For hundreds of years, people have remarked on the futility of expecting corporations to behave as though they have some sort of conscience. Edward Thurlow, Lord Chancellor of Great Britain in the last decades of the 18th century famously said, “Corporations have neither bodies to be punished, nor souls to be condemned; they therefore do as they like.”
So, the Obama administration’s recent push for “economic patriotism” as an antidote to the trend of “corporate inversions” – U.S. corporations changing their official domicile to other countries for tax purposes – feels like little more than an attempt to wring some political advantage from a problem that can really only be solved through legislation. Specifically, through corporate tax reform.
Currently, the U.S. has one of the highest corporate tax rates in the world, and is practically alone among advanced economies in taxing domestically headquartered companies on the profits they earn overseas when that money returns to the U.S. Virtually all of our significant competitors have long since switched over to a “territorial” system of taxation, where only the profits earned domestically are taxed.
As a result, U.S. corporations – which, again, are not patriots in any coherent sense of the word – have become very good at avoiding repatriation of their profits, and are now increasingly finding the prospect of headquartering overseas attractive.
The administration has proposed to Congress a number of steps that fall short of corporate tax reform, but which would make corporate inversions impossible, but lawmakers left town without acting on them. Now, according to The New York Times, the administration is considering unilateral action on the issue.
“But until Congress addresses the more fundamental problems, creative corporate tax planners will figure out new ways for their clients to escape U.S.-residence taxation,” writes Eric Toder, co-Director of the Tax Policy Institute and a former Treasury Department Assistant Secretary for Tax Analysis.
“We need to recognize that taxation based on corporate residence is unsustainable,” Toder continues. “Multinational companies have investments, employees, sales, and shareholders throughout the world. Their place of tax residence is increasingly a legal construct with no real economic meaning. We cannot sustain a system that penalizes companies simply for having a tax residence in the United States.”
The current system is so perverse that, theoretically at least, a corporate inversion could result in a company returning more money in the U.S. After it is no longer headquartered here, if a firm brings foreign-earned profits to the United States, whether to invest in operations or to pay dividends to shareholders, it is no longer taxed.
Assume a U.S.-headquartered company already in the highest corporate tax bracket of 35 percent wants to use foreign earnings to build a $1 million-dollar facility in the U.S. If it already paid, for example, 15 percent tax on its profits in the country where they were earned, it would owe the U.S. 20 percent on whatever was returned. That means, in order to have $1 million remaining after taxes, the country would need to repatriate $1.25 million. That’s a 25 percent premium over what it would pay post-inversion.
Most people who have looked seriously at the issue have concluded that the U.S. must, eventually, switch to a territorial system. This includes many Democrats, who have traditionally balked at the idea of giving up claims on tax revenue. Former Treasury Secretary Tim Geithner, during the debates over the federal debt ceiling two years ago, told Congressional Republicans that the administration was prepared to support the change.
“We are prepared to move off decades of Democratic orthodoxies,” he said at the time, and to move toward a territorial system.
The biggest problem right now is getting anything related to taxation through Congress. Even topics on which there is broad agreement, like the need to overhaul the corporate code, are delayed out of concern that passing them will dilute the enthusiasm for an overhaul of the entire U.S. tax code.
And given the current Congress’s historic levels of unproductivity, nobody is expecting large scale tax reform any time soon.
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