How do we keep U.S. companies at home?

Last month Milwaukee-based Johnson Controls became the latest American firm to move overseas in pursuit of tax savings. Politicians of all stripes decry these moves, but they have radically different ideas about what to do about them.

Johnson Controls is renouncing its US corporate citizenship by selling itself to Tyco International, domiciled in Ireland, in a deal valued at $14 billion. The move, called a corporate inversion, is the restructuring of an American company’s corporate form such that it becomes a foreign corporation based in a country with low corporate taxes. It is legal and has become a popular way for American companies to reduce their domestic tax payments.

By moving its headquarters to Ireland, Johnson Controls will pay a corporate tax rate of 12.5 percent and reduce its tax bill by at least $150 million annually. About 50 companies have inverted in the past decade and more are expected to vote with their feet.

These deals allegedly reflect the United States’ failure to change the corporate tax code to make it more attractive for American companies to stay that way. The statutory corporate tax rate of 35 percent (39.1 percent when combined with state rates) is unchanged since 1993 and is the highest among industrialized countries.

The federal government taxes all companies doing business in the U.S. on the income they earn here. It also taxes American firms on their foreign income. This is called a worldwide income tax system. Many countries only tax income generated inside their borders. Because they tax their residents (regardless of citizenship) only on domestic income, such countries are said to use a territorial income tax system.

America is now alone among developed countries in taxing the worldwide income of its corporations. This is in addition to the taxes they pay to foreign governments, but American firms are permitted to avoid double taxation by claiming credits for foreign tax payments.

American companies are also permitted to defer domestic tax liabilities on certain unrepatriated foreign profits until they actually receive such profits in the form of dividends. It is estimated that U.S. firms are keeping roughly $2 trillion in profits abroad to reduce their taxes. If an American citizen tried to play the same game of hide and seek, he or she would be in big trouble with the Internal Revenue Service.

When it comes to arguments in support of lowering the corporate rate, cheerleaders never tire of telling the public that American companies can’t compete in a global economy when they are handicapped by the highest corporate tax rate in the developed world. They argue that a significant reduction in the corporate tax rate would improve America’s competitive position, stem the tide of companies leaving the country and perhaps even reverse it by giving foreign corporations an incentive to locate and invest in the U.S.

Overlooked in these arguments is the fact that while on paper American companies are supposed to pay the 35 percent federal income tax rate, the country’s most successful companies pay at just a 19.4 percent rate after accounting for tax credits, deductions and exemptions, according to the Citizens for Tax Justice. If true, this certainly undermines the primary argument for reducing the corporate tax rate.

Neither Democrats nor Republicans like inversions, but they disagree on what to do about them. The former see the issue as one of corporate abuse and want strong rules to stop the exodus of tax dollars; the latter see it as the result of high corporate tax rates and argue for an overhaul of the corporate tax code.

As with so many issues today, you would be right to conclude that achieving consensus on how to halt corporate inversions is the equivalent of cleaning out the Augean stables with the horses still in them.

originally published: February 2, 2016

Bringing corporate earnings back into the U.S.

A member of Congress was walking along one of St. Bart’s sandy beaches on holiday. Suddenly she stumbled on an old lamp that had washed up on the beach. She picked it up, rubbed it and, of course, a genie appeared.

The genie said, “I am the most powerful genie who has ever lived. I can do great and wonderful things, including granting you your dearest wish, but only one.”

This member of Congress was well attuned to international affairs, so she pulled out a map of the Middle East and said her dearest wish was a solution to the Israeli-Palestinian conflict.

The genie stroked his beard; looked around worried and said, “Oh dear that is a tough one. You should probably make another wish.”

The congresswoman was disappointed.but understood. “Alright,” she said, “I want you to rewrite the American tax code so everyone can understand it.

After a long silence, the genie said, “Let’s have another look at that map.”

With Republicans back in charge of Congress, corporate tax reform is on the agenda for 2015. Although it is hard to see how they can reduce corporate tax rates without also doing something for individual taxpayers.

If congressional leaders can cobble together a set of reform proposals, their next problem would be how to pay for them. Given the large federal debt, many policymakers believe corporate tax reform should be revenue neutral. To do that, any reduction in corporate tax revenue must be made up for by things like eliminating tax preferences, cutting spending programs, or adding to the deficit passed on to future generations.

