Who Stole the American Dream?

by Hedrick Smith

  As Buffett has frequently pointed out, the super-rich make most of their money from the stock market and other investments, which are taxed at the 15 percent capital gains rate, much lower than the tax rate on most middle-class salaries. As we saw earlier, Buffett paid a rate of 17.4 percent on his multimillion-dollar income in 2010, and that was the lowest tax rate in his office. Buffett advocates not only repealing the Bush tax cuts for the super-rich, but imposing a supertax on income over $1 million a year and a super-super rate on income over $10 million a year. Others propose a special tax on corporate stock options to CEOs and other top executives.

  Another important move would be to close the exemption in the payroll tax now enjoyed by the rich. Ordinary employees pay a 7.65 percent payroll tax to fund Social Security and Medicare, but the income from investment gains of CEOs and super-rich investors is exempted from the payroll tax. In fact, multimillionaires pay a much lower payroll tax rate on their salaries and bonuses—as low as 1 percent—because all their income over $106,800, even their salaries and bonuses, is also exempt from the payroll tax. Removing that $106,800 tax cap would not only make everyone pay the same rate, it would go a long way toward solving the funding shortfall for Social Security and Medicare.

  But the simplest, broadest tax reform to achieve a more level economic playing field would be to end the special low 15 percent capital gains tax rate and to tax investment gains at the same rate as wages and salaries (35 percent). Exceptions could be made for assets such as a house, a farm, a small business, or even a stock investment owned for a truly long term, say, for twenty years or more—to compensate for long-term inflation.

  A majority of Americans favor raising capital gains taxes to 35 percent or higher, according to a New York Times poll taken in January 2012, when the political controversy broke out over Republican presidential candidate Mitt Romney’s 13.9 percent tax rate in 2010 on his $27 million income. Romney is fairly typical of the super-rich since virtually all of his income came as capital gains, which are by far the main source of income for the richest Americans. Those gains are heavily concentrated at the top. The tiny sliver at the peak of our economy—the top 0.1 percent of all income earners—captures almost half of all the capital gains in America.

  All these tax reforms taken together—on capital gains, on payroll taxes, on closing loopholes, and on a special tax on executive stock options—would make the U.S. tax code much fairer, plus it could cut the national debt by $1 trillion over a decade.

  Step #5: Fix the Corporate Tax Code to Promote Job Creation at Home

  Step #5 is to fix the corporate tax code by lowering the rate and closing loopholes, because that would make the United States more globally competitive by enacting reforms that would discourage U.S. firms from offshoring jobs and reward those that hire at home.

  American business leaders complain that they are hurt competitively by the U.S. corporate tax rate, and it is true that the U.S. corporate tax rate is one of the highest in the world. But in practice, most U.S. multinationals pay far less than the official 35 percent rate. When Citizens for Tax Justice examined the records of 280 major firms, it found that from 2008 to 2010, their true federal tax rate averaged 18.5 percent. What’s more, the rate varied widely. Some companies paid the full 35 percent rate or close to it. Others cashed in heavily on loopholes and tax breaks that corporate lobbyists and pro-business members of Congress have written into the tax code—loopholes that were worth $1.2 trillion in reduced business taxes over a decade, according to the Treasury Department.

  The multinationals that have been most successful in avoiding U.S. federal taxes include Boeing, DuPont, ExxonMobil, General Electric, IBM, Merck, United Technologies, and Wells Fargo, according to Citizens for Tax Justice, because the way they do business qualifies them for large tax credits. General Electric, for example, made nearly $10.5 billion in profits from 2008 through 2010, and instead of paying taxes, GE got a federal tax rebate of $4.7 billion by using loopholes and claiming tax credits. Companies that pay roughly 35 percent in taxes include retailers such as CVS Caremark, Home Depot, Target, and Wal-Mart; domestic-oriented insurance companies such as Aetna and Humana; trucking companies; and electric utilities, food processors, restaurants, and hotels—mostly firms that do the bulk of their business inside the United States.

  In terms of the tax code’s impact on jobs in America, what counts most is that U.S. multinationals that have large overseas operations often pay very low U.S. taxes or none at all. Many of them are high-tech firms that qualify for tax credits for spending on research and development or on new plants and equipment, but often their biggest loophole is paying no taxes at all on their overseas profits—unless and until they transfer their foreign earnings back to the United States.

  Apple: Shifting Profits to Avoid Taxes

  High-tech companies such as Apple have big moneymaking products like iPads and iPhones made overseas, often in China. They can allocate their profits on lucrative patents on iPads and iPhones to their overseas operations or they can sell software applications from low-tax countries overseas, shifting around tens of billions in income from country to country with legal but cleverly devised bookkeeping to avoid taxes in the United States and in other countries, too. Earlier this year, The New York Times reported that Apple had pioneered an accounting technique known as the “Double Irish with a Dutch Sandwich,” which cut Apple’s taxes drastically by routing profits through Irish subsidiaries to the Netherlands and then to the Caribbean. Today, hundreds of other U.S. corporations have copied tactics invented by Apple, which, in 2011, paid only $3.3 billion in taxes on $34.2 billion in profits.

