Read Online Free Lunch by David Cay Johnston - Free Book Online Page A

interests was completed, an exercise not in locking the barn door after the horse ran off, but
in merely affirming that the latch had been left open.
    Lax oversight has particular ramifications
for national security, but broader and equally dire economic consequences arise from the unique way that the United States
subsidizes offshoring through our tax system. This important story begins with a most curious Chinese law.
    After President Nixon’s visit to China in 1972, American oil companies sought to explore there. Right off, they
asked the Chinese to enact a corporate income tax. The Chinese were bewildered. To a Communist Party official, taught that the
state should own the means of production, a corporate income tax was a bizarre idea. Besides, who ever asks to be
taxed?
    All became clear when the Americans explained their intent. The American oil
companies did not want to actually pay taxes, but to reduce their obligations to the United States government. The American
businessmen and their tax lawyers explained that Congress taxes corporations (and individuals) on their worldwide income. With a
Chinese corporate income tax, however, the taxes they owed to the United States would go down for two reasons. The first reason
is that American business profits earned overseas are not taxed so long as the money stays offshore. The second reason is that
the United States allows American companies to reduce taxes on their profits by the amount they pay to foreign governments. This
is not the usual deduction worth 35 cents on the dollar, but a dollar-for-dollar credit. Thus a dollar of tax paid by Exxon Mobil to
Beijing is a dollar not paid to Washington.
    Like the Chinese income tax, this U.S. tax credit
originated with the oil industry. Back in the 1920s, when drilling for oil was a risky game with many dry holes, the oil industry paid a
uniform 12.5 percent royalty to the owners of oil taken from the ground. The House of Saud, having emerged victorious over the
competing Arabian Peninsula warlords and in need of cash to maintain its newly consolidated power, wanted to raise the royalty
rate. The Treasury secretary at the time, Andrew Mellon of the Pittsburgh banking and oil family, suggested a different approach. He
recommended that the Saudis just tax the oil companies to raise money. Mellon then persuaded Congress to adjust the corporate
income tax to give the oil companies—and any other companies earning profits overseas—the dollar-for-dollar credit against taxes
due to Washington.
    Mellon’s change in the government’s rules was brilliant from the point of
view of an oilman. The Saud family would get more money, the oil companies would be indifferent because American taxpayers
would be picking up the cost of enriching the Saudis and, most important of all, there would be no competition over royalty rates,
no risk that royalty rates would increase. Adam Smith would not have approved. He had warned of government fixing the market to
benefit those with power and property. But then, who wants to compete when the government will fix the market for
you?
    The Chinese communists agreed to the request that they enact a corporate income tax,
having experienced one confirming example of Lenin’s dictum that “the capitalists will sell us the rope with which we will hang
them.”
    The corporate income taxes paid in China are not like those in the United States.
Instead of going for the general support of the government, money paid to Beijing is often used to benefit the company that pays.
Taxes may finance a new road or railroad spur or police presence and other services the company requires.
    The lesson in all this is that the top Chinese communist officials may have learned more from Adam Smith
than the American capitalists who so often invoke his name. What the Chinese took from Smith is a deeper understanding of how
government policy can guide, and misdirect, the