Should Americans be worrying about tax inversions?

The recent news of Burger King’s takeover of one of Canada’s largest coffee makers, Tim Horton, has sparked the interest of many mainly because of an underlying reason behind this acquisition – tax inversions. Tax inversions refer to the process where companies move their operations overseas in order to avoid harsher domestic corporate tax rates. In this case, the third largest fast food company is taking over Tim Horton’s so they can legally move to Canada, allowing them to take advantage of the lower effective tax rate they will face compared to that in America. Indeed the executives of Burger King have recently come out and said this deal is not motivated by tax, but it nevertheless seems to be a relevant factor given that the Canadian base allows them access to future international profits without having to pay any more incremental repatriation of taxes.

This is not the only case of a large company moving for tax inversion purposes in recent times either. Since 2012, the graphic below displays that some of the biggest global mergers have resulted in company’s moving their headquarters to other countries with more lenient tax restrictions:

Figure 1

 

These relocations are however hardly surprising. Many businesses consider America to have some of the most hostile corporate tax rules in the whole world. The following graphic displays the corporate tax rates of many countries, showing that America’s corporate tax rate is considerably higher than any other country.

Figure 2

Furthermore, this coupled with America’s extremely complex tax laws explains the recent trend for companies to resituate their operations to take advantage of foreign tax laws.

Despite fostering this unaccommodating corporate environment, in the last couple of months there has been extreme backlash over such deals. President Obama himself has led aggressive rhetoric against such corporate inversions, denouncing them as abusing an “unpatriotic tax loophole”. Ohio Senator Sherrod Brown has gone so far to actually call for the “boycott of Burger King” due to this curtailing of US taxes. Furthermore, numerous bills are being drafted to make it more difficult for companies to re-establish themselves overseas and sidestep these taxes.

The question to be asked here is: are politicians simply over-exaggerating the severity of the situation or is the issue at hand in fact as bad as they are making it out to be? In order to answer this question, what must first be considered is the loss in tax revenue that the US government faces as a result of these deals. A tax inversion deal does not relieve a company of its existing tax burden, but rather only allows them to access future foreign earnings without having to pay an additional US repatriation tax (they will only be taxed at the foreign country’s tax rate). An independent research panel forecasted that over the next decade, the US government will lose approximately 19.5 billion dollars in taxation revenue. Let’s put this into context – the US government borrows approximately 28 billion dollars in new debt every week. Just comparing these figures illustrate how minute the loss of this much tax really is.

So perhaps, the excessive antagonism towards corporate inversions is actually misplaced. The trend towards tax inversions should not be halted in a statist way but viewed as a signal that companies are trying to conduct their own self-help tax reform. With U.S corporate tax rates nearing 40% it becomes difficult for American companies to compete with foreign-owned companies in foreign markets. This tends to hurt U.S companies and as a result we get a flow-on effect that adversely affects U.S operations and workers. So what’s the solution? Simple, the only way to reduce tax inversions sensibly is to reduce the corporate tax. Canada was not always an attractive environment for businesses to operate. However in 2013, Canada slashed its federal corporate tax rate from 28 per cent to a mere 15%. The effect? Not only have more businesses shifted reported profits into Canada and boosted domestic investment there, but tax revenue is also now 1.9% of their GDP up from 1.7% in the financial year ending 2014. Both businesses and government benefited in this situation.

Congress should not be concerned with preventing companies from leaving America. Closing tax loopholes such as these have proved time and time again to be too difficult and too slow a process. Instead, policy makers should focus on discouraging relocation by creating a much simpler tax code with a lower corporate tax rate.

 

Further reading:

Burger King Plans to buy Tim Hortons

Just one way to stop corporate inversions: cut taxes

Obama: Tax loophole that allows companies to leave the U.S. is ‘unpatriotic’

Burger King, Tim Horton merger plans raises tax inversion issue

Ignoring the Facts on Corporate Inversions

U.S. Stands to Lose Billions from Corporate Tax Inversions