By James Carter —
Physics teaches us that for every action, there is an equal and opposite reaction. This is true not just in the physical world but also in the world of corporate taxes and we are seeing more of it. Barely a week goes by in which we do not read stories about companies moving their offices or operations to lower-tax nations, employing accounting techniques to reduce their tax liability, investing foreign-earned profits overseas or elected officials issuing statements about how this company or that has “dodged” taxes or found “loopholes” by which they can engage in “tax avoidance.”
But in virtually each case we study, what we are really seeing are vivid examples of how writers of tax law got what they asked for but not what they wanted. They wanted more tax revenue but instead, they got changes in business behavior based on law, allowing these companies to provide increased value to their shareholders by legally reducing their tax liability. Corporations carefully examine the tax laws of various jurisdictions and do what is in their best interest, in full compliance with laws voted upon by legislatures, parliaments and other governing bodies.
Because the media are disinclined to publish stories under a headline reading, “Company Obeys Law, Saves Money,” Americans are being increasingly bombarded with claims of corporations engaging in something that is vaguely wrong. In truth, there is nothing to suggest anything these corporations did was improper.
They are in fact mere manifestations of what White House Council of Economic Advisers Chairman Jason Furman told the International Tax Policy Forum in Washington, DC. “In a lot of ways our international tax system is the most broken aspect of our tax system in that right now it does a combination of raising relatively little revenue and doing that while imposing a substantial distortion,” said Furman. He could not have been more accurate.
The corporate tax structure in the US provides tremendous incentives for multinational companies to not bring their foreign-earned profits home, sparing that capital from the ravages of America’s 35% corporate tax rate, the highest in the developed world. This makes it attractive for American companies to buy and invest in foreign companies rather than American companies. Why? All else being equal, investing one dollar of foreign earnings abroad generates a higher return for a US-based company than investing in the US after paying Uncle Sam the additional layer of tax to bring the money home.
But as current events clearly demonstrate, today’s international tax scheme distorts more than the repatriation of overseas profits. As the non-partisan Tax Foundation recently reported, “U.S. companies are merging with and acquiring foreign companies at an accelerating rate, often with the goal of moving the headquarters abroad where corporate tax rates are much lower.”
Moreover, because American multinational companies with substantial foreign earnings pay higher taxes on those earnings than would non-US companies with those same earnings, those companies are often more valuable in foreign hands than US hands. That makes them vulnerable to foreign takeover. The result is that hundreds of American companies are acquired and moved offshore every year. An analysis by Thomson Reuters of business acquisitions showed that at least 484 US firms, with a value of more than $43.6 billion, were acquired by foreign interests in the first half of 2013 alone.
The negative impact of our corporate tax laws ripples throughout the economy at every level. The flow of US companies overseas means fewer jobs in the United States. If one objective of public policy is to prevent US jobs from moving offshore, staunching the tax-driven flow of US-headquartered companies abroad should be step #1.
While foreign investment in the US is generally a positive development to be welcomed, US tax policy should not, as it currently does, drive US-based companies into foreign hands.
Much of the economic distortion described by Furman and others could be remedied by reforming our tax code with a modern, competitive hybrid system, where profits earned abroad can be returned to the US without the harsh tax levy currently in place. Reducing America’s tax rate to one that is more consistent with the international community – 25% or lower is the most commonly cited figure – would also go a long way toward increasing investment in the United States.
Unfortunately, the prospects of Congress tackling corporate tax reform this year are bleak. The sheer complexity of the enterprise and competing congressional interests suggest action will be delayed until after the midterm elections. But in the interim, it’s assured that more companies, American and otherwise, will channel their capital and the jobs it creates elsewhere. Congress can take action to spur more economic growth through tax reform; the only question is ‘when?’
Mr. Carter was a deputy assistant secretary of the U.S. Treasury Department under President George W. Bush.