Outsourcing Vs Obama

While American companies are up in arms about U.S. President Barack Obama’s new tax plans, Indian companies are just plain confused.

Take, for instance, his fixation on Bangalore. Talking about the old tax code which he intends to reform, On May 4, Obama described it as one “that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.” (For more, see this story from India’s Economic Times, a BusinessWeek content partner.)

Great stuff. But what does it actually mean?

To figure that out, one needs to keep in mind the difference between outsourcing and offshoring. Offshoring is when a U.S. company sends jobs that once existed within that U.S. company overseas to a subsidiary of its own – for instance, if an IBM coding engineer’s job gets moved to Bangalore, but the new employee is still an IBM worker. Outsourcing is when a U.S. company pays another company altogether for doing that job - much of it ends up in India, but a grocery store in Kansas could outsource its book-keeping to a firm in Topeka.

The difference matters, especially since the way this tax code revision is written, it could, theoretically make off-shoring slightly more expensive for U.S. companies, with the extent of the increase depending on the tax rates of the country the jobs go to. (For countries like Ireland, which the president mentioned, the corporate tax is as low as 12.5%. In India, the corporate tax for foreign companies can actually be higher than the U.S.’s – as much as 44% in some cases. )

But its impact on outsourcing? As far as tax experts - and the Indian IT industry has a lot of them – can figure out? Nada. Zilch.

The change, as best as I can understand from speaking to both U.S. and Indian tax experts, will reverse a Bush-era policy where U.S. companies were able to “defer” paying corporate tax on income earned overseas until they brought it back to the U.S., either as dividends or as retained profits on their balance sheets. They got a tax credit for whatever tax they paid overseas already, and paid the difference to the U.S. Government.

Now, if the change goes through, U.S. companies must pay U.S. corporate tax immediately, but will continue to get that credit. Keeping in mind that companies spend a lot of money figuring out loopholes and deductions to keep their tax rate low, the difference between U.S. and Indian corporate tax rates is pretty low already – no more than a few percentage points.

So first, the offshoring company continues to save a huge amount of money due to wage differences, and then, it pays a marginal amount of extra tax because of this change. That’s not going to be enough to stop offshoring, at least to India. After all, IBM didn’t hire nearly 75,000 employees in India to save tax dollars – it hired them because they cost as little as 1/5th or 1/6th of their American counterparts and often produce the same quality work.

Instead, says Rosanne Altshuler, a co-director of the Washington, D.C.-based Tax Policy Center, this change to deferrals policy might just encourage companies to merge with foreign multinationals, or move their headquarters overseas so that they fall under a different country’s territorial tax system. “This takes the former U.S. MNC’s foreign income out of the reach of the U.S. Treasury,” she says. “I don’t see how the change will increase jobs at home.”

As far as outsourcing goes, which arguably has resulted in a large number of jobs being created in India instead of the U.S., the impact is even less. The U.S. subsidiaries of Indian companies like Infosys or TCS do have some earnings in the US or from non-India based operations but the bulk of the earnings – which add up to billions of dollars a year – are generated in India. So far, there is nothing in the Obama budget or even the statement from Monday that affects Indian outsourcers directly.

So why single out Bangalore? Well, for one reason, U.S. voters have always responded to the fear that the best American jobs could flee overseas, where wage differences are tempting and the young, trained labor pool is virtually limitless. Nobody ever lost a popularity contest by calling outsourcing or offshoring bad names.

The other reason? Well, it’s just likely that Obama isn’t done yet. He had made outsourcing an election issue, and has brought it up repeatedly since he got elected. Even after this bill is done, he has promised further tax reforms, where there could be a more direct attack on outsourcing.

For now though, Indian outsourcing giants are waiting to see what’s next. So far, they’ve heaved a sigh of relief.