In the thriving world of global business, national borders have become a mere formality as corporate reach extends to every corner of the earth. As globalization leveled the playing field, companies scoured foreign lands in the endless pursuit of lowering their costs and bolstering their bottom line. While you’ve likely heard of exporting jobs to lower-cost countries, corporations are now exporting their headquarters to lower-tax countries, and are saving a fortune in the process.
What may be the biggest accounting trick of all time is called a corporate inversion, and its sole purpose is to save a bundle in taxes. The somewhat common legal arrangement goes as follows: an American company legally “sells itself” to a company in a country with a lower tax burden. The company then proceeds to incorporate in the newly adopted country, and sets up a headquarters of convenience. The original company remains largely intact and its principal offices don’t even have to move. The company is rechristened as a foreign company, and is treated quite differently by American tax authorities.
Many bright minds at the helm of the country’s most successful corporations are likely enticed by corporate inversions. This bizarre behavior of leaving the United States is easily explained, because our maddening tax system is uniquely terrible among developed countries. Nearly anywhere else is better for an American company that makes a boatload of profits overseas. A US-based company has to pay a hefty about of taxes on profits earned abroad unlike its foreign competitors. Not surprisingly, American companies have more than two trillion dollars in profits sitting abroad. If they bring that money home, it would be subject to extremely high taxation.
If a company decides to invert and become a foreign corporation, it doesn’t pay taxes on its profits earned outside of the United States. While this is a quick fix for many American companies, this isn’t good news for the American tax base. The Congressional Budget Office says “when firms choose to shift either their investments or their reported income abroad, U.S. revenues from corporate income taxes decline.”
It’s a bizarre proposition to consider that while perhaps half of the world would like to emigrate to the United States, companies are lining up in droves to leave the country. Burger King inverted to Canada last year, and Pfizer is planning on doing so next year. Pfizer’s proposed purchase of Allergen would create the world’s largest pharmaceutical company. It’s not coincidental that Allergen is based in Ireland, which enjoys the lowest corporate taxes in the developed world.
The latest wave of corporate inversions is causing a firestorm in Washington. Pharmaceutical companies enjoy a bonanza in the United States with the highest drug prices in the world. Considering prices for brand name drugs have gone up more than 100% since the recession, Pfizer’s move is likely politically risky, and there’s little doubt many will be flabbergasted at the proposed move to another country.
The US Treasury Department has attempted to dissuade corporations from moving abroad, but this has done little to stem the tide. On paper, we have the highest corporate tax rate in the world, but there’s debate as to whether in practice, it’s really that high. While most companies take advantage of generous loopholes and pay less than the top tax rate, it’s obvious our tax system is not working for America or American companies.
Tax reform is a rare space where liberal and conservatives may agree that our present system needs to be overhauled. The perverse incentives created by our tax code drives companies to export themselves and hoard profits overseas. Congress may want to consider changing our tax strategy, as taxing overseas profits is slowly eroding our tax base and luring flagship American companies to faraway lands.
