A new study from a leading think tank should put an end to the myth that attempting to build a metaphorical tax wall to stop U.S. firms from seeking lower tax rates abroad is at all productive. The study, by economist Wayne Winegarden for the Pacific Research Institute, found that not only are such anti-“inversion” policies counterproductive, they’re harmful to the economy in any number of ways.
At issue is a trend that has building throughout the globalization era in which both domestic and foreign firms have become more willing to move assets to jurisdictions with lower tax rates, and to prevent that same income from being taxed in the U.S. and other countries. Part of the reason is the decreased cost of communication in the new, “flat” world. It’s also a result of stiffer competition owing to the larger global marketplace.
Many countries, including those the “old” Europe countries we typically think of having high tax rates and a difficult business climate, have moved to lower corporate rates and simplify their tax codes in an effort to retain domestic firms. The U.S., meanwhile, has been resting on its laurels as a historically favorable business climate, allowing those countries to leave its policies behind. Surprisingly, the U.S. now has the highest corporate tax rate in the developed world, and, although there are many, many deductions which ensure the top rate isn’t paid by many firms, those deductions themselves are a cause of economic stagnation because they distort decision-making.
Winegarden’s thesis is that inversions are merely the symptoms of the diseease that is U.S. tax policies. “Attempts to punish companies that are pursuing corporate inversions misdiagnose the problem and, in so doing, make a bad situation worse,” he writes.
In painstaking detail, Winegarden shows the real-world advantage foreign companies have over U.S. firms they are competing with. For example, the U.S. corporate rate is nearly 15 percent higher than the average rate levied by nations in the Organization for Economic Cooperation and Development, a loose collection of the largest 34 market economies.
Every year, U.S. firms lose a significant share of their profit compared to foreign firms they are increasingly pitted against in the global marketplace to higher U.S. tax rates. Additionally, the U.S. has an exceptionally burdensome international tax system that taxes income earned overseas at U.S. rates, unlike nearly every other country.
Actually, under the circumstances, inversions are actually a net plus to the economy as a whole, creating more wealth and jobs for American citizens. The same cannot be said for the tax revenues brought in by the federal government, but most people would place higher importance on economic growth.
That’s not to say that inversions are the ideal solution to a problem of high tax rates and a complicated tax code. The status quo is creating real costs on the economy, resulting in fewer jobs and lower wages. Winegarden analyzes one proposal in particular, a bill from Rep. Devin Nunes (R-CA) that would transition the U.S. into a territorial tax system and lower corporate rates while clearing out much of the clutter in the code.
Though faulting the legislation for various pitfalls like a five-percent transition tax on foreign earnings brought back into the U.S., Winegarden concludes it “would be a significant improvement in the incentives for U.S. based corporations to grow and expand.”
Reading Winegarden’s paper, most readers will conclude as he does that there’s simply no evidence that punitive tax policies are either good for the economy, nor good for their intended purpose of levying higher taxes on U.S. businesses. But don’t expect the issue to disappear so quickly. The danger from Hillary Clinton, facing a stiff challenge from a socialist rival, and other politicians demagoguing on inversions is real. It’s a classic case of a political issue for which wrongheaded, counterproductive responses make for alluring sound bytes for candidates trying to prove their independence from the financial industry.
But don’t mistake heated rhetoric for argument. As the research shows, inversions are the symptom of a larger disease: the U.S. tax code.