Many of my colleagues in Congress insist we should pass legislation to stop or dissuade corporate inversions. I agree. But as we do so, let us first be clear about the actual consequences and motivations of these transactions, and second, let’s solve the underlying problem.
In a typical inversion, an American company purchases a foreign firm and then transfers the American headquarters to the country of the acquired company. Contrary to many press accounts, such a reorganization generally does not reduce the taxes the previously American company owes Uncle Sam on income earned in the United States. Under U.S. tax law, corporate income earned in the United States is taxed by the federal government, at U.S. rates, regardless of the domicile of the company’s parent.
An inversion does, however, typically reduce the taxes the previously American company owes the United States on income earned outside the country. Unlike most developed countries, the United States imposes taxes on its companies’ global income — not just the income earned here. And while we allow companies a credit against their U.S. tax liability for income taxes paid overseas, they still must pay the difference between the foreign and the typically much higher U.S. tax rate. This results in a bigger tax bill than just about any other country imposes on its own multinational companies. Multinational companies can avoid this extra layer of tax only by leaving foreign-earned income overseas rather than bringing it home.
In short, our uncompetitive tax code punishes U.S. multinationals for earning income overseas and then investing it in America. The predictable results: Profits stranded overseas instead of invested here; and companies seeking to avoid this unique American punishment by reincorporating overseas.
Some Senate Democrats have proposed dramatically restricting the criteria that would allow an American company’s inversion to be recognized for U.S. tax purposes. This approach does not address the underlying problem of our uncompetitive tax code and would encourage foreign multinationals to acquire U.S. overseas subsidiaries and U.S. multinationals themselves, costing us jobs and investment in America.
Instead, we should fix our broken tax code by lowering corporate tax rates to a level competitive with the rest of the world. This would eliminate the incentive to invert. We should accompany rate reduction with the elimination of counterproductive deductions, credits and write-offs that clog our unwieldy tax code and distort economic activity.
Unfortunately, President Barack Obama and Senate Democratic leaders have demonstrated no interest in tackling comprehensive corporate-tax reform, so a solid, pro-growth rewrite of our ridiculous tax rules will probably have to await Republican majorities in both houses of Congress.
In the meantime, there is a more modest change we could make this year that would end tax-driven corporate inversions, simplify our tax code somewhat, and unleash hundreds of billions of dollars in job-creating investment in America: Stop taxing American companies’ overseas profits when they bring those profits home to invest in America. Start treating our own businesses the way the rest of the world treats theirs.
According to a study conducted by Laura Tyson, chairwoman of President Bill Clinton’s Council of Economic Advisors, this relatively simple change to our tax code would result in $114 billion in new investment in America each year while boosting annual gross domestic product by $22 billion and creating 150,000 new jobs. Our economy would get a much-needed boost and we would put people back to work.
Some of my Democratic colleagues object to this approach, arguing that it encourages companies to “offshore” American jobs. They fundamentally misunderstand the nature and purpose of the vast majority of American companies’ overseas subsidiaries, which exist not to export jobs, but to serve foreign markets and, in the process, create American jobs. Great American companies make products in Europe and Asia not to import to the United States, but to sell to European and Asian customers. They hire Americans to help manage those ventures. There is no good reason for our tax code to discourage this.
This issue should be addressed this year. I am ready to work with my Republican and Democratic colleagues to modernize our tax code, end inversions and create jobs in America. I hope Senate Democrats are willing to do the same.
Pat Toomey, a Republican, is the junior senator from Pennsylvania.