  Under current tax law, U.S. multinationals are allowed to write off all their overseas costs immediately, even though they don’t pay tax on those overseas profits until the money is repatriated. One big loophole, created inadvertently by the U.S. Treasury and worth billions in tax reductions for multinationals, allows them to “Check the Box” on IRS form 8832 to identify their subsidiaries as doing business overseas, not subject to U.S. taxes. This is an automatic process, rarely given close IRS scrutiny. On paper, U.S. companies can work accounting rules to their advantage by shifting profits realized in America (for products sold in the United States) to the financial books of overseas subsidiaries (where the products were made).

  In this way, U.S. multinationals periodically accumulate $1 trillion or more in foreign earnings over several years, and then, as a group, they lobby Congress for “a tax holiday”—a very low tax rate on foreign profits repatriated to the United States. In 2005, the Bush administration pushed through a low 5.25 percent tax rate on repatriated profits and gave 843 of America’s largest corporations a $265 billion windfall gain.

  All sides agree on the need to rewrite the corporate tax code. Pro-business conservatives want to lower the maximum corporate tax rate from 35 to 25 percent. In terms of job creation in the United States, that would leave more capital in the hands of companies that operate inside America, enabling them to expand and hire. To balance such a tax reduction, pro-jobs progressives want to close the $1.2 trillion in corporate tax loopholes—above all, the tax exemption on overseas profits. Economists estimate that if overseas corporate profits were fully taxed, it would generate $100 billion a year in new corporate tax revenues—$1 trillion over a decade. What’s more, they argue, taxing corporate profits at the full rate would curb questionable corporate accounting stratagems used to avoid U.S. taxes. It might even persuade U.S. multinationals to keep more production at home and bring jobs back from China and India.

  Policy makers within both parties agree in principle on giving businesses tax credits for research, innovation, and new facilities, to stimulate more job creation at home. But jobs advocates such as Leo Hindery Jr., want tax reform to require proof from employers that their tax credits are actually being used to expand their U.S.-based workforce. They also want to tie tax breaks to job creation at home to apply to companies repatriating profits from overseas. Wh
en U.S. multinationals were given a special 5.25 percent tax rate on repatriated profits in 2005, they said the money would create jobs, but economists tracked those funds and found out that 92 percent of that money went to investors and corporate executives through dividends and stock buybacks and only 8 percent went for job creation. This time, jobs advocates want ironclad provisions to make sure the multinationals actually create more jobs in the United States.

  Step #6: Push China to Live up to Fair Trade to Generate Four Million Jobs in the United States

  Step #6 is strong action by the United States and other countries to combat China’s unfair trade practices and to rebalance global trade. Economists estimate it would generate four million jobs in America and significantly cut the U.S. trade and budget deficits if world currencies were revalued and if China was required to live up to the fair trade rules of the World Trade Organization.

  The American economy and American workers are being hurt in three major ways by Chinese trade practices, experts say. First, they contend, China manipulates the value of its currency by fixing a low rate of exchange between the Chinese yuan and the U.S. dollar. A low exchange rate boosts Chinese exports by making them very cheap, and it cuts down U.S. exports to China by making them very expensive. Economists say the yuan would be priced 25 to 50 percent higher if it were allowed to float freely, letting trade flows and the global market determine the value of the yuan relative to the U.S. dollar. It is not just the Chinese yuan that poses a problem for the United States and Western European countries. Other Asian currencies in Hong Kong, Singapore, Taiwan, and Malaysia are pegged to the Chinese yuan, and their low currency values also hurt the U.S. trade balance with Asia.

  Second, American businesses accuse the Chinese of widespread intellectual piracy—stealing copyrighted intellectual property, patents, and inventions and illegally copying foreign-made products, from Microsoft software to General Motors cars. A major national intelligence report to Congress on economic theft and espionage stated bluntly in late 2011 that “Chinese actors are the world’s most active and persistent perpetrators of economic espionage” and went on to cite several cases where American companies had lost patented material through cyberespionage.

  Finally, Americans accuse the Chinese government of regularly violating rules of the World Trade Organization by dumping products on the world market at below the cost of production and giving illegal subsidies, land grants, and other cost-saving advantages to both Chinese and foreign firms. In fact, American CEOs say they save more on their investments in China through Chinese subsidies and tax breaks than from cheap labor.

  Correcting those problems would have a major impact on the U.S. job market. The United States would gain 2.25 million jobs if China let its currency (and others linked to it) rise 25 percent, according to Robert Scott, a China trade specialist at the Economic Policy Institute. If this happened, Scott says, the U.S. unemployment rate would fall by 1 percent and the government’s budget deficit would be cut by at least $621 billion and perhaps by as much as $857 billion over a decade.

  The United States would gain another 2.1 million full-time jobs if the Chinese stopped violating international copyright laws and intellectual property protection, according to the U.S. International Trade Commission.

