Inversions and Rick Santorum

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There’s been a recent rise in a tax-saving gimmick called “inversions.” An inversion is the purchase of a small international company by a large US-based company in order to transfer profits to another country with lower corporate taxes. After buying a smaller company based in a low-tax country, the large US-based company transfers patent ownership to, or borrows money from the smaller firm. Interest payments to the smaller company can be deducted from US-based income and interest received in a low-tax country is taxed at a lower rate. In the case of patents, the off-shore company can collect lucrative patent royalties while being taxed at a lower rate. The result of both is a lower overall tax rate for the company. It’s these kinds of strategies that allow large corporations like Boeing and GE to pay almost no taxes.

This is not a new phenomenon, but has stepped up in recent weeks with familiar companies like AbbVie and Walgreens contemplating such a move. So, the question is, why the sudden interest? Thisweekinstupid’s answer is that there’s a downside to hiding profits over seas. In order to pay those profits to share-holders as dividends, you have to bring that money back to the United States and in doing so, it will be taxed at US rates. This is why companies such as Apple and Google are accumulating large piles of cash in subsidiaries based in Ireland or the Cayman Islands. But what good does that cash do these companies? The answer is, not much. Periodically, you hear shareholders grumbling about these inaccessible profits, and calls for companies to “repatriate” the capital, pay the taxes, and give shareholders a dividend. So far, the companies have resisted. The critical question is why.

One possible answer is Republican electoral success. Companies are hoping that Republicans will, at some point, declare a tax discount or even a “holiday” for repatriated capital–that at some point in the future, Republicans will manage to shove through Congress, a law that (temporarily, probably) allows capital brought back to the US to be taxed at some lower rate. The last time this happened was in 2004. At that time, the argument was that this capital trapped in other countries could be used to revitalize the US economy. Yes, it not fair, we told ourselves, but if it’ll get American working again, we’ll do it. And so, we allowed foreign cash brought back to the United States to be taxed at just 5.75%, rather than the 35% corporate rate that the time.  The Congressional Research Service studied the effects of that policy and concluded that companies that repatriated capital did not hire more, did not devote more funds to research and development, but did give larger salaries and bonuses to CEOs and other high level executives. Even the conservative Heritage Foundation has dubbed that experiment a failure. And yet, in 2014, here’s Mitch McConnell calling for a “one-time” tax holiday to pay for highway repairs.

Now, ThisWeekInStupid is not stupid. We know that both parties are almost wholly-owned subsidiaries of corporations. But history seems to suggest that it’s most often Republicans who favor lower tax rates or tax holidays. Last election cycle, Rick Santorum mentioned this all around the country as part of his economic plan. There was a vast, untapped reservoir of money, he said, that could be channeled back into the US economy if we’d allow, just this once, another tax holiday. In recent years, the justification for an “extraordinary” measure like Santorum’s proposal has largely disappeared, but lower tax rates for corporations has been on the Republican agenda since Barry Goldwater and before.

It’s not accident that inversion mania coincides with improving Republican fortunes. The New York Times now gives the Republicans a 60% probability of controlling the Senate after the 2014 elections. With a 2016 Presidential election right around the corner, if you were a multinational corporation, now might be the time to start stockpiling your tax free profits in off-shore subsidiaries.

Now, perhaps paradoxically, ThisWeekInStupid is in favor of replacing our current system with very small corporate tax rates with dividends and capital gains taxed as ordinary income. This makes taxation of company profits more progressive since the dividends and capital gains of billionaires could be taxed at a higher rate than your granddad’s IRA or your family’s 10,000 nest egg. This would, of course, allow multinationals to avoid the taxes they would have paid under the current system unchanged. But, perhaps it’s best to reform the broken system in one swift stroke and let the capital flow to unhindered to where it’s most needed.

The key, in our opinion, is to avoid “extraordinary” measures. If it were made clear to companies and their stockholders that the same system will be in place for 30 years, you might see the boost in repatriation that McConnell and Santorum hope to create.

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