Wave Goodbye to Capital Seeking a Warmer Climate

For the past 50 years, the United States has embarked on a path from an industrial economy to a service-based economy, and the tax bill now (American Jobs and Closing Tax Loopholes Act) under consideration in Congress takes great strides in offshoring some of the United States’ most lucrative service industries in areas such as finance and insurance.

 

In the modern world economy, money can change hands across oceans and currencies in fractions of a second, and multinational holdings have skyrocketed in the last decade to coincide with the trends of globalization. Likewise, a business’s location no longer has much bearing on its ability to participate in markets. For proof, just consider that the Wall Street flash crisis occurred in large part due to orders from Waddell & Reed Financial Inc., an Overland Park, Kansas, brokerage and mutual-fund firm.

 

Given these considerations, the comment from House Ways and Means Chairman Sander Levin of Michigan that "By promoting jobs here in the U.S. and cracking down on loopholes that encourage companies to move overseas, we strengthen opportunities for American workers and businesses," makes little sense in light of the bill on the table and the financial reform bill passed yesterday in the Senate.

 

Aside from the bill’s blatant Democratic pandering to buy votes with over $5.6 billion directed to core constituencies like Native Americans, black farmers, and teens, it takes aim directly at the type of firms and professionals who foot most of the tax bill. It endeavors to change the way that those who run hedge funds, private-equity groups, venture-capital funds, and real-estate partnerships report their capital gains income earned as the "carried interest", taxing those gains at one-quarter capital gains rates, and three-quarters ordinary income tax rates.  This bizarre treatment raises the tax rate on these capital gains from 15 percent today to 37.25 percent once the 2001 tax relief expires at the end of this year and Obamacare's investment surtax goes into law in 2013.  This is a 150% increase in the tax rate on this important type of capital gains.

 

Moreover, it would increase the tax burden on professionals and small-business owners by imposing the Medicare payroll tax (soon to rise to 3.8 percent for most small business profits) on small, service-sector Subchapter-S corporations.  This means the top rate on service-sector S-corporations with three or fewer service-providing owners will rise from 35 percent today to 42.6 percent once the 2001 tax relief expires at the end of this year, which would raise tax receipts by about $10 billion over the next ten years. Finally, the bill attacks many of the strategies that multinationals use to prevent double taxation on their income earned abroad, to the tune of $14 billion in additional US taxes on funds already taxed overseas.

 

In short, this bill along with yesterday’s restrictions on the ways in which many firms can invest or hedge against risk do nothing but incentivize them to flee to more hospitable business climates in Europe and Asia. If the U.S. wants to keep high-grossing high-education service jobs here, then it must create an environment that gives businesses and professionals reasons to stay considering the ease with which they can leave.

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