To Stop Inversions, Fix the Tax Code

August 07, 2014

Per a Politico report, President Barack Obama says he will act on inversions:

“Obama has asked Congress to address the practice, known as inversions. However, he made clear Wednesday that he also plans to take whatever unilateral steps he can to rein in the phenomenon.

“What we are doing is examining: Are there elements to how existing statutes are interpreted by rule, or regulation, or tradition, or practice that can at least discourage some of the folks who may be trying to take advantage of this loophole,” the president said.”

In his fiscal year 2015 budget, the president presents what is likely preferred solution: a stricter restriction on the international companies that domestic firms can merge with. We explained the potential change in previous analysis:

“The current rule says a U.S. company can invert only if the U.S. parent company would be no more than 80 percent of the new combined post-merger company, in terms of shares. Additionally, there are penalties for inverting if the U.S. parent is 60 percent or more of the combined company. That effectively prevents really big U.S. corporations, such as Apple and Amazon, from leaving, since a) it’s hard to find willing partners outside the U.S. that approach that size, and b) it’s hard to justify the costs of such a big merger. The Obama administration proposes to make it even more difficult for more companies by lowering the 80 percent rule to 50 percent.” 

Proposed changes like this try to address a symptom instead of curing the illness: the United States’ uncompetitive tax code.

While the countries in the rest of the developed world have cut their corporate tax rates, the U.S. has remained stagnant at about 39 percent since the late 1980s. At that time the OECD average was at about 45 percent. Today, it is 25 percent.

To make matters worse, the U.S. is one of only six OECD countries with a worldwide tax system and one of only three countries with worldwide systems that has a tax rate above the OECD average.

This combination continuously puts U.S. businesses at a disadvantage as they operate domestically and abroad.

But the lack of competitiveness created by the corporate tax isn’t the only issue: at its core, the corporate tax is inherently not neutral. It is highly distortive, opaque, and economically damaging tax. Let’s take these one by one.

Highly Distortive: It drives companies to make decisions they otherwise would not make (a company leaving the U.S. for Ireland or the U.K., for example).

Opaque: It is largely hidden from the people who bear the ultimate burden of the tax—a combination of consumers through higher prices, workers through lower wages, and shareholders through lower returns. This is to say nothing about the huge compliance burdens it creates.

Economically Damaging: It increases the cost of investment to make it a major drag on economic growth. In fact, the OECD finds that the corporate tax is the most harmful tax to the economy.

The corporate tax has set back the U.S. economy. But there are solutions to address the root issue. Some suggest we replace the corporate tax with higher taxes on shareholder. Others would just like to see a lower rate.

The bottom line is this: the U.S. corporate tax system needs to be fixed. If we want our companies to compete, create jobs, and help jumpstart the economy, at a minimum, the corporate rate needs to come down and we need to move to a territorial system.

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