The big news in the tax world today is Treasury Secretary Jack Lew’s speech on corporate inversions.
Unfortunately, it’s clear that the Obama Administration still doesn’t understand this easy issue.
Inversions are inevitable if you have a flawed tax system. Multi-national companies have offices around the world. They can set up headquarters in America, or in any number of different countries. No matter where they hang a shingle, they will have to pay the full U.S. corporate income tax rate on all U.S. profits. So what’s the big deal here? The big deal is that our tax system is the worst in the world for these type of employers, and inversion is the entirely predictable result.
Worldwide vs. Territorial taxation. The U.S. is virtually the only country in the world that requires its companies to not only pay taxes on profits it earns here, but also exposes profits earned overseas to U.S. taxation when repatriated. This is known as a “worldwide tax regime.” Other countries have what we should have, a “territorial tax regime,” where taxes are owed only where they are earned.
The highest tax rate in the world. Combine this double taxation with the highest corporate income tax rate in the developed world (over 39 percent, compared to a developed nation average under 25 percent), and you have a recipe for corporate inversions to happen. Companies are simply not going to expose their profits earned overseas (and which already have faced taxation abroad) to even more taxation in the United States, which taxes more heavily than anyone else.
A simple solution: lower the tax rate, stop double taxing. Responsible policymakers know that there is a very simple, two-pronged approach to stopping inversions–dramatically lower the tax rate on businesses, down to the developed nation average of 25 percent (or even less).
That by itself will do most of the work.
Combine that with adopting a territorial tax regime, and the problem is solved. Companies not only won’t want to move abroad to protect their shareholders, employees, and customers from unfair tax rules–we will actually see other countries’ companies wanting to set up shop here.
The Obama Administration just doesn’t get it. It’s clear, unfortunately, from Lew’s speech that the Obama Administration just doesn’t get it. Let’s break it down:
Lew calls for a phony corporate tax reform with a top rate of 28 percent and higher taxes than before. A top rate that high simply isn’t enough to make America competitive around the world. We would still have a tax rate significantly higher than the developed nation average. Combine this with tax increases to pay for it even bigger than the rate reduction, and companies are worse off than before.
They want to use the net tax increase money for another round of stimulus spending on roads. If there’s something we do know, it’s that companies are doing inversions because they are overtaxed. Increasing their taxes, and then using the money to finance union-contract road deals, is only going to make the problem worse.
Where’s the end to double taxation? You won’t find it here. Not only does the administration not ending the worldwide double tax regime–they are actually proposing making it worse.
Retroactive tax increases on companies who should have hired psychics. Arguably, the most offensive part of the plan is that it would apply to companies who have already made the inversion decision, months or even years before the law is passed. Apparently, the companies who were making sound business decisions at the time neglected to hire psychics to divine what Congress might do (and apply backwards) months or years in the future. There’s a reason the Constitution forbids “ex post facto” laws, and this is it.