It’s rare that a tax issue is exciting enough to dominate mainstream national news. But, lately, that’s precisely what is occurring. Suddenly, the Treasury Secretary is making headlines by calling for a “new sense of economic patriotism” and decrying companies for “inverting.” The president, too, is noting his “interest in economic patriotism,” suggesting that action is needed to stop companies from “deserting” the United States and to “close this unpatriotic tax loophole for good.” What are inversions? Are companies “fleeing?” Since when are patriotism and taxes bedfellows? Let’s explore.
An Antiquated, Outdated, and Uncompetitive Tax Code
The United States has an uncompetitive and outdated tax system. Its corporate income tax rate, at 35%, is the highest in the developed world. Further, the United States is one of the few countries that clings to a worldwide tax system. This means that American multinational companies are taxed here on their U.S. profits (just like domestic companies), taxed abroad on their foreign profits, and then taxed again when those foreign profits are brought back home (i.e., “repatriated”). By contrast, virtually all foreign multinational companies are taxed under a territorial tax system in which they pay taxes on their home country profits in their home country and on their foreign profits in the foreign country, but their foreign profits are not taxed a second time when they are brought home. Thus, the double taxation of foreign profits is avoided.
Recently, other countries, including the United Kingdom and Canada, have shifted to more globally competitive regimes— slashing tax rates and shifting to territorial systems. By simply standing still, the United States has fallen further behind.
The last time that the United States overhauled its tax code was 1986. And while tax reform discussions and draft legislation have percolated in recent years, nothing has advanced that would lower rates and provide a more internationally competitive tax system. American companies have grown restless. They struggle with how to level the playing field to compete with foreign multinationals as well as how to fulfill fiduciary duties to shareholders to maximize value, knowing if they don’t, shareholders will not support them.
Under our current international tax system, an American company can end up paying more taxes than an identical American company that is owned by a foreign parent. Some attempt to rectify this difference and regain equal footing with their competitors by essentially becoming foreign domiciled multinationals, aka inverting.
Simply, an inversion is defined as a series of transactions that results in an American company becoming newly incorporated in a foreign country. By creating or buying a foreign parent, an American company essentially mimics the territorial tax system its foreign competitors enjoy—thereby eliminating the anti-competitive second layer of U.S. tax on its foreign earnings. This frees up cash for myriad purposes, including shareholder payments, capital investments, and expansion.
The recent wave of companies considering or completing inversions is a direct result of the differences between the U.S. tax system and those under which our foreign competitors operate. This differential creates real economic valuation differences between being an American and foreign domiciled company. That real value difference puts into action market forces to reduce that differential.
If American companies don’t invert, then their stock prices will be reduced by this value differential, reducing returns to investors and limiting the company’s ability to grow and create jobs. This makes these companies more vulnerable to foreign acquisition.
Recent cries about “economic patriotism” have given way to tomfoolery on the Hill and Pennsylvania Avenue as politicians rush to craft legislative solutions to stop these inversions and seize on election-year messaging. These congressional and administrative proposals attempt to artificially limit the ability to mitigate this value differential but would do little more than exacerbate the very problem they attempt to address. Let’s review current law and current proposals.
Under present law, an American company can reincorporate overseas (i.e., invert) only if more than 20% of its shares are transferred to foreign shareholders. If less than 20% of the company is controlled by foreign shareholders, then the company will continue to be taxed in the United States as a domestic corporation, meaning that the company will continue to be subject to double tax on its foreign earnings.
This anti-inversion legislation was enacted in 2004 in response to a series of inversions pursuant to which U.S. corporations simply reincorporated in foreign tax jurisdictions to help level the playing field.
Recent corporate inversions involve substantive transactions that come with both risk and benefit. Companies are expanding their operations in foreign markets, and they are structuring those expansions in the most cost-efficient way so that they can compete in global markets (including the United States).
Corporate Relocation Legislation
First out of the gate for legislative consideration was Sen. John Walsh’s (D-MT) Bring Jobs Home Act, a bill that sought to provide a tax credit for relocating an offshore business unit to the United States and deny deductions for certain expenses related to moving a business unit offshore. This legislation initially was brought up for consideration not in reaction to inversions but, rather, as a political messaging bill for Walsh, who was up for reelection.
As with its first go-around, this bill once again had no problem ignoring that outside America’s borders are markets that represent 80% of the world’s purchasing power, 92% of its economic growth, and 95% of its consumers, and that it is well documented that American worldwide companies maintain a large presence in America relative to the size of their foreign operations. Consideration of this bill was procedurally blocked; however, Senate Majority Leader Harry Reid (R-NV) could move to bring it up again this fall. As an aside, this bill, purportedly like Walsh’s war thesis, is a recycled effort, having first been introduced by Sen. Debbie Stabenow (D-MI) in 2012, and proof that bad ideas rarely die inside the Beltway.
