The President found time in his fundraising schedule today to make a speech at a technical college in Los Angeles, where he became the latest in a long line of prominent Democrats to rail against the practice of “inversion.” Inversion is a simple, if a bit obscure, method of avoiding the US’s grossly excessive corporate taxation and oppressive regulatory regime. Briefly, a US domiciled corporation buys a (usually much smaller) company in a country with a smarter government and saner tax laws, formally merges the US company with it, and then declares the low-tax country to be their “tax home,” the latter being a technical term in taxation circles about where you pay your taxes, while leaving their US operations pretty much untouched. This permits the US company to transfer most of their profitability back to the “corporate headquarters” and avoid a lot of US taxation; sometimes billions of dollars. The scheme is similar, but not quite identical, to companies– Apple is usually the poster child– who transfer their intellectual property ownership to low-tax countries, thereby placing a big chunk of their corporation’s total tax liability beyond the reach of the IRS.
“We need to stop companies from renouncing their citizenship just to get out of paying their fair share of taxes,” Obama said. “It sticks you with the tab to make up for what they’re stashing offshore through their evasive tax policies,” he said. “If you’re a secretary or you’re a construction worker, you don’t say, ‘you know what? I feel like paying a little less so let me do that.’ You don’t get a chance to do that — these companies shouldn’t either. ”
Republicans generally consider this sort of thing to being election year politicking. Several Democrats have been off about this lately besides Obama: Reid, Chuck Schumer, the usual suspects. There is basically no chance they can do anything about it, Republican opposition is strong and they are joined by a number of Democrats. Republicans– and I– tend to argue the actual problem is the incredibly high corporate tax rates and the fix for the problem is to do tax reform.
Myself, I’d go farther. Corporations, by their nature, can not pay taxes; they are pass-through entities. Taxes levied on corporations are paid either by their customers in the form of higher prices, or by their owners in the form of lowered profitability, or both. At best, corporations are unpaid tax collectors for the government. (Getting to be time to recycle this article, I see…)
Further, corporate taxation causes a lot of distortion in the market that causes more trouble than it’s worth. To offer a single example, under current US tax law dividends paid by a corporation to their stockholders are not tax deductible to the corporation, they must be made with after-tax dollars. Interest payments made to the bank, OTOH, are tax deductible and are therefore made with pre-tax dollars. This forces a preference for debt over equity financing in the corporate world. You won’t read it many other places, but one of the reasons the economic downturn in 2007 was so painful was because every company on Wall Street was in debt to their eyeballs, while very short on equity capital, for the specific purpose of lowering their tax bill. When the economy went toes-up, corporate income streams became income trickles and those companies were not able to meet the interest payments, never mind pay down their debt. That’s why so many of them folded. This is hypothetical, of course, so it can’t be quantified, but you can take it from me that had this disparity not existed– both forms of capital paid for with either pre- or post-tax dollars– the downturn, while still painful, would not have been as bad, nor would as many companies have folded or needed bailouts, because they’d have naturally had a greater percentage of their capital requirements satisfied with equity rather than debt. Partly because this is easier, and partly because equity capital is naturally both cheaper than debt capital and because it is more forgiving. If a company hits hard times, and they skip a dividend, their stockholders may be unhappy, but they don’t repossess the CEO’s mistress the way a bank would. And, since the stockholders are undergoing hard times themselves, and seeing everybody else in the country is doing the same, they’re a bit more understanding about it than a bank would be. They’re owners, not creditors. An owner wants long-term viability; a creditor wants his interest money on the 15th.
(Off topic, but whilst I hold it in my mind: another favorite Dem bellyache is the huge stacks of cash corporations are sitting on. Partly they don’t like this because if that cash were invested it would generate GDP and jobs, thereby making the Dems look better. And partly because they sense– most of them are not well enough acquainted with actually having to earn a living to know– sitting on tons of cash like that is an indication the sitters have a lack of confidence in the economy, which opinion reflects poorly on the Democrat Party. The D’s are right about the latter; part of the reason why companies are getting cash heavy is because they don’t see anything attractive they’d like to fund; especially considering the excessive taxation and oppressive regulations Democrats love. But another part of the reason, a big one, companies are hoarding cash is they have re-learned the old Great Depression lesson of the Proverbial Bullet-Proof Balance Sheet. When hard times come, there’s nothing like a great big stack of liquid dollars to see you through. If you subscribe to technical publications with names like CFO Quarterly— I don’t, but I read them occasionally– you would have seen, ten years ago, all the articles were about new and exotic ways to leverage your borrowing power and squeeze your equity capital fraction down into low single digits. Not any more. End parenthetical digression.)
Therefore, I say the problem is not specifically that corporate income tax rate are too high, but rather that they exist at all. It would be much smarter tax policy, and generate higher tax revenue, to let corporations run their operations free of income taxation, and to tax the profits as ordinary income to the owners when the profits are distributed. I do not suggest the States shouldn’t use franchise taxes, or that corporations should be exempt from excises or import duties, or other special purpose taxes. I’m talking about income taxes. Taxing corporate income is like feeding the goose that lays the golden eggs slow poison.
As to the subject of the article, ‘corporate desertion,’ that’s nonsense plain and simple. The practice will end naturally shortly after the Congress comes to understand we have a globalized economy now, that the US does not have a choice about competing for capital in the global market and enacts a business friendly taxation and regulatory suite; and it will not end until they do. If you ask me, the concept of ‘economic patriotism’– I keep waiting for Democrats to come up with a coherent definition that does not permanently destroy their electoral chances; waiting, but not holding my breath– also includes teaching the Congress when they’re making a mistake.