Former Chief of Staff for the congressional Joint Committee on Taxation (JCT), Edward Kleinbard, writing in the Wall Street Journal, argues that “tax inversions must be stopped now.”
Kleinbard may understand taxes but like so many on the left has a weak grasp on economics and on the proper relationship between a government and its citizens (including those operating within corporations).
Tax inversions involve an American company buying a foreign firm in order to move its tax domicile to the lower-tax foreign location. Some of the most common recent inversions involve buying Irish companies.
For example, Medtronic, a Minneapolis-based maker of medical devices (especially pacemakers), is buying Covidien which has its tax domicile in Ireland — a country with a 12.5 percent corporate tax rate as compared to the U.S. rate of 35 percent — before the average 4.1 percent state tax rate for a statutory rate of 39.1 percent, the highest in the industrialized world. According to the Minneapolis Star-Tribune, “Medtronic Inc. could avoid $3.5 billion to $4.2 billion in U.S. taxes on funds it holds overseas” as a result of the transaction.
Kleinbard isn’t the only critic of these transactions.
Senator Ron Wyden (D-OR) calls these deals a “plague” and is pushing for retroactive legislation to end any tax benefits for recent inversion mergers and acquisitions. Says Wyden, “The underlying sickness continues to gnaw away at the American economy with increasing intensity.” Senator Chuck Schumer (D-NY) is focusing on ending the ability of companies which enter into these transactions to deduct interest expenses between foreign and domestic subsidiaries and/or the foreign parent company.
On July 15, Secretary of the Treasury Jack Lew, a man with a remarkably poor comprehension of basic economics considering his position and background, sent a letter to House Ways and Means Committee Chairman Dave Camp saying that firms entering into inversions “are attempting to avoid paying taxes here, notwithstanding the benefits they gain from being located in the United States.” Lew seems to miss entirely the benefits the United States gains by the companies being located here.
Mr. Lew argues, as do others on the left, that the companies are “effectively renouncing their citizenship to get out of paying taxes.” Tell that to the many American employees of these corporations who continue to pay federal income taxes. We’ll have more from Clueless Jack Lew in a moment.
Mr. Kleinbard, a long-time donor to the Democratic Party, disagrees with firms that argue that their inversions are “harmless to U.S. tax-revenue collection.”
It is true, as Kleinbard notes, that inversions “enable inverted firms to shed their domestic U.S corporate tax liability.” Kleinbard, Wyden, Schumer, and Lew assume that reducing tax liability is harmful to the nation in part because they, like most leftists, misunderstand basic economics.
The simplest way to put it is this: Companies don’t pay tax; people do.
Who is primarily involved with a company’s cash flow? The consumers buying their products or services, the employees providing those goods or services, and the owners (usually shareholders) who earn any remaining profits.
As a thought experiment, consider a nation in which the corporate income tax is eliminated. This would allow the reallocation of money that would go to our wasteful and largely incompetent government instead to flow to consumers, workers, or shareholders.
Some part of the tax savings might go to lowering the cost of whatever the corporation is selling. (The more competitive the industry, the more this will be the case.) The savings to consumers leaves them with more money to spend on other things, whether a better education for their children, a new car, a house in a safer neighborhood, a vacation, or putting away a few dollars for retirement. As the consumer spends the money left over by lower prices, the government gets a piece through sales tax and future generations may have to support slightly fewer people needing welfare and food stamps.
Some of the savings might to go employees in the form of higher salaries or better benefits, or just better job security from a more financially secure company. Higher salaries would raise income taxes collected by government.
And some of the savings will go to shareholders who will then pay taxes on either dividends or capital gains.
If you reverse this thought experiment and imagine a nation that suddenly imposes a corporate income tax, you should understand that the true cost of the tax can only fall on actual people, not on an inanimate (and therefore unsympathetic) “legal fiction.” The corporate income tax results in higher prices, lower wages, and lower investment returns for future retirees.
As Tim Worstall writes in Forbes, “It’s worth noting that there is absolutely no disagreement at all on this point. This is not a theory, isn’t some right wing or neoliberal fabrication. It’s not even a political point. This is simply the correct description of the world we live in.”
And for those of you who assume that the vast majority of the cost of the tax falls upon the shareholders (whom leftists seem eager to penalize), a 2006 Congressional Budget Office paper concludes that “domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden.”
The corporate income tax contributes approximately 10 percent of federal tax revenue. Slashing the rate would stop “inversions,” encourage business formation in the United States, and increase tax revenue through other taxes such as sales, income, and even property.
It may not be certain that these effects would completely offset the loss of federal tax revenue, but it is reasonable to assume that the offsets would cause that loss to be far less than the $130 billion annual decline in tax payments that the JCT estimated last year. (I even hesitate to use the word “loss” which implies that the money belongs to the government rather than to those who earned it.)
The JCT uses the sort of static modeling that biases any analysis in favor of tax hikes by ignoring pro-growth effects of tax cuts. Using a dynamic model, The Tax Foundation concludes that “cutting the federal corporate tax rate from 35 percent to 25 percent would raise GDP by 2.2 percent, increase the private-business capital stock by 6.2 percent, boost wages and hours of work by 1.9 percent and 0.3 percent, respectively, and increase total federal revenues by 0.8 percent.” (A short-term loss in tax revenue would soon be offset by a permanent increase in revenue due to economic growth.)
Mr. Kleinbard says that there is a “kernel of truth” in the proposition that inversions are “a necessary response to our anticompetitive world-wide corporate tax system.” That’s like saying that there is a kernel of truth in the assertion that the Obama administration is incompetent and corrupt. It’s not the kernel of the thing; it’s the most obvious thing about it.
Kleinbard’s solution is to eventually lower the corporate tax rate (though not enough) while “imposing a stable international regime” by which he likely means trying to end beneficial tax competition — at least beneficial for everyone except the highest-taxing governments. But first he wants to “enact a temporary law to preserve the status quo.”
But not all corporations are American. So a company domiciled in a nation with lower tax rates and more rational tax policy has a competitive advantage against American companies, thus risking the wages and jobs of hundreds of thousands of American workers in U.S.-based firms that must shoulder an excessive tax burden. Those workers, and the politicians who represent them, should gratefully thank corporate management who successfully execute an inversion (at least one which makes a modicum of economic sense in addition to the tax benefits).
House Republicans won’t go for the left’s economic ignorance, though the political pressure may be intense if enough “moderate” (meaning economically illiterate) Senate Republicans (meaning most of them) go along with Democrats to pass anti-inversion legislation. Again, corporations just aren’t sympathetic victims of government, though victims they are.
The most disturbing aspect of this whole discussion, however, is distilled in one sentence in Treasury Secretary Jack Lew’s recent letter: “What we need as a nation is a new sense of economic patriotism, where we all rise or fall together.” This is an even more politically extreme version of Sen. Elizabeth Warren’s “There is nobody in this country who got rich on his own” and Barack Obama’s “You didn’t build that.”
Had I told you that that bit of fascistic nonsense was written by Benito Mussolini or Leonid Brezhnev or Kim Il-Sung you would likely have believed me. If not them, George Orwell might come to mind when hearing such Newspeak. Coming from the most important person in the Obama administration regarding economic policy, Mr. Lew’s assertion is horrifying.
There is nothing patriotic about being a slave to your country and unable to succeed on your own efforts, courage, and creativity. This does not mean an atomized society with no interpersonal or inter-business relationships. It simply means that such relationships should be voluntary and based on economics, not a false definition of patriotism.
Not only is there almost no aspect of the real economy that works Mr. Lew’s way (yes, suppliers care about the health of the companies that buy from them but Ford doesn’t care about — and doesn’t want to have to care about — how McDonald’s does.) Furthermore, I don’t succeed or fail based on whether my neighbor does. And, it bears repeating, I don’t want to.
We are citizens of the nation, but we are not owned by it. We have neighbors and partners and customers and clients and suppliers, but we are not owned by them. And that is why we are exceptional, President Obama’s objections notwithstanding.
Tax inversions are good for everyone but the federal government — which means they are good. A better solution would be to slash the corporate tax rate so that even more of the benefit of reducing companies’ tax burdens would accrue right here in the United States.
But until then, tax inversions are an appropriate, rational, predictable, and — yes, Jack — patriotic, response to our sclerotic tax policy that is unable to compete against smart, aggressive, entrepreneurial nations such as Ireland.