The Fallacy of President Obama's Tax on the Rich

In his State of the Union Speech, President Obama said that people making over $1 million a year should receive no tax breaks and that people making over $250,000 a year should pay more in taxes. The people making $250,000  is slightly over the proverbial “1%” that already pays 38% of the income taxes in the United States.

President Obama, in particular, is going after the people who are paying 15% on the capital gains tax instead of the maximum 35% marginal rate they would probably be paying had the income  been from “ordinary (wage)” income.  What Mr. Obama does not seem to understand, or, perhaps, does not want the voters to understand, is that this income is taxed twice.  The income is first taxed at the corporate level and then at the individual level.  Large corporations face an official marginal tax rate of 35% on their profits. Most do not pay that rate.  From 2006 to 2009 the effective tax rate (What companies actually pay.) for American multinational corporations was just over 22%.   This was an average. Some companies paid more and some companies paid less.  General Electric paid no federal income taxes in 2010, while other, probably less well connected companies, certainly paid more than 22% in federal income taxes.  So on average, a dollar that people receive from corporate dividends is actually taxed at a total rate of a little over 37% by the government of the United States because it is not taxed once, but twice and now President Obama wants to increase the taxes on both the corporations and the individuals paying those taxes.

Why is this important? It is important because the United States is no longer in a world where the US is the only industrialized nation as it was at the end of World War II and into the 1960’s. The world has changed.  The United States no longer represents the vast majority of the world’s gross domestic product as it did in 1945, but something close to 30%. The US is in competition with other societies for jobs, industry, growth and prosperity.  But it is still acting as though there are no other choices.  The US has the highest official corporate income tax rate in the world because Japan lowered its corporate income tax rate last Spring and from 2006 to 2009 had the second highest effective corporate income tax rate in the world at just over 22%.  As a result, multinational companies are keeping their money outside the US; investing their money outside the US; and hiring outside the US.  President Obama’s response to this is to raise taxes further which will only serve to drive major corporations to continue to keep ever more money outside the US; invest more money outside the US; and hire more people outside the US.  Needless to say this will not serve to spur the economy or lower unemployment in America, but it will probably help countries where multinational corporations choose to invest.

President Obama also threatened to tax the profits that are being held by American multinational firms outside the US.  President Obama should remember that there is nothing preventing major American corporations from reincorporating in other, more friendly venues.   In the UK this has been going on for a number of years with many British firms reincorporating in Ireland.  Going from Dublin to London is like taking the shuttle from New York to Washington.  The problem for the British is that these British firms are going to require Irish staff, Irish accountants and Irish barristers and are going to become a lot more Irish and a lot less British in the future.  What this will mean for both Ireland the the United Kingdom remains to be seen.

On an individual level, the rich will vote with their feet. A few years ago, only about 50 Americans a year gave up their citizenship. American citizenship is one of the most prized possessions in the world and people risk their lives every day to come to America.  But in the first two quarters of last year, over 1,000 mostly wealthy Americans living outside the US  turned in their passports, thereby giving up their citizenship.  Most of them did it for tax and investing reasons as living outside the US, today, presents American investors with many problems and limitations that individuals of other nationalities do not have.  Wealthy people are not going to pay higher taxes if the taxes get high enough.  They will leave.  This is not because they are unpatriotic; it is because they are rational.

Today we have a global economy not a national economy.  That means that what goes on in the rest of the world will have an affect on what goes on in the United States.   Canada has an effective tax rate that is 5.7% lower than in the United States.  That means that on $1 million of profit a company will pay $57,000 less in taxes in Canada than in the United States; $570,000 less in taxes on $10 million.    Canada is not the country with the lowest effective corporate tax rate; it is only the closest.

The small individual businessperson that would be included in President Obama’s $250,000 annual profits cut-off already pays over 27% in federal income taxes, about 5% more than is already paid on average by American multinational corporations and 10% more than is paid by his NAFTA competitors in Canada.  President Obama wants to increase taxes on these small businesses, making it more difficult for them to hire people. The average cost of a manufacturing employee in the United States in the first quarter of 2010 was just under $59,000 a year. This included all costs: wages; benefits; etc.  Raising taxes on a company making $250,000 a year is going to make it just that much more difficult to hire employees.

The senior management of a corporation has a fiduciary responsibility to protect and grow the investment of the stockholders.  If that means keeping the money outside of the United States, investing the money outside the United States; and hiring employees outside the United States so as to grow and enhance the stockholder’s investment, rather than paying some of the highest corporate income taxes in the world to the American government, then they have the fiduciary responsibility to do so.

The United States is in competition with the rest of the world for business, jobs, growth and continued prosperity.  As Thomas Wilson, the CEO of All State has said, “I can get workers anywhere in the world. It is a problem for America, but not necessarily for American business …. American business will adapt.”  The attitude of American multinational corporations is described in McKinsey’s Global Institute 2010 Report on Multinational Corporations as, “US multinational corporations must pursue new growth opportunities and continually improve global operations to remain competitive…They go where the markets are expanding; where the talent lives; and where they can earn superior returns.”