Tax Inversions

[cm husker]

Can this administration be more wrong headed on economic issues than they are today? The developments in tax policy today are hugely negative despite the populist rhetoric to the contrary.

 

I hope to god sanders loses soon. If he were to edge into the presidency, that would be disastrous.

[NebraskaHarry]

[ZRod]

I love when people contribute interesting insights. This not so much.

[JJ Husker]

Eco comic? Is that like a cross between Euell Gibbons and Sam Kinison?

[zoogs]

Tax inversions are econ comedy.

 

By creating or buying a foreign parent, a company escapes U.S. tax on worldwide income. Most importantly, perhaps, companies that invert overseas can take advantage of the generous U.S. system of interest deductions for payments to their own affiliates abroad — benefits that are only available with a foreign parent company. And the change of address doesn’t necessarily mean a real move. Companies are free to keep their top executives in the U.S., and most of them do.

[cm husker]

The law on world wide income taxation is wrong headed to begin with, but in reality, this is really about taking a shot at foreign companies that have operations in the US. Instead of simplifying the system, they've added another distructive one on top of an already messy system.

[Lil' Red]

The U.S. Treasury Department took new steps on Monday to curb tax-avoiding corporate "inversions," with the pending $160 billion merger of Pfizer Inc and Allergan Plc seen as a potential casualty.

The Treasury said in a statement it will impose a three-year limit on foreign companies bulking up on U.S. assets to avoid ownership limits for a later inversion deal.

 

"In simple words, Allergan's key deals in the prior 36 months won't be counted (as far as meeting the inversion threshold is concerned) when doing the ownership math for the Pfizer-Allergan deal," Evercore analyst Umer Raffat wrote in a note.

Link

 

Is this what you are referring to? If so, why is it a bad thing?

[cm husker]

Yes, Lil' Red, that's what I'm referring to.

 

To understand why this is a bad thing, first you have to understand why tax inversions are pursued in the first place, and it's for two important reasons:

 

1. The United States has the world wide highest tax on corporate earnings (this is partly the justification for a lower capital gains tax imposed on individuals' stock earnings - under the theory that by the time the earnings trickle down to shareholders, they've been taxed 35% already).

 

2. The United States imposes "taxation on worldwide earnings" of any individual (including companies). This is also exceedingly rare among other countries, for either companies or individuals.

 

What this means is easiest to understand in a hypothetical:

 

Let's assume I own a US company (called USCO) that has 80% of its business operations based in the US (yay! American jobs), 10% in the UK and 10% in China, but USCO's sales are split 50/50 between US and UK buyers (let's say USCO sells suits (very nice suits based on revenue numbers). In today's system, all of the income of USCO is taxed at the worldwide highest tax rate of 35%*** (minus a complex layer of regulations related to deductions,exemptions and deferrals based on when I "repatriate" the cash rather than keep it invested in USCO's foreign operations - see example related to Apple with $100bn sitting in foreign components of company).

 

So, assuming taxable earnings totaling $100 million in a year, USCO earned $50 million in the US and the same in the UK. But, due to US policy, off the top comes $35 million (again, based on taxable income... the actual effective rate on earnings is much lower; the concepts are the same and this is easier math). Then, in most cases, the foreign country taxes the income that was earned "at the source" (i.e., from UK sales). In which case, UK applies a tax of 20% to the $50 million. That's $10 million for a total tax bill of $45 million on the $100 million in earnings.

 

Now, let's compare that to a UK-based company (UKCO) is competing against me and mirroring USCO's income profile (i.e., 50/50 split on $100 million in taxable income between the US and UK sales). Applying UK tax law, UKCO pays the 20% tax on its UK-based earnings for a UK bill equal to $10 million. Applying US tax law, UKCO pays the US tax rate of 35% on the $50 million in taxable US-sourced income for US tax bill of $17.5 million. However, unlike the USCO, the UK does not required UKCO to pay taxes on US-sourced income. The net effect is that UKCO's total tax bill is $27.5 million, which is almost 40% less than USCO's tax burden.

 

That's real money. That money goes towards all sorts of things that would make UKCO more competitive, such as R&D or simple price slashing.

 

As owner of USCO, I look at this and think "wow, what's the best way for me to cut costs and keep competing?" One way is to pick up all of my operations and move them to a foreign jurisdiction and rebrand as IRISHCO. This is obviously not desirable in most cases for almost anyone involved - US jobs are lost, companies' lose the benefit of some of the things that make the US-based companies competitive such as fairly steady rule of law, and companies may end up in places where workers aren't as equipped to perform as well as their US counterparts were.

 

The other option is to move USCO's HQ to Dublin but keep all of the operations in US (accomplished by having an Irish company buy USCO through an "inverted" merger). This means I can keep running USCO (Ireland) operations in the US, but now I pay the same tax profile as UKCO. That's it. That's all a tax inversion really is. It really shouldn't be that controversial. A company just does an intelligent thing and moves its legal domicile to a foreign country that has a better tax rate for its foreign earnings (remember, it still pays US taxes on US earnings).

 

As recently as a few years ago, almost all politicians agreed that the best solution to this perceived problem is that we should AT LEAST lower the corporate tax rate. Many economists, and some politicians, also advocated moving away from worldwide taxation and toward joining the rest of the world in using territorial-based taxation. This was because it was widely accepted that the US corporate tax laws were draconian (ranking 98th among 100 countries.. just ahead of Venezuela and Argentina if I recall).

 

Unfortunately, it's election season, and this has become a convenient political football. So instead of working to fix bad laws, we are trying to create (including by treasury fiat) more bad laws in an effort to make sure that US companies can't reduce operating costs by avoiding the original bad laws. Worse, the effort has been hamfisted and takes a swipe at foreign competitors as well as our own US companies, which, cynically, may be the real intent anyway (I can try to explain that in another post if you desire, or there's a good op-ed in the financial times about it).

What is the ultimate result? Well, USCO could eventually lose out to UKCO and go bankrupt. Or, USCO elects to shift more of its operations overseas and eventually just relocates in totality to another country (i.e., elects option 1 from above). None of this is ultimately good for the United States or even the world economy.

 

 

Interestingly, I don't think states are allowed to do this under the commerce clause. Essentially, income I earn in California can only be taxed in one state or another. It's not at all clear why we should hold US companies over the barrel between international borders when it's unconstitutional for a state to try to do so across state borders.

 

*** (I need to confirm that, as there was a push to lower it to 28%, but I don't think it went through).

[cm husker]

The last half of this oped touches on how this rule may actually be used to hurt foreign competitors who are investing in US operations. http://www.forbes.com/sites/thetaxfoundation/2016/04/05/treasury-proposes-third-set-of-anti-inversion-rules/#77f6a4361a58

 

The scary thing about these debates is that the lure of "stop the cheating" is so appealing that we ignore whether the rules that are being "cheated" are even appropriate.

[zoogs]

The tax rate can be any %. As long as there's a way to get a better deal than that -- and there always will be some country out there -- and a legal loophole, companies with the wherewithal will take it.

[cm husker]

The tax rate can be any %. As long as there's a way to get a better deal than that -- and there always will be some country out there -- and a legal loophole, companies with the wherewithal will take it.

True. And the solution is to compete better by dropping rates. Not trying to build walls against rational economic behavior.

[zoogs]

I'm not defending the status quo tax policy as perfect, but that doesn't mean we need to engage in an arms race of rate-dropping against countries that can always go a bit lower. These guys will be fine without this sort of maneuvering open to them.

 

That it's rational is exactly the problem. It seems healthier for the market overall to me if engaging in these tactics isn't that big of a win. Plainly it's a hurdle that not every company leaps; should those who can be rewarded for their 'innovation'? I'm interested in seeing more companies emerge and compete, not in protecting tactics used to find loopholes at the margins. Especially the larger companies will always, always, always find and use as many of these as they can. It's not wrong what they do -- it's just not worth deference and protection.

 

With everyone at such loggerheads, it's hard to imagine sweeping or comprehensive changes in tax policy, but you never know. This just seems like a small step in a relatively sane direction, though.

[cm husker]

I actually think that a rates race would be great. We shouldn't assume that it would be bad. Profitability and production are good! Because, what people need to understand is that "these guys" are really pensioners and mutual fund owners (and the US who needs growth to pay their obligations).

 

I agree 100% on your argument that we should reward competitors, not tax experts. That's why more laws on top of more laws is the problem. It gives an advantage to the crafty and to large companies that can pay for the crafty.

 

 

I disagree hat this a step in a sane direction. This is like porche barring the doors on people trying to leave to go to Toyota.

[cornographic]

Well, the corporations are constantly looking for places where there is the lowest tax rate and cheapest labor, so, obviously that would not be in the USA. Hence, not enough tax revenue is generated to run necessary public programs, like schools and infrastructure, etc, then everybody bitches that things are falling apart--which they are--the huge national debt, etc. We're told we are competing globally which basically means the US standard of living, as dictated by the corporations, involves a race to the bottom for most of the population. There's an inherent contradicition between corporate greed and The People, so I don't know how it would change: it's raw capitalism.

 

Bernie wants to make the corporations pay their fair share, but the US worships corporations so much, and they have all the power, can't see how it's going to change anytime soon, if ever.

 

Funny thing is, re: inversions in Ireland, I guess it's not necessarily doing the Irish well either as there has been a great wave of Irish emigration:

 

 

 

Since 2008, 400,000 people have left Irish shores, from a population of just over 4.5 million. Almost 250 leave the country every day, prompting many to ask if Ireland has returned to old habits. Is the Emerald Isle once again exporting its population?

 

http://www.csmonitor.com/World/Europe/2014/0315/A-new-great-Irish-emigration-this-time-of-the-educated

[AR Husker Fan]

Interesting study recently completed by the Government Accounting Office (GAO). Finds that the Effective Tax Rate for corporations is significantly below the Statutory Tax Rate (what is paid verses the actual tax rate).

 

 

 

In each year from 2006 to 2012, at least two-thirds of all active corporations had no federal income tax liability. Larger corporations were more likely to owe tax. Among large corporations (generally those with at least $10 million in assets) less than half—42.3 percent—paid no federal income tax in 2012. Of those large corporations whose financial statements reported a profit, 19.5 percent paid no federal income tax that year. Reasons why even profitable corporations may have paid no federal tax in a given year include the use of tax deductions for losses carried forward from prior years and tax incentives, such as depreciation allowances that are more generous in the federal tax code than those allowed for financial accounting purposes. Corporations that did have a federal corporate income tax liability for tax year 2012 owed $267.5 billion.

Here's the study: Most Large Profitable U.S. Corporations Paid Tax but Effective Tax Rates Differed Significantly from the Statutory Rate