Over the past few weeks, I’ve engaged in a number of debates about “tax inversions”—where US companies merge with foreign companies to reincorporate in a country where they can pay less taxes.
Let me tick through some of the issues here, including some key policy flashpoints, and link to some useful work on the subject.
–As Tom Hungerford stresses in a very useful review of the topic, don’t think of this as relocation of economic activity as much as pure tax avoidance. Perfectly legal—i.e., avoidance, not evasion—but problematic nevertheless.
–Allen Sloan also has a worthwhile take on the issue, wherein he admittedly rants on the lack of economic patriotism of the corporate inverters. Treasure Sec’y Jack Lew made similar points in a speech this week. (By the way, as WaPo journalist Ylan Mui pointed out to me, calling this tax avoidance scheme “inversion,” which sounds technical and even mathematical, is a nice, antiseptic way to obfuscate what’s really going on here.)
I must say, while I’m totally sympathetic to this patriotism argument, it doesn’t really move me. This is globalization in action, a dynamic which most policy makers praise on a daily basis. It’s companies maximizing after-tax profitability and shareholder value—though I’m not so sure about that last part, as you’ll see below—goals that are pretty solidly American.
As Jeff Faux pointed out years ago, globalization erodes social contracts between elites and others, rendering the idea of corporate responsibility to the US Treasury’s coffers a quaint anachronism.
Sloan points out that the cruise ship firm Carnival, “a Panama-based company with headquarters in Miami, was happy to have the U.S. Coast Guard, for which it doesn’t pay its fair share, help rescue its burning Carnival Triumph. (It later reimbursed Uncle Sam.)” Others note that inverters who pay taxes “over there” but locate operations here take unfair advantage of our public goods from education to infrastructure without paying their fair share of the bill.
All true, and all play second fiddle, if not third viola, to the motivation to maximize profits and avoid taxes. I’m not saying we shouldn’t play the “shame-on-you” card. To the contrary, we should early and often. But we unquestionably need a strong “plan B.”
–In that regard, my main man Chuck Marr tells of Congressional actions being contemplated, though I see mostly D’s cited in his review. It’s not at all hard to imagine that the buzzsaw of House R’s will let tax law around inversions stand as is.
–In a CNBC debate this AM (clip to come), I touted my favorite solution: require that pre-inversion shareholders hold 50% of the value of the newly formed company as opposed to the 20% under current rules. As Chuck points out, hurdles like the 20% rule erected a decade ago are now being easily cleared. So they need to go up.
Hungerford adds the requirement that new merged company “…be treated as a U.S. corporation if it is managed and controlled in the United States, and had “significant domestic business activities” in the United States.” That’s a good idea too, but squishier and easier to game.
Interestingly, my interlocutors on TV accepted the higher 50% stock ownership bar, but insisted such a change occur in tandem with broader tax reform. To which I say a) “why wait??!!”—even corporate tax reform, which everyone says they want, is surely way, way off, with many inversions betwixt here and there, and b) tax reform could help dampen the inversion impulse, but maybe not by much. The Irish statutory business tax rate is 12.5%. We’re not going to match that.
–Do inversions really maximize shareholder value? Sure, the share price gets a pop when the inversion is announced and it makes sense that higher after-tax profits could raise share prices for the longer term, for which there’s some anecdotal evidence.
But the original shareholders typically owe capital gains taxes on appreciated shares in the new, merged company, and a complete analysis of the benefit/cost outcome must include this factor. I’ve not seen such analysis and thus do not assume that inversions are an obvious winner for all shareholders.
One final thought, and it’s one that some commenters here at OTE recently noted around other corporate tax discussions. Engage in this and related debates for a while and you quickly start to wonder if the US corporate tax system is even worth having around anymore. As the figure below reveals, it’s nothing like the revenue generator it once was and not a day passes wherein someone doesn’t complain about how it’s hurting our ability to compete internationally. (Though I’m not sure how those two facts—corps paying less revenue yet the tax is more of a competitive burden—actually square off.)
End of the day, however, I say: mend it don’t end it. The various schemes to replace it tend to be fraught with complexities (e.g., taxing unrealized capital gains from public companies and ?? re private ones) or unrealistic assumptions about the ability of the system to tax income flows from businesses to households. Better to simplify the current system and hammer away as best we can at the loopholes, from inversion to deferrals to pass-throughs, etc. I actually think the Obama administration’s white paper on this sets forth an under-appreciated, useful framework.
But while we’re contemplating larger reform, there’s no reason to fall prey to inversion diversion. This is a problem we should take action against starting yesterday.
Source: OMB, table 2.3