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Archive for the ‘Territorial Taxation’ Category

On April 17, the Supreme Court heard oral arguments in South Dakota v. Wayfair, Inc., a case dealing with whether states should have the power to levy taxes on companies in other states.

Most observers see this issue as a fight over taxing the Internet, taxing online sales, or a battle between Main Street merchants and Silicon Valley tech firms. Those are all parts of the story, but I’ve explained that this also is a contest between two competing approaches to taxation.

On one side are pro-market people who favor origin-based taxation, which is based on the notion that sales should be taxed where the merchant is based.

On the other side are pro-government people who want destination-based taxation, which is based on the notion that sales should be taxed where the consumer lives.

Needless to say, I’m not on the pro-government side of the battle. Here’s some of what I wrote when I was at the Heritage Foundation way back in 2001.

Requests to establish this destination-based tax authority should be denied. Such a regime would create an anti-consumer sales tax cartel for the benefit of profligate governments. It also would undermine privacy by requiring the collection of data on individual purchases. And it would violate important constitutional principles by giving state and local governments the power to impose their own taxes on businesses in other states.

All of that is still true today, but let’s look at some more recent analysis of the issue, all of which is tied to last week’s hearing at the Supreme Court.

George Will opines on South Dakota’s revenue grab for the Washington Post.

South Dakota has enacted a law contradicting a 26-year-old court decision concerning interstate commerce, and a law Congress passed and extended 10 times. It wants to tax purchases that are made online from vendors that have no physical presence in the state. South Dakota wants to increase its revenue and mollify its Main Street merchants. …In 1992, in the Internet’s infancy, the court held that retailers are required to collect a state’s sales taxes only when the retailers have a “substantial nexus” — basically, a physical, brick-and-mortar presence — in the state where the item sold is purchased. Such a nexus would mean that the retailer benefits from, and should pay for, local government services. Absent such a nexus, however, states’ taxation of sales would violate the Constitution, which vests in Congress alone the power to impose such burdens on interstate commerce. …Internet commerce…could not have flourished if vendors bore the burden of deciphering and complying with the tax policies of 12,000 state and local taxing jurisdictions, with different goods exempted from taxation. …the Internet Tax Freedom Act…is intended to shield small Internet sellers from discriminatory taxes and compliance burdens. …South Dakota is seeking the court’s permission for its extraterritorial grasping. …Governments often are reflexively reactionary when new technologies discomfort established interests with which the political class has comfortable relations of mutual support. The state’s sales-tax revenue has grown faster than the state’s economy even as Internet retailing has grown. …Traditional retailing will…prosper or not depending on market forces, meaning Americans’ preferences. State governments should not try to prevent this wholesome churning from going where it will.

The Wall Street Journal also has opined in favor of limits on the ability of states to impose their laws outside their borders.

The Supreme Court’s landmark 1992 Quill decision protects small businesses across the country from tax-grubbing politicians across the country. …At issue in South Dakota v. Wayfair is whether governments can tax and regulate remote retailers that don’t enjoy the state’s representation or benefit from its public services. …Fast forward 25 years. States complain that online commerce is eroding their tax base. Brick-and-mortar stores grouse that remote retailers are dodging taxes, putting them at a competitive disadvantage. …Politicians would prefer to soak out-of-state retailers rather than their own taxpayers. But America’s founders devised the Commerce Clause to prevent states from burdening interstate commerce and making long-arm tax grabs.

Here’s a troubling tidbit from the WSJ editorial. The Trump Administration is siding with South Dakota politicians, using the same statist rationale as the European politicians who are trying to grab more money from high-tech American companies.

The Justice Department has filed a brief supporting South Dakota… Seriously? According to Justice, businesses that operate a website have a “virtual” presence everywhere. The European Commission has invoked the same argument to impose a digital tax on Silicon Valley tech giants, which the Trump Administration has denounced as an extraterritorial tax grab.

Wow, the incompetence is staggering. The Stupid Party strikes again.

Veronique de Rugy explains in her Reason column that state governments want to overturn Quill because they don’t want tax competition.

