A recently released study by liberal group Americans for Tax Fairness (ATF) misrepresents why inversions occur and fails to propose solutions that would fix the problem. Most remarkably, the study completely fails to recognize that inversions are a side effect of having the worst tax code in the developed world when it comes to business competitiveness.
The study starts by hitting Pfizer – a company that recently announced an inversion – for having income held offshore. But this criticism actually speaks to the failings of the archaic U.S. tax code, it has nothing to do with any particular company.
The U.S. tax code is one of the few worldwide systems meaning it taxes all income regardless of where it was earned. If an American business were based in almost any other developed country it could freely send this after-tax income to its parent company.
This is only fair, because the company has already paid taxes on this income when it was earned. Instead, the convoluted U.S. system is one reason why many American companies have no choice but to move their headquarters overseas through an inversion.
Not only does the study misrepresent & downplay America’s failed code, it proposes a number of new regulations that would do nothing to fix the problem.
One proposal changes what is permissible under an inversion by increasing the threshold of foreign ownership required for the combined new company. Again, this ignores the fact that the problem is a tax problem, not a business problem.
As a report prepared by Ernst & Young explains, the U.S. is also losing when it comes to the merger & acquisition (M&A) market. In the past ten years, America has had a net loss of assets of $179 billion because of foreign acquisitions. In effect, U.S. businesses represent a target rich environment because the American tax code leaves them vulnerable.
This points to the greater problem that U.S. businesses face, with a tax rate approaching 40 percent compared with companies in other developed countries which pay an average of 25 percent. This long standing inequity has real consequences, one of which is inversions.
If this proposal went into effect, it would fail to fix the underlying problem of American competitiveness. Businesses would inevitably find other ways to flee the U.S. tax system or would be acquired by foreign companies at greater frequency.
The second proposal would try to stop earnings stripping, a practice used by businesses to allocate profit. While it is potentially open to abuse, its true impact is overstated and it is a common, legitimate, and important tool for businesses.
In fact, research by Rita Nevada Gunn and Thomas Z. Lys of the Kellogg School of Management found that inverted companies typically do not use earnings stripping to the extent that some claim. Similarly, a report examining earnings stripping by the Treasury Department was unable to find any conclusive evidence on its impact.
What the study ignores is that regulations have been tried in the past, yet have failed to fix the problem. In 2004, Congress passed regulations designed to curb the problem, but since then almost 50 inversions have occurred and this quick pace shows no sign of slowing.
Indeed, the solution to stopping inversions is not complex new regulations. It is as simple as addressing two problems in the tax code. One, lower the corporate tax rate to be more competitive with the rest of the world. Two, change from the outdated worldwide tax system to a territorial system, like the rest of the world.