is inferior. 


Wellstone and DeLauro are appealing to xenophobic sentiments, allowing people to believe that their amendments will encourage the government to buy American. This is ironic, since their initiatives likely will reduce American jobs. Companies that expatriate keep their headquarters and factories in the United States, but they will be barred from providing goods and services to the Department of Homeland Security. Companies with foreign workers and foreign headquarters, by contrast, will be allowed to bid on government contracts.

More than anything else, this demonstrates that Wellstone and DeLauro are motivated by a political agenda. They are willing to sacrifice American jobs in exchange for a campaign issue, when the right approach is fixing a tax code that is hindering America's competitiveness.



[1] A conference committee will now consider the Wellstone and DeLauro amendments to the Homeland Security bill and conclude what language, if any, should be included in the final version of the bill.


Center for Freedom and Prosperity
Alexandria, Virginia

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