If you think internet companies aren’t paying any taxes for online sales and that’s killing bricks-and-mortar retailers and states’ budgets, you, my friend, have been duped. Nothing could be further from the truth. …Most state lawmakers want to see Quill overturned, allowing them to force out-of-state companies to collect sales taxes on their behalf. This argument was just heard by the Supreme Court If the states were to win, they would be able to reach into the pockets of that mom selling her paintings on Etsy, even though she may live on the other side of the country, didn’t elect other states’ officials, and never agreed to those states’ tax laws. …tax competition among states would also be lost if Quill were overturned. Under the new regime, online consumers—no matter where they shop or what they buy—would lose the ability to shop around for a better tax system. Without the competitive pressure and the fear of losing consumers to lower-tax states, lawmakers would not feel the need to try to rein in their sales tax burden. It’s that pressure, which limits their tax grabbing abilities, that these lawmakers resent and want the Supreme Court to put an end to. …There is a lot to be lost in the Wayfair case. If Quill were to be overturned, compliance costs could skyrocket for many retailers, and good principles of taxation would be thrown out the window. Healthy tax competition is at stake. Let’s hope the highest court in the land makes the right decision.

In a column for the Wall Street Journal, Chris Cox, former Congressman and former Chairman of the Securities and Exchange Commission, debunks the notion that states are suffering for a loss of tax revenue.

‘Our states are losing massive sales-tax revenues that we need for education, health care, and infrastructure,” South Dakota’s Attorney General Marty Jackley told the U.S. Supreme Court… His state’s Supreme Court opined that sales tax revenues have “declined.” The state Legislature, citing its own “finding” to this effect, enacted a law requiring out-of-state retailers to collect sales tax on purchases shipped to South Dakota.

Here’s the data debunking Jackley’s claim about South Dakota “losing massive sales-tax revenues.”

…the law is based on a false premise. The state’s own data show that sales and use tax revenue grew from $787.7 million in 2013 to $974.7 in 2017—considerably faster than the state’s rate of economic growth. The governor’s budget for 2018 projects the state’s sales and use tax revenue will be more than $1 billion, 4% higher than last year, with no change in rate. That’s 29% higher than five years earlier. Sales-tax revenues have been booming in other states, too.

In other words, politicians are greedy and they’re willing to prevaricate. They want more and more revenue and they don’t want to face competitive pressure that might limit their ability to extract more money that can be used to buy votes.

Is anyone shocked?

P.S. The fight between “origin-based” and “destination-based” approaches to consumption taxation is very analogous to the fight between “territorial” and “worldwide” approaches to income taxation.

P.P.S. Given that it arguably has the best (or least-destructive) tax system of any state, it’s disappointing to see South Dakota politicians taking a lead role in an effort that would undermine tax competition.

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The Republican tax plan is based on some very attractive principles.

Unfortunately, the GOP isn’t planning to completely fix these policies, largely because there’s no commitment to control government spending. But any shift toward better tax policy will be good for the nation.

Another goal to add to the above list is that Republicans want to create a level playing field for American-based firms by replacing “worldwide taxation” of business income with “territorial taxation” of business income.

For those who have wisely avoided the topic of international business taxation, here’s all you need to know: Worldwide taxation means a company that earns income in another country is taxed both by the government where the income is earned and by the government back home. Territorial taxation, by contrast, is simply the common-sense notion that income is taxed only by the government where the income is earned.

In a column for the Wall Street Journal, two authors explain how America’s anti-competitive system of worldwide taxation undermines U.S.-domiciled companies.

…earlier this month Iconix , the U.S.-based company that owns the rights to Charles Schulz’s comic characters, announced it will sell them to Canada’s DHX Media. That makes Charlie Brown America’s latest expatriate. It’s a clear signal that U.S. corporate taxes are nudging business elsewhere. …why? In part because the U.S. corporate tax system hampers U.S.-based businesses by subjecting them to world-wide taxation. Canada’s aggregate corporate taxes are about 10 percentage points lower. …America’s high corporate tax rate and its practice of taxing international income is out of step with the rest of the world. The solution is so clear even a cartoon character should grasp it: Cut tax rates and adopt a system for taxing international income that more closely resembles those used by the country’s international competitors.

Indeed, it’s worth noting that the entire “inversion” controversy only exists because of America’s worldwide tax regime.

Simply stated, American-domiciled multinationals have a big competitive disadvantage compared to their foreign rivals. So it’s understandable that many of them try to protect shareholders, workers, and consumers by arranging (usually through a merger) to become foreign companies.

That’s the bad news.

The good news is that the Republican tax reform plan ostensibly will shift America to a territorial tax system. As explained above, this is the sensible notion of letting other nations tax income earned inside their borders while the IRS would tax the income earned by companies in the United States.

This would be good for competitiveness, particularly since the United States is one of only a handful of nations that impose a worldwide tax burden on domestic firms.

But not everybody likes the idea of territorial taxation.

One reason for opposition is that some people see corporations primarily as sources of tax revenue. So when there are discussions of international tax, their mindset is nations should compete on grabbing the most money. I’m not joking.

