UPDATE on April 5: U.S. Chamber of Commerce Executive Vice President for Government Affairs Bruce Josten today issued the following statement regarding President Obama’s comments about tax inversions: “Punitive one-off ‘anti-inversion’ regulatory efforts make American companies even less competitive on the global playing field and will do little to stem the flood of outright acquisitions of U.S. firms by foreign companies. Further, protectionist measures that are punitive to all foreign companies deter foreign investment in the United States. Punishing the business community, as the Obama administration has proposed, is not the answer. The real solution is comprehensive tax reform that lowers rates for all businesses and shifts to a competitive international system that both allows American companies to compete globally and attracts foreign investment to the United States. There is nothing ‘patriotic’ about politicians bullying America’s job creators for legally trying to level the playing field. Instead of focusing on soundbites, Washington should do its job and comprehensively reform the tax code.”
Editor's note: This article originally published Dec. 29, 2015.
Robert Reich, the former Secretary of Labor under President Clinton, penned an article entitled “How Should we Punish Disloyal Corporations?” It was an article on corporate inversions, in which he stated that, “Rather than lower corporate tax rates, an easier fix would be to take away the benefits of citizenship.” Reich's piece is full of mistakes, half-truths and pure vitriol, and it seeks to address a problem by mislabeling it, demagoguing it, vilifying it and then punishing it.
Reich begins by labeling corporations that legally change their country of incorporation as “disloyal” and refers to them as deserters. Granted, that's not necessarily surprising when one considers that the president has called such companies “deserters.” But is it accurate? Not one bit.
Corporations do not have citizenship in the way that people do. They cannot vote or hold office, and they do not qualify for social security. The choice of where to incorporate is a business decision and corporations choose to incorporate or domicile in a state or country for a whole host of economic and legal reasons, including but not limited to the tax code. Once a business makes that decision, it agrees to obey the laws and regulations of that state or country but it does not take an oath of fealty—or an oath of citizenship.
Moreover, many companies that incorporate in the United States operate on a worldwide basis and compete with other international companies at home and abroad. It is this competition that drives their decision-making and in part dictates whether they remain a U.S. corporation. All companies - whether foreign or domestic - that operate in the U.S. pay taxes on the income they earn here. However, the federal government also requires companies incorporated in the U.S. to pay taxes on what they earn abroad.
Of course, American companies get a credit for foreign taxes paid, and they can defer that tax until the foreign earnings are brought home, but U.S. companies nevertheless owe U.S. taxes on what they earn abroad. In contrast, most foreign countries (including all the OECD nations) do not force companies incorporated in their jurisdictions to pay home country taxes on the earnings they make outside of the home country. This gives worldwide companies domiciled outside of the U.S. a distinct tax advantage.
When some American companies try to level the playing field by legally changing their country of incorporation, Reich labels them disloyal and says they should be punished by having any “benefits of citizenship” taken away. Reich seems to be suggesting that U.S. companies retain the benefits of U.S. incorporation even when they incorporate abroad or become part of a foreign incorporated company. On this count, he is simply wrong. When an American company merges with a foreign company and legally adopts the home country of its foreign partner as its new country of incorporation, it becomes a foreign owned company and gets only those privileges afforded to every other foreign-owned company.
Now, many of the privileges that Reich cites as “benefits of citizenship” such as patent protection, the ability to contribute to political campaigns, the benefits of trade deals, and protection of assets via the court system are accorded to the U.S. subsidiaries of foreign owned companies and would also be accorded to a U.S. company changing its country of incorporation. Surely, Mr. Reich cannot be suggesting that we treat a U.S. company that changes its country of incorporation worse than a foreign domiciled company operating in the U.S.?
Reich also singles out Pfizer for particular attention because Pfizer has recently announced its intent to merge with Allergan and incorporate the new entity in Ireland, the latter's home country. Reich labeled this move a “tax-inversion," which it is not. The Pfizer/Allergan deal is projected to see Pfizer’s current stock holders retaining less than 60 percent of the stock of the new entity and as such this merger does not come under the restrictions of s7874 of the tax code (the section that deals with inversions). Thus, according to the tax code, it is not an inversion, but rather a cross-border merger.
Oh, and by the way, there are hundreds of such cross-border mergers each year - and most of them are not "tax inversions," either.
The lessons here are simple. For starters, our tax code puts U.S. companies at a competitive disadvantage, and that disadvantage is great enough that U.S. companies choose to maximize their shareholder value by becoming part of a foreign company. In doing so, these companies lose the benefits of incorporating in the U.S. but retain the benefits accorded to foreign companies and their subsidiaries operating inside our borders. Second, this issue is complex, and truly fixing the problem requires fixing the tax code - not trying to punish or place more restrictions on companies that respond sensibly to market forces by joining with companies incorporated abroad. Finally, it would be more helpful if people like Reich would first become fully informed on the issue before penning another diatribe.