Want to Stop Corporations From Fleeing Vis-à-Vis Corporate Inversions?: Lower Taxes

Those in society tend to look down upon those who avoid responsibility as weak, incapable, or lacking the courage to act on basic decency. It is through this moralistic lens that some look at corporations who are "fleeing the country" through what is known as a corporate inversion. A corporate inversion is when a corporation completes a merger with a company in another country that is often smaller. The merger allows for the U.S. company to be treated as a foreign country in the U.S. tax system, even in spite of the fact that U.S. shareholders own more than 50 percent of the company stock post-inversion. Operations often stay in the United States, but it the legal headquarters is changed to a lower-tax jurisdiction. In 2014, Obama accused companies pursuing corporate inversions as being deserters, followed by a call for "economic patriotism." For Obama, paying taxes is a form of being patriotic since it helps support the government. By using the tax code to pay less taxes, the loophole is seen by inversion critics as avoiding one's patriotic duty. I want to challenge this notion of "economic patriotism" and see what the deal is with inversions, least of all because standard microeconomic theory states that a business primary goal is to make a profit (i.e., profit motive).

This line of thought comes in light of a report released by the Congressional Budget Office (CBO) on corporate inversions. The report had two main findings. The first main finding is that within the next decade, corporate inversions will cost the government $12 billion (CBO, p. 2). The second main finding is that on average, a corporation saved itself $45 million after the first financial year of completing the inversion (CBO, p. 1). The second finding of the CBO bolsters why corporations feel the need to go through an inversion in the first place: to pay less in taxes (also see Col et al., 2017).

If you have looked at corporate taxes, it is not difficult to see why corporations in the United States want to flee. It's because the corporate tax rates are high. The CBO released a report in April with corporate tax rates in G20 countries. The United States has the ranks highest in top statutory rate of 39 percent. Statutory is the rate that is "on the books," which is different than what is actually paid (i.e., effective rate). The United States still has the fourth highest rate of 18.6 percent. While the corporate tax revenue as a percent of GDP has declined over the years, overall tax revenue from corporate taxes has generally increased since the 1930s because U.S. GDP has grown considerably over the years. Also, these studies do not account for state corporate tax rates or the fact that 30 percent of companies pay as an S-corporation, a tax status in which the corporation pays individual income tax instead of corporate income tax.

It is true that the corporate tax rate in theory (statutory) is double what it is in practice (effective). At the same time, it is high enough where over 60 companies since 1993 went through the headache and paperwork to legally move. It is bad enough where U.S. corporations are at a competitive disadvantage. I scrutinized the corporate tax three years ago when Walgreens was looking to make its inversion. I found a few things, one being that the tax incidence falls on the workers in the form of lower wages. I also found that it reduces labor productivity, slows down economic growth, and creates a double-taxation effects. The OECD opined that it was bad enough where it deemed the corporate tax the least efficient and most harmful tax (OECD, 2008, p. 2).

When looking at corporate tax rates in the United States, we have to remember that our tax code is not in isolation. U.S. corporations are competing with corporations in other countries with lower tax rates. Having a disadvantage in paying more taxes could result in a lower market share, as well as affect the workers at the corporation, many of whom are not bigwig executives. Combine this with the negative effects of the corporate tax, and it should be no wonder that corporate inversions are trending. The libertarian Cato Institute pointed out something interesting with regards to corporate inversions: it tends to be the CEO and other corporate executive that benefits from the inversion, not long-term investors. Executives' incentives are misaligned with those of shareholders, and that creates additional issues.

Inversions are a symptom of and a reaction to a malfunctioning tax code, which means that cutting corporate taxes to disincentivize inversions is better than some retroactive regulation or converting to a territorial system, the latter of which would create greater incentives to shift U.S. profits overseas to avoid taxation. Ireland and Canada are two examples of countries that have benefited from lowering their corporate tax rates. Canada was able to collect more tax revenue when it reformed its corporate tax rate in the early 2000s, which suggests that a cut in the corporate tax rate could lead to more tax revenue. Plus, corporate tax reform has something else uncommon in our day in age: bipartisan support, which means it would be politically feasible to pass.

The United States has a tax code that is over 10 million words long, which makes it all the more difficult to navigate. Again, it should be no surprise why certain corporations find it easier to complete an inversion than deal with the U.S. tax code. Simplifying the tax code by lowering or eliminating the corporate tax would be a step in the right direction for all involved.