Cover Story February 28, 2008, 5:00PM EST

Multinationals: Are They Good for America?

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Moving operations overseas gives a multinational an almost infinite number of legal and quasi-legal strategies for reducing U.S. corporate taxes. It can borrow in high-tax countries to take maximum advantage of interest-rate deductions; it can transfer intellectual property to low-tax countries, in exchange for below-market royalty payments; and when it ships goods to its foreign affiliates, it can charge low prices to shift profits to low-tax jurisdictions. The result is that collections of U.S. corporate income taxes have been dropping significantly as a share of total global profits for U.S. companies. "Companies have taken advantage of these favorable cost-shifting agreements," says Jack Mutti, an economist at Iowa's Grinnell College and an international tax expert. "The law gets so complicated that very few people can understand what the trade-offs are."

BIG TAX SHIFT?

To encourage multinational expansion in the U.S., it may be necessary to revise the corporate tax system, a step for which there is surprising support from Democrats and Republicans alike. One proposal—with the arcane name "formulary apportionment"—would tax the earnings of multinationals based on the proportion of their customer base in the U.S. For example, under this system it's possible a U.S. company that only exported would pay virtually no corporate income taxes, while a foreign company that was a big importer to the U.S. would pay a hefty chunk of change on its worldwide income. Other economists believe the corporate income tax hasn't adjusted to the global economy and think it should be eliminated.

The other big question is whether the U.S. needs to subsidize multinationals to entice them to keep jobs in the U.S. That comes up a lot in industries such as semiconductors, which require heavy capital investment. "We have to choose to compete on the investment level and match other countries' offerings on incentives and tax breaks," says Scalise of the Semiconductor Industry Assn. "If we don't do this, it will be very difficult for us to maintain our leadership in technology and innovation." Adds Hector Ruiz, CEO of Advanced Micro Devices (AMD): "It's not corporate welfare. [This is] a competitive world."

Perhaps the smartest long-term policy would be to cultivate future multinationals. The real boost to national economies comes from the formation of new multinationals, which in their early hypergrowth years create an enormous number of jobs and put down deep roots. No American would deny that the U.S. is better off because Google started there rather than somewhere else. The European economists Mayer and Ottaviano argue that policymakers shouldn't "waste time helping the incumbent superstars." Instead, they should "nurture the superstars of the future." That may mean simplifying the amazingly complicated system for taxing multinationals, which both collects relatively low revenue and imposes big compliance costs. "Put in place as few barriers as possible for all companies," says Bernard. "The good ones will rise to the top."

These new multinationals of the future won't arrive in time to help the U.S. in this credit crunch, however. It's going to be the big multinationals of the present who will—or won't—make the difference.

With Steve Hamm in New York and Christopher Farrell in St. Paul, Minn.