This is the first in a two-part series that analyzes the political balloon of tax inversions, and their effect on federal revenues, and consumer confidence.
When Walgreens, the largest drugstore chain in the United States, let it be known last month, that it was not going to move its operations to either the United Kingdom, or Switzerland, following a buyout of European Alliance Boots, there was a sigh of relief among both local and federal elected officials, but in its wake it left more than a whiff of controversy, and even prompted President Obama to brand such corporate moves as “an unpatriotic tax loophole.”
Monday the treasury secretary and other officials met to assemble "a list of administrative options for Secretary Jacob Lew to consider for ways to deter or prevent U.S. companies from reorganizing overseas primarily to avoid paying federal taxes,” said the Wall Street Journal.
While economists, taxpayers and lawmakers debate the various ways that it can be accomplished, the die is cast.
Tax inversions are calculated to gain a lower corporate tax, than in the United States, where the corporate tax rate is 35% - the highest in the world. And, a June report from Barclay’s had estimated that Walgreen would save $797 million a year in taxes if it inverted.
Now the entire issue of tax inversions – a corporate loophole used when there is significant foreign revenue – has reached Congress, and Democrats have vowed “to crack down on US companies,” that has caused one senior member to act, and the proposal last week by “Sen. Chuck Schumer (D., N.Y.), would also restrict the practice of earnings stripping, where U.S. companies borrow money from overseas parents and deduct the interest expense on U.S. taxes,” as reported by the Wall Street Journal.
"It now allows you by financial alchemy not to pay taxes on your U.S. profits," said Schumer, in his initial announcement.
And, in a nod to the upcoming midterm elections the Democrats have tax inversion in their sightline, to avoid not merely the loss of revenue, but the subsequent loss to the nation’s infrastructure and economy, as individuals would be forced to make-up the difference.
“Under the arrangements, the new overseas parent frequently lends money to its U.S. subsidiary, which then repays the debt with interest. Those interest payments are tax deductible, giving the new U.S. subsidiary a way to lower the taxes owed on the revenue that remains in the U.S,” as defined by the Journal.
Politically speaking, the move may not become law as soon as lawmakers might wish because the Republican controlled House of Representatives has not been eager to even advance as short-term measure, for fears of perceived corporate vulnerability to foreign takeover.
Democratic lawmakers also noted that some companies with “very little foreign income were ready to jump on the bandwagon and follow in the footsteps of larger companies that have other incentives to invert,” despite the original profile of a company poised for inversion due to significant overseas business.
The Obama administration faced with this dilemma has looked at a variety of ways that it can attack inversions, among them, according to the Journal " is to use section 385 to authorize a new tax regulation that would limit the amount of debt a company could hold and use for the purposes of tax deductions,"
The second is for possible changes “to prohibit a type of 'earnings stripping' in which a company loads up its U.S. division with debt and then uses interest payments on that debt to offset taxable income."
And, finally a third possibility is to limit tax inversions. One part of current regulations, gives the regulatory impression that Treasury officials could interpret to give them broad powers to provide intervention in both their scope, and content.
Yet some disagree, among them Forbes magazine columnist, Mike Patton who noted that “U.S. companies are competing on a global stage and in my opinion, may the best country win. It’s not a question of patriotism. It’s a question of economics. Hence, the sooner Congress accepts this fact, the sooner the U.S. economy will begin to prosper.”
Patton notes that Washington’s actions in effect “hold U.S. corporations hostage with threats of punitive actions for those who utilize inversions.”
He is also not immune to holding the lens of politics, especially the Affordable Care Act, when he notes that it “included a 2.3% medical device tax on manufacturers on said items? Well, Medtronics, one of the largest makers of these devices, and of whom I mentioned in a previous article on Obamacare, has used this strategy and moved to Ireland. First, it purchased Ireland-based Covidien. The next step is for the merged company to renounce its U.S. citizenship and declare Ireland as its domicile.”
It’s plain to see that issue is not going to go away anytime soon, and even more so now that the Republicans have their eyes on dominating the Senate in the elections, and that this is an issue that can easily serve their motives well, not only on the campaign trail, but also if they do predominate, thus eventually killing the proposal and painting the Obama administration as being unfriendly to business, as they have done so, in the past with their objections to the Affordable Care Act, known as Obamacare.
The US corporate tax is the highest in the world, and with current estimates “that U.S. corporations are holding more than $2 trillion overseas to avoid the U.S. corporate income tax,” this proposal is bound to go beyond the talking-points of academia, and some have noted, “If these corporations were to repatriate these dollars, they would be forced to pay taxes at a rate of 35% or around $700 billion.”
Wall Street Journal columnist, John Dorfman wrote that one of the main problems is that the United States has such an idiosyncratic tax system. "If you are a U.S. citizen or corporation and earn money in Germany or Japan," he notes, "you are expected to pay tax on it to Uncle Sam. Most other countries don't do it that way. They follow the principle that income is taxed where it is earned."
It’s an argument that is hard to debate, when the math is done, but the real dilemma may have historical roots in the tax policies of this country, since the Tax Reform Law of 1986 and its restriction of long-term growth, something that Treasury Secretary Jacob Lew noted when he said, “Enacting comprehensive business tax reform is clearly the best way to address the problems in our tax code that trigger inversions,” in an op-ed piece for the Washington Post.
The Act, which had evolved for decades, was designed to not only to streamline the return process, one that often took individuals much longer than the few days, we see now see; but to also close corporate loopholes, and avoid having them take huge tax deductions, and in some cases avoid paying any taxes, through rebates, what economists term as negative taxes.
While it broadened the federal tax base, and financed steep cuts in tax rates, taking $120 billion dollars from the individual taxpayers to corporations till 1992, it also had some shortcomings: it did not provide for long-time growth, and did not provide for aggregate tax receipts, by closing the federal deficit.
However, the Act also had the unfortunate effect of raising consumer prices, because of the increased taxes paid by corporations, plus taxes paid to individual shareholders, and this so-called “double-taxation,” was passed onto the consumer in the form of higher prices.