Tax Inversions are the Canary in the Coal Mine

September 24, 2014

In old mining tunnels, the workers would often bring a caged bird with them. The bird would function not only as a pet, but also as an advance warning of dangerous carbon monoxide. If the bird – more sensitive to changes in air quality – fell ill, it was a sign that the tunnel was also dangerous for the miners.

Corporate inversions are also a sign. While corporate inversions are actually not costly to the treasury up front, they are a signal that doing business as a U.S.-domiciled corporation is becoming prohibitively difficult. U.S. businesses face increasingly arcane international tax rules designed to preserve an outdated system that most countries no longer use.

It is costly to restructure an organization. It’s costly to uproot practices that grew organically with the business, and it’s costly to artificially graft two companies together. Shareholders would greatly prefer not to expend value on all of this administrative nonsense.

Corporations have been inverting only because the U.S. worldwide system of corporate taxation is actually worse administrative nonsense than the costs described above. The whole system is based on a fundamentally unserious idea that the United States should tax economic activity that happens beyond its borders. Of the 34 OECD countries, 28 of them have abandoned worldwide taxation and moved to the superior territorial system.

When taxpayers flee a poor tax system, it is tempting to look at only those taxpayers leave. For example, the French “Millionaire Tax” resulted in several prominent Frenchmen threatening to leave the country last year. But, as with the French tax, it’s not just about the people who respond directly. It’s also about the indirect responses. An American company might simply avoid expanding to the U.K. in the first place, because it can’t compete with the British companies. Not because it’s less valuable or less talented – but because it has to pay both British taxes and U.S. taxes, while the British company is not similarly encumbered.

These unseen effects may be much larger than the seen ones. Inversions are just the visible sign of a much greater sickness.


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