New regulations aimed at inversions will not solve the underlying American competitiveness problem and may backfire, a bipartisan group of 18 former Treasury officials said today in a letter to Secretary Jacob J. Lew.
Earlier this month, Treasury released new regulations on earnings stripping, the process by which international businesses borrow and allocate debt across subsidiaries and modified thresholds at which a newly inverted company is counted as foreign or domestic under the U.S. tax code for future inversions.
While these new regulations may stop existing proposed inversions, it will do little to fix the problem. Inversions are just one symptom caused by America having the world’s worst tax code. As the letter points out, they will likely have unintended consequences or outright make the problem worse.
For one, new regulations will result in American businesses becoming targeted for foreign acquisition at increased frequency. As a report by Ernst & Young explains, overcomplex and burdensome regulations put U.S. businesses at comparative disadvantage within the global economy and make them an easy target for acquisition. In effect, this new regulation will mean American companies leave the U.S. through foreign acquisitions, rather than inversions.
Perhaps worse still, new regulations will create unneeded uncertainty that puts a damper on foreign investment. Ultimately, American businesses will lose out and have a harder time competing with already advantaged foreign business.
Rather than new regulations, Treasury could better devote its time working with Congress toward a lasting solution that fixes the problems in the U.S. tax code. There are two major tax problems that are causing U.S. businesses to invert or be acquired by foreign competitors.
First, America has a corporate income tax rate far higher than the rest of the developed world, with a combined state and federal average of 39.1 percent. In comparison, the average rate in the Organisation for Economic Co-operation and development is just 25 percent.
While other countries have pro-actively reduced their business tax rate to compete in the global economy, the U.S. rate has remained unchanged since the Tax Reform Act of 1986. As a result of this inaction, the U.S. rate remains at a level far above major competitors.
Second, the U.S. retains an outdated worldwide tax system, even as the rest of the developed world has a moved toward a territorial tax system. In 2000, just 14 developed countries had a worldwide system, but the increasingly global economy has meant this number has doubled since then. Today, the US is just one of six OECD countries that retains the worldwide system.
This means that any U.S. business with operations overseas must first pay taxes in the country it earned this income and then pay U.S. taxes when bringing this income back. Needlessly to say, this double taxation leaves American businesses at a substantial disadvantage, because they face higher taxes and a more complex system than their competitors.
As the signers conclude, “current rules regarding corporate inversions don’t need revision.” That’s because the problem is not that there are too many inversions, but that the U.S. tax code is the worst in the world and results in an American competitiveness problem.