The Underlying Causes of Tax Inversions

The Underlying Causes of Tax Inversions

Over the last year, the tax-policy debate has really taken a dive. Where once there was cautious optimism for an overhaul of the tax code, now there is discussion of "corporate deserters" and tax inversions. In part, this is the inevitable march of time towards a midterm election, when the opportunity for genuine policymaking diminishes in the face of campaign-season messaging.

The prevailing discussion of tax inversions -- driven by the recent spate of announcements by U.S. multinationals of their intention to merge with overseas partners -- is a nod to the latter over the former, and no one should be fooled into thinking otherwise. The president's budget and several proposals in Congress contain policies that seek to artificially arrest a trend that is driven by far larger forces: uncompetitiveness in a global economy.

The United States is outstanding, and not in a good way, in terms of how it taxes businesses. First, the Treasury Department subjects U.S. firms to the highest corporate tax rate in the world. And second, the U.S. maintains a "worldwide" tax system, applying that high rate to income earned abroad by U.S. multinationals (though credits are given for any taxes paid overseas). The U.S.'s major trading partners have a different approach: lower rates and "territorial" tax systems -- meaning that income earned abroad is largely or entirely exempted from taxation at home. The reasoning is pretty straightforward: Overseas income has already been taxed in a foreign country, so why tax it again? Couple these factors with growing overseas markets, and it's easy to understand why companies start to think about hopping the proverbial fence.

Under current law, a company can't simply weasel its way onto the books in the Bahamas or some other tax haven and act like nothing happened. A series of regulatory and legislative changes have pretty much put an end to that practice, the so-called "naked inversion." Instead, what we see now are companies merging with overseas partners. These are costly undertakings, so firms avoid inverting unless doing so is really beneficial. But inversions happen for a host of reasons, tax considerations being one of them.

Congress and the administration have failed to address these underlying forces in a positive way -- reforming the tax code to make the U.S. more competitive. The president literally off-shored the chairman of the Senate tax-writing committee at a time many thought there was genuine hope for tax reform. So instead of real reform, some lawmakers are attempting to make campaign fodder out of these corporate mergers. Invoking populist rhetoric and maintaining blithe ignorance of the structural reasons for these moves abroad, the president and some members of the House and Senate have proposed nibbling around the edges of this issue by trying to make these mergers harder. The only problem is the structural incentives to leave U.S. shores remain. Some of the proposed "fixes" would exacerbate this flight by incentivizing firms to move their headquarters-based jobs abroad -- placing, as I estimate in a new paper, 42,000 U.S. jobs at risk.

This is an example of the pitfalls of reactionary policymaking. The U.S. has been in a sluggish economic recovery since 2009, with little promise of a gear change. Instead of reacting to headlines or trying to chase a few extra tax dollars to spend, Congress and the administration should be working to fix what's broken with the U.S. tax code -- not just to keep these companies at home, but also to make them more competitive abroad.

Gordon Gray is fiscal-policy director at the American Action Forum.

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