With the presidential campaign season in full swing, no one should be surprised to find politicians using hyperbole and demagoguery to energize supporters while vastly oversimplifying complex policy problems.
However, when it comes to a recent example of yet another so-called “corporate inversion,” the knee-jerk political response of attacking and shaming the company reveals a political class that is dangerously out of touch with global economic reality.
An inversion occurs when a U.S.-based company merges with a foreign corporation and relocates its headquarters overseas. This allows the company to compete in foreign markets without being held back by the anchor that is the U.S. corporate tax code.
The last decade has seen around 50 inversions and 20 since just 2012. One of the most recent examples is a proposed merger of major pharmaceutical company Pfizer with the Ireland-based Allergan, news of which prompted swift denouncements from the two current leading Democratic candidates. Bernie Sanders called it a “disaster,” while Hillary Clinton alleged that Pfizer was attempting to “shirk its United States tax obligations.”
Little could be further from the truth.
Many have also slammed those that invert as “unpatriotic” or called them “Benedict Arnold” companies, as if corporations exist solely to fill the coffers of the U.S. Treasury, or that their first duty is to politicians and tax collectors instead of shareholders.
In reality, it is the latter to whom any CEO must answer.
They have a fiduciary duty to shareholders, meaning it is a legal responsibility to put their interests first. And contrary to popular rhetoric, shareholders aren't primarily found on Wall Street, but among the half of all Americans with pension ties or investment portfolios in the stock market.
It's worth noting that, contrary to the impression given by opportunist politicians, inverted companies still pay U.S. taxes – just only when they're actually operating in the U.S. market. It is the unreasonable demand, unique to America's worldwide tax system, that companies also pay up to the excessive 39 percent U.S. corporate rate even for products entirely made and sold overseas which has forced their hands on inversions.
Under the current system, U.S. companies are put at a huge disadvantage compared to foreign competitors. A French-owned company with an affiliate selling in Ireland, for instance, would only be subject to Ireland's low 12.5 percent because they use a territorial system that taxes only within their borders, whereas an American-owned company looking to sell the same goods in the same market would not only pay Ireland's rate, but also the remaining difference up to the much higher U.S. corporate rate. With the U.S. rate so much higher than the OECD average of 25 percent, that creates a serious impediment.
It's fair to point out that after various deductions are made the total corporate tax bill will come in below the statutory rate. However, business decisions are made on a marginal basis – meaning the tax on the next dollar earned is what determines whether or not an activity occurs. According to the Tax Foundation, the U.S. has not only the highest statutory rate among developed nations, but also the highest marginal effective rate.
The overseas tax handicap for American companies doesn't only hurt shareholders, but also workers by reducing opportunities for expansion and growth. The system also discourages investment in the U.S. because companies are incentivized to keep profits overseas due to what's known as deferral. Specifically, the U.S. tax is only applied when the money is brought home, which encourages it to be kept abroad where it cannot be put to work growing America's domestic infrastructure and creating jobs.
While the incentives it creates are a problem, simply ending deferral would be even worse than the current system because American companies would then have no release valve for dealing with the economic pressure imposed by an uncompetitive tax code. They would simply invert or find other ways to leave American shores faster than ever before.
Attempting to rig the rules to prevent inversions is also not a viable solution. It's been tried before and has never worked. So long as cross border economic mobility is an option – a given in the globalized economy – companies will flee from uncompetitive and confiscatory tax regimes. Nor should we wish to stop them even if it were possible, as the threat of capital flight is an important mechanism for keeping politicians from trying to extract too much from the productive sector of the economy.
If U.S. companies don't invert or leave on their own accord, they will simply be bought out by foreign corporations. The tax code makes assets currently owned by American companies more valuable to foreign conglomerates who face lower tax burdens, which is why foreign takeovers last year doubled in terms of dollar value. With these takeovers come a greater likelihood of research and development or jobs moving overseas.
Ironically, even the government is harmed by the current burdensome tax code by driving productivity and investment overseas. In contrast, Canada has both a lower corporate tax rate – having reduced it from 43 percent in 2000 to 26 percent today – and collects more corporate revenue as a share of GDP than the U.S.
Rather than publicly shaming companies for making responsible economic decisions, politicians bemoaning inversions need to look in the mirror. It has been 30 years since the last major corporate tax overall. In that time the rest of the world has left us behind by reforming their own systems and reducing corporate tax burdens. It's time for the U.S. to be a leader again by shedding the worldwide tax system and lowering corporate rates to help unleash innovation and growth, while keeping American companies at home.
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