Just about everyone agrees that U.S. corporate tax laws are a mess. President Obama says so. Congressional leaders of both parties say so. The 35 percent nominal rate is about 10 points higher than the average for the rest of the developed world. Such a high rate is made bearable by a labyrinth of credits, deductions and sundry crony capitalist gimmicks that serve little purpose other than to misdirect and waste resources.
One of the nastier quirks of U.S. corporate taxation lies in where income is taxed. Just about everyone else follows a simple rule: You pay taxes to the country where the income is earned. Income earned in France is taxed under French law and paid to the French treasury. Income earned in Portugal is taxed under Portuguese law. And so forth.
But that’s not good enough for Uncle Sam. If income earned abroad by a U.S. corporation is brought back to the United States, after being taxed in the country where it is earned, the income is taxed again under U.S. law (and typically at a higher rate) with a credit for taxes already paid to the country of origin.
That difference can be in the billions of dollars in U.S. taxes on top of foreign taxes already paid. It’s a big incentive for U.S. corporations to become foreign corporations by buying or merging with a foreign company and changing their domicile to the foreign address. The nickname for this is “tax inversion.” Burger King buying Canadian restaurant chain Tim Hortons and Pfizer merging with Irish drugmaker Allergan are recent examples that have made the news, but dozens of other large deals have been made largely to avoid taxes.
When you see business decisions being made for tax reasons that serve no productive purpose, there’s a pretty strong presumption that something is seriously wrong with the tax code. CEOs who engineer such deals are vilified as un-American tax dodgers. But who can really blame them? If a company wants to use foreign earnings to invest or pay dividends in the United States and a tax inversion legally avoids a sizable tax hit for repatriating those earnings, a CEO would be derelict in his or her duty to shareholders not to look for an inversion partner.
If the political leadership agrees the tax code is loopy, how about a simple solution? Fix it.•
Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to firstname.lastname@example.org.