European Union regulators’ tax crackdown on Amazon.com Inc. — like the EU’s case against Apple Inc. — should spur U.S. policy makers to address companies’ aggressive offshore tax-avoidance strategies before it’s too late, experts said. …“Really, what we are seeing is a race by the different taxing jurisdictions to claim a share of the tax prize represented by the largely untaxed streams of income that U.S. multinationals have engineered for themselves,’’ said Ed Kleinbard, a professor at the University of Southern California and the former chief of staff for Congress’s Joint Committee on Taxation. “If the United States doesn’t join the race, it will just lose tax revenue to more aggressive host countries around the world.’’ The EU rulings “do make it clear that if we are not interested in protecting our corporate tax base, other countries will be more than happy to tax the income,’’ said Kimberly Clausing, a professor of economics at Reed College in Portland, Oregon.

Call me crazy, but I think American policymakers should be in a race to create jobs, boost investment, and increase wages. And that means doing the opposite of what these supposed experts want.

Unsurprisingly, left-wing groups also are opposed to territorial taxation. Here are some passages from a report published by the Hill.

One hundred organizations, including a number of progressive groups and labor unions, are urging Congress to reject a major international tax change proposed in Republicans’ framework for a tax overhaul. In a letter dated Monday, the groups speak out against the framework’s move toward a “territorial” tax system that would largely exempt American companies’ foreign profits from U.S. tax. …”Ending taxation of offshore profits would give multinational corporations an incentive to send jobs offshore, thereby lowering U.S. wages,” they wrote.

Both assertions in that excerpt are wrong and/or misleading.

First, territorial taxation doesn’t mean that profits are exempt from tax. It simply means that the IRS doesn’t impose an additional layer of tax on income that already has been subject to the tax system of another country.

And other countries impose plenty of tax on American firms operating overseas.

Second, the incentive to shift job overseas is caused by America’s high corporate tax rate. That’s what makes it attractive for firms to operate in other nations.

Worldwide taxation is not the way to fix that bias since foreign-domiciled companies wouldn’t be impacted and they easily can sell into the American market.

By the way, the Republican tax plan doesn’t even create a real territorial tax system. Returning to the Bloomberg story cited above, the GOP proposal basically copies a very bad idea that was being pushed a few years ago by the Obama Administration.

…the GOP tax framework contemplates a so-called “minimum foreign tax’’ on multinationals’ future earnings that would apply in cases where a company’s effective tax rate fell below a pre-determined threshold.

To be fair, the Republican approach is less punitive that what Obama wanted.

Nonetheless, I worry that if Republicans adopt some sort of global minimum tax, it will just be a matter of time before that rate increases. In which case a shift toward territoriality actually plants a seed for a more onerous worldwide system!

Without knowing what will happen in the future, there’s no right or wrong answer, but I’m wondering whether the smart approach is to simply leave the current system in place. Yet, it’s based on worldwide taxation, but at least companies have deferral, which creates de facto territoriality for firms that manage their affairs astutely.

Such a shame that the GOP isn’t capable of simply doing the right thing.

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If you get into the weeds of tax policy and had a contest for parts of the internal revenue code that are “boring but important,” depreciation would be at the top of the list. After all, how many people want to learn about America’s Byzantine system that imposes a discriminatory tax penalty on new investment? Yes, it’s a self-destructive policy that imposes a lot of economic damage, but even I’ll admit it’s not a riveting topic (though I tried to make it culturally relevant by using ABBA as an example).

In second place would be a policy called “deferral,” which deals with a part of the law that allows companies to delay an extra layer of tax that the IRS imposes on income that is earned – and already subject to tax – in other countries. It is “boring but important” because it has major implications on the ability of American-domiciled firms to compete for market share overseas.

Here’s a video that explains the issue, though feel free to skip it and continue reading if you already are familiar with how the law works.

The simple way to think of this eye-glazing topic is that “deferral” is a good policy that partially mitigates the impact of a bad policy known as “worldwide taxation.”

Unfortunately, good policy tends to be unpopular in Washington. This is why deferral (and related issues such as inversions, which occur for the simple reason that worldwide taxation creates a huge competitive disadvantage for U.S.-domiciled companies) is playing an unusually large role in the 2016 election and concomitant tax debates.

Consider the tax controversy involving Apple. The CEO does not want to surrender money that belongs to shareholders to the government.

Apple CEO Tim Cook struck back at critics of the iPhone maker’s strategy to avoid paying U.S. taxes, telling The Washington Post in a wide ranging interview that the company would not bring that money back from abroad unless there was a “fair rate.”

