Corporate executives are being criticized
for bad decisions, some of which have crossed the line into
criminal behavior. This heightened attention has helped to create a
political environment in which all corporate actions are
suspect--including decisions by some companies to re-incorporate in
low-tax jurisdictions (a step commonly known as inversion or
expatriation). At the very least, critics accuse these firms of
being unpatriotic. In many cases, they have asserted that such
companies are engaged in a questionable form of tax evasion.
claims are absurd. The decision to re-incorporate in a low-tax
jurisdiction should be viewed as a prudent and responsible business
reaction to a tax code that severely hinders the ability of
U.S.-chartered firms to compete in world markets. Expatriation
allows a company to compete on a level playing field with
foreign-based firms while maintaining its headquarters and jobs in
America--a combination that advances U.S. interests. And since the
company continues to pay tax on all income earned in the United
States, the evasion issue is a red herring.
How the Tax Code
Makes U.S. Companies Less Competitive. About two dozen
companies in the last few years have re-chartered or are in the
process of re-chartering in low-tax jurisdictions. In virtually
every instance, anti-competitive tax policy is cited as the reason.
There are two main reasons why the internal revenue code makes it
difficult for corporations chartered in the United States to
First, the U.S. corporate tax rate is very
high. The federal government imposes a 35 percent tax on corporate
income, and states on average grab another 5 percent. This
cumulative 40 percent tax rate is significantly higher than the 30
percent average corporate tax burden in other developed
Indeed, the tax burden on U.S.-based
corporations, which is currently the fourth highest in the
industrialized world, will soon be the second highest once Belgium
and Italy implement their planned tax rate reductions.
Second, U.S.-chartered firms must pay tax
to the Internal Revenue Service on income earned in other nations.
This "worldwide taxation" policy puts American-based companies at a
disadvantage since many of our trading partners rely on
"territorial taxation"--the commonsense notion that governments
only tax income earned inside their borders.
combination of these misguided policies is crippling U.S.
competitiveness. Consider what happens, for instance, when a U.S.
company competes against a Dutch company in Ireland. Because
Holland has a "territorial tax" system, the Dutch company pays only
the 10 percent Irish corporate income tax on its Irish income. The
American company, though, must pay the 10 percent Irish tax and the
35 percent U.S. corporate income tax.
American company can claim a tax credit for the taxes paid to
Ireland and the U.S. tax can be deferred under some circumstances,
but the ultimate tax burden on the American company is still about
three times higher than the tax burden on the Dutch company. Adding
insult to injury, America's international tax rules impose
disproportionately heavy compliance costs on U.S.
competitive disadvantage puts American firms in an untenable
situation. If U.S.-based companies do nothing, they inevitably will
lose market share--which means fewer jobs for American workers and
lower returns for American shareholders. Or they can allow
themselves to become a subsidiary of a foreign company, which now
occurs in 75 percent of cross-border mergers.
What Is the
Answer? There are three possible political responses to
- Lawmakers can fix the tax code;
- They can choose to do nothing; or
- They can implement fiscal protectionism by
prohibiting companies from re-chartering in jurisdictions with
better tax laws.
#1: Fixing the tax code is the best way of responding to
corporate inversions. If lawmakers shifted to a territorial tax
system, companies would no longer have any incentive to expatriate.
U.S.-based firms could compete on a level playing field with
foreign-based companies, and compliance costs would drop
significantly. But lawmakers also should reduce the corporate
income tax rate. This would substantially improve incentives to
create jobs in the United States.
#2: Doing nothing is an acceptable option. Bad tax law
would still be in place, but companies would be able to sidestep
the anti-competitive policy by re-chartering. In effect,
expatriation is a "do-it-yourself" form of territorial taxation.
Like companies based in many other nations, companies that
expatriate would pay just one layer of tax to each nation where
profits are earned, including all applicable taxes to the IRS on
income earned in America.
#3: Some lawmakers want to prohibit companies from
expatriating. But fiscal protectionism is the wrong response.
High-tax California, for instance, should not be allowed to stop
companies from moving to low-tax Nevada, and Vermont should not be
able to hinder the flow of businesses to New Hampshire. Barring
companies from re-chartering in other jurisdictions is particularly
shortsighted, since it condemns U.S. companies to declining market
shares and leaves them vulnerable to tax-motivated foreign
Conclusion. Corporation bashing may be
fashionable, but it is not constructive. Instead of blaming the
victim of their poor tax policies, Members of Congress should fix
the tax laws that cause companies to expatriate. The United States
imposes a higher corporate tax rate than those of Sweden and
France, two of the world's most socialist nations, and it even
imposes that burden on income earned in other nations.
lawmakers choose not to fix the tax code, the best response is
inaction. Expatriation helps U.S. workers and shareholders, since
the newly formed company still maintains its U.S. operations, but
is able to compete more effectively with businesses that operate
overseas. Companies that re-charter escape the IRS's "worldwide"
tax system, but they still keep their operating headquarters--and
their jobs--in the United States.
J. Mitchell, Ph.D., is McKenna Senior Fellow in Political
Economy in the Thomas A. Roe Institute for Economic Policy Studies
at The Heritage Foundation.