American businesses are inevitably subject to heated criticism when announcing a business inversion. This criticism is often based on the false belief that businesses are abandoning the U.S. to pay less in taxes.
In fact, Hillary Clinton recently blasted the practice as a corporate loophole, and President Obama has even called inversions “unpatriotic.”
But this rhetoric from Clinton & Obama shows a fundamental misunderstanding behind why inversions occur, as demonstrated by research by Rita Nevada Gunn and Thomas Z. Lys of the Kellogg School of Management.
First, an inversion is a U.S. business acquires or merges with a foreign headquartered business. This new business then places its headquarters overseas.
Based on their analysis of 122 inversions occurring after January 1, 2004 Gunn & Lys argue that the controversy may be “much ado about nothing,” and is used by some as “political capital.”
They do not leave taxpayers “holding the bag,” as Clinton characterized one recently announced merger, because post-inversion companies actually pay more in taxes and invest more in the economy than they did in the past. As Gunn and Lys explain:
“Inversions do not reduce taxes collected by the U.S. Treasury, contrary to the strongly held assertions by Congress. In fact, the most likely outcome is that inversions actually increase taxes to the US treasury, in the form of taxable and possibly tax differed capital gains and increases in post-inversion cash dividends.”
This study bases its conclusion on three findings.
First, the new post-inversion company will typically chose to bring more of their foreign earned income back to the U.S. than they would as an American based company. This is because they are no longer subject to the international taxation system of the U.S. tax code, and as the study notes, this means money invested in the U.S. economy.
Second, post-inversion company typically pays more in revenue to the US treasury post- inversion, even as their marginal tax rate decreases. It is important to note that the hysteria that inverted companies are abandoning the U.S., post-inversion companies continues to pay taxes on their U.S. operations.
Lastly, the authors found concerns over earnings stripping – the transferring of assets to low-tax jurisdictions – is overstated and not used to the extent that critics of inversions contend.
This findings are echoed by Curtis Dubay of the Heritage Foundation who likewise concluded that inversions don’t lead to significant loss of tax revenue:
“Inversions are a problem because they lead to the loss of high-level jobs and community involvement; their negative impact on the overall economy and tax revenues is relatively minimal.”
While this latest report helps dispel some of the myths behind inversions, they are nevertheless an issue Congress should look to address. But rather than impose new, convoluted regulations they should look to reform the failing U.S. tax code.
Indeed, if politicians like Hillary Clinton are so eager to stop inversions, the reforms necessary are clear – change the tax code to a territorial system and lower the business tax rate. In the meantime, they should stop misleading the American people about corporate inversions with heated rhetoric.