Competitiveness Among Nations: Government Downsizing (Part Two)

…Continued from Part One of the series.

The challenge, and the great opportunity that the redomiciliation of corporations for tax purposes offers resides in responding to the market mechanism in an open, sincere and straightforward manner.

Ignoring the strong signals the market mechanism sends does not do any lasting good to anyone. Quite the opposite!

The table in this link provides provides a very powerful content. As it can be seen, in the World Bank’s general ranking of Doing Business 2013, the US is placed in a very high overall position, 4th, only behind Singapore (1st), Hong Kong (2nd), and New Zealand (3rd). That is a laudable accomplishment.

Likewise, the US’ overall standing in the Global Competitiveness Report 2013 of the World Economic Forum is also a very commendable 7th place —ranking 5th the previous year—, very much aligned with the Doing Business Survey already mentioned.

However, when analyzing the Paying Taxes sub-ranking of the Doing Business Report (8th column to the left of the table (click here), the findings are quite worrisome, since the US is placed in a very poor position, 64th, ironically tied with Russia. The distance between ranking #4 in the overall standing and #64 in the tax area couldn’t be more dramatic, a huge misalignment. Naturally, the logical aim is to look for realignment in this most crucial aspect by improving in the tax area not by deteriorating the overall standing.

In a recent speech in the West Coast, President Obama stated “You don’t get to pick which tax rate you pay” also mentioning that US companies that were redomiciling themselves to lower tax countries were “Technically renouncing their U.S citizenship”.

Obama was perfectly right in the second remark, yet a rather irrelevant point (please refer to Chapter 5 of my book, GLOBALIZATION,  “The Dysfunctional Traditional Nationality Concept”), and utterly wrong in the first one. In fact, globalization provides an extraordinary opportunity for the  rationalization of resources, across the whole spectrum and the globe, taxes included. Hence, contrary to Obama’s opinion, corporations have the right to choose and change when deemed convenient, the country where their legal residence will be.

Multinational organizations, by the mere reason of being so, already have been taking (fair) advantage of that condition. To expect a global corporation to behave like a local one is completely out of reason. Granted, global corporations ought to comply with all local laws and regulations in each and every country and jurisdiction they operate; that’s implicit. The core point is where to draw the line between local and global.

Appealing to blind nationalism does not make much sense. Economic principles must prevail at all times. No sensible local (or global) regulation should be aimed at trying to overrule economic principles; otherwise, the corporation’s profitability will be threatened and, at the extreme, even self-sustainability. That, in turn, would hurt the earning power of the citizens whose country is transgressing elementary economic principles (more on this here).

The wellbeing of a nation has to rely on the wellbeing of its citizens, including corporations (corporate citizens); it cannot be any other way. Simply put, the nation is the overall aggregate of many components; citizens and corporations happen to be the major ones.

Insulation and protectionism are terrible malaisses. They have never conducted to prosperity; quite the contrary. (read our article, Does protectionism Protect?)

The very essence of the market mechanism is to send signals to economic (and political, in this instance) actors so they can adjust —hopefully quickly and well— to new realities. At the core of this lie the concepts of limits and discipline —or their lack thereof. In summary, what are the true limits of taxation that governments have?

Undoubtedly, a difficult question to answer. However, and most fortunately, there is a perspective where a reply can be made with full confidence of correctness: the market itself sets the limits of taxation; that is to say, the rest of the world is a most legitimate and valid benchmark.

In this regard, there shouldn’t be any fundamental difference with the business world. The price mechanism —supply and demand— set the guiding lights for market participants. Governments are not and should not be an exception.

From this focus, companies that have moved away from the US to different jurisdictions with substantially lower overall tax rates have done so as an utmost logical response to preserve their economic interests. There is nothing wrong in that behavior, since it’s a very rational way of acting.

The right signal that mature, well-intentioned politicians should get from this trend is that the US has already gone overboard in the taxation area.

