Companies Must Maximize What They Don't Pay In Taxes
Few tax issues generate as much political controversy as so-called "corporate inversions." While the details can get immensely complicated, the basics are comprehensible. Corporations have their permanent establishment ("headquarters") in particular countries. Where a company is headquartered can have a significant effect on its overall tax liability as well as its competitiveness. In recent years, a growing number of U.S. firms have engaged in mergers with (or have been acquired by) a foreign competitor with the newly formed corporation headquartered in the competitor's country rather than the U.S.
Critics have decried this practice, which can reduce corporate tax liability even while leaving the company's pre-merger operations largely intact. Some even argue that it is "un-American," likening it to a wealthy individual who renounces her citizenship to enjoy lower rates on investment income. By "leaving the country" (on paper at least), the new post-merger company gets the same benefits of operating in the U.S. it enjoyed before, but supposedly avoids its "fair share" of paying for them, thereby shifting the burden to individuals (despite substantial evidence that the ultimate burden of corporate taxes likely falls very heavily on individuals such as workers and consumers).
To understand why a U.S. company would contemplate changing its headquarters and enduring severely negative publicity from some quarters, it's important to understand that U.S. headquartered companies face some of the very highest marginal tax rates (nearly 40% when state and local taxes are included) in the world, and are taxed on a "worldwide" basis (i.e., their earnings are ultimately subject to U.S. tax regardless of where in the world they are earned). Meanwhile, their foreign headquartered peers generally enjoy significantly lower tax rates (OECD average 25.2), and their earnings are mostly taxed only where earned. Because taxes constitute a cost of "doing business," an international corporation that faces higher effective marginal rates will suffer a loss of competitiveness vis-à-vis those that face lower ones.
While the growth of corporate inversions has become extremely controversial, Washington is (unsurprisingly) divided on what they signify and therefore what to do about them. Republicans are prone to see inversions as an unfortunate but rational response to an outdated U.S. corporate tax code. They would reform it along the lines that countries such as the United Kingdom, Canada, Ireland and others have in recent years.
Democrats tend to see inversions as a loophole in need of immediate closure. The Obama administration has already taken administrative steps attempting to limit their benefits, thereby reducing the incentive enough to perhaps stop some more marginal deals. But others, most notably the recent Pfizer-Allergen deal, are still moving forward. Bills pending in Congress would place limitations on inverted companies' use of interest deductions and bar them from receiving federal contracts.
At the end of the day building a higher wall for U.S. firms looking to leave is likely to be counterproductive. U.S. policy makers will have to abandon an outdated and parochial world view that America is the only country capable of generating and sustaining world class business enterprises. In recent years other countries have crafted more competitive tax systems, and inversions serve to remind us that the window for the U.S .to retain economic leadership is closing by the day. To the degree that they can be stopped without improving the U.S. tax code, there are greater opportunities for foreign companies to purchase U.S. firms, which can have even worse results than inversions for the U.S. tax base, American jobs and our communities.
Judge Learned Hand famously opined that "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." No home owner would fail to take deduct her mortgage interest nor a donor to write off a charitable donation. Likewise we cannot expect companies to structure themselves in tax inefficient manners. Forcing them to do so will hurt workers, shareholders and customers in the short run. And if they cannot compete globally in a world where 95 percent of the people live outside our borders, the U.S. tax payer will be the long term loser as well.
