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Tuesday, April 13, 2010 4:36 AM

Mish Mailbag: IBM Abandons U.S. Workers

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Here is an Email from "Voice in the Dark" about IBM and outsourcing. VID writes ...

Hello Mish

I read your blog every day. I do not comment much, but I think the MSM and most blogs are missing out on the greatest story not being told.

Large corporations are abandoning the US. I work for IBM. Here is a snapshot of IBM's US headcount:

2005 133,789
2006 127,000
2007 121,000
2008 115,000
2009 105,000
2010 98,000 estimate

These are all good paying jobs that can support a family and pay taxes.

Today, 75% of the total headcount is overseas. The overseas revenue is 65%. The company reported record profits last year. IBM decided to stop reporting their US headcount this year.

You know that many companies are moving their resources overseas. China is the new spot to build development centers. These incremental loses are adding up. But the saddest thing is that they are giving away the building blocks for innovation.

I just read a few weeks ago the Applied Material is planning to replace their US research center for a new one in China. That is another example of what is going on.

And no venture capitalist would attempt to build a solar panel factory from scratch in the US. The costs and the EPA will prevent that.

Please tell this story.

Sign me: Just Another Voice in The Dark
Hello "Voice in the Dark".

I covered the situation with Applied Materials in High Tech Research Moves From U.S. To China
Goodbye Silicon Valley, hello Xi’an China. Applied Materials will do new cutting edge research on solar panels in Xi’an. ...
Please see Brain Drain as a followup.

Two Drivers For Outsourcing

Outsourcing jobs has been going on quite some time. Let's address why.

For starters, global wage arbitrage is one huge factor in play.

Unfortunately, wage equalization and standard of living adjustments between industrialized countries and emerging markets will be a long painful process for Western society.

On that score, there is little that can be done except reduce wages and benefits in the public sector and stop wasting money being the world's policeman. We simply can no longer afford it. Besides, neither of those things ever made any sense anyway.

US Tax policy is another reason for outsourcing, and that can easily be addressed, at least in theory.

US corporate tax policy allows deferment of profits overseas, but profits in the US have a tax rate of 35%. This policy literally begs corporations to move profits and jobs, overseas.

Obama Seeks To End Corporate Tax Breaks

Please consider Obama Seeks End of Corporate Tax Break to Raise $190 Billion
In 2004, U.S.-based multinational corporations paid about $16 billion in U.S. taxes while earning about $700 billion offshore, an effective tax rate of about 2.3 percent, according to the administration statement. The top marginal tax rate for U.S. companies is 35 percent; drug companies such as Amgen Inc. and technology companies such as Microsoft are among companies that make the biggest use of tax-deferral benefits.

The rules were originally designed to reduce paperwork for companies and the IRS by allowing companies to classify entities within their corporate structure in the most tax-efficient manner without inviting a tax challenge.

Unintended Consequence

Clinton administration officials realized they also had made it easy for multinationals to create entities whose only purpose was to shift profits into low-tax countries and out of reach of the tax authorities, according to a January Government Accountability Office report that found 83 of the 100 biggest companies had subsidiaries in tax havens.

Once the assets were in the haven, the U.S. parent company borrowed from the subsidiary. The interest payments were deductible in the U.S. and tax-free in the haven, the GAO said. The nonpartisan congressional Joint Committee on Taxation recommended in 2005 that the rules be repealed.

GE, for example, has deferred tax on a cumulative $75 billion over the last decade, according to filings. Palo Alto, California-based Hewlett-Packard Co. has deferred U.S. tax on $12.9 billion since 2005, while Microsoft has accumulated $7.5 billion that has never been taxed by the U.S. Even American International Group Inc., bailed out by the U.S. in 2008, deferred $3.9 billion in taxes on its foreign earnings in the same year.
Shifting Gains To Low Tax Countries

At a ratio of 35% to 2%, any company in its right mind would seek to shift losses to the US and profits (as well as jobs) overseas. By shifting profits overseas, while keeping the losses at home, GE actually ended up with a huge tax credit.

Forbes discussed this situation recently in What The Top U.S. Companies Pay In Taxes
As you work on your taxes this month, here's something to raise your hackles: Some of the world's biggest, most profitable corporations enjoy a far lower tax rate than you do--that is, if they pay taxes at all.

The most egregious example is General Electric (GE). Last year the conglomerate generated $10.3 billion in pretax income, but ended up owing nothing to Uncle Sam. In fact, it recorded a tax benefit of $1.1 billion.

How did this happen? It's complicated. GE's tax return is the largest the IRS deals with each year--some 24,000 pages if printed out. Inside you'll find that GE in effect consists of two divisions: General Electric Capital and everything else. The everything else--maker of engines, power plants, TV shows and the like--would have paid a 22% tax rate if it was a standalone company.

It's GE Capital that keeps the overall tax bill so low. Over the last two years, GE Capital has displayed an uncanny ability to lose lots of money in the U.S. ...

It only makes sense that multinationals "put costs in high-tax countries and profits in low-tax countries," says Scott Hodge, president of the Tax Foundation. Those low-tax countries are almost anywhere but the U.S. "When you add in state taxes, the U.S. has the highest tax burden among industrialized countries," says Hodge. In contrast, China's rate is just 25%; Ireland's is 12.5%.

Corporations are getting smarter, not just about doing more business in low-tax countries, but in moving their more valuable assets there as well. That means setting up overseas subsidiaries, then transferring to them ownership of long-lived, often intangible but highly profitable assets, like patents and software.
Who Is Hurt By US Corporate Tax Policy?

Unlike IBM and GE, small businesses do not have the luxury of hiring an army of lawyers to figure out how to avoid taxes.

The solution is lower but equal taxes across the board, not higher taxes as President Obama is clamoring for. If one insists on a skew, it would be far better from a jobs standpoint to defer taxes in the US than overseas.

My own personal preference would be to slash the corporate tax rate to 10% or lower, preferably zero.

This would level the playing field between small and large corporations. It would also eliminate the need for a whole army of lawyers and lobbyists whose only function is to game the system.

Finally, elimination of corporate taxes would spur job creation at small businesses, right here in the US, where we desperately need Jobs. To top it off, money would flow to the US, in dollars, instead of overseas in some other currency.

President Obama's solution is ass backwards.

Mike "Mish" Shedlock
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