Since the discussion is about income that Apple has earned in other nations (and therefore about income that already has been subject to all applicable taxes in other nations), the only “fair rate” from the United States is zero.

That’s because good tax systems are based on “territorial taxation” rather than “worldwide taxation.”

Though a worldwide tax system might not impose that much damage if a nation had a low corporate tax rate.

Unfortunately, that’s not a good description of the U.S. system, which has a very high rate, thus creating a big incentive to hold money overseas to avoid having to pay a very hefty second layer of tax to the IRS on income that already has been subject to tax by foreign governments.

Along with other multinational companies, the tech giant has been subject to criticism over a tax strategy that allows them to shelter profits made abroad from the U.S. corporate tax rate, which at 35 percent is among the highest in the developed world.

“Among”? I don’t know if this is a sign of bias or ignorance on the part of CNBC, but the U.S. unquestionably has the highest corporate tax rate among developed nations.

Indeed, it might even be the highest in the entire world.

Anyhow, Mr. Cook points out that there’s nothing patriotic about needlessly paying extra tax to the IRS, especially when it would mean a very punitive tax rate.

…a few particularly strident critics have lambasted Apple as a tax dodger. …While some proponents of the higher U.S. tax rate say it’s unpatriotic for companies to practice inversions or shelter income, Cook hit back at the suggestion. “It is the current tax law. It’s not a matter of being patriotic or not patriotic,” Cook told The Post in a lengthy sit-down. “It doesn’t go that the more you pay, the more patriotic you are.” …Cook added that “when we bring it back, we will pay 35 percent federal tax and then a weighted average across the states that we’re in, which is about 5 percent, so think of it as 40 percent. We’ve said at 40 percent, we’re not going to bring it back until there’s a fair rate. There’s no debate about it.”

Cook may be right that there’s “no debate” about whether it’s sensible for a company to keep money overseas to guard against bad tax policy.

But there is a debate about whether politicians will make the law worse in a grab for more revenue.

Senator Ron Wyden, for instance, doesn’t understand the issue. He wrote an editorial asserting that Apple is engaging in a “rip-off.”

…the heart of this mess is the big dog of tax rip-offs – tax deferral. This is the rule that encourages American multinational corporations to keep their profits overseas instead of investing them here at home, and it does so by granting them $80 billion a year in tax breaks. This policy…defies common sense. …some of the most profitable companies in the world can put off paying taxes indefinitely while hardworking Americans must pay their taxes every year. …that system creates a perverse incentive to keep corporate profits overseas instead of investing here at home.

I agree with him that the current system creates a perverse incentive to keep money abroad.

But you don’t solve that problem by imposing unconstrained worldwide taxation, which would create a perverse incentive structure that discourages American-domiciled firms from competing for market share in other nations.

Amazingly, Senator Wyden actually claims that making the system more punitive would help make America a better place to do business.

…ending deferral is a necessary step in making sure…the U.S. maintains its position as the best place to do business.

Wow, this rivals some of the crazy things that Barack Obama and Hillary Clinton have said.

Though I guess we need to give Wyden credit for honesty. He admits that what he really wants is for Washington to have more money to spend.

Ending deferral will also generate money from existing deferred taxes to pay for rebuilding our country’s crumbling infrastructure. …This is a priority that almost all tax reform proposals have called for.

By the way, can you guess which presidential candidate agrees with Senator Wyden and wants to impose full and immediate worldwide taxation?

If you answered Hillary Clinton, you’re right. But if you answered Donald Trump, that also would be a correct answer.

This is a grim example of why I refer to them as the Tweedledee and Tweedledum of statism.

Though to be fair, Trump’s plan at least contains a big reduction in the corporate tax rate, which would substantially reduce the negative impact of a worldwide tax system.

The Wall Street Journal opines on the issue and is especially unimpressed by Hillary Clinton’s irresponsible approach on the issue.

Mrs. Clinton is targeting so-called inversions, where U.S.-based companies move their headquarters by buying an overseas competitor, as well as foreign takeovers of U.S. firms for tax considerations. These migrations are the result of a U.S. corporate-tax code that supplies incentives to migrate… The Democrat would impose what she calls an “exit tax” on businesses that relocate outside the U.S., which is the sort of thing banana republics impose when their economies sour. …Mrs. Clinton wants to build a tax wall to stop Americans from escaping. “If they want to go,” she threatened in Michigan, “they’re going to have to pay to go.”

Ugh, making companies “pay to go” is an unseemly sentiment. Sort of what you might expect from a place like Venezuela where politicians treat private firms as a source of loot for their cronies.

