There is nothing sexy about corporate tax law and, even if there was, most of us wouldn't get it. The average American is more than happy to cede the details of such economic mechanics to "the few, the proud, the brainy."
Nevertheless, every once in a while, something happens in that esoteric world of fiscal arcana that breaks through the fog and grabs our attention. The proposed tax inversion deal between American icon Burger King and Tim Hortons Canadian donut empire, following close on the heels of Walgreen's thwarted attempt to do a runner, is one such event.
Burger King's corporate doings are attention-grabbing for the reason I stated above. Burger King is an iconic American brand. Where else in the world could Burger King have grown from a one-off drive-in restaurant known as Insta-burger to a $9 billion dollar global company whose logo is as recognizably American as the American flag?
Suddenly Americans are aware that a lot of American companies, controlling a lot of American jobs, are re-incorporating outside of the country. As it turns out there are far more American companies leaving than most of us realize because their brands don't grab headlines the way Walgreen's and Burger King do.
Here's a snapshot of American corporate flight over just the last year:
As Harvard-based economist, N. Gregory Mankiw wrote yesterday, in The New York Times:
The most obvious problem is that the corporate tax rate in the United States is about twice the average rate in Europe.That, at least, can be solved quickly by cutting the rate . . .
A more subtle problem is that the United States has a form of corporate tax that differs from that of most nations and doesn’t make much sense in the modern global economy.Going back to the heart of the matter leads us to the source of so many pressing American problems these days -- our thoroughly dysfunctional political sphere.
A main feature of the modern multinational corporation is that it is, truly, multinational. It has employees, customers and shareholders around the world. Its place of legal domicile is almost irrelevant. A good tax system would focus more on the economic fundamentals and less on the legal determination of a company’s headquarters.
Most nations recognize this principle by adopting a territorial corporate tax. They tax economic activity that occurs within their borders and exclude from taxation income earned abroad. (That foreign-source income, however, is usually taxed by the nation where it is earned.) Six of the Group of 7 nations have territorial tax systems.
The exception is the United States, which has a worldwide corporate tax. For companies incorporated in the United States, the tax is based on all income, regardless of where it is earned. Again, moving our tax code toward international norms would help slow corporate inversions.
As Prof. Mankiw points out:
If tax inversions are a problem, as arguably they are, the blame lies not with business leaders who are doing their best to do their jobs, but rather with the lawmakers who have failed to do the same. The writers of the tax code have given us a system that is deeply flawed in many ways, especially as it applies to businesses.And, suddenly this problem is one that is weighing heavily on Congressional as well as administration minds.
President Obama has said:
I don’t care if it’s legal. It’s wrong. You shouldn’t get to call yourself an American company only when you want a handout from the American taxpayers.Treasury Secretary Jacob Lew, speaking at the CNBC Delivering Alpha conference recently, suggested passing a package of business reforms to include cutting the corporate tax rate to 20%. However, he also echoed the president's sentiments in a recent letter to Congress explaining that:
The firms involved in these transactions still expect to benefit from their business location in the United States, with our protection of intellectual property rights, our support of research and development, our investment climate and our infrastructure, all funded by various levels of government. But these firms are attempting to avoid paying taxes here, notwithstanding the benefits they gain from being located in the United States.To that end, right before Congress' August recess, four Democrats -- Sen Richard Durbin (D-IL) and Sen. Carl Levin (D-MI), along with Rep Rosa DeLauro (D-CT) and Rep Lloyd Doggett (D-TX) -- introduced a bill that they are calling the No Federal Contracts for Corporate Deserters Act, which would withhold federal dollars from relocated companies by allowing federal agencies to stop doing business with companies if they subcontract with inverted corporations.
Introducing the bill, Sen Durbin said:
With every successful inversion, the tax burden increases on the rest of us to pay what the corporate inverter doesn’t. The burden is made worse by allowing companies to profit off of federal contracts paid for by U.S. taxpayers, while those very companies run from their U.S. tax responsibility. We should make permanent the longstanding ban on federal contracts for corporations that have renounced their American corporate citizenship.All well and good, as there appears to be bipartisan support for stemming the flow of business out of the country but solutions to urgent problems appear to be too much to expect from our dithering Congress right now. So the administration is currently considering possible executive action to at least put the brakes on corporate emigration until a more comprehensive tax reform is feasible.
Earlier this month, Stephen Shay, a former Obama administration Treasury Department official, who now teaches at Harvard, suggested some executive actions available to President Obama in a recent Tax Notes journal article.
Julie Hirschfeld Davis writing in the New York Times parsed the significance of Prof Shay's suggestion:
His article referred to a section of the tax code that allows the Treasury secretary to issue rules for determining whether a given financial instrument should be treated as debt or equity. The idea would be to limit the degree to which a foreign parent company could load up a United States subsidiary with debt, which can be deducted for tax purposes, and require that any excess be designated as equity, which is not eligible for deductions.Given the 113th Congress' track record, I'd say Plan B has a lot better chance of seeing the light of day.
Mr. Shay also proposed other administrative moves to reduce the use of offshore earnings without paying United States tax.
“They have the authority to go after those two incentives to do the deals under existing law,” Mr. Shay said of Mr. Obama’s team.
A person involved in the deals told Mr. Shay that without those two prospective benefits, 75 percent of the inversions underway would not occur.