Prospecting for Fool’s Gold in Inversion Mines

Jul 25, 2014 - 9:15am

Senior Vice President, Economic Policy Division, and Chief Economist

There’s an old saying that when you’re in a hole, it’s time to stop digging.  When it comes to the corporate inversion issue, President Obama seems to have missed that one because even as a distraction, this issue’s just about played out.  Want proof?  The President today suggested that corporations that move their headquarters overseas are renouncing their citizenship; hyperbole and prattle in lieu of substance are sure signs of issue exhaustion. 

The President upped the ante on the view expressed by Senator Carl Levin (D-MI) when introducing his anti-inversion bill.  In a released statement, Senator Levin said corporations were threatening to “drain the U.S. Treasury of tens of billions of dollars”, dodging “their tax obligations, while still benefitting from this country’s laws, infrastructure, and workforce.”

Senator Levin appears to share a widely held confusion regarding U.S. tax policy.  The fact is, whether a company headquarters in the U.S. or abroad, income earned in the U.S. is taxed by the U.S.

For example, suppose U.S. company A operates in the U.S. and abroad, earning income in the U.S. and abroad.  It thus owes U.S. tax on all this income.  Now imagine U.S. company A merges with foreign company B.  B also operates in the U.S. and abroad, earning income in both places and paying U.S. tax on income earned in the U.S.  In a sense, A and B are mirror images of one another, with strategic complementarities driving the merger. 

Now, in the course of the merger the question arises whether the company should headquarter in the U.S. or abroad?  In B’s home country or maybe another entirely?  Many factors come into play, but tax is surely one of them.  Either way the new combined company will pay U.S. tax on the combined U.S. income.  Nothing changes here.

But if the headquarters sites in the U.S., with the highest corporate tax rate and most punitive international tax system in the industrialized world, then all of A’s income earned outside the U.S. will continue to be taxed at this highest rate under the most punitive system, and all of B’s foreign income will be newly taxed at this highest rate under the most punitive tax system. 

Not very appealing; is there a better option?  absolutely.  Headquarter the new company abroad.  Not only does this protect B’s income earned outside the U.S. from the U.S. tax, but it means A’s foreign income is no longer subject to U.S. tax.   This is a pretty obvious choice, made all the more so as foreign countries tend to reduce their rates further and further, leaving the U.S. more and more the disadvantaged outlier.  It’s not the company’s fault the Administration refused to lead on comprehensive tax reform to address these issues, and it is not the company’s fault the Senate remains similarly inert.

There is a grain of truth in Senator Levin’s comment about corporate revenue loss to inversions, which fairness demands attending, but it’s a very tiny grain as the chart above shows.  According to the Congressional Budget Office the federal government is projected to bring in just over $4.5 trillion in corporate tax receipts over the next ten years as shown in the bar on the left. It is hard to figure how much revenue would be lost to inversions under current policy, but according to the Joint Tax Committee the leading proposal to halt inversions is projected to reduce this total by about $20 billion over 10 years, or by about 50 cents per $100 in receipts.  This is shown on the bar on the right, which is perceptible if one looks very carefully.

Cross-border corporate mergers would (and should) occur even if the whole world abandoned business income tax altogether.  It’s part of how businesses become more globally competitive.  However, corporate mergers resulting in the emigration of U.S. headquarters is not at all natural, and however slight any revenue lost to the Treasury as a result is lamentable. The U.S. should be the best place in the world to do business, including locating a corporate headquarters.  These transactions in which the merger results in a foreign domiciled business are a real and consequential symptom of very serious flaws in the U.S. tax system.  In lieu of empty speeches, the President and Senate should to stop playing political games with the U.S. economy and start fixing real problems.  The tax code would be a good place to start.

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About the Author

About the Author

Senior Vice President, Economic Policy Division, and Chief Economist

Dr. J.D. Foster is senior vice president, Economic Policy Division, and chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.