The United States currently has the highest corporate tax rate among the 34 nations in the Organisation for Economic Co-Operation and Development (OECD), in addition to being one of the few nations still using a “worldwide system.” This puts businesses headquartered in the United States at a considerable disadvantage compared to companies headquartered elsewhere in the world.
Under the worldwide corporate tax system, U.S.-based corporations are taxed on the income they earn in other countries. Since these companies already pay taxes in host countries, corporations are subjected to double taxation. Of the OECD countries, eight have such worldwide systems, but the top tax rate in those countries is considerably lower than the top U.S. rate.
Companies that want to avoid the high U.S. corporate tax have few legal options. Many U.S.-based companies operating internationally keep their foreign earnings in subsidiaries overseas, which has kept billions of dollars of capital in more tax-friendly countries. Another strategy, which has come under considerable scrutiny recently, is called corporate inversion.
With corporate inversion, companies reduce their corporate tax burden by relocating their headquarters to a lower-tax nation while retaining the bulk of their operations in the country of origin. In recent years, several U.S. companies have merged with similar firms overseas and moved their headquarters to the partner company’s country. U.S. companies such as Burger King, AbbVie, and Medronic have bought foreign competitors, in part or in whole, to move their headquarters overseas and thus reduce tax rates.
Given the loss of tax revenue and the increasing popularity of inversions among corporations, politicians have begun to demonize the practice, calling the deals unpatriotic. In the last month, legislative proposals to discourage the practice began to emerge. The most prominent bill was introduced in early September by Democratic Senators Charles Schumer of New York and Dick Durbin of Illinois.
The bill would disallow companies that have undergone inversion from using several popular tax reduction techniques. According to Bloomberg News, the bill would first reduce the amount of deductible interest for inverted companies to 25 percent of U.S. taxable income, down from 50 percent. More importantly, the bill would apply to any corporate inversion that took place after April 17, 1994. This would include several companies that inverted decades ago, such as Ingersoll-Rand and Tyco.
The proposal would also disallow these companies from engaging in earnings stripping, in which a company reduces its overall tax liability by moving earnings from one taxing jurisdiction to a lower-tax jurisdiction, a popular method of limiting tax liability done by loading up interest deductions in the United States. According to Bloomberg, the Schumer-Durbin proposal would also require companies that undertook inversion to obtain approval from the Internal Revenue Service for transactions between different parts of the same company for 10 years.
The companies undergoing corporate inversion are not unpatriotic; they are merely making the logical and legal decision to move away from a corporate tax system that is unnecessarily high, burdensome, and inefficient. The United States needs fundamental corporate tax reform. Instead of trying to punish these companies, Congress and the president should lower corporate tax rates and switch to a territorial system. That would make the United States more competitive economically, bring foreign earnings back home to invest, and encourage more companies to set up headquarters here.
The following articles examine corporate tax inversion and corporate taxes from multiple perspectives.
Schumer Anti-Inversion Tax Plan Could Reach Back to 1994
http://www.bloomberg.com/news/2014-09-07/schumer-draft-plan-against-inversions-could-reach-to-1994.html
Richard Rubin of Bloomberg News examines a new Senate proposal to limit future deductions for companies that moved tax addresses out of the United States as many as 20 years ago to penalize so-called “inversion deals.”
2 Senators Introduce New Anti-Inversion Bill
http://dealbook.nytimes.com/2014/09/10/2-senators-introduce-new-anti-inversion-bill/?_php=true&_type=blogs&_r=0
David Gelles of The New York Times discusses how corporations have become a political punching bag in Washington, with many politicians beginning to call inversion deals “unpatriotic.” Gelles discusses the new bill from Senators Schumer and Durbin that would ban companies that have inverted from using several popular tax reduction techniques.
Blame Government Policies, Not Companies, for Reincorporations Abroad
https://heartland.org/news-opinion/news/blame-government-policies-not-companies-for-reincorporations-abroad?source=policybot
Writing in Heartlander, Steve Stanek discusses the recent growth in reincorporation and notes the real reason for these relocations is poor U.S. tax policy: “Defenders of the companies, however, say they are merely responding to terrible U.S. tax policies,” Stanek wrote. “There would be no need for tax credit programs to induce companies to remain headquartered in the United States if the federal government were to adopt a corporate tax system similar to those in most other industrialized countries, including our largest trading partner, Canada, said Chris Edwards, director of tax policy at the Cato Institute.”
