Varner: Taxes and international trade
A while back in Germany, I was driving on the straight as an arrow B-1. That is Bundesstrasse, the equivalent of a U.S. highway, a notch below the Autobahn. Roads tend to curve around farmers’ fields, having been there first.
The B-1 from Cologne on the Rhine toward Berlin was built by Napoleon, whose engineers cared little about farmers’ rights, and aimed straight at one town church spire after another. I saw a big flag saying “Mitsubishi.” Sure enough, the window stickers all said the same thing, “Normal, Illinois USA.”
Trade among the three involved countries has been open and free. But as one issue disappears, others arise. Tax is often at the forefront. Assume the car engine is made by Mitsubishi in Japan and shipped to Normal, where it was put in the car. The finished product was sent to and sold in Germany, hopefully at a profit. Mitsubishi then paid tax on its revenue, less expenses. That might sound simple until one asks where the profit was really made. Understandably, Japanese, American and German authorities are all eager to collect. While the bottom line is all Mitsubishi, there was value added and expense in each of the countries, and each country is entitled to its share. Treaties do protect Mitsubishi from being taxed twice on the same profit.
That engine made in Japan must be “sold” to the operation in Normal and the finished car again to the German branch. Now comes the accounting. It is well known that the U.S., at 35 percent, has the highest corporate tax rate in the world. Japan has about 30 percent and Europe averaged 25 percent, with Ireland a very attractive to business at 12.5 percent. Mitsubishi wants to charge itself a high price for those Japanese-made engines and then the American branch almost gave away the cars to Germany, shifting the profit to lower-tax Germany.
The law, however, requires what is called the transfer price to be “fair,” whatever that might mean. A lot of energy goes into finding that number and the U.S., with its high tax rate, is usually on the short end of the stick. Hiding revenue is illegal tax evasion, but in transfer pricing, all the numbers are on the books and the fair value of that engine is not an easy call. You can bet companies are well aware of what they can get away with. A more world competitive tax rate might bring in more money.
Mitsubishi is closing here and we all hope there will be some interest in the facility. Suppose both General Motors, headquartered near Canada, and Bavarian Motor Works from Munich would find the Normal facility attractive. Business has been good in Europe and both companies have $500 million socked away in a European bank ready to go. Wouldn’t it be a thrill if we could help turning out those Bavarian buggies? Wouldn’t be bad, either, but there is an additional problem of taxes. BMW, as a foreign company, is more than welcome to invest European profits in Normal but GM would have to pay a heavy tax to bring those foreign profits home. BMW, of course, pays no U.S. tax on European profits but GM as an American corporation has to pay the difference between the 35 percent and the lower foreign rate only if it repatriates the money.
Some years ago, American toolmaker Stanley and just recently Walgreen’s flirted with going offshore. Pfizer has gone to Ireland. In the last week or so, Johnson Controls of Milwaukee also is going for that 12.5 percent tax rate in Ireland.
Some politicians have called for laws to prevent our companies from leaving. It won’t be that easy. Treaties allow American companies to buy up foreign firms and, in this two-way street, a corporate inversion allows a foreign company to “acquire” a much larger American firm, moving its seat of incorporation overseas. Others say our corporations should pay our higher tax up front.
A Chinese student told me recently that he felt that Chinese worked very hard but that Americans are the creative ones. I agree. So let’s give the system a couple of tweaks and put that can-do energy into productive business and not tax avoidance.