The US tax law does allow for a timing lag, since the differential tax (between the US tax rate and the tax rate on the foreign income) does not have to be paid until that foreign income is repatriated back to the US. To illustrate, assume that you have a US company that generates $50 million of its income in the US (with a tax rate of 40%) and $50 million of its income in China (where the tax rate is 25%). The company will pay a total of $32.5 million in taxes when it generates that income, 40% of the $50 million of US income and 25% of the $50 million of Chinese income, If the company now returns the $50 million in Chinese income to its US domicile, it will have to pay the differential tax of $7.5 million, reflecting the differential tax rate of 15% (US tax rate - Chinese tax rate). What happens if the company chooses to leave the cash in its Chinese subsidiary? That cash of $50 million cannot be used for investments in the United States or to pay dividends/buybacks to stockholders. In effect, it is “trapped”, but it can be used for investments anywhere else in the world. The longer the company continues to hold back cash in foreign locales, the larger the trapped cash balance becomes and after a decade of not repatriating cash, it can amount to hundreds of millions or even billions of dollars.
- The trapped cash that the company has is no longer trapped and the differential tax due to the US dissipates into thin air. The larger the current trapped cash balance, the greater this immediate benefit will be.
- The second tax benefit is that the company’s future income in China is no longer subject to a differential tax and is thus released from that obligation. The tax benefits from relocation will therefore be greater for companies that expect their foreign operations to grow at a higher rate than their domestic (US) business.
Given how large these potential benefits can be for many US companies, relocation becomes an attractive option and inversion is one way of accomplishing this objective, though a 2004 law does put restrictions on its use. With inversion, the company will acquire a Singapore-based company of sufficient size (to meet the law's requirements) and relocate the headquarters of the combined company after the merger in Singapore.
- US companies are more global: As the rest of the world's economies have grown, the US economy has become a smaller part of the global economic order and US companies are increasingly dependent on their foreign operations. In 2012, almost 50% of the revenues of S&P 500 companies came from foreign locales, with the number varying widely across sectors (with utilities getting almost no revenues from outside the US and technology companies getting about 58%). In fact, this document has an exhaustive breakdown of this phenomena. It is also worth noting that in 2012, the companies in the S&P 500 paid $146 billion to the US government and $139 billion to foreign governments as taxes, which should dispense with the canard that the foreign income of US companies is somehow untaxed.
- The US corporate tax rate has become high, relative to the rest of the world: In the early 1980s, the US corporate tax rate was 46% but that tax rate would have put the US in the middle of the global pack in that period. The US federal marginal tax rate on corporations dropped to 35% in 1993, and has stayed at that level since. With state and local taxes added on, the marginal tax rate on US corporate income is now close to 40%. The rest of the world seems to have shifted to lower corporate tax rates, giving the US the higher marginal corporate tax rate in the world in 2014, as can be seen in the global tax map below ( maintains an excellent public database of marginal tax rates, by country):
|Effective Tax Rate: 2013|
|Marginal & Effective Tax Rates: 2013|
- The first step is an appeal to patriotism, where corporations are asked "what they will do for their country of incorporation, rather than what that country will do for them". In fact, the taxation of global income at the US tax rate is not restricted to US corporations. It applies to all US citizens who work abroad, requiring them to pay not only the taxes due in the country in which they work in but the additional tax that they would owe the US, if that country has a lower individual income tax rate than the US does. Thus, long-term expatriates working in low-tax locales are given a choice of whether they want to continue to be US citizens (and pay the extra tax) or give up their citizenship. In effect, their patriotism is put to the test and while many people pass that test (even if it means paying extra taxes), more and more chose to give up their US citizenships each year. There are some who think that US corporations can be put to the same patriotism test, I don't think that the argument make sense. Since a publicly traded company is owned by its stockholders, should we determine patriotic standing based upon the nationality of the stockholders who hold its stock? Thus, should a US company where Chinese own 51% of the outstanding shares try to maximize taxes paid to the Chinese government? Even if you don’t buy the “stockholders as owners” argument, what if more than 50% of your employees now work in a different country? Is it your patriotic duty to maximize taxes paid to that country?
- Shame corporations into paying their "fair" share of taxes: An extension of the patriotism argument is to push the theme that it is shameful for taxpayers not to maximize taxes paid to the government. You may view this as a sign of my moral decay or ethical shortcomings, but I don't believe that taxpayers (individual or business) should be required to maximize taxes paid to the government. That does not preclude individual taxpayers who want to maximize taxes from doing so, but you cannot demand that other taxpayers (individuals or corporations) do more than pay what they legally owe in taxes.
- Force immediate tax payments (and ban inversions): The punitive solutions almost always revolve around legislation. You could change the US tax code to force all multinationals to pay the US marginal tax rate on their global income, when the income is earned, not when it is repatriated and the trapped cash problem will go away, we are told. Really? I will argue that passing this law will create two consequences. The first is that if you think that US companies moving their headquarters outside the US is a problem now, it will become a deluge, if you pass this law. The second is that even those multinationals that choose to stay US-based will spin off their foreign subsidiaries as stand-alone companies. I guess you can try to pass more laws to prevent both these developments, but legislation that goes against common sense (and economic self interest) is doomed to fail.
Long term Solution
A pessimistic end note
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