Can Obama curb offshoring with tax code?

Experts say no, because the real draw is the low cost of skilled labor in places like India

WASHINGTON -- President Barack Obama today unveiled tax code changes that he said could curb offshoring, but analysts and tax experts believe the plan will have little or no impact on the megatrend that threatens as many as one in four IT jobs at large companies.

The criticism boils down to this: It isn't the tax code that created the offshore outsourcing industry over the last decade; it's the low cost of highly skilled labor.

Obama didn't address the wage gap today, but he is arguing that the tax code has played a contributing role in the growth of offshoring, and that includes the outsourcing of jobs for highly skilled professionals.

In his remarks, he cited a major Indian IT outsourcing center, Bangalore, as one of the places that has benefited from tax loopholes. The U.S. has developed "a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, N.Y.," Obama said.

These tax loopholes give companies that create jobs overseas the ability to take deductions on expenses "when they do not pay any American taxes on their profits," he said.

The proposed tax changes, which must be approved by Congress, may affect IT vendors that run subsidiaries overseas by denying deductions for offshore payments on things like payroll expenses, said Alan Appel, a tax attorney at Bryan Cave LLP in New York.

"By denying the deduction, the hope is that it will be more expensive to operate offshore and it will give incentives to create jobs in the U.S," Cave said.

The proposed tax code change is about as close as the White House has come to addressing the issue of IT offshoring. Whether the administration addresses the use of the H-1B visa, which is heavily used by Indian outsourcers, is still a question mark.

Alan Greenspan, former chairman of the Federal Reserve, said last week that the U.S. should increase the supply of foreign workers and said that the H-1B cap is keeping wages high by protecting U.S. workers from global competition and creating a "privileged elite" in the U.S.

The major motivation for moving work overseas is the difference between salaries in the U.S. and overseas. A job that pays $100,000 here may cost only one-sixth that amount in India, said Peter Bendor-Samuel, CEO of Everest Group, an outsourcing consultancy in Dallas.

"If there is a tax consequence here, it's de minimis to the overall impact" of outsourcing, Bendor-Samuel said. In any case, he said, "this idea that people are doing outsourcing to avoid taxes is simply wrong."

Sang Kim, a partner in the international tax practice at East Palo Alto, Calif., office of law firm DLA Piper, also said he doubts that the legislation will impact outsourcing. "The argument is that it should stem the flow of jobs leaving the U.S., but the reality is I don't think the jobs are moving outside the U.S because of tax policy," Kim said.

If anything, the tax code changes could accelerate the flow of jobs overseas to offset the larger tax bite, he said.

Kim said there could be unforeseen consequences to the tax changes. A foreign country could, for instance, offer subsidies to U.S. companies to create jobs as a way of mitigating any tax impact, he said.

The Hackett Group Inc., a business consultancy whose clients include many multinational companies, reviewed data collected from 200 companies and found that at companies with revenues of at least $5 billion, as many as one quarter of IT jobs will be moved offshore by 2010.

Copyright © 2009 IDG Communications, Inc.

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