Obama’s Anti Outsourcing Tax Plan – Who will it Hurt?

US president, Obama, in order to save $210Bn has announced a plan to clamp down on US companies who outsource overseas.

We believe in a level playing field. Unfortunately, we have a tax code that gives businesses that invest and create jobs overseas a competitive advantage over those who invest and create jobs at home.

Payments by US companies who create jobs overseas are treated as normal expenditures – but the new law (if passed by both Houses of Congress) will entail companies to pay tax on these expenditures as well (increase of almost 50%).

Cisco, which had north of $30 billion in cash at last count, earned $5.6 billion overseas in 2008. By deferring taxes on those earnings, it enjoyed a 16 percent reduction in its U.S. tax rate, according to a Wall Street Journal analysis of SEC filings. Google got a 17.4 percent break thanks to tax deferrals on $7.7 billion of overseas earnings. HP, which reported a net profit of $1.8 billion in its last quarter, can defer taxes on $12.9 billion worth of foreign earnings, – source

To simplify, if a company sets up shop overseas, it will pay 35% tax on it’s profits from US (+ X% on overseas profit, X is determined by the jurisdiction of geography)– while a company running it’s operations only in US will have to pay 35% tax on corporate profit.

To put things in perspective, HP/Google/Microsoft/Cisco and IBM saved $7.4Bn (in total) by taking advantage of lower tax rates.

While the attempt is to promote companies to not outsource, Obama is missing few points that will hurt American companies in the long run.

Loss of Competitive Advantage

Owing to the tax burden, companies like IBM will have to increase their hourly rate in order to maintain the same profit margin. If the new law makes through both the houses, Indian IT companies will have the last laugh – their American counterpart will struggle over finding a cost competitiveness.

One needs to realize that many of these US companies have built competitive advantage by understanding diff. geographies (by building global org/investing in global products) – wiping this out will hurt US in the long run.

Is US the world?

Emerging markets are the next big source of revenue and is expected to account for 45% of world’s GDP by 2010.

The more US companies are restricted over tax laws, lesser would be the flexibility/risk taking to try out newer geographies – to build ‘global’ products.

Data points:

  • The number of US companies in Top 100 InfoTech Companies Worldwide has been declining at a constant rate.
  • Also, most of the large American companies have more than 50 percent of their revenues coming from markets outside the US and would be affected by the proposed tax reforms.

Outsourcing was never about Tax structure

Outsourcing boom was all about better quality at lower cost – US still won’t be able to match the two factors.

Most of the big companies save 75% of their cost by outsourcing and the number goes higher for high-end BPOs.

Is Obama doing anything increase the quality (and maintain costs) in US?

Constraint like these will make US companies far lesser competitive as compared to their foreign competition.

What’s your opinion? Is Obama punishing few companies for their global vision?

Will this short-term vision hurt US companies in the long run?

Also see: Local Companies vs. MNCs in the Emerging Market

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