Thus sprach President Barack Obama to a joint session of the Congress – “we will restore a sense of fairness and balance to our tax code by finally ending the tax breaks for corporations that ship our jobs overseas.” Everyone stands up to applause and I am a little confused.
First, how does someone even implement this proposition? I am yet not sure of the legal fine print but does it mean GE (example) will lose its tax breaks if it offshores customer support to Wipro Technologies in India (example) but will not if it sets up GE India Pvt Ltd for the exact same purpose? Most offshoring happen like this. An US company signs an outsourcing contract with an US subsidiary of (say) an Indian outsourcing vendor, which then sub-contracts the job out to its Indian parent at a price. The Indian company pays tax on the profit it earns from the arm’s length transaction with its US subsidiary while the US subsidiary pays tax as per the laws of its domicile country, that is the United States of America. The US earnings attracts Indian taxes only if the US subsidiary repatriates profits earned in the US in the form of dividend to its Indian parent company. Given this situation it is not intuitive how President Obama can implement his rhetoric.
Secondly, a country loses jobs to offshoring when it no longer enjoys comparative advantage of performing a function or a task. The per transaction cost of answering a phone in Manila is way too low compared to Minnesota, so it is a given that Philippines becomes a preferred destination for that function. The folks at Minnesota graduate to doing stuff they are relatively more efficient in doing (like designing marketing campaigns for which the phones will ring in Manila). This outward movement of functions have been happening for a very long time with the US, especially in manufacturing. It can be argued that at a macro level the skill of car making shifting out of Detriot into South Korea and Japan is some sort of factor-induced non directed offshoring. So is it even possible to reverse an economic process by constructing non-tariff barriers? Or have we reached a situation where Americans have lost their relative advantage in significantly high number of functions and offshoring is a consequence of that rather than mere cost (or tax law) arbitrage? President Obama goes on to say – “… I do not accept a future where the jobs and industries of tomorrow take root beyond our borders – and I know you don’t either. It is time for America to lead again”.
I wonder how it is possible for America to resume leading by doing tasks that Manilla had been doing for it up until now.
Update: Kishore has a very clear minded and precise analysis of this issue in this post in his blog – View of My World