Tax Inversions are a Symptom, Corporate Tax Reform is the Cure

Washington legislators are introducing bills to stop “tax inversions,” or the process by which corporations merge with foreign companies and move abroad to lower corporate tax burdens. This follows Medtronic’s recent inversion and comes as Walgreen Co. shareholders exert pressure on the Illinois-based corporation to do the same.

Recent legislative proposals aim to keep corporations in the U.S. and to stop the erosion of the nation’s corporate tax base. Senator Dick Durbin has introduced a bill that would provide a tax credit of $1,200 per employee to any corporation that stays in the U.S., while Senator Carl Levin has proposed legislation that would place a two year moratorium on corporate inversions. And indeed, the revenue implications are significant: Medtronic stands to save around $4 billion annually in taxes with its move, while Walgreen Co. would save nearly $800 million per year.

What’s interesting, though, is that American corporations already foot large corporate tax bills on income earned abroad. In fact, U.S. corporations paid an average effective tax rate of 27.2 percent on foreign profits in 2010, or approximately $128 billion in taxes out of $470 billion in taxable income. To put that number in perspective, that is 2.7 percent above the OECD average of 25 percent.

Still, U.S. corporations seem undaunted, and a steady stream of corporations are moving abroad —fourteen have done so since 2012. The fact that corporations are jumping to leave under these circumstances should be a sign to Washington: a more competitive corporate tax code might be the best solution to keep corporations at home.

The U.S. is one of only six developed nations with a “worldwide” tax system that subjects its domestic corporations to double taxation. Income earned by American corporations abroad is taxed once by the nation in which it was earned, and again when the income is brought back within our borders – up to the federal rate of 35 percent. When combine with state and local corporate taxes the U.S. has the highest corporate tax rate among the world’s 34 most industrialized nations at 39.1 percent. This double taxation, and at such a high rate, discourages saving that promotes business investment, hiring, and production.

Instead of lambasting corporations for fleeing the U.S. and its punitive corporate tax code, Congress might have better success keeping corporations in the United States if they address the root of these tax inversions. Lowering the corporate rate to the OECD average and abandoning worldwide taxation in favor of a territorial system would be a suitable start.