The WSJ correctly points out that the problem is America’s anti-competitive worldwide tax regime, combined with a punitive corporate tax rate.

…the U.S. taxes residents—businesses and individuals—on their world-wide income, not merely the income that they earned in the U.S. …the U.S. taxes companies headquartered in the U.S. far more than companies based in other countries. Thirty-one of the 34 OECD countries have cut corporate taxes since 2000, leaving the U.S. with the highest rate in the industrialized world. The U.S. system of world-wide taxation means that a company that moves from Dublin, Ohio, to Dublin, Ireland, will pay a rate that is less than a third of America’s. A dollar of profit earned on the Emerald Isle by an Irish-based company becomes 87.5 cents after taxes, which it can then invest in Ireland or the U.S. or somewhere else. But if the company stays in Ohio and makes the same buck in Ireland, the after-tax return drops to 65 cents or less if the money is invested in America.

In other words, the problem is obvious and the solution is obvious.

But there are too many Barack Obamas and Elizabeth Warrens in Washington, so it’s more likely that policy will move in the wrong direction.

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Imagine if you had the chance to play basketball against a superstar from the NBA like Stephen Curry.

No matter how hard you practiced beforehand, you surely would lose.

For most people, that would be fine. We would console ourselves with the knowledge that we tried our best and relish he fact that we even got the chance to be on the same court as a professional player.

But some people would want to cheat to make things “equal” and “fair.” So they would say that the NBA player should have to play blindfolded, or while wearing high-heeled shoes.

And perhaps they could impose enough restrictions on the NBA player that they could prevail in a contest.

But most of us wouldn’t feel good about “winning” that kind of battle. We would be ashamed that our “victory” only occurred because we curtailed the talents of our opponent.

Now let’s think about this unseemly tactic in the context of corporate taxation and international competitiveness.

The United States has the highest corporate tax rate in the industrialized world, combined with having the most onerous “worldwide” tax system among all developed nations.

This greatly undermines the ability of U.S.-domiciled companies to compete in world markets and it’s the main reason why so many companies feel the need to engage in inversions.

So how does the Obama Administration want to address these problems? What’s their plan to reform the system to that American-based firms can better compete with companies from other countries?

Unfortunately, there’s no desire to make the tax code more competitive. Instead, the Obama Administration wants to change the laws to make it less attractive to do business in other nations. Sort of the tax version of hobbling the NBA basketball player in the above example.

Here are some of the details from the Treasury Department’s legislative wish list.

The Administration proposes to supplement the existing subpart F regime with a per-country minimum tax on the foreign earnings of entities taxed as domestic C corporations (U.S. corporations) and their CFCs. …Under the proposal, the foreign earnings of a CFC or branch or from the performance of services would be subject to current U.S. taxation at a rate (not below zero) of 19 percent less 85 percent of the per-country foreign effective tax rate (the residual minimum tax rate). …The minimum tax would be imposed on current foreign earnings regardless of whether they are repatriated to the United States.

There’s a lot of jargon in those passages, and even more if you click on the underlying link.

So let’s augment by excerpting some of the remarks, at a recent Brookings Institution event, by the Treasury Department’s Deputy Assistant Secretary for International Tax Affairs. Robert Stack was pushing the President’s agenda, which would undermine American companies by making it difficult for them to benefit from good tax policy in other jurisdictions.

He actually argued, for instance, that business tax reform should be “more than a cry to join the race to the bottom.”

In other words, he doesn’t (or, to be more accurate, his boss doesn’t) want to fix what’s wrong with the American tax code.

So he doesn’t seem to care that other nations are achieving good results with lower corporate tax rates.

I do not buy into the notion that the U.S. must willy-nilly do what everyone else is doing.

And he also criticizes the policy of “deferral,” which is a provision of the tax code that enables American-based companies to delay the second layer of tax that the IRS imposes on income that is earned (and already subject to tax) in other jurisdictions.

I don’t think it’s open to debate that the ability of US multinationals to defer income has been a dramatic contributor to global tax instability.

He doesn’t really explain why it is destabilizing for companies to protect themselves against a second layer of tax that shouldn’t exist.

But he does acknowledge that there are big supply-side responses to high tax rates.

…large disparity in income tax rates…will inevitably drive behavior.

Too bad he doesn’t draw the obvious lesson about the benefits of low tax rates.

Anyhow, here’s what he says about the President’s tax scheme.

The President’s global minimum tax proposal…permits tax-free repatriation of amounts earned in countries taxed at rates above the global minimum rate. …the global minimum tax plan also takes the benefit out of shifting income into low and no-tax jurisdictions by requiring that the multinational pay to the US the difference between the tax haven rate and the U.S. rate.

