PANGEA3 LLC

Obama’s proposals to end deferral of US income tax on foreign subsidiary earnings of US companies, coupled with his employment restrictions on professional immigrants is likely to result in a substantial reduction in American GDP and American jobs resulting in further contraction of the US economy.

The traditional tax treatment of US companies and their foreign subsidiaries, long before talks on Obama’s proposals started, had already put American companies at a competitive disadvantage vis-à-vis their non-American peers. This disadvantage arises because many countries only tax companies on income earned in their home country and exempt them from tax on earnings of foreign subsidiaries. America, on the other hand, ultimately imposes additional US taxes on those foreign subsidiaries to the extent that the US tax rate is higher (e.g., after a credit is accorded for the foreign taxes). For example, in the case of a company enjoying a tax holiday in India, many European parent companies would pay no tax in their home country on the Indian subsidiary’s earnings, but in the US, a parent company would have to pay US taxes making the benefit of the Indian tax holiday worthless. Under current rules, the US tax system in most cases imposes that additional tax only when the earnings are brought back to the United States. President Obama’s proposed rules would impose that tax in the year the foreign subsidiary generates the earnings even before the earnings are sent back to the United States, putting those companies at an even more unfavorable competitive position. The European companies and the local companies with which they are competing have no such additional tax burden. The US simply can’t afford to make its corporate citizens even less competitive than they already are today.

Take for example, a US based IT services company with operations in India as compared to an India based IT services company with similar operations in India. The India based company pays little or no taxes in India because of Indian tax holidays. Under Obama’s new tax proposals, the US based company would have to pay taxes to the US government of 35% on the same type of income. This means that the US Company has 35% less after tax profits or must increase its prices for customers by 35% to be in the same position as the Indian company. Let’s say that both, the US company (US CO) with all of its operations in its Indian subsidiary and an Indian company (India Co) each earn $1 billion in revenue and incur aggregate expenses of $500 million resulting in a net profit of $500 million. In certain circumstances both the India Co and the Indian subsidiary of US Co would pay no taxes in India under typical STPI/EOU programs. But US Co would end up paying 35% ($175 million) in taxes to the US Government as opposed to zero for India Co. The only way for US Co to get to the same after tax profit as India Co would be to charge 35% higher prices or earn 35% more revenue through more business.

To make matters worse, the new immigration restrictions are tied mostly to government bailout funds and restrict banks and recipients of TARP and other bailout funds from employing professionals in the United States on H-1B visas. This makes it difficult for leading financial institutions and other firms to hire highly qualified experts and professionals. The new proposals to restrict H1-B and L1-B employment beyond government bail-out recipients could ultimately result in an exodus of talent from the country, along with the revenue generation that would have been attributable to them and the spending they would have incurred.

This clearly makes it a double hit to America.

Obama’s immigration restrictions actually force Indian entrepreneurs and professionals out of the US to India where they establish more off-shoring business and the tax policies make the US based companies less competitive with the Indian based companies such that more and more US dollars flow to the Indian companies. While this appears to lack wisdom from the standpoint of the US economy and corporate, one must also appreciate that Obama is thinking of the average American individual who is angry about American companies making money by getting work done in India rather than in the United States.

The irony however, is that these protectionist policies are likely to harm American individuals much more than others since it makes the way for less jobs for Americans. The flip side is that they also signal good news for the Indian IT/BPO industry. The policies force more business and revenue to Indian based companies operating in India by making US companies less competitive and by precluding what might have been on-shore activity.

The reality is that the best way to protect American jobs is to eliminate the trade barriers and the immigration barriers—facilitating commerce by enabling foreigners to come into the US and for US companies to operate outside the US. Immigration and tax policies that make it difficult or preclude foreigners from doing business in the US and for US companies operating outside the US respectively simply push dollars and jobs outside the US. It may be good politics but it is bad for the economy.

It is very unfortunate for Americans that President Obama is out fooling the American public into believing that opportunity lies in the heartland of America protected by artificial barriers at the border known as Visas and tax disincentives. At some point the American public will realize that opportunity lies not in the heartland but across the internet sea in Bangalore where people are truly free to do work anywhere in the world they please.