By: George Noga – October 24, 2014
I had not planned a posting about corporate tax inversions but I am working this in because I believe you will read a perspective herein not to be found anywhere else and, as a CPA, I don’t need to invest a lot of time in research. To begin, a tax inversion is the relocation of a US corporation’s headquarters to a lower tax nation so that it “inverts“, i.e. becomes a foreign corporation for US tax purposes. The US, unique among developed nations, imposes taxes on income earned abroad by American corporations – but the tax is not payable until the income (cash) is repatriated, i.e. returned to the US from abroad. Although there often are crucial non-tax considerations involved in inversions, the main driver usually is avoidance of US tax on income earned abroad and the ability to repatriate such funds.
Because US taxes are not due until the foreign-earned profits are repatriated, US corporations with foreign operations keep the money offshore. For perspective, 75% of US corporations’ cash is kept outside the US – about $2.1 trillion currently. For example, Microsoft has $70 billion but less than $10 billion is in the US. Money held outside the US can’t be used for investment in plant, equipment or training in the US or to hire Americans; instead, it stays abroad.
The Obama administration rails against inversions because they assert it reduces the amount of corporate income tax collected. Bear in mind that most companies currently do not pay the tax anyway – that’s why they keep the $2.1 trillion overseas. Following an inversion however, profits (cash) can be brought back into the US without tax and be used to invest within the US to create new American jobs. The increased productivity from this added investment in capital goods, job training and hiring of new workers helps all Americans and increases their standard of living. Arguably, inversions are a net blessing to America in the long run even if corporate tax collections suffer in the short run.
I return to tax inversions and repatriation infra, but inversions do not exist in a vacuum. They are but one part – and a rather small one at that – of the overall US tax scheme. To put inversions into a proper framework, we must step back, understand what is really going on and look at US tax policy from 30,000 feet.
Getting the Most Feathers from the Geese with the Least Amount of Hissing
As described in the above aphorism from Louis XIV’s finance minister, Jean-Baptiste Colbert, politicians approach taxation as an art form in which they pluck the geese (taxpayers) to get the most feathers with the least hissing. The main alternatives (cutting spending or raising taxes directly) are anathema. Politicians always enact or raise taxes to make everything as opaque as possible to taxpayers. This, of course, is diametrically opposed to the best interests of taxpayers who should want all taxes to be as transparent and direct as possible. The best tax for taxpayers would be a tax on consumption or a flat tax on income with no deductions or exemptions whatsoever.
“Don’t tax me; don’t tax thee; tax the man behind the tree.”
Let’s postulate the US had a flat consumption tax of 19% with no other federal taxes, exemptions, or deductions whatsoever and that 19% tax represented 100% of the revenue to the government. If politicians wanted to increase spending, the only alternative would be to raise the tax rate to 20% or higher. Such a tax increase would be 100% transparent to every American every time he/she purchased anything. Citizens would know the true cost of government and everyone would have an interest in keeping spending under control. The reason we have a corporate income tax (and are now discussing tax inversions) is because it is a tax that takes many feathers from the geese without the geese ever being aware they are missing feathers. This is an important concept and is explained below.
Corporations Never Pay Taxes – Only People Pay Taxes
Wouldn’t it be nice if no homo sapiens ever again paid tax? Only artificial constructs like corporations, with no heartbeat or pulse, would be taxed. This is like the mythical Germanic kingdom where candy grew on trees, lemonade flowed in rivers and the fattest, ugliest and stupidest man was king. Alas, non humans paying tax can’t happen even though politicians would like you to believe it. All taxes always are paid by real, living, breathing people; corporations never have, do not now and never will pay a penny of tax. If the government increases the tax on a company by “say” $1 gazillion, there are three, and only three, possibilities for bearing the burden of the tax.
It is true that businesses may remit tax revenue to the government, but it is not their money; they are simply transmitting funds to the government they have collected from other people. If the business chooses to pay the tax by reducing its profits by $1 gazillion, the owners (stockholders) pay the tax via lower dividends and/or a lower stock price. Most stockholders are ordinary thinking, feeling Americans investing through mutual funds, IRAs or 401(k) plans. Second, the company can cut its costs $1 gazillion; this of course means firing employees – again, very much alive ordinary Americans. Third, the company can increase its prices by $1 gazillion (and this is what happens 90% of the time) meaning consumers, again scient, feeling ordinary Americans, are paying the tax in the form of higher prices.
In reality, unlike in the mythical German kingdom, corporations don’t pay income taxes; there are only real-life human beings paying taxes; but politicians want to beguile you into believing fat-cat corporations are somehow not paying their fair share. Politicians want you to buy into their class warfare canard and they are counting on keeping you ignorant. In reality, the issue of tax inversions is moot and is a contrived tempest-in-a-teapot. Moreover, as observed supra, inversions in the long run may be a net benefit to ordinary Americans as it enables more money to be repatriated which can be used in America for capital investment to increase productivity and to employ more Americans.
Now that we all understand just how inconsequential inversions are, we still are faced with a political issue searching for a solution. The US corporate tax rate is the highest in the world at 35% federal and 6% state for a total of 41%. Everyone, including President Obama, agrees it should be lowered. Everyone also agrees the $2.1 trillion being kept abroad should be repatriated. A reasonable compromise would be to lower the US tax rate to 20% for a combined federal/state rate of 26% even though this still is higher than many countries that are between 12.5% and 20%. This should be combined with a tax holiday for companies to bring home the $2.1 trillion being held offshore by paying a nominal one-time tax. This was done in 2004 and 800 companies participated, repatriating over $300 billion in overseas profits.
In any other time with any other president, a compromise would be easy. However, President Obama, is intransigent; he will only compromise to lower the tax rate and to repatriate the funds if new and highly punitive corporate tax measures are part of the deal. Consequently, nothing will happen while Obama remains president. Inversions will continue; trillions of dollars will remain offshore; and ordinary Americans will suffer the consequences. Obama is banking that these same ordinary Americans will succumb to his anti-business, class warfare narrative that corporations pay tax and that inversions are a manifestation of corporate greed. In short, he is demagoguing the issue to death.