The U.S. Corporate Tax Monster and Economic Patriotism
There is a rush by U.S. Corporations to flee the country for more business friendly locations in Europe. One of the latest is Walgreens, but they were preceded recently by Medtronic, Mylan, AbbVie, Salix and an attempted takeover of AstraZeneca by Pfizer (Wall Street Journal 2014). The process is not new, but it has accelerated recently with 14 prominent announcements so far in 2014. The recent exodus has been dominated by use of an inversion, in which an American company acquires a foreign company in a country with lower taxes.
HIGH AND LOW TAX COUNTRIES
The United States has the highest corporate tax rate (35%) among developed countries, and lower taxes are the main motive for the inversion. Where are the companies moving? Not to France and other high tax countries. The most common destinations have been low tax countries, such as Ireland (tax rate 12.5%), the United Kingdom (21%, and the Netherlands (25%). To make the merger profitable, the host country must also have promising companies that are good matches for the acquiring firm. The host country must also have a good reputation for enforcing property rights and contracts. Low tax rates are not sufficient to attract foreign funds.
IDIOSYNCRATIC US CORPORATE TAX
What are the effects of the U.S. tax rate being above those in other developed countries? Without some offsetting relief, U.S.- based corporations would be at a competitive disadvantage relative to foreign-based companies whose other costs are similar. Consequently the Congress has introduced many complex exemptions into the tax code, including allowing firms to defer paying U.S. taxes on foreign earnings until the funds are returned to the U.S. The United States is one of the few countries that taxes global earnings of a corporation, rather than just domestic earnings. An unintended consequence of the high tax rate and the peculiar exemptions is that U.S. companies held approximately $2 trillion abroad at the end of 2013 (Bloomberg 2014). Keeping funds abroad is intended to avoid U.S. taxes, but it is perfectly legal.
TAX REVENUE IN HIGH AND LOW TAX COUNTRIES
What are the effects of the recent flight of corporations to lower tax domiciles? Tax revenue received by the U.S. Treasury is billions of dollars less than it would have been. One Congressional staff estimate was for a revenue loss of $20 billion in the next decade. Conversely governments in low tax host countries receive more revenue, and they usually welcome inversions. In the U.S., shareholders (especially influential institutional shareholder) have encouraged inversions. U.S. government officials and some populists have opposed inversions. Secretary of Treasury, Jacob Lew, denounced guilty corporate executives for being unpatriotic. (Graetz 2014)
THE CORPORATE TAX MONSTER
The corporate tax rules have evolved into a Frankenstein monster. No rational individual would have designed such a bizarre creature. Who is responsible for the tax monster? The rules were created by various Congresses and signed by Presidents, but the current Congress and President are ultimately responsible. They are authorized to change all the tax rules today or on any day that they have the will. Congress and the Executive branch are continuously lobbied by various coalitions, some advocating higher tax rates, others advocating lower rates and/or larger loopholes to provide relief from high rates. Congress and the Administration must evaluate these competing interests and take responsibility for their actions, rather than blaming corporations for responding to incentives created by the government.
Companies that have move abroad or are openly discussing moving abroad for tax reasons have been criticized by presidents, members of Congress, and the public for being unpatriotic (Graetz 2014). Secretary of Treasury Lew, has called for corporations to abandon their greed and engage in “economic patriotism”. It is an odd notion of patriotism, since the companies are abiding by all US tax laws, and corporate executives are satisfying their fiduciary obligations to their shareholders. To be considered an economic patriot, does one have to pay more than 100% of one’s legal tax obligations? If individuals itemize their tax deductions and include exemptions such as mortgage interest on loans, are they being unpatriotic? Most Americans do not compute and file their own income taxes, because the rules are too complicated. Are the tax accountants they hire to find additional deductions for them also unpatriotic? Why wouldn’t it be patriotic for those who make tax laws to repeal rules that put U.S. corporations at a disadvantage relative to their competitors in other countries?
CORPORATE TAX REFORM
The U.S. corporate tax code includes the highest tax rate in the developed world and various complex exemptions. The resulting tax monster provides legal incentives for American to send trillions of dollars abroad. More generally, in a world of internationally mobile capital, high tax countries will experience capital outflows by profit-motivated companies. However, tax-induced capital outflows can be reduced by fundamental reform of the tax code, without appealing to patriotism. The government could receive the same total revenue from the corporate tax by engaging in fundamental reform. They could lower tax rates and close tax loopholes without losing revenue, and U.S. corporations would be more competitive. In the long run, a more fundamental reform could be the elimination of the corporate income tax (McArdle 2014). Corporate earnings are currently taxed twice, once as corporate profits, and again as dividend income and capital gains of shareholders. Currently capital gains are taxed at a lower rate, but tax reform could include taxing capital gains as ordinary income.
INDIVIDUAL INCOME TAX
The issue of corporations moving their assets in response to international tax differences also applies to internationally mobile individuals. Countries with steeply progressive income tax rates have discovered that high income individuals are willing and able to relocate to lower tax domiciles. A recent study of high- paid European soccer players has demonstrated their high degree of international mobility (Kleven et al 2013). Legal tax avoidance by people gaming the tax system is also common in a purely domestic context. The U.S. individual income tax also combines progressive tax rates with extensive tax exemptions that allow certain wealthy individuals, such as Warren Buffett and Mitt Romney to legally pay lower tax rates than many people with lower incomes. The federal government could earn the same amount of revenue they currently receive without distorting people’s behavior, by lowering marginal tax rates and closing the extensive loopholes in the current tax code.
Recently, American corporations have been fleeing to more friendly locations to avoid U.S. taxes. In some cases they have used inversions to move their headquarters abroad. In other cases, corporate headquarters have remained in the U.S., but assets were sent abroad. In both cases, their actions were legal and rational responses to perverse tax incentives created by the U.S. government. Congress and the Administration are authorized to change the rules any day, and criticizing corporate officials for lack of patriotism is a feeble attempt to shift the blame from its ultimate source. If Congress were willing to carry out fundamental reform of corporate taxation, they could lower tax rates and broaden the tax base without losing any revenue, and funds would flow home without any appeal to patriotism.
Bloomberg. 2014. “Cash Abroad Rises $206 Billion as Apple to IBM Avoid Tax”. March 12.
Graetz, Michael. 2014. “Inverted Thinking on Corporate Taxes”. July 17.
Kleven,Henrik, Camille Landais, and Emmanuel Saez. 2013. “Taxation and International Migration of Superstars”. American Economic Review, 103(5): 1892-1924.
McArdle, Megan. 2014. “We Don’t Need a Corporate Income Tax”. Bloomberg View, July 16.
Wall Street Journal . 2014 “Walgreen Eyes Its Own Tax Inversion”. July 16
Wall Street Journal. 2014 “US Firms Pack Up for Tax Benefits”. May 12.
6 Responses to “The U.S. Corporate Tax Monster and Economic Patriotism”
This is the practice of true freedom. To submit to voluntary financial abuse, is to subject yourself to slavery. Maintain the status quo and the same destructive policies, but expecting different results….. why continue this insanity?
If businesses (or individuals) are threatened if they do not pay more than their legal tax
obligations, doesn't this sound like extortion? Senator Sanders says businesses are using U.S. government services, but not paying for them. Isn't that what legal taxes are for?
"Corporate earnings are currently taxed twice, once as corporate profits, and again as dividend income and capital gains of shareholders." Nonsense. Corporations either are legal persons or they're not. If not, the owners of the business are partners, and as such, they are all legally personally liable for the losses caused by the business they own.
It's called "personal responsibility," a phrase often uttered by the whining wealthy who hold lots of stock. If the corporation is a person, then only that person is legally liable and the wealthy shareholder gets a government-granted get-out-of-liability card essentially free. But if the corporation is a legal "person," then it is also a taxpayer, distinct from those who own that person. Everybody–one hopes–pays his, her, or its taxes, and no one is double taxed. And to the retort that it's nevertheless unfair to tax corporate profits before and after they're distributed, what about the poor unfortunate personal-injury victim of corporate business activity who is left to eat the loss under the government-mandated wealth transfer mechanism that is the corporation. Perhaps the wealthy should pay a bit for what they get.
The corporate mechanism has been, without question, an enormous benefit to virtually all mankind. The economic prosperity it has and continues to generate is beyond anything otherwise achievable or conceivable. But it is a government game, one that implicates government responsibility and a game that does not function for long without government regulation and control. Any reform that does not recognize such fundamentals and the need to balance "market forces" with political realities (domestic and international) and public interest and welfare is silly at best and dangerous at worst.
Corporations are legal entities with privileges (enter contracts, issue bonds and stocks) and
responsibilities (pay wages, pay taxes). The corporate tax has proven to be a very inefficient
tax as demonstrated by tax inversions and trillions of dollars held abroad in response to tax loopholes. Since all corporations are owned by shareholders, eliminating the corporate tax
could be offset with any tax on the incomes of shareholders.
I agree that the corporate form of business organization has made a large contribution to economic prosperity. The poorest countries in the world have only rudimentary stock markets.
I am not against prudent regulation of corporations, including not for profit corporations. I am
against grossly inefficient corporate tax laws, such as the monster that the government of the United States has created. Corporate tax reform by the Congress is overdue, and prudent reform should take account international capital mobility by multinational corporations.
I really like your writing style, excellent information, regards for posting : D.
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