It’s time for the US to lower its overall tax structure to regain competitiveness among other nations in this extremely important area. Deregulation will also be of great help towards this end.

cut-spendingFrom another angle, how can nations like Ireland, Singapore, Switzerland, and Canada, just to name a few, not only survive but thrive with a tax structure substantially below the US’s. The answer to this is very simple: by providing a more effective way of doing business to its citizens (individual and corporate), and by having a more efficient management of their public finances, and of their overall tax structure (compared to the US’). It is as simple as that.

Sports provide a very valid and illustrative example of what we are talking about. The beating the German football team gave to Brazil’s in the World Cup Final back in July, was a superb manifestation of the significant superiority of Germany’s team over Brazil’s. Naturally, there are plenty of lessons to learn from this (read Globalization and the Olympics). There is no benefit in trying to hide the truth. Brazil’s team used to be almost unbeatable in its home-turf. Not anymore. If Brasil aims to regain its former global soccer preeminence, it has to adjust, learn, and command new techniques and procedures.

Likewise, countries that are performing poorly against the rest of the world in an specific area  should make the necessary changes to reverse their bad ways, and reposition themselves regaining lost ground.

Ideally, politics shouldn’t be substantially different … but they have been, up to now.

That’s represents a monumental opportunity for improvement in the wellbeing of the citizens of any nation flagrantly losing its competitive advantage, like the US has been doing in the tax area.

Just as every consumer has the inalienable right to choose which cable/internet provider best fits its economic needs, every corporation has the same right to choose where it is more cost efficient to hire personnel, to invest, and yes, also to pay its taxes.

Doing it otherwise, would be exactly the same thing as dictating to consumers which cable/internet provider to compulsory select and/or which toothpaste brand (and company behind it) must be used. A complete non-sense, only partially understandable when considering that successfully overcoming feudal and protectionist instincts and practices has been very difficult for mankind (read more here).

Ignoring market signals —at any level, including the transnational and global one— is as absurd, and foolish, as a person ignoring strong and recurring headaches, trying to solve them only with aspirin. At the individual level, strong and recurring headaches more often than not will imply a severe health imbalance requiring a deeper medical examination.

The US Congress should bite the bullet and go after a profound and sensible reengineering and restructuring of its finances, particularly its costs. If all this is appropriately conceived and executed, it will inexorably mean a drastic reduction of the size of government. Most fortunately, the benefits are humongously higher than the costs implicit in this utmost challenge currently facing the US.

Unfortunately, gridlock and hesitancy are two characteristics usually present in most governments. We all are well aware of the colossal costs they inflict upon society. In the US’ case, the costs of gridlocks are in the hundreds of billions a year, and hundreds of thousands of lost jobs.

The lack in tax competitiveness of the US should be a top priority of its Congress and President. If society does not exert the right pressure to correct this, the consequences will continue to be increasingly damaging to the US economy and its society.

The world should not continue to approach global challenges with mostly local solutions. All too often, local rigidities and dysfunctionalities get in the way of otherwise fair and constructive global processes.

Sound finances are a fundamental pillar of any prosperous nation. In turn, the tax system lies at the hearth of solid finances. When excessive tax rates are at work, the harmful spillover effect to the economy is inescapable. If out of control, consequences can be devastating.

Virtuous cycles can be reached if taxes are sufficient to finance government work. However, when checks and balances are insufficient and ultimately dysfunctional, a pernicious cycle begins to develop.

Judging by the relocation of some prominent US corporations to offshore countries, that pernicious cycle is already in progress in the US. It is both, the responsibility of the executive and the legislative powers to stop and reverse this trend.

Ironically, corporations that are relocating to lower tax jurisdictions, as a side effect, are rendering a most valuable service to their country of origin, by implicitly denouncing the US’ dangerous lack of competitiveness in its tax system.

Part Three of series coming next week.

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About Martin Marmolejo

Global Investment Manager | Founder & Managing Director at MMA Global Investment Management | Proud husband and father | Follow me @globalmarmolejo.

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