How the US Could Fix Tax Inversions

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.图片 1       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

Works Cited

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.

https://www.treasury.gov/press-center/press-releases/Pages/jl0405.aspx

“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.

http://eu-un.europa.eu/articles/en/article_5683_en.htm

 

 

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3 Responses to How the US Could Fix Tax Inversions

  1. samuelhu92 says:

    It’s an interesting try that cast spotlight on hidden area of corporate operation strategy. Although it’s a pretty common measurement for corporates to seek as much profit as possible by reducing tax cost. I didn’t pay any attention to it ever, which however, is worth a thorough analysis.
    As far as I am concerned, it’s reasonable and irresistible for federal government to address this problem. Not only because the great loss in domestic tax income tax inversions might occur, the international political and economic competitions are essential for the consistence of dominated power of the country.
    In addition, tax inversion is not an issue only confuses USA. The WTO has declared it as a violation of WTO rules which incentivizes tax competitions in target countries to lower taxes to draw rich countries and increase revenue. The Obama administration, if succeed, would be a pioneering impletion to counter this worldwide puzzle, leading a more equivalent and healthy global business network.

    • Sofia Orive Garza says:

      Very interesting article. Upon reading it I immediately thought of Pfizer. At the end of last year they announced that they would be merging with Allergan who is headquartered in Ireland. The deal was said to be an incredible $160 billion. One of the largest mergers in history of pharmaceuticals. This of course, outraged so many people as it was clear that this move was simply to save themselves so much more on lower tax rates which was said to save them $1 billion a year. Not too long ago, however, Pfizer announced that it was scrapping this deal after the Obama administration set forth the new U.S Treasury rule you mention on your blog. In the end, Pfizer only lost $150 million to pay Allergan for all the expenses incurred from the making of this deal.
      It looks like many agree that tax inversions are not good for America or for the world in general. You posed a very interesting point that I had not thought about before regarding how governments would act if tax inversion were completely allowed. The repercussions from having governments enter a tax rate war of sorts would be monumental both nationally and globally. I believe that making these deals as difficult as possible for companies is the best way to deal with this situation. Making it illegal would run into all sorts of ethical and constitutional dilemmas. I believe some amount of incentives to companies that stay domestic would also help but governments should be careful not to make these incentives seem like a first step towards competition with other governments for better companies.

  2. Sofia Orive Garza says:

    Very interesting blog post. Upon reading it I immediately thought of Pfizer. At the end of last year they announced that they would be merging with Allergan who is headquartered in Ireland. The deal was said to be an incredible $160 billion. One of the largest mergers in history of pharmaceuticals. This of course, outraged so many people as it was clear that this move was simply to save themselves so much more on lower tax rates which was said to save them $1 billion a year. Not too long ago, however, Pfizer announced that it was scrapping this deal after the Obama administration set forth the new U.S Treasury rule you mention on your blog. In the end, Pfizer only lost $150 million to pay Allergan for all the expenses incurred from the making of this deal.

    It looks like many agree that tax inversions are not good for America or for the world in general. You posed a very interesting point that I had not thought about before regarding how governments would act if tax inversion were completely allowed. The repercussions from having governments enter a tax rate war of sorts would be monumental both nationally and globally. I believe that making these deals as difficult as possible for companies is the best way to deal with this situation. Making it illegal would run into all sorts of ethical and constitutional dilemmas. I believe some amount of incentives to companies that stay domestic would also help but governments should be careful not to make these incentives seem like a first step towards competition with other governments for better companies.

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