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Tax Inversions Deals Show Upside Down Corporate Tax Code

July 17, 2014 J

By Eric Peterson

America’s stratospheric 35 percent corporate tax rate is one of the highest in the world.  The tax is so high, in fact, that it has made the U.S. a prohibitively expensive place for many American companies to invest their overseas profits.  Rather than bringing those profits home to grow the economy and create jobs, America’s punitive tax structure has resulted in many of these companies seeking investment opportunities abroad

One recent example of this phenomenon comes to us courtesy of Illinois-based AbbVie  Inc. and Pennsylvania based Myland Inc . — both of whom are in the market to purchase foreign competition.  Myland and AbbVie are just the latest in what is a seemingly unending stream of such potential deals that have made the news.  Although unlikely to be a topic of conversation at the water cooler, these deals help shed light on the perverse incentives created by the fundamentally broken U.S. tax code.

These deals are often referred to as “tax inversions,” a process in which U.S. firms take advantage of lower foreign tax rates (in the form of mergers or acquisitions) as opposed to the punitive U.S. rate on overseas income.  There have been a number of such mergers in recent years, with the latest being a $42.9 billion deal between U.S. based medical device manufacture Medtronic and Ireland-based Covidien.  Rather than being forced to pay the U.S. punishing tax rate of more than 35 percent, Medtronic will pay the Irish rate of 12.5 percent – saving millions of dollars in tax liabilities.  Not surprisingly, the frequency of these tax inversion deals has been rapidly increasing, with 4 of the largest 6 mergers this year offering potential tax benefits according to the Wall Street Journal.

wsj deal demands 2 300x260 Tax Inversions Deals Show Upside Down Corporate Tax Code

Fearing a fleeing corporate tax base, politicians have proposed a variety of “solutions” to this dilemma without much success – primarily because these “solutions” seek to treat the symptom rather than the disease.  The most recent attempt, entitled the “Stop Corporate Expatriation and Invest in American’s Infrastructure Act of 2014,” comes to us courtesy of Representative Chris Van Hollen (D-Md.). The legislation would classify any company as “domestic” if more than 60 percent of ownership remained based in the U.S. compared to the current rate of 80 percent. Firms would simply alter the terms of the mergers to get around this new rule and Van Hollens new rule won’t be worth the paper it’s printed on.  Moreover, if any proposal akin to Van Hollen were to gain traction, it would likely speed up corporate inversions – with companies rushing to get overseas while the getting is still good.

The fundamental problem with this proposal – as with so many others that have come before it – is that it fails to address the root cause for these mergers: the outrageously high U.S. corporate tax rate. Rather than creating a competitive tax code incentivizing companies to stay, or even move to the U.S., businesses are placed in a position of having to choose to seek foreign investment opportunities or face a competitive disadvantage with their global rivals.

Reforming the U.S. tax code would have secondary benefits beyond preventing the flight of U.S. corporations.  Approximately $2 trillion of foreign earnings by U.S. companies are sitting unused due to the repatriation rates imposed by the broken corporate tax code. Bringing down these rates to the developed nations average would not only boost domestic investment and job growth, but provide a windfall to taxpayers.

Rather than face reality and deal with the systemic problem of a wildly uncompetitive tax code, lawmakers are again attempting to put out a forest fire with a garden hose.  It’s time to put America back on the path to prosperity and that means fixing America’s broken corporate tax code.

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