Protecting the tax base: the importance of trying to block tax inversions
Here’s a tax policy issue I humbly submit you should agree with me on even if we have polar opposite views on taxation: an eroding tax base is a bad thing.
If you share my perspective, you recognize that we will need more, not less, revenue in the future to meet the basic challenges we face. The more money that is shielded from taxes, the more we’ll have to raise rates on the dwindling share that remains. Also, the parts of the base that are eroding are the types of income held by the wealthy, so base erosion leads to higher after-tax inequality.
But even if, unlike me, you’re a supply-side trickle-downer who wants lower rates, an eroding tax base means you’re not going to be able to lower rates without blowing up the deficit — that’s true even if you make unrealistically flattering growth assumptions.
That’s why partisans of all stripes should applaud the fact that the Treasury is reportedly about to release new administrative rules — “targeted guidance,” as they call it — to reduce the incentives for American companies to “invert” their tax status.
Corporate inversions, as Treasury Secretary Jack Lew recently put it, occur when a firm “…changes its tax residence to reduce or avoid paying U.S. taxes…a U.S.-based company engages in an inversion when it acquires a much smaller foreign company and then locates the merged company, for tax purposes, outside the United States, typically in a low-tax country.”
The key point is that the main thing the inverting company changes here is its tax mailbox and thus where it books its profits, not its actual location. So it’s still taking advantage of our infrastructure, our markets, and our educated workforce — it’s just significantly cutting what it contributes to them.
That’s classic tax avoidance and tax-base erosion. The process can’t be blocked without legislation, but Congress has refused to take action, so Treasury has every right to go after it with whatever tools they possess.
Basically, the Treasury can enact speed bumps on the road to perdition inversion. Over a year ago, they announced changes to the tax code designed to thwart some of the tricks domestic firms engage in to qualify for inversion. Under current law, U.S. companies can invert when the new foreign parent holds more than 20 percent of a company’s total equity. Inverters use “cash boxes,” “skinny downs,” and “spinversions” to artificially inflate what counts as foreign-parent-company equity, and the rules proposed in Treasury’s last run at this go after these cute-sounding ploys.
For reasons I do not understand, the IRS has yet to formally incorporate these year-old changes in the tax code. Moreover, what would really help here is Congressional action to raise the invertible equity share to 40 or 50 percent, as Rep. Sandy Levin (D-Mich.) et al proposed to do earlier this year.
I expect that, for their next act, Treasury will go after “earnings stripping,” the inversion version of the classic multinational tax avoidance strategy where you take your deductions in the high-tax country and book your profits in the low-tax country.
But isn’t the problem that when it comes to corporate taxes, we’re the high-tax country? Not really. Our statutory corporate tax rate (35 percent) may be higher than that in many other countries, but because of all these tax avoidance schemes, the effective corporate rate is closer to 20 percent. Many of our multinationals already pay much less than that; the pharmaceutical company Pfizer, a firm that’s long been looking to invert, paid an effective tax rate of 7.5 percent in 2014.
We can’t win that race to the bottom. Realistic plans to lower the corporate rate take it down to the 25 to 30 percent range, and those plans depend on broadening the base. Since blocking inversions prevents base erosion, it’s complementary to corporate tax reform, but we can’t realistically dis-incentivize them by taking our rate down to single digits.
No question, we need corporate tax reform that tackles these and many more problems with the code. But there’s no chance of that happening anytime soon. In the meantime, Treasury must protect the base. I look forward to hearing about their next move and strongly urge them to get their proposed changes on the books and enacted.
After all, who knows who’ll be getting ready to move into their offices a year from now?
Update: Treasury announced their new proposal, which does not include going after “earnings stripping,” so strike that suspicion noted above (though they said they may try to get back to that in coming months). The new proposed rules build on the ones announced last year and are targeted mostly at limiting the ability of firms to invert based on ownership restrictions and on reducing the tax benefits of inversion.