Would Kerry cut foreign investment?

Robert Gottliebsen, The Australian’s business columnist, is ringing alarm bells over Senator Kerry’s threat to attack US tax incentives for foreign direct investment and ‘offshoring’. But the incentives are only a small fraction of the US income from foreign direct investment; their withdrawal would be unlikely to impact China and India at all. Gottliebsen quotes Kerry’s nomination speech at the Democratic Convention on his plan to eliminate tax incentives for so-called ‘off-shoring’—that is, the relocation outside the USA of US-owned manufacturing production and jobs (this is_not_ the same thing as ‘out-sourcing’—the use of contracted supply of goods or services from foreign producers) He concludes bq. If Kerry is elected US president, he is firmly committed to turning the global outsourcing market upside down with profound effects on China and India as well as the current dynamic driving the US economy …
Kerry … proposes to change the basic business model that underpins current world trading(“The Australian”:http://www.theaustralian.news.com.au/common/story_page/0,5744,10839619%5E16946,00.html) Well… not really. Hampering the relocation of prodution or even of supply outside the US is bad for the US economy, as Alan Greenspan, among many others, has “pointed out”:http://news.com.com/Greenspan+Offshoring+laws+could+harm+U.S./2100-1022_3-5172975.html?tag=nl.  It has the effect of raising US prices and shrinking the US economy and the number of US ‘onshore’ jobs. But Kerry’s plan to change foreign investment tax incentives complies with the United States’ international obligations: under WTO, for example. Current US tax laws allow companies to defer US taxes on income earned by their foreign subsidiaries. A US company that is trying to decide between locating production or services in the United States or in a foreign low-tax haven is actually given a tax incentive to re-invest subsidiary profits abroad rather than to repatriate them. Note that this means that the Kerry tax plan would have no effect on ‘outsourcing’ where no foreign direct investment is involved. If US consumers are willing to pay a sufficiently high price for goods made in the USA rather than abroad, the Chinese or Indians likely will ‘offshore’ their own production as the Japanese learned to do in the 1980s in response to US trade barriers on automobiles and consumer electronics. If the Kerry plan is enacted, the projected $12bn loss of tax incentives for ‘offshoring’ investors would equal only 7 percent of the annual income from US FDI ($164bn last year, see the Table below). At this level, the loss of the incentives could certainly have some impact on total outflows. But Gottliebsen is exaggerating to say that it would “turn the market upside down”. Kerry says that he’ll apply the $12bn in savings to reducing the total corporate tax burden. So the companies that lose the ‘offshoring’ incentive will get some of it back in lower taxes on their US-earned income. It’s possible that a serious attack on offshoring/outsourcing by a Kerry administration could impact demand for Australia’s products, for example our raw materials supply to China, as Gottliebsen alleges. But I think this is unlikely. China is not a favoured destination for US offshoring, so probably doesn’t have much to lose. In fact, a lot of US ‘offshoring’ goes not to China and India but to Mexico—the United States’ NAFTA partner—and to Central America (particularly garments) and to Europe. As the distribution of US foreign direct investment shows (see the table below that I pulled together from “US Treasury data”:http://www.bea.doc.gov/bea/di/usdctry/longctry.htm), there are a large number of destinations for US foreign investment that far outweigh China and India: ‘offshoring’ limits would have a bigger impact in Ireland. “Here’s”:http://releases.usnewswire.com/GetRelease.asp?id=28000 the Kerry campaign media kit about the investment incentive story. Also, you might want to skim through the conservative Cato Institute’s dissection of “Kerry’s trade record”:http://www.cato.org/dailys/08-23-04.html. On the whole, his record is not nearly as bad as it might seem from this idea.

US stocks of foreign direct investment
$US millions, 2003
Destination Stock at historical value Income
Canada 192,409 17,354
Europe 963,087 81,751
Of which
France 47,914 4,339
Germany 80,163 4,062
Ireland 55,463 8,281
Luxembourg 66,919 7,780
Netherlands 178,933 15,791
Switzerland 86,435 10,738
United Kingdom 272,640 13,756
South America 69,942 4,541
Central America 71,507 6,766
Of which
Mexico 61,526 5,750
Other Western Hemisphere 162,574 13,245
Africa 18,960 2,864
Middle East 16,942 2,645
Asia Pacific 293,490 35,546
Of which
Australia 40,985 3,707
China 11,877 2,371
Hong Kong 44,323 5,071
India 3,609 391
Japan 73,435 9,167
57,589 6,974
All countries 1,788,911 164,712

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