Here’s why Congress lets U.S. companies dodge taxes
There’s growing outrage over American firms that establish overseas headquarters in order to lower their tax bill. But one group seems surprisingly unperturbed: Congress.
The latest big U.S. company to attempt a “tax inversion” is drugmaker Mylan (MYL), which plans to acquire a Dutch entity and relocate its HQ to the Netherlands, where taxes are lower. Mylan’s CEO happens to be Heather Bresch, the daughter of Sen. Joe Manchin (D-W.Va.); she says she has spent plenty of time explaining to members of Congress why the U.S. tax code drives corporations overseas. “You know what they all say?” Bresch told the New York Times. “‘Yeah, uh huh, O.K. Uh huh.’”
President Obama raised the stakes recently by calling on Congress to pass legislation--such as a provision contained in his latest federal budget proposal--that would ban tax inversions. "Congress should enact legislation immediately .. to shut down this abuse of our tax system," Treasury Secretary Jack Lew wrote in a letter to Congressional leaders. "What we need is a new sense of economic patriotism." But the legislation Obama favors is controversial and unlikely to pass in the runup to this year's midterm elections.
Tax inversions have become a trendy new way for big companies to cut costs by taking advantage of tax rates in many other developed nations that are lower than U.S. rates. There have been more than 20 such deals since 2012, with at least a dozen more pending, involving firms such as Walgreen (WAG), Medtronic (MED), Chiquita Brands (CQB) and a division of Merck (MRK).
You might think Congress would take an urgent interest in government policies that effectively drive the nation’s own companies out of the country — especially since there’s so much bellyaching in Washington about government deficits and the need for more revenue. Yet aside from a few proposals from individual lawmakers, there’s no sign of Congressional action anytime soon to address the problem.
It's just not that much money
Here’s one reason why: As mercenary as the practice may seem, tax inversions, so far, aren’t likely to cost the U.S. government a great deal of money. The Wall Street Journal recently reported “the U.S. stands to lose billions” from the practice, as if “billions” is an outrageously large sum. The analysis that article is based on, however, found that a new bill aimed at preventing inversions would raise just $19.6 billion in additional taxes — over 10 years. So at the current pace, tax inversion only costs Uncle Sam about $2 billion per year.
To you and me that’s a lot of money, but $2 billion is less than one-tenth of one percent of all federal revenue. The tax savings are important to a firm such as Mylan, which competes with other firms already taking advantage of lower foreign tax rates. So there’s pressure on CEOs to make such deals, no matter how objectionable they may seem to U.S. taxpayers. But the impact on federal finances is tiny.
To put the number in context, Congress is now trying to figure out how to plug an annual hole in the Highway Trust Fund of about $10 billion. So even if Congress were to overcome frantic corporate lobbying and change the law to make tax inversions harder to accomplish or even illegal, it would still generate just one-fifth of the revenue needed to solve another pressing problem. Many members of Congress probably weigh the cost of a political battle with the powerful business lobby and figure it’s not worth the trouble.
Corporate taxes as a whole, in fact, account for a lot less of the government’s revenue than many people think. Taxes paid by companies generate just 10% of all federal revenue, or about $300 billion per year. Personal income taxes account for 47% of federal revenue, with payroll taxes — used to fund Medicare and Social Security — providing another 34%. Excise taxes, estate taxes and a variety of fees generate the remainder.
Instead of passing new laws meant to outlaw tax inversions, Congress could change the tax code to better align U.S. taxes with rates in other countries and reduce the incentive for U.S. firms to skip town. The federal corporate tax rate of 35% is one of the highest in the developed world, and even after factoring in loopholes and deductions, U.S. firms, on average, pay an “effective” tax rate higher than in all other developed nations except Japan and France. Republicans have pressed for years to lower the nation’s corporate tax rate, and even President Obama favors lowering the U.S. rate to 28%, provided loopholes are closed.
But tax reform is one of those legislative priorities that seems impossible in such a hostile political environment, even if there’s general agreement across the spectrum that it’s badly needed. Many Republicans and Democrats agree in principle on the need to simplify the tax code. But they differ sharply on how to do it, which augurs a huge political fight if Congress even tries. Easier to complain about those unpatriotic corporations while tacitly supporting the status quo.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.
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