Our Feeble Attempt to Stop Tax Inversion

“Showrooming” is a serious issue for big box retailers across the United States. I’m as guilty of it as the next person, going into Best Buy or Microcenter to see that new tablet in person before dropping several hundred dollars on the less expensive Amazon (but I would never illegally evade paying sales tax).

Best Buy’s first response to showrooming (which they deemed stealing and immoral) was a P.R. nightmare: ban the use of smartphones in their store. The move generated bad press in the tech world, and didn’t even work, since nothing they did could stop customers from heading home, stripping down to their underwear, and buying the product online (because all online shopping has to be done in underwear). They’ve dropped that attempt and have since moved to more competitive methods to fight showrooming.

What does showrooming have to do with tax inversion? Quite a bit, actually.

Tax inversions are not new. There’s legislation as far back as 1998 trying to combat the tactic by making shareholders of inverted companies recognize an up front gain for foreign incorporations (which has worked out about as well as our executive compensation rules). Back in 2002, then Representative James Maloney (CT-D) said of Stanley Work’s inversion, “Connecticut hasn’t seen such a shameful day since Benedict Arnold sailed away,” a rhythmic quote that could almost as easily been in last week’s New York Times.

Benedict Arnold Actor

I’m looking forward to the reenactment of Stanley’s inversion.

Like Best Buy’s initial response to showrooming, the knee jerk reaction to the latest wave of tax inversion is condemning the “immoral” act. The proposed legislation simply disallows US companies from inverting to a foreign country, at least for a two year period before Congress can figure things out (as if two years is enough time for the government to figure out anything).

Best Buy has mostly fought off showrooming for now by addressing the main concern: lower prices online. The government might have the power to stop established companies from moving overseas, but without addressing the root cause of inversions, it’ll encourage more companies to drastically reduce their presence in the US in the first place. We’ll get the moral victory at the expense of chopping off our foot.

It’s not hard to figure out why companies are using tax inversion: First, the US has the highest corporate tax rate in the world. Second, the US is one of only a handful of countries that requires all worldwide profits brought back to the US to be re-taxed as the difference between US rates and the rates of the countries where they were earned (the rest of the industrialized world allows income to only be taxed where its earned).

If we want to keep companies in the US (and attract new ones), how about removing the strong incentive to leave rather than forcing companies to stay? We’d be absolutely horrified if Best Buy were to lock their customers in until they purchased the product at their store. Why are we fine when the US locks Best Buy in until they buy our country’s product?

By lowering corporate tax rates and allowing foreign profits to come back to the US untaxed, the tax inversion problem will mostly take care of itself. We might have a company or two trying to capitalize on certain debt restructuring or intangible benefits, but for most the cost of inversion will heavily outweigh the benefit.

No accounting article would be complete without a brief look at the cost. C Corporations, the entity type this would affect, are a dying breed. There were 2.6 million of them in 1986, 1.8 million in 2008, and 1.6 million in 2010. And under our current tax system, the number will continue dropping. That means Corporate Income Tax receipts, which make up only 10% of the total Federal Tax Revenue, will make up an even small percentage in the coming years unless we make a change.

Tax Collection as Percentage of Total

To put that all in perspective –Source: http://www.whitehouse.gov/omb/budget/Historicals

By locking the doors on our domestic companies, we’re desperately trying to keep a diminishing source of revenue from straining through our fingers. Instead of passing laws that try to jam our fingers tighter together, why don’t we remove the huge incentive to leave?

 

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Great picture by Larry Miller. Those eyes look menacing.