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Allow the practice: Inversions are an improvement over the status quo

By WAYNE WINEGARDEN
p04 winegardenWinegarden    Sometimes in a breakup, you are responsible; but if you learn the right lessons, the breakup can lead to something much better.
    In the case of U.S. corporations and the federal government, many companies have been considering whether a corporate restructuring commonly known as a tax inversion makes sense. A tax inversion is an acquisition where a U.S. company purchases a foreign owned company and registers the new entity outside of the U.S.
    Instead of trying to punish companies considering a corporate inversion – such as Hillary Clinton’s ill-conceived “exit tax” or the Obama administration’s ex-post rule changes that were implemented with the goal of scuttling the Pfizer-Allergan inversion – the federal government should ask itself why a company would consider such a restructuring in the first place?
    When companies consider tax inversions, they are telling the federal government that the costs associated with being a U.S. registered company put them at too much of a competitive disadvantage compared to their global competitors. The driver of these excessive costs is the overly-burdensome U.S. corporate income tax system. Since the federal government is unwilling (or unable) to implement effective corporate income tax reform, these companies are taking the actions they can to remove the policy-imposed competitive disadvantages.
    When evaluating the economic impacts from a tax inversion, it is useful to begin by noting what a tax inversion is not. A tax inversion is not a relocation of jobs or production outside of the U.S. Following an inversion, the former U.S. company can, and often will, maintain the same number of factories, offices and employees in the U.S. as before the inversion. Nor does a tax inversion reduce the income taxes paid by U.S. companies on income earned in the U.S. Following an inversion, the income taxes owed by the former U.S. company on its income earned in the U.S. are precisely the same.
    Instead, a tax inversion is a means for U.S. companies to remove an unsustainable competitive disadvantage that the U.S. corporate income tax code imposes on U.S. companies compared to their global competitors.
    The corporate income tax code in the U.S. levies the highest marginal corporate income tax rate among the industrialized countries (a combined federal and average state tax rate of 39.1 percent). The U.S. corporate income tax code is also overly-complex, difficult to understand, full of special interest carve-outs, taxes the same income multiple times, and taxes U.S. companies based on their global income.
    The anti-growth aspects of the U.S. tax code are widely recognized. The Congressional Budget Office and President Barack Obama’s 2015 Economic Report of the President have both noted the problems. Studies have also linked the uncompetitive U.S. corporate income tax code to slower income growth for U.S. workers, lower returns for U.S. investors, and less investment in the U.S. economy.
    Perhaps worst of all, the global tax basis of the U.S. corporate income tax system creates a significant competitive disadvantage for U.S. companies. By statute, U.S. companies pay taxes on income earned in the U.S. They then must pay the difference between the higher U.S. income tax rate on their income earned in Europe, Asia, or anywhere else in the world and the income tax rate levied by the governments in these countries.
    Most other industrialized countries impose a territorial tax system – companies only pay taxes on income earned in the home country. A Canadian company pays U.S. corporate income taxes on profits earned in the U.S., and pays Canadian corporate income taxes on profits earned in Canada. Canada does not tax Canadian companies on income earned outside of Canada. This difference in tax bases ensures that an equally situated U.S. company will earn lower after-tax profits when compared to its foreign competitor.
    With little chance for effective corporate tax reform in the near-term that would eliminate the U.S. imposed competitive disadvantages, tax inversions are an improvement over the status quo. Through a tax inversion, U.S. companies are able to obtain equal treatment on their non-U.S.-based income compared to their global competitors.
    Eliminating the competitive disadvantages facing U.S. companies also empowers an inverted company to more profitably invest in the U.S. economy and create more U.S. jobs. In fact, a 2016 analysis of the economic consequences from corporate inversions by economic consulting firm Bates White found that, in general, the evidence “suggests that inversions do not lead to job losses, reduced investment, and weaker companies but more likely the opposite.” As opposed to an economic negative, corporate tax inversions are a growth enhancing restructuring given that the U.S. corporate income tax code is not being fixed.
    Policymakers should recognize that the punitive U.S. corporate income tax system is driving away economic activity. Instead of penalizing firms that are attempting to eliminate impediments to competition, policymakers should enact effective corporate income tax reform that lowers the marginal tax rate, simplifies the tax system, enables the expensing of capital expenditures, and reforms the tax basis to a territorial tax system.
    Wayne Winegarden, PhD is a Senior Fellow in Business and Economics at the Pacific Research Institute and a partner in the economic consulting firm Capitol Economic Advisors.