In Obama's budget, it's techies vs. taxes

By Jia Lynn Yang, writer

There's a frequent line in President Obama's speeches that makes every U.S. tech executive cringe: his vow to cut tax breaks for “companies that ship our jobs overseas.”

Obama's brushing over some details here. The U.S. tax code does not literally give a company a tax break every time it moves a job offshore. But it does allow companies to defer paying taxes on their overseas profits, so long as the money remains invested outside the U.S.

Obama has vowed to change this part of the law, and for months tech CEOs have been coming through Washington howling about the dire consequences of raising such taxes on multinationals. They've made some inroads with the administration, but based on what's in the president's 2011 budget released last week, Silicon Valley and DC are far from done battling over taxes.

The details are buried in the budget on page 161, Table S-8 under the heading "Reform the U.S. international tax system" (a word of warning: the link takes you to a sizeable PDF). If the proposed changes go through, the administration estimates it will bring in $122.2 billion in added tax revenue.  As far as the administration is concerned, the added money will not only help close the gaping deficit, but stop U.S. companies from ducking out of domestic taxes by shopping around for which country has the best tax rate. For instance Ireland, with a rate of 12.5%, has become a popular destination for manufacturing.

Tax cheats?
In the U.S., it’s tech companies who have raised the biggest stink about the proposed change.  Tech companies argue that they’re being treated like tax cheats when all they’re trying to do is find the best place to make their products.  The distinction isn’t always easy to see.  “It's not like there's a good group of companies and a bad group of companies,” says George Yin, a tax professor at the University of Virginia School of Law. “There's a blend of activities going on, some of which you might think of as good and legitimate, and others that are designed to reduce the overall tax liability.” Yin says the problem with the president's proposal is that it doesn't do enough to differentiate between so-called good activity and so-called bad activity.

And it's the “good activity” that the president must be careful not to step on as the economy slowly recovers. James Hines, a professor of economics and law at the University of Michigan, points out that if foreign competitors are exploiting the lower tax rates of other countries, maybe U.S. companies should be able to do the same, even if the so-called loopholes look distasteful. “Your sense of what's right and wrong has to be conditioned by what the rest of the world does,” Hines.

How the money comes home
Not only that — many economists argue that Obama is simply wrong when he asserts that companies expanding abroad cost jobs at home. Hines has done research showing that for U.S. companies in manufacturing industries from 1982 to 2004, 10% greater foreign investment was associated with 2.6% greater domestic investment. In other words, discouraging overseas activity is exactly the wrong way to create jobs inside the country.

“We want to help the Administration generate new jobs and expand the manufacturing base domestically,” said Intel's vice president and legal and corporate affairs director Peter Cleveland in an email. “To do that, the President's ideas on innovation are spot on…But some of the international tax policies create financial strain for the company and will restrict our ability to grow the business.”

Someone seems to be listening to Intel (INTC). Last year's budget proposed changes to the international tax code that would've added $210 billion in taxes from multinationals, almost $100 billion more than this year.  One major change is the administration has walked away from its proposal to override so-called “check the box rules” relating to how a company classifies its subsidiaries for tax purposes. Critics say the current system makes it easy for corporations to shift income from their foreign affiliates into tax havens.

Washington may still raise taxes but it’s not ignoring Silicon Valley altogether.