Simultaneously percolating were some more direct anti-inversion proposals. In the 2015 Greenbook, which details the administration’s proverbial wish list of revenue raising provisions, the president proposed raising that ownership threshold to 50%—basically requiring an American company to buy a foreign company larger than itself.
Additionally, Sen. Carl Levin (D-MI), never one to miss the opportunity to promote protectionism, introduced the Stop Corporate Inversions Act of 2014, which would increase the foreign ownership threshold to 50%. Levin’s bill also calls for a second test that would disallow any inversion where “management and control of the merged company remains in the U.S. and either 25% of its employees or sales or assets are located in the U.S.” This bill would be retroactive, effective for inversions completed after May 8, 2014, and would sunset May 9, 2016. In the House, Congressman Sandy Levin (D-MI) introduced a similar bill, but he omitted sunset language.
Unfortunately, these bills not only fail to address the problem, but they would do little more than encourage larger foreign companies to acquire smaller American companies. Moreover, the management and control provisions would simply incite companies to move high-paying corporate jobs overseas.
You need to look no further than the revenue score of this proposal to see its ineffectiveness. One would presume, if this proposal were going to curb inversions and stop this “widespread offensive” behavior, a large revenue haul would follow. Not so. The Joint Committee on Taxation (JCT), Congress’ official scorekeeper, found this proposal to curb inversions raises $20 billion over 10 years. To put that in perspective, according to the Congressional Budget Office (CBO), the federal government is expected to bring in just over $4.5 trillion in corporate tax receipts over the same time period. In other words, Levin’s proposal raises just 0.44% of the total corporate tax take over that 10-year period.
As if further evidence of the ineffectiveness was needed, the White House has taken to touting falsehoods to demagogue the American people, claiming that everyday Americans will see their tax bills rise as a result of American companies re-domiciling offshore. Not true! First, as noted, the revenue loss is minuscule. Second, no one will see his or her tax bill rise because a company inverts; how much one taxpayer pays has zero impact on what another taxpayer owes.
In addition, the White House claims that inverted companies will still get the benefit of U.S. protections but won’t be paying their fair share of taxes for such public goods. Also false! Inverted companies, like every domestic company, U.S.- headquartered multinational company, and foreign company doing business in the United States, will continue to pay U.S. taxes on money earned in the United States. It’s time that the White House stops fear mongering.
Earnings Stripping Proposals
Never one to miss out on an opportunity to get himself in front of a camera, Sen. Chuck Schumer (D-NY) is now threatening to release his own proposal, purportedly favoring the Levin 50% threshold but replacing the management and control aspect with an earnings stripping proposal—restricting the ability of the American subsidiary of the newly inverted company to take a deduction for interest expense against its U.S.-based income. At press time, details are scarce.
Also getting in on the game is Congressman Levin, rumored to be introducing an earnings stripping proposal in addition to his anti-inversion legislation. It remains unclear how this would quell the tide of inversions; instead, it seems likely to punish a large swath of foreign companies doing business in the United States, thereby deterring foreign investment within our borders, which is far from a laudable tax policy objective.
Democratic Limits on Contracting
Recently, both amendments to appropriations bills and stand-alone legislation have been introduced by Reps. Rosa DeLauro (D-CT) and Lloyd Doggett (D-TX) and Sens. Dick Durbin (D-IL) and Levin, which would withhold government contracts from inverted companies. This would do nothing to solve the current surge in inversions that have been driven by our outdated tax system. These bills would exacerbate a bad situation by making inverted companies that employ American citizens and create jobs and growth in America even less competitive than they are now and potentially make fully non-American companies even more competitive. Driving American jobs and income growth into companies with no ties to the U.S. economy is bad public policy.
Durbin Part Deux and Trois
In addition to his government contracting bill, Durbin has taken to the press, bashing Illinois companies that are considering overseas moves. To quote Durbin’s November challenger, “There is nothing ‘patriotic’ about a career politician bullying a job-creating Illinois company for legally using the tax code he helped create. Instead of haranguing companies that employ thousands of Illinoisans, Dick Durbin ought to do his job and reform our tax code, which includes the highest corporate tax rate in the world.” Well said.
But the poor ideas just keep coming. Durbin also introduced the Patriotic Employer Tax Credit Act, a misguided piece of legislation that offers companies a tax incentive to keep jobs and offices in the United States and end tax breaks for companies that move jobs overseas. He, like Walsh, has no problem ignoring the global markets outside our borders or that American global employment is a complement, not a substitute, for American jobs.
The Wrong Approach
These punitive proposals take the wrong approach—focusing on how we stop companies from leaving for countries with more favorable tax regimes. Instead, the focus should be on how we make the United States a more favorable location for investment, jobs, headquarters, and research and development (R&D). To achieve this, we need comprehensive tax reform that lowers tax rates for all businesses and provides an internationally competitive tax system, not politicians who use demagoguery and misinformation to seek political advancement.