Inversion: Is it Fair to Vote with Your Feet?

by Tom Yamachika, President, Tax Foundation of Hawaii

Recently, U.S. Treasury Secretary Jacob Lew wrote to Congress’ tax-writing committees about “inversion,” which occurs when a U.S. company merges with a foreign company and moves its headquarters to the foreign country. He wrote: “The firms involved in these transactions still expect to benefit from their business location in the United States, with our protection of intellectual property rights, our support of research and development, our investment climate, and our infrastructure, all funded by various levels of government. But these firms are attempting to avoid paying taxes here, notwithstanding the benefits they gain from being located in the United States.”

Wait a minute. That’s not how the U.S. tax system works.

When a U.S.-based corporation earns income in the United States, that income is subject to the U.S. corporate income tax. When a foreign-based corporation earns income in the U.S., that income is subject to the same corporate income tax, at the same rate.

In addition, any corporation operating in the U.S. pays other taxes associated with doing business. They pay property taxes on any land or property they own, payroll taxes on wages they pay to their workers, and state taxes in the state(s) in which the entity operates.

The big difference is in the way our tax code treats income earned OUTSIDE of the U.S. The U.S. corporate tax system subjects U.S.-based corporations to tax not only on income earned in the U.S., but also on income earned anywhere else in the world. The code gives such corporations a “foreign tax credit” so that if they do pay tax to another country they don’t have to pay those dollars twice, but that credit is the lesser of the tax paid to the foreign country or the U.S. tax imposed on the same income.

For example, a French-based corporation doing business in the U.S. pays our federal tax rate of 35 percent, and when it does business in the United Kingdom, it pays the U.K.’s tax rate of 21 percent. France has a territorial tax system, which means that income is taxed in the location in which it was earned, period. Most countries in the developed world have this type of territorial tax system. For the most part, Hawaii’s corporate tax system also works this way.

If the same company were instead based in the U.S., it would pay a tax rate of 35 percent on U.S. income as well, but on income earned in the U.K., it again pays a tax rate of 35 percent. There, 21 percent would go to the U.K. and the company would get credit for it, but the remaining 14 percent would go to the U.S. just because the company has its corporate headquarters in the U.S.

Not surprisingly, U.S. companies, trying to remain competitive against their foreign counterparts, feel the need to get out from under this system. They are voting with their feet – namely, if the U.S. is going to keep up an inhospitable tax regime, the companies affected want the chance to walk away. Does that justify Congress enacting retroactive legislation, as requested by Secretary Lew, to punish companies that have done this legitimately within the current tax law?

If we want our companies to be competitive in the global marketplace, we can’t be asking them to do this with their hands and feet in the shackles of an ancient and anticompetitive tax system. Let’s ask for revenue where we can fairly ask for it, and let’s not be asking for billions of dollars simply for the privilege of saying that their headquarters is in the U.S.

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