I have argued thus far that (ignoring foreign taxes and the possibility that a US tax would drive Sue out of the US) the US should tax Sue on her foreign surgeries. Even under the assumptions thus far, however, the analysis is incomplete. I must address the argument that we should not tax Sue as that would undermine her competitiveness.
The competitiveness argument is that, if Sue is taxed, she is handicapped in competing with foreign doctors who would not have to pay income tax on the same surgeries. It is not clear that Sue's competitiveness, in this sense, is in the best interests of the US. This would be true only if total US welfare is higher if the US does not tax Sue than if she is taxed. This could be the case, say, if the taxes would drive Sue out of business altogether, which does not seem likely. More likely, the benefits to America of Sue paying her fair share of taxes outweigh any marginal burden on her. But, this is a very difficult question which I cannot answer with any authority.
While it is hard to decide if we want to make Sue competitive, it is important to note a more straightforward defect in the competitiveness argument: Taxing Sue probably does not make her less competitive. If Sue is paid the same amount for foreign surgeries as she would in the US, not taxing the foreign surgeries just would encourage her to ply her trade offshore. She is less competitive only if the foreign surgeries pay proportionately less due to the lack of foreign income taxes on other doctors who would perform the surgeries. (The foreign surgeries may pay less, for example, because of more limited malpractice liability, but that is not a tax concern.) While possible, this seems sufficiently unlikely that the entire competitiveness argument seems questionable.
Tomorrow: Those pesky European taxes.
Even if we buy into the premise that it’s differential taxation that drives compeitiveness (yes, I realize you are only adopting the premise of the defenders of low-tax regime, but I would suggest the evidence is stacked against this premise), we must realize that most places where multinationals actually do business also have relatively high tax rates. There are lots of factories in places like China, France, Germany, and Mexico – but how many factories do we see in the Cayman Islands? Attorneys overlooking beaches and post office boxes – but not factories.
This analysis seems rather silly to me because the underlying premise, viz. that the competitveness of a surgeon depends on the U.S. income taxation of foreign source services income, is patently absurd. The surgeon will be much more concerned about her malpractice insurance premiums than the U.S. income tax on her foreign source income. Indeed, I seriously doubt U.S. physicians are concerned at all about the taxation of their medical services rendered outside the U.S. since so few of them are actually licensed to practice outside the U.S. Quite frankly, if Sue prefers to live in Europe, then more power to her and good riddance. Where have you been hiding George?
In my experience, business location decisions are based on many factors, one of which is taxation. Access to the local market — does the phrase “Buy American” ring a bell? It has its counterparts in many foreign countries, both officially and unofficially. Local pricing — if the price is controlled, directly or indirectly, local production may be necessary to get a good price. Transportation costs — if the product has a low intrinsic value the cost of transportation from a low tax jurisdiction may eat up the tax savings. Manufacturing resources and raw materials — does the low tax jurisdiction have available labor and mid-level management, power, reliable transportation to the markets, communication, etc.. Can the manufacturing process be broken into segments that can be performed at different places?
Looking at the same set of facts, different companies will make different decisions, all of which are right for them. Heavy equipment manufacturers are not present in Puerto Rico or Ireland, but drug companies are. Software companies are in Ireland and India but not Puerto Rico. Garment manufacturing used to be big in Puerto Rico, but no more. The businesses left because wage increases outstriped any tax advantages the businesses might have enjoyed.
All things being equal (which is never true), effective tax rate will probably be the determining factor. Even in the real world, tax rates will always be a major factor because a dollar saved translates directly into a dollar of net income. Most other factors are diluted as they are filtered through the financial statements.
Based on my experience of almost 40 years as a tax attorney, tax rates are one, albeit an important one, of the factors driving business location decisions. Access to the local market does the phrase buy American ring a bell? It has its counterparts, both official and unofficial, in other countries. Transportation costs products with low intrinsic value will have transportation costs that outweigh tax advantages. Pricing approval how important is local production in the decision process? Official approval to market will local approvals be dependant on local manufacturing? Manufacturing resources, conditions, and raw materials available local labor, power, mid-level management, convenient transportation, climate, reliable communications, political stability, etc..
The decisions made will be different, but right, for different types of companies. Often the decisions will be different, and still right, for different companies in the same business. Heavy equipment companies are not present in Puerto Rico, Ireland, or the Cayman Islands, for that matter. Drug companies are in Puerto Rico and Ireland. Software companies are in Ireland and India (the latter of which is not normally thought of as a tax haven). Garment manufacturers left Puerto Rico when wage increases outweighed any tax advantages.
Discounting any altruistic motivations that Sue may have that induce her to perform foreign surgeries, Sue will make the choice about which surgeries to perform (foreign or domestic) based on the net amount of money she will pocket for performing those surgeries. What other surgeons in the country make is irrelevant to her. If the combined tax burden is higher for foreign surgeries, she will be less likely to perform them. The lower malpractice insurance premiums and other factors may offset the marginal disincentive of a higher tax rate, but the net effect of higher effective tax rates on foreign when compared with US surgeries would be to discourage Sue from performing foreign surgery. As a policy, it is unwise to discourage US resident businesses from foreign transactions. Why? because Sue will spend the money earned in foreign venues in Manhattan-at the grocery, clothing store, real estate office, and in contributions to her local charities (maybe her alma mater). Double taxation would be unfair to the grocer, the tailor and the real estate agent.
This argument could be used to justify no tax on any income if carried to its extreme, but the surgeon, the grocer, the tailor and the agent or their ancestors voted to pay part of their wealth to support government services. Sue should pay some taxes to support those services. You’ll get to consumption taxes soon in your discussion of European taxes, but that sort of tax more exactly equates Sue’s payment with her use of services.
I think Jim has missed the point I made above. Surgery is not at all similar to manufactured goods or certain services (e.g. software design or telemarketing services) that do not require the business to be physically present where the services are consumed. People do not choose where they live (as opposed to outsourcing parts of their business) based on tax considerations, at least not most reasonably sane people. People may move around some to avoid taxes (e.g., move to Northern Virginia from DC), but people rarely give up citizenship or move far from friends and family just to save taxes. Even billionaires are hestiant to ex patriate for tax reasons. Accordingly, a surgeon normally (indeed, almost invariably) will not choose to practice medicine in a low-tax country merely because the country is low-tax. At least not in the real world. . .
However, I thought Dan gave a real nice summary of some of the factors ultimately affecting the location of manufacturing and truly portable services. I also sympathize with Dans 40-years of practice as a tax attorney. But I suppose it beats the other inevitable: death.
I would be interested in Jims thoughts about consumption taxes, and especially whether he thinks any meaningful federal tax reform should include a VAT (like the Treaury I proposal of 1985).
Finally, where is the input of the creator of this discussion thread. Can college life truly be so good for Dr. Mundstock that he has no time left in his busy day to respond?
Tom, I try to hide that all tax lawyers are self-loathing, and you are showing this to the readers of your comments. Shhhhhhhh
Trivia Question: What happened to the tax partner in the first episode of LA Law?
Answer to Trivia Question: The poor fool died before the closing credits. I understand the surviviors are still fighting over his corner office!
Died before OPENING credits.
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