The bottom line is that American companies would be taxed by the IRS for doing business in low-tax jurisdictions such as Ireland, Hong Kong, Switzerland, and Bermuda.

But if they do business in high-tax nations such as France, there’s no extra layer of tax.

The bottom line is that the U.S. tax code would be used to encourage bad policy in other countries.

Though Mr. Stack sees that as a feature rather than a bug, based on the preposterous assertion that other counties will grow faster if the burden of government spending is increased.

…the global minimum tax concept has an added benefit as well…protecting developing and low-income countries…so they can mobilize the necessary resources to grow their economies.

And he seems to think that support from the IMF is a good thing rather than (given that bureaucracy’s statist orientation) a sign of bad policy.

At a recent IMF symposium, the minimum tax was identified as something that could be of great help.

The bottom line is that the White House and the Treasury Department are fixated at hobbling competitors by encouraging higher tax rates around the world and making sure that American-based companies are penalized with an extra layer of tax if they do business in low-tax jurisdictions

For what it’s worth, the right approach, both ethically and economically, is for American policy makers to focus on fixing what’s wrong with the American tax system.

P.S. When I debunked Jeffrey Sachs on the “race to the bottom,” I showed that lower tax rates do not mean lower tax revenue.

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I wrote recently about the Pfizer-Allergan merger and made the case that it was a very sensible way to protect the interests of workers, consumers, and shareholders.

That’s the good news.

Why? Because companies should be allowed to engage in a do-it-yourself form of territorial taxation to minimize the damage caused by bad tax policy coming out of Washington.

The bad news is that the White House, with its characteristic disregard of the rule of law, promulgated a regulation that retroactively changed existing tax law and derailed the merger.

Now the White House has produced an infographic designed to bolster its case against inversions, which I have reprinted to the right.

You can click on this link to see the full-sized version, but I thought the best approach would be to provide a “corrected” version.

So if you look below, you’ll find my version, featuring the original White House document on the left and my editorial commentary on the right.

But if you don’t want to read the document and my corrections, all you need to know is that the Obama Administration makes several dodgy assumptions and engages in several sins of omission. Here are the two biggest problems.

  1. No acknowledgement that the U.S. corporate tax regime drives inversions because of high rates and worldwide taxation.
  2. A bizarre and anti-empirical assertion that money is spent more productively by governments compared to the private sector.

And here’s the entire “corrected” infographic.

The bottom line is there aren’t any “loopholes” being exploited by inverting companies.

Instead, there’s a very anti-growth American tax system that makes it very difficult for American-domiciled firms to compete in global markets.

The solution is a simple, low rate flat tax.

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The United States has what is arguably the worst business tax system of any nation.

That’s bad for the shareholders who own companies, and it’s also bad for workers and consumers.

And it creates such a competitive disadvantage that many U.S.-domiciled companies are better off if they engage in an “inversion” and shift their corporate charter to a jurisdiction with better tax policy.

Unsurprisingly, the Obama White House doesn’t like inversions (with some suspicious exceptions) because the main effect is to reduce tax revenue.  But the Administration’s efforts to thwart them haven’t been very successful.

The U.K.-based Economist has just published an article on American companies re-domiciling in jurisdictions with better tax law.

A “tax inversion” is a manoeuvre in which a (usually American) firm acquires or merges with a foreign rival, then shifts its domicile abroad to reap tax benefits. A spate of such deals last year led Barack Obama to brand inversions as “unpatriotic”. …The boardroom case for inversions stems from America’s tax exceptionalism.

But this isn’t the good kind of exceptionalism.

The internal revenue code is uniquely anti-competitive.

It levies a higher corporate-tax rate than any other rich country—a combined federal-and-state rate of 39%, against an OECD average of 25%. And it spreads its tentacles worldwide, so that profits earned abroad are also subject to American taxes when they are repatriated.

And that worldwide tax system is extremely pernicious, particularly when combined with America’s punitive corporate tax rate.

Given these facts, the Economist isn’t impressed by the Obama Administration’s regulatory efforts to block inversions.

Making it hard for American firms to invert does precisely nothing to alter the comparative tax advantages of changing domicile; it just makes it more likely that foreign firms will acquire American ones. That, indeed, is precisely what is happening.

So what’s the answer?

If American policymakers really worry about losing out to lower-tax environments, they should get rid of the loopholes that infest their tax rules, drop the corporate-income tax rate and move to a territorial system. …jobs would be less likely to flow abroad.

In a companion article, the Economist lists some of the firms that are escaping from the IRS.

