Senator Grassley Floor Speech

Reid-Durbin-Dorgan's "Creating American Jobs and Ending Offshoring Act"

Delivered, September 27, 2010

Mr. President, I rise to speak out against the Reid-Durbin-Dorgan bill, S. 3816.  This bill is being sold as somehow having the potential to create American jobs, but it would likely have the exact opposite effect - it would lead to a net decrease in American jobs.  For that reason, I encourage my colleagues to vote against this bill.

The bill has three key aspects:  1) a payroll tax holiday for employers hiring U.S. workers to replace foreign workers; 2) a denial of business deductions for any costs associated with moving operations offshore; 3) and ending deferral for income of foreign subsidiaries for importing goods into the U.S.  This last provision, according to Senator Dorgan, is the "principal issue" of the three.  It certainly is the most dangerous, so I would like to address that in detail.

To understand this partial repeal of deferral, it is best to consider the topic of deferral more generally and then we can consider this particular idea in context.

The term "deferral" refers to how a U.S. corporation pays U.S. income tax on the foreign earnings of its foreign subsidiaries only when those earnings are repatriated to the U.S.  That is, the U.S. tax is deferred until the earnings are paid by means of a dividend back to the U.S. parent corporation.

Deferral is not a new policy.  Rather, it has been a feature of the tax law for a century.

President Kennedy proposed outright repeal of deferral, but the then-Democratic Congress did not agree with him on that.  Instead, the Congress and the President compromised.  The compromise was this:   For passive kinds of income (such as interest, dividends, royalties and the like) earned by the foreign subsidiary, the U.S. parent company would pay immediate U.S. tax - whether or not the foreign subsidiary sent the earnings back to the parent.  However, for active business income of the foreign subsidiary, there would be no U.S. tax until the foreign subsidiary sent such money back to the parent.

In short, the compromise was this:  For passive income, deferral was repealed.  For active income, deferral would still be allowed.  That compromise is embodied in Subpart F of the Internal Revenue Code.  That compromise was hammered out in 1962.  And, with slight tweaks at the margin, that compromise has stayed in place for the last 48 years.

The compromise struck in 1962 was the right one.  Passive income is easy to move from one jurisdiction to another.  If a U.S. corporation had a lot of interest income, it was very easy to instead have a foreign subsidiary earn such interest income in a low-tax jurisdiction.  So, when interest income was earned by a foreign subsidiary of a U.S. parent corporation, there was a high likelihood that it was earned in the foreign jurisdiction out of a motivation to avoid U.S. tax.

But with active business income, there are usually legitimate non-tax business reasons for the income to be earned overseas.  The reason a U.S. car company sells cars in Hong Kong is not out of some desire to avoid U.S. tax, but rather out of a desire to sell cars to customers in Hong Kong.

So, the underlying rationale to the Subpart F compromise is this:  If there is a high likelihood that a particular type of income is earned overseas out of a desire to avoid U.S. tax, then deferral will not be allowed.  And if there is not a significant likelihood of that, then deferral will still be allowed.

And this is a very sensible rationale because one of the most fundamental tax principles of all is this:  Transactions should not be tax motivated, but should be motivated by business or other non-tax reasons.  Tax-motivated transactions should not be allowed the benefits of the favorable tax-treatment sought.  This fundamental tax principle prevents the tax laws from distorting decision-making and from distorting the economy.

But this Reid-Durbin-Dorgan "runaway plant" bill cannot be justified by any similar rationale.  They say they want to repeal deferral for a foreign subsidiary having income from importing goods back into the United States.

But are they claiming that when a foreign subsidiary of a U.S. company imports back into the U.S. that there is a high likelihood that the production of the good would have been in the U.S., but for a motivation to avoid U.S. tax?  They would have to be claiming that if they wanted to be consistent with a half-century of reasons why certain specific limitations on deferral have been justified.

But that simply can't be.  There are numerous non-tax reasons for having a foreign subsidiary of a U.S. parent company import goods into the U.S.  I would like to mention just a few of those reasons here.

One reason could be that there's only small demand for the product back in the United States as compared with its overseas markets.  For example, diesel-engine cars are very popular in Europe, comprising 50% of all car-sales there.  Here, in the U.S., diesel-engine cars are well less than 10% of all car-sales.  So, there are very good business reasons for having diesel-engine cars made in Europe, and not here.  Nonetheless, the Reid-Durbin-Dorgan bill acts as if the reason these cars are not made here is tax-motivated.

It may be that some items simply aren't found in appreciable quantities in the U.S.  For example, there is no diamond mining, nor chromium mining, to speak of in the U.S.  A U.S. parent mining corporation with a foreign subsidiary engaged in diamond mining, or chromium mining, where such diamonds or chrome are imported into the U.S., may find deferral repealed.  This could be true to the extent that the parent had any domestic restructuring at the same time it starts up any foreign operations.

But obviously the reason for the diamond and chrome mining outside the U.S. is not tax avoidance - the reason is that those minerals are not found here.  So, I would like the sponsors of this bill to make clear whether minerals not found in the U.S. and imported into the U.S. would be included in this proposal.

I would also like to know whether this proposal would have applied to Ford Motor Company's ownership of Volvo.  Ford owned Volvo Cars from 1999 to 2008.  During that time, many Volvos were made in Sweden and imported to the U.S. for sale.  If the acquisition had happened after date of enactment, deferral would be denied in this situation - at least to the extent that Ford may have been shutting down any plants in the U.S.  However, no one can seriously claim that the reason the cars were made in Sweden rather than the U.S. was from a desire to avoid U.S. tax.

Keep in mind that another foreign car company, let's say Volkswagen, would not be treated the same way Ford's Volvo car income would be treated.  Volkswagen would be better off tax-wise on competing auto sales into the U.S. market over Ford's Volvo, thanks to this bill.

There are lots of non-tax reasons for having foreign subsidiaries of U.S. companies import into the U.S.  But it seems that the Reid-Durbin-Dorgan bill does not recognize that.  Or does not care.  Perhaps the bill is motivated not by a desire to curb tax-motivated transactions, but by something else.  Perhaps the bill has anti-free-trade motivations.  Perhaps the bill is attempting to make it more difficult for American companies to conduct business outside the U.S..  Whatever the case, the bill's sponsors should make the rationale clearer - is it to curb tax avoidance?  Or something else?

Perhaps the bill's sponsors will admit that the bill has nothing to do with curbing U.S.-tax avoidance.  Perhaps they will say that it instead has to do with preserving and creating U.S. jobs.  But if that is their position, that cannot be right.  In some limited circumstances, perhaps it would increase employment in the U.S. (although probably mostly for tax lawyers than anybody else).  But whatever the case, the net effect would be to decrease employment in the U.S.

Allow me to explain why the net effect of the bill would be to decrease U.S. employment.

First of all, if a U.S. parent company has a foreign subsidiary, then this creates managerial headquarters jobs in the U.S. that would not otherwise be there.  The Reid-Durbin-Dorgan bill might encourage American companies to simply sell off their foreign subsidiaries.  This would in turn mean laying off employees at management positions at the American headquarters.

A bigger way this bill would hurt employment in the U.S. would be to discourage assembly jobs in the U.S.   A U.S. parent company could have foreign subsidiaries engaged in manufacturing parts that are shipped back to the U.S. parent.  The U.S. parent in turn might assemble those parts here in the U.S. into a finished product.  So, yes, just maybe this bill would encourage the company to repatriate the parts production, but it's just as easy to imagine that this bill would encourage the company to expatriate the assembly jobs.  So, this bill is an unacceptable gamble with American jobs.

In the words of the late Senator Moynihan in speaking in opposition to this proposal 14 years ago:  "Investment abroad that is not tax driven is good for the United States."

More recently, Senator Baucus' concerns that this would put the United States at a competitive disadvantage are exactly right.  Last Thursday, Senator Baucus was quoted in Congress Daily saying, "I'm looking at it.  I think it puts the United States at a competitive disadvantage. That's why I'm concerned."

Phil Morrison, the Treasury Department's International Tax Counsel, criticized this proposal in Congressional testimony in 1991.  Mr. Morrison noted that the bill would be very hard to administer and that it departed from the traditional focus of the limited areas where deferral is denied.

As President Clinton's International Tax Counsel, Joe Guttentag explained in 1995, "Current U.S. tax policy generally strikes a reasonable balance between deferral and current taxation in order to ensure that our tax laws do not interfere with the ability of our companies to be competitive with their foreign based counterparts."

This proposal has been made year after year for 20 years.  I ask that my colleagues again reject it, in an effort to keep American companies globally competitive, to protect American jobs, and to preserve the underlying rationale of why deferral should only be denied in limited circumstances.

Finally, let me briefly comment on one other aspect of the bill - the payroll tax holiday.  This too has provisions that will be difficult to administer - for example, do foreign workers actually have to be fired to have their employer get the payroll tax holiday in the U.S., or do they need only to be re-assigned job roles?

This provision only scores, according to the JCT, as costing $1 billion.  So, let's make sure we are clear on this point - the other side is seriously considering raising taxes on small businesses - the lead creator of jobs - by tens of billions of dollars by letting top individual rates go back up in 2011, but, in an effort to support job creation, they offer up this $1 billion payroll tax holiday?

According to the Joint Committee on Taxation, 50% of small business flow-through income will be hit by a marginal tax hike of 17 to 24%.  That tax increase is scheduled to hit these job-creating small businesses in a little over three months.  Finance Committee Republican tax staff calculate the effect of that tax hike to be 50 times the benefit provided by this bill.  On our side, we don't see the logic of raising $50 in taxes and providing a complicated tax benefit of $1.

Why aren't we dealing with the real problem, for the folks responsible for creating 70% of America's jobs.  I'm talking about a time-out on the tax hit that's coming to those small businesses.  That's what we ought to be debating here on the Senate Floor.

But the Democratic Leadership would rather spend valuable time talking about a bill that's artfully politically labeled a "jobs" bill.  Given that the bill will lead to a net loss in American jobs, it seems there might be a truth-in-labeling claim against the Democratic Leadership.

Let's have votes on real job creation incentives.  Let's get out of this gamesmanship.  Let's do the people's business and forestall the big tax hike coming at American small business.

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