Achieving broad tax reform is further complicated by political realities of 2016 presidential politics. Several senators are considering a run.

While the prospects for broad tax reform may be dim, one bright spot is a bipartisan proposal by Sens. Barbara Boxer, D-California, and Rand Paul, R-Kentucky, to bring back some of the estimated $2 trillion of foreign earnings that are now parked in foreign banks by reducing the corporate tax rate on profits earned abroad from 35 percent to 6.5 percent for the next five years.

Revenue from this short-term tax would be used to maintain the solvency of the Highway Trust Fund that is scheduled to run out of money in May unless Congress and the president do something.

In theory, repatriating the money would also increase investment in plant and equipment and new technology, thereby strengthening the economy and creating jobs at the same time it increases federal revenues.

There is no assurance that the repatriated corporate earnings wouldn’t instead be used for things like executive compensation, higher dividend payouts, and stock buybacks.

The president also waded in this week. Instead of a voluntary repatriation tax holiday, his $4 trillion 2016 budget proposal includes a one-time 14 percent tax on the $2 trillion of foreign earnings held overseas, with much of the proceeds going to fund infrastructure. There is no reason to believe that Republicans will embrace this proposal.

It doesn’t have to be this way if Congress and the administration had the minerals to fund the HTF by increasing the 18.4-cent per gallon federal fuel tax for the first time since 1993. If adjusted for inflation, the fuel tax would be 30 cents a gallon today.

Corporate taxes should be addressed in the context of broader tax reform. The American people are sick and tired of short-term fixes and lurching from crisis to crisis. They want a system that is simpler, eliminates unfair and inefficient loopholes, and levels the playing field for the middle class.

originally published: February 7, 2015

Time to make overt corporate tax inversions

Every political season brings new issues and controversies. One of the big ones this time around is “corporate tax inversions.” Unfortunately, the trend is a symptom of a bigger problem that will require the kind of long-term solution that is rarely crafted in even-numbered years.

In business terms, inversion is the restructuring of a U.S. company’s corporate form such that it becomes a foreign corporation based in a country with low corporate taxes, basically turning the corporate structure on its head. American multinational corporations undertake these transactions because the top U.S. corporate tax rate of 35 percent is higher than in many other countries and the U.S. taxes worldwide income at a time when foreign income is increasing substantially.

One example is Medtronic Inc.’s recent agreement to buy Covidien for $43 billion. The move enables Medtronic to domicile to Ireland, take advantage of low corporate tax rates and access its overseas cash without having to pay high repatriation costs.

These inversion deals allow American corporations to reduce their average combined federal and state corporate tax rate of 40 percent. This rate is one of the world’s highest, double the European average more than triple the 12.5 percent rate in Ireland. Over the past 25 years, almost all countries in the Organization for Economic Cooperation and Development except the U.S. have lowered their top corporate tax rate.

The increased number of American firms that have incorporated abroad to reduce their tax burden has prompted a series of congressional hearings, where representatives can express their frustration and anger at maximum strength about firms reducing the U.S. corporate income tax base. The Joint Committee on Taxation estimates that future deals will cost the U.S. almost $20 billion in corporate tax revenue over the next 10 years.

The flurry of inversion deals has also angered President Obama, who has said the practice is “wrong” and urged Congress to close the loophole.

High corporate tax rates are not the only problem. What is frequently overlooked in these contentious discussions is that the United States, unlike many other countries, employs a worldwide taxation system, taxing corporate foreign income at the same rate as domestic income while permitting corporations to claim limited tax credits for income taxes paid to foreign governments to mitigate the possibility of double taxation.

By anyone’s standards the U.S. has a very complex tax code. Corporate tax reforms must recognize global economic changes and resolve the fundamental contradictions in the current corporate income tax structure.

All this strongly suggests that truly solving the problems created by the current corporate tax regime requires a long-term fix and cannot be solved unilaterally by the U.S. Some second-order benefits may be gained by plugging specific loopholes, but a real long-term solution requires better international coordination of tax rules to minimize tax avoidance activities by multinational corporations.

Not too long ago, a corporation could be successful by focusing on making and selling goods and services within its national boundaries. Profits earned from exporting products were considered frosting on the cake but not really essential to corporate success. That is no longer the case, and the U.S. needs to reform its corporate tax code to reflect this new reality.

originally published: August 2, 2014