…companies have continued to tiptoe out of America to places where the taxman is kinder and has shorter arms. On August 6th CF Industries, a fertiliser manufacturer, and Coca-Cola Enterprises, a drinks bottler, both said they would move their domiciles to Britain after mergers with non-American firms. Five days later Terex, which makes cranes, announced a merger in which it will move to Finland. For many firms, staying in America is just too costly. Take Burger King, a fast-food chain, which last year shifted domicile to Canada after merging with Tim Horton’s, a coffee-shop operator there.

I’ve previously shared lists of inverting companies, as well as a map of where they go, and this table from the article is a good addition.

So how should Washington react to this exodus? The Economist explains once again the sensible policy response.

The logical way to stem the tide would be to bring America’s tax laws in line with international norms. Britain, Germany and Japan all have lower corporate rates and are among the majority of countries that tax firms only on profits earned on their territory.

But the Obama Administration’s response is predictably unhelpful. And may even accelerate the flight of firms.

…the US Treasury has been trying to make it harder for them to leave. …Despite such speed bumps, inversions still make enormous sense for companies with large overseas operations. If anything, the rule changes have led to more companies looking to get out before it is too late.

The Wall Street Journal opined on this issue earlier this month and reached a similar conclusion.

…a mountain of evidence that an un-competitive tax system has made the U.S. an undesirable location for corporate headquarters and investment. …high tax rates matter a great deal in determining where a company is based and where it grows.

The WSJ also pointed out that taxpayers have a right and an obligation to legally protect themselves from bad tax policy.

Shareholders deserve nothing less from management than the Warren Buffett approach of paying the lowest possible legal tax rate.

But since the White House isn’t very interested in helpful reform, expect more inversions.

Which is one more piece of evidence that punitive corporate taxation isn’t good news for workers.

…absent American tax reform will end up pushing more U.S. companies into foreign hands. …The ultimate losers in all of this aren’t so much the owners as American workers, who often lose their jobs when a company moves abroad. …It’s well past time for our government to stop creating advantages for foreign competitors.

In looking at this issue, it’s easy to be discouraged since the Obama Administration is unwilling to even consider pro-growth policy responses.

As such, the problem will fester until at least 2017.

But it’s possible that there could be pro-reform legislation once a new President takes office.

Particularly since the Senate’s Permanent Subcommittee on Investigations (which used to be chaired by the clownish Sen. Levin, infamous for the FATCA disaster) has produced a very persuasive report on how bad U.S. tax policy is causing inversions.

Here are some excerpts from the executive summary.

The United States has the highest corporate tax rate in the industrialized world, and (alone among its peers) has retained a worldwide system that taxes American companies for the privilege of repatriating their overseas earnings. Meanwhile, most other nations with advanced economies have adopted competitive tax rates and territorial-type tax systems. As a result, U.S. firms too often have a significant incentive to relocate their headquarters overseas. Corporate inversions may be the most dramatic manifestation of that incentive… The lesson policymakers should draw from our findings is straightforward: The high U.S. corporate tax rate and worldwide system of taxation are competitive disadvantages that make it easier for foreign firms to acquire American companies. Those policies also strongly incentivize cross-border merging firms, when choosing where to locate their new headquarters, not to choose the United States. The long term costs of these incentives can be measured in a loss of jobs, corporate headquarters, and revenue to the Treasury.

Those are refreshing and intelligent comments, particularly since politicians were in charge of putting out this report rather than economists.

So maybe there’s some hope for the future.

For more information on inversions and corporate tax policy, here’s a short speech I gave to an audience on Capitol Hill.

P.S. Let’s close with some political satire.

I’ve written about Bernie Sanders being a conventional statist rather than a real socialist.

But that wasn’t meant to be praise. He’s still clueless about economics, as illustrated by this amusing Venn diagram.

Though I’m sure many other politicians would occupy that same space.

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In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system.

1. High tax rates that penalize productive behavior.

2. Pervasive double taxation that discourages saving and investment.

3. Corrupt loopholes and cronyism that bribe people to make less productive choices.

These problems all need to be addressed, but I also acknowledged additional concerns with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms an civil liberties.

In a perfect world, we would shrink government to such a small size that there was no need for any sort of broad-based tax (remember, the United States prospered greatly for most of our history when there was no income tax).

In a good world, we could at least replace the corrupt internal revenue code with a simple and fair flat tax.

In today’s Washington, the best we can hope for is incremental reform.

But some incremental reforms can be very positive, and that’s the best way of describing the “Economic Growth and Family Fairness Tax Reform Plan” unveiled today by Senator Marco Rubio of Florida and Senator Mike Lee of Utah.

