The U.S. Treasury Department took a major step last week toward putting the brakes on corporate tax inversions. Those are deals made by U.S. companies with smaller foreign ones that allow the American corporation to assume the foreign headquarters address of its new partner, and thereby reduce its exposure to the high U.S. corporate tax rate.
Nothing requires a business to run its affairs to maximize its tax liability, of course, and inversions that have taken place have not been illegal. But they have been vexing to the U.S. government, which sees them as depriving the treasury of substantial tax income.
The new administration rules zero in on an accounting activity that typically accompanies inversion deals. Companies that have relocated their headquarters to foreign countries often make loans to their U.S. subsidiaries for operational expenses, and then deduct interest payments for the loans from their overall earnings. Since interest deductions are not taxed, the companies enjoy reduced domestic tax liabilities.
It is because the average corporate U.S. tax rate is 35%, among the highest in the industrialized world, that countries like Ireland, with its 12.5% rate for most companies, make tempting inversion targets.
Under the new rules, though, such debt will be treated as equity, and the interest payments as dividends, which are not deductible. So the government will have the power to tax those types of debt transactions at the higher U.S. rate. The regulations also disallow gains from previous inversions in the three prior years to count toward the size of a foreign company, which has to be of a certain size relative to an American partner for an inversion to take place.
The impact of the Treasury Department’s move was immediate. New York-based pharmaceutical giant Pfizer, which had been working on a $160 billion deal to acquire a Dublin-based company called Allergan, called off the deal because of the new rules. Pfizer in fact characterized the administration’s action as aimed at derailing the deal.
Other large corporations have also expressed their dismay over the new rules, and make the case for the benefits of inversions, both to their shareholders and to the American economy as a whole.
They point out that by reducing their tax burdens companies can grow their businesses and hire more employees. And that lower tax bills allow the businesses to invest more money domestically.
All of that may be true, but the bottom line here is that permitting unregulated inversions, in the end, deprives the U.S. of substantial tax revenues.
And there is also a reason why U.S. tax rates are so high: Ireland — and Bermuda and the Cayman Islands, other countries favored for inversions — do not maintain major armed forces or crucial military presences around the world, and their infrastructure needs and other responsibilities to their citizens pale beside those of the United States.
Taxes are what allow our country to meet the needs of the nation and the citizenry, and what allow the U.S. to protect its interests domestically and abroad, and to promote peace and freedom around the globe.
There is no escaping it: When large multinational companies pay less in taxes, American taxpayers will have to pay more. Or the government will have to do less. And so, rules to ensure that successful conglomerates shoulder a fair share of the nation’s tax burden are not onerous or unfair.
Which is not to say that the tax code couldn’t use a major overhaul — which could well include lowering the corporate tax rate. Such a re-examination of the tax structure, however, cannot come from any administration or government department. It is Congress’ responsibility.
And in the long term, only a legislative restructuring of the tax code will work to close the many loopholes available to major corporations, or at least make them less tempting. Several bills aimed at doing that have long circulated among lawmakers but have fallen victim to partisan congressional bickering.
Last Tuesday, for what little it might be worth during an election year with a lame duck president, President Obama urged Congress to take action on corporate tax reform, accusing wealthy corporations and individuals of “gaming the system,” and contending that “When companies exploit loopholes… it sticks the rest of us with the tab and it makes hard-working Americans feel like the deck is stacked against them.”
Only a Congress willing to engage in a spirit of good faith and to make compromises can effect a comprehensive tax code restructuring. That needs to happen soon.