  Congress is ready to take a tougher line toward China. “China’s currency manipulation is like a boot on the throat of our economic recovery,” asserted New York Democratic senator Charles Schumer. “There is no bigger step we can take to promote U.S. job creation, particularly in the manufacturing sector, than to confront China’s currency manipulation.” Republicans such as Senator Lindsey Graham of South Carolina have shown a willingness to co-sponsor legislation with Democrats to impose stiff tariffs on Chinese goods unless China raises its currency value. The last time Congress threatened action, China allowed its currency value to rise a fraction but pressures have been building again for action by Congress.

  Confronting China is not easy. Foreign policy experts urge collective action rather than unilateral U.S. moves. Western European and Latin American countries such as Brazil and Mexico are also hurt by China’s cheap currency and restrictive trade policies. International economists suggest that the best way to move China and other Asian countries on the currency issue is through global negotiations on rebalancing world trade. On China’s unfair trade policies, economists point to the success of the case brought by several Western nations that accused China of violating free trade rules through export controls on certain industrial minerals that are essential components for producing sophisticated electronics. The World Trade Organization ruled against China in early 2012 and ordered Beijing to end those policies, a ruling that offers precedent for future cases.

  In the meantime, it is essential for Congress to fund the retraining of Americans thrown out of work when trade with China and other low-cost countries wipes out their jobs. Under the Trade Adjustment Assistance program, which started in the 1960s, the government spent close to $1 billion in 2008 to give aid to plants shut down by import competition and to provide career retraining for displaced American workers. But in 2011, Tea Party budget deficit hawks blocked all funding for this retraining program. House Republican leaders finally relented after the Obama administration refused to send Congress Washington’s new trade agreements with South Korea, Panama, and Colombia until the worker benefits were guaranteed. Corporate America wanted the trade agreements, so Republican leaders agreed to restore modest funds for worker retraining. Now this vital worker safety net needs to be expanded.

  Step #7: Save on War and Weapons

  Step #7 is to cut spending on wars overseas and to reduce the Pentagon budget by $1 trillion over the next decade—savings that would generate funds for a domestic Marshall Plan and underwrite a middle-class agenda.

  The Obama administration began in 2012 by announcing $450 billion in projected defense cuts, plans for a leaner army and marines, and moves to bring home troops from Europe and reorient U.S. defense strategy. Another $500 billion in cuts would be imposed in January 2013 under the 2011 congressional debt reduction agreement—unless Congress comes up with an alternative.

  Military advocates from the Joint Chiefs of Staff and Defense Secretary Leon Panetta to defense hawks in Congress oppose a $1 trillion overall cutback, protesting that it would endanger the nation. But former Pentagon officials such as Assistant Defense Secretary Lawrence Korb and other experienced defense experts disagree. They assert that $1 trillion can be cut from projected defense spending over ten years without jeopardizing national security. Former Pentagon officials point out that defense spending now runs $200 billion a year higher than at the peak of the Cold War, adjusted for inflation, and the United States faces no comparable strategic nuclear threat today. Moreover, cutting $1 trillion in military spending over ten years, says longtime congressional defense analyst Winslow Wheeler, would still leave defense spending at the very high 2007 level of $470 billion a year. That level would still enable the Pentagon to spend more than the defense budgets of the next largest-spending seventeen nations combined.

  Defense spending cuts are long overdue. This is not just because the United States is pulling back from the wars in Iraq and Afghanistan, wars that will ultimately cost the nation more than $3.5 trillion in deficit spending. It is also because the basic Pentagon budget has been given unprecedented increases for thirteen years in a row.

  A cutback of $1 trillion over the next decade would fit past precedents. After the Korean War, President Dwight Eisenhower reduced defense spending by 27 percent. After the Vietnam War, President Richard Nixon reduced Pentagon spending by 29 percent. As the Cold War ended, President Reagan scaled back military spending, too, and so did his successors George Herbert Walker Bush and Bill Clinton. But then it shot back up again after 2001, under President George W. Bush.

  What is more, Pentagon critics contend that the U.S. military establishment has become grossly inefficient and wasteful in buying new weapons and needs
to be more strictly controlled. Even such defense advocates as Senator John McCain and Vice Admiral Norb Ryan, Jr., president of the Military Officers Association, have chastised the Pentagon for weapons programs that keep escalating in cost far beyond original estimates and that are so out of control that the Defense Department cannot pass an outside audit.

  In November 2011, Admiral Ryan decried the “gross mismanagement and cost overruns in expensive weapons programs, few of which have any relevance to the wars our troops are fighting today.” In a Senate floor speech, McCain issued a savage critique of one weapons system after another, pointing at “spectacular, shameful failure” and accusing the Pentagon of “a shocking lack of any accountability” for cost overruns or matching new weapons to actual combat needs.

  It was Dwight Eisenhower, the Republican president who had commanded Allied forces in Europe against Nazi Germany during World War II, who warned against the danger of overspending on the military and, in the process, sapping the nation’s economic strength—America’s primary source of national security.

  Better than anyone, this West Point–trained five-star general understood the trade-offs. “Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed,” Ike declared. “This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children.”

  In 2008, candidate Barack Obama opposed the war in Iraq and promised a peace dividend: “Instead of fighting this war, we could be fighting to rebuild our roads and bridges. I’ve proposed a fund that … would generate nearly two million new jobs….”