The two GOP senators have a column in today’s Wall Street Journal, and you can read a more detailed description of their plan by clicking here.

But here are the relevant details.

What’s wrong with Rubio-Lee

In the interest of fairness, I’ll start with the most disappointing feature of the plan. The top tax rate will be 35 percent, only a few percentage points lower than the 39.6 percent top rate that Obama imposed as a result of the fiscal cliff.

Even more troubling, that 35 percent top tax rate will be imposed on any taxable income above $75,000 for single taxpayers and $150,000 for married taxpayers.

Since the 35 percent and 39.6 percent tax rates currently apply only when income climbs above $400,000, that means a significant number of taxpayers will face higher marginal tax rates.

That’s a very disappointing feature in any tax plan, but it’s especially unfortunate in a proposal put forth my lawmakers who wrote in their WSJ column that they want to “lower rates for families and individuals.”

What’s right with Rubio-Lee

This will be a much longer section because there are several very attractive features of the Rubio-Lee plan.

Some households, for instance, will enjoy lower marginal tax rates under the new bracket structure, particularly if those households have lots of children (there’s a very big child tax credit).

But the really attractive features of the Rubio-Lee plan are those that deal with business taxation, double taxation, and international competitiveness.

Here’s a list of the most pro-growth elements of the plan.

A 25 percent tax rate on all business income – This means that the corporate tax rate is being reduced from 35 percent (the highest in the world), but also that there will be a 25 percent maximum rate on all small businesses that file using Schedule C as part of a 1040 tax return.

Sweeping reductions in double taxation – The Rubio-Lee plans eliminates the capital gains tax, the double tax on dividends, and the second layer of tax on interest.

Full expensing of business investment – The proposal gets rid of punitive “depreciation” rules that force businesses to overstate their income in ways that discourage new business investment.

Territorial taxation – Businesses no longer will have to pay a second layer of tax on income that is earned – and already subject to tax – in other nations.

No death tax – Income should not be subject to yet another layer of tax simply because someone dies. The Rubio-Lee plan eliminates this morally offensive form of double taxation.

In addition, it’s worth noting that the Rubio-Lee plan eliminate the state and local tax deduction, which is a perverse part of the tax code that enables higher taxes in states like New York and California.

Many years ago, while working at the Heritage Foundation, I created a matrix to grade competing tax reform plans. I updated that matrix last year to assess the proposal put forth by Congressman Dave Camp, the former Chairman of the House Ways & Means Committee.

Here’s another version of that matrix, this time including the Rubio-Lee plan.

As you can see, the Rubio-Lee plan gets top scores for “saving and investment” and “international competitiveness.”

And since these components have big implications for growth, the proposal would – if enacted – generate big benefits. The economy would grow faster, more jobs would be created, workers would enjoy higher wages, and American companies would be far more competitive.

By the way, if there was (and there probably should be) a “tax burden” grade in my matrix, the Rubio-Lee plan almost surely would get an “A+” score because the overall proposal is a substantial tax cut based on static scoring.

And even with dynamic scoring, this plan will reduce the amount of money going to Washington in the near future.

Of course, faster future growth will lead to more taxable income, so there will be revenue feedback. So the size of the tax cut will shrink over time, but even a curmudgeon like me doesn’t get that upset if politicians get more revenue because more Americans are working and earning higher wages.

That simply means another opportunity to push for more tax relief!

What’s missing in Rubio-Lee

There are a few features of the tax code that aren’t addressed in the plan.

The health care exclusion is left untouched, largely because the two lawmakers understand that phasing out that preference is best handled as part of a combined tax reform/health reform proposal.

Some itemized deductions are left untouched, or simply tweaked.

And I’m not aware of any changes that would strengthen the legal rights of taxpayers when dealing with the IRS.

Let’s close with a reminder of what very good tax policy looks like.

To their credit, Rubio and Lee would move the tax code in the direction of a flat tax, though sometimes in a haphazard fashion.

P.S. There is a big debate on the degree to which the tax code should provide large child credits. As I wrote in the Wall Street Journal last year, I much prefer lower tax rates since faster growth is the most effective long-run way to bolster the economic status of families.

But even the flat tax has a generous family-based allowance, so it’s largely a political judgement on how much tax relief should be dedicated to kids and how much should be used to lower tax rates.

That being said, I think the so-called reform conservatives undermine their case when they argue child-oriented tax relief is good because it might subsidize the creation of future taxpayers to prop up entitlement programs. We need to reform those programs, not give them more money.

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