Obama Treasury’s Corporate Inversion Regulations Simply Won’t Work
The Treasury Department today came out with a series of arcane new tax regulations in the hopes of stemming corporate inversions. Inversions happen when U.S. companies merge with a foreign company while usually retaining U.S. operations. Their purpose is to avoid punitive U.S. double taxation on income earned overseas. The Treasury regulations (far too boring to get into any detail) seek to curb the most common ways in which income is shifted to avoid IRS taxation on income which has already faced taxation in other countries.
I’ve got bad news for the Treasury Department: every large company in America has a team of super smart accountants who have already come up with ways around these new regulations. Regulations will never be able to catch up with the ingenuity of super smart accountants in suspenders who think depreciation jokes are funny. Not gonna happen.
Look, inversions happen for two basic reasons. Until such time as we actually fix these two causes of inversions, they will continue to happen.
The U.S. has the highest corporate income tax rate in the developed world. When state income taxes are included, our corporate income tax rate stands at nearly 40 percent. The developed nation average, by contrast, is under 25 percent and falling. I’m not even going to bother linking to the OECD tax database, since you’ve seen this written hundreds of times over the past decade.
And it’s the marginal rate that matters. If a company is going to make an extra billion dollars, they would rather do it in a country where that billion dollars will lose 25 percent in taxes than in a country where it will lose 40 percent in taxes.
The U.S. double taxes income earned abroad. If a U.S. company earns income in (say) France, it will pay French corporate income tax on that income. So long as the income remains abroad, it never faces U.S. taxation, a provision known as “deferral.” But if our U.S. company tries to bring those after-tax profits made in France back to the U.S., it must pay an additional tax to the IRS. The additional tax is equal to the difference between the U.S. tax rate and the French tax rate. And since we have the highest corporate income tax rate in the developed world, there’s always a positive delta for the IRS.
There’s a simple, two-part policy solution to corporate inversions:
1. Lower the corporate income tax rate from 40 percent to under 25 percent. In order to do that, the federal rate must come down to 20 percent or lower, since states will still impose their own layer of tax.
2. Move from a “worldwide” tax system (where double taxation almost always results today, and still would result often even with a lower rate), to a “territorial” tax system (where only U.S. source income is taxed, not income earned overseas). Most developed nations have a territorial or mostly territorial tax system, so we would merely be catching up to best practices.
