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The Obama Administration’s Wrong Answer for Corporate “Inversions”

by and Tyler Moran | July 17th, 2014 | 02:06 pm
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Faced with an exodus of tenants, most owners would immediately correct defects in their buildings. But faced with a wave of corporate “inversions”—namely US firms seeking the corporate nationality of another country—Treasury Secretary Jacob Lew has instead called upon Congress to lock the front door and deal with the underlying causes at an uncertain date.

Congress should ignore Lew’s call and first address the root causes of business dissatisfaction. Unhappy tenants can crawl through the window, and dissatisfied firms can find ways to get around the tax law fix proposed by the Treasury. The Treasury’s proposed front door lock would raise the foreign control percentage to 50 percent before a firm can invert.1 If this faulty fix is enacted, that will simply invite Congress and the administration to procrastinate on giving serious attention to the underlying causes.

Inversions are one of the answers that business firms give to the worst corporate tax system in the world, namely the US Internal Revenue Code. Under the code, US-based multinational corporations (MNCs) pay higher tax rates than their competitors based in Canada, Europe, Japan, and other countries. Not only are US tax rates higher, but they are potentially applied to US MNC income earned anywhere in the world (the “worldwide system”), whereas nearly all foreign MNCs pay home country corporate tax only on income earned at home (the “territorial system”).

Faced with these competitive disadvantages, which have lasted for decades, it is no wonder that US MNCs seek to book their profits abroad and move their headquarters to friendly tax locales like Zurich, London, and Toronto.

The right answer is not to put more locks on the front door, but to make the United States at least as friendly, from a corporate tax standpoint, as advanced countries in the Organization for Economic Cooperation and Development. This requires two big changes. First, the federal corporate tax rate should be cut from 35 percent to 20 percent. On this score, the Obama Administration’s proposal is far from the mark: a 28 percent US corporate rate.2

Second, the federal corporate tax should not apply to active business income earned abroad. Taxation of that income should be left solely to the host country. Unlike present law, the United States should not apply its own taxes when US-based MNCs repatriate their earnings from subsidiaries around the globe.

The adoption of territorial taxation would put US-based MNCs on the same tax footing as their foreign competitors when they do business abroad. Again, the Obama Administration is off the mark: It has repeatedly proposed to apply the US corporate tax to foreign income in the year earned, even before earnings are repatriated. The Obama proposal, which eliminates the long-standing practice of “deferral”—namely applying the US tax bite only when foreign earnings are brought home—would make the bad US tax system that much worse and tempt many more US firms to relocate abroad.

These two big changes—a lower corporate tax rate and a territorial system—would not only entice US firms to stay at home and boost their capital spending but would also attract foreign MNCs to American shores. Few if any tax locks would be needed on America’s front door.3

But would these changes be a giveaway to the rich? Not if accompanied by sensible increases in personal income tax rates paid by the top 10 percent. It makes no sense to deny good jobs to millions of Americans through a corporate tax system that erodes US competitiveness and kills employment when inequality can be addressed much better and more directly by progressive personal income taxation.

Notes

2. White House, Office of the Press Secretary, "Fact Sheet: A Better Bargain for the Middle Class: Jobs," July 30, 2013.

3. Gary Clyde Hufbauer and Tyler Moran, “More Wrong than Right: Senator Baucus’s Foreign Tax Provisions,” Peterson Institute for International Economics blog: RealTime Economic Issues Watch, November 25, 2013.