Corporate inversions, where U.S companies merge or are acquired by foreign firms to relocate their legal headquarters abroad in order to reduce their tax burden, will no doubt be a key part of the conversation on tax policy during this election season. The populist arguments of higher taxes on the rich and corporations still fuel the political machine by liberals to convince many people that redistributive policies will alleviate these concerns. Self avowed socialist and presidential candidate Sen. Bernie Sanders will be sure to ride this wave and so will Hillary Clinton as she tries to compete with Mr. Sanders.
Making the repetitive rounds in the media and political fundraisers will be the sound bites of 'it sounds good’ economics that target so called ‘unpatriotic’ companies (according to President Obama) so they pay their ‘fare share’ of taxes. This argument misses the point of what is really necessary to actually promote investment in the U.S economy while raising tax revenues and economic growth. That is, pro-growth tax reform that would encourage economic freedom, the free movement of capital to where they are most productive.
Republicans and those who understand the benefits of economic freedom need to make a more populist case why pro-growth tax reform to address inversions will help the poor and middle class. They should argue that this can be done when these reforms promote allocating capital to areas that boost jobs and incomes while enhancing income mobility. Such reforms would result in companies bringing back more of their profits earned overseas to the U.S to be invested here. In addition, it would attract more foreign companies and job creators to want to make the U.S their prime location. It would be a win-win situation because tax revenue would rise along with economic growth. However, the key part of tax reform that involves lowering corporate tax rates does not fit the liberal populist narrative of soaking the corporations, the purported benefits of having government redistribution and control of corporate capital via high taxes and regulations.
The U.S corporate tax rate is the highest in the industrialized world at almost 40%. The U.S has a worldwide tax system that taxes profits by U.S based companies earned abroad at this rate when they bring those earnings back to the U.S. All other G7 countries instead have a territorial tax system that imposes little or no tax on repatriated earnings because they were already taxed in the country where they were originally earned. The high corporate tax rate and double taxation elements of the current U.S tax policy is making the U.S less competitive on the world stage, and driving investment capital away from areas where they otherwise would be productive in the U.S economy.
In an article in The Wall Street Journal, Michelle Hanlon accounting professor at MIT’s Sloan School of Management explained, “ To compete with foreign-based companies that have lower tax burdens, US. Corporations have developed do-it -yourself territorial tax strategies. They accumulate foreign earnings rather than repatriate the earnings to pay U.S taxes. This lowers a company’s tax burden, but it imposes other costs.
For example, U.S. corporations hold more than $2 trillion in unremitted foreign earnings a substantial portion of which is in cash. This is cash that currently is not being invested in the U.S or given to shareholders. As a consequence, companies are borrowing more in the U.S. to fund domestic operations and pay dividends. Another potential effect is that companies invest the earnings in foreign locations.
In short, our international tax policy encourages U.S multinational corporations to keep cash abroad, borrow more in the U.S and invest more in foreign locations than they otherwise would. Everyone loses: the U.S government gets little if any tax revenue from foreign earnings, and shareholders and the U.S. economy is deprived of valuable resources. See the full Wall Street Journal article- The Lose-Lose Tax Policy Driving Away U.S Business.
This analysis by Ms. Hanlon sums up well why the efforts of President Obama, Treasury Secretary Jack Lew and some members of Congress to prevent inversions are counter productive to what they claim these efforts will achieve for the American economy. It also fosters uncertainty, as investors become skeptic if they think possible tax and regulative policies will diminish the returns on their long-term investment. The regulative approach favored by President Obama et al. exposes the underlying question. Who is more effective of allocating capital to where it is more productive, the state or the entrepreneur?
Many times it has been proven that the more the state seeks to redistribute capital, the less incentive there is for capital to be created and thus less available to be redistributed and invested towards productive uses. Human capital suffers the most when this happens because while the supply human capital keeps increasing (more people being born or coming into the job market etc.) the opportunities for them to be productive diminishes when there are fewer jobs and resources available to be used for innovation. Furthermore, the state in turn increases taxes and cuts services on everyone in order to gain more revenue to make up for loss due to slow growth.
In short, the free movement of capital to where they are most productive will lift incomes and economic growth especially when it outpaces the rise in human capital. This is because the reduced ratio of the human capital to investment capital raises the value and demand of the human capital.
The persistent populist narrative by liberals of bashing or punishing corporations and the rich because of their profits (except at big ticket fundraisers that the president frequently visits to get contributions from the them) has put a stigma on wealth creation and free movement of capital. The impression sought is that regulations against inversions are necessary so the corporations will have to pay their ‘fair share’ to the government who in turn will have more revenue to spend for the public good.
Ironically, according to data from the Office of Management and budget, despite a rise of inversions in recent years revenue for corporate taxes has been rising steadily. See: Can Jack Lew Add? However, if U.S tax policy keeps driving away capital, it is not certain how long this trend will last. Republicans who seek to reform U.S. tax policy so it is more globally competitive and pro-growth, need to make a concerted and clear effort as to why it would help everyone and not just corporations or rich investors. In addition they must make the case why a pro-growth tax policy would create a business environment that reduces inversions, as there would be incentives to expand locally and divert capital earned overseas back into the U.S economy. They might even get bi-partisan support for pro-growth tax reforms from Democrats such as Sen. Tom Carper (Del.) who recognizes that the “root causes” for inversions is the need for corporate tax reform.
A good place to start would be to use examples here in the U.S where pro growth tax policies in Republican led states like Texas, Louisiana, the Carolinas, Florida and Indiana have led to jobs and rising income mobility while increasing tax revenues. They have successfully competed with high tax slow growth liberal states that have been governed by the same ‘punish the corporation’ ideology that now seeks to regulate corporate inversions.
In addition, there are international examples such as in Canada and Ireland where multinational corporations are relocating because of attractive tax policies and reinvesting their capital there. ‘Sound good’ populist economics often win at the polls due to the perception of its purported claims and by the dedication of the messengers who promote them. It is time for those who believe in economic freedom and pro-growth policies to have the same tenacity, fortitude and clarity to explain why these elements work. Corporate inversion is not the only reason for pro-growth tax reform, it is just one of the symptoms of inefficient tax policies that misallocates and diminishes capital from being used for productive uses.
Some presidential candidates such as Jeb Bush, Marco Rubio, Rick Santorum have pitched very detailed plans on pro growth tax reform which involves inversions. As other candidates come out with their own ideas, it would serve the election process and the country well if this election is based on competing ideas that promote growth rather than based on competing personalites.