In a new paper, entitled "Policy Responses to Corporate Inversions: Close the Barn Door Before the Horse Bolts," the Economic Policy Institute's (EPI) Thomas Hungerford looks at the reasons why the United States Congress should immediately pass legislation to tackle corporate inversions, rather than waiting for comprehensive tax reform.
Hungerford discusses policy solutions to halt the flow of US multinationals that are being seen to use corporate inversions when merging with an offshore counterpart to move their headquarters abroad. However, "if Congress does not settle on a targeted legislative fix and do it soon, the US could essentially lose much of its corporate tax base," the paper states.
The EPI notes that, while inversions are typically portrayed as a way of escaping the relatively high US 35 percent statutory corporate tax rate, "corporations have many ways of lowering their tax bill. Despite what you hear in the media, inversions have never been primarily about fleeing high statutory corporate tax rates."
Hungerford believes that "the principal reason for inverting is to avoid paying taxes on foreign-sourced earnings held overseas – taxes already owed to the Treasury. For these firms, inverting is a way of dodging their tax bill, not a natural result of the US corporate tax rate."
"Most of the firms seeking to invert have a large stash of tax-deferred earnings sitting offshore. These earnings are subject to the US corporate income tax (with a credit for foreign taxes paid), but only when they are repatriated to the US parent as dividends," the paper adds. "By inverting and then using a variety of schemes, the firms can have access to these earnings virtually free of US taxes. This is undoubtedly the primary motivation to invert."
In opposition to recent commentators who have suggested that comprehensive tax reform to lower the US corporate tax rate is the only real cure for the inversion problem, the EPI is therefore convinced that, given the way that reform is likely to be structured, it will not fix the inversions problem by itself.
Hungerford points out that, "not only is it unlikely that tax reform will pass before too many companies invert, but if tax reform is revenue neutral (as most proposals are), it will lower the statutory tax rate but not the average effective tax rate. Hence, corporate tax reform won't reduce the incentive companies have to invert."
Instead, he recommends specific and immediate legislation to address the incentives and ability of firms to invert. While "changes in tax regulations (which the US Treasury Department could promulgate without congressional approval) are a necessary stopgap measure to reduce the outflow of the US corporate tax base, Ö only targeted legislation that reduces the incentives and ability of firms to invert can truly protect the corporate tax base."
He recommends, for example, the rules that have already been suggested in Congress and by the Administration, and that would require that current shareholders of the US firm own less than 50 percent of the new merged foreign firm, rather than 20 percent under current law, and that firms be treated as US corporations if they are managed and controlled in the US and have significant domestic business activities here.
Additional measures could include preventing the practice known as "earnings stripping," by denying interest deductions where US companies had debt over a certain level, and preventing corporations from using tax-deferred offshore cash in ways that benefit US shareholders without paying US taxes.
"If companies want to become foreign entities, then they should have to actually become foreign entities," Hungerford concluded.