U.S. corporate income tax is self-defeating

For many years, policymakers have criticized the strategies that American corporations use to reduce their taxes by shifting income and capital offshore. The impetus behind these strategies is the U.S. corporate income-tax rate — at 35 percent, the highest of any industrialized nation, easily surpassing countries such as the U.K. (20 percent) and Canada (15 percent).

Reducing this rate would end a self-defeating policy that distorts corporate behavior, weakens domestic companies and ultimately harms the U.S. economy.

The insurance industry offers a good example of how this tax can have unintended consequences. Over the past 20 years, the wide disparity in international corporate income-tax rates has encouraged property and casualty insurers to shift capital offshore.

In part, this has been made possible by a provision in the federal tax code that permits insurers to move future earnings and capital associated with premiums paid domestically to more favorable tax jurisdictions by reinsuring their U.S. policies with foreign-based affiliates.

Reinsurance is insurance for insurance companies. An insurer will pay some of its premium revenue to the reinsurer, which in turn will take on some of the risk and liability associated with a set of policies. Reinsurance is important: It adds capacity to the market, diversifies the industry’s overall risk pool and enables insurers to offer competitive premiums.

But the equation changes significantly when U.S. insurers purchase reinsurance from their own foreign affiliates. When this occurs, there is no real transfer of risk outside the corporate family. All liability remains shared among related companies.

The results are clear. It would be difficult to identify any major property and casualty insurance company that has been formed in the U.S. in the past 25 years. Yet more than 10 new insurers have started up over the same period in Bermuda alone. Even the venerable Chubb Corp., a storied American insurer, is set to come under foreign ownership when it’s acquired by Ace Limited, now headquartered in low-tax Switzerland.

Recouping this lost income and ensuring that U.S. insurance companies remain competitive should be a priority for Congress. As an initial matter, lawmakers should disallow deductions for reinsurance premiums paid to foreign-affiliated reinsurers.

A much better fix is to lower the tax rate. A recent study commissioned by the Business Roundtable, a trade group, found that at a 25 percent corporate tax rate, U.S. companies would have acquired $590 billion in cross-border assets over the past 10 years instead of losing $179 billion in assets.

Thoughtful management teams should continue to act in the best interests of their shareholders. In that regard, taxes are a cost of doing business, much like any other, and as a consequence companies will continue to make decisions to lower their effective rate.

Given the significant competitive advantages of being domiciled in the U.S. and the added costs associated with being domiciled offshore, leveling the playing field doesn’t mean rivaling the lowest foreign corporate income-tax rate. But it does mean significantly narrowing the differential.

Unless Congress acts, we should expect more U.S. companies to use existing tax laws to level the playing field themselves, including by moving their operations or investments offshore. And, sadly, we should expect more foreign corporations to acquire iconic U.S. companies like Chubb.