Lawmakers have a tendency to fix problems by treating the symptoms rather than the causes. That’s what happened yesterday with the White House’s response to the recent wave of corporate inversions, the practice of acquiring a foreign company and then relocating one’s legal headquarters out of the U.S for tax purposes.
The reason for inverting is obvious to most economists: U.S. companies doing business abroad are put at a terrible disadvantage because of our punishing corporate-income-tax system. The U.S. has the highest rate of all the OECD countries (35 percent at the top federal level, and close to 40 percent when you add state taxes). In addition, the U.S. taxes income on a worldwide basis: It means that a U.S. company operating in Ireland pays the Irish rate first on its Irish income, and then, it will pay the U.S. rate minus the tax paid in Ireland when it brings the income back to the U.S. If it has, say, a French competitor in Ireland, the French company pays the low Irish rate of 12.5 percent, period. To cope with the penalty, or to try to stay competitive, U.S. companies are either not bringing back their income to the U.S. or they’re performing inversions.
In the same way that people don’t renounce their citizenship lightly, companies do not resort to inversion lightly. Inversion is legal. It is not tax evasion. The companies that use inversion will continue paying U.S. taxes on their U.S. income. But it’s a symptom of a serious problem: high tax rates and our worldwide tax system. If the U.S were to cut its corporate-income-tax rate dramatically, much of the problem would go away.
Unfortunately, rather than do what is right, the administration has decided to make it harder for companies to invert without addressing the reasons behind the inversions.
As the Wall Street Journal editorial board explains this morning, the idiotic move is actually going to make it harder for companies to bring money earned overseas for investment in the U.S. It will also reinforce the practice of U.S. companies keeping their money abroad to shelter it from high tax rates. This should be the last thing we want during a weak recovery. But following now a well-known trend, Obama-administration officials seem obsessed with the notion of tax fairness as defined as the government being able to tax every single dollar one earns at the highest possible rate. And for what? It isn’t clear, as the Wall Street Journal notes:
“Inversion transactions erode our corporate tax base,” said Treasury Secretary Jack Lew on Monday. Mr. Lew may be famously ignorant on matters of finance, but now there’s reason to question his command of basic math.
Corporate income tax revenues have roughly doubled since the recession. Such receipts surged in fiscal year 2013 to $274 billion, up from $138 billion in 2009. Even the White House budget office is expecting corporate income tax revenues for fiscal 2014 to rise above $332 billion and to hit $502 billion by 2016.
The nearby chart shows the corporate tax boom as a share of total federal revenues. Corporate tax receipts are climbing back from the recession trough to nearly 11% of total tax revenue this year and will hit 14% in 2016. So how are inversions hurting revenues again?
As for fairness, Mr. Lew said on Monday that inversion transactions “may be legal, but they are wrong, and our laws should change.” It must be fun for corporate executives to get a moral lecture from a guy who took home an $800,000 salary from a nonprofit university and then pocketed a severance payment when he quit to work on Wall Street, even though school policy says only terminated employees are eligible for severance.
What’s really wrong is a U.S. tax code that has the highest corporate rate in the developed world and is also one of only six industrialized countries that demands to get paid on money earned outside its territory. In a Monday visit to our offices, Sen. Tom Carper (D., Del.) said the “root cause” of inversions is the need for corporate tax reform.