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Using Corporate Tax Policy to Stop Corporate Inversions

Published onOct 04, 2014
Using Corporate Tax Policy to Stop Corporate Inversions

Politicians, business leaders, and legal professionals have spent a great deal of time this year talking about corporate inversions.  Inversion is the term for a business transaction, perhaps a merger or acquisition, between a U.S. corporation and a foreign corporation with the objective of headquartering the new combined corporation in the foreign nation to take advantage of a better corporate tax rate.

Opposition to corporate inversions has been widespread and forceful due to its known and suspected consequences.  For example, corporate inversions are lowering tax receipts in a time of great national debt, can result in the loss of U.S. jobs, and may change the cultures of the former U.S. corporations in unpredictable ways.  These are consequences which neither political party welcomes.

Moreover, neither side likes the political fallout from classic American companies  joining the movement and grabbing headlines.  When Burger King announced plans to merge with Canadian restaurant chain Tim Hortons in late August, it turned the nation’s attention to corporate inversions like never before.  Embarrassed politicians on the left and right were united after the Burger King announcement is declaring that something must be done to stop corporate inversions.

Despite consensus around the desire to stop inversions, there isn’t an obvious and workable solution.  However, various parties are trying to rally support around three very different proposals.  The three proposals are: changing the U.S. corporate tax code to make U.S. headquarters more attractive, using the bully pulpit to pressure corporations into staying put, and using existing provisions in the tax code to punish and deter inversions.  This blog post will address the proposal for changing the U.S. corporate tax rate to make it more globally competitive. 

First, however, it is necessary to dispense with the argument that the tax rate is competitive.  Some, albeit a shrinking minority, continue to replay the old argument that the U.S. tax rate is just a statutory rate and it isn’t actually the rate that corporations pay.  This is a fair argument until you consider that the same could be true of all the national statutory rates.  Those sticking to the old argument are asking us to compare apples to oranges after claiming their opponents are comparing apples to oranges.

The application of logic also leads one to dismiss the old argument about tax rate competitiveness.  Why would large, well-managed U.S. corporations be fleeing if they weren’t actually expecting profits to increase through the move?  They wouldn’t.  It isn’t a matter of narrative, as the political class calls communication, or of bad business judgment.  It is a matter of poor incentives and disincentives to locate a corporation in the United States.

It is relief to see that most participants on both sides of the aisle are now acknowledging the tax rates aren’t competitive and that something needs to change to prevent corporate inversions.  Within the proposal to change the tax code are actually two distinct proposals for changing it.

One of those proposals is to make the corporate tax rate more attractive by lowering the rate itself.  This proposal has received support from conservative think tanks and politicians.  The Cato Institute, for example, has argued through its tax policy director that the only way to stop corporate inversions is to cut corporate tax rates.  Predictably, Republican members of Congress have rallied around the idea of lowering taxes.  Congressman Paul Ryan (R-WI) has proposed a reduction on U.S. corporate tax rates from 40% to 25%.  Fellow Republican Congressman Dave Camp (R-Mich) has issued his own calls for lowering the corporate tax rate to stop inversions along with reforming the rest of the U.S. tax code.

Rep. Paul Ryan (R-WI)

The premise on which the proposal to lower U.S. corporate tax rates to fight inversions is that the U.S. corporate tax rate is uncompetitive in comparison to those of other developed market nations.  KPMG, a globally-recognized accounting firm, has compiled a list of corporate tax rates from around the world.  The list reveals that the U.S. corporate tax rate is, in fact,  not competitive with other developed nations.  Comparing the U.S. rate to those of other individual nations here would be overly complicated.  However, a comparison between the U.S. and some sets of nations illustrates the point.

The United States corporate tax rate, by contrast, is a startling 40%.  The KPMG list reveals that the average rate within the European Union is 21.34%.  The OECD, a global collection of 34 developed nations, maintains an average of 24.11% even though the high U.S. rate is included.  The global average corporate tax rate is 23.57%.  If these rates are to be believed, the only question remaining is why any corporations agree to pay the U.S. corporate tax rate.

Not everyone, of course, believes that the answer to the inversion problem is to engage in a global contest for the more attractive corporate tax rate.  Some believe that lowering corporate tax rates will generate a race to the bottom in which everyone, especially a U.S. government with increasing social welfare costs to cover, ultimately loses.  If the U.S. won’t lower its corporate tax rate, it will have to utilize other methods of persuasion to keep U.S. corporations at home.  But what methods must be used?  If not carrots, then the answer has to be sticks!

Several liberal think tanks and legislators have stepped forward to suggest a stick or two to use on U.S. corporations.  Kimberly Clausing wrote on behalf of the liberal Urban-Brookings Tax Policy Center to introduce the center’s proposals for punishing inversions.  One of the many proposals put forth in Clausing’s paper is to charge corporations executing an inversion an exit fee high enough to prevent most or all inversions.

Sen. Dick Durbin (D-IL)

Democratic members of Congress have rallied around the proposal to charge corporations executing inversions a substantial exit fee.  Senators Charles Schumer (D-NY) and Dick Durbin (D-IL) introduced a bill on September 10th that would severely punish any U.S. corporation which executes an inversion.  In fact, that bill would penalize some corporations which have already left the country.  The Senators argued in introducing their bill that inversions will only accelerate if they are not checked now by a strong new disincentive in the tax code.  This insistence that their proposal is the only way to stop inversions echoes the claims of their Republican opponents.

With Congressional gridlock on this issue being so firm it is unlikely that either side will get their ideal bill through both houses of Congress.  This being an age in which compromise is unfashionable, those of us interested in the issue should settle in for a long fight with each new inversion announcement fueling the animus of the fight.  Each side will blame the other for losing pieces of American culture.

Without action, we can be certain that there will be more inversions.  After all, the global tax conditions which have inspired so many inversions already will still be in effect.  The rate of inversions is likely to increase, in fact, as more corporate directors have become aware of the maneuver and more financial experts are offering inversion as a business solution.

Perhaps the best hope can be found outside of Congress.  There are other proposals which seek to solve the problem without asking Congress to take on the Herculean task of passing legislation.  Those proposals, however, are a topic for another day.

*John I. Sanders is a second year law student at Wake Forest University School of Law. He holds a Bachelor of Arts in History, with minors in Economics, from Wake Forest University. He also holds a Masters in Business Administration from Liberty University.  Upon graduation, he intends to practice corporate law.

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