Good politics, bad economics

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Obama’s new tax rules and employment restrictions will drive away skilled Indian professionals and harm American businesses, argues Sanjay Kamlani

US President Barack Obama’s decision last year to tax the foreign subsidiary earnings of American companies is a combination of political finesse and economic incompetence. These proposals, coupled with new employment restrictions and increased visa fees for professional immigrants, are likely to slash American jobs and shrink US GDP. The US economy will inevitably contract as India’s talented workforce withdraws and returns to its homeland.

Sanjay Kamlani
Sanjay Kamlani

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 by imposing additional US taxes on foreign subsidiary income, unlike most other countries. Many countries tax companies only on income earned in their home country and offer tax exemptions on earnings of these entities’ foreign subsidiaries.

The US, on the other hand, imposes additional income tax on the foreign subsidiaries of US companies. A European company would not be taxed in its home country for earnings generated by its foreign subsidiary enjoying a tax holiday in India. In contrast, a US parent company in the same situation could be taxed at the rate of 35% on those earnings, making the benefit of Indian tax holidays worthless.

A US-based legal process outsourcing services provider (LPO) with operations in India would therefore face severe financial constraints when compared to an India-based LPO provider with similar operations in India. An India-based company would contribute 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 the US government 35% tax 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.

Under current US tax rules, tax paid on foreign earnings is, in most cases, imposed only when the earnings are brought back to the US. One of Obama’s proposals (recently blocked by Republicans) was to impose a tax in the year the foreign subsidiary generates its earnings, even before those earnings are sent back to the US. Competing European and offshore companies have no such additional tax burden. The US simply can’t afford to make its corporates even less competitive than they are today.

To make matters worse, new immigration restrictions and surcharges make it more difficult for Indian outsourcing companies to send employees to the US to facilitate service delivery. A large number of Indian students in US-based professional degree programmes who would normally have been employed in the US under such work visas are now being forced out of the country. Across industry, from banking and technology to legal services, Indian businesses are dealing with Obama’s harsh restrictions by exploiting technology aggressively.

Through online collaboration tools and video conferencing, these businesses are doing offshore what they would have ordinarily done onshore in the US. In the ’80s, when immigration restrictions were more open, the labour arbitrage between India and the US was achieved by businesses bringing large numbers of Indian software engineers into the US. Increasingly restrictive immigration rules since that time have caused most of those businesses to migrate that activity to India, closing down most onshore US-based activity that generated a large number of jobs for Americans. The newer restrictions are simply aggravating that trend. The result of the clampdown means all of the revenue and spending associated with these professionals is pushed offshore for the benefit of the Indian economy.

The tax disincentives could result in the closure of US companies’ India operations, thereby pushing more revenue away from American companies to their Indian counterparts. Although Obama is understandably thinking of the average American individual who is angry about American companies making money through their India operations, his proposals lack wisdom and are clearly flawed.

The best way to protect American jobs is to eliminate trade and immigration hurdles to facilitate commerce by enabling foreigners to enter the US, and for US companies to operate outside their country. Immigration and tax policies that hinder business in the US and hamper American companies operating outside the US risk pushing US dollars and jobs outside America. It may be good politics but it is bad for the economy.

It is very unfortunate that Obama is fooling the American public into believing that opportunity lies in the heartland of the US, protected by artificial barriers like 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 work anywhere in the world they please.

Sanjay Kamlani is the co-CEO of Pangea3.