The Obama administration is attempting to tighten the US tax code. The modifications thus far aim to make it more difficult for companies to avoid federal corporate profits without making it illegal. Doing so requires legislation from Congress (U.S. Department of the Treasury). In response to globalization, corporations developed massive legal teams to lower their tax rate, finding loopholes that provide tax exemptions (Collins, Shackelford 152). Tax inversions – or the acquisition of a US company by a foreign parent – allow corporations to pay their taxes to a different government with a lower tax rate. Outside nations are incentivized to lower their tax rates (Devereux and Loretz 765). Tax inversions have received a lot of attention in the US press in particular, but also cause problems in the larger picture of world trade. The United States government can and should take action to abate the practice of corporate tax inversions to benefit global trade as a whole. Source: OECD
A corporate tax inversion is a legal practice whereby a corporation acquires a smaller subsidiary abroad to change its country of domicile and take advantage of a more favorable tax rate. US multinational corporations prefer this as they pay one of the world’s highest corporate tax rates at about 35 percent (OECD). While inversions are technically legal, they deprive the domestic government of tax revenue that would have been collected on the foreign profits. US multi-national corporations face a higher tax burden than US domestic-only corporations (Collins, Shackelford 167). That is quite a bizarre finding. Essentially, an independent company headquartered and operating in the United States pays a higher tax rate than an identical company owned by a foreign corporation. The US multi-national pays a higher tax rate on profits earned in the US, and it also pays the same tax rate on profits earned abroad. Meanwhile, the foreign multinational pays the foreign tax rate on its profits. Tax inversions have an impact domestically because they deprive the government of tax revenue, while the corporation continues to benefit from domestic government spending on infrastructure, technology, and legal systems (Obama).(click Obama to watch the video). However, tax inversions are not just an issue for the US.
The World Trade Organization (WTO) repeatedly condemns such practices of “Extra-Territorial Income Exclusion” (ETI). In 2006 for example, the WTO states: “The US FSC/ETI tax subsidies have been declared in violation of WTO rules by a WTO panel, the two WTO Appellate Body reports and two WTO compliance panels” (Delegation of the EU to the UN). Tax inversions can incentivize competition among governments in a so-called “race to the bottom” to lower tax rates to draw rich companies and increase revenue. As Devereux and Loretz found, “tax competition in its most extreme form may not be a desirable outcome” (765). Just because a company attracts many corporations does not mean it will maximize tax revenue. It is in the best interest of all participants in world trade, that sovereign nations ban favorable tax treatment for companies abroad (Devereux and Loretz 765). The WTO has allowed European Union nations to enforce economic sanctions on the US as a deterrent for tax inversions (Delegation of the EU to the UN). As previously mentioned, the Obama administration has attempted to make tax inversions more complicated by plugging some of the leaks in the US tax code (U.S. Department of the Treasury). Despite the efforts made thus far, the real solution lies in the US government’s ability to reform tax policy, so that US companies have no incentive to turn themselves into US multi-nationals.
True corporate tax reform will allow the US to eliminate the incentives for tax inversions. One way to do this would be to tax companies based on where profits are earned only. Lowering the tax rate removes part of the incentive for US companies to seek lower tax rates. Taxing profits where they are earned ensures that a company would still need to pay the US tax rate on profits earned domestically. Many countries already employ a territorial system. Relatively few companies have completed corporate tax inversions so far, but the practice is on the rise. It would serve world trade well to address the problem before it becomes even more complex
Collins, Julie H., and Douglas A. Shackelford. “Do U.S. Multinationals Face Different Tax Burdens Than Do Other Companies?”. Tax Policy and the Economy 17 (2003): 141–168. Web.
Devereux, Michael P., and Simon Loretz. “WHAT DO WE KNOW ABOUT CORPORATE TAX COMPETITION?”. National Tax Journal 66.3 (2013): 745–773. Web.
Obama, Barack. “Remarks by the President on the Economy.” The White House. The White House, 05 Apr. 2016. Web. 12 Apr. 2016. https://www.whitehouse.gov/the-press-office/2016/04/05/remarks-president-economy-0
Pomerleau, Kyle. “Everything You Need to Know About Corporate Inversions.” Tax Foundation. Tax Foundation, 04 Aug. 2014. Web. 13 April. 2016.
“Table II.1. Corporate Income Tax Rate.” Table II.1. Corporate Income Tax Rate. Organisation for Economic Co-operation and Development, 12 Apr. 2016. Web. 12 Apr. 2016. https://stats.oecd.org/Index.aspx?DataSetCode=TABLE
“WTO Condemns US Tax Subsidies; EU Calls on US to End Illegal Tax Breaks for Boeing, Others.” EU@UN –. Delegation of the European Union to the United Nations, 13 Feb. 2006. Web. 11 Apr. 2016.