07.31.2010 0

The Reverse Smoot-Hawley Act

  • On: 08/03/2010 19:58:40
  • In: Uncategorized
  • By Bill Wilson

    In the Great Depression, the Smoot-Hawley Tariff Act was enacted in 1930 to make goods imported from overseas more expensive to American consumers than domestic goods. The thought was to incentivize the purchase of U.S.-made goods during a devastating economic downturn, boosting the bottom lines for American businesses.

    While Smoot-Hawley did not cause the Great Depression, there is wide consensus that the trade war it provoked made it much worse. U.S. exports took a big hit immediately as the world retaliated, dropping from $3.84 billion in 1930 to $2.08 billion in 1931, and bottoming out in 1932 and 1933 at $1.61 billion and $1.67 billion, the years Herbert Hoover was thrown out of office and Franklin Roosevelt assumed control of Washington, respectively.

    Exports would not significantly recover until after the 1934 Reciprocal Trade Agreements Act, which enabled the Roosevelt Administration to negotiate the reduction of tariffs on a bilateral basis. By 1937, exports had recovered to $3.34 billion on the eve of World War II. The war itself was a tremendous boon for exports, as the U.S. armed Europe against the fascists. By 1941, they had risen to $4.74 billion.

    The lesson learned from Smoot-Hawley was that just because a law — in this case punitive tariffs on imported goods to boost domestic consumption — has good intentions, does not mean it will have good outcomes. Often, there are unintended, real consequences to economic policies that must also be considered alongside the stated goals the political class offers for their schemes.

    Fast-forward to 2010, where Congress is now considering what can only be called the “Reverse Smoot-Hawley Act.” Today, the Senate is expected to vote on a bill that will limit the use of the Section 956 foreign income tax credit by U.S. companies that operate overseas.

    No longer seeking to inflict punishment on foreign competitors, now Congress wants to inflict pain on American companies. Proponents argue that because the U.S. levies higher corporate taxes — 35 percent in the top bracket — than the rest of the world (except Japan), that American companies that make profits overseas and pay taxes at a lower rate there are not paying their “fair share.”

    Let’s say an American company rakes in $20 million in profits abroad, and pays $5 million in corporate taxes over there at 25 percent. Right now, the company gets to keep the $15 million without being double-taxed on corporate profits. But the federal government is not happy. It’s thinking it would have gotten $7 million in taxes if those profits had been generated at home, and therefore that it is entitled the $2 million difference.

    Proponents think they are removing an incentive to do business overseas in what they call “tax havens.” In fact, increasing taxes on foreign profits will remove an incentive to do business here, especially if a majority of a company’s profits are generated overseas. The incentive will become to simply keep the profits abroad, or even to wholly shift operations there.

    Four left-wing nonprofit groups, posing as small business advocates, estimate that closing this “tax gap” will generate $37 billion in new revenue from $149 billion of overseas profits.

    But, instead of the federal government gaining $37 billion in revenue as supporters of the legislation pretend, the U.S. economy will more likely lose the $149 billion in capital flows that are never repatriated. Why?

    This is essentially a tax on account transfers from any money earned overseas, or a tariff on capital flows, if you prefer. It’s a perverse incentive that will harm those capital flows back into the U.S., much of which are generated by exports. U.S. companies that operate overseas account for nearly half of all American exports, and employ 22 million people. But now they will be put at a woeful disadvantage to foreign competitors that will not be subject to similar double-taxation in thier home nations.

    Eliminating the foreign income tax credit for American companies will cost the U.S. jobs, exports, and even whole companies, which will increasingly be shifted abroad. It will also cost the U.S. critical investment capital that could instead be devoted here at a time when the weak recovery is slowing down and unemployment remains high.

    These unintended consequences are the Smoot-Hawley of our time, and the responsibility for shipping investment capital and jobs overseas will be borne by those U.S. Senators that today cast their votes in favor of it.

    Bill Wilson is the President of Americans for Limited Government.

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