When Washington intervenes in the economy to fix a perceived problem, more often than not it ends up causing more confusion and doing more harm than good.
Take the Treasury Departments sweeping new earnings-stripping regulations designed to stop so-called inversions, a rational business strategy allowing U.S.-based companies to recover some of the competitive advantages they have lost because America imposes the highest combined federal, state and local corporate tax rates on the planet (among OECD countries, only France comes close). By merging with a foreign corporation and moving its headquarters to another country with a lower tax rate, U.S. companies can raise their after-tax earnings, thus supplying the wherewithal for more investment, expanded production and additional hiring.
Calling inversions unpatriotic and contributing to capital flightsending investment and jobs overseasthe U.S. Treasury has been pushing new regulations in recent months to make it more difficult for businesses to avoid paying their fair share of the taxes flowing into governmental coffers.
Previously announced reforms did little to stop businesses from pulling up stakes here at home and moving to friendlier tax environments, so Treasury buckled down in April and proposed new regulations under Section 385 of the Internal Revenue Code. Those regulations would empower the Internal Revenue Service (IRS) to classify how related-party interests in a corporation can be treated as income rather than debt. The significance? Bigger corporate tax bills.
Despite being rolled out with some fanfareincluding a host of laudatory comments from President Obamafinancial institutions, business groups, accounting firms and both parties on Capitol Hill have been unimpressed, arguing that the new regulations go too far, overturn long-standing tax case law and upend foundational tax principles. As a result, businesses not even contemplating inversions will find themselves paying higher taxes for simply managing inter-company debt transactions.
News flash: businesses do not pay income taxes, only people (owners, employees, suppliers and customers) do. The corporate tax burden is shifted backward and forward in various ways depending on the nature of the industry in which the company operates. Moreover, corporate income is taxed twice: once at the level of the firm and then again at the level of individual shareholders when distributed to them as dividends. Any increases in the market value of the corporation (capital gains) are taxed when investors sell their shares. Recognizing these other taxes on corporate incomes, a principled argument can be made that the optimal corporate income tax rate is zero.
Even if one is not willing to go that far, extensive analysis conducted by Ernst and Young concluded that, The proposed regulations reach well beyond the inversion transactions that may have been their primary impetus; they extend to routine financing transactions for both non-US-based and US-based multinational corporations, for some majority-owned subsidiaries, for private equity funds and their portfolio companies, and for taxable real estate investment trust subsidiaries. In addition, if finalized in their current form, the proposed regulations would dramatically affect a wide range of mergers and acquisitions (M&A) transactions and ordinary course [of business] corporate finance and tax operations.
Alarmingly, some companies, such as Procter & Gamble, estimate that compliance with the new regulations would raise their annual operating costs by between $220 and $340 million. Earnings that otherwise would go to hiring new employees, investing in research and development or inventing new products and services instead will by sucked up by the federal government.
After a three-month public comment period during which myriad commentatorsindividual taxpayers, large and small businesses, economists, accountants and former government officialsweighed in on the changes, a senior Treasury official was forced to concede that the proposal was a blunt instrument [that] might have overdone it.
The problem isnt inversions, its our overly complex, anti-growth, anti-investment corporate tax code. And the simplest and most effective way of fixing the problem is bringing U.S. corporate tax rates more in line with our global competitors. Do that and inversions will stop without resorting to more regulations and hiring more IRS agents to enforce them.
|William F. Shughart II is Research Director and Senior Fellow at the Independent Institute, J. Fish Smith Professor in Public Choice in the Jon M. Huntsman School of Business at Utah State University, Editor-in-Chief of Public Choice, and editor of the Independent Institute book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.|
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