Expect More Companies to Quit U.S., International Advisor Warns
https://heartland.org/news-opinion/news/expect-more-companies-to-quit-us-international-advisor-warns
George Prior warns living standards, jobs, and long-term economic growth are at risk because an increasing number of U.S. firms are likely to relocate overseas in response to the nation’s current “uncompetitive and anti-business” corporate tax rate.
Barriers to Mobility: The Lockout Effect of U.S. Taxation of Worldwide Corporate Profits
https://heartland.org/publications-resources/publications/barriers-to-mobility-the-lockout-effect-of-us-taxation-of-worldwide-corporate-profits?source=policybot
John R. Graham, Michelle Hanlon, and Terry J. Shevlin examine the corporate response to the one-time dividends-received deduction in the American Jobs Creation Act of 2004. They describe the firms’ reported sources and uses of the cash repatriated, and they examine non-tax costs companies incurred to avoid the repatriation tax prior to the Act. Finally, they investigate whether firms would repatriate cash again in response to a similar act. Overall, the evidence is consistent with a substantial lockout effect resulting from the current U.S. policy of taxing the worldwide profits of U.S. multinationals.
Territorial Tax Study Report
https://heartland.org/publications-resources/publications/territorial-tax-study-report
The National Foreign Trade Council evaluates the efficacy of implementing some form of territorial tax exemption system in the United States: “Based on its evaluation, the Territorial Study Group concluded that a broad based traditional territorial exemption system would improve the competitiveness of those U.S. companies that have substantial foreign active business income taxed at source country rates that are significantly less than U.S. tax rates.”
Burger King’s Migration Highlights Flaws in U.S. Corporate Tax Policy
https://heartland.org/news-opinion/news/burger-kings-migration-highlights-flaws-in-us-corporate-tax-policy
William McBride of the Tax Foundation discusses Burger King’s announcement it will move its headquarters to Canada and compares the tax systems of the United States and Canada: “First, Canada has a much lower corporate tax rate: 15 percent at the federal level plus another 11 percent on average from provincial corporate taxes. Compare that to the U.S. federal corporate tax rate of 35 percent, plus an average state corporate tax rate of about 4 percent.”
Research & Commentary: Worldwide vs. Territorial Taxation
https://heartland.org/publications-resources/publications/research–commentary-worldwide-vs-territorial-taxation
Matthew Glans of The Heartland Institute examines worldwide and territorial tax systems and the effects of both. “Our current worldwide tax system puts the United States at a competitive disadvantage versus other nations with lower, less-complicated corporate tax rates. Switching to a territorial system would make the United States more competitive by bringing foreign earnings back home to invest while encouraging more companies to set up headquarters here,” Glans wrote.
Just One Way to Stop Corporate Inversions: Cut Taxes
http://www.cato.org/publications/commentary/just-one-way-stop-corporate-inversions-cut-taxes
Chris Edwards of the Cato Institute discusses corporate tax inversions and how they have become so popular. Edwards argues the only way to limit inversions is to improve the U.S. tax system and cut tax rates. “The solution to the inversion problem is the same as for our economic growth problem: cut the corporate tax rate,” he wrote. “The good news for policymakers—as Canada has shown—is that federal coffers won’t be drained with such a reform, and may even gain from it.”
Everything You Need to Know About Corporate Inversions
http://taxfoundation.org/blog/everything-you-need-know-about-corporate-inversions
Recently, Congress and media have been abuzz over “corporate inversions.” Some worry the recent wave of inversions will harm the United States and its tax base. Others point to them as evidence of a broken U.S. corporate tax code. In this article, Kyle Pomerleau of the Tax Foundation addresses some common questions and answers about corporate inversions, how they interact with our tax system, and why they matter.
Business Inversions: Tax Reform Is the Only Way to Curb Them
https://heartland.org/publications-resources/publications/business-inversions-tax-reform-is-the-only-way-to-curb-them
Curtis Dubay of The Heritage Institute discusses the recent surge of interest in U.S. business inversions. He argues the policies currently proposed to stop the migration of businesses out of the United States will not work because they do not address the cause: “[T]he tax code’s high business tax rate and antiquated way of taxing multinational businesses (the so-called worldwide system), which puts American businesses at a steep disadvantage. Only modernization, by reducing the business tax rate and moving to a territorial system through tax reform, can stop the wave of inversions.”
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Economy News Web site at https://heartland.org/topics/economy/index.html, The Heartland Institute’s Web site at http://heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on the topic, Heartland can assist you. If you have any questions or comments, contact Heartland Institute State Government Relations Manager Logan Pike at [email protected] or 312/377-4000.
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance.
