The U.S. Treasury Department issued new rules last month designed to make it more difficult for U.S. companies to strike “tax inversion” deals — transactions in which a U.S. company merges with a foreign business located in a lower-tax jurisdiction, and then reincorporates overseas in order to reduce its tax bill to Uncle Sam.
Tax inversions are driven by two key factors: first, the U.S. tax code, alone among developed countries, seeks to impose income taxes on the worldwide profits of U.S. companies, not just U.S. profits; second; the 35 percent U.S. corporate income tax rate is the highest of any developed country, and even though a credit is granted for any foreign income tax paid on non-U.S. source income, the rate differential is still likely to result in a substantial U.S. tax bill. No other country does it this way. They don’t tax extra-territorial profits, and the territorial profits they do tax are taxed at lower rates.
As a result, U.S. companies and their shareholders are placed at a distinct and measurable disadvantage. Their worldwide income is, in effect, taxed at the high U.S. 35 percent rate. So they “invert”, and become foreign corporations for tax purposes, and henceforth only their U.S. profits are taxed at the 35 percent rate, putting them on the same level tax playing field as their global competitors. Nothing illegal, sinister or unpatriotic about it. (U.S. companies don’t have to pay taxes on foreign profits until that money is “repatriated” into the U.S., but that is yet another issue for yet another day.)
The growth of tax inversions in recent years stands as compelling market-driven evidence that our corporate income tax system is in serious need of an overhaul. As the inversions demonstrate, the rate is too high and the reach too broad. High tax rates discourage U.S. investment. Investment decisions should be based upon economic merits, not tax considerations.
Level the playing field — lower the corporate tax rate and lessen its reach. Otherwise, the incentive remains for U.S. companies and their cadre of tax advisors and lobbyists to find their way around the rules, and U.S. investment will suffer.
Whenever the topic of tax reform rears its head, it is useful to remind ourselves how relatively unimportant the corporate income tax is as a revenue source, and how easily we could get along without it. In recent years, the corporate income tax has generated approximately 10 percent of total tax revenue. The real revenue raisers are the individual income tax and payroll taxes (paid equally by employee and employer), which together raise about 80 percent of all tax revenue. I can only imagine the positive energy that would flow into the U.S. economy if Congress were to pass, and the President sign, legislation doing away with the corporate income tax altogether. U.S. investment would skyrocket. The economy would grow. New jobs would be created, salaries would rise, and in relatively short order the increased tax revenue from the individual income tax and payroll taxes — the real tax revenue generators — would more than compensate for the corporate income tax.
Guest blogger Jeff Lerner is a tax attorney who resides in Fort Worth, Texas. Over a 40 year career, he has provided legal representation to a diverse list of clients, including railroads, energy companies and Indian tribes. He was formerly Vice President-Taxes for the Burlington Northern Railroad Company (now BNSF).