Tax Analysts Blog

It’s Not Clear How to Effectively Deal With Inversions

Posted on Aug 5, 2014
There is almost no one left in official Washington who doesn’t think something should be done about inversions. But there is a lot of variety in the solutions being proposed, which makes consensus almost impossible. Most Republicans and some Democrats think inversions can be dealt with only through broad corporate tax reform. The Obama administration and the Levin brothers want to strengthen section 7874 to prevent inversions from changing corporate residency. Harvard professor and former Obama administration member Stephen Shay wrote recently that Treasury and the IRS should use regulatory power. And a small group of lawmakers, including taxwriters, are now looking at measures that would limit earnings stripping.

Over the weekend, The Washington Post editorial board surprisingly sided with Republicans and wrote that the only way to deal with inversions was through corporate tax reform that cut the U.S. rate significantly. The Post said that “a truly durable reform would make it cost-effective for U.S. firms to stay, not prohibit them from leaving.” It added that “the wave of tax inversions is . . . symptomatic of a U.S. tax code that rewards system-gaming rather than productive activity.” It expressed skepticism that the Levins’ solution would work, pointing to Michigan professor Mihir Desai’s July 22 congressional testimony in which he argued that changing the section 7874 thresholds would lead to fewer, larger mergers, but wouldn’t protect the U.S. tax base.

The Post parts ways with Republicans on the issue of shareholder taxation. The paper wants a lower corporate rate, but higher taxes on dividends. “The key to genuinely resolving the inversion problem, as opposed to patching it up -- or exploiting it -- in an election year, is to shift the focus of corporate taxation to the people who actually own a given company: shareholders,” it said. The paper then mentions Michael Graetz’s tax reform plan, which (among other things) would tax dividends at the highest individual rate. The editors also take a dig at the GOP’s position on tax reform, blaming the party for stymieing tax reform efforts that would raise any new revenue.

The Post’s belief that only tax reform will solve the inversion problem puts the paper at odds with Democrats and administration officials who want short-term, targeted legislation. The type of tax reform being pushed by the editorial board is also at odds with plans proposed by House Ways and Means Chair Dave Camp and former Senate Finance Committee Chair Max Baucus. Camp and Baucus would not have completely overhauled the tax system a la Graetz, but would have lowered the corporate rate and paid for it by putting in place complicated anti-base-erosion rules. (Incidentally, Martin Sullivan of Tax Analysts and others have pointed out that the Camp and Baucus plans, along with most other tax reform proposals, would do little to change the incentives in favor of foreign-based companies. The anti-base-erosion rules in both plans would, in fact, continue to push firms to relocate offshore despite a lower U.S. corporate rate.)

While a radical tax overhaul could certainly reduce or even eliminate the benefits of changing a company headquarters, such a change to the U.S. system isn’t all that likely. But a strengthened section 7874 isn’t much more probable given Republican opposition and the GOP’s control of the House. And Shay’s plan to use regulatory authority has come under criticism. (Politico quotes Michigan professor Jim Hines as saying Shay’s proposal wouldn’t work and would be struck down by the Supreme Court, which is probably a bit of an overstatement.)

What is the solution to inversions? There probably isn’t one in the short term. As Sullivan has pointed out before, until the political calculations change on Capitol Hill, which would require significantly more public demand, both anti-inversion and earnings stripping legislation are long shots. So those craving some kind of congressional intervention should root for major, brand-name companies (like Walgreens) to explore or propose inversions. That’s the only way voters will take notice and influence rank-and-file Republicans to actually care about the issue.

Read Comments (2)

edmund dantesAug 4, 2014

If you really want to increase the dividend tax to the top marginal rate, it's
only fair to reduce the corporate tax rate to 0%. That's a marvelous
simplification approach as well. Inversions would end overnight.

Double taxation of corporate income has long had pernicious effects on the
economy. The current taxation of qualified dividends similarly to long-term
capital gains only partially reduces the damage.

emsig beobachterAug 7, 2014

World wide combined reporting with formulary apportionment and lower marginal
rates and end deferment. Or, as Edmund noted, make all businesses doing
business in the U.S pass-through entity.

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