Margaret Thatcher once quipped that the problem with socialism is that eventually you run out of other people’s money. For the past several decades, American politics largely has been based on giving things to a great many people, paid by other, usually far fewer, people. That scheme can only last so long. The building media and political firestorms over “tax inversions” is the latest sign that a giant tax hangover is coming to spoil the left’s party.
Tax inversions, whereby a US company acquires a foreign firm and, in the process, shifts its headquarters out of the US and becomes a foreign company, have been increasing over the past 18 months. The maneuver has primarily involved relatively little-known health care and biotech companies. The announced plan by iconic US restaurant Burger King to employ this tactic in its acquisition of iconic Canadian donut chain Tim Hortons has captured the public’s attention in a way the previous deals hadn’t. That the deal involves hamburgers and donuts surely has something to do with this.
Most reporting on the Burger King deal has focused on the fact that, as a newly-minted Canadian company, Burger King will face a much lower corporate income tax rate. In the US, the corporate income tax rate is 40%, whereas in Canada the rate is 26%. The US, in fact, has the highest corporate income tax rate in the industrialized world. They average rate among OECD countries is 25%. The US rate is even higher in a number of states that impose higher rates than the overall state average.
The difference in rates between the US and other countries is just a small part of the story, however. Burger King will still pay the 40% tax rate to the federal government on earnings from operations in the US, even after the company moves its headquarters north. The real tax savings come not from the lower rate, but from how foreign earnings are treated. The US is the only country that imposes its corporate tax on business dealings outside the country.
If an American company has a subsidiary in New Zealand, for example, the US will tax the profits from the subsidiary’s activities, even if only Kiwis are involved in the transactions. In other words, the US will tax profits from transactions involving only suppliers, customers and workers in New Zealand, simply because the parent company is headquartered in the US. No other country does this for the simple reason that, outside of ideology, it makes no sense as a matter of tax or economic policy. Other countries tax activities conducted within their borders. In contrast, the US tax code follows the citizen wherever they go in the world.
US corporations have responded to this by keeping a portion of their foreign profits “parked” overseas in other countries. The tax to the US is due when the corporation brings back to America, or repatriates, these foreign profits. It is estimated that US corporations currently have over $2 trillion in profits “parked” outside the US to avoid the country’s high tax. This may be a sound tax decision, but it could have very negative economic repercussions. It limits how a company can use its earnings to continue investments and fuel its growth. It also limits the amount of these profits that can be reinvested within the United States.
After years of trying to get some sanity in America’s tax policy, corporations may be signaling they are giving up and shifting their legal residency to better align themselves with the world economy. In recent years, individual American living overseas have increasingly surrendered their US citizenship due to the US tax treatment of overseas earnings. A recent poll of American ex-pats found that 80% were strongly considering changing their citizenship because of this tax treatment. Corporations are following their lead.
The left is under a grand illusion that the total of economic activity, earnings and wealth is a fixed point around which we can debate what share should be taxed and transferred to other activities. If someone earns X, the nation can impose Y tax and have Z to spend on government programs and services. The left seems genuinely surprised that people may change their behavior based on the outcome of this debate.
In recent years, the left has pushed cigarette taxes in New York state to the highest in the country, for example. Today, it is estimated that over 56% of cigarettes bought in the Empire State are purchased illegally, avoiding or minimizing the tax. People, even smokers, adapt.
It is silly to think that corporations won’t adapt as well. Having it “your way” doesn’t just apply to burger chains.