Corporate Inversion: A Popular Trend

round-glass-offices-architecture-1229592-sThe idea of a multinational corporation has become more attractive in recent months. Becoming a multinational corporation, also known as MNC, is currently the go to method for maximizing profits. One the major benefits of becoming an MNC is avoiding paying taxes. The act of merging with a foreign company in order to relocate to another country that has a lower tax rate is known as corporate inversion. In 2004, Congress did take measures to limit this activity. But because of a gaping loophole, the recent surge of corporate inversion has been ever present. Two industry giants that have recently engaged in this act are Walgreens and Pfizer. Walgreens is currently inverting to Switzerland, which is known to be a tax haven for companies. It is reported that over the course of five years they will cost the US economy $4 billion in tax revenue. Pfizer, who is attempting to become a UK company by merging with AstraZeneca, has roughly $73 billion in earnings in offshore subsidiaries. Assuming that nothing happens to restrict their inversion, Pfizer can avoid ever paying taxes on those earnings. On the surface this seems like a big problem that should be rectified immediately. However, many who oppose this type of activity do not consider why companies are doing this. They also fail to realize one of the core foundations of US capitalism, which is economic and market freedom.


There are many who seek to have the Obama administration do something to make corporate inversion less appealing. Obama could impose a 1969 tax law (known as HR 4985) that would avoid a congressional gridlock and restrict US companies from using loans and interest deductions to cut their US taxes. This tax law will address two problems. The first one is corporate inversion. If more than 50% of the newly formed company’s stockholders are the same as the former US company, or if the MNC continues to be managed and has significant activity in the US, they will be treated as domestic for the purposes of taxes. Secondly, that revenue will be used for roads and other infrastructure, which will create more jobs in the US.


If Obama were to utilize this tax code, corporate inversions would likely cease or at least significantly decrease, for the time being. This would affect a great number of people, mostly domestic. On the grand scheme of things MNC’s are typically large corporations. The success and financial stability of a single large MNC can have positive and negative externalities on the entire economy of a country or at least a particular industry. The state of the economy affects the average citizen, regardless of whether or not they have a connection to the firm. More directly, implementing this tax law would have a negative impact on the stakeholders, investment bankers, and private equity firms. From a financial perspective, the goal of a company is the maximize profits for shareholders. Paying millions of dollars in taxes does not help to accomplish that. However, workers and the American public will be positively affected. It would put a significant amount of money directly into the US economy, and transportation infrastructure would be greatly improved.


The underlying issue that persists is government controls versus free markets and economic freedom. Critics point to the fact that the US is the only industrialized country to tax companies on their revenue earned abroad. This puts domestic firms at a disadvantage to their foreign competitors that are free to invest as they please. Therefore, it is really not that surprising those firms seek out other ways to increase revenue. It has become too costly to keep up with competition. Of course there are times when the government has to step in to prevent complete economic recession or even worse, depression. We can look back to the collapse of the housing market in 2006 or the government bailing out GM and numerous other “too big to fail” companies as examples of intervention. However, too much government regulations, controls, and taxes lowers the return on capital. When a country’s economic policies are considered inappropriate, export of a nation’s capital occurs. This is known as capital flight. Through merger, companies are redistributing their capital abroad because they feel like the current tax rate is too high.


The new tax law should not be implemented, but rather tax reforms to the current corporate tax rates should happen. There needs to be a balance, an in-between area where both corporations and the US economy can be content. US domestic firms pay a corporate tax rate of close to 40% whereas the average foreign firm pays 25%. This means that foreign competitors have a clear advantage when it comes to financial investments. The real issue may not be about corporate inversion, but rather about reforming the US corporate tax law to make it appealing for domestic firms to remain domestic.  However, it is unrealistic to immediately be able to cut the current rate down to match the worldwide average. But some kind of incentive has to be given, which is why a show of faith from the government by lowering the tax rate or at least a pledge to gradually lower it would be more effective. Capital flight occurs because citizens and companies do not trust the government and its economic policies. This is precisely why communism does not work. John Fichtner, a free market enthusiast says, “Legislative proposals that attempt to treat the symptoms of the corporate tax code’s problems—rather than issues causing them—are doomed to fail”. Companies want to hire domestically. But they can’t because their number one priority is to maximize profits.


There is a large portion of the public that do not trust MNCs and other large corporations in the US, and they have every right to feel that way. The past decade, has been rife with scams, scandals, fraud, and corporate irresponsibility. We can look to Freddie Mae and Freddie Mac, Enron, and a several large American banks as examples. The perception of corporate America could be better. Unfortunately, there is a stigma that companies will be irresponsible, and in fact many probably contribute corporate inversion as part of corporate greed.  However, it does not change the fact that these places are ones that hire a lot of American workers. The less money they make, the less they can afford to hire. Even some of those who are supporters of Obama implementing the tax law can agree that the core root of the problem is not inversion, and that the ultimate solution is more along the lines of tax reform. Sen. Ron Wyden, who along with Obama proposed the tax law, says, “these sort of loopholes may be a sign that the tax code in general needs to be fixed because our current system ‘is an anti-competitive mess’ which requires ‘comprehensive tax reform.’”. Therefore, the President and Congress should let the invisible hand of economics do the work, instead of utilizing regulations and control.


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