Treasury's Costly Mistake on Inversions

Millions of families are filing their 1040s this extended Tax Day, and, while the entire tax code certainly needs reform, there's an especially pressing tax problem that affects nearly all Americans.

The problem is that our corporate tax system puts American businesses at a competitive disadvantage against the rest of the world, suppressing U.S. capital investment, economic growth, and reducing jobs and wages. The money U.S. companies earn from their foreign operations is "stranded" overseas rather than being deployed at home for new factories, research, and hiring. To access those profits and to compete on a level playing field with foreign companies some U.S. firms have turned to a process known as inversion, merging with companies based abroad and moving headquarters to a foreign country.

On April 4th the Treasury Department issued new regulations to curb inversions, surprising businesses with a retroactive change in tax rules. We understand the political attractiveness of taking action to prevent companies from fleeing the U.S. - President Obama does too, since he talked about the rules himself, which is unusual attention for tax tweaks. But those regulations are actually highly problematic, and will end up harming rather than helping the U.S. economy. President Obama's politically-driven action will cost American jobs rather than save them.

This is the point made by 18 former Treasury officials in a letter to Secretary Jacob Lew, asking him to reconsider the rules, avoid a costly mistake, and focus his attention instead on reforming the U.S. corporate tax laws.

The bipartisan signers of the letter include officials from six administrations. Among them are George Shultz, Treasury secretary under President Nixon and holder of three other Cabinet positions including Secretary of State, and the distinguished economist John Taylor, who was under secretary for international affairs under President George W. Bush and also served in the Carter, Ford, and George H.W. Bush administrations.

The U.S. corporate tax code has many problems, starting with having the highest tax rate in the developed world. Combining state and federal taxes, the U.S. marginal tax rate on corporate income is 39 percent, compared with an average of 25 percent for all 34 members of the Organization for Economic Cooperation and Development (OECD). Taxing corporate income is a poor way to redistribute wealth - a fact understood by countries with strong concern for social welfare, like Sweden, whose rate is 22 percent, and Canada, at 26 percent.

Going after corporations may make for good rhetoric but it produces harmful results. The corporate income tax is paid not just by shareholders, including the millions of middle-class workers with 401k plans, but also by workers and consumers. A higher corporate tax means lower investment, and thus weaker productivity, and this in turn translates into lower wages. Corporations pass along these taxes so American families pay higher prices and have less purchasing power. The corporate tax does little to narrow inequality, but costs the economy dearly in lost economic growth.

Nobel Laureate Robert Lucas once remarked that reducing or abolishing the corporate income tax is the closest thing there is to a free lunch he's ever seen. The Tax Foundation concluded that "a wide variety of empirical economic literature has concluded that corporate incomes taxes are more harmful than any other tax to economic growth."

What is especially striking is that this administration seeks to wring more money out of the corporate tax code at the same time that the rest of the world is doing precisely the opposite. It is no surprise that American companies are moving-the fault is our tax code, not some faulty decision-making by CEOs.

In addition to the high tax rate, the U.S. also taxes profits that U.S. companies earn overseas while other countries tax only domestic revenue. This puts world-class U.S. companies at a disadvantage. Caterpillar, for example, faces an effective tax rate well above what its Asian competitors pay in their overseas operations. Few OECD countries impose taxes on foreign-sourced income, and the ones that do have low rates.

Companies can avoid additional U.S. taxes on overseas income in two ways. The first is to leave their cash outside the U.S., making it no surprise that more than two trillion dollars' worth of firms' earnings are now held overseas.

The second way to avoid the high U.S. rate and worldwide tax regime is to acquire a foreign company in a country with a lower tax rate and a territorial (domestic-only) regime, and then to change its corporate address to that foreign location. Inversions are the symptom of a U.S. tax code that harms our own economy.

Neither political party is happy with the current situation, and there have been several proposals to address it. The most sensible solution is to do what the rest of the developed world has done: cut corporate tax rates and tax profits only at home. The outcome would be higher saving and investment, and more job creation at home.

The White House, on the other hand, prefers to tighten regulations on inversions-going after the symptom rather than the problem. Rather than a solution, this approach makes it less appealing to be a U.S. company. This will make U.S. companies more attractive targets for foreign acquirers who already have the better tax regime-the new Treasury regulations actually favor foreigners over American companies. The result is to give U.S. business an incentive to move their entire operations -- including their headquarters employees -- overseas to avoid the punitive U.S. tax code.

As our fellow signers wrote, a positive economic agenda for President Obama and Treasury Secretary Lew to pursue in their last few months in office would be to address the root causes of subpar U.S. economic growth, including our harmful corporate tax code.