Tax inversions are a symptom of much bigger problems with America’s corporate-tax regime
IT IS the corporate equivalent of burning the American flag. A “tax inversion” is a manoeuvre in which a (usually American) firm acquires or merges with a foreign rival, then shifts its domicile abroad to reap tax benefits. A spate of such deals last year led Barack Obama to brand inversions as “unpatriotic”. The Treasury formulated rules to stamp out the practice.
That stemmed the flow of inversions for a while. Now a flurry of deals has put them back in the spotlight (see article). This month alone, Terex, a cranemaker, has announced a deal with Konecranes that will move its headquarters to Finland; and CF Industries, a fertiliser-maker, and Coca-Cola Enterprises, a bottler, have unveiled transactions in which they will redomicile in Britain. Policymakers are talking about making inversions even harder. The perverse consequence would be to make it more likely that taxes and jobs will leave America.
The boardroom case for inversions stems from America’s tax exceptionalism. It levies a higher corporate-tax rate than any other rich country—a combined federal-and-state rate of 39%, against an OECD average of 25%. And it spreads its tentacles worldwide, so that profits earned abroad are also subject to American taxes when they are repatriated. To this problem, the tinkering of officials is no answer at all. Making it hard for American firms to invert does precisely nothing to alter the comparative tax advantages of changing domicile; it just makes it more likely that foreign firms will acquire American ones. That, indeed, is precisely what is happening.
Salix, an American drugs firm that was seeking to invert before last year’s saga, has since been bought by a Canadian company called Valeant, which reckons it can save more than half a billion dollars in tax over five years by changing Salix’s domicile. Shire, an Irish drugs firm, has turned from prey to predator: once the target of an American company called AbbVie, it is now hunting Illinois-based Baxalta and dangling tax savings as part of the rationale for the deal. Since the start of the year foreign firms have announced acquisitions of American targets worth $315 billion, according to S&P Capital IQ, a data provider. The annual record, set in 2007, is $326 billion.
Tax is not the only factor in these deals, but it plays a big part. At the moment, the earnings that American firms keep abroad ($2.1 trillion and counting) act like a magnet for tax-advantaged acquirers. Research suggests that the higher the amount of these locked-out earnings, the more likely it is that an American firm will be snapped up by a foreign one. If American policymakers really worry about losing out to lower-tax environments, they should get rid of the loopholes that infest their tax rules, drop the corporate-income tax rate and move to a territorial system.
That would have three effects. First, trapped foreign earnings would be more likely to come back to America. Second, American firms would be more likely to buy than be bought: a 2013 paper reckoned that switching from a worldwide system of taxation to a territorial one would result in a 17% jump in cross-border acquisitions by American firms. Third, jobs would be less likely to flow abroad. Moving domiciles may once have been about moving the office nameplate, but as attitudes to tax avoidance harden, changes of corporate control will increasingly involve senior people upping sticks.
It is hard for American politicians to explain to voters that taxing firms’ foreign earnings is a poor idea. So Mr Obama has instead proposed taxing foreign profits at a lower rate, whether or not the money is repatriated. Alas, that would only cement the advantages of foreign ownership.