By the Editorial Board of The Wall Street Journal

President Obama revealed Monday that he’s half a supply-sider. If only someone could explain to him the other half. We have a tax code, the President said, "that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York." That sounds like a great argument for lowering taxes on the guy creating jobs in Buffalo. Alas, that’s not what he has in mind.

Set aside that India is a poor example to make Mr. Obama’s point, since its corporate tax rate on foreign-owned companies can be as high as 55%. The President’s argument is that U.S. tax-deferral rules make it more expensive for American companies to reinvest overseas profits at home than abroad. This, he claims, creates a perverse incentive for companies to "ship jobs overseas" and reduces investment and job creation in the U.S.

He’s right, except that his proposals would only compound the problem. His plan would limit the tax deferral on income earned abroad by tightening the rules, limiting allowable deductions and restricting eligibility for foreign-tax credits. This "solution" is antigrowth, job-destroying, protectionist and unlikely to raise the tax revenue Mr. Obama predicts. Other than that . . .

The current tax-deferral system is a clumsy attempt to deal with the fact that most other countries don’t tax their companies’ overseas profits. A German firm doing business in Ireland, say, pays no German income tax on its Irish profits, but it does pay Ireland’s corporate income tax at its 12.5% rate. The U.S. company competing with that German business in Ireland, by contrast, pays Ireland the same 12.5% on its profits — and it then pays Uncle Sam up to 35%, minus a credit for what it paid the Irish. And because almost everyone else’s corporate tax rates are lower than America’s (see nearby table), U.S. companies end up paying higher taxes than their international competitors.

Congress long ago created the corporate tax deferral to compensate for this competitive disadvantage. Under deferral, a company doesn’t have to pay the U.S. corporate rate until it repatriates its earnings. It can retain them overseas or reinvest them abroad with no penalty. But if it brings them home or pays them as dividends, the tax bill comes due.

The German company faces no such quandary. It pays the Irish tax, and it’s free to invest that money in Ireland or Germany or anywhere else. This territorial tax system, embraced by most of the world, eliminates the perverse incentive to hold money abroad that America’s deferral system creates. Adopting a territorial system would be the most obvious and simplest way to eliminate the distortion that tax deferral creates. Alternatively, Mr. Obama could lower the U.S. corporate tax rate to a level that is internationally competitive.

Yes, we know: Few major U.S. companies pay 35% of their profits in taxes because of the foreign tax-deferral and other deductions, credits and loopholes. But that’s precisely why Mr. Obama should want to take the better path to corporate tax reform by reducing the rate and removing loopholes. America now has the worst of both worlds — a high statutory rate and a tax code so riddled with complexity that it is both expensive to administer and inefficient at collecting revenue. And yet Mr. Obama’s proposal to limit deferral only layers on the complexity.

In promoting its new global tax raid, the White House fingered the Netherlands, which it lumped with Ireland and Bermuda as "small, low-tax countries" that supposedly account for an outsize share of reported foreign profits of U.S. firms. The Dutch corporate tax rate is 25.5% — which isn’t even all that low by current European standards. And the U.S. is the largest foreign investor in that "small, low-tax country," according to the Dutch Embassy. Perhaps reducing American investment there and slamming the Netherlands as a tax haven is Mr. Obama’s way of reaching out to friends and allies.

But the Netherlands won’t be the only country hurt. The explicit goal of this plan is to reduce the incentive for U.S. companies to invest abroad, which Mr. Obama derisively calls "shipping jobs overseas." Foreign companies may relish the loss of U.S. corporate competitiveness that his proposal will bring in the short term. But in the long term, reducing U.S. investment globally will hurt everyone. And that investment is a two-way street — the Netherlands is also the fourth-largest foreign investor in the U.S.

Some of Mr. Obama’s advisers understand all this, but then their real goal isn’t tax reform or U.S. competitiveness. It’s a revenue grab, one made easier by the fact that overseas tax "avoidance" is easily demagogued. To that political end, Mr. Obama conflates tax deferral with the offshoring of jobs — hence the sly reference to Bangalore, India. With trillions of dollars of new spending, the White House and Treasury are desperate for new tax sources to pay for it all.

But even as a revenue raiser, this is likely to fail. Fewer companies will keep their headquarters in the U.S., especially small or mid-sized firms that can slip away without becoming a political target. Those companies that can’t flee will sooner or later demand relief from Congress, which will be happy to create even more loopholes.

See also:

A Tax Attack on America’s Top Companies

EXCERPT:

In the name of tax reform, Pres. Barack Obama has announced $190 billion of tax hikes on many of the biggest U.S. employers. By reducing after-tax profits, these tax hikes could hammer stock prices that reflect investor expectations of future profits. . . .

The stocks of these companies are in millions of portfolios held by individual investors, mutual funds, and pension funds, as well as endowments at colleges, hospitals, museums, and other institutions. Obama’s business-tax hike will hit Americans whose jobs and pensions depend on these companies’ success — particularly in tough times. Colleges will have a harder time keeping tuition affordable if Obama hammers their portfolio holdings, and hospitals will be under more pressure too.

Obama claims his tax hikes will “level the playing field.” He reasons that since U.S.-based companies doing business exclusively in the U.S. don’t get to defer U.S. taxes on profits earned overseas, U.S..-based multinationals shouldn’t be able to defer taxes either. He wants all U.S.-based companies to be fully subject to U.S. business tax rates that are among the highest in the world.

But U.S.-based multinationals are already paying taxes in the countries where they operate. Almost all countries impose taxes based on residency; you pay taxes where you live or operate. The United States is the major exception, imposing taxes based on citizenship. This means an American stationed abroad must pay taxes both to the country where he or she lives as well as to the United States — double taxation. Although an American can claim a credit on a U.S. tax return for foreign taxes paid, he or she will still have to deal with tax bills from two countries. In 2006, Pres. George W. Bush signed a tax increase on Americans living abroad, and the New York Times reported there was an increase in the number of Americans renouncing their U.S. citizenship. . . .

Obama, who lacks business experience, seems to imagine that the only reason U.S.-based multinationals have offshore operations is to achieve tax savings. Actually, a company is in a better position to compete with local firms if it has an operation close to its market, compared with a U.S. firm that ships its goods thousands of miles away. An offshore operation is more likely to understand local market conditions, tastes, and trends. Obama’s double taxation would provide perverse incentives for U.S.-based companies to give up knowledge, relationships, and other advantages they spent years developing firsthand in world markets.

Another possibility is that Obama’s double taxation triggers an exodus of U.S.-based multinationals that re-incorporate offshore. We have seen how, during the past several decades, high New York City taxes played a major role in the dramatic exodus of Fortune 500 headquarters to lower-tax states. More recently, we have seen how California’s high taxes have stimulated an exodus of companies from that state, contributing to high-tech “clusters” elsewhere in the country.