Kerry's clever tax cut

Larry Kudlow
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Posted: Mar 27, 2004 12:00 AM

Sen. John Kerry moved to the right of Walter Mondale by proposing a small cut in the corporate tax rate, which he would lower to 33.25 percent from 35 percent. In political terms, it's a clever ploy. In economic terms, it merely provides a small offset to the significant tax hikes Kerry proposes on capital formation, where he would slap small businesses, top-bracket taxpayers, dividends and capital gains.

The Kerry proposal to roll back the Bush tax cuts would raise the after-tax cost and reduce the post-tax investment return on capital by more than 54.5 percent. Taking out the upper-bracket labor-income component -- which is still investment capital -- the Kerry tax hike would reduce investment incentives by nearly 47 percent and work-effort returns by more that 7.5 percent. A big hit.

Offsetting that, Kerry's corporate tax cut would raise after-tax returns on corporate income by almost 2.75 percent. But that's only a tiny amount compared to the overall tax-hike proposal.

Kerry would also terminate the extra-territorial tax credit for multinational companies with offshore operations. In doing so, he's both giving and taking away. More, he's pandering to the current political hysteria over so-called jobs outsourcing, a misinformation campaign that Kerry compounds with his threats to terminate a number of free-trade agreements.

As the profits of U.S. firms are taxed overseas as well as at home (when the income is transferred back to the United States), companies are unfairly double-taxed on their earnings. This is the big issue regarding the current corporate tax debate in Congress. Why should American companies be double-taxed on a worldwide basis when nearly all other foreign companies, including those in Europe, are only single taxed? (Europeans provide a rebate to their companies in the amount of the extra-territorial tax burden.)

U.S. multinational companies operate abroad, largely through foreign sales corporations, because that's where the market customers are. A little-known factoid shows that roughly 90 percent of all worldwide markets (in population terms) are located outside the United States. When asked why he robbed banks, Willie Sutton responded, "That's where the money is." If you asked GE, Gillette, Intel or Microsoft why they go offshore, they'd each say, "That's where the customers are."

Narrow-minded members of Congress who are obsessed with the phony outsourcing argument are trying to punish international companies, arguing that the "loophole" that lets corporations defer foreign-earned profits with a special tax credit is merely a reward for creating offshore jobs. This is Kerry's argument.

But the truth is, the territorial tax break is only a small part of the corporate rationale to locate part of an operation overseas. The greater justification is to be closer to foreign customers. And yes: Why should companies be double-taxed at home and abroad?

As for the outsourcing argument, that's old-fashioned fearmongering. Recent trade data show that there's far more insourcing of service jobs from foreigners who invest directly in the United States than outsourcing of jobs from U.S. foreign investment. In manufacturing, there is a net outsourcing, but that number hasn't changed in 20 years, a period during which the United States created 38 million new domestic jobs. "Outsourcing" today is a phony war against American business and open international trade.

Surprisingly, the Bush administration has not weighed in on the corporate tax-cut issue necessary to accommodate a WTO ruling that the extra-territorial tax credit is illegal. The most sensible solution would be a reduction in the marginal tax rate on corporate income from 35 percent to somewhere around 30 percent.

House Ways and Means chair William Thomas is trying to get a 3 percent cut in the corporate rate. So Sen. John Kerry has weighed in with a smaller 1.75 percent drop. Again, he's clever. Democrats don't usually propose cutting tax rates.

But Kerry's rollback of dividends, cap-gains and the top-bracket tax cuts instituted by President Bush would do great harm to the economic recovery and the stock market boom. Higher after-tax returns that reduce the risk of owning stock have attracted investors back to equities. After a three-year bear market, these higher post-tax returns were exactly what the doctor ordered.

The choice come November is clear. Bush is the pro-investor candidate, which should provide him with a comfortable re-election majority. (Two of every three voters were stock market investors in the 2002 and 2000 election cycles.) But a recent poll by Scott Rasmussen shows that only 36 percent of likely voters (down from 44 percent in January) believe that Bush is doing a good or excellent job with the economy.

Bush has work to do. Both the economy and the markets are recovering strong, but the president can't be bashful in making his case with clarity and vision.