The new inversion rules are a fine start, but the business tax code needs serious attention.

September 26th, 2014 at 9:23 am

Now that the dust has settled a bit on the Treasury’s exciting announcement of their new inversions rules, let’s kick back and cogitate a bit more on a few of the many remaining issues in the US corporate code.

Inversions: The Treasury has thus far created but a speed bump on the international tax avoidance highway. As I read it, they’ve made it harder for newly merged corporations to make their deferred earnings—profits the former US parent company was holding abroad to avoid US taxation—appear to be property of the new foreign firm. (Treasury: “Today’s notice removes benefits of these “hopscotch” loans by providing that such loans are considered “U.S. property” for purposes of applying the anti-avoidance rule.”)

I suspect that changes the marginal calculus for some firms considering inversions—most analysts view this issue of distributing foreign holdings tax free as the main motivator for many an inverter—but no one who follows this sees it as a game changer. That’s not a dis of the Treasury; as I wrote the night the rules came out, this is a bold, albeit limited, move to do what they can without Congress to partially close a loophole and protect the eroding tax base. But I expect them to return to this well, both on their own (next up, I’d guess: rule changes to block “earnings stripping”) and, in the unlikely event that they can find some dance partners, with Congress.

Debt Financing:  CEA chair Jason Furman just presented a paper on corporate tax reform, mostly reviving ideas that the administration put forth a few years ago—lower rate, broader base, minimum tax on deferred foreign earnings. In the process, he updated two charts of which you should be aware.

Suppose I told you a fable about a country that massively favored debt financing for business investment over equity financing, where “massive” implies almost a 100% difference. You might think: there’s a country that is asking for over-leveraging problems.

Well, according to Furman’s chart, that’s no fable. Since interest is a deductible expense, the marginal tax rate for debt financing in the corporate sector is negative 60%; for equity, it’s +37%. Jason notes that the “…United States has the lowest tax rate on debt-financed investment in the OECD and the largest debt-equity disparity in the OECD.” The solution, likely not coming anytime soon to a tax reform near you, is to reduce this huge tilt by limiting the amount of interest that can be deducted.


Source: CEA, Furman.

Monster Tax Havens on Steroids: If you pay any attention to the tax avoidance problem you know that there’s been a sharp rise in the amount of what Ed Kleinbard calls “stateless income,” basically stealth profits that are designed to fly under the radar of any country that might tax them. So this next chart won’t surprise you, but the magnitudes are still worth observing.

It shows the ratio of offshored US corporate profits relative to the GDP of the countries where these dollars reside. In Bermuda, the British Virgin Islands, and the Cayman’s, that ratio is over 1,000%. I hope you’ll allow me to speculate that such location decisions are not the result of corporations answering the question, “in terms of growth, innovation, and productivity, where’s the best place for us to invest our profits?”


Source: CEA, Furman.

These three points provide good examples of the extent of base erosion, incentives to overleverage, and the distorted behaviors generated by our benighted corporate code. They also show you why corporate tax reform is such a heavy political lift. Policy makers and wonks like me can talk all day about the economic benefits of squeezing these inefficiencies out of the system, but the vested interests have huge bucks invested in a) the status quo, and b) members of Congress who will do their bidding to keep things just the way they are.

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6 comments in reply to "The new inversion rules are a fine start, but the business tax code needs serious attention."

  1. Tiree says:

    When people say that both parties are the same, it is usually these issues of corporate privilege that they have in mind. There are only minor differences in the positions of the parties on these issues the way I see it. Add to that the only slightly different historical positions of the parties on minimum wage and labor rights, and it is easy to see why people don’t vote.

    Nothing short of a rabble rouser is going to change that. A president cannot act reasonable and moderate and still expect to have a major effect on these problems.

    • smith says:

      I would fundamentally disagree with much of that analysis, though I would concede the validity of current corporate privilege sameness of the major parties (both sellouts and corrupt to a large extent). Officially, there are major differences however, both in terms of rhetoric and actual policy. This is muddied by the constant movement of both parties to the right, led by Republicans, who are followed by the unprincipled or triangulating Democrats.
      But historically, there has been a huge difference regarding minimum wage and labor rights. There are many reasons people don’t vote, but I doubt historical differences in labor and wage policy is significant.

      The country does not need a rabble rouser, but a cable speaker with experience, who promotes a progressive agenda would be welcome. A president must be reasonable and moderate to be effective, but must convince the American people the opposition are unreasonable and extreme. Just as Reagan made conservatism mainstream, and the Roosevelts made progressive government popular, framing the debate can be done without rancor and upheaval. The right wins by saying they are restoring order, the left can win likewise by saying lets go back to what previously worked, Eisenhower tax rates, and the Depression ending New Deal.

      • Tiree says:

        We’ll agree to disagree, I think.

        Historically, I’m speaking of Bill Clinton, who purposely decided not to attempt to raise the minimum wage by much so he could use the issue in the future to get votes. Our difference of analysis looks like an inside vs. an outside view. The inside analysis is what causes the Democratic party to continue creeping to the right.

        Most people younger than the boomer generation don’t remember much before Bill Clinton, so you really can’t go back further than that with a meaningful analysis.

        So we disagree because we don’t agree upon cause and effect. When the party uses policy in a way to gain votes in an underhanded way, and when they believe so strongly that their analysis is correct, they alienate everyone.

        Voters are much smarter than party leaders. Much smarter. And you’ve just proven my point, because you are claiming that the rhetoric matters, and in this case it doesn’t. Nobody listens to the rhetoric anymore because everyone knows they’re liars.

  2. smith says:

    One suspects the so called party of reform, the Democrats, are largely bought and paid for by monied and business interests, same as everyone else. They put up token opposition and then let Republicans do their dirty work, inserting anti-reform elements into bills labelled reform.

    But even allowing for good faith efforts, the Democratic strategy of appeasement and compromise is a losing proposition. A prime example is the “lower the corporate rate, broaden the base” meme, repeatedly lent credence by Obama and advisors. The way to close loopholes is to close loopholes, an idea that Obama is now only belatedly acting upon.

    The great harm done otherwise is in not allowing simple debate the public can understand. Reagan changed the country by advocating a stronger defense, lower taxes, less spending on social welfare programs. Unable to gut so many programs, most would argue two out of three ain’t bad. I’d favor an honest debate about the business tax code, but any premise that votes need to be bought by leaving measures revenue neutral should be a non-starter. Bring on the Senators Warren and Sanders wing of the Democratic party, look at the Piketty data on taxes, the fallacy of the race to the bottom, observe record corporate profits, there is no need for lower rates. There is no need to concede defeat before the battle is even engaged.

  3. David Morse says:

    What we really need is a congress who will work on Sales Factor Apportionment. The Democrats need to realize the era of World-wide tax is over and the GOP needs to realize that you can’t let corporations tell the government one set of numbers and their shareholders a second set. SFA uses a system limited to territorial collection but with the caveat that the same sales numbers they report to shareholders are the numbers used to judge their profits. Those profits are where you collect the tax from. I know some would like formulary apportionment instead, but that creates an obvious disincentive to employ domestic labor or invest capital. A corporation can move alot of things, but they can’t move sales. A study from the District Economic Group can be found at which establishes this will result in a revenue positive approach.

    • smith says:

      Why is the world wide tax over? Because American companies don’t benefit from the fact that they are based in the U.S.? Because other countries say it’s over (if other countries jumped off the George Washington Bridge, would we?) Because we need yet another reason for American companies to boost sales overseas and neglect domestic markets, which naturally funnels investment and jobs opportunities outside the U.S.? When exports don’t generate tax dollars or jobs, just increased profits to business, how exactly is that beneficial to the averages Joe? When corporate profits are breaking records, why again would we even consider any tax break, let alone one that would reap billions to those least in need to the detriment of those most requiring the most attention? It may get the support of liberals like Robert Reich, but guess what, that doesn’t make it right. Much of noise for reform is a smokescreen for corporations hoping for a tax break to induce repatriation ($1.6 trillion). As a side note, has no information on who they are, what they represent, or how they are paid. It could be one guy interested in promoting tax policy, or a corporate front. Plenty of links, so why the mystery of who runs it. Yes, I comment anonymously, but that’s as an alternative to launching a site where I’d expect to have to declare who I am. (whois is supposed to do that but ICON regulations are a joke)