There’s a bigger picture when it comes to inversions. The Obama administration wants to discourage companies from striking deals to move overseas and reduce their tax bills. America’s levy on offshore profit, however, is a big driver of domicile-driven M&A. It’s a fudge, whereas U.S. companies could use a clear decision about whether tax is local or global.
U.S. Treasury boss Jack Lew on Monday said his department is working out how to reduce the appeal of deals like AbbVie’s $55 billion agreed purchase of Dublin-based Shire. As he essentially conceded, though, he can only tinker. Lawmakers, by contrast, can change the tax code. A new draft proposal from New York Senator Chuck Schumer unfortunately seems narrowly focused on reducing the tax deductibility of interest for U.S. subsidiaries of foreign companies that used to be American.
Such initiatives at best address symptoms. One underlying cause that deserves more exposure in the context of inversions is the treatment of overseas profit. U.S. companies pay tax in the jurisdiction where they make money. An extra levy payable to Washington, taking the total up to 35 percent, is also due, but only when the relevant cash is brought home.
This helps companies compared to individual taxpayers, who can’t defer tax on foreign income. But it has become a distorting influence, causing U.S. corporate cash to become “trapped” overseas. Of $1.6 trillion held by non-financial firms at the end of 2013, nearly 60 percent of it fit the description, reckons Moody’s Investors Service.
Take the average 26 percent tax rate paid by U.S. companies in foreign jurisdictions between 1992 and 2010, according to the Tax Foundation, and that leaves an $85 billion incentive – concentrated within relatively few cash-rich companies – to make sure the U.S. tax is never payable, for instance by moving overseas.
Most developed nations sidestep this problem by taxing companies and individuals alike on a territorial basis. The United States still targets global income. One of Republican presidential candidate Mitt Romney’s ideas in 2012 was to limit tax to profit generated on U.S. soil. An alternative would be to retain the global approach but at a lower rate and without the half-baked deferral concept. Either one offers a better, long-term fix than all the minor fiddling under discussion.