There's a Very Easy Corporate-Inversion Solution

Tax inversions, something ninety-nine percent of people had never heard of before this year, are suddenly Washington's favorite bogeyman. A tax inversion occurs when an American company buys a foreign company but assumes the corporate identity of the foreign company so as to avoid some U.S. taxes. To hear Democrats talk about it, such behavior is pure evil and must be stopped. After all, if corporations do not pay taxes, who will have to take up the slack?

Before pointing out the ridiculousness of complaining about tax inversions, a moment's digression is worthwhile here. Corporations do not pay taxes out of some magic pot of money that self-generates. Rather, corporations pay taxes using money they got from their customers. So if corporations successfully avoid taxes, individuals will end up paying more if government is to collect the same amount. But since those individuals will no longer be charged by the corporations for taxes no longer paid, we individuals will end up paying exactly the same amount of taxes as before.

There is only one difference between a tax system in which all taxes are paid by individuals and one in which individuals and corporations share the burden: corporate taxes are hidden from us. We see when we pay income taxes-either in a payroll deduction or a check we have to write to the U.S. Treasury, but corporate taxes are hidden in the price of goods and services that we buy as we blissfully go about our lives. I will come back to this point, because it is the important one for understanding the political rage over this issue.

The U.S. is the only major country that levies corporate taxes on worldwide income. Everyone else taxes only the income earned in their country. Hence, other countries do not have to worry about their corporations following the American lead on tax inversions as in other countries the home country designation is meaningless. Any business earning money in the U.K., France, Germany, etc., owes that country the exact same tax bill regardless of where they claim to be incorporated.

Congress and the President should abandon any thought of legislation that stops tax inversions. My first rule of political economy is that people are always smarter than the government. There is zero chance that any law can be written that the lawyers and accountants working for major corporations, along with their investment bankers and legal advisors, cannot find a way around.

So if Congress and the President wish to stop tax inversions they have two options. First, they can pass corporate tax reform that changes our tax system to the same system the rest of the world uses: tax only earnings from American operations. That one simple change would stop the entire problem. Without an economic incentive, such mergers will only happen when they truly make business sense.

Such a change seems fair, as well. After all, why should Burger King (the latest to pursue an inversion) pay taxes in the U.S. on profits it receives from selling burgers in Egypt, Cambodia, and Jamaica? Burger King must pay taxes in each of those countries based on their earnings within their borders. In fact, those taxes become tax credits on Burger King's U.S. taxes, so we only collect taxes on foreign earnings when our tax rate is higher than the rate in the other country.

The second option would be even better than the first: eliminate all corporate taxes. Since corporations get all their revenue from customers, it would be much simpler to simply tax personal income. Then business would operate based on customer demand and market conditions, not be influenced by the latest tax loophole, incentive, or penalty devised in Washington, D.C. in order to socially engineer the way companies operate.

Since most people cannot afford the fancy lawyers and accountants that find all the loopholes that lead corporations to pay an average tax rates of around 13 percent when the stated rate is 35 percent, taxing people is likely to be an easier task for the government. Individual taxes already bring in $6 for every $1 in corporate tax collections, so why not take advantage of the substantial efficiency gains from simply taxing people?

Unfortunately, the answer to that question was mentioned above. Corporate taxes are hidden from most of us, most of the time. We see the individual taxes that we pay directly to the government while overlooking all the embedded taxes in every product we buy. Politicians like hidden taxes because people do not complain about what they do not notice.

The Democrats don't like tax inversions because they might have to replace a hidden tax with one we can see. They realize the best hope for collecting as much tax revenue as possible is to keep us from noticing what they are doing. If you are in favor of lower taxes and lower prices for the things you buy, let's stop the tax inversion bandwagon by changing the tax code so that inversions are unnecessary. When taxes are visible, we will have fewer of them.