Inversions Are a Symptom of a Failing Tax Code

Once again, a possible corporate inversion is making headlines and once again, the Obama administration has proven it does not understand the real reason inversions occur.

In response to news that pharmaceutical firms Pfizer and Allergan are in merger discussions, the Obama Treasury department has suggested it would do its utmost to block the deal.

As reported by the Wall Street Journal, Treasury is determined to take action against inversions using a “broad range of options,” including imposing heavy penalties and burdensome new rules on businesses.

While new regulations will make life difficult for companies looking to merge, it will ultimately not solve the problem. Indeed, Treasury’s comments demonstrate an unwillingness to understand and address the root cause behind inversions.

In effect, inversions occur when a US company merges with a foreign company. The new company then bases its headquarters in the foreign country. These type of mergers occur for two reasons.

First, the U.S. has one of the highest corporate tax rates in the developed world. Including state income taxes, the business tax rate is nearly 40 percent for corporations and approaching 50 percent for flow-through firms. By comparison, the UK’s rate is 20 percent, and Germany and Canada’s rate is just 15 percent.

Lowering the business rate to under 25 percent, the average rate among developed countries, would put US business on a more even playing field. All of a sudden, companies would have less rationale to invert because they are now subject to a fairer marginal tax rate.

Second, the U.S. double taxes income earned abroad. Most of the world has a territorial tax system. They tax money earned in their country but welcome the return of money earned abroad tax-free. This makes sense because this money is already taxed in the country where it was earned.

The US is among a handful of countries that does things differently. We have a worldwide tax system, which means that if you are an American business, the IRS tries to tax everything you earn regardless of where you earn it. Incidentally, every other country that has a worldwide tax system has lower rates than the US.

Moving to a worldwide system of taxation will mean the IRS no longer goes after every penny US companies earn, and will remove a key reason that companies look to inversions.

The issue of double taxation has been raised during past inversions. Critics of the Burger King – Tim Horton inversion last year complained that this merger would mean that Burger King would no longer be paying its “fair share.”

What this really meant was that Burger King would no longer be subject to double-taxation on income it had earned abroad, and already paid taxes on in the country of origin.

If the “pay your fair share” crowd were really serious about addressing this issue, they would recognize that the tax burden the US subjects business to far exceeds that of other developed countries in both scope and complexity.

The fact is, inversions occur because of a US tax code that is fundamentally more onerous and complex than the tax codes in other developed countries. Until the administration gets serious about addressing the real problem, inversions will continue to happen, regardless